A 2020 US Slowdown (near-recession) Scenario

Transcription

1 Economics & Strategy Weekly A 2020 US Slowdown (near-recession) Scenario DBS Group Research 19 October 2018 Taimur Baig Chief Economist taimurbaig@dbs.com Samuel Tse Economist samueltse@dbs.com Please direct distribution queries to Violet Lee violetleeyh@dbs.com We see a sharp growth slowdown in the US in As per our scenario, growth could slow to zero (if not outright negative) by 4Q 2020 What would drive this? (i) negative fiscal impulse (as stimulus expires), (ii) drag from trade wars on investment and exports, (iii) policy uncertainty ahead of the US presidential elections, (iv) still-high inflation preventing the Fed from cutting rates, and (v) spill-over from weak non-us demand, hurt by rising rates and tight USD liquidity It is hard to price this scenario; the yield curve would likely steepen in 2019 and then begin flattening in 2020; the USD would strengthen first and then soften; inflation will peak but remain uncomfortably high for the Fed A beneficiary of a sharp US slowdown or technical recession in 2020 could be the large, domestic demand oriented emerging market economies, which would still register decent growth while catching a breather from a peaking dollar and rates US growth could be sharply lower by 2020, but that may not be a bad thing At first glance, this may appear to be an odd time to talk about an impending growth slowdown in the US. Presently, real GDP is expanding robustly (Atlanta Fed s Nowcast has been tracking around 4% since June), inflation is modest (latest prints show core PCE at 2% and headline at 2.3%), wages are picking up gradually (average weekly earnings growth has been over 3% so far this year), the Fed is hiking as per expectations, and business surveys reflect buoyant confidence. Trade wars, oil price increase, mid-term elections, rising rates, and a strong dollar have not dented the momentum of the world s largest economy. At least not yet. Indeed, we think that near-term downsides to the US economy are minimal. Labour market tightness, wage upside, fiscal stimulus (tax cut, farm subsidy, defence spending), and strong business sentiment will likely to keep growth comfortably in the % range next year, in our view. The chance of wage and inflation surprising on the upside is rising, but we don t see anything alarming in the pipeline. Fiscal slippage concerns are real, and the supply of treasuries has ballooned, but the gap between supply and demand does not appear glaring as long-term rates have not galloped ahead of Fed policy tightening so far. We therefore see 2019 growth remaining impressive by historical standards, averaging 2.5% for the year, with core inflation nudging up toward 2.5%, keeping the USD strong, pushing the 10-year yield to over 3.5%, and allowing the Federal Reserve to keep hiking policy rates at the rate of one per quarter. This will take place regardless of likely criticism from the White House, in our view, as the Fed will be keen to assert its independence. But a year from now, as the fourth quarter of 2019 comes along, we expect economic conditions to become challenging along multiple dimensions: After two years of strong support, fiscal impulse will likely turn negative in We think it will become progressively difficult to come up with further fiscal relaxation through legislative initiatives by then. Refer to important disclosures at the end of the report

2 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% Having stimulated the economy through record fiscal deficits and stimuli (tax cuts and defence spending increases), the political room for additional measures will exhausted by then, in our view. This is especially likely as the 2020 presidential election nears, and the legislature remains divided (we expecting the House to swing to the Democratic party in next month s mid-term elections). Strong growth now; a slowdown in 2020 Consumption Net exports GDP Source: Bloomberg, DBS Investment Government China-US battles will likely transcend trade wars and spill over into geopolitical tension, but the key economic drag will stem from assorted uncertainties and cost increases associated with tariffs and other trade restriction measures. The full impact of the resulting recalibration will be felt from 2020 onward, and it will be a net negative, in our view. We are forecasting a slowdown in both investment and exports in In addition to likely challenges with fiscal and trade wars, we see it as quite plausible that both the economy and markets will struggle with looming political and policy uncertainties as the 2020 presidential elections loom. This could readily hurt consumer and business sentiments. Given the prevailing tightness in the US labour market, wages will continue to rise through 2019, and the momentum could well last through the following year, even as growth begins to slow. Headline and core inflation pressures would therefore remain high, making it difficult for the Fed to relent. The problem for the Fed would be that the level of output (not delta) and the prevailing wage/price dynamics will make it nearly impossible to ease policy in With high rates and tight liquidity in place, and having grown well above potential, it will take fairly small shocks for the economy to experience a sharp slowdown in growth or an outright (mild) contraction. Opposing direction of unemployment and wages 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Source: Bloomberg, DBS Unemployment rate Avg Weekly earnings growth Finally, given that a very large number US companies derive a bulk of their earnings from the rest of the world, external demand considerations will come into play sooner or later. Hurt by rising rates and tight USD liquidity, as well as difficulties around trade wars, growth in emerging markets will likely struggle, which will in turn spill back into weak international sales and profits for US companies by It is hard to price this scenario; the yield curve would likely steepen in 2019 and then begin flattening in 2020; the USD would strengthen first and then soften; inflation will peak but remain uncomfortably high for the Fed. In the following forecast table, we illustrate this contrasting dynamic between 2019 and What are the risks to this scenario? We fear that the chance of wages and inflation remaining benign, a scaling back of Fed policy normalisation if markets sell off (socalled Powell Put ), or further fiscal support in the pipeline are rather low. Page 2

