Economic Update: BRIC by BRIC. Brought to you by CME Group and Profit & Loss

Transcription

1 Economic Update: BRIC by BRIC Brought to you by CME Group and Profit & Loss 1

2 Presenters Samantha Azzarello Economist, CME Group Bluford Putnam Chief Economist, CME Group Moderator: Nicola Tavendale echannels Editor, Profit & Loss 2

3 Economic Update: BRIC by BRIC The research views expressed herein are those of the author and do not necessarily represent the views of the CME Group or its affiliates. All examples in this presentation are hypothetical interpretations of situations and are used for explanation purposes only. This report and the information herein should not be considered investment advice or the results of actual market experience. Blu Putnam Chief Economist November, 2013 Samantha Azzarello Economist

4 Disclaimer Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All references to options refer to options on futures. Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the meaning of section 1(a)12 of the Commodity Exchange Act. Swaps are a leveraged investment, and because only a percentage of a contract s value is required to trade, it is possible to lose more than the amount of money deposited for a swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates. CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX, New York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark of Commodity Exchange, Inc. KCBOT, KCBT and Kansas City Board of Trade are trademarks of The Board of Trade of Kansas City, Missouri, Inc. All other trademarks are the property of their respective owners. The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this presentation are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official Exchange rules. Current rules should be consulted in all cases concerning contract specifications. Copyright 4

5 Economic Update: BRIC by BRIC BRIC Country Overviews Global Issues challenging Emerging Markets FX and Equity Contagion 5

6 Country Reviews 6

7 Brazil Brazil has sustained an increased standard of living for its citizens. This has been partly fueled by economic growth and partly financed by an increase in credit. Demographic Shifts with the rise of the C class ( a lower-middle class) The C class is defined by individuals who earn between $ USD/year 2005 this demographic represented 21% of the population This demographic has increased to 54% of the population in 2013 C class presents a great opportunity for companies in Brazil with a new range of products and services being made available. Lower priced versions of traditionally higher end goods and services Examples include hairstyling, chocolate 7

8 Percent Change Year over Year Brazil 10% Brazilian Real GDP Growth 8% 6% 4% 2% % -2% -4% Source: Data from Bloomberg Professional (BZGDYOY) 8

9 Brazil Slowing economic growth comes at a time when a large class of people who s economic status had been improving steadily and are now expecting and demanding more from their government. The government provision of basic services against the backdrop of massive spending for World Cup/Olympics has led to protests. Quality of life issues are at the core of the protests health care, education, transport and education. All these issues are longer-term structural issues which cannot be affected immediately. 9

10 Brazil Social Services Examples of lacking social services include: A healthcare system with a shortage of doctors, there has been recent efforts by the government to attract doctors from other Latin American countries. The Justice system and police force are considered by some as a system which favors the wealthier classes. Education in Brazil had quality and quantity issues. Education reform is cited as being highly needed. 10

11 Brazilian Real per USD Brazilian real depreciation set-off by Fed taper talk and Geopolitical events 2.50 Brazilian Real Exchange Rate Fed announces plans to taper QE Source: Brazilian Real (BRL) from Bloomberg Professional. 11

12 Brazil FX Brazilian government announced a FX intervention program in August The program is in place and ready to be utilized in order to halt the decline in the Real. The 60 Billion Real program is intended to provided liquidity. The technical details are that the Central Bank of Brazil we be able to provide liquidity through selling currency swaps and repos, with the aim of decreasing volatility in the FX market. Brazil wants to avoid the inflationary pressures associated with a weakening Real. 12

13 Brazilian Real per USD Brazil 2.65 Brazilian Real Exchange Rate 2.45 Real depreciating Source: Brazilian Real (BRL) from Bloomberg Professional. 13

