May 2012 1 Global Economics & Markets Rob Carnell Chief International Economist June 2012
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May 2012 1
Global Economics & Markets
Rob CarnellChief International Economist
June 2012
Rob CarnellChief International Economist
June 2012
May 2012 2
Eurozone - what else could go wrong?
Run on banks
AAAs downgraded Greece leaves euro
EU17 bailout fund not expanded
LTRO impact fades
Portugal debt restructuring
IMF resources not expanded
Fiscal compact fails
Popular backlash against fiscal austerity
Eurozone depression
May 2012 3
Eurozone: Greece - the “mad guy” in the lift?
“Give me the money”…
…“Or I shoot the puppy”
Greece realises finally that it has bargaining power
But the rest of Eurozone is playing “tough guy”
Who is going to blink first?
Don’t let “logic” blinker your analysis
May 2012 4
Presidential and parliamentary elections
2012 2013 2014 2015 2016
US presidential and senate election
6 Nov 2012
German federal election
27 Aug – 27 Oct 2013
Italian general election
Apr 2013
Portuguese parliamentary election
2015
Portuguese presidential election
2016
Greek presidential
election
2015
Greek re-run parliamentary
election
17 June 2012
Netherlands snap
parliamentary election
12 Sep 2013
French Parliamentary
elections
10-17 June
May 2012 5
Greece…the troika plans – doomed
To succeed, everything needs to go 100% right
Privatisation receipts
Tax implementation, and co-operation
Public sector spending cuts
GDP growth returns…
…and central banks make up some shortfall with profit donation
And then it still falls short of the target
No plan B
May 2012 6
The logistics of a new currency
Assuming Greek notes were all burned then what can be done?
Each euro note has a serial number with a letter code so it could work off this:
X (pictured) = Germany
P = Netherlands
U = France
Y = Greece
But notes have moved across borders – check your wallets & purses
De La Rue – 4 months to print enough Euro for Greece
Bank runs?
Czechoslovakia style stamping?
May 2012 7
A new Greek drachma: Hello and good-bye
FX performance after failed FX regimes
0
20
40
60
80
100
120
1 51 101 151 201 251 301 351 401 451 501
Days after January 1st of crisis year
Jan
1st
of
cris
is y
ear
= 1
00
0
20
40
60
80
100
120Mexico 1994
Thailand 1997
Indonesia 1997
Korea 1997
Russia 1998
Brazil 1998
Turkey 2000
A Greek exit and a return of the Drachma is now on the table
The implementation challenge is huge
On arrival we would expect it to fall up to 80% against the EUR….
….generally at the lower end of performances of failed FX regimes
May 2012 8
The result of failure: catastrophe…
If only Greece were to leave, it would suffer the most, but others would not be immune
Under a total break up, output could fall by 10%+ in the first two years…
…the losses to even Germany would dwarf the effects of the Lehman brothers bankruptcy
Output effects of Eurozone break up
Real GDP projections in breakup scenario
-14 -12 -10 -8 -6 -4 -2 0
Germany
France
Netherlands
Belgium
P ortugal
Italy
Spain
Ireland
Greece
Greek exit Total break-up
Cumulative output loss 2012-2014 (% relative to base)
.
