The global recovery is on track, but uneven. Europe should not derail the rest of the world.

Transcription

1 June 17, 20 The global recovery is on track, but uneven. Europe should not derail the rest of the world. LBS Economic Research Carlos Leitao Chief Economist Sébastien Lavoie Assistant Chief Economist Marie-Claude Guillotte Economist Emir Coskun Deleveraging in American debt underscores the absence of inflation. The biggest cloud on the horizon: Global imbalances. Subscription: Martine Bérubé Stéphanie Fortin

2 Sébastien Lavoie Assistant Chief Economist The Monitor The global recovery is on track, but uneven Most economic news shows that the global economic recovery is underway with renewed vigour: Industrial output in the euro zone advanced for the eight consecutive month in April (0.8% m/m, 9.5% y/y). Chinese exports would have jumped by almost 50% between May 2009 and May 20, according to China s government. While retail sales in the US declined in May (-1.2% m/m) for the first time since last fall, the Michigan confidence index continues to show improvement, reaching in June its highest level in 30 months (75.5). Unlike the financial markets, US households do not seem discouraged by the financial tensions in Europe Source: Haver Analytics Gold / Crude Oil Prices Ratio University of Michigan: Consumer Sentiment NSA, Q1-66= Secondly, markets began to wonder how private demand will compensate for the waning stimulus. Investors start to think that this transition will not go as smoothly as public authorities hope for. Notably, investor attention turned to the austerity measures announced by the major European countries. At the beginning of the month, German Chancellor Angela Merkel put forth a plan aimed at reducing public spending by 80 billion to allow Germany to reduce its deficit of 5% of GDP this year to less than 3% in France also wants to meet this criterion of the Maastricht Treaty, and has set a goal to reduce its current deficit from 8% to 3%. David Cameron, England s new Prime Minister, is likely to announce a budget on June 22 where cutting the deficit now 12% of the country s GDP will be the centre of attention Source: University of Michigan /Haver Analytics Europe should not derail the rest of the world So far, so good, but why then market jitters blossomed this spring? Firstly, the markets started to question the capacity of PIGS (Portugal, Ireland, Greece and Spain) to control their public debt in May. The anxiety can be seen notably in a few key financial stress indicators, including the TED spread and the ratio of gold to crude oil prices. Both of these indicators have been up slightly lately, without, however, flirting with the levels reached during the crisis of Ted Spread (on a daily basis) Thirdly, doubts naturally swirl, and more deservedly so, about the capacity of Europe s medium-sized financial institutions to resist the aftermath of the debt crisis and austerity measures. Furthermore, we must highlight that banks will eventually have to face yet more music down the road: the Basel III proposals. The new rules that target reducing systemic risk, or "the probability that the financial system will not function as needed to support economic activity" as Governor Carney stated so eloquently, will muddle things up. We do not yet know what the Basel III measures will call for exactly. As a result, it is very difficult to know how these measures will impact lending activity and economic activity. The odds are, however, that regulators will encourage or force banks to hold a greater number of government bonds, adding some downward pressure to US yields in the years ahead. These measures, which should be announced by the end of 20, would come into force around A restrictive fiscal policy will undoubtedly dampen growth in Europe in the next few years. However, one need not go as far as to say, as some investors think, that this era of austerity will, by itself, plunge the world into a double-dip recession. The severity of the impact of austerity measures on European banks' activities is where the biggest risk to the European economy lies. In turn, this explains perhaps why European authorities want to publish the "stress test" results soon. 0.0 MAY JUN 09 JUL AUG SEP OCT NOV DEC JAN FEB MAR APR MAY Source: Haver Analytics 0.0 2

