Economy & Rates December 2015 (figures and charts updated on 10 December 2015) Bruno Cavalier - Chief Economist, [email protected], 33.(0)1.44.51.81.35 Fabien Bossy - Economist, [email protected], 33.(0)1.44.51.85.38 The Seven Year Itch Tables of forecasts pages 16-17 Statistical and chart appendix pages 19-43 “Being normal is boring”. (Marilyn Monroe)
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Economy & Rates Rate 12...Economy & Rates December 2015 (figures and charts updated on 10 December 2015) Bruno Cavalier - Chief Economist, [email protected], 33.(0)1.44.51.81.35 Fabien
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Economy & Rates
December 2015 (figures and charts updated on 10 December 2015)
Bruno Cavalier - Chief Economist, [email protected], 33.(0)1.44.51.81.35
• 16 December 2008 – 16 December 2015. Seven years. The Fed will thus have maintained its zero interest-rate policy for seven years. At the end of 2008,
nobody imagined that this measure, taken urgently to avert a 1930s-style depression, would last so long. Nor that it would be replicated in many other
countries, especially in Europe, where interest rates have even gone below zero. Nor that it would be reinforced by massive quantitative easing. In the
past two years, US central bankers have made dozens of speeches about the normalisation of their policy, and everyone has weighed up the arguments
for and against. This is the most painstakingly prepared decision in modern economic history. A return to a more “normal” monetary policy should not
in principle surprise anyone. Can we be so sure about that?
• Despite being warned, no investor can stay completely calm ahead of a change of regime affecting the actions of the most powerful institution in the
world’s leading economy. This change is set to occur in unusual circumstances. Firstly, since there is no precedent for this type of policy (ZIRP + QE),
there is no precedent for its normalisation either. It is not a question of a applying a guiding principle tried and tested by experience. What’s more, the
Fed has demonstrated through its hesitations over the past year that its assessment of the risk and rewards of a rate hike have fluctuated sharply. At the
start of the summer, the Fed seemed to be on the verge of exiting the ZIRP. At the end of the summer, this decision was put on hold, and today, three
months later, it is back on the table. We shudder at the thought that each rate increase (the second, third, etc.) will give rise to similar reversals. The Fed
claims to manage market expectations by setting a course, but it creates volatility if it does not follow it.
• The monetary question is inseparable from that of inflation. It is the weakness of inflation that has allowed the Fed to justify being so patient. Now that
the US economy has returned to full employment and wages are starting to accelerate, the context is quite different. Although global forces continue to
put pressure on prices (technology, ageing demographics and China’s economic transformation), inflation did not weaken in 2015 beyond what is due to
plummeting commodity prices. Excluding the oil effect, inflation has picked up slightly in developed countries. Core inflation is not abnormally low by
historic standards. In the Eurozone, where capacity utilisation is still far from its pre-crisis level, the ECB president nonetheless recently acknowledged
that “the risk of deflation in the Eurozone is firmly off the table” (4 December). This is a thematic rotation that appears highly important to us.
• In 2015, world growth will have been a little weaker than hoped. It will have slowed instead of accelerating. More than 40% of the disappointment is down
to two countries, Brazil and Russia (a total of around 6% of world GDP), the only two countries to be mired in a severe recession. The rest of the
slowdown is due to other emerging countries and commodity producers, and more modestly to China (despite concerns of a hard landing). In contrast,
the Eurozone is the sole region to have delivered positive surprises in 2015. This point is often overlooked or underestimated. The factors for a
continued acceleration of the European recovery are in place: an expansionary policy mix, a credit recovery and a decline in unemployment.
• There are risks in any scenario. One of the possible sources is oil. In 2015, few subjects have been spared the repercussions – positive or negative – of
the oil counter shock: a redistribution of growth, low inflation, capital flows, volatility in exchange rates and stock market indices. The central view of oil
experts is that prices will be stable or rise modestly over the next two years. This is the working assumption behind our macroeconomic forecasts, but
basic caution obliges us to recognise that very different scenarios are possible, both on the upside and downside. Geopolitical risks have intensified in
recent months, creating the combination of a migration crisis and a security crisis in Europe. The direct effects on activity will be modest, but the
political consequences may be considerable, both in the lead-up to the French presidential election and in the debate over Brexit in the UK.