14 Russia - WTO Entry into the World Trade Organization (WTO) has been disappointing not a driver of growth as hoped. Entry was confirmed after 18 years of negotiations. Russia is the EU s third largest trade partner, entry into the WTO would make trade between the two countries more standardized. Russia has to reduce import tariffs Especially hard-hit Russian sectors include agriculture Entry into WTO was meant to be a catalyst to diversify and modernize the Russian economy. Proposed benefits had been to attract foreign investment more easily, and move towards a more diverse economy less reliant on Energy exports over the long term. Issue of timing where increase competition will be beneficial over the long term, shorter term adjustments will not support GDP and export numbers. 14

15 Russia - Energy Energy exports are 70% of Russia s total exports Tax on export duties of oil and gas is the largest source of tax income for the Russian government. Russian government is highly dependent on increasing oil output and increasing Brent prices to finance government receipts. Flat lining of energy exports in dollars suggests government revenues will not grow. Government revenue stagnating will be exacerbated if a structural change occurs where Russian gas prices are no longer tied to oil prices as they are currently. 15

16 in Billion USD Russian Commodity Exports Russian Commodity Exports in US Dollars $160 $140 Export revenues are flat lining $120 $100 $80 $60 $40 $20 $0 Source: Central Bank of Russia, Key Economic Indicators

17 Russia - Energy Russia dominance in world energy markets has been challenged by the US energy boom, which is having a large impact on prices and increasing total supply. The tie of Russian gas prices to Brent oil also is unsustainable as gas prices worldwide fall. Gazprom recently lost a case against German energy company, RWE over oil-indexing the gas price on its contract. A court tribunal in Vienna ruled against the formerly accepted practice of oil-indexing gas prices. Gazprom is being forces to adjust its gas price contract with RWE. 17

18 Russian Ruble per USD Russia 40 Russian Ruble Exchange Rate 35 Ruble depreciating /2007 9/2008 9/2009 9/2010 9/2011 9/2012 9/2013 Source: Russian Ruble (RUB) from Bloomberg Professional. 18

19 India Oil Subsidies The magnitude and continued growth of government subsidies in India are concerning for government fiscal health. Oil Subsidies Oil subsidies are deemed as unsustainable in the longer term India imports 80% of its oil which is then subsidized for consumers At the end of India s 2013 fiscal year in March the total fuel subsidy cost was $23.5 Billion (1.6 trillion rupees). Oil refining and marketing companies import crude oil at market rates. They are then required to sell the 3 key products: kerosene, diesel and LPG at subsidized rates. Gas or oil bought by the refining companies from Indian oil producers is purchased at a significant discount. Approx. 40% of the subsidy burden is borne by the Indian oil producers. The remaining 60% is by the oil refiners and government. 19

20 India Oil Subsidies The issue of oil subsidies is being exacerbated by the decline in the Rupee. Global oil contracts are priced in US dollars. In something of an FX intervention plan, the Reserve Bank of India announced it would be selling US dollars to the largest state run oil companies. A few oil subsidy reforms are slowly occurring: A small increase in the price of subsidized diesel, and a limit on the supply of subsidized cooking gas to households. 20

21 As percent of GDP India Current Account Deficit Worsening 4% Indian Government Current Account (as percent of GDP) 2% 0% -2% -4% -6% Source: Data from Bloomberg Professional (EHCAIN). 21

22 India Food Subsidies New Program, the Food Security Bill has an estimated cost of 21 B. Program will subsidize rice, wheat and grains for 2/3 of the population Pregnant women, and certain categories of mothers and children will be eligible for free daily meals Subsidy programs shake investor confidence on India s ability to manage the growing budget deficit. A growing current account deficit works to depreciate the rupee, this in turn leads to inflation pressures. India is highly dependent on FDI to fill the gap left by the deficit furthermore the FDI flow is temperamental with regards to markets appetite for risk. 22

23 Year-over-Year Percent Change India 12% India Wholesale Price Inflation 10% 8% 6% 4% 2% % -2% Source: India Wholesale Price Index (INFINFY) from Bloomberg Professional. 23