85
90
95
100
105
05 06 07 08 09 10 11 12 13 14 15 1685
90
95
100
105
Germany NL, AUT, FIN, LUX Southern -Europe (GIPS)
Real GDP (2011 = 100)
May 2012 9
Slow motion Euro deposit flight
75
80
85
90
95
100
105
110
115
120
Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12
Jun-2010 = 100
Source: ECB * Excluding deposits held by MFIs and central governmentSource: ECB * Excluding deposits held by MFIs and central government
Bank deposits* in selected Eurozone countries
NL
Spain
Italy
Germany
Greece
Ireland
France
May 2012 10
European bailout fund not big enough…
Peripheral Eurozone debt maturities Euro bn
0
100
200
300
400
500
600
<1Y
r
1-2Y
r
2-3Y
r
3-4Y
r
4-5Y
r
5-6y
r
6-7Y
r
7-8Y
r
8-9Y
r
9-10
Yr
10-1
5Yr
15-2
0Yr
20-2
5Yr
25-3
0Yr
30Y
r+
Portugal
Ireland
Greece
Spain
Italy
Source: Reuters
May 2012 11
Spanish & Italian banks - LTRO carry trade
-20
-10
0
10
20
30
40
50
60
SP IT IR LU GR AS PT BE FR DE NL
Commercial bank net purchases of gov’t securities
Cumulative in Dec-11 & Jan-12 (EUR bn)
Far from solving the Eurozone’s problems, LTRO may have made them worse
May 2012 12
…ECB reluctant lender of last resort…
Securities Markets Program
Italian Draghi - SMP is “temporary and limited”
In reality it will probably become permanent and unlimited
ECB bond buying (€bn)
0
5
10
15
20
25
Apr-10
Jun-10
Aug-10
Oct-10
Jan-11
Mar-11
May-11
Aug-11
Oct-11
Dec-11
Mar-12
0
20
40
60
80
100
120
140
160
180
200
220
240Weekly bond purchases (lhs)
Cumulative total (rhs)
May 2012 13
…but still trails behind the Fed & BOE
ECB started off with the sovereign market program, which was fully sterilised - NOT QE
ECB reluctant to do QE so lent €1trn to the banks to do it - >90% of which has ended up back on deposit with the ECB
The BoE has done £325bn of QE and the Fed has done over $2trn
Scaling up ECB bond buying to Fed & BoE levels would amount to around €1.8trn- €2trn – more than the entire Italian bond market!
Central Bank asset purchases (% of GDP)
0
2
4
6
8
10
12
14
16
18
20
22
24
Bank of England FederalReserve
Bank of Japan ECB
LTRO
QE still to come
May 2012 14
Fiscal austerity… FOREVER!!
If fiscal policy is going to be so tight then monetary policy will have to be ultra loose to compensate
Low rates and bond yields forever = currency to depreciate versus emerging market growth engines…
Cyclically adjusted primary balance required for sustainable debt
-8
-6
-4
-2
0
2
4
6
8
10
12
14
Spa
in
Ger
man
y
Fra
nce
Italy
Net
herla
nds
UK
US
Gre
ece
2010
2020-2030
2020-2030 including age related spending
(% of GDP)
May 2012 15
Population demographics – bad for Europe
Europe will soon see its population shrink making a drive for exports all the more important
Europe’s working age population will fall even more quickly…
… meaning the fiscal pain will be even greater
Growth rates of populations of working age
-40
-20
0
20
40
60
80
100
120
140
160
Eur
ope
Nor
th A
mer
ica
Asi
a
Oce
ana
Wor
ld
Latin
Am
eric
a
Afr
ica
2010-2030
2010-2050
(% change)
May 2012 16
How can we get out of this mess?
