Reflation comes, with constraints

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1 Global Economic Research January 7 Reflation comes, with constraints Bruce Kasman Chief Economist (-) 8- bruce.c.kasman@jpmorgan.com JPMorgan Chase Bank NA See the end pages of this presentation for analyst certification and important disclosures. *Updated version

2 Main points: Reflation: Disinflationary drags are fading and real growth as well as inflation are set to rise. Both global growth (.8%) and consumer price inflation are expected to move back to recent trend performance Reflation expected to unwind divergences in regional and sectoral performances that opened up in -6 An important step on this path has already been taken as H6 nominal growth and corporate profits accelerated Rebound in profits is key to what happens next: business confidence and spending picks up promoting Manufacturing poised to bounce. Following two years of less than.% growth, output to rise at close to a % pace during H7. Firming goods demand a key catalyst, levered by a turn in the inventory cycle. Japan and Asia are key beneficiaries. Headline inflation rises almost everywhere, but wide divergences push core in different directions. Constraints curb our enthusiasm. EM, credit remains tight and China policy to ease less. Globally, corporates are expected to remain cautious, limiting spending upturn. US election to have small growth impact. Broad policy changes expected, but fiscal stimulus will prove small. Impact of regulatory, health care and tax code changes could be large beyond 7. US policy surprise a wild card Recent sentiment rise is global. Hopes for animal spirits to emerge is a key upside risk. The Fed refocuses on observables as downside risks fade and labor markets approach full employment. US potential growth is below.%, implying labor markets will tighten further Little support for Yellen s high-pressure labor market experiment. Fed to move gradually this year, but bias is for a more hawkish and less conventional Fed in 8 as FRB turns over

3 Forecasting stronger growth and inflation Global real GDP %oya. GDP deflator, Global %oya (LCY)... Average Potential growth Sour ce: J.P. Mor gan

4 alongside narrowing regional and sectoral divergences Real GDP deviation from potential %oya. Global real GDP and manufacturing output %q/q, saar; both scales Real GDP.. Developed Emerging Mfg output 6 7 Real consumption and fixed investment, DM %oya; both scales 6 Real consumption Sour ce: J.P. Mor gan Investment Sour ce: J.P. Mor gan 6 7

5 Driver: Global fiscal and commodity sector drags fade Fiscal impact on real GDP growth, DM %-pt impact. US energy sector investment %q/q, ar Petroleum and natural gas structures investment (sa) Rig count (nsa) , IMF; Defined as change in structural deficit with some adjustments Source: Baker Hughes, BEA, J.P. Morgan EM real GDP %chg q, saar 6. Brazil/Russia 6... EM ex Brazil/Russia. 6 7 Sour ce: J.P. Mor gan

6 Driver: China policy cushions EM demand shock China real GDP growth by industry %oya Headline GDP Manufacturing Services 6 Sour ce: NBS China fixed asset investment %oya Source: NBS, J.P. Morgan Public Private China total social financing %oya 8 6 TSF 6 Including local govt debt swap China monetary conditions Percent per annum 6 SHIBOR 6 7 Index, = TWI 6

7 Driver: Euro area recovery finds its legs Tracking Euro area GDP growth with the PMI %q/q saar PMI-based tracker Euro area real consumption and investment %q, saar; both scales Consumption Actual GDP - Investment Source: Markit, Eurostat, J.P. Morgan estimates Euro area major purchases at present % bal, sa Sour ce: EC - 6 Sour ce: Eur ostat, J.P. Mor gan %oya, adj. for loan sales/securitizations Euro area bank lending to real economy - Non-financial corporates - 6 Households - 7

8 What s next: reflation lifts profits and business spending Global nominal GDP and corporate profits %oya; both scales ; MSCI earnings Profits Nominal GDP Global profits and capex %m/m Global ex China capex spending %q/q, saar %m/m, saar JPM capex 6 proxy Capex (ex China) Corporate profits Real capex (ex China) %q/q, saar

9 What s next: global manufacturing poised to bounce Global manufacturing output PMI and actual output DI, sa; 9 8 %m, saar; Nov 6 is est 6 Output PMI Mfg output Global final goods demand %m/m, saar; both scales; w/ Nov 6 est Retail sales Capex proxy (ex Chn) Manufacturing: inventories and PMI orders DI, sa 8 6 %mm, saar Mfg inventories (avg of US, Jpn, Kor, Twn) Global orders

10 Curbing our enthusiasm on breaking global growth bounds Global real GDP %ch at annual rate over quarter 6 Trend-line since 6 7 Credit standards, as reported by banks % balance; above zero indicates tightening EM G China floor space sold and auto production mn sq. meters, sa thousand units Auto production Floor space sold