24 Indian Rupee per USD India Indian Rupee Exchange Rate Sharp depreciation: India implements capital controls /2007 9/2008 9/2009 9/2010 9/2011 9/2012 9/2013 Source: Indian Rupee (INR) from Bloomberg Professional. 24

25 India Gold Contributing to India s growing current account deficit is gold imports which stand at $16.5 billon/quarter. India is the world s top importer of gold, followed closely by China. The Indian government acknowledges the imbalance with the implementation of tight new rules to decrease gold imports. A tax on gold imports was raised from 2% to 15% since beginning of

26 Gold Lack of inflationary pressures in the US diminishes gold s appeal as a safe-haven asset. Investment demand for gold has fallen in 2013 as investors look to return to high-yield investments in equities. This has inter-played with expectations of Fed tapering and a move to higher interest rates. Markets also took notice of the slowdown in EM countries, leading to expectations that gold demand at current levels will not be sustainable from countries such as India and China. Gold still has appeal as a balancing asset in portfolios. 26

27 Commodities Weaker economic growth in EMs equates with less demand growth for commodities and raw resources. Also slower demand will not put upward pressure on prices. Another factor at play is EMs weaker currencies, which increase the price domestically of raw materials which are quoted in USD. An exception to this is China, who s currency has strengthened. Advanced economies growth is less raw material intensive but much more energy-use intensive. 27

28 China China s aim to transition to a more consumption-based economy from a infrastructure and investment based economy is occurring at a time of lackluster global economic growth. Steady, if not lower growth in the US Stagnant growth in Europe Emerging Market countries no longer pulling up global growth These less than ideal global growth conditions condition s are slowing Chinas export growth. 28

29 Percent Change China 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% Chinese Exports in Billion USD Percent Change Year over Year Stagnant or slow growth in many of China's major export partners Source: Data from Bloomberg Professional (CNFREXP$). 29

30 Percent Change European Imports on the Decline Not a source of export capacity for BRICs 40% 30% 20% European Union Imports in Million euros Percent Change Year over Year 10% 0% -10% -20% -30% -40% Source: Data from Bloomberg Professional (XTTIEZ). 30

31 China China is moving towards financial market modernization and integration with world markets. However the pace is slow. China wants to utilize financial innovation to spur growth. Use asset securitization as a method to make better use of bank credit Loosening control of interest rates occurred in Summer 2013 Residential Mortgage rates still have restrictions and caps Liberation of deposit rates currently there exists a ceiling on the rate banks can pay depositors, this has effectively guaranteed profits for Chinese banks. 31

32 US Financial Modernization A parallel can be made to conditions in the US in the 1970 s: Low growth and high inflation - stagflation, very high interest rates High unemployment, oil price shocks of 1973 and 1979 Less than ideal economic conditions at the time were a catalyst to see the beginnings of financial innovations and modernization USD moved from fixed peg to full floating currency. Change from fixed to completely competitive brokerage commissions on the NYSE Increased use and research on options Interest rate ceilings on deposit accounts phased out completely 32

33 Chinese Renminbi per USD China 8 Chinese Renminbi Exchange Rate 7 Loosening of the Renminbi rate in the managed float system 6 5 9/2007 9/2008 9/2009 9/2010 9/2011 9/2012 9/2013 Source: Chinese Renminbi (CNY) from Bloomberg Professional. 33

34 China Financial Market Modernization China is moving towards financial market modernization and integration with world markets. However the pace is slow. Example of the slow place is the re-introduction of Chinese Government 5-year bond futures. Closed trading in 1995, re-introduced 18 years later Restrictions on who can trade major players including banks and insurers are not allowed currently. Certain firms, including mutual funds, can trade only for hedging purposes Margin requirements are being set higher than the legal minimum Limit of holdings was also revised downwards by 20% from draft regulations 34

35 in Billions of Renminbi China China New Loans in Renminbi New Government stimulates economy Source: Data from Bloomberg Professional (CNLNNEW) 35

