Aurelia Butler

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.The decision by Iran to escalate its conflict with Israel by launching a barrage of armed drones and missiles brings the risks of open war between the two countries, possibly involving the US, yet closer. It is no secret, after all, that Benjamin Netanyahu, Israel’s embattled prime minister, has long wished to destroy Iran’s nuclear programme. Some in the US feel similarly. Is this not the hawks’ chance?In a column published in October 2023, I argued that such an escalation was the principal danger to the world economy posed by the murderous attack on Israel by Hamas. Even though the oil-intensity of the world economy has more than halved over the past 50 years, oil remains an essential source of energy. Severe disruption to supply would have large adverse economic effects.Moreover, the Gulf region is far and away the world’s most important energy-producer: according to the 2023 Statistical Review of World Energy, it contains 48 per cent of global proved reserves and produced 33 per cent of the world’s oil in 2022. Worse, according to the US Energy Information Administration, a fifth of world oil supply passed through the Strait of Hormuz, at the bottom of the Gulf, in 2018. This is the chokepoint of global energy supply. A war between Iran and Israel, possibly including the US, could be devastating.You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.The policymakers responsible for the world economy gathering in Washington this week for the spring meetings of the IMF and World Bank are spectators: they can only hope that wise counsels prevail in the Middle East. If disaster were indeed avoided, what might the world economy look like?On this issue, as usual, the IMF’s World Economic Outlook, offers clarification. This is not because its forecasts will necessarily prove correct. If anything big were to happen, they definitely would not. But they provide a systematic overview of where the world is now.You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.Briefly put, as Pierre-Olivier Gourinchas, the IMF’s chief economist, explains in his introduction, the recent performance of the world economy has been notably better than feared, despite the shocks to output and inflation caused by the pandemic, Russia’s assault on Ukraine, the surge in commodity prices and sharp tightening in monetary policy. As he notes, “despite many gloomy predictions, the world avoided a recession, the banking system proved largely resilient, and major emerging market and developing economies did not suffer sudden stops” in finance. Notably, the inflation surge did not trigger uncontrolled wage-price spirals. In all, the world economy has proved more flexible and inflation expectations better anchored than many expected. This is all good news.It is noteworthy that cumulative output growth in 2022 and 2023 exceeded the IMF’s October 2022 forecasts for the global economy and every significant grouping within it except, crucially, for low-income developing countries (LIDCs). The same was true for employment, except in the LIDCs, again, and China. The US economy has been particularly buoyant, though that of the eurozone very much less so.An interesting question is why the monetary tightening has had so little effect on output. One explanation is that fiscal policy was supportive, notably in the US. Another explanation is that real interest rates fell, rather than rose, because inflation went so high. That is now changing. Another is that a high proportion of mortgages are at fixed rates: there has been a particularly big increase in the share in the UK. Moreover, the surge in savings in the pandemic helped finance spending. Yet this is now ending. Tight monetary policies might still have a sizeable lagged impact.While the short-term performance of the world economy has been surprisingly good, the longer-term performance has been the opposite. Marked declines in growth of real GDP per head have occurred across the world since the early years of this century. The collapse in the growth of “total factor productivity” — the best measure of innovation — has been particularly significant. In the LIDCs, the growth of TFP even turned negative between 2020 and 2023.You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.The slowdown in growth of TFP accounted for more than half of the overall decline in growth. According to the WEO, growing misallocation of capital and labour across businesses within sectors explained a large part of this slowdown. One can change such things. But it will not be easy to do so. One reason for this slowdown is likely to be the loss of dynamism in world trade, which is always a potent source of competition.The principal lessons of this WEO, then, are surprisingly buoyant recent economic performance, except worryingly among LIDCs, together with a marked slowdown in long-term growth, largely due to the slowdown in economy-wide productivity growth. Yet, needless to say, there are also big uncertainties.On the upside, we might see a short-term surge in election-related fiscal loosening. Positive surprises, notably in labour supply, might further accelerate the decline in inflation. Artificial intelligence might deliver a positive surprise shock to the generally poor productivity growth. Successful reform might also accelerate the growth in potential output. Yet, on the downside, China’s growth might fall sharply. There are also all too evident risks to global financial, fiscal, political and geopolitical stability. World trade might be battered by protectionism. War between Israel, the US and Iran could blow up the Middle East, with huge consequences for energy and commodity prices. The biggest victims of such mayhem would, as usual, be the poorest.We may have managed shocks better than expected. But we are walking on eggshells and we must tread [email protected] Martin Wolf with myFT and on Twitter More

