Fiscal stimulus – The next uplift for commodities

01 November 2016

Should the globe slowly but surely shift away from monetary policy stimulus towards infrastructure spend, commodity demand and prices should be supported.

Introduction

In September 2015 the USD was the strongest global currency; the rand was weakening and commodity prices were rapidly declining having peaked in 2011. Global perceptions were for a series of US interest rate increases on the premise of an accelerating economy. Moreover, commodity prices were declining on concerns of a slowing Chinese economy and a potential “hard landing”.

A year later and how the world has changed! The US only raised rates by 25bpts in December 2015, and expectations of interest rate increases have since moderated considerably. Furthermore, the US dollar has weakened on a trade weighted basis from the highs of December 2015.

The response by China over concerns of a “hard landing” were averted through total social financing accelerating to 6.59 trillion yuan in 1Q 2016 (first quarter).

Coincident with this funding there was a surge in economic activity and a concomitant increase in commodity prices. Industrial production increased 1%m/m in March 2016 and growth in fixed investment rose to 11.1%oya. Recent economic data reveal that investment by state firms increased by 21.4% in the first eight months of the year. This increase in fixed-asset investment spend has been a major contributor to rising commodity and resource share prices in the first nine months of the year. Currently, market participants are questioning the strength and durability of the currently prevailing commodity prices.

Fiscal stimulus

At the time of, and following, the global financial crisis both monetary and fiscal stimulus was used to support the global economy in the period between 2008 and 2009. Thereafter, fiscal consolidation took place across most advanced economies and only monetary policy was used as the means to support economic growth. However despite these actions, global growth remains subpar and inflation is well contained. This monetary policy action has resulted in very low bond and cash yields in the developed world. In some instances yields are negative.  Some eight years later it is questionable if monetary policy has achieved the results hoped for and fiscal policy measures are being talked about and slowly reintroduced. These fiscal measures are designed to once again drive economic growth forward.

This year Japan announced a 28.1trn yen stimulus programme, incorporating 13.5trn yen of fiscal measures that include upgrading port facilities, and the construction of a high-speed rail line. The Canadian Prime Minister Justin Trudeau, has pledged a further C$60bn in new infrastructure spend over the next ten years which when added to the existing fiscal package, totals C$120bn. Coupled with this development, Prime Minister Trudeau has promised tax cuts to middle class workers. China has recently announced the “Northeast Revitalisation Plan 2.0”, where a 1.6tn yuan fiscal package will be introduced over the next three years in an effort to stimulate growth in this industrial region. South Korea has announced a 20trn won package including a supplementary budget amount of 10trn won to boost growth.

In the US both presidential candidates have pronounced on implementing various fiscal stimulus strategies should they be elected. Donald Trump is to achieve his infrastructure spend initiatives through tax cuts and more borrowing.  In particular Trumps tax proposals would reduce the personal income tax rate from 39.65% to 25% and corporate tax rates from 35% to 15% while cutting back on education, energy and healthcare expenditure. Hillary Clinton on the other hand, is proposing a $275bn infrastructure spend programme to be introduced within her first 100 days in office. This would be funded through planned tax increases. The top tax bracket is indicated to be increased from 39.6% to 43.5%. The bottom line being, no matter the presidential outcome, 2017 should see an increase in fiscal stimulus in the US.

In the US both presidential candidates have pronounced on implementing various fiscal stimulus strategies should they be elected. Donald Trump is to achieve his infrastructure spend initiatives through tax cuts and more borrowing.

Within the European Union conditions are ripe for fiscal stimulus given the anaemic economic growth, low bond yields and inflation. The implementation of fiscal stimulus in the union is unfortunately influenced by politics. However, there are signs of potential fiscal measures being announced in 2017. The German finance minister has implied that the economy has the ability to lower taxes and in September the European finance ministers met to discuss a common fiscal strategy.  Furthermore, should there be changes to the governments of the Netherlands, France and Germany in 2017; the new governments may accelerate fiscal stimulus packages to appease voters’ demands for change.

Currently, the UK has implemented easing by the Bank of England subsequent to the Brexit vote. However, the Chancellor of the Exchequer Phillip Hammond, at the recent Group of 20 finance ministers meeting in China, indicated a potential fiscal response by the UK government at their autumn statement. If announced the magnitude of the fiscal response will be closely watched given a forecast slowdown of the economy over the next 12 months.

In terms of emerging markets, especially commodity producing countries, fiscal consolidation is taking place. However these geographies have the capability to employ monetary policy easing should circumstances permit.  In China it is unlikely that a large-scale fiscal-stimulus package will be introduced.  It appears more likely that the current fiscal stance will be maintained.

ASEAN Fiscal demand

One of the global geographic areas that will require significant infrastructure spend is The Association of Southeast Asian Nations (ASEAN) which comprises Singapore, Malaysia, Indonesia, Thailand, Philippines, Brunei, Vietnam, Cambodia, Laos and Myanmar.  Leggett (2015), in a Nielsen research document, has forecast that the Asean middle class will more than double between 2012 and 2020 from 190 million to 400 million people. According to these forecasts the ASEAN region will have the third-largest middle-class population after China and India. In order to accommodate the demands from the increasing middle class, infrastructure spend will have to accelerate.  The political will is evident through the simplification of taxes, foreign investment, and customs, including a crackdown on corruption through enforcing the law. The Asian Development Bank estimate that USD 583.1billion of infrastructure spend will be required by 2020.

Conclusion

Should the globe slowly but surely shift away from monetary policy stimulus towards infrastructure spend, commodity demand and prices should be supported. Many of the planned infrastructure projects appear to be focussed on power generation, transport and water. If these developments manifest themselves it will be, in the medium term, the emerging markets and, in particular, the ASEAN region, supported by developed-market infrastructure projects that take over the infrastructure baton from China.

Bulk and industrial commodities such as iron ore, coal and copper would benefit from the projected increase in infrastructure spend.  Similarly the demand for consumer-orientated commodities such as diamonds, platinum and palladium could well benefit from a projected 41% increase in the global middle-class population between 2012 and 2020.