Global Economic Outlook

Transcription

1 By John Praveen, Chief Investment Strategist of Prudential International Investments Advisers, LLC.* For Market Commentary Interviews Contact: or follow Praveen on Global Summary: Global Growth Risks Exacerbated by Eurozone Debt Contagion & U.S. Debt Downgrade. However, Slowdown/Recession Fears Exaggerated. Fed & ECB Respond to Calm Markets Fed s Stealth Easing & ECB Buys Bonds John Praveen s Global Economic Outlook continues to expect a GDP growth rebound in H2 after the growth disappointments of H1. However, we acknowledge that the U.S. debt downgrade, the escalating Eurozone debt crisis and growing possibility of downgrades of other Eurozone sovereign debt have raised fears of a sharp global slowdown/recession. We think these fears are exaggerated and expect a modest recovery in the U.S. in Q3 and a sharp rebound in Japan as supply chain disruptions are reversing and high oil prices are easing. Eurozone GDP growth is expected to moderate while growth in the emerging economies remains solid in H2 2011, though slowing from the strong H1 pace in response to policy tightening measures. The U.S. Fed left rates on hold in August and made a commitment to keep rates at current low levels through mid The Fed also left the door open for QE 3. With the debt crisis escalating, the ECB announced the resumption of bond purchases, and subsequently extended the purchases to Italy and Spain. The ECB also announced measures to provide liquidity to commercial banks with three-month and six-month funds. The BoJ extended its asset purchase program by 10trn and intervened to stem yen appreciation. Headline inflation has peaked in the U.S. with falling energy prices offsetting rising food prices. However, core prices are edging up modestly. Eurozone inflation moderated in July but still remains above the ECB target. Inflation continues to trend higher in the emerging economies even in the face of interest rate tightening by emerging central banks. Global Economic Outlook Global Slowdown Fears Exaggerated. Modest H2 Recovery in U.S. & Sharp Rebound in Japan. ECB Resumes Bond Buying. Fed Freezes U.S. Rates until Mid-2013 and Open to QE 3 Growth: Global Growth Risks Exacerbated by Eurozone Debt Contagion & U.S. Debt Downgrade. However, Recession/Slowdown Fears Exaggerated with Modest Recovery in U.S., Sharp Rebound in Japan. Eurozone Moderates After the growth disappointments of H1, the global economy was poised for a rebound in H2. However, the U.S. debt downgrade, the escalating Eurozone debt crisis and growing possibility of downgrades of other Eurozone sovereign debt has raised fears of a sharp global slowdown/recession. However, we think these fears are exaggerated and expect a modest recovery in the U.S. and a sharp rebound in Japan as supply chain disruptions are reversing and high oil prices are easing. The U.S. economy slowed to a crawl in Q2 with a disappointing 1.3% annualized GDP growth. In addition, GDP growth for Q1 was revised down sharply to just 0.4% from 1.9% earlier reported. Positive contributors to Q2 GDP growth were net exports (0.6%), business investment spending (0.6%), inventories (0.2%), residential investment (0.1%), and consumer spending (0.1%). Government spending (-0.2%) was a drag on Q2 GDP. Personal consumption spending rose just 0.1% in Q2 with durable consumer goods spending down -4.4% due to a 22% drop in motor vehicle spending due to Japan supply chain disruptions. Business investment spending rose 6.3% with spending on structures up 8.2%, while equipment and software rose 5.7%. Residential investment rose 3.8%. The Japanese economy remains on track for a V-shaped recovery in H2. GDP is expected to rebound around 5.5% QoQ annualized in Q3 and around 5% in Q4. Consumption growth is recovering from the sharp decline in late Q1. Business investment spending is set to recover in H2. Government spending is likely to strengthen further in H2 with increased spending as part of the disaster relief program. Net exports are on track to post a strong recovery in H2 after supply chain disruptions led to a plunge in Q2. Eurozone GDP growth is expected to moderate in Q2 to around 2% from the 3.4% growth pace in Q1. Within Eurozone, the Periphery continues to struggle with fiscal tightening and elevated funding costs while the weakness appears to be spreading to some Core countries such as France and Italy. Eurozone Economic Sentiment Indicator fell to in July from 105.1, its lowest level in a year. The current level of economic sentiment points to GDP growth of around 2%. Emerging Asia economies continue to post strong growth with China Q2 GDP at 9.5%. GDP growth remains solid in Emerging Europe while Latin America is moderating. *Prudential International Investments Advisers, LLC. (PIIA) is a business of Prudential Financial, Inc., (PFI), which is not affiliated in any manner with Prudential plc, a company headquartered in the United Kingdom. For Informational Use Only. Not Intended As Investment Advice. See Disclosures on the last page for important information. Page 1