Summary The Seven Year Itch
Strictement confidentiel
[Date]
3
Post-mortem of 2015: forecasting errors As in 2014, global growth is half a point below the level forecast at the start of the year. The oil counter shock has
• Global growth in 2015: estimated at 3.1% vs. 3.7% forecast
– 43% of the disappointment stems from Brazil and Russia
• US: a weak Q1 (temporary shocks)
– Real growth remains above its potential rate
• Eurozone: the only zone to surprise on the upside
– The ECB’s negative message is at odds with reality
• China: high volatility around the same downward trend
– The real surprise concerns the agenda of Chinese authorities
• Global inflation in 2015: estimated at 1.9% vs. 2.9% forecast
– Almost all of the disappointment is due to the oil/commodities effect
• Global core inflation has picked up slightly
– No second-round effects from oil prices on other prices
• Stable medium-term inflation expectations
– Unlike in 2014, when these declined (Eurozone)
• Inflation spike in countries that have suffered an FX crisis
– Latin America, Russia
Weight Forecast* Actual Surprise Forecast* Actual Surprise
2014 at end 2014 at end 2015 at end 2014 at end 2015
PPP$ (a) (b) (b-a) (a) (b) (b-a)
World 100% 3.7% 3.1% -0.6% 2.9% 1.9% -1.0%
US 15.9% 3.0% 2.5% -0.5% 1.9% 0.1% -1.8%
EMU 11.8% 1.1% 1.5% 0.4% 0.6% 0.1% -0.5%
- Germany 3.4% 1.3% 1.5% 0.2% 1.2% 0.3% -0.9%
- France 2.4% 0.8% 1.1% 0.3% 0.6% 0.1% -0.5%
- Italy 2.0% 0.3% 0.7% 0.3% 0.4% 0.1% -0.3%
- Spain 1.4% 1.9% 3.2% 1.3% 0.4% -0.5% -0.9%
UK 2.4% 2.6% 2.4% -0.2% 1.3% 0.1% -1.2%
Japan 4.4% 1.1% 0.7% -0.4% 1.4% 0.8% -0.6%
China 16.6% 7.0% 6.8% -0.2% 2.1% 1.5% -0.6%
Russia 3.3% 0.1% -3.8% -3.9% 7.5% 15.5% 8.0%
Brazil 3.0% 1.0% -3.7% -4.7% 6.5% 8.9% 2.4%
RoW (e) 42.6% 4.3% 3.7% -0.6% 3.9% 1.9% -2.0%
* based on consensus forecasts data (Bloomberg or Consensus Inc.)
Real GDP growth 2015 Inflation 2015
Strictement confidentiel
[Date]
4
Post-mortem of 2015: the themes Macro developments in 2015 have largely reflected the oil counter shock at end-2014/early 2015: very weak inflation,
recession in producer countries/sectors, capital flows and a boost to real consumer income.
Sources: Thomson Reuters, IMF, Oddo Securities.
1) The oil price has changed equilibrium (market supply glut)
– More generally, confirmation of the inversion of the commodities super-cycle
2) Unconventional monetary policies (ZIRP/NIRP/QE) have decreasing
returns
– This explains communication errors/hesitations by central banks
3) Emerging countries truly deserve their name
– Their economic cycle has a much higher beta than that of mature countries
4) Chinese leaders are neither infallible nor omnipotent, but they are
maintaining control of their economic cycle
– The stabilisation of the yuan is a sign of international monetary cooperation
5) The US economy is in full employment but without profits
– It has become untenable for the Fed to maintain the zero interest-rate policy, but at
the same time it is very tricky to exit
6) Deflationary risk in the Eurozone is “off the table” (Draghi)
– The economy is out of the woods, but what about the political landscape?