3 In contrast, the chance of the Fed feeling compelled to push up policy rates above the neutral rate given that output is well above potential has risen (this possibility has been flagged by a number of FOMC members in recent months). Inflation could readily surprise on the upside as oil, tariffs, and wages compress margins and gives producers ample reasons to raise prices. We consider the decision by Fed chairman Powell to hold a press conference after every policy meeting from now on, as opposed to once per quarter, to be significant. Doubling the number of times he gets to explain the central bank s decision to the markets and the population is a strategy to attain greater policy flexibility, including the option to hike more than once a quarter, if needed. In our assessment of risks, this is more likely than a Fed relent. The timing of curve steepening and flattening would also come forward in this scenario (relative to our baseline). US forecast summary F 2019F 2020F Real GDP growth, yoy%, ave Headline inflation, yoy%, eop Core PCE inflation, yoy%, eop Monetary policy rate, %, eop USD per EUR, eop 10-year yield, %, eop Source: Bloomberg, DBS Taimur Baig Silver lining A beneficiary of a sharp slowdown or technical US recession in 2020 could be the large, domestic demand oriented emerging market economies, which would still register decent growth while catching a breather from a weakening dollar and peaking rates. Brazil, China, India, Indonesia, the Philippines, Russia, and Vietnam are in this camp, in our view. Indeed, having grown at well above potential rate for a few years on the back of an unsustainable fiscal stimulus, we think that it will probably be healthy for the US to undergo a temporary and mild correction. Page 3

4 Strategy FX: Europe & Asia under pressure Global markets have found themselves painted into a corner again. The US dollar is well underpinned by a strong US economy keeping Fed hikes intact. Asia and the Eurozone have not able to fend off growth worries fanned by Trump s trade policies and higher USD funding costs. Apart from external pressures, Europe is preoccupied with unity challenges from Italy and Brexit, while Asia confronts difficult policy choices between maintaining financial stability and supporting growth. The euro is vulnerable after having fallen below Speculators have scope to add more to their recently established net short euro positions. They have started to fret about the unity of the single market from Italy s intransigence to defy Brussels/market in pushing through a wide budget deficit. Across the English Channel, the British pound is set to depreciate below 1.30 again on more uncertainties into the deadline to achieve a Brexit deal in November-December. Both Italy and the UK share a common dilemma they can achieve a compromise with the EU or their own political parties, not both. Asian currencies are on the defensive again. This was best reflected by the depreciation in the South Korean won after the Bank of Korea signalled a possible dovish hike in November. In downgrading its growth forecasts amidst a stable and benign outlook, the BOK s priority has shifted from cushioning growth from global trade risks to safeguarding financial stability. Raising rates will help to address 1) the easy monetary policy blamed for fuelling household debt to record levels; and 2) preventing a further widening in the positive US-Korean rate differentials from leading to potential capital outflows. Expectations have increased for the Chinese yuan to depreciate towards its psychological 7 level against the USD. The rise in central parity rate above 6.90 into and after US Currency Report has not gone unnoticed. Today s China GDP report will be closely watched to affirm the need for more reductions in the required reserve ratio to cushion a slowing economy from escalated trade tensions. Rating agencies have started pay more attention to corporate debt on signs that deleveraging has taken a back seat to supporting growth. Rates: Tweaking US, SG and HK forecasts for 2019 Worries about rising rates were well-founded this year. Our USD, SGD and HKD rates forecasts were generally on point and USD rates rose to price in a more aggressive Fed, tighter labour markets and higher inflation expectations. We have tweaked our forecasts slightly for 2019 (see Forecast table in the previous section), keeping to our view of four Fed hikes for the year. With 10Y US yields at 3.20% (up by 80bps for the year), we believe that the bulk of the rise in 10Y UST yields may already be behind us and see a grind higher to 3.60% in USD rates would probably peak in 2019 in line with US economic activity. Yields are likely to ease somewhat once a slowdown (on the back of fading fiscal stimuli) gets reflected in late On balance, we see scope for modest curve steepening into mid-2019 and flattening thereafter. Our 3M Libor numbers have been shaded modestly lower even as our Fed projections did not change. This is done to reflect tighter Libor-OIS and Libor-Fed funds spread assumptions in the coming quarters. Our short-term SGD rates forecasts are nudged lower for the immediate few quarters, reflecting the two rounds of monetary tightening that the Monetary Authority of Singapore (MAS) has undertaken this year. With an estimated SGDNEER slope of 1%, this would automatically put more downward pressures on SORs and Sibors vis a vis Libors. The MAS statement appears to be modestly hawkish and there is the possibility that the slope may be steepened further in To be sure, this is not a done deal. Much depends on how high-frequency data plays out. Notably, the US-China trade war has not led to any discernible impact on Singapore (yet) and inflation appears to be on the high side. If these dynamics maintain in 2019, another round of tightening would be in the offing. We continue to see SGD rates outperformance versus USD rates in the coming quarters. Eugene Leow Philip Wee Page 4