2 Inflation: Headline Peaks in U.S., Core Edging Up. EU Headline Above ECB Target. EM Inflation Peaking U.S. headline consumer price inflation held steady at 3.6% YoY in June after rising from 3.2% in May. Falling energy prices offset rising core and food prices in June. U.S. core inflation edged up to 1.6% YoY in June from 1.5% in May. Eurozone headline HICP inflation fell to 2.5% YoY in July from 2.7% in June. U.K. headline inflation eased to 4.2% YoY in June after holding at 4.5% in May. Japanese core inflation rose 0.4% YoY in June, pressured higher by fading of base effects due to high school tuition fees holiday ending, and the earlier rise in global commodity prices. Inflation continues to trend higher in the emerging economies even in the face of policy rate tightening by developing central banks. Interest Rates: Fed On Hold Till Mid ECB on Hold, Resumes Bond Buying. EM Rate Hikes Continue With stock markets sell-off accelerating following the U.S. debt downgrade and the Eurozone debt contagion spreading to Italy and Spain, central banks needed to hit the RESET button to stabilize stock markets since a fiscal policy response is largely ruled out. The ECB responded by resuming bond purchases and extended the program to the beleaguered Italian and Spanish bond markets. The Fed committed to keep interest rates around zero through mid The U.S. Fed left rates unchanged at its August meeting. While the Fed did not announce another round of asset purchases (QE 3), it committed to keep interest rates at current low level around zero through mid The Fed also reiterated it will keep its reinvestment policy in place, thereby keeping the Fed balance sheet steady and preventing premature passive tightening of policy. The ECB held rates unchanged at 1.5% in August after hiking rates by 25bps at their July meeting. The ECB also stepped up to take measures to calm markets with the European debt contagion spreading beyond the peripheral markets to Italy and Spain, announcing that it would undertake purchases of Spanish and Italian bonds following announcements by those governments of additional austerity measures. The Bank of England left rates unchanged at 0.5% in August. The BoJ kept rates on hold in August but increased the size of asset purchases to 50trn and intervened in currency markets to stop yen appreciation. Emerging central banks continue to raise rates with inflation elevated. China, India, Taiwan and Brazil hiked rates in June/July. Currencies: Dollar to Remain Strong Against Euro, Yen Pullback Likely after Recent Run-up The ongoing Eurozone debt crisis with growing risk of contagion to Italy and Spain remains a big negative for the euro. Elevated inflation is a negative for the sterling. The yen is likely to pullback after recent strength on fears of further currency intervention. Further gains are expected for EM currencies on stronger growth and central bank hikes. Regional Outlook - USA, Eurozone, UK, Japan, China, India & Other EM USA: U.S. GDP Slows to a Crawl in H1. Inflation Peaking. Fed on Hold, Door Open for QE 3 Growth: Q2 GDP Disappoints & Q1 GDP Revised Down. GDP on Track to Modest Rebound in H2 The U.S. economy slowed to a crawl in Q2 with a disappointing 1.3% annualized GDP growth. In addition, GDP growth for Q1 was revised down sharply to just 0.4% from 1.9% earlier reported. Positive contributors to Q2 GDP growth were net exports (0.6%), business investment spending (0.6%), inventories (0.2%), residential investment (0.1%), and consumer spending (0.1%). Government spending (-0.2%) was a drag on Q2 GDP. Personal consumption spending rose just 0.1% annualized in Q2 with durable consumer goods spending down -4.4% due to the sharp drop in motor vehicle spending associated with Japan supply chain disruptions. Business investment spending rose 6.3% annualized in Q2 after 2.1% in Q1 with spending on structures up 8.2%, while equipment and software rose 5.7%. Residential investment rose 3.8%. Inventories accumulation added 0.2% to Q2 GDP growth, while trade contributed 0.6%. Government spending, however, was weak, falling -1.1% annualized in Q2 after an even sharper -5.9% decline in Q1. While the U.S. economy was very weak in H1, the factors which depressed growth in Q1 and Q2 appear to be easing. Japan supply chain disruptions appear to have reversed in early Q3 as reflected in the rebound in transport segment of durable good orders, while gas prices moderated as crude prices declined. Consequently, the economy is expected to post a modest rebound in H2, with around 3% GDP growth in Q3. Annual GDP data revisions indicate substantial downward adjustments to U.S. GDP growth over the past three years. The revisions indicate that the recession was deeper than previously reported with the peak-to-trough GDP decline now estimated at -5.1% (previously -4.1%) and the current recovery is estimated to be shallower with GDP, up 5.0% to Q Page 2

