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As expected, the FOMC kept rates unchanged. The key change to the policy statement was the insertion that "near-term risks to the economic outlook have diminished." This, coupled with a more upbeat view of the economy, supports our forecast that the FOMC raises rates as soon as September.
The FOMC refrained from providing a clear signal as to the timing of the next rate increase. We did not expect the Fed do so, since telegraphing the possibility of an imminent rate hike in the spring proved premature.
Reflecting firmer economic data, including the strong June non-farm payroll and retail sales data, Fed officials painted a more upbeat view of the economy.
In particular, policy makers pointed to further tightening in the labor market.
The Fed funds futures market now sees odds of a September or December rate hike at 26.4% and 45.2%, respectively.
Not surprisingly, Kansas City Fed President George once again dissented in favor of an immediate 25 basis point rate hike.
June plunge in civilian aircraft orders rendered a whopping 4.0% decline in June durable good orders. Excluding civilian aircraft and related parts orders durable good orders would have risen by 0.2%.
our July global macro chartbook we summarise key global themes
and our asset views. We also highlight contributions of our recent research.
Much of the focus in Saudi Arabia has been looking at the impact of a plunging oil price on a deteriorating public finance position. But we believe it is also important to analyse a worsening balance of payments situation, and predict future trends based not only on changes in the oil price but also due to the implementation of the country’s Vision 2030, post-oil plan. Our main conclusion from the analysis is that Saudi Arabia should not only maintain adequate foreign reserves, but that pressure on its currency peg will be limited and that growth will steadily recover, though it does leave the Kingdom more vulnerable to renewed external shocks.
The overall balance of payments plunged into its first deficit since 2009 last year at US$115bn. A 47% drop in the oil price saw the current account post a deficit of US$53bn, its first since 1998. The financial account was in deficit at US$62bn, resulting in net foreign assets falling to US$609bn by end-2015. We see the overall balance of payments in deficit by a further US$111bn in 2016.
But the outlook looks more promising over the medium-to-longer term. Not only will a gradually rising oil price narrow the current account deficit, but other developments are forecast to be increasingly positive, too. These include reforms to boost non-oil exports, FDI and portfolio flows, and a switch increasingly to financing the budget deficit via international bond and syndicated loan issues.
We see the current account deficit moving into broad balance by 2020, with surpluses thereafter. The financial deficit is forecast to halve between 2016 and 2020 and continue to decline. The overall balance of payments is projected at just US$35bn in 2020, around one third its size in 2016. This will mean that the pace of decline in net foreign assets will slow and still represent 17 months of import cover and 125% of GDP in 2020. Furthermore, in the longer term, it is likely that the creation of the world’s largest sovereign wealth fund and partial sale of Saudi Aramco will have additionally positive impacts on the balance of payments.
Positive data on the monetary front today. Both money and loan growth in the Eurozone picked up in June. Meanwhile, credit flows to the private sector also increased over the previous month on the back of strong numbers for household lending. Overall, figures continue to show that the healing process of lending in the Eurozone, although uneven, remains in place.
Consumer sentiment indicators for Germany, Italy and France corroborate the notion suggested by the data published last week that the confidence shock stemming from Brexit has been, so far, rather tame. In Spain, retail sales for June confirm that consumers continue to ignore the country’s political turmoil.
As expected, the preliminary estimate for Q2 GDP came in strong with quarterly growth of 0.6%. But this was largely due to an exceptional April performance, after which there was a notable loss of momentum.
The weak May and June mean a soft launchpad for Q3 even before the impact of Brexit is factored in. Therefore, the stronger Q2 is likely to represent one last hurrah before the economy enters a softer and more turbulent period.
We use a ‘scenario tree’ approach to look at the possible outcomes of the negotiations around the UK’s exit from the EU. Given how little common ground there is between the two sides, we find that a relatively loose relationship is the most likely outcome, with the UK set to leave the EU by mid-2019.
The negotiating positions of the UK and EU are diametrically opposed. The UK wants to end the free movement of labour, cease making contributions to the EU budget and regain ‘sovereignty’ from Brussels, while retaining as much access to the single market as possible. But the EU’s starting position is that single market access is dependent upon agreeing to the four freedoms and that this is non-negotiable.
So far all signs are that the UK will prioritise the ability to control immigration over single market access. Thus the EEA and EEA-minus options are very unlikely to be viable over the longer-term – our scenario tree analysis gives them a probability of just 6% and 12% respectively – though these may be adopted as an interim step.
