Global economy continues to struggle

The global economy continues to struggle, with China's slowdown, the downward bias in commodity prices, and the renewed increase in financial market turbulence risking further weakness. There are not enough growth engines around the world. Only the U.S., the U.K. and India can be considered relative outperformers, countries which appear to be the most resilient and have the potential to generate stronger, and importantly, more sustainable activity. In contrast, most nations and regions are reporting moderate output growth. And a number of large nations, including Brazil, Russia and Venezuela, are still mired in recession. 

Financial market volatility around the world has increased dramatically in recent weeks. The large and synchronized sell-off in global stock markets, followed by only a partial rebound, continues to grind lower and highlights a downgraded assessment of economic conditions and corporate earnings. The increase in risk aversion has put added downward pressure on already low sovereign bond yields throughout the advanced economies, and even in the U.S. where strengthening employment and output growth threaten to boost wages and inflation.

The biggest downside risks are in the resource-sensitive regions. Many emerging market and developing nations - ranging from the Asia-Pacific region to Latin America - are being negatively affected by the combination of the slowdown in China, the decline in commodity prices, persistent U.S. dollar strength, and the intensifying weakness in currency and financial markets. More advanced economies - including Canada, Mexico and Australia - are also being squeezed by the investment, output and employment adjustments needed to rebalance operating conditions to the new reality of oversupply, lower prices and reduced earnings.

The Fed is poised to raise short-term interest rates, with expectations being deferred to December. But the timing and extent of prospective rate hikes will depend upon the strength of the U.S. expansion and 'core' inflation, and the potential for any spillover from the volatile financial market and economic conditions around the world. The composition of the Fed's portfolio of U.S. Treasury and mortgage-backed securities, together with potential asset allocation shifts from core creditors such as China and Japan, will be an important driver of long-term yields over the next year.

The current softness in the global economy is expected to give way to renewed economic traction as the drag from structural adjustments and financial market instability abates. Considerable pent-up demand in the U.S. should underpin steady consumer spending and housing-related gains. Increasing monetary and fiscal stimulus should help stabilize conditions in China. Persistently low borrowing costs and low oil prices remain supportive of improved economic performances internationally. And in contrast to the Great Recession, many banks around the world are much better capitalized and capable of financing increased activity.