3 Inflation: Headline Inflation Elevated but Peaking. Core Inflation Below Target but Rising Modestly U.S. headline consumer price inflation held steady at 3.6% YoY in June after rising from 3.2% in April. Headline prices fell -0.2% MoM in June after 0.2% in May as falling energy prices offset rising food prices in June. Energy prices fell - 4.4% MoM in June, while food prices rose 0.2% after 0.4% in May. U.S. core inflation edged up to 1.6% YoY in June from 1.5% in May. Core inflation rose 0.3% MoM in both May and June. However, on a 3m/3m annualized basis, core inflation has accelerated to 2.5% at the end of Q2 from 1.7% in Q1 and 0.6% at the end of Hence, while core inflation is still contained, there are increasing short-term pressures that appear to have led the Fed to raise its 2011 core inflation forecast from 1.3% - 1.6% in April to 1.5%-1.8% in June. Interest Rates: Fed on Hold Till mid QE 2 Completed. Fed Leaves Door Open for QE 3 The U.S. Fed left rates unchanged at its August meeting. While the Fed did not announce another round of asset purchases (QE 3), the Fed committed to keep interest rates at the current low level of around zero through mid In earlier meetings, the Fed indicated that it would keep rates low for an extended period. The commitment to hold rates around zero through mid-2013 appears to be an acknowledgement of the faltering economic recovery in H1 and increased risks to the GDP growth outlook. The Fed also reiterated it will keep its reinvestment policy in place, thereby keeping its balance sheet steady and preventing premature passive tightening of policy. Earlier, in the June Fed statement and in Chairman Bernanke s July semi-annual Humphrey-Hawkins testimony to the U.S. Congress, the Fed left the door open for fresh asset purchases or QE 3. Eurozone: Eurozone Growth Moderates in Q2. ECB on Hold in August, Resumes Bond Purchases Growth: Moderating Eurozone GDP Growth Driven By Germany/France. U.K. GDP Growth Sluggish Eurozone GDP growth is expected to moderate in Q2 to around 2% from the 3.4% growth pace in Q1. Within Eurozone, the Periphery continues to struggle with fiscal tightening and elevated funding costs while the weakness appears to be spreading to some Core countries such as France and Italy. Eurozone Economic Sentiment Indicator fell to in July from 105.1, leaving the index at its lowest level in a year. The decline was broad-based by sectors. But more concerning is the breakdown by country, which showed sentiment weakening in the previously solid core Eurozone countries as well as the struggling periphery. This raises questions about whether the struggling peripheral countries can ride the strong growth coattails of the core countries as in Q1. Nevertheless, the current level of economic sentiment points to annual GDP growth of around 2%, a slowdown from Q1 s strong, but unsustainable pace. The U.K. economy remains sluggish with Q2 GDP rising just 0.7% QoQ annualized, down from 1.9% in Q1. Full details are not yet available, services and construction output grew 2% annualized but was offset by a 5.6% drop in production with weakness in mining, utilities, and agriculture (manufacturing only fell a modest -1.2%). On an annual basis, GDP rose 0.7% YoY after 1.6% in Q1. The Q2 growth disappointment was caused by a range of temporary factors. Inflation: Eurozone and U.K. Inflation Elevated, But Easing Most Recently Eurozone headline HICP inflation fell to 2.5% YoY in July from 2.7% in both May and June. Headline inflation rose in Germany (2.7% in July from 2.4% in June), edged down in France (2.1% in July from 2.3% in June), edged down in Italy (2.9% in July from 3%), and held in Spain (3% in July). Eurozone core inflation (excluding food, energy, tobacco & alcohol) edged up to 1.6% YoY in June from 1.5% in May and 1.6% in March. U.K. headline inflation eased to 4.2% YoY in June after holding at 4.5% in May. Prices fell -0.1% MoM due to falling core inflation. Nevertheless, components of