Brazilian President Luiz Inácio Lula da Silva’s government is seeking to loosen its own budget targets as investor concerns rise about the risk of fiscal slippage in Latin America’s largest economy.The leftwing administration has presented proposals that would water down its prior aim of achieving a primary surplus next year and in 2026. They would need congressional approval to proceed.The original commitments were laid out a little over a year ago and underpinned Brasília’s claims of balancing responsible management of the public accounts with increased state expenditure.But now ministers intend simply to balance the budget next year, replacing the previous goal for income to exceed outgoings by 0.5 per cent of gross domestic product.The 2026 forecast for a primary surplus — which excludes interest payments — is also to be reduced from 1 per cent to 0.25 per cent of GDP. This will delay the stabilisation of public debt levels, according to official forecasts.You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.Finance minister Fernando Haddad said the deficit had been a structural problem since 2015. “Brazil is growing less because of this. Our effort is to bring order to it,” he told GloboNews TV on Monday.Budget holes have been an Achilles heel for the South American nation before, with knock-on effects on public borrowing, inflation and interest rates.Many analysts had already warned that the current deficit targets were unrealistic and likely to be tweaked. They were introduced as part of a new set of fiscal rules designed to boost public spending under veteran politician Lula, who began his third non-consecutive term last year.Luiz Maciel, chief economist of Brazil macro at Bahia Asset Management in Rio de Janeiro, said the proposed amendments nevertheless sent a “negative message”.“It is yet another demonstration that this is not a government willing to guarantee the [stabilisation] of public debt. There is a consensus in the market that the government is wasteful,” he said.The Brazilian real slipped to its lowest level against the US dollar in more than a year on Tuesday, trading at 5.27 against the greenback.Investors have expressed growing concerns about Brazil’s economic approach under Lula, who was credited with anti-poverty programmes during his previous terms between 2003 and 2011.Some see warning signs that there could be a repeat of mistakes that marred the previous period of rule by his Workers’ party, or PT, which ended in a fiscal crisis contributing to the country’s worst recession on record.Sérgio Vale, chief economist at MB Associados, criticised a “poorly designed” fiscal policy reliant on increasing receipts — mainly through taxes, often subject to factors such as growth that are outside the government’s control — rather than cutting costs.The framework launched a year ago stipulates that public spending must increase every year above inflation, in a band between 0.6 and 2.5 per cent. Overall budget expansion is limited to 70 per cent of revenue increases.This replaced a previous, tougher rule that restricted annual expenditure growth to the rate of inflation. That was deemed fundamental to stability by investors but ended up politically unpopular.“The government will have to do something far more drastic to deliver a zero deficit. But it has low popularity and wants to invest and spend more,” said Vale. “The consequence of this poorly calibrated fiscal [arrangement] is to worsen long-term interest rates, which makes investments more inexpensive and harms growth.” In his bid to raise living standards following a decade of stagnation, Lula has increased welfare payments and the minimum wage, while unveiling a major public works programme.His critics say this will force up public borrowing, which was already relatively high for a developing economy at 75.5 per cent of GDP in February.Sceptics of the loose fiscal stance also fear it could stir inflation and impede the central bank’s ability to keep cutting interest rates. Lula has attacked the institution’s monetary policy as a drag on growth.The bank’s governor, Roberto Campos Neto, said on Monday that “the ideal is not to change the [fiscal] targets”.