Global Outlook (November 2017)

Absorbing The Excess Capacity

“The unemployment rate is the most understandable measure of excess capacity and if we look across the developed markets we can see that it is close to the lows of previous cycles.”

– Richard Jerram, Chief Economist, Bank of Singapore

The dislocation caused by the Global Financial Crisis (GFC) is fading. Much of the excess capacity has been absorbed by years of steady growth. Inflation is still unusually low and so interest rates are below normal, but that will gradually correct over the next couple of years across most developed markets.

The unemployment rate is the most understandable measure of excess capacity and if we look across the developed markets we can see that it is close to the lows of previous cycles. It might be that the structural and technological changes of recent years mean that unemployment can fall to lower levels than in the past, but even so it is clear that most of the workers who became unemployed after the GFC have been successfully reintegrated into the workforce.

From a peak of 8.6 per cent at the end of 2009, the OECD unemployment rate is down to 5.6 per cent. The U.S. cycle is relatively well-advanced as the unemployment rate has dropped from a peak of 10 per cent down to just 4.2 per cent.

United States

Temporary effects from hurricanes have distorted some of the economic releases in America, but the overall trend is still an economy growing close to the 2.2 per cent average of the current cycle, leading to a steady tightening of labour markets.

Tax reform is progressing but still has a long way to go before it is law, and not many current proposals might survive from a cut in the corporate rate. The proposed 20 per cent rate looks too aggressive, due to its impact on the budget deficit, but 25 per cent could be achievable.

The U.S. Federal Reserve is already concerned that the unemployment rate is unusually low, but soft inflation readings give it time to adjust interest rates back up to neutral levels. If a fiscal giveaway stimulates growth then the Fed might need to move faster than the four rate hikes planned by the end of 2018 (which we currently think is realistic).


So far the Eurozone economy has been surprisingly unaffected by the rebound in Euro over the past six months with the manufacturing PMI rising close to post-GFC highs. It looks like the benefits of structural reform, the end of the drag from fiscal austerity and the improved transmission of monetary policy through a healthier financial system are combining to support growth.

Political events in Austria and Spain are a reminder that such a large and diverse region will never be entirely stress free. Italy will be the next area of concern. However, the core of Europe looks stable after elections in France and Germany, and improving economic conditions are reducing support for political extremism.

United Kingdom

Brexit talks are making little progress and before long the UK will need to start to make preparations for a hard exit from the European Union in March 2019. The complexity of the process argues against the type of last minute agreement that has been common in the EU.


Prime Minister Abe’s comfortable victory in Japan’s snap election means no change in policy direction. The immediate challenge will be a decision over replacing or reappointing Bank of Japan Governor Kuroda. With inflation still well-below target there is no pressure for any material change and it looks as though Japan will be the last of the major developed economies to move away from its extreme monetary policy settings. Structural reform is more problematic, especially in labour markets where action is needed to increase flexibility and improve supply.


As expected, the Party Congress did not give many clues about the direction of policy. It is hard to see how they can resolve the contradiction between rigid political control and increased acceptance of market forces in resource allocation, so reform is unlikely to be radical. Experience elsewhere shows that the challenge becomes more intense as income levels rise.

The immediate response to confirmation of the dominance of President Xi is positive, as it promises political stability and creates the environment for effective policy making. At the same time, history is full of examples of economies that have been damaged by a dominant leader, where no critical voices are prepared to challenge misguided policies. Even China’s recent past provides the examples of the Great Leap Forward, where tens of millions starved, and the Cultural Revolution, which was a huge set-back to human capital development.

Emerging Markets

Compared to four years ago, when we saw a sharp reaction to then-Fed Chair Bernanke’s “taper tantrum”, the situation in emerging markets looks much more solid. The stress that has historically accompanied U.S. monetary tightening has so far been absent, thanks to lower imbalances and economic reform. Moreover, tighter monetary policy has been offset by stronger demand from developed markets as well as firmer commodity prices.

Developed market unemployment rate near cyclical low

European business confidence still strong