0
3
6
9
12
10 11 12 13 14 15
y/y% Real GDP growth: developed vs emerging countries
Developed countriesEmerging countries ex-ChinaChina
0
20
40
60
80
100
120
140
160
70 75 80 85 90 95 00 05 10 15
2015 $ Real price of crude oil *
1st oil shock (1973)
2nd oil shock(1979)
* nominal price adjusted for the US core CPI and denominated in 2015$shaded areas are periods or real oil price decline of more than 45% y/y
Gulf war (1990)
Iraq war (from 2003)
Strictement confidentiel
[Date]
5
Snapshot of the world economy at the end of 2015 The industrial slowdown amid an oil recession and the inversion of the commodities super-cycle is no longer
worsening. Trade is gradually recovering after a poor H1. Non-industrial sectors are proving resilient to shocks,
allowing unemployment to continue falling
Sources: Thomson Reuters, Oddo Securities.
-1
0
1
2
3
4
5
10 11 12 13 14 15
y/y% G3 inflation * G3 core inflation *
*US-EMU-China
rising oil prices
collapsing oil prices28
30
32
34
36
38
10 11 12 13 14 15
millions Unemployed (in developed countries*)
*US, EMU, UK, Japan
48
50
52
54
56
58
10 11 12 13 14 15
points World business confidence : non-manufacturing
World business confidence: manufacturing
-10
0
10
20
30
10 11 12 13 14 15
3m/3m % (ar) World trade index (volume)
Strictement confidentiel
[Date]
6
Theme of 2016: global inflation With the US and Europe growing above their potential rate, the output gap will continue to narrow as long as monetary
policy remains ultra-accommodative overall. These are the ingredients for a rise in inflation. Upside pressure may
• Technical rebound (inversion of base effects on oil)
• Narrowing of the output gap (spillover effect on US wages)
• Rise in post-QE expectations (Eurozone)
• Geopolitical risk (war, trade frictions)
• Still some downside pressures: China, ageing, technology
• Implications
• Monetary policies
• Bond yields
4.0
6.0
8.0
10.01
2
3
4
04 05 06 07 08 09 10 11 12 13 14 15
% (inv)y/y% US: wage growth vs unemployment
US wage metric*
US jobless rate (rhs)
* simple arithmetic average of various wage and compensation indicators
40
60
80
100
120
140
1.5
1.7
1.9
2.1
2.3
2.5
13 14 15
$/b% EMU: inflation swap 5y5y Brent (rhs)
2% = ECB's target
30
40
50
60
70
80
90
100
110
120
2014 2015
Brent price ($/b)2014
2015
January July December
-55%-50%
-37%
Strictement confidentiel
[Date]
7
Theme of 2016: US profitability at full employment The erosion of domestic profits (≈ -5% y/y) reflects the twin oil + dollar shock. Even if these effects will ease, the US
economy is no longer in the natural phase of accelerating profits. Without productivity gains, growth will slow. Market
• Domestic growth is levelling off (second half of the cycle), although it
is still solid today.
• Companies’ pricing power remains weak
• The underemployment of labour has disappeared
• Financial conditions are tightening (corporate spread)
• Implications
• US stock market
• Volatility
10
12
14
16
18
20
22
24
77 80 83 86 89 92 95 98 01 04 07 10 13 16
% US corporate profits/value added ratio
-3
-2
-1
0
1
2
77 80 83 86 89 92 95 98 01 04 07 10 13 16
Z-score US: Labour Market Conditions Index (Fed's LMCI)
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
5
10
15
20
25
30
35
40
45
77 80 83 86 89 92 95 98 01 04 07 10 13 16
ratio US Shiller's CAPE ratio US Tobin's q ratio (rhs)
Strictement confidentiel
[Date]
8
Theme of 2016: the reflation of the Eurozone The Eurozone recovery has external sources (oil, euro) and internal sources (job market, credit and policy mix). In the
short term, there are no unsustainable economic imbalances, not even public debt. A virtuous circle is underway. This
is the zone with the most acceleration factors.
Sources: Thomson Reuters, Oddo Securities.