CPI that are not part of core inflation rose to 8.7% YoY from 7.9%, with some assistance from base effects. U.K. core inflation has corrected sharply in recent months, easing to 2.7% YoY in June from 3.4% in May. Interest Rates: ECB Pauses in August, Resumes Bond Purchases. BoE on Hold The ECB held rates unchanged at 1.5% in August after hiking rates by 25bps at their July meeting. The ECB continued to highlight "upside risks to price stability and that monetary policy remains accommodative. However, the ECB also acknowledged growth risks noting a deceleration in the pace of economic growth. The emerging growth risks combined with the escalation of the debt crisis suggests that the ECB is unlikely to raise rates in the near future. The ECB also stepped up to take measures to calm markets with the European debt contagion spreading beyond the peripheral markets (Greece, Portugal and Ireland) to Italy and Spain. The ECB announced that it would resume bond purchases under its Securities Markets Program (SMP) which had been dormant since March The ECB initially indicated that it would buy peripheral governments bonds (Portugal and Ireland). However, as markets deteriorated further, the ECB announced that it would undertake purchases of Spanish and Italian bonds following announcements by those governments of additional austerity measures. The Bank of England left rates unchanged at 0.5% at the August meeting and the stock of asset purchases fixed at 200bn. With U.K. inflation remaining well above the BoE s 2% target and relatively weak GDP growth, the BoE is torn between members wanting to keep rates low to support growth and several pushing for hikes to combat inflation. Page 3

4 Japan H2 GDP Rebound after H1 Plunge. China: Solid H2 GDP After Strong H1 Growth Growth: Japan H2 GDP Rebound After H1 Plunge. China Growth Remains Solid in H2 After Strong Q2 The Japanese economy remains on track for a V-shaped recovery in H2. Current expectations are for GDP to rebound around 5.5% QoQ annualized in Q3 and around 5% in Q4. Japan s GDP is expected to decline around -3% in Q2 after contracting a sharper than expected -3.5% in Q1 driven by broad based declines across all components of GDP growth. Consumption growth is recovering from the sharp decline in late Q1 due to the earthquake. Retail sales were strong in June, rising 2.9% MoM, after rising 2.4% in May. Business investment spending is set to recover in H2 after pulling back in H1 in the aftermath of the earthquake as reconstruction efforts aid growth and increased investments in construction, oil refining and electric machinery. Industrial Production (IP) rose 3.9% MoM in June after posting a strong 6.2% rise in May. Government spending is likely to strengthen further in H2 with increased spending as part of the disaster relief program. Net exports are on track to post a strong recovery in H2 after supply chain disruptions led to a plunge in Q2. Real exports accelerated to 8.6% MoM in June after +4.5% in May, and has now retraced 81% of the decline after the earthquake. China s GDP rose a stronger than expected 9.5% YoY in Q2 after 9.7% in Q1. On a QoQ basis GDP growth edged up to 2.2% from 2.1% in Q1. The stronger than expected GDP growth was due to upside surprises in Industrial Production and resilient investment growth which eased fears of a hard landing despite tightening efforts by policy makers and slower global economic activity. Fixed Asset Investment remains resilient, rising 25.6% YoY in June after 25.8% in May while IP growth accelerated to 15.1% in June from 13.3% in May. Consumption remains solid with retail sales rising 17.7% YoY in June from 16.9% in May. GDP growth is likely to slow further in coming quarters due to the effect of ongoing policy tightening measures. However, solid FAI growth and strengthening consumption growth are expected to keep GDP growth above 9%. Easing supply-side bottlenecks and GDP rebound in the U.S. and Japan are further supports for Chinese GDP growth in H2. India s GDP growth is expected to moderate to around 7.5% in Q2. Earlier, Q1 GDP growth slowed to 7.8% YoY in Q1 from 8.2% in Q Activity in the services sector remained solid, rising 8.7%. Manufacturing slowed to 5.5% from 6% in the previous quarter, and was the main drag on GDP. Economic activity continues to slow on the back of rising interest rates. However, the stalled policy reforms are likely to get more attention from the government, leading to an improvement in investment spending in H2. Consumption spending remains solid although moderating due to the impact of rising interest rates. Agriculture is likely to remain a positive contributor to GDP