“Whenever you have a change in the government, that makes the fiscal anchor less transparent or less believable . . . So the cost of monetary policy becomes higher,” he told an event in the US.Brazilian central bank governor Roberto Campos Neto said ‘the ideal is not to change [fiscal] targets’ More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.Britain may this year fail to achieve even the tepid growth rates recently predicted by the government’s official economic forecaster, the IMF suggested on Tuesday as it downgraded UK growth estimates.UK gross domestic product is tipped to grow by just 0.5 per cent this year in the IMF’s latest World Economic Outlook, 0.1 point slower than its January prediction.The forecast is the second-slowest growth rate after Germany among G7 countries and lower than the 0.8 per cent predicted by the Office for Budget Responsibility in March.UK growth will pick up to 1.5 per cent in 2025, according to the IMF, but that is also 0.1 percentage point weaker than the fund’s January outlook. The IMF figures underscore the difficult task that Prime Minister Rishi Sunak has in galvanising a more robust recovery before the election expected this year.The UK’s poor growth prospects reflect the impact of multiple interest rate increases by the Bank of England, coupled with sluggish productivity and investment growth.The IMF forecast comes as chancellor Jeremy Hunt argues the UK’s economic performance is “on the up” on a trip to Washington DC to attend the spring meetings of the fund and World Bank. The government said it has been bolstering the UK’s performance after inflation fell from a peak of more than 11 per cent to 3.4 per cent and as wages grow more quickly than prices. “The forecast for growth in the medium term is optimistic, but like all our peers, the UK’s growth in the short term has been impacted by higher interest rates, with Germany, France and Italy all experiencing larger downgrades than the UK,” the Treasury said.The IMF estimates for the UK contrast with the picture for the US, which is forecast to grow by 2.7 per cent this year on the back of strongly expanding supply and demand. The BoE’s February outlook was for even weaker growth than that predicted by the IMF, as it projected an expansion of a quarter of a percentage point this year and three-quarters next.The IMF suggested that inflation is on track to continue falling in the UK, forecasting inflation will drop from 7.3 per cent last year to 2.5 per cent in 2024 and 2 per cent next year — the BoE’s target.Given sluggish demand in the UK, this should leave the BoE on track to start easing interest rates from a 16-year high of 5.25 per cent later this year, the IMF said.However, it added that it only expects two rate reductions this year, less than the cuts predicted for the US and eurozone. Official UK price growth data for March is set to be released on Wednesday. More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.The risk of a broader conflict in the Middle East threatens to reverse a surge in the price of riskier assets since the start of the year, the IMF’s top financial stability official has warned. The fund’s Global Financial Stability Report, published on Tuesday, said expectations that the world economy would avoid a much-feared recession had driven up prices in assets such as stocks and lower-grade bonds since the turn of the year. “At the beginning of the year we saw a lot of optimism in markets. There was this expectation of a soft landing globally, of inflation coming back to target,” said Tobias Adrian, director of the fund’s monetary and capital markets department. Lending costs had fallen “substantially”, he added, especially for higher risk borrowers. But Adrian told the Financial Times that the recent “risk-on” rally could soon be over. Global stock markets sank and Asian currencies fell on Tuesday amid waning hopes for rapid US interest rate cuts and fears over an escalation of tensions in the Middle East. Heightened tensions between Israel and Iran had already triggered a “classic flight to quality” assets, such as US Treasuries, away from stocks. On Friday, the 10-year US Treasury yield — a key barometer of global borrowing costs — fell from 4.56 per cent to 4.5 per cent, while equities fell. Adrian said oil prices would be a crucial factor in determining the outlook for financial stability. Benchmark Brent crude has fallen slightly but remains close to $90 a barrel, having risen more than 6 per cent over the past month. “The risk is that [higher] oil prices lead to a further run-up in commodity prices more broadly, which pressures inflation and then triggers a change in stance for monetary policy and would lead to an impact on valuations more broadly,” he said. Adrian said he also expected supply chain disruptions to hit oil importers, such as most European countries, harder than producers such as the US. The US and its European allies have tried to dissuade Israel from striking back after Iran launched drone and missile attacks in retaliation for an Israeli strike on its diplomatic compound in Syria. However, Israel has signalled that it is likely to respond, risking a full-blown Middle East conflict.Such a scenario, Adrian said, would invite further “questions around the level of valuations and the level of [debt] issuance we have seen”. “That could ultimately impact financial stability and downside risks,” he added. While the IMF’s central scenario remains a soft landing for the global economy, Adrian said how restrictive monetary policy would need to