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A recovery in trade
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The largest 100 cities: a clear shift Eastwards
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Although data revisions have resulted in the outturn for GDP growth in 2016 being downgraded from 2.0% to 1.8% and our forecast for 2017 being revised up from 1.6% to 1.8%, in reality the overall situation is little changed. We still expect growth to slow through this year as higher inflation erodes household spending power and weakens consumer spending growth.
New home sales were up 3.7% in January, less than expected. The gain was driven by an increase in sales in the Northeast, Midwest and South. Sales in the West declined. Despite the somewhat softer gain in sales in January, our outlook for new home sales going forward is still positive. Gains in household income and increases in single-family construction should support a solid increase in new home sales in 2017
Consumer sentiment fades from 13-year high in February, remains elevated overall. Inflation expectations remained fairly steady overall.
Our 2017 outlook for Latin America (ex-Venezuela) remains cautiously optimistic. After more than a decade of spectacular growth followed by a sharp downturn, this year marks a turnaround as terms of trade across the region will show a firm improvement for the first time since 2011, paving the way for a recovery in activity. This will help LatAm return to growth after two consecutive years of recession and prompt a convergence towards a less frantic, more sustainable path of growth.
This note is based on a client presentation we gave on 9 February in Miami.
The adjustment process that took place in 2011-16 following the deterioration in terms of trade imposed discipline on the region. However, this adjustment was far from homogeneous. Fiscally prudent Andean countries experienced only a moderate slowdown in growth, while Brazil and Argentina went through sharp recessions that ended the populist governments of Rousseff and Fernandez, bringing about a wholesale change in the macro policy framework.
The cyclical upturn in 2017 will be led by Brazil and Argentina emerging from deep recessions while the slowdown in Mexico is not going to be as bad as what is currently implied in asset prices. Meanwhile, Colombia and Chile should benefit from a mixture of falling inflation and interest rates, as well as from a stabilisation of the FX rate. Yet, we caution that the recovery will remain fragile for most of 2017 and only really gain traction from 2018 onwards.
The risks to our forecast remain skewed to the downside, as the recovery will be heavily dependent on a positive external environment (especially in Argentina, given its weak external liquidity position), a reduction in political noise in Brazil and President Trump not imposing across-the-board tariffs on Mexican exports to the US.
Consumer confidence in France remained at a ten-year high in February, shrugging off political uncertainty surrounding the presidential elections later this year. Part of this is due to consumers expecting lower inflation, which suggests that confidence will be hit as inflation rises this year.
Italian sentiment is also resilient to political uncertainty, rising in February. Furthermore, while manufacturing increased, service sector confidence was broadly unchanged, which will be supportive of growth in Q1.
We estimate a substantial hit to the economy from demonetisation in the short term. But growth is expected to surge to 7.5% y/y in the last quarter of this year, from below 7% in H1 2017, as pent-up consumption demand comes through. Accordingly, we forecast FY 2017/18 GDP growth at 7.1%, up from an estimated 6.6% in FY 2016/17. With the central bank now focused on keeping inflation close to 4% on a sustained basis, the mid-point of its inflation target range, we do not expect any further interest rate cuts.
Finding value in emerging market (EM) currencies has been complicated by the election of President Trump and the resulting shake up of global financial markets. We develop some metrics to compare yields on EM FX with their risk profile. Several EM currencies offer considerable ‘carry’ over US dollar funding plus a risk profile that is relatively favourable in the new global environment – e.g. the Brazilian real and Russian rouble. Valuation also matters: Turkey, Egypt and Mexico look to have undervalued currencies – but risks there are high.
We construct ‘Trump sensitivity’ scores for a set of 19 EM currencies based on exposure to stronger US growth, protectionist risk, net commodity exports and the vulnerability of their external liquidity position. The performance of EM currencies since November broadly tallies with these scores.
Being a commodity exporter has been the most important positive factor since last November, while having a weak external liquidity position – and so being vulnerable to a stronger dollar and higher US interest rates – has been the main negative. Several commodity exporters offer generous carry, e.g. Brazil, Russia and Colombia combined with low/moderate Trump sensitivity. But other high yielders, such as Turkey, Argentina, Egypt and India offer a less attractive risk/reward ratio.