3 While LBS Economic Research does not wish to minimize these disruptions, we must highlight that Europe s contribution (excluding England) to global growth will be limited to 5% in 20 and This is little compared to fast-expanding China, which will power almost onethird of global GDP growth in the years to come. Put simply, a doubledip recession is not the most likely outcome at this stage. Deleveraging in American debt underscores the absence of inflation In the US, deleveraging is front and center. Washington has seen its debt climb by $1,446 billion in a single quarter from Q to Q1 20. Yet, debt reduction in the private sector ($1,669 billion) was greater than the public sector s overall debt. Borrowing by US banks in particular plunged by $1,336 billion in the same period. Households' borrowing fell by $429 billion. At the end of the day, the total market debt as a percentage of US GDP only fell from 358% in Q to only 342% in Q1 20, a sign that this long process will extend throughout a good portion of the decade. Given a prolonged deleveraging, investors should be more concerned about the absence of inflation, or even the risk of deflation. Regardless of whether we look at consumer price variations over 12 months, 6 months or 3 months, we are clearly closing in on the zero-mark. In this context, we forecast the -year US bond yield to stay below the 4% mark this year. Furthermore, it would be wrong to think that the emergence of wage increases in China (Honda: +24%; Foxconn: +70%) will lift inflation in industrialized countries. These wage increases will not cut into the profit margins of multinationals in any meaningful way, as labour costs represent a small percentage of total production costs in most cases. After all, the monthly compensation of a Honda or Foxconn employee will still be very meagre (US$300) despite these new wage increases, a drop in the bucket compared to the average weekly rate of a Canadian worker ($815). In addition, a study by the Bank of done in 2007 suggests that the weight of Chinese imports in the CPI basket is less than 2%. The biggest cloud on the horizon: Global imbalances In other words, the salary gains in China do not mean higher inflation in industrialized countries where these goods are consumed. However, the risk of ramping inflation on domestic consumer prices is much greater. If the sharp wage increases granted to the employees at Honda and Foxconn plants spread to China s other regions and industries, inflation in China runs the risk of swelling. Inflation has already exceeded the 3%-mark (3.1% in May), due to rising costs for housing and commodities. China has still not reached the turning point where its work supply will no longer be unlimited. However, if compensation growth were to become widespread, in the absence of productivity gains, consumer prices would soar. China s central bank could have to hike interest rates in this context. All in all, low inflation in the highly indebted US and accelerating inflation in the high saving country of China clearly shows the global economic imbalance. China will not always be able to function based on its economic model where investment and exports (+50% in annual change as mentioned earlier) are master and commander. US Treasury Secretary Timothy Geithner had good reason to tackle this issue recently, repeating that China s yuan is an obstacle to global rebalancing. While China is not quite ready to adjust its currency, it may not have much choice but to get there eventually, once its domestic market becomes the main economic driver. 3

4 North American Forecasts This Week's Forecasts (%) This Week Next 4 Weeks In 3 Months 3-Month T-Bills Year Bond Year Bond Canadian Dollar (CAN$/US$) Month T-Bills Year Bond Year Bond Yen (Yen/US$) Euro (US$/Euro) /17/20 Historical Data Forecasts* Q Q Q Q4 20 Q1 20 Q2 20 Q3 20 Q Q Q2 Overnight Rate Month Treasury Bills Year Bond Year Bond Year Bond Federal Funds Rate Month Treasury Bills Year Bond Year Bond Year Bond Canadian Dollar (US$/C$) Canadian Dollar (Euro/C$) Euro (US$/Euro) Yen (Yen/US$) Quarter-end data and annual averages June 4th, 20 Interest-Rate and Exchange-Rate Forecasts 4

5 Market Review: Bonds and Currencies International 3-Month Rates Current Spreads (b.p.) against U.S. Yield Jun week -4 weeks -1 quarter - 1 year Jan-04- U.S UK #N/A #N/A France International Bonds: Benchmark -Year Yield Current Spreads (b.p.) against U.S. Yield Jun week -4 weeks -1 quarter - 1 year Jan-04- U.S UK France Germany Greece #N/A #N/A Portugal #N/A #N/A Spain #N/A #N/A Japan Provincial Bonds: Benchmark -Year Yield Current Spreads (b.p.) against Yield Jun week -4 weeks -1 quarter - 1 year Jan Alberta British Columbia Prince Edward Island Manitoba New Brunswick Nova Scotia Ontario Quebec Saskatchewan Newfoundland Currencies Currencies Jun week -4 weeks -1 quarter - 1 year Jan-04- (%) (/US$) (US$/) Australia (Australia/US$) U.K. (US$/ ) Japan (US$/Yen) Euro (US$/Euro) Data updated as at: 16/06/20 5