• Should we be worried about an economy where…
• The unemployment rate has been falling for two years
• Household consumption has rarely been as dynamic
• Financial fragmentation has disappeared
• The credit cycle has picked up over the past year
• Public deficits have returned within the authorised limits
• Domestic political risks are secondary
• However, the principal driver, Germany, is experiencing several shocks
• Macro (global demand), sectoral (VW) and political (migrants)
-4
-2
0
2
4
03 04 05 06 07 08 09 10 11 12 13 14 15
EMU: real retail sales* (year-over-year %)
* 3M moving average -12
-9
-6
-3
0
3
6
03 04 05 06 07 08 09 10 11 12 13 14 15
%GDP EMU credit impulse to the private sector (6mma)*
* credit impulse is the change in new borrowings (as a % of GDP)
7
8
9
10
11
12
13
03 04 05 06 07 08 09 10 11 12 13 14 15
EMU: unemployment rate (% of LF)
Strictement confidentiel
[Date]
9
Theme of 2016: the BRICs, especially the BR (Brazil and Russia) China has loosened its economic policy to stabilise its growth. The trend remains that of a slowdown amid an
expansion of the service sector. Concerns about a hard landing may resurface but are not the baseline scenario.
Elsewhere, trajectories vary: India (strong growth), Russia (stabilisation), Brazil (recession)
Sources: Thomson Reuters, Oddo Securities.
• Russia – Brazil: comparable points
• In 2015, the two countries have experienced a very severe recession
(real GDP contracted by almost 4% on average).
• Their currencies have depreciated sharply (by around 40% against
the dollar), triggering a strong inflationary spiral.
• Russia – Brazil: differentiating points
• The policy mix response was swifter, more flexible and, in the end,
more effective in Russia (monetary and fiscal easing). Brazil has lost
all monetary and fiscal credibility (downgrade).
• Signs of a stabilisation of activity in Russia, but not in Brazil.
• The risk of political instability is higher in Brazil than in Russia.
1.5
3.0
4.5
25
50
75
11 12 13 14 15
vs USDvs USD Russian Rubble (lhs) Brazilian Real (rhs)
4
6
8
10
12
14
16
18
11 12 13 14 15
% Russia policy rate Brazilian policy rate
-6
-4
-2
0
2
4
11 12 13 14 15 16
%GDP Russia and Brazil: net public lending (ex. interest)
Russia Brazil
fiscal easing
(e)
Strictement confidentiel
[Date]
10
Theme of 2016: Fed’s normalisation After many hesitations, the Fed will end seven years of the ZIRP. There is little disagreement about the end point of the
cycle. But views within the Fed about the trajectory to get to the “normal” level of the Fed Funds rate remain divergent.
This is conducive to communication and management errors.
Sources: Thomson Reuters, Fed, Oddo Securities.
• The advantage of being “gradual” (Bernanke, 2004)
• Take into account the uncertainty of the economic system
• Manage expectations and the reaction by bond yields
• Reduce the risk of financial instability
• “Gradual”… compared with what?
• Past normalisation cycles
• Market expectations
• Macroeconomic figures (unemployment and inflation)
• The frequency of hikes (auto pilot)
3.25
3.50
3.75
4.00
4.25
Ap
ril 2
012
Jun
e 2
012
Se
pt. 2
01
2
Dec. 2012
Mar.
2013
Jun
e 2
013
Se
pt. 2
01
3
Dec.2
013
Mar.
14
Jun
e 1
4
Se
pt. 2
01
4
Dec.2
014
Marc
h 1
5
Jun
e 2
015
Se
pt.2015
% Fed funds: FOMC members average estimate of long-run level
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
0 18 36 54 72
Fed funds at end-of -year (individual FOMC views in Sept. 2015)
end 2015 end 2016 longer run
* each dot represents one FOMC participant
end 2017
median=0.38%
sdt.dev=0.25%median=1.38%sdt.dev=0.69%
median=2.63%sdt.dev=0.72%
median=3.50%sdt.dev=0.25%
end 2018
median=3.38%sdt.dev=0.32%
-4
-2
0
2
4
6
8
60 65 70 75 80 85 90 95 00 05 10 15
% Fed funds rate in real terms (nominal rate - inflation*)
mean
* 5YMA of CPI inflation
Strictement confidentiel
[Date]
11
Theme of 2016: the ECB’s decoupling and the euro Inflationary risk in the Eurozone is asymmetrical and biased towards the downside. The ECB has no reason to halt its
unconventional policy prematurely. There is no operational or legal limit to the extension of QE as long as inflation
remains below the target. Divergence from the one-size-fits-all policy will increase.