Current EM currency valuations vary considerably. In general, we do not think that the commodity currencies (especially Russia) look particularly ‘cheap’ given recent rallies and the slump in commodity prices since 2011. India also looks unattractive on a valuation basis. Investors looking for ‘recovery stories’ would better look at Mexico, Egypt and Turkey where valuations still look low and yields are high side – but all three countries are also very risky.
A crackdown on illegal immigration could reduce real GDP growth by 0.2-0.3 percentage points this year via reduced demand and significant supply chain bottlenecks.
German domestic demand was the main contributor to the 0.4% rise in GDP in Q4 2016. Imports again rose by more than exports, which helped reduce the current account surplus last year. Nonetheless, Bundesbank governor Jens Weidmann also highlighted that Germany should ramp up its investment.
In France, centrist Francois Bayrou announced yesterday that he will work with Macron in the presidential elections. This has boosted Macron’s chances of winning, thereby easing markets fears about a possible Le Pen victory.
The hawkish tone of the minutes of the January 31-February 1 FOMC meeting echoed Chair Janet Yellen's semi-annual monetary policy testimony. The minutes make it clear that Fed officials are considering raising rates “fairly soon”. This renders the March meeting as “live”, but we see a greater probability of a rate increase at the May 2-3 meeting. We had expected the FOMC to wait until June, but the more hawkish tone of Fed speakers and higher than forecast inflation readings have tilted the odds in favor of May.
Discussion has started and will continue about when and how to shrink the Fed’s balance sheet. It was noted, however, that more primary dealers now expect balance sheet adjustments to commence once the fed funds rate is around 1-1.5% which is line with our view of early 2018.
Yesterday, Banxico announced that it will offer currency hedging instruments to the market to be settled in local currency for up to US$20bn. The first auction will take place on 6 March for up to US$1bn. This new policy tool should allow Banxico to dampen excess volatility in the MXN market without burning through international reserves. And even if the peso were to depreciate more than the agreed forward, we think that the fiscal cost would be very limited.
Importantly, we do not see this programme as a replacement for tighter monetary policy and continue to expect Banxico to raise its policy rate by another 75bp to 7.0% before the end of the year. Our end-2017 forecast for the peso is also unchanged at MXN20/US$, though we see potential for further appreciation as long as the NAFTA re-negotiations do not turn hostile.
US threats to levy taxes on imports and/or impose tariffs on economies running current account surpluses are rightly setting off alarm bells in Germany. At the same time, the protectionist rhetoric may prompt Europe’s export engine to reduce its net savings in return for Eurozone unity on free trade which would benefit both, the single currency bloc and its largest economy.
The healthy rise in the German Ifo index in February provides further evidence that, for now at least, the economy has continued to shrug off the uncertain political backdrop and the squeeze on real incomes from rising inflation.
This suggests that the risks surrounding our forecast for Eurozone and German quarterly GDP growth to slow slightly in Q1 now lie to the upside. However, the fact that the surveys have recently tended to over-predict GDP growth, along with the lack of hard data for Q1, suggests that it is too soon to judge that the recovery has shifted up another gear.
Real GDP expanded by 1.2% q/q in Q4, bringing growth for 2016 as a whole to 1.9%, well above the consensus forecast of 1.5%. GDP was boosted by exports and surprisingly strong consumer spending, but overall external trade weighed on headline growth as imports rose faster than exports.
The government unveiled the 2017-18 Budget today. Anticipating a large surplus of HK$92.8bn for 2016-17, the administration announced a wide range of relief measures, including tax rebates and a boost for the tourism sector. These may provide some upside potential to growth; however, the external backdrop remains challenging and uncertain.
An upward revision to GDP in the last quarter of 2016 lifted growth from 0.6% to 0.7%. And rebalancing was in evidence, with a sizeable contribution to GDP from net trade.
However, there were some ominous developments. Total investment stagnated, while the business component dropped by 1%. But in battling the headwinds facing the economy this year, activity at least starts from a decent base.
Canadian policy makers are eager to clarify what exactly US President Donald Trump means when he says he wants to “tweak” the NAFTA agreement. They are justified: with exports to the US representing about 20% of its GDP, Canada is a small, open economy that is vulnerable to a significant trade shock if Trump implements protectionist measures.