6 Market Review: Fixed Income Charts % U.S. Yield on 3-Month T-Bills % Yield on -Year Federal Bonds U.S Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun- Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun- % Yield Curve 11-Jun- -1 month -1 year 3m 6m 2y 5y y % U.S. - Yield Curve 11-Jun- -1 month -1 year 3m 6m 2y 5y y 30y Yield Spreads in basis points ( minus U.S.) 11-Jun- -1 month -1 year Spreads on 2-Year Federal Bonds (Can-U.S., base pts) m 6m 2y 5y y - Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar- Jun- 6

7 Market Review: Stocks Exchange and Commodities Stock Market Summary Level Change (%) Jun-11-52w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan-04- S&P/TSX 11,667 12,281 9, S&P/TSX S&P/TSX Small Cap Index S&P 500 1,092 1, Dow Jones,211 11,205 8, Nasdaq 2,244 2,530 1, International U.K. - FTSE 0 5,164 5,825 4, Germany - DAX 6,048 6,332 4, France - CAC 40 3,556 4,066 2, Japan - Nikkei 225 9,705 11,339 9, Hong Kong - Hang Seng 19,872 22,944 17, Russia - RST 1,335 1, Australia - ASX All Ordinaries 4,517 5,024 3, Brazil - Bovespa 63,605 71,785 48, S&P/TSX Sector Summary Level Change (%) Jun-11-52w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan-04- S&P/TSX 11,667 12,281 9, Energy Materials Industrials Consumers Discretionary Consumers Staples Health Care Financials Information Technology Telecommunication Services Utilities Commodities Level Jun-11-52w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan-04- London -- Gold (US$/once) London -- Silver (US$/once) Copper (US$/LB) WTI Crude Oil (US$/barrel) Natural Gas (Henry Hub) (US$/MMBTU) Data updated as at: 16/06/20 7

8 Calendar of Major Economic Indicators Date Time Release Unit Data for: LBS * Consensus Previous Jun 14 8:30 New Motor Vehicle Sales M/M April % -4.2% Jun 15 8:30 Labor Productivity Q/Q 1Q - 1.2% 1.4% Jun 17 8:30 Wholesale Sales M/M April % Jun 18 8:30 Leading Indicators M/M May % Jun 18 8:30 International Securities Transactions Billions April * Laurentian Bank Securities Forecast Consensus from Bloomberg L.P. KEY ECONOMIC INDICATORS WEEK OF JUNE 14, 20 Date Time Release Unit Data for: LBS* Consensus Previous Jun 15 8:30 Import Price Index M/M May % 0.9% Jun 15 8:30 Import Price Index Y/Y May - 7.8% 11.1% Jun 16 8:30 Producer Price Index M/M May % -0.1% Jun 16 8:30 PPI Ex. Food & Energy M/M May - 0.1% 0.2% Jun 16 8:30 Producer Price Index Y/Y May - 4.9% 5.5% Jun 16 8:30 PPI Ex. Food & Energy Y/Y May - 1.1% 1.0% Jun 16 8:30 Housing Starts Thousands May Jun 16 8:30 Building Permits Thousands May Jun 16 9:15 Industrial Production M/M May - 0.8% 0.8% Jun 16 9:15 Capacity Utilization - May % 73.7% Jun 17 8:30 Consumer Price Index M/M May % -0.1% Jun 17 8:30 CPI Ex. Food & Energy M/M May - 0.1% 0.0% Jun 17 8:30 Consumer Price Index Y/Y May - 2.0% 2.2% Jun 17 8:30 CPI Ex. Food & Energy Y/Y May - 0.9% 0.9% Jun 17 8:30 Initial Jobless Claims Thousands June Jun 17 :00 Philadelphia Fed Index M/M June Jun 17 :00 Leading Indicators - May - 0.4% -0.1% 11/06/20 8