5 Equities: Hong Kong retailers to benefit from better transport links with China A few leading retailers based in Hong Kong (HK) have issued their latest operating data. Amongst the segments that capture a high proportion of PRC tourist sales, major jewellery retailers continued to outperform the overall retail market and sustained double-digit samestore sales growth (SSSG). Cosmetics retailing, however, was showing a slower momentum, partly due to the latter s relatively higher correlation with RMB trends and consumer sentiment. The outlook for key jewellery retailers should remain broadly positive, as they continue to see good support from wedding-related sales that are more resilient in nature. Gold sales in HK/Macau have been robust during recent months. The RMB depreciation this year, the lower gold price, and rising uncertainties on the escalating trade war between China and the US might have also led to a higher tendency for customers to purchase more gold. On the other hand, we stay watchful on the sales momentum of cosmetics retailers. Sales from major retailers were flattish. This could be largely attributable to the mega typhoon which saw sales down 20% during the typhoon week, and sales during the latest golden week (1-7 Oct 18) just scored 7.4% growth for HK/Macau, which were below expectations in our view. The bright spot is in its stronger demand from PRC tourists vs. consumption from locals. Management also stays hopeful from positive effects of the Greater Bay Area in the medium-term. The 26-km HK section of the Guangzhou-Shenzhen-HK Express Rail Link runs from West Kowloon in HK to the boundary of HK and Shenzhen inaugurated in Sep Aside from shortening the travel time between HK and Shenzhen (Futian) to only 14 minutes (versus minutes using existing facilities: e.g. train, bus or private car), the Express Rail Link will also connect with the 25,000-km National High-speed Railway Network in Mainland China, thus significantly reducing transportation time between HK and the major cities of China. Our sensitivity analysis also suggests, under normal conditions, the Express Rail Link that connects HK to China s High-Speed Railway could bring more than 3 million additional mainland visitors in its first year of operation. Meanwhile, the HK-Zhuhai-Macau Bridge connecting the 3 regions are expected to start commissioning in late October. With a higher number of mainland tourists visiting HK, local retailers should benefit to a good extent. Many visitors will somehow ride on HK s tax-free shopping and purchase some merchandise, be it a lip stick, or more expensive products such as jewelleries & watches for more tax savings. We believe better transport links with China driving mainland tourist arrivals and retail sales is a medium-to-long term theme that will support the sector. In the near term, the major concern is on overall consumer sentiment given the latest global market crash. Recovery in inbound tourism has supported retail sales Tourist arrivals, retail sales value and rent % (YOY) % (YOY) 40 Retail shops rental (RHS) 8 30 Visitor arrivals 6 20 Retail sales value Aug-14 Aug-15 Aug-16 Aug-17 Aug-18 Joanne Goh Page 5