Ireland EM U 1.2 1.1 1.0 0.7 0.5 0.2 0.1 0.0 -0.1 -0.2
Italy EM U 1.6 1.5 1.2 1.1 0.9 0.5 0.3 0.2 0.0 0.0
Spain EM U 1.7 1.6 1.3 1.2 0.9 0.6 0.4 0.1 0.0 0.0
UK 1.9 1.8 1.7 1.6 1.4 1.3 1.0 0.8 0.6 0.5
US 2.3 2.2 2.1 2.1 1.9 1.7 1.5 1.3 1.0 0.6
Portugal EM U 2.5 2.3 2.1 1.9 1.4 1.1 0.7 0.3 0.2 0.0
Yield on government bonds at various horizons (years)
Strictement confidentiel
[Date]
12
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
14 15 16
y/y% EMU: inflation dynamics under various oil scenarios
low scenario
high scenario
Theme of 2016: the oil unknown Oil experts (e.g. the IEA) are forecasting a modest rise in the oil price as the supply surplus is run down. But it is
easy to imagine very different trajectories, both on the upside (in case of conflict in the Middle East) and the
downside. The implications for all macro parameters would be severe.
• Alternative scenario for oil
1. Doubling of the price (towards $80/b): decline in OPEC/US shale
production, supply shortages in the Middle East
2. Halving of the price (towards $20): slowdown in demand, increase in
supply (e.g. from Iran)
• Inflation
1. Sharp acceleration in headline inflation (above targets)
2. Return to zero or even negative territory in developed countries
• Activity
1. Consumption ↓ exports ↑
2. Consumption ↑ exports ↓
• Fed / ECB
1. Acceleration of Fed rate hikes, premature end of the ECB’s QE
policy
2. Return of US rates to zero, more QE/NIRP in Europe
• Currencies
1. Depreciation of the dollar, appreciation of emerging currencies
2. Appreciation of the dollar, review of dollar pegs (e.g. Saudi Arabia)
1000
1050
1100
1150
1200
1250
1300
1350
1400
3200
3300
3400
3500
3600
3700
3800
3900
4000
12 13 14 15
bn$ China FX reserves OPEC FX reserves (rhs)
Sources: Thomson Reuters, Oddo Securities.
Strictement confidentiel
[Date]
13
Theme of 2016: political/geopolitical risk in Europe The migration crisis (a consequence of the Syrian civil war) and the security crisis (Islamic attacks in Europe) are
separate. But they are both increasing the risk aversion of European populations, swelling public deficits and slowing
trade. They are a blessing for anti-EU parties (France, UK).
Source: Wikipedia, Oddo Securities
• Map of political forces in France (at 6 December 2015)
– Front National: 28%, centre-right: 27%, Socialist party: 23%
• Three-party French political landscape
– A 2017 presidential campaign geared to the first round
– Security theme takes priority over economic themes
– Who will Marine Le Pen come up against in the second round of the
presidential election?
• Map of the Schengen area
– Temporary reintroduction of internal border controls
• Responsibilities and consequences of the migration crisis
– Greece: incapable of controlling the external border
– Germany: generous political welcome, with no preparation
– UK: debate about Brexit (see following page)
Strictement confidentiel
[Date]
14
Theme of 2016: Brexit and other risks ending in “xit” For internal policy reasons, PM Cameron has promised a referendum on a Brexit by 2017, probably in mid-2016.
Fundamentally, a Brexit makes no sense since the UK is not in the euro or in Schengen. The migration crisis totally
changes the terms of the debate (economy vs. migration) and increases the risk of a Brexit.