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Increasingly robust growth
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With crude oil prices having entered a bear market this week – down 20% from their early-2017 high – it's now more likely that inflation edges closer to 1% than 2% over the next six months. This will prevent another Fed rate hike this year and likely constrain 10-year Treasury yields below 2.3% by year-end.
The service sector-driven fall in the Eurozone composite PMI in June might be the first sign that the recovery is beginning to slow. Nonetheless, the composite index remains at a high level and is consistent with GDP growth of 0.7% in Q2. Furthermore, consumer confidence continues to soar, contrasting with the weakness in the June services PMI.
French GDP growth was revised higher (yet again) in Q1, but remains below the Eurozone average as net trade drags and private consumption fails to grow.
Turkey and South Africa are clearly the bottom 'two' of the scorecard. Turkey's vulnerability score has deteriorated further in the last month, driven by the latest evidence of a marked re-acceleration in credit growth since the middle of last year – in part reflecting government measures to boost short-term growth. These developments could, however, cause problems for the economy's future stability. Meanwhile, the country's fiscal position is no longer as robust as it used to be and the high inflation rate is way out of line with other leading EMs. In South Africa, lower inflation has boosted the 'protection' from real interest rates, but external metrics are fragile, the real exchange rate is at a stronger level than in 2014 and the growth outlook remains dismal (made worse by major political tensions).
The national accounts released yesterday showed that the Argentine economy expanded by 1.1% q/q in Q1, considerably stronger than our forecast of 0.6%. The better-than-expected print was driven by a robust expansion in consumer spending while all the other components behaved in line with our forecast.
Any clear indication of the ECB’s plans to unwind asset purchases is likely to be an adverse shock for European government bond markets. We expect Italian BTPs and Spanish Bonos to be more vulnerable than German Bunds. But the likely impact of tapering on the periphery will, in our view, still not deter the ECB from scaling back its asset purchases from the start of next year.
Italian bank Intesa San Paolo has made an offer to buy the business activities of two distressed Venetian banks. While providing both banks with a more certain future is good news, this solution seems very beneficial for Intesa shareholders and less so for taxpayers.
Survey data in France remain positive. June’s business indicators are consistent with 0.5% GDP growth in Q2.
Equities in Argentina were poised to sustain the boom observed since December 2015 amid widespread hopes that the country would be upgraded to the Emerging Market MSCI Index. Inclusion would also generate more capital inflows. But bulls betting on this milestone were caught by surprise by Tuesday’s decision to keep the country on the review list for a potential reclassification.However, we expect that the sell-off seen yesterday in the country’s equity market will be short-lived as investors take advantage of discounted prices and improving macroeconomic fundamentals. Moreover, the impact of the decision on the exchange rate should be limited as the bulk of portfolio inflows into Argentina are of debt rather than equities. We have changed our exchange rate forecast slightly, expecting the peso to weaken to 16.5/$ by year-end, as opposed to 16.1/$ previously.
The G20 summit on July 7-8 provides an opportunity for policymakers to tackle key issues that are holding back world growth, such as creeping protectionism, slow productivity growth and unhelpful fiscal policies.
However, we do not have high expectations of progress in these areas. There is a danger that the summit will lead to polarisation between the US and other countries on issues like climate change and financial market regulation. And the recent modest global upturn may make policymakers complacent – which would be a mistake given its relatively fragile foundations.
Don’t expect a Macron moment at any forthcoming Italian election. Unlike in France where the new strong reformist government should help unlock growth, our most likely scenario for its neighbour is a weak centrist coalition government and GDP growth of no more than 1% in the medium term. The risk of a populist government hasn’t completely gone away either.
Recent headline growth figures are misleading. We think 3.7% annualized real GDP growth in Q1 overstates the underlying pace of activity. Without robust support from the energy and housing sectors – two key sources of growth in recent years – the economy is likely to grow at a pace of only around 2%.
Today’s speech by Bank of England Chief Economist Andrew Haldane indicating his support for a rate hike later this year has further complicated the task of MPC kremlinologists.