Growth momentum remained solid at the start of 2017 with goods export and import volumes growing fast and PMI surveys suggesting continued expansion. But we expect GDP growth to slow to 6.3% this year as the tightening of housing purchase restrictions in many large cities will weigh on real estate investment and policymakers are moving to place somewhat more emphasis on reducing financial risks and less on ensuring at least 6.5% GDP growth.
The Eurozone PMI reached 56.0 in February, a level not seen since 2011 and consistent with Q1 quarterly GDP growth of 0.6%. However, the PMI numbers have been painting an overly-optimistic picture recently and other indicators, such as consumer confidence released yesterday, are less upbeat.
At yesterday’s Eurogroup meeting, there was some progress on the Greek case, and a solution is likely to be found over the next few months. The EU cannot contemplate the failure of the current programme or a Greek euro exit.
Preliminary estimates show that the economy may have contracted less than expected in 2016, indicating that it weathered the impact of sanctions and lower oil prices better than anticipated. But while the economy likely exited recession in Q4 2016, we think that a substantial recovery will remain elusive. Consumers are still very cautious about spending, while macro policy is expected to stay conservative. We forecast GDP growth of just 1.2% in 2017 and 1.3% in 2018.
Though January’s borrowing figures were surprisingly soft, favourable historical revisions means that borrowing over 2016-17 as a whole looks set to come in well below the OBR’s forecast of £68.2bn.
However, with lower borrowing accompanied by stronger growth, the OBR is likely to deem the improvement to be largely cyclical, so we do not expect a material change in the fiscal stance in next month’s Budget.
Former Italian Prime Minister Matteo Renzi resigned as leader of the Democratic Party on Sunday, which means that the party will have a leadership election within the next four months. While Renzi is likely to be re-elected as PD secretary, the odds of the left-wing of the party breaking away have risen. As a result, a general election before the autumn now looks very unlikely.
In Germany, the polls continue to point to gains in support for the centre-left SPD, led by Martin Schulz. Indeed, a poll released on Sunday shows the SPD overtaking Angela Merkel’s conservative CDU/CSU with a projected 33% of the vote. While Schulz’s rise in the polls seems to be strengthening the German political mainstream against challengers like AfD, if sustained it could also increase the risks of a non-grand coalition government.
Growth in consumer borrowing has returned to rates reminiscent of the pre-financial crisis era. But in a low interest rate environment, there is reason to be fairly relaxed about this for both UK households and banks.
China’s current account (CA) surplus is on course to fall to a level that should put the criticism of currency undervaluation to rest. In fact, we expect the CA surplus to almost halve by 2020 which will reduce the buffer against capital outflows and weaken the country’s resilience to financial turmoil.
We introduce fortnightly updates to track the economy in the aftermath of demonetisation, focusing on money supply and related indicators.
The ongoing recovery in currency in circulation and the easing of withdrawal restrictions on savings accounts by the RBI broadly support our view that cash liquidity should normalise by the end of this quarter. This should facilitate much faster GDP growth at the end of 2017 than at the start.
GDP grew by 0.4% q/q (seasonally adjusted) in Q4, unchanged from Q3, bringing growth for 2016 as a whole to 3.2%. As expected, growth was driven by a rebound in public spending which helped to offset a negative contribution from net exports, underpinned by weaker tourism and higher imports.
Looking ahead, we expect tourism activity to recovery from Q4's weak outcome and the public sector to continue to support activity. We expect GDP growth to average slightly above 3.0% this year.
Net financial outflows moderated to about US$57 bn in January, while the stock of FX reserves fell below US$3 trn. We think that policymakers will continue to dampen depreciation pressures via FX intervention and clamp down on financial outflows in order to limit the fall in FX reserves. However, to achieve a turn-around in outflows large enough to stabilize the stock of FX reserves, the authorities are eventually likely to resort to the kind of contentious steps that they have so far been trying to avoid.
In our global macro chartbook, we summarise our take on current global themes as well as our key macro and asset views. This month, in particular, we explore the implications of upcoming elections in Europe, the outlook for fiscal policy amid the rise of populism and we review Donald Trump’s campaign promises.
The weaker yen profile and a gradual improvement in global trade is expected to support an ongoing recovery in exports during the course of 2017-18. Moreover, fiscal and monetary policy will remain supportive, with government infrastructure spending set to rise and cash handouts and solid employment to underpin a modest recovery in household consumption. We forecast GDP to grow by 1.2% in 2017, and by 1.3% in 2018 as business investment recovers.