6 Credit: Contrasting geopolitical developments We expect sentiment in the Asian credit markets to remain weak in the near term and investors largely sidelined given continued volatility in broader markets. Over the past week, secondary market spreads held up relatively well despite the volatility seen in equity markets. Primary market issuance was confined largely to investment grade and quasi-sovereign issuers. A key development was the missed repayment by a Chinese solar company on a USD denominated bond, in a reminder of rising credit stress in the region. Highlights of the week: SGD rates have outperformance potential India chart book Volatility overshadows growth Indonesia: Easing some pressure Outside Asia, Turkey and Saudi Arabian credits saw contrasting fortunes on geopolitical developments. Turkish bonds reacted positively to the release of US pastor Andrew Brunson on 12 October, which is a significant step in de-escalation of US-Turkey tensions. Taking advantage of the favourable market conditions, the Turkish sovereign issued USD2bn of 5Y notes at 7.5% with an order book of around USD6bn another significant development given concerns over Turkey s market access. That said, given that risk remain over Turkey from an economic perspective, we prefer not to chase the rally at this stage (see Macro Strategy dated 15 October). In contrast, Saudi Arabian credit spreads widened on the back of allegations of the Saudi authorities involvement in the killing of journalist Jamal Khashoggi. We expect spreads to remain under pressure (potentially wider further) until there is clarity on the ongoing investigations. Neel Gopalakrishnan Page 6

7 Key Forecasts GDP growth, % YoY CPI inflation, % YoY, ave f 2019f f 2019f China Hong Kong India* Indonesia Malaysia Philippines** Singapore South Korea Taiwan Thailand Vietnam Eurozone Japan United States*** * refers to year ending March ** new CPI series *** eop for CPI inflation Policy interest rates, eop 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 China* India Indonesia Malaysia Philippines Singapore** South Korea Taiwan Thailand Vietnam*** Eurozone Japan United States * 1-yr lending rate; ** 3M SOR ; *** prime rate Exchange rates, eop Q1 18 Q2 18 Q3 18 Q4 18 Q1 19 Q2 19 Q3 19 Q4 19 China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Thailand Vietnam Australia Eurozone Japan United Kingdom Australia, Eurozone and United Kingdom are direct quotes Page 7

8 Rates forecasts Q1a Q2a Q3a Q4 Q1 Q2 Q3 Q4 US 3m Libor Y Y Y-2Y Japan 3m Tibor Y Y Y-2Y Eurozone 3m Euribor Y Y Y-2Y Indonesia 3m Jibor Y Y Y-2Y Malaysia 3m Klibor Y Y Y-3Y Philippines 3m PHP ref rate Y Y Y-2Y Singapore 3m Sibor Y Y Y-2Y Thailand 3m Bibor Y Y Y-2Y China 1 yr Lending rate Y Y Y-3Y Hong Kong 3m Hibor Y Y Y-2Y Taiwan 3m Taibor Y Y Y-2Y Korea 3m CD Y Y Y-3Y India 3m Mibor Y Y Y-2Y %, eop, govt bond yield for 2Y and 10Y, spread bps Page 8

9 Group Research Economics & Strategy Taimur Baig, Ph.D. Chief Economist - G3 & Asia taimurbaig@dbs.com Nathan Chow Strategist - China & Hong Kong nathanchow@dbs.com Masyita Crystallin, Ph.D. Economist Indonesia & Philippines masyita@dbs.com Joanne Goh Regional equity strategist joannegohsc@dbs.com Neel Gopalakrishnan Credit Strategist neelg@dbs.com Eugene Leow Rates Strategist - G3 & Asia eugeneleow@dbs.com Chris Leung Economist - China & Hong Kong chrisleung@dbs.com Ma Tieying Economist - Japan, South Korea, & Taiwan matieying@dbs.com Radhika Rao Economist Eurozone, India & Thailand radhikarao@dbs.com Irvin Seah Economist - Singapore, Malaysia, & Vietnam irvinseah@dbs.com Samuel Tse Economist - China & Hong Kong samueltse@dbs.com Duncan Tan FX and Rates Strategist - Asean duncantan@dbs.com Philip Wee FX Strategist - G3 & Asia philipwee@dbs.com Sources: Data for all charts and tables are from CEIC, Bloomberg and DBS Group Research (forecasts and transformations). Disclaimer: The information herein is published by DBS Bank Ltd (the Company ). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified. DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore Tel: Company Registration No E. Page 9