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A recovery in trade
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Export growth has remained fairly slow over the past two years despite a much weaker Canadian dollar. We believe that a mix of cyclical and structural drags have been and will continue to weigh on export growth and offsett some of the competitiveness gains from a weaker currency.
Stronger economic activity and higher inflation have prompted comments in the markets that the ECB may start unwinding its crisis measures as soon as this year by raising the deposit rate. We disagree. We think the ECB will tread more cautiously and start policy normalisation by tapering QE in January 2018, while rates will not rise until the second half of next year. After that though, unconventional policy will be rolled back faster than markets currently expect.
New home sales were stronger than expected in February, increasing 6.1% to a SAAR of 592,000. Unlike existing homes, the market for new homes is benefiting from steady increases in inventory.
Demand for the ECB’s TLTRO funding today significantly outstripped expectations, as banks stocked up on cheap long-term ECB loans at what is likely to have been its last ultra-cheap auction.
Meanwhile, French business and German consumer confidence surveys are showing signs of turning down after a period of strength, and therefore converging with the more subdued hard data. In Germany, the ongoing rebound in inflation is eating into consumer confidence. French business confidence has also softened, due to much weaker manufacturing sentiment.
Following three successive monthly falls, February’s 1.4% increase in retail sales volumes offered some reassurance that shoppers haven’t quite lost their appetite to spend more.
But February’s growth is unlikely to be enough to prevent Q1 2017 from recording the first quarterly decline in sales volumes since the end of 2013. And with shop price inflation heading up, this year remains on course to be a difficult one for the retail sector.
The situation in Ukraine has taken a sudden turn for the worse. The blockade of transport links with the separatist regions, initiated by a group of nationalist activists, has led to the nationalisation of Ukrainian enterprises in the breakaway regions and now an official severance of trade links. This risks derailing Ukraine’s fragile recovery, and is likely to trigger another bout of UAH devaluation as the IMF continues to postpone the release of the fourth tranche of funding under the Extended Fund Facility programme.
We also note that Ukraine remains one of the riskiest emerging markets despite a sharp correction in current account and fiscal imbalances since 2014. While the IMF is unlikely to walk away from the programme, Ukraine’s sluggish growth means that the debt burden remains unsustainable and its ability to start repaying its debts from 2019 remains limited.
Treasuries are higher on a risk-off bid as markets worry about passage of the American Health Care Act. However, if Republicans can push the bill through it would raise hopes for quicker passage of fiscal stimulus this year.
At first sight, the composition of Italian and French banks’ balance sheets suggests that their financial position would not severely deteriorate because of ‘currency mismatch’, in the event of either economy leaving the Eurozone.
But this observation is flawed. As Greece’s experience has shown, concerns about a future Eurozone exit can dramatically alter the composition of banks’ balance sheets and quickly result in large direct costs associated with currency redenomination and devaluation.
The only way to avoid this kind of deposit flight would be a sudden exit or capital controls in the build-up to a final decision on whether to exit the currency bloc. The former is unlikely to be politically feasible, while the disruption created by the latter would provide voters with an indication of the potentially huge costs of exit, undermining support for the leave option.
China's economic growth picked up in the first two months of the year, reflecting stronger investment and exports as well as restocking in industry. Following this solid data and the signalling of a slightly more accommodative macro policy stance during the NPC compared to what we had expected, we now expect GDP growth to slow to 6.5% this year, up from 6.3% previously.
Political developments continue to be in the news. With just a month until the first round of the French elections, the Fillon scandal continues to run. We still see Macron as the most likely candidate to move into the Elysee Palace in May.
US trade rhetoric towards Mexico has substantially moderated in the last few weeks, increasing our conviction that trade tariffs will not be imposed on Mexican exports to the US, as we have assumed since President Trump's election. Thus, our GDP growth forecast remains unchanged at 1.9% and 2.0% respectively for 2017 and 2018.
The latest vulnerability scorecard shows Turkey, South Africa and Malaysia as the most fragile economies, with Turkey's situation deteriorating further over the last month because of a worsening inflation outlook and a re-acceleration of credit growth over the last four or five months. In South Africa, low real interest rates and large external imbalances remain key vulnerabilities. At the other end of the spectrum, Korea, Thailand and India (replacing the Philippines this month) score as the least vulnerable.