If the EU takes a mercantilist approach, it will have little incentive to come to an agreement with the UK over single market access for services, given the UK’s large trade surplus with the EU for these activities, implying that UK firms may face growing non-tariff barriers after the UK has left the EU. The UK’s large deficit on goods trade with the EU gives a better chance of agreeing a FTA for goods, though with any FTA requiring agreement from all 27 members, the UK would have to be prepared for lengthy negotiations and make extensive concessions. Therefore, we think that a reversion to WTO rules (40%) is slightly more likely than agreeing a FTA (37%).
A relatively quick Brexit would appear to benefit all sides because it would reduce the degree of uncertainty and mean that the UK leaves the EU prior to the 2019 elections for the European Parliament and the 2020 UK General Election.
CPI inflation rose by only 1% y/y in Q2 and is forecast to remain below target for much of 2016. The weak CPI outcome supports our view that the RBA will cut interest rates in August to a fresh record low of 1.5%. Another interest rate cut cannot be discounted but see limited room for more stimulus. Instead fiscal policy, in the form of government investment, needs to do more to support domestic demand.
There are seven caveats signalling current equity prices have outrun underlying macro fundamentals. Foremost, while equity bulls cheer the latest strength in the macro data since it could boost corporate revenues, this also provides reason for the Fed to raise interest rates more than the market expects. Equity prices will likely pull back moderately in H2 2016.
Low interest rates have helped propel equity prices higher as S&P 500 dividend yields have outstripped bond yields. If interest rates start to rise, this will dampen some of the current capital flows from bonds into stocks.
Similarly, as the labor market has reached full-employment, workers' wages should continue to rise. This places downward pressure on profit margins. The positive offset is that productivity growth should rebound as well, but it may lag behind.
We believe equity bulls are overestimating the strength of the economy following the strong gains in June non-farm payrolls and retail sales. While economic growth is rebounding from the languid Q1 performance, we expect it to average around 2.5% for the remainder of this year. While this is rapid enough to persuade the Fed to raise rates, it is not strong enough to spur a sharp upturn in corporate revenues.
With the Fed raising rates while other major central banks are leaning in the other direction, the dollar likely appreciates further. This is another headwind for equities.
Sluggish global demand should continue to weigh on exports and corporate earnings.
We do not anticipate support to equities from a further expansion in PE ratios at this mature stage of the business cycle.
However, improved credit conditions should provide downside support in the near-term, while a rebound in productivity growth should provide medium-term support.
Economic activity expanded by 1% on the month in May recovering most of April's lost ground (-1.2% m/m). Yet, we think GDP growth will slow to 2.2% y/y in Q2, from 2.8% in Q1. For 2016 as a whole, we forecast GDP will grow by 2.4%.
On the external front, the trade deficit of US$7.2bn in H1 was in line with our forecast. For the remainder of the year, we expect both exports and imports to contract sharply, taking the trade deficit to its highest level since 2008.
Consumer Confidence Index essentially unchanged at 97.3 in July. Current Conditions remain strong and should support consumer spending, concerns about six-months expectation less volatile with news cycle.
Policy simulations using the Oxford Economics Model suggest that the combined effect of monetary and fiscal ease would give a major temporary boost to growth. But the fiscal effects inevitably fade and a lower exchange rate has a significant influence on outcomes.
As the UK prepares to leave the EU, we look at contrasting experiences of three EFTA members (one of them former): Norway, Switzerland and Austria. Focusing on the latter two as counterfactuals, we find that Switzerland's delayed participation in the single market led to meaningful productivity losses, while Austria's EU accession was accompanied by restructuring and competitiveness gains, leading to stronger economic growth.
Rather than a conscious policy choice, the respective modes of cooperation in Norway and Switzerland were a consequence of circumstances. Both applied to join the EU along with three other EFTA members, but failed to do so as a result of their referenda. Norway was left with a single market membership (EEA), while Switzerland, where even the EEA was rejected, had to go through seven years of negotiations of piecemeal bilateral agreements.
Switzerland's delayed and partial integration with the EU appears to have entailed productivity losses. In Austria, in contrast, EU membership and associated reforms have boosted productivity and added around 0.5pp to its annual GDP growth in the first decade of membership. Later studies suggest this gain has risen to a 1pp gain.
The risk of productivity losses is exactly what has been flagged in various ex ante studies on Brexit. The available historical evidence from Switzerland seems to suggest that pursuing a route of protracted bilateral negotiations and compromises would represent a step back for the UK economy.
However, neither the Swiss nor the Norwegian options seem acceptable to the UK given their embrace of all four freedoms, including free movement of people. This makes it more likely that the eventual agreement may end up being more restrictive for the UK and hence entail higher productivity losses.