growth with early indications of the monsoon encouraging. Taiwan s Q2 GDP growth surprised to the upside growing 4.9% YoY after a strong 6.2% in Q1. Private consumption was a strong driver of GDP growth even as export growth decelerated from the previous quarter. Taiwan s GDP growth is expected around 5% in 2011 even as H2 growth is expected to weaken from the stronger than expected H1 growth. The Korean economy grew 3.4% YoY in Q from 4.2% in Q due to moderating exports growth. For Q3, GDP is expected to grow by 4% YoY, driven by resilient export growth and higher facilities investment. Korean GDP growth is expected to increase by ~4.3% in 2011 driven by strong exports and consumption growth. Brazilian growth is expected to ease in Q2. While industrial production rose strongly in Q1, it has been mixed in Q2. Further, business confidence has weakened in Q2. In addition, unemployment is edging up. Nevertheless, consumer confidence has improved, retail sales are rising strongly, and the trade surplus is widening. Brazilian GDP growth is expected to come in around 4% YoY in Q2. Mexican growth is expected to continue to post modest growth in Q2 after slowing in Q1. It appears that global IP has slowed in early Q2 due to disruption from the Japanese earthquake. Business confidence, the consumer outlook, and trade all appear to be on a weak footing in early Q2. Mexico s GDP is expected to rise around 4.3% YoY in Q2, but maintain modest growth QoQ annualized. Inflation: Japanese Inflation to be Dragged Down by Base Year Change. China Inflation Remains Elevated Japanese core inflation (excluding fresh food) rose 0.4% YoY in June, pressured higher by a fading of base effects due to high school tuition fees holiday and pass through of higher commodity prices. Core inflation is likely to decline sharply from the July release as the base year changes to 2010 from 2005, lowering core CPI by around 0.8% points. China s headline inflation made a new high in July reaching 6.5% YoY from 6.3% in the previous month. On a MoM basis, headline inflation accelerated 0.5% in July from 0.3% in June. The higher than expected inflation was driven mainly by food prices which rose 14.8% YoY from 14.4% in June. Non-food inflation declined to 2.9% from 3% in June. India s June WPI inflation inched higher to 9.4% YoY from 9.1% in May. On a MoM basis, headline inflation rose 0.5% after the -0.2% decline in May. Food inflation remained firm at 8.4% while Non-Food articles moderated to 18.6% in June from 22.3% in May. The fuel index rose 12.8% in June after 12.3% in May. The pass through of higher crude oil prices to domestic prices is likely to keep the WPI above 9% in coming months. Korea s headline inflation rose further to 4.7% YoY in July from 4.4% in June and 4.1% in April. On a MoM basis, headline inflation rose 0.7% in July from 0.2% in June. The rise in headline inflation was driven by higher food and oil prices. Core inflation continued to trend higher to 3.8% YoY in July from 3.7% in June. Page 4

5 Taiwan s headline inflation surprised to the downside falling to 1.3% YoY from 1.9% in June. On a MoM basis, prices declined -0.3% in July after rising 0.6% in June. The decline was driven by a decrease in food inflation due to a drop in fruit and vegetable prices. Core inflation declined to 1.1% YoY from 1.2% in June. Brazilian IPCA inflation rose 6.7% YoY in June after 6.6% in May. On a MoM basis, prices rose 0.2% after 0.5% in May and around 0.8% in each month from January through April. Due to tightening monetary policy, the slowdown in monthly price increases will likely result in downward pressure on headline inflation later in the year. Mexican consumer prices edged up to 3.6% YoY in July from 3.3% in June and 3.2% in May. Prices rose 0.5% MoM after being flat in June and falling -0.7% in May. While core inflation rose a modest 0.2%, non-core inflation jumped 1.4% after falling four consecutive months. Interest Rates/Currency: BoJ Increases Asset Purchases, Intervenes in Yen. China Tightens Monetary Policy The BoJ left its policy rate in the 0-0.1% range but increased the size of asset purchases to 50trn in August. While the BoJ upgraded its economic assessment, it is likely to remain on hold through 2011 given the uncertainties in the global economy. In response to the strong yen appreciation, the BoJ intervened by selling 1trn yen to moderate the yen and prevent it from short circuiting the expected H2 GDP rebound. The bank could intervene again if the currency appreciates significantly. The People s Bank of China (PBC) hiked benchmark interest rates by 25 bps in early July to take the benchmark lending rate to 