1. Relax austerity – countries meant to have deficits less than 3% by 2013, so delay this until 2016
2. Talk down the euro to boost competitiveness – shouldn’t be hard
3. ECB rate cuts, LTRO3, possible QE – will also feed through into weaker euro – but ECB must be prepared to take losses
4. Lower oil prices – Saudi oil minister says oil should be $100/bbl
5. Common Euro-bond?
May 2012 17
Competitiveness still to be addressed
Relative unit labour costs
60
80
100
120
140
160
180
200
00 01 02 03 04 05 06 07 08 09 10 11
GER FRA ITA
SPA NLD BEL
IRE GRE POR
J an 2001 = 100
OECD: Manufacturing Unit labour costs - sa
The likes of Portugal, Spain, Italy, and Greece still have a mountain to climb in terms of competitiveness…
…but it can be done…
Ireland did it, and now runs a current account surplus
May 2012 18
Shale Gas – Race to the bottom
Natural Gas - relative price
0
20
40
60
80
100
120
140
160
180
200
08 09 10 11 12
Europe US Henry Hub
index $ per unit
US Natural Gas prices are their lowest in years……thanks to the growth of shale gas production…
…this has only just taken off in other regions…though we can expect a similar price reduction in time elsewhere
Shale Gas Reserves
US, 862Other North
America, 1069
South America, 1225
Europe, 624Africa, 1042
Asia, 1404Australasia, 396
Technically Recoverable ResourcesTcf
Recoverable shale gas deposits are widely distributed
May 2012 19
Oil shock: Israel vs Iran
Prospects for a Middle East clash uncertain
Iranian or Hezbollah retaliation?
Oil at $200/bbl? Mining the Straits of Hormuz?
Crude oil prices
0
20
40
60
80
100
120
140
160
J an 07 J an 08 J an 09 J an 10 J an 11 J an 12
Brent crude WTI
$/bbl
May 2012 20
Impact of fuel shock
oil price in US$
pump price ($c/gall)
average cost 1 car ((13 gallons per week ($))
avg annual cost 1 car
% median after tax income 2 cars
% median after tax income
100 297 38.94 4050 4.1 8100 8.1
110 322 42.22 4390.91 4.4 8781.818 8.8
120 347 45.50 4731.82 4.7 9463.636 9.5
130 372 48.78 5072.73 5.1 10145.45 10.1
140 397 52.05 5413.64 5.4 10827.27 10.8
150 422 55.33 5754.55 5.8 11509.09 11.5
160 447 58.61 6095.45 6.1 12190.91 12.2
170 472 61.89 6436.36 6.4 12872.73 12.9
180 497 65.17 6777.27 6.8 13554.55 13.6
190 522 68.44 7118.18 7.1 14236.36 14.2
200 547 71.72 7459.09 7.5 14918.18 14.9
Potential cost of US Fuel
At current prices - $120-$130/bbl, gasoline consumption is costing a 2 car household about 9.5-10% of annual income.
At $200/bbl, this increases to about 15%
Of course, if you drive an SUV – double all the figures above!
May 2012 21
SPR – 30m barrels = about $0.50-$1.00 3m
In recent history, there have been three instances of an SPR drawdown
The resulting fall in retail gasoline prices was about $0.50 - $1.00, though the counterfactual is unclear
Is few cases, was the impact sustained for more than 3m
Moral: Don’t overestimate the price effect of the SPR
SPR Drawdowns
500000
550000
600000
650000
700000
750000
99 00 01 02 03 04 05 06 07 08 09 10 110
50
100
150
200
250
300
350
400
450
Strategic petroleum Reserve, lhs
Retail gasoline prices, rhs
low distillate levels in NE30m b
Hurricane Katrina 11m b
Arab Spring30m b
May 2012 22
EUR/USD … the known unknowns
IMPACTLow High
High
Low
PR
OB
AB
ILIT
Y
US elections/ protectionism
Early Fed tightening
Fed QE3
Greece leaves EMU
Eurozone breaks up
Iran Conflict
Eurozone hard-landing
Chinese hard landing
EUR/USD
Positive factors
Negative factors
0% 15% 30%
May 2012 23
Monetary Shocks – policy error?
The Fed’s proposed first rate hike by no sooner than “late 2014” seems difficult to take seriously
Markets are registering their doubt through Eurodollar and Fed fund futures contracts – Fed taking a chance with inflation – bond yield spike later in 2012?
