Europe to Recover, Emerging Markets to Retract

Eurozone economies will receive a boost as consumer confidence returns and with it spending, while emerging markets feel the effects of Fed indecision

Robert Johnson, CFA 26 September, 2013 | 10:14AM
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European economies could look better going forward, emerging markets worse. Europe’s recovery could begin to feed on itself as consumers begin to feel more confident and businesses continue to rebuild inventories. A stronger market for exports to China could help, too. Also, some of the more onerous government austerity programs are beginning to fade as well. This should be good news for U.S. and Chinese exporters. However, Europe is not completely out of the woods. Many financial institutions are still undercapitalized, and some countries still carry more debt than they ever hope to repay. Also, the rebound in France, Europe’s second-largest economy, has not been as robust as in several other European countries.

Developing markets in general are slowing, with the exception of China. At the end of the second quarter, China appeared to be slowing, at least partly because of a government attempt to move to a more consumption-oriented economy and partially because of a weak market for exports. Growth in China had fallen from the 10%-12% range to about 7.5% recently, its lowest reading since 1990. As Europe picked up steam and as Chinese infrastructure spending and other investment spending grew again, China appears to have reversed course. Recent Chinese export and manufacturing data has improved notably. Whether the rebound is sustainable is less than certain.

The rest of the emerging markets were hit hard as the effects of potential U.S. Federal reserve tightening were understood more clearly. When U.S. rates were held incredibly low by the U.S. Federal Reserve, emerging markets saw massive capital inflows due to their higher growth rates and more attractive yields. With the Fed’s threat of ending bond purchases, U.S. rates jumped sharply. Those higher rates drew more capital back to the U.S. Those outflows from emerging markets depressed currencies and ignited more inflation, slowing growth at least temporarily. Many currencies are now at record lows, which will eventually aid growth longer term. However, the short-term effects are devastating. Oil prices, which are up even in U.S. dollar terms because of the Syria issue, are compounded in emerging-markets countries whose currencies are sharply lower. To protect the currency, many of these countries are raising interest rates, which is further slowing economic growth.

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Robert Johnson, CFA  is director of economic analysis with Morningstar.

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