The European Commission will decide tomorrow whether to fine Spain and Portugal for their failure to tighten fiscal policy as requested. But the maximum 0.2% of GDP fine seems unlikely, as Italy and France are likely to oppose it.
Italy has created a second private sector bank rescue fund: Atlante 2. With an expected €4bn of capital, the fund should help recapitalise Monte dei Paschi di Siena (MPS) with minimal public funds.
The EU refugee-deal with Turkey continues to hang by a thread with Turkish President Erdogan accusing the EU of not sticking to its promises.
Following an upwardly revised Q1, GDP growth accelerated in Q2 supported by a rebound in consumption and solid pick-up in capital investment.
Looking ahead, the outlook for H2 is clouded by the ongoing corporate restructuring drive in Korea and a challenging external outlook.
The FOMC will stand pat this week. However, we see high odds of a rate hike at the September 20-21 meeting since the labor market is back to full employment, inflation readings are firming, growth is poised to be 2.5% on average Q2-Q4, and strains in the credit markets have eased.
The immediate market tumult following the post-Brexit vote and the rising uncertainty surrounding the global economic outlook have kept the Fed in a watch and wait mode.
However, with financial markets settled and many policy makers expecting little medium-term impact from Brexit on the US economy, this should not be a constraint to Fed tightening.
The bond market is pricing in rising probability of a rate hike by year-end, though the odds are still below 50% at this point.
The FOMC only publishes its policy statement on Wednesday – there will be no updates of macro forecasts, dot plot estimates or press conference.
We do not expect the Fed to telegraph in its forward guidance that an imminent rate hike is coming since doing so in the spring proved premature.
The policy statement should include a more upbeat assessment of overall economic conditions, particularly with regards to the labor market in light of the strong rebound in job gains in June. Moreover, inflation readings are firming.
A key concern for the Fed as it considers a prospective rate increase will be how the dollar reacts. A surge in the value of the dollar could forestall rate increases.
The disappointing performance of many activity indicators justifies the RBI’s accommodative policy stance. But with inflation hovering around the upper end (6%) of RBI’s target range and monsoon-related risks lurking in the background, we expect it to err on the side of caution and keep interest rates on hold until the risks to inflation appear more balanced. But the prospect for further easing now also depends on the leanings of the incoming RBI Governor; however, the government has yet to make an announcement on the appointment.
Indeed, political developments are a key focus at the moment: PM Modi has reshuffled his cabinet (affecting some key portfolios) this month and efforts to pass the Goods and Services Tax (GST) bill have also intensified. An increasing number of state governments are now supporting the GST and expectations of the bill being passed in the monsoon session of the Parliament have risen. However, we remain cautious.
We expect GDP growth of 7.5% this year, led by private consumption, but we remain concerned by the sluggish performance of investment.
June data hint at the start of a general improvement in regional trade across Asia, with export volumes higher than a year earlier for an increasing number of countries. However, looking forward, the recovery is likely to be modest – given the subdued prospects for US, Chinese and EU import demand – and vulnerable to setbacks, particularly in the next couple of quarters. Nevertheless, it is a less gloomy background than has generally been the case over the last 18 months.
July’s modest fall in the German Ifo survey confirms that the initial impact of the UK referendum on Eurozone business and consumer sentiment has been small. This support our view that further ECB action is far from inevitable –a view which Governing Council member Ewald Nowotny appeared to echo on Friday when he noted that QE changes in September were unlikely.
Our Economic Presidential Election Model shows Democrats earning 50.5% of the two-party votes in the upcoming presidential elections.
Solid growth in real disposable, modest inflation and a low unemployment rate are the main factors giving the slight economic edge to Mrs. Clinton.
Monthly economic data suggest that growth may be gaining some momentum. Exports in US$ terms maintained their recent upward trajectory in June while household spending indicators picked up. With regard to the second half of 2016, although prospects for exports are clouded by heightened global uncertainty, we believe that domestic growth will be supported by healthy private consumption and higher infrastructure spending.
Having implemented 100bp of easing in H1, Bank Indonesia’s policy stance during H2 will be influenced by how markets respond ahead of the next US interest rate hike, which we expect in September. Meanwhile, the latest data do not warrant any immediate action from the central bank. As such, unless there is evidence that the domestic economic recovery is suddenly losing momentum, we do not expect the central bank to unleash further easing in the next couple of months.
Although the Eurozone PMIs weakened slightly in July, the fall was much smaller than anticipated by most in the wake of the Brexit vote. Accordingly, we maintain our view that, after a sluggish Q2, growth in the Eurozone should remain fairly solid in the second half of the year.