9 North American Economic Indicators Period Monthly Chg. (% or Level) Cumulative change Current Previous - 3 Month - 1 Year Gross Domestic Product (GDP) March 0.6% 0.2% 1.5% 3.1% Manufacturing Shipments March 1.2% 0.0% 2.8%.2% Housing Starts ( ' 000) * April Retail Sales March #N/A #N/A #N/A #N/A Trade Balance (M$) * March ,373 Employment ( ' 000) * * May Unemployment Rate * May Wages (avg. hourly earnings) May 2.4% 2.0% 1.8% 3.5% Total CPI inflation April 1.9% 1.6% 1.9% -0.3% Inflation ex-food & energy April 1.9% 1.8% 2.1% 2.0% Industrial Product Price Index April 0.3% -0.4% 0.0% -0.4% Raw Materials Price Index April 1.7% 0.8% 2.9% 17.3% Period Monthly Chg. (% or Level) Cumulative change Current Previous - 3 Month - 1 Year ISM - manufacturing * April ISM - Non-manufacturing * April Industrial Production * April Capacity Utilization Rate * April Consumer Confidence Index * May Retail Sales April 0.6% 2.1% 3.3% 9.0% Trade Balance (M$) * March -40,047-40,148-37,132-28,445 Housing Starts ( ' 000) * April Existing home sales April 7.6% 7.0% 14.3% 22.8% Median price of ex. home sales April 2.1% 3.0% 5.0% 4.0% Non-Farm Payrolls ( ' 000) * * April Unemployment Rate * April Wages (avg. hourly earnings) April 2.3% 2.1% 2.6% 3.3% Total CPI inflation April 2.2% 2.4% 2.8% -0.6% Inflation ex-food & energy April 1.0% 1.2% 1.5% 1.9% Producer Price Index April -0.1% 0.7% 0.0% 5.4% - Ex-Food & Energy April 0.2% 0.1% 0.3% 1.0% * Level * * Change in level for the last month, 3 months and 1 year * * * Annual % change Data updated as at: 16/06/20 9