Mr Haldane’s hawkish shift surprised given the opposing tone struck by Mark Carney yesterday and is at odds with a slowing economy and the lack of any serious domestic inflationary pressure. We still think it highly unlikely that the Bank will tighten policy this year.
MSCI’s decision to include mainland Chinese shares in its emerging markets index ultimately only has symbolic value. The actual portfolio flows impact is miniscule given the proposed 0.73% weight.
The shift in royal succession announced this morning should help underpin the durability and credibility of the economic reform process in Saudi Arabia. Market reaction was positive, underlining local confidence in the move. But the challenges facing the economy remain just as great as yesterday, with several areas of economic policy requiring important changes to spur private sector job creation. Improving the competitiveness of the large number of young Saudis entering the workforce each year is key amongst these.
May’s public finances numbers delivered some unexpected good news. Borrowing of £6.7bn in the month compared with £7.1bn in May 2016, with growth in tax revenues bouncing back from April’s disappointing performance.
Moreover, the deficit in 2016-17 was revised down to £46.6bn, £5.1bn lower than the OBR forecast in March’s Budget. Hence, the Chancellor may have a bit more wiggle room to respond to “austerity fatigue” in planning his autumn Budget.
With labour market conditions to tighten further we expect wage growth to pick up. However, there are structural characteristics of the Japanese labour market that will cap wage momentum. We expect wages to grow 0.9% pa over the next two years. This will mean that inflation will fall short of the BoJ's 2% inflation target. As such, we expect the BoJ will maintain its current monetary policy stance, targeting 'around' 0% on 10-year government bond yields in 2017-18.
Speeches this morning by Mark Carney and Philip Hammond at Mansion House offered a little more insight into thinking behind macroeconomic policy.
Governor Carney struck a more dovish tone than the minutes of last week’s MPC meeting, reinforcing our view that the Committee’s recent hawkish shift is likely to be temporary. Meanwhile, the Chancellor acknowledged the role of economic growth in deficit reduction. But the idea that fiscal policy might have a direct role to play in spurring growth continues to be persona non grata.
With inflation unlikely to reach 2% this year or next, and very low odds of a substantial fiscal stimulus program, we now see the economy remaining in its 2% growth mode and the Fed raising rates only twice in each 2017 and 2018. Balance sheet tapering will be key in signalling ongoing policy normalization.
The Hungarian government bond (HGB) yield curve is among the steepest in emerging markets (EM), and it offers the highest carry and rolldown return in the Central and Eastern Europe (CEE) region.
A relatively stable inflation outlook, low market volatility and the Hungarian central bank’s continued excess liquidity provision all point to attractive riskadjusted excess returns on financed long-end HGB positions.
Political and economic pundits have started to trot out the familiar adage that political uncertainty emanating from the UK general election may hurt the economy. But we think there are good reasons not to worry too much.
The tangible economic impact of recent episodes of political uncertainty is hard to identify. Effective monetary policy should be able to offset any drag from this source on demand. And the role of uncertainty as a “whipping boy” in economics should inject caution in using it as a catch-all threat to the economy.
High policy uncertainty means we’re likely going to remain in a 2% GDP growth mode. While our June baseline forecast foresaw real GDP growth picking up from 2.2% in 2017 to 2.7% in 2018 – on the back of a fiscal stimulus program – our forthcoming July baseline forecast will not contain much fiscal stimulus. A more subdued growth (around 2%), employment and inflation backdrop than previously will translate into a more cautious Fed. While we previously expected three rate hikes in each 2017 and 2018, we now only expect two rate hikes in each year.
Silvana Tenreyro has been announced as Kristin Forbes’ replacement on the Monetary Policy Committee (MPC).
Professor Tenreyro is currently an academic at the London School of Economics. While her views on monetary policy are unknown, we still think that the MPC is likely to move in a dovish direction when it meets next in August.