Since April 2016 the relative rankings of Brazil and Russia have improved the most. In April last year, the scorecard suggested that Brazil was the most risky large EM, but the subsequent impeachment of President Rousseff facilitated a huge change in economic policy and a resurgence of market confidence, paving the way for dramatically lower inflation, easing monetary policy, planned fiscal consolidation (which now must be credibly delivered) and an eventual economic recovery. In addition, the country's banking sector is much less stretched than it was a year or so ago.
Russia's improvement in the rankings has, in part been driven by the stronger oil price outlook than seemed likely eleven months ago, helping both the government's fiscal position and the escape from recession. But the inflation outlook is also noticeably better, helped in part by a stronger rouble. However, the exchange rate may now be overvalued, but central bank intervention in the FX market will likely limit further strength over and above what would be implied by oil prices.
Emerging market (EM) currencies may have entered a long cycle of strength, unless significant risks materialise. We see positive momentum; and EM currencies have historically tended to follow long cycles associated with flows of capital into emerging economies. However, we find that average EM currency performance is quite closely correlated with developments in global financial markets, which limits diversification benefits.
The first debate of the French presidential election saw Emmanuel Macron outperform Marine Le Pen, according to two snap polls. Against Le Pen’s attacks, Macron repeated that he sees a “strong France in Europe”. We still see Macron as the most likely winner of the presidential election. However, he will find it difficult to assemble a majority in the parliament needed to implement his reformist programme.
Elsewhere, talks between the Greek government and the Eurogroup continue, with both sides hoping an agreement can be reached in order to approve the long-stalled second review of the country’s bailout.
Economic growth across the Gulf Cooperation Council (GCC) region will fall to its weakest since the financial crisis this year at just 1.1%, depressed by OPEC-led cuts in oil production. But in underlying terms, the outlook is improving as budget deficits are reined in and large sovereign bond issues ease pressures on the financial system. Growth is forecast to rebound to 3.3% in 2018.
There was a modest upside surprise in February’s inflation data, with both the CPI and CPIH measures coming in at 2.3%. We continue to expect inflation to peak at around 3% in late-2017, as the weaker pound continues to feed through. Another set of strong borrowing figures has left the Government well-placed to undershoot the OBR’s full-year forecast of £51.7bn.
The government’s economic plans for 2017, presented at the National People’s Congress, indicate that, despite more emphasis on containing financial risks, solid economic growth is still a key objective. The planned macro stance is somewhat less generous than last year. But, although cutting excess capacity is set to continue, overall the approach to reform seems timid.
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 discuss reflation as well as forces that are still holding back long-term global growth. Furthermore, we discuss and quantify key global risks including populism in Europe and uncertainty about US policy.
Eurozone labour cost growth rose slightly in Q4. Although wage growth remains weak by historical standards, this provides further evidence that domestically-generated inflation will start to appear as the recovery in the Eurozone continues. Amid a picture of gradually rising price pressures, the ECB continues to consider a range of options to withdraw stimulus.
The increasing divergence in US-Japanese monetary policy over the next two years will drive a further depreciation in JPY/USD to over 120 by end-2018. Such a yen trajectory increases Japan's vulnerability to more substantial threats of trade protectionism from the US administration. But if the weak yen becomes a larger point of contention, Japan could opt to guide JPY/USD stronger. We expect this would need to be through changes in its monetary policy.
India’s remonetisation process has progressed at a reasonable pace, allowing the RBI to remove all restrictions on withdrawals from 13 March. But currency in circulation is still 31% below the pre-demonetisation levels, raising concerns about a renewed episode of cash shortages.
Some private banks have introduced new fees on cash transactions, and other banks may also follow suit. This may dampen the demand for cash, lead to renewed enthusiasm for digital transactions and hasten the process of economic normalisation.
A diplomatic conflict between China and Korea has escalated following the initial delivery of the US THAAD missile defence system, raising concerns over the economic impact on the languishing Korean economy.
Although Korea is vulnerable to Chinese retaliation, we do not expect a significant slowdown in growth. But with presidential elections set for 9th May, a resolution to the situation will be high on the agenda of the new administration.
Yesterday, the Chilean central bank decided to cut its policy rate by 25bp, in a move largely expected by markets. On the back of a dovish communique and the continuing combination of sluggish growth and weak inflationary pressures, we have changed our call on interest rates, and now expect the bank to deliver an additional 25bp cut next month. And should activity fail to pick up, we cannot rule out a further extension of the easing cycle.
Plunge in utilities keeps industrial production flat in February. Meanwhile, manufacturing and mining output both recorded upbeat gains. Excluding utilities, industrial production would have been up around 0.5% in February. Industrial activity is expected to strengthen over the course of 2017, supported by higher oil prices and stronger domestic activity.