11 US election to have a small 7 growth impact Impact of Trump fiscal plan: JPM Forecast % of GDP Tax cuts, per year Personal Corporate Trump plan ($Bn) % of GDP...6 JPM Assumption Implemented ($Bn) % of GDP...8 M ultiplier.6.. GDP impact (%GDP) Year : H7-H8... Year : H8-H9... %pt, Q/Q Cumulative...8 Source: J.P. M organ US federal budget deficit Forecast Spending (over yrs) We expect broad policy change, but fade extremes: - Net fiscal stimulus to be small - No disruptive trade conflicts Longer run impact of tax reform, regulatory reset, ACA repeal, and infrastructure could be significant but won t be felt in 7. Election has limited 7 Fed impact. But FRB seats likely to turn over by mid-8. While there is a bias towards a more hawkish, the biggest risk is a shift to unconventional Fed leadership.

12 US rebounds to % growth, with rotation back to business US GDP growth % change at an annual rate Q- Q Q6 Q7 (f) GDP.7.. Private consumption..7. Business investment Equipment Structures Intellectual property.7.8. Residential investment Government spending..7. Exports Contributions (%-pt) Domestic final sales.9.. Net exports Inventories Corporate profits Saving rate (eop), level Unemployment rate (eop), level..9. Source: BEA, J.P. M organ Q- Q6- US real equipment spending & consumption %chg q, saar; both scales , BEA %chg q, saar Equipment spending Consumption US real business inventories and exports Source: BEA, J.P. Morgan Exports Inventories

13 But lift from animal spirits is possible US business sentiment indicators Standard deviation from -6 average Capex plans - Fed svys NAHB NFIB US household wealth and saving Ratio to income Gap worth % on PCE as of Q Wlth-income ratio (inverted) Saving rate % 8 6 Global consumer confidence Standard deviation from historical average EMU US - EM Global business confidence DI, sa 8 6 St. dev from -pres avg Services PMI - Business. business expectations confidence

14 Headline inflation rising, core paths diverge Global headline inflation %m, saar (assumes oil constant at $6/bbl through 7) Model fit Actual 6 7 Output gap and core inflation, developed % of potential %oya Core inflation.9 Core inflation, G- %oya US UK EMU Japan 6 7 Output gap and core inflation, emerging % of potential %oya Core inflation Output gap. - Output gap

15 Global supply slide a serious medium-term constraint Global labor productivity %oya (dashed show -6 avg) Emerging * Developed ; * Productvity is GDP/Employment (excludes China, India) US growth in productivity and working age population %chg over qtrs, saar Working age population % year-over-year Global population and old age share %yoy % of population.... Population 6 Age Sour ce: J.P. Mor gan; United Nations Nonfarm productivity Sour ce: BLS, Census Bur eau

16 US potential growth below.%. Policy won t change this Growth rate of capital services with forecast %, ar JPM forecast Source: San Francisco Fed, J.P. Morgan Tech investment as a share of GDP Percent; both scales Software.. R&D. IT equipment Contributions to potential growth in business output Period Average realized potential Labor force contribution Labor quality contribution Capital services contribution TFP contribution Forecast Source: San Francisco Fed, J.P. M organ College enrollment and share of workforce aged - % of population aged 6-6 College enrollment (age 6-) , Census Workforce aged - % 6

17 For the US supply side constraints are already biting Part-timers in U6 suggest more slack than U %, sa 9 Shadow U 8 7 U 6 'NAIRU' Source: BLS and J.P. Morgan. US wage indicators %oya Wages/Salaries (avg hrly earnings) Wage tracker (AtlantaFed) Number of employed, by usual weekly hours Index of -mo ma, Feb. = hours hours -9 hours Source: BLS, J.P. Morgan ACA passed Mar , BLS, BEA, Atlanta Fed ECI - Wages, private sector workers 7

18 Rebound in US labor supply unlikely to persist US labor supply and productivity %oya. Labor force.. Participation rate: model vs actual %, sa Model based on age-sex 6 group following pre-7 6 trends Source: BLS, J.P. Morgan Actual.. Productivity Contribution to US labor force partipation rate %-points since Q8. Disability Other Retirement Source: Fujita, J.P. Morgan 8

19 US core inflation is drifting higher and that s good US measures of core inflation %oya Core CPI Core PCE price index Percent Rental vacancy rates and PCE tenants rent 9 9 Rental vacancies (inverted) PCE- tenants rent %oya - US import prices and core goods CPI % change 6mos, saar, both scales Core goods CPI Non-fuel imports ( mos ahead) Source: BLS - %ch over months US healthcare inflation Healthcare PCE Healthcare ECI 9