remain to fully rein in price pressures was now “the key question”. After raising rates sharply in 2022 and 2023 to tackle the worst bout of inflation for a generation, central banks on both sides of the Atlantic are expected to cut rates in the coming months. However, that outlook for global borrowing costs would be challenged should disinflation prove unexpectedly slow — or go into reverse, as investors fear. “Stalling disinflation could surprise investors, leading to a repricing of assets and a resurgence of financial market volatility,” the GFSR said. More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.The writer is global chief investment officer at State Street Global AdvisorsEven as inflation eases, the global economy appears resilient and equity markets grind higher, investors need to remain on the lookout for pockets of vulnerability and risk. The combination of aggressive fiscal stimulus during the pandemic alongside multi-decade highs in interest rates have brought back a degree of anxiety about debt sustainability that we have not seen globally since the 2008 financial crisis.While we agree that debt levels are worrying, particularly given persistently higher rates, we do not think debt servicing is a particular cause for concern. The primary problem, we believe, is that high levels of government debt coupled with persistently high real yields crowd out other government spending, limit policy flexibility when the next downturn comes and ultimately become a drag on growth.Despite soaring debt levels globally, there are important nuances in debt sustainability. Household debt, for example, has changed drastically since the 2008 crisis when the US consumer was at the eye of the storm. Given a decade of steady deleveraging, American household debt ratios and service costs (as a share of income) are manageable, decreasing from 10.2 per cent in 2004 to 7.3 per cent in 2024.The story is starkly different on the public debt side, with the country leading the pack on government spending. US government debt has rocketed and at present stands at $34tn, with gross federal debt as a percentage of gross domestic product having doubled from 60.2 per cent to 120.6 per cent over 20 years. The rise in government debt globally matters because it could have a major impact on economies as three knock-on effects collide: lower future spending, rising vulnerability to market shocks and trickier policy decisions for central bankers and governments which will be forced to choose winners and losers as the cost of debt rises. The US economy has outperformed developed-market peers in the post-Covid recovery. The US economy is now 8.2 per cent larger than it was in the fourth quarter of 2019, against the eurozone’s 3.5 per cent gain, Japan’s 2.8 per cent and the UK’s 1.1 per cent. This outperformance has been largely driven by a massive transfer of money from government to consumers and businesses since early in the pandemic. The 2022 Inflation Reduction Act (IRA) and the Chips and Science Act also provided notable tailwinds, directing hundreds of billions of dollars in funding to clean energy and to bolster US semiconductor manufacturing capacity. At some point, the tide will turn. How gently or how dramatically this occurs will depend on what type of political mandate emerges out of the US presidential election. But for the economy, even flatline spending would mean fiscal policy becomes a headwind to growth.The US dollar’s role as global reserve currency means there is little danger that the Treasury would fail to find buyers for the debt it issues. But the question is, what price will buyers demand? On a very basic supply and demand level, the more supply, the lower the price. But in this case, the lower price of US debt means a higher interest rate. Yields on benchmark Treasuries rise, exacerbating the US government’s spending trade-offs.There is another twist. American banks own a significant amount of US government debt. As the yield on that rises, the paper losses associated with the holdings rapidly multiply. A fiscal “accident” — such as the UK’s “mini” Budget which sent bond yields soaring in September 2022 — could have immediate unforeseen ripple effects throughout the US banking and financial system. The more substantial these losses, the more reserves banks would need to keep and the more constrained their lending activity would be.Growing debt levels put policymakers in a tight spot. Outsized levels leave less financial flexibility to deal with unexpected events, making it more difficult to recover from shocks.What are the implications for investors? Perhaps counter-intuitively, investors should continue to embrace bonds, which look attractively priced. We continue to favour high-quality sovereign debt, including US Treasuries. We expect vulnerability in some overleveraged sectors — particularly commercial real estate — some parts of the asset-backed securities markets and lower-rated high-yield debt. Slowing growth rates could also derail equities. As public debt mounts worldwide, debt sustainability has become more urgent. Past politicians have left massive deficits for future generations to fix. The future has arrived. We are living on borrowed time. More