In January, the Eurozone trade surplus fell to its lowest level since March 2015 as imports rose strongly across all core Eurozone economies. Slightly slower exports and a contraction in the construction sector continue to contradict upbeat January survey data. Yet hard data prints should rebound in February as weather-related effects may have weighed on activity in January.
Less dovish comments from the ECB and a potentially more modest US rate path following the Fed hike earlier in the week have led to some euro strength. But this is likely to be reversed soon as the differential between US and European rates continues to widen, putting downward pressure on the euro.
The Swedish krona’s recent comeback has a good bit more life in it, thanks to a resurgence in global trade and it stands to outperform the neighbouring Norway’s krone – reversing the 10% rally in NOK against SEK last year. As Norway’s economy slowly transitions away from oil to other tradeable sectors, Sweden is better placed to capitalise on global growth in the next few years.
Real GDP finished 2016 on a fairly strong note, growing at a 2.6% annualized pace in Q4. The gain was underpinned by boosts from household consumption and a one-off decline in imports. In 2016 as a whole GDP growth averaged a sluggish 1.4%, restrained in large part by the continued adjustment of Canada's economy to much lower oil prices. Looking ahead, we expect that GDP growth will pick up to 1.9% in 2017, supported by rising non-energy activity, accommodative monetary and fiscal policy and gently rising oil prices. However, elevated house prices, overburdened household balance sheets, possible NAFTA renegotiation, and a renewed decline in oil prices all continue to pose risks to the outlook.
Oil prices have tumbled in March as the market loses confidence in the OPEC rebalancing story. While OPEC compliance has been very high at 98%, non-OPEC cuts have been feeble and US production is set to accelerate sharply. Our price forecast remains unchanged and is still “lower for longer”. We expect Brent oil prices to average US$52pb this year and next, but downside risks to our 2017 forecast are mounting.
The shutdown of 23 (out of 41) mines in the Philippines has raised concerns over its economic impact. We expect the consequences to be largely political, given that mining and quarrying account for less than 1% of the country’s GDP.
The impact on global nickel prices is also likely to be muted. While the Philippines’ is currently the world's top producer of nickel ore, the large global supply overhang and the return of Indonesian ore to the market, point towards a low risk of substantial price rises for the commodity.
Given a powerful domestic mining lobby, this issue will mainly serve to test the governments' commitment to its stance on responsible mining.
Growth in export volumes accelerated in February, with broad based growth recorded across domestic exports and non-oil re-exports. Although the first two months of the year are distorted by the different timing of the Chinese New Year, combined January-February exports were still up 7.3% y/y.
We expect exports to make another solid contribution to GDP growth this quarter. However, we do look for growth to moderate from the rapid pace of recent months and the outlook is still subject to many uncertainties, including the risk of increased protectionism.
The US economy is facing a very peculiar environment where stock valuations and confidence are inflated by promised fiscal stimulus and deregulation, but private sector outlays remain cautious. Solid fundamentals continue to support consumer spending but inflation is taking a bigger bite out of real disposable income. Trade and investment are rebounding but only gradually.
The French economy continues to show signs of strength despite uncertainty ahead of the presidential elections. Business sentiment surveys are now back at their 2011 levels across all sectors, indicating the recovery is broad-based and more resilient to external shocks. We still forecast GDP growth will rise to 1.4% this year from 1.1% in 2016, with a further pick-up to 1.6% in 2018.
The central bank (CBRT) kept its main interest rates on hold, but raised its late-liquidity window rate by 75bp, in line with market expectations, as inflation rose to a five-year high in February.
The most eye-catching aspect of March’s MPC minutes was Kristin Forbes’ vote for a rate hike. But Ms Forbes only has two meetings left so her views have little relevance beyond the very short-term. There were mixed signals from the other eight, with some suggesting they might vote for a hike if activity continues to hold up, but the overarching messages are very similar to last month. We continue to expect growth to slow through 2017 and that the MPC will keep policy unchanged until well into 2019.
Although the German economy seems to have made a strong start to the year, we still expect the pace of growth to moderate a touch in 2017 as a whole. In addition to the exceptional support from low inflation fading, ongoing uncertainties may prompt firms to take a cautious stance towards investment. We continue to forecast a slowdown in GDP growth from last year’s outurn of 1.8% to 1.5% in 2017, with a further slight easing to 1.3% in 2018.
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