6.56%. The PBC kept the Required Reserve Ratio (RRR) at a record high 21.5%. The PBC is likely to hike rates once more and hike the RRR further if inflation remains elevated in the coming months. Inflation risks still far outweigh concerns over growth. However, with signs of previous tightening measures taking effect, the PBC Is likely to hike rates modestly going forward. The yen appreciated a sharp 4.4% against the U.S. dollar in July after appreciating 1% in June. The RMB rose 0.4% against the dollar in July after rising 0.2% in June. The RMB is expected to continue to rise to around 6.4 per dollar by the end of The Reserve Bank of India (RBI) aggressively hiked rates in July, raising the repo and reverse repo rates by a larger than expected 50bps each to 8% and 7% respectively. The cash reserve ratio (CRR) remains at 6%.The larger than expected tightening was motivated by headline inflation running above 9%, which is three times the RBI s medium term target of 3%. With inflation likely to remain elevated, signs of sustained downturn in inflation are unlikely in the near future. Hence, there could be further 25-50bps tightening by end of The Taiwan Central Bank (CBC) hiked rates by 12.5 bps in June and is likely to raise rates again at its September meeting. The bank of Korea (BoK) left rates unchanged at 3.25% at its June meeting. The Bok s policy statement remains hawkish signaling another rate hike in the near future. The BoK is likely to increase rates by another 25 bps in 2011 bringing the rate to 3.5% before the end of the year as inflationary pressures remain. The Banco Central do Brasil (BCB) raised the Selic rate by another 25bps to 12.50% at its July meeting after last raising 25bps in both April and May and 50bps in both January and March. Given the current, elevated level of inflation, there is still a chance that there is an additional hike at the next meeting before pausing. Mexico s central bank (Banxico) continued to hold overnight rates at 4.5% at their latest meeting in early July. Banxico is looking to coordinate its interest rate normalization with the U.S. Fed. With the Fed on hold well into 2011, Banxico is unlikely to make any changes to its interest rate policy soon. Disclosures: Prudential International Investments Advisers, LLC. (PIIA), a Prudential Financial, Inc. (PFI) company, is an investment adviser registered with the Securities and Exchange Commission of the United States. Pramerica is a trade name used by PFI and its affiliated companies in select countries outside of the United States. PFI, a company incorporated and with its principal place of business in the United States of America is not affiliated in any manner with Prudential plc, a company headquartered in the United Kingdom. The commentary presented is for informational purposes only, and is not intended as investment advice. This material has been prepared by PIIA on the basis of publicly available information, internally developed data and other third party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information. All opinions and views constitute judgments of PIIA as of the date of this writing, and are subject to change at any time without notice. There can be no assurance that any forecast made herein will be realized. Distribution of this information to any person other than the person to whom it was originally delivered and to such person s advisers is unauthorized and no part of this material may be reproduced or distributed further without the written approval of PIIA. These materials are not intended for distribution to, or use by, any person in any jurisdiction where such distribution would be contrary to local law or regulation. The companies, securities, sectors and/or markets referenced herein are included solely for illustrative purposes to highlight the economic trends, conditions, and the investment process, but may or may not be held by accounts actually managed by PIIA. The strategies and asset allocations discussed do not refer to any service or product offered by PIIA or by its affiliates The global asset and strategy allocation models presented are hypothetical allocation models shown for illustrative purposes only, and do not necessarily reflect the management of any actual account. Following the allocation recommendations presented will not necessarily result in profitable investments. Past performance is not an assurance of future results. Nothing herein should be viewed as investment advice to adopt any investment strategy, nor should it be considered an offer to provide investment advisory or other allocation services. 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