20 Fed 7 outlook: A return to the observables Observables: Fed Forecasts, Dec LR Real GDP as of Dec.... Unemp rate as of Dec PCE inflation as of Dec PCE core inflation as of Dec.6.9. Fed funds as of Dec.... Note: Forecast are medians of FOMC participants; Source: FRB Average change in Fed "dot plot" %-pts:.8 Hawkish.. Contribution from: Data (observables) Structure Residual Unobservables: FOMC long-run projections y* u* r* Dovish Source: Federal Reserve Board, J.P. Morgan Source: Federal Reserve Board

21 US expansion has entered a mature phase US domestic corporate profit margin % of corporate value added 8 6 US ULC and nonfarm business price deflator %chg over 8 quarters, saar Nonfarm business price deflator - - ULC Source: BEA, FRB

22 US recession risk: Short-term is falling, but medium-term is elevated Probability of recession within years from multivariate regression model % 8% 6% Probability of recession within months 7% 6% % % Baa spread + S&P Economic data, with background risk % % % % % % % Jan-6 Mar-6 Jun-6 Sep-6 Dec-6 Economic data, near-term composite

23 Debt / GDP Gap Debt / Income Gap Liabilities / GDP Gap Debt Growth Over yrs Net Debt / Income Debt / Assets Interest / Income Average Imbalances are a feature of recession dynamics US nonfinancial leverage heat map Sector Total private nonfin. % % % % % % 9% %..Household 7% 6% 7% % 8% 7% % %..Total nonfin. bus. 9% % % 9% 8% % % 7%...Corporate 7% 68% 7% 69% % % 6% 7%...Noncorporate 6% % % % 7% 8% 9% 9% Total government 8% 76% 8% 9% 96% 88% % 67%..Federal gov. 8% 8% 8% % 96% % % 6%..State & local gov. % % % % % % % 8% Source: BEA, Federal Reserve, J.P. M organ. Figures represent the percent of the time since 98 that the indicated leverage metric has been below its current level. "Gap" measures are calculated as difference from -year average. Commercial property prices are high Index, Q= 6 8 Real commercial property prices Nonfinancial corporate debt Ratio to GDP Source: BEA, Federal Reserve Board, J.P. Morgan US equity prices and the business cycle Cumulative return throughout the cycle % % % 8% 6% % % % % % % % of expansion or recession completed Current Cycle (8 years) Average Expansions Recessions

24 Extending the cycle: How do you spell relief? US productivity and non-farm business implicit price deflator %oya Inflation moves toward % (limited by Fed) Wage inflation stays below %, due to sustained labor supply boost Productivity growth returns to % Non-farm business price deflator Tax cuts keep profit growth up in face of rising ULC (temporary) Fed stays willfully behind the curve (short-term gain, medium-term pain) Productivity Nonfarm productivity during expansions (%q/q, saar, avg.) Expansion midpoint First half Second half Difference 9Q Q Q Q Q Q... 98Q Q Q Q..7.7 Q. Average across cycles.6.. Source: BLS. Note: M idpoint quarter included in both halves when expansion had odd number of quarters.

25 Unpleasant divergent business cycle arithmetic G- core consumer price inflation %oya US Euro area Japan (ex. VAT hike) Broad private non-financial credit % of GDP; both scales; Q6 is an est EM (dashed is ex. China) 8 DM , BIS, IMF 8 7 EM private nonfinancial credit & nominal GDP, ex China %oya (Q6 is an est) Nominal GDP 6 Source: BIS, J.P. Morgan Credit, constant Fx rates US expansion is mature and can t sustain growth above % much longer Euro area and Japan are moving too slowly to reflate EM private sector deleveraging is only beginning now The US can manage a recession as it has healed; the rest of the world can t

26 It s never too soon to prepare for the next recession US macroeconomic performace in recessions Period Duration (months) GDP drop (%) U-rate increase (%-pt) Fed easing (bp) FY, % of potential GDP Automatic stabilizers U.S. Federal Budget , CBO Budget ex. automatic stabilizers Average Note: Duration and Fed easing are calculated over recession period. GDP drop and unemployment rate is from peak to tough, for u- rates this typically lasts longer than the recession period. Expected policy rates, end- -month OIS forward, %p.a..... JPY EUR.. USD