36 in Billion USD China 4000 China Central Bank International Reserves (Billion USD less gold) /2009 9/2009 5/2010 1/2011 9/2011 5/2012 1/2013 9/2013 Source: Data from Bloomberg Professional IMF Database ( ) 36

37 Global Issues challenging Emerging Markets 37

38 Global Challenges to EM US Federal Reserve monetary policy has had severe implications for EMs. The initial EM FX sell-off in 2013 started as the Fed hinted that the beginning of tapering QE would be soon. The switch or change in investor sentiment characterized by risk-on vs. risk-off means that EM are still heavily influenced by geopolitical worries. 38

39 Percent Change in Index Level Contagion: Risk Off 4% 2% Emerging Market Equities Change in Index from January 2013 to September % 0% -2% -4% -6% -8% -10% -12% -14% Brazil India Russia China -11.1% -6.4% -12.0% Source: Data from Bloomberg Professional (IBOV, SHCOMP, SENSEX and RTS). Calculations by CME Economics. 39

40 Percent Change in Index Level Contagion: Risk Off Rebound 60% Emerging Market Equities Change in Index May 2013 to September % 49.1% 40% 30% 20% 10% 0% -10% -3.1% 2.3% 1.6% Brazil India Russia China Source: Data from Bloomberg Professional (IBOV, SHCOMP, SENSEX and RTS). Calculations by CME Economics. 40

41 Percent Change in Index Level US Equities, Bull Run in % 24% 20% 16% 12% 8% 4% 0% S&P 500 Equities Percent Change in Index Year over Year Source: Data from Bloomberg Professional (SPX). Calculations by CME Economics. 41

42 Contagion: EM Policymaker Options Increase Rates Defend FX Do nothing Slow Growth Deplete Reserves Currency Falls Markets Grow wary, affects confidence and selling cycle continues 42

43 Change in Reserves in millions India Indian Central Bank International Reserves Year over Year Change (USD less gold) $8000 $6000 $4000 $2000 $0 -$2000 -$4000 -$6000 -$8000 -$ $12000 Declining Reserves as Rupee depreciated Source: Data from Bloomberg Professional IMF Database ( ) 43

44 Change in Reserves in millions Brazil Reserves Brazilian Central Bank International Reserves Year over Year Change (USD less gold) $20000 $15000 $10000 $5000 $0 -$5000 -$ $15000 Source: Data from Bloomberg Professional IMF Database ( ) 44

45 Change in Reserves in millions Russian Reserves Russian Central Bank International Reserves Year over Year Change (USD less gold) $25000 $20000 $15000 $10000 $5000 $0 -$5000 -$ $15000 Source: Data from Bloomberg Professional IMF Database ( ) 45

46 Trading Opportunities cmegroup.com/fx Averaging $123 billion in daily notional liquidity, CME is the world s largest regulated FX marketplace. The leading FX platform of choice for a global and increasingly diverse customer base, with growth rates that continue to outperform the broader overthe-counter (OTC) market. 61 futures: standard- and E-micro (1/10th standard) contract sizes, including 20 non- U.S. dollar cross-rate pairs 31 options contracts: more than $8 billion in daily turnover (+50% year over year) and increasingly electronic (85%) markets 21 global currencies: spanning the majors and a full suite of emerging markets currency pairs, including the entire BRICS offering with the following new additions: Indian rupee (INR) futures Off-shore Chinese renminbi (CNH) futures U.S. dollar-denominated South African rand (ZAR) futures 46

47 Economic Update: BRIC by BRIC The research views expressed herein are those of the author and do not necessarily represent the views of the CME Group or its affiliates. All examples in this presentation are hypothetical interpretations of situations and are used for explanation purposes only. This report and the information herein should not be considered investment advice or the results of actual market experience. Blu Putnam Chief Economist November, 2013 Samantha Azzarello Economist