A split in Italy’s Democratic Party looks increasingly likely after former prime minister Renzi called for an early congress of the party to discuss the possibility of an early general election – a solution opposed by the party’s more left-wing members.
Early elections in June look less likely than before, while elections later in the autumn now look the main option to us. If the Democratic Party does split, there is an increasing risk that the Five Star Movement will become the largest single party in Italy.
The South Korean economy grew by 2.7% in 2016. However, a weak outturn for the final quarter suggests that growth momentum is starting to ebb. The construction boom that supported growth throughout last year is showing signs of fading amid a less buoyant housing market and a diminishing appetite for credit. And in the absence of construction investment, there is little impetus from elsewhere, although a pick-up in government spending should cushion on the downside. We expect that GDP growth will cool to 2.4% in 2017 before picking up to 2.9% pa in 2018 and 2019.
January’s 0.3% fall in retail sales volumes disappointed expectations and represented the third successive monthly drop. Moreover, sales fell on a three-month-on-three-month basis for the first time since December 2013.
Rising inflation appears to be squeezing demand, with shop prices rising by 1.9% on a year earlier, a 43-month high. Although retail spending will receive some support from low unemployment and loose credit conditions, intensifying price pressures are setting up the sector for a difficult 2017.
The prospect of aggressive US tariffs against China and Mexico remain a concern, and the economic impacts will ripple far beyond the targeted countries—including potentially the US itself. We examine supply chain linkages across major manufacturing sectors to identify what regions and countries are most at risk.
As expected GDP growth was revised up to 12.3% q/q saar in Q4, from the advance estimate of 9.1%. The revision was underpinned by an upgrade to growth in the manufacturing and service sectors, which more than offset the decline in construction.
Near-term growth prospects are promising, however the recovery in global trade is likely to be bumpy and prone to setbacks. As a consequence, GDP growth this year is again likely to be sub-trend.
Without a new productivity miracle it is hard to see global growth improving much from its modest pace: we expect world growth at 2.6% p.a. in 2016-25, a shade lower than in 2006-15. Stronger growth would require much faster productivity and/or investment growth. But some of the factors depressing productivity gains look deep-seated and there are also new risks from protectionism and slow world trade expansion. A productivity miracle looks unlikely, implying limited upside for global interest rates.
Global growth over the next decade and beyond will face headwinds from worsening demographic trends that can only be overcome by faster growth in the capital stock or productivity growth. But the economic slowdown in China limits the extent to which emerging markets can provide this.
Some other forecasters, notably the OECD, are expecting a strong rebound in productivity and investment growth in the G7 countries over the coming years, but it is unclear to us where this will come from. The slowdown in productivity growth in the advanced economies has now outlived the global financial crisis by several years and indeed appears to have begun before that crisis got underway.
There appear to be deep-seated factors damaging productivity performance in the G7. Lingering effects from the global financial crisis may be one, together with the rise of low-productivity ‘zombie’ firms, linked to weak banks. Our review of the evidence suggests this may be important in some countries including some peripheral Eurozone states. Another factor is a loss of dynamism in the G7 evidenced by slower rates of company formation and labour ‘churn’.
Rising global interest rates may, paradoxically, force some productivity improvements but much broader structural reforms are also necessary. Meanwhile, slow world trade growth will not help the process of dissemination of productivity improvement – and recent trends toward protectionism are a serious additional risk.
Concerns over the future policy stance of Donald Trump continue to rise, according to the results of our latest quarterly survey of global risk perceptions. The survey was conducted during the first three weeks of Trump’s presidency.
In the upcoming elections, a surprise win for the centre-right opposition front runner, Guillermo Lasso, would result in a rally for Ecuadorian bonds, but a win for the government's candidate, Lenín Moreno, would mean just a continuation of the status quo. Markets do not seem to have priced in this upside risk.
According to the latest polls, it is very likely that Lenín Moreno will have to face Guillermo Lasso in a run-off election on 2 April, as Moreno is unlikely to gather sufficient support to win the presidency in a first round vote on 19 February. If this is the case, then an opposition victory in April is quite plausible.
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