Volatile is the New Up

Up. A simple, 2-letter word, but one of the most difficult in current econo-speak. It has been redefined almost endlessly on our up-deprived, post-crisis planet. Some may even wonder whether it belongs in a forecast title anymore. Volatile, on the other hand, resonates; there has been enough of that lately, and it seems to be on the rise, fanning a new round of fears about a new round of weakness. Could we have it all wrong – could current volatility actually be a signal of liftoff?

Volatility is the easy part – it seems to be everywhere. The CBOE volatility index tells the tale for the US: it has recently hit 3-year highs, and its climb may not be over. Other indicators are experiencing much wilder swings. Oil prices have more than halved. Base metal prices have also plunged, and precious metals are sliding too. Currencies fill out the turbulence list. Against the currencies of US trading partners, the greenback is up on average by 17 per cent in just over a year. Swings in commodity-based currencies are larger. The list goes on, and to it we could add geopolitical and meteorological volatility. A simple conclusion is that ‘up’ is as elusive as it has been for eight years. How could ‘up’ possibly have anything to do with this?

Well, let’s start with GDP growth. US figures for the second quarter keep getting revised up; the current one? A stunning 3.9 per cent, annualized. True, third-quarter early estimates aren’t as impressive; these may also be revised up. Then there’s Western Europe. This may come as a surprise, but there, growth has been above the long-run trend for four successive quarters, and it looks like there’s a fifth on the way. There are signs that emerging markets are catching on. True, there are key problem-spots, but even China is ahead of expectations. So much for the data; given market mayhem, is this sustainable?

Check out the US scene, where potential growth remains strong on three broad fronts: consumers are sturdy, thanks to solid job growth, rising real wages, restored confidence, better-managed household budgets and a $100 billion bonus from lower gasoline prices. Housing markets are rising smartly, and demand is still well ahead of new building activity. Cash-rich businesses are bumping up against very tight capacity constraints as orders continue to rise. Imports are taking some of the pressure off, but there’s no question that on balance, underlying conditions can sustain above-trend growth for at least the next two years. In Western Europe, fiscal progress is generally allowing economies to breathe again, and in the process they are discovering pent-up demand of their own. Moreover, Europe’s exporters are capitalizing on a weaker currency and revived US demand.

Rising economic pressure is the reason the Fed is on the verge of tightening. This is the clearest evidence that growth is back. And it’s also the reason behind the volatility. After years of low rates and endless outsized liquidity injections, the Fed is now reeling in its extraordinary stimulus – and with it, the unintended, persistent inflation of asset prices. Get it? In most growth cycles commodity prices and affected currencies would be on the rise, and liquidity would be increasing. This time, it’s the reverse – for now, growth and volatility are inextricably linked.

What does this mean for EDC’s Autumn 2015 Global Economic Forecast? Developed markets will rise first, with growth climbing from 2.0 per cent this year to 2.4  per cent in 2016. Emerging markets will follow with 3.8 per cent growth this year and 4.4 per cent next, continuing to contribute a higher share of overall output, but clearly following the lead of the advanced economies. This will bring world growth to 3.0 per cent this year and 3.6 per cent for 2016, a noteworthy increase.

Canada’s exporters are following suit. Plunging prices are decimating energy and metals exports, but currency weakness has spurred double-digit gains elsewhere. On balance, things will be flat this year, but 2016 should see a 7 per cent increase that is enjoyed by a broad range of sectors.

The bottom line? Far from a warning of danger, recent volatility is a clear sign that growth is back, and on a broader base. Canada is already capitalizing, and is expected to build on this year’s success into 2016 and through the medium term.

This has been written by Peter G Hall, EDC Vice-President and Chief Economist.