10 North American Forecasts 2009Q4 20Q1 20Q2 20Q3 20Q4 2011Q1 2011Q2 2011Q Real GDP (%) 4,9 6,1 2,5 2,6 2,3 2,4 2,0 2,9-2,5 3,3 2,5 3,4 2,7 Consumption 3,9 4,4 3,2 2,5 2,4 2,0 2,3 2,3 0,4 3,5 2,3 3,1 2,3 Business investment -9,4 2,6,5 12,5,1 8,7 8,0 7,8-20,0 1,9 9,2 8,9 8,1 Non-residential structures -11,4-5,4 8,0,0 12,0,0 8,0 7,5-19,5-4,1 9,4 5,9 8,4 Machinery and equipment -8,1 7,5 12,0 14,0 9,0 8,0 8,0 8,0-20,3 5,7 9,1,6 8,0 Residential construction 26,3 23,6 7,0-18,0-22,0 -,0-4,0-3,0-8,2 8,7 -,1-4,1-4,6 Government spending 9,1 2,2 2,6 2,5 2,2 1,8-2,7 0,1 5,1 4,6 0,8 2,4-0,2 Exports 13,8 12,0 11,5 8,0 6,0 7,0 9,0 8,0-14,2 9,1 7,8 9,3 8,0 Imports 12,4 14,1 8,0 6,0 4,0 4,0 5,5 5,0-13,9 11,3 5,0 8,0 4,9 Current account balance in % of GDP -3,1-2,4-1,7-1,5-1,3-1,1-1,1-1,1-3,4-1,7-1,1 - - Inflation (%) Total CPI (y/y) 0,8 1,6 1,4 2,4 2,3 1,9 1,9 1,7 0,3 1,9 1,9 2,3 2,0 Core CPI (y/y) 1,6 1,9 1,7 1,7 1,4 1,8 1,9 2,0 1,8 1,7 1,9 1,4 2,0 Unemployment rate (%)* 8,4 8,2 8,1 7,9 7,8 7,8 7,7 7,5 8,3 8,0 7,6 - - Employment 1,3 1,5 3,4 1,0 0,9 1,3 1,5 1,8-1,6 1,4 1,5 1,7 1,6 Housing starts (000s) Before-tax Corp. Profits (y/y) -12,1 16,8 31,6 23,5 18,2 12,7 13,5 12,5-32,3 22,2 12,2 18,2,2 *Average rate for the quarter or the year. Forecasts as of June 11th, 20 Period-Over-Period Annualized Per Cent Change Unless Otherwise Indicated Annual Average 4th Qtr/4th Qtr Period-Over-Period Annualized Per Cent Change Unless Otherwise Indicated Annual Average 4th Qtr/4th Qtr 2009Q4 20Q1 20Q2 20Q3 20Q4 2011Q1 2011Q Real GDP (%) 5,6 3,0 3,5 2,6 2,5 2,6 2,8-2,4 3,2 2,7 2,9, 2,7, Consumption 1,6 3,5 2,8 2,0 1,9 1,8 1,9-0,6 2,3 2,0 2,5 1,9 Private investment 6,7 4,2 5,4 6,7 6,6 8,7 8,7-17,6 3,2 7,8 5,7 8,7 Machinery and equipment 19,0 12,7 9,0 8,0 8,0,0,0-16,6 9,6 9,3 9,4,0 Residential construction 3,7 -,7 6,2 2,0 3,0 3,5 2,5-20,5-0,1 3,0-0,1 2,7 Government spending -1,3-1,9 4,0 2,6 2,7 1,3 1,3 1,8 1,2 1,9 1,8 1,2 Exports 22,8 7,2 8,0 6,8 6,2 5,6 5,5-9,6,5 6,0 7,0 5,5 Imports 15,8,4 5,2 5,2 5,3 3,9 2,8-13,9 8,9 4,0 6,5 3,2 Inflation (%) Total (y/y) 1,5 2,4 1,9 1,5 1,2 1,7 2,0-0,3 1,8 1,9 1,2 1,8 Core (y/y) 1,7 1,3 1,0 0,9 0,8 1,0 1,2 1,7 1,0 1,2 0,8 1,5 Unemployment rate (%)*,0 9,7 9,8,2,0 9,8 9,7 9,3 9,9 9,7 - - Housing Starts (000s) 564, Before-tax Corp. profits (%, y/y) 30,6 31,0 12,0,0,0 5,0 7,5-3,8 15,2 8,1,0,0 * Average rate for the quarter or the year. Forecasts as of June 1st, 20 This document is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of Laurentian Bank Securities (LBS), a wholly owned subsidiary of the Laurentian Bank of. The author has taken all usual and reasonable precautions to determine that the information contained in this document has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze it are based on accepted practices and principles. However, the market forces underlying investment value are subject to evolve suddenly and dramatically. Consequently, neither the author nor LBS can make any warranty as to the accuracy or completeness of information, analysis or views contained in this document or their usefulness or suitability in any particular circumstance. You should not make any investment or undertake any portfolio assessment or other transaction on the basis of this document, but should first consult your Investment Advisor, who can assess the relevant factors of any proposed investment or transaction. LBS and the author accept no liability of whatsoever kind for any damages incurred as a result of the use of this document or of its contents in contravention of this notice. This report, the information, opinions or conclusions, in whole or in part, may not be reproduced, distributed, published or referred to in any manner whatsoever without in each case the prior express written consent of Laurentian Bank Securities.