The manufacturing PMI fell sharply in July but activity in the services sector showed remarkable strength and remained broadly unchanged over the previous month. Once again, the Germany’s service index very strong, reaching the highest level in over two years, as the European locomotive shrugged off Brexit woes. Growth in France, on the other hand, remains weaker, although the composite PMI climbed to 50 points.
Though the headline PMI readings both dropped sharply in July, the survey makes clear that the magnitude of the slowdown is closer to that seen in the Eurozone crisis of 2011 than the Global Financial Crisis of 2008.
The detail of the survey confirms the importance of exchange rates moves, with more promising signs for exporters but higher import costs causing problems.
Existing homes sales rose 1.1% in June, helped by an increase in first-time homebuyers. Low-mortgage rates and income growth should support sales going forward, but tight inventories and rising home prices will temper the pace.
As anticipated, the ECB’s Governing Council decided at its July interest rate meeting not to provide new policy support measures. But on balance, President Draghi struck a less dovish tone than expected by declining to provide any hints that a September policy stimulus would be forthcoming.
We remain comfortable with our out-of-consensus call that the ECB will end its asset purchase programme in March 2017. Further action may be more likely to come via other measures such as more direct support of the lending channel.
The "one size fits all" discussion regarding a single monetary policy for the Eurozone is an old and familiar one. In this Briefing, we take a look at the exchange rate part of this debate. Predictably, we find that a single exchange rate is not an optimal solution for economies with huge divergences in their external positions and different levels of productivity and inflation.
To do so, we look at the concept of an equilibrium exchange rate, a rate consistent with both internal and external balance. Using our Global Economic Model (GEM) we calculate what a "fair value" for a euro in different countries would be. By using Germany and Spain as examples, this exercise illustrates how core and peripheral economies in the Eurozone require different very exchange rates.
Our GEM shows that an equilibrium euro exchange rate for Germany would be close to $1.40, whereas for Spain it would be around $1.00. These results show in a clear and intuitive manner how economies with different productivity and price levels and with huge disparities in their foreign asset positions require very different exchange rates in order to achieve equilibrium.
Germany's trade balance has seen a massive increase since the introduction of the euro. While the country's extreme competitiveness plays a big role, a relatively weak currency compared to what a "German euro" would be has also been a key factor. Conversely, Spain has been forced to operate with a currency often too strong, leading to a deterioration of its external balances during most its euro membership.
But there is a silver lining to this. By removing the exchange rate as an easily available policy tool to increase competitiveness through devaluations, peripheral economies are being forced to implement structural reforms to raise relative productivity and remain competitive. While a slow and often painful process, the results have started to become apparent in Spain in recent years.
Broad money growth in the ex-China ex-Japan Asia-Pacific (APAC) region continues to slow. Latest data show the 12-month rate already at a 13-year low and the 3-month annualised numbers imply further weakness.
Moreover, the trend for weaker broad money growth is widespread, with only the Philippines posting an acceleration in 2016 relative to 2015. It is also true for real broad money growth.
The monetary data imply weaker activity in H2 2016 and into 2017. This goes against our baseline forecast, which is for economic growth to accelerate slightly in most countries in the region.
Should the monetary indications nevertheless be right, or if either of our China downturn scenarios come to pass, there is scope for easing monetary policy. Policy interest rates are relatively high by current global standards, meaning there is still space for conventional measures (i.e. interest rate cuts). Meanwhile, with the exception of Japan, none of the countries in the region have yet tried unconventional measures.
On a technical point, we have expanded our APAC broad money measure to include also India and the larger advanced economies in the region (Korea, Australia, Hong Kong, Taiwan and Singapore).
In a move that surprised the markets but was in line with our forecast, Bank Indonesia left the benchmark policy rate unchanged at 6.5% following the July policy meeting.
Nonetheless, given the headwinds to growth, there is still the possibility of future easing. However, Bank Indonesia’s policy stance will largely be influenced by how markets respond ahead of the next US interest rate hike, which we have pencilled in for September.
Both the Eurozone consumer confidence published yesterday and the French business indicators released this morning point to a muted confidence shock from Brexit. This is in line with our view of a small effect of Brexit on the Eurozone. But we have to wait until tomorrow morning, when the flash PMIs will be published, to have a more comprehensive assessment of the momentum in the Eurozone economy.
Meanwhile, it looks like the Italian government wants to accelerate the rescue of Monte Paschi di Siena (MPS) before the EBA stress test publication on the 29 of July. The plan envisages a public intervention, and some bail-in, if MPS fails to recapitalize itself in the markets.
The noticeable depreciation of the CNY in recent months has left markets unmoved, in large part because net financial outflows have receded. Meanwhile, the weakening has removed the overvaluation that had developed in 2015. Looking ahead, we expect some modest further weakening – but not much – before gradual trend appreciation resumes.
