Fed Stimulus Withdrawal, Slower Global Growth Hurt International Equity Prices
International equity prices corrected in September as investors became concerned about slower global growth and the continued withdrawal of monetary stimulus by the U.S. Federal Reserve. Stronger than expected U.S. growth could support the global economy in the coming quarters, but has made investors anxious of early interest rate hikes. The Euro-zone economic recovery is faltering yet again as growth has slipped in most large countries.
In Japan, consumer spending continues to rebound gradually following the tax hikes assessed in April. Delays in further reform measures promised by the Japanese government have also dulled investor sentiment. Emerging market economies remain relatively stable, though renewed fears about slower growth in China and select commodity exporting countries have made investors cautious more recently.
Near-Term Outlook
Fears about the Euro-zone slipping into another recession are rising as policymakers have been slow in introducing fiscal and monetary measures necessary to rekindle consumer and business spending. Policy initiatives needed to improve competitiveness, such as restructuring of industrial capacity and making labor markets more flexible, remain politically unpopular in most Euro-zone countries. In this scenario, a sizable quantitative easing program and short-term fiscal stimulus measures remain viable policy tools to revive economic growth. The European Central Bank has announced a bond purchase program, expected to start later this year. Increased public spending on infrastructure and other areas by countries with sufficient fiscal flexibility such as Germany could make the monetary measures more effective.
On the positive side, countries that were at the center of Europe’s fiscal crisis are in relatively better shape. Spain has one of the fastest growth rates in the region today while the fiscal balances of other troubled countries have improved. Accordingly, the risk of sovereign defaults remains low and fears of a currency union breakup have receded. Most large banks in the region have strengthened their balance sheets and, with appropriate policy prompts, are in a position to expand credit availability. In addition, the recent Euro weakness should make the region’s exporters more competitive.
Despite the subdued trends in recent months, the Japanese government and central bank remain confident that the economy could see a rebound in the coming quarters. The weaker yen should help exporters, but part of the potential gains could be offset by subdued global demand. The Bank of Japan may expand its quantitative easing program if growth remains weak and inflation hovers below target. The Japanese government has the difficult task of deciding on another consumption tax hike, currently planned for next year. The shift by the Government Pension Investment Fund from Japanese bonds in favor of equities should stimulate additional growth in the securities market.
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