The risk of the ECB opting for a more gradual unwinding of QE has grown in response to the ongoing weakness of underlying inflation and recent slowdown in wage growth. Inflation and wage developments over the summer will be the key factors in determining the ECB’s next steps. But for now, our baseline view is still for QE to be tapered by €10bn a month from January 2018.
Political tensions in South Africa related to dynamics within the ruling African National Congress (ANC) have, through the impact on credit ratings and general confidence, seriously weakened the real economy.
Continuing his winning streak, French president Emmanuel Macron secured an overwhelming majority in the parliamentary elections.This will lend him enough support to rapidly implement his pro-business reform programme.
Nonetheless, small risks remain. A high abstention rate suggests Macron is likely to face public protests, potentially stifling the reform process.
Macron’s reforms should give more flexibility to the labour market, as well as stimulate private sector hiring and spending through lower corporate taxes and a €50bn investment plan, all giving a boost to economic growth. Thus, we raise our growth forecasts to 1.7% for 2018 (+0.2p.p.) and to 1.6% in 2019 (+0.1p.p).
We have lowered our annual headline PCE inflation forecast for 2017 to 1.7% from 2.1% previously and for core PCE prices we see an advance of just 1.6% versus 1.9% previously. Our bottom-up analysis, along with the rising risk of getting no or little fiscal stimulus next year, suggests inflation may not reach the Fed’s 2% target. Therefore, we expect the Fed to do a “rethink” on its interest rate outlook. We now see no additional rate hikes for this year, followed by just two more rate hikes in 2018 (versus three previously).
The Central Bank of Russia (CBR) has slowed its pace of monetary easing, cutting its one-week policy rate by 25bp to 9%, following a 50bp cut in April.
Despite inflation falling to its target, the CBR chose to implement a smaller rate cut at the latest meeting, signalling that there are medium-term risks to inflation staying on target. We think the CBR will remain cautious, cutting the main policy rate by 25bp at each of the four remaining meetings to 8% by year-end.
Greece’s creditors have agreed to release the latest loan tranche, which the government will use to pay its upcoming debt obligations in July. However, the IMF will not contribute money to the new loans, as the deal fell shy of what it deems enough to put debt on a sustainable trajectory.
Labour costs in the Eurozone continue to grow at a pace below their post-financial crisis average. This partly reflects labour market reforms in countries like Finland and Spain, and sticky wages in Germany.
With global bond yields heading lower again as inflation fears recede amid the shortage of “safe assets”, G7 governments are underestimating their ability to provide more fiscal stimulus and break out of the low growth equilibrium. Fears of a negative reaction in the bond market are overblown. With real bond yields low or even negative, there is arguably plenty of space for governments to push up spending.
With inflation returning to near target in Sweden, markets are likely to question the viability of the Riksbank’s ultra-loose monetary policy heading into H2. This reassessment could lift the short-end of the yield curve, and thereby the krona, helping it outperform the euro as the Eurozone’s elevated growth wanes.
The BoJ left policy on hold at its June meeting against a backdrop of improving economic growth but inflation still far below target.
We continue to expect that the growing divergence in US-Japanese monetary policy will weaken the yen. We expect the JPY to be at 113.7 by end-2017, and to fall further to 118.5 by end-2018. However, the yen is vulnerable to 'risk-off' episodes that could see the yen stronger than our baseline forecasts.
Exports rebounded in May following a temporary setback in the previous month. Growth was underpinned by a surge in oil exports, while in line with recent regional trends, re-exports of non-oil goods were also stronger. However, the trade balance, in real terms, narrowed to S$4.2bn from S$4.8bn a year ago, imports also recording strong growth (notably oil imports)
With the PMI survey continuing to signal relatively strong demand, notably in the electronics sector, near-term export prospects should remain firm. However, we do look for growth to moderate from the rapid pace of the past couple of quarters as Chinese demand eases.
We identify how “defaultlessness” factors affect fundamental valuations across 50 EM sovereigns. The factors – characterised by the smaller share of sovereign dollar debt relative to total debt – have slashed incentives to default. We pinpoint their role in the context of a broad range of other vulnerabilities.
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