A 0.9% monthly fall in retail sales volumes in June will no doubt get Brexit-fears a tizzy.But given the strength of volumes in the preceding two months, a decline was unsurprising. Indeed, Q2 saw sales volumes rise at the fastest pace since the end of 2014.
Meanwhile, there was a rare piece of good news on the public finances front. A jump in income tax receipts contributed to monthly public sector borrowing falling by more than expected. But with the economy likely to see a marked slowdown, deficit reduction ambitions will now have to take a back seat.
The sharp decline in Venezuela's oil production in May could be a permanent shift. We estimate it will trim an additional 0.9 percentage points from GDP growth this year as well as cutting the country's dwindling FX reserves by an additional 12% (US$1.5bn).
Yet, we maintain our view that PDVSA will pay bondholders in full this year before seeking a friendly debt restructuring ahead of its 2017 maturities.
A precautionary fiscal loosening among the advanced economies has much to recommend it and is becoming increasingly likely. Even before the UK Brexit vote world growth was sluggish, and while global markets have regained their post-Brexit losses downside risks to world growth remain significant. The stimulus should focus on government investment, which has been neglected over recent years. Sharp falls in bond yields over recent weeks make a government investment programme unprecedentedly cheap.
We forecast world growth at a sluggish 2.3% this year, with a strong risk of growth sliding below 2%. A key weakness of the global recovery has been low investment, with declining government investment a major factor in this – G7 government investment fell 10% in real terms from 2009-15.
With interest rates close to the zero bound (and negative in real terms), it is likely that a government investment boost would be especially effective in boosting economic growth, with a lack of ‘crowding out effects’.
Simulations using the Oxford Global Economic Model suggest a 1% of GDP rise in government investment over two years could raise the level of GDP in individual G7 countries by 0.6-1.4% by 2017, with even larger increases if all G7 countries did this at once.
Our modelling also suggests a fiscal boost of this sort could substantially pay for itself by generating extra GDP growth and tax revenue. Loosening fiscal policy also makes sense given that, on current policies, fiscal policy across the G20 will actually turn restrictive next year.
National data published this morning support the view that Brexit has not triggered panic amongst Eurozone households. While we expect the flash EC consumer sentiment index published later today to have fallen, a steep plunge in confidence seems unlikely.
The three months to May saw the LFS unemployment rate drop below 5% for the first time since September 2005. And the single month measure suggests that further declines are in prospect.
Of course, the possibility of a Brexit-inspired slowdown may quickly change this picture. But reassuringly, the latest Bank of England’s Agents’survey found that a majority of firms did not expect a near-term impact on hiring plans.
The deterioration in external conditions has taken a toll on the economies of the Commonwealth of Independent States (CIS). Lower oil prices, reduced remittances from Russia and significantly weaker currencies have dampened the near-term outlook. Further east, the slowing Chinese economy is posing a significant challenge, but the nature of its slowdown offers the region important trade and investment opportunities.
The adjustment of CIS economies to less favourable external conditions has not been pain-free, and we expect the region to remain in recession this year. Oil exporters' high dependence on energy revenues has led in sharp currency depreciation and rising inflation. Meanwhile for oil importers, the loss of remittances has more than offset the positive impact of lower oil prices.
But the region also has to contend with China's slowing economy. Strong trade and financial linkages mean the slowdown in China is significantly dampening regional trade, through reduced demand for both commodities and manufactured exports.
But this need not all be negative for the CIS. First, given the extent of real currency depreciation, especially against the CNY, these economies will benefit from large competitiveness gains, boosting their potential to increase exports to China.
Second, the nature of China's slowdown matters. The rebalancing of the Chinese economy away from investment and towards consumption and services augurs well for CIS and other countries' manufacturing exports, particularly at the low-skilled level.
Finally, many countries in the region are well placed to benefit from the funding being allocated to China's new Silk Road policies. Chinese investment and loans will have a positive impact by improving regional infrastructure and economic diversification.
Housing starts and permits increase in June. The June data are consistent with softer momentum in residential investment in Q2 GDP.
Inflation is forecast to come in well below the RBA’s 2-3% inflation target band in Q2 marking nearly two years of sub-target inflation. Real activity is firm, but the RBA has signalled that the inflation outlook is its main concern –hence we look for the RBA to cut the policy rate by 25bp to 1.5% in August. Low interest rates and solid employment growth are supporting domestic demand while exports will benefit from a competitive currency. However, weak business investment, especially in the mining sector, is offsetting these positives. We see GDP growth of 2.9% this year and 2.7% in 2017.
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