0
1
2
3
4
5
2012 2013 2014 Longer run
% Fed member assessment for appropriate interest rate
May 2012 24
US is not immune to the Eurozone
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Banking sector P ublic sector Other total
GIIP S Other Eurozone UK
EURtr
Exposure of US banks to Europe through deposits, loans etc amounts to about $1.8tr (inc UK)
…and exposure through CDS written amounts to a further $2.2tr
If the crisis does re-ignite…
…then the US will not be immune to Eurozone developments
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
Belgiu
m
Franc
e
Ger
man
yIta
ly
Luxe
mbo
urg
Nethe
rland
s
Austri
a
Gre
ece
Irelan
d
Portu
gal
Spain UK
EUR tr
Ultimate country risk exposure
Country and CDS
May 2012 25
US fiscal policy tightening set to bite
US growth has been helped by the fact the government has been quicker to loosen and slower to tighten fiscal policy than has the Eurozone…
…this is beginning to change
Bipartisan politics mean more sun-setting of stimulus from 2013, and more fiscal drag
-3
-2
-1
0
1
2
3
4
2009 2010 2011 2012 2013 2014
US Europe
GDP %
“Tax-mageddon”
May 2012 26
Debt burden still very heavy
Household debt has fallen – mainly due to debt default
But overall burden still extremely high…
…three times average individual salaries
Likely to weigh on consumer spending growth for years
The US debt burden*
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
52 56 60 64 68 72 76 80 84 88 92 96 00 04 08
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
Federal & localgovernment debt
Household
Average salary
* debt per person of working age
($) ($)
May 2012 27
China – avoiding a hard landing?
Export growth has been slowing…
…but some of the lead indicators for exports are not too bad…
…and in any case, wasn’t China supposed to be moving to a more domestically oriented growth model?
Exports and Export PMI
25
30
35
40
45
50
55
60
65
70
31/01/2005 31/01/2007 30/01/2009 31/01/2011
-40
-30
-20
-10
0
10
20
30
40
50
60
Export orders PMI
Exports, rhs
index YoY%
May 2012 28
Key currency attributes in 2012
Very few currencies demonstrate all the attributes of safety, liquidity and return
Return
LiquiditySafety
AUD
CAD
GBP
JPY
NOK
CHF
SEK
USD
NZD
EUR
EMEA
ASIA ex CNY
LATAM
CNY
-6 -4 -2 0 2 4 6
JPY
EUR
AUD
SEK
CHF
CAD
NOK
GBP
NZD
Year-to-date vs. USD (% chg)
INR
May 2012 29
Global FX – valuations to impact returns
Currency pain thresholds
-15 -10 -5 0 5 10 15 20 25 30
UKUS
South KoreaEurozone
MexicoJapan
SwedenHungary
TurkeyIndia
NorwayMalaysia
South AfricaThailand
NZIndonesia
SwitzerlandCanada
SingaporeChina
AustraliaRussia
Brazil
Percent of REER index above/below 10-year average
May 2012 30
Summary
The best case, is for ongoing, prolonged, low level risk aversion and weak growth from the G-10
Assuming no Euro break up: fiscal tightening, credit constraints, and de-leveraging will weigh on economies and assets for year (decades?) to come
The worst case is for massive economic and market disruption in the event of Eurozone break up
The rest of the G-10 will not be immune to the fallout
Choosing between a number of binary outcomes (Greece in or out for example), makes forecasting almost impossible
Adding politics to the arguments makes logic irrelevent
Most of the arguments point to further euro weakness. And also to low(er) rates and bond yields (for core Europe, and non-Europe)
May 2012 31
Forecasts
2011 2012 2013 2014USGDP 1.7 2.2 2.0 2.3CPI 3.2 2.1 2.4 2.5EZGDP 1.5 -0.4 0.9 1.2CPI 2.7 2.4 1.7 1.8EUR/USD 1.30 1.15 1.2 1.25UKGDP 0.7 0.2 2.0 2.7CPI 4.5 2.7 2.0 2.3GBP/USD 1.55 1.53 1.56 1.56JapanGDP -0.7 1.9 1.3 1.2CPI -0.3 0.2 -0.1 0USD/JPY 77 85 95 110ChinaGDP 9.2 8.2 8.4 8.4CPI 5.4 3.0 3.0 3.0USD/CNY 6.32 6.24 6.18 6.18
All figures annual averages, except for exchange rates, which are year end
Forecast summary
May 2012 32
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