27 JPMorgan CB forecast Official Current Change since (bp) Forecast Forecast (%pa) Last change Nex t mtg rate rate (%pa) -7 av g oy a nex t change Mar 7 Jun 7 Sep 7 Dec 7 Mar 8 Global ex cluding US Developed Emerging Latin America EMEA EM EM Asia The Americas United States Fed funds.7-8 Dec 6 (+bp) Feb 7 Jun 7 (+bp) Canada O/N rate. - Jul (-bp) 8 Jan 7 On hold..... Brazil SELIC O/N Nov 6 (-bp) Jan 7 Jan 7 (-bp) Mex ico Repo rate.7-9 Dec 6 (+bp) 9 Feb 7 Jun 7 (+bp) Chile Disc rate. - 7 Dec (+bp) Feb 7 Mar 7 (-bp)..... Colombia Repo rate Dec 6 (-bp) Jan 7 Jan 7 (-bp) Peru Reference. 7 Feb 6 (+bp) Jan 7 On hold..... Europe/Africa Euro area Refi rate Mar 6 (-bp) 9 Jan 7 Q (+bp)..... United Kingdom Bank rate Aug 6 (-bp) Feb 7 On hold..... Norw ay Dep rate Mar 6 (-bp) 6 Mar 7 On hold..... Sw eden Repo rate Feb 6 (-bp) Feb 7 On hold Czech Republic -w k repo. - Nov (-bp) - Q 8 (+bp)..... Hungary -m dep May 6 (-bp) Jan 7 On hold Israel Base rate. - Feb (-bp) Jan 7 Q 7 (+bp)..... Poland 7-day interv. -7 Mar (-bp) Jan 7 On hold..... Romania Base rate May (-bp) 6 Jan 7 Feb 8 (+bp) Russia Key pol rate. N\A - 6 Sep 6 (-bp) Feb 7 Jun 7 (-bp) South Africa Repo rate Mar 6 (+bp) Jan 7 On hold Turkey -w eek repo Sep 6 (-bp) - Mar 8 (-bp) Asia/Pacific Australia Cash rate Aug 6 (-bp) 6 Feb 7 Q 7 (-bp)..... New Zealand Cash rate Aug 6 (-bp) 8 Feb 7 Q 7 (-bp) Japan Pol rate IOER Jan 6 (-bp) Jan 7 On hold Hong Kong Disc. w ndw Dec (+bp) 9 Jan 7 Jun 7 (+bp)..... China -y r w orking. -7 Oct (-bp) - Q 7 (-bp)..... Korea Base rate Jun (-bp) Feb 7 Q 7 (-bp)..... Indonesia BI rate Oct 6 (-bp) 9 Jan 7 On hold India Repo rate Dec 6 (+bp) 8 Feb 7 Feb 7 (-bp) Malay sia O/N rate. - - Jul 6 (-bp) Mar 7 On hold..... Philippines Rev repo. - - Sep (+bp) 9 Feb 7 On hold..... Thailand -day repo Apr (-bp) 8 Feb 7 On hold..... Taiw an Official disc Jun 6 (-.bp) Mar 7 On hold

28 JPMorgan US forecast Q6 Q6 Q6 Q6 Q7 Q7 Q7 Q Gross domestic product. Real GDP Final sales Domestic Consumer spending Business inv estment Equipment Structures Intellectual property products Residential inv estment Gov ernment Net ex ports ($bn, chained $9) Ex ports (goods and serv ices) Imports (goods and serv ices) Inv entories (ch $bn, chained $9) Contribution to real GDP growth (% pts):. Domestic final sales Net ex ports Inv entories Income and profits (NIPA basis) 8. Adjusted corp profits Real disposable personal income Nominal disposable personal income Sav ing rate Prices and labor cost. Consumer price index Core Producer price index Core PCE deflator Core GDP chain-ty pe price index S&P/C-S house price index (%oy a) Employ ment Cost Index Productiv ity Other indicators. Housing starts (mn units, saar) Industrial production, mfg Light v ehicle sales (mn units, saar) Unemploy ment rate Pay roll employ ment (ch, 's, samr) Nominal GDP Current account balance ($bn) % of GDP Federal budget balance ($bn) % of GDP %q/q, saar %q/q %y /y 8

29 Global Economic Outlook Summary Real GDP Real GDP Consumer prices % over a year ago % over previous period, saar % over a year ago Q6 Q6 Q6 Q7 Q7 Q7 Q Q6 Q6 Q7 United States.6 h..8.. h Canada. i.9 i i. i. i. i h Latin America h i Argentina h -.9 h Brazil i Chile Colombia Ecuador Mex ico Peru Uruguay....7 h. h Venezuela Asia/Pacific Japan h Australia New Zealand.. h.7.7 i. h.7 i.7. i..... EM Asia China India Ex China/India Hong Kong Indonesia Korea Malay sia Philippines Singapore Taiw an Thailand Western Europe h.6 h i.8 h Euro area i. h Germany h.8 h France h. h Italy h Spain h.8 h Norw ay Sw eden.. h.... h United Kingdom....6 i. h EMEA EM i. i Czech Republic Hungary Israel Poland Romania Russia i.8 i South Africa Turkey Global h h Dev eloped markets h Emerging markets i Global PPP w eighted.. h... h.9 i i.6 *Underline indicates beginning of JPMorgan forecast 9

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