Sunday, November 29, 2015


2016 outlook

   As the year draws to a close it is time to look forward to the new one. At this point, the trends in place indicate that 2016 will be much like 2015, punctuated by low economic growth and low inflation. Therefore, trade growth is also likely to continue slowing. For the freight movement industry, this indicates that for most segments, competition will remain intense and it will be difficult to raise prices and therefore grow profits. However, some possible events could improve the outlook.
   The fundamental reason for slow economic growth is that improving consumer spending is offset by weak business and public sector investment.
   In Europe, the United States and China, the growth rate of retail sales has been increasing over the last six months. Growing consumer spending has induced companies to hire more employees, which in turn results in more consumer spending. This virtuous cycle has been boosted by central banks in all three economies either lowering interest rates or keeping them at historically low levels, as well as the decline in energy costs.
   Over the same period, industrial production growth has slowed to less than 1 percent in the United States and declined significantly in China. Europe has had steady, but low industrial production growth. The global slowdown in industrial production is driven by the mining and energy industries. These industries have been incurring losses as commodity prices have fallen below the cost of production in many locations. Investment in plants, property and equipment in the United States contracted 4 percent in the third quarter, led by a 46 percent decline in investment by the mining and oil industries.
   The pain that the mining and energy industries are going through traces back to high growth rates in production capacity investment in anticipation of sustained high demand growth from China. Over the last 15 years, China has become the world’s largest consumer of many commodities such as oil, coal, metals and agricultural products. Since 2011, the pace of investment spending in China has declined and, therefore, growth in demand for raw materials has slowed.
   As if slower demand growth from China wasn’t enough, the U.S. dollar has been strengthening against most currencies over the last 12 months, gaining on average 20 percent. The significant negative correlation between the commodity price indexes and trade-weighted U.S. dollar exchange rate indexes was illustrated and discussed in the September edition of this column (“Consequences of a stronger dollar,” page 16).
   As commodity prices, denominated in U.S. dollars, decline, U.S. exports become less competitive with that of other countries because they benefit from their currencies losing value. For example, if the price of a commodity denominated in U.S. dollars falls 10 percent, the U.S. exporter’s revenues will fall by 10 percent. If the Brazilian real depreciates by more than 10 percent against the U.S. dollar then a Brazilian exporter’s revenues in reals will increase. Under those circumstances, the Brazilian exporter can undercut prices offered by U.S. exporters.
   U.S. exports are struggling because the dollar is cyclically strong. However, the U.S. dollar is structurally weak due to various long-term demographic and economic trends. It is hard to see how the U.S. dollar will appreciate another 20 percent. It is reasonable to expect the U.S. dollar to begin losing value against other currencies over the next few years as other economies, particularly Europe, continue to recover. As that happens, U.S. exports will pick up. For the next few years, it is likely that imports will grow faster than exports, worsening the trade deficit.
   It is also likely that economic growth will outpace trade growth in the United States and Europe. The service sectors, like leisure, healthcare, finance, legal and education, account for most economic activity in developed economies. About 90 percent of U.S. employment is in services industries. In both the United States and Europe the service sectors have been expanding.
   Global economic growth is likely to be below its long-term average in 2016. While this is not a particularly bright picture, at least it doesn’t seem likely there will be a contraction. Furthermore, it seems the balance of risk to that view is to the upside. If governments were to take advantage of low commodity prices to improve and build new infrastructure, many of the trends dragging on economic growth could reverse. A removal of the trade embargos between Russia and Europe and the United States would also help matters. On the downside, if inflation were to pick up then central banks would have to raise interest rates aggressively, which would slow economic activity and maybe even result in a contraction. However, there appears to be little risk of inflation rising. If anything, a modest rise in inflation would be welcome.
   For the freight movement industry it might make sense to back off a bit on capacity investment. At least until economic activity picks up a bit more.
   Kemmsies is chief economist at Moffatt & Nichol, an infrastructure engineering firm. He can be reached at (212) 768-7454, or email at