Global Economic Perspective

Transcription

1 FEBRUARY 201 Perspectives from the Franklin Templeton Fixed Income Group Christopher Molumphy Michael Materasso Roger Bayston Michael Hasenstab John Beck US GROWTH FUNDAMENTALS REMAIN INTACT NO RE-RUN OF ASIAN CRISIS SO FAR EUROPEAN OUTLOOK US GROWTH FUNDAMENTALS REMAIN INTACT Having already cut back its monthly asset purchases by US$10 billion in January, the US Federal Reserve (Fed) announced it would taper them by a further US$10 billion (to US$6 billion) in February, and seemed on course to halt its monthly purchases entirely later this year should the labor market continue to improve, inflation show signs of normalizing and the US economy continue to see sustainable growth. Fed tapering has led to a flight of capital from some countries, with much of the liquidity that seeped out of the US as a consequence of Fed asset purchases coming back home. The marked drop in implied borrowing costs in January and early February triggered by these developments seemed to surprise some observers who had been expecting a rise in bond yields as the Fed stepped back from the market. An important question is whether market scares in some relatively small emerging markets together with softer domestic data were simply an excuse for some market participants to re-position their portfolios after a long run-up in risk assets, thus triggering the recent rally in benchmark government bonds (and drop in global stock prices), or whether these market gyrations reflect legitimate concerns about growth prospects in the months ahead. The recent drop in bond yields can be partly attributed to weaker US economic data, most notably a drop in durable goods orders in December, as well as a decline in auto sales in January and an Institute for Supply Management (ISM) survey that suggested the US manufacturing sector barely grew in the same month. Along with some moderation in job creation in December and January and slowing corporate earnings, these data have raised concerns that US economic growth might be starting to weaken. Chart 1: Interest Rates (%) 10-Year US Treasury Yield Daily Yields January 2008 January Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-1 Jan-1 Source: Bloomberg, data as of 1/1/1. Past performance does not guarantee future results. For our part, we suspect that recent developments are the consequence of investors having become perhaps a bit too optimistic about the pace of US growth on the basis of the.2% annualized gross domestic product (GDP) growth seen in the fourth quarter of 201 and.1% growth seen in the prior quarter. To be clear, we continue to believe that the US recovery is well entrenched and nothing has changed in the fundamental strengths of the US economy in recent weeks for us to change our view. We think some of the disappointing data reports for December and January can be explained simply by exceptional winter weather, which curbed spending and hiring. But a comparison of year-overyear data rather than month-over-month data show the US is on the right path, in our opinion. The US recovery is being helped by a number of factors, not the least of which is the fading of the effects of last year s cuts in federal spending and hikes in tax rates. The congressional budgetary deal struck in November may also help stabilize growth prospects. As a consequence, barring a major emerging-market crisis,

2 we expect benchmark US Treasury yields could resume their climb. There may, however, be some breaks in this trend as the market adjusts to potentially higher interest rates, as well as the potential for further reversals of capital flows to emerging markets and occasional data disappointments. Chart 2: US Unemployment Rate (%) January 2008 January Source: US Bureau of Labor Statistics, data as of 2/07/1. As determined by the National Bureau of Economic Research, there was one recessionary period from 12/08 to 1/1; it occurred from 12/07 to 6/09. Shaded area represents approximate recessionary period. Recessionary periods only cover actual released GDP figures. Chart : A Sluggish US Recovery (%) Quarter-Over-Quarter Annualized September 0, 2009 December 1, 201 Estimate Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-1 Apr-1 Jul-1 Oct-1 Jan-1-2 Sep-09 Jun-10 Mar-11 Dec-11 Sep-12 Jun-1 Mar-1 Dec-1 Actual Estimate Source: US Bureau of Economic Analysis, Bloomberg, National Bureau of Economic Research, as of 2/1/1. There is no assurance any estimate will be realized. However, although we expect bond rates in general could rise, it may be at a moderate rate and in line with US economic growth, which may also be moderate. The fourth-quarter US GDP report showed consumers have begun to spend again, while consumer confidence in January reached a five-year high. But alongside these positive factors, wage growth has remained relatively slow (in spite of recent drops in unemployment and strong productivity gains), and job gains in December and January were well below the average pace for 201. In addition, lending standards that remain structurally tighter than before the financial crisis and the recent rise in long-term interest rates (due to Fed tapering) could potentially curb activity. Nonetheless, the fourth-quarter GDP report also suggested that many businesses however cautiously have started to boost investment spending thanks to very good profitability, interest rates that remain historically low and less uncertainty over the economic outlook and government policy. While January s ISM index of manufacturing activity disappointed, the equivalent index of nonmanufacturing (a much larger part of the US economy) showed services activity continued to expand. At the same time, an improving global economy, including recovery in Europe, has been boosting US exports, while increased domestic energy production has weighed on import growth. NO RE-RUN OF ASIAN CRISIS SO FAR Emerging markets have faced a tumultuous few weeks, caught by a mixture of localized political problems (most notably in the case of Thailand, Turkey and Ukraine), declines in a number of currencies as the Fed reduces its asset purchases, and the perception of a rebalancing of global economic prospects toward the developed world. We continue to believe that investors must differentiate between countries that continue to post solidly underpinned growth fundamentals (such as low debt levels, solid current account balances and strong currency reserves) and those that have become overly dependent on short-term credit inflows or suffer from some other heretofore overlooked deficiency. There are indeed some signs the markets are differentiating between countries according to fundamentals. Thus, among free-floating currencies, the South Korean won, Taiwanese dollar and Mexican peso have declined far less over the past three months than has the Turkish lira, South African rand or Indonesian rupiah, for example. Gulf Cooperation Council countries have generally remained strong, thanks to a string of positive data releases and the pegging of national currencies to the US dollar. However, one cannot deny that financial assets throughout emerging markets have been buffeted at least to some extent by developments since late last year. 2

3 Chart : Recent US Dollar Strength versus Major Currencies January 201 January Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Jan-1 Source: Federal Reserve H.10 Report, 2/0/1. Weighted Average of the Foreign Exchange Values of the US Dollar Against a Subset of Broad Index Currencies. Index base = March 197. Past performance does not guarantee future results. But the turmoil of recent weeks may at least act as a spur for emerging markets to implement the reforms needed to maintain economic dynamism and to adopt monetary policy as circumstances dictate. The aggressive (albeit belated) hike in overnight lending rates by the Turkish central bank at the end of January and adoption of a more orthodox monetary policy helped the Turkish lira claw back some of its losses in the following days. Also in late January, the Reserve Bank of India pushed through its third rate increase in five months and made it clear it was considering an inflation target. Even the decision by Argentina's central bank to stop intervening in the markets to defend the peso a policy that had drained Argentina of its foreign currency reserves bespeaks a new realism, in our view. As the Fed continues to taper its asset purchases and as currency movements could continue to mirror the growth in the US economy, market interest rates seem likely to us to resume their upward slant, potentially causing further bouts of volatility. Thus we believe the ongoing divergence in performance between individual countries is likely to continue. Nonetheless, we are far from convinced that there could be a re-run of previous emergingmarket crises such as what occurred in the late 1990s and early 2000s. Data out of the US since the beginning of this year have been decidedly mixed, which means increases in US base rates should still be some way off and renewed rises in market rates should be gradual. In addition, the debt fundamentals of the majority of emerging-market countries are far better than they were during those crisis periods, and currency reserves today generally are far higher. Local debt markets have gained in depth and maturity, and local institutional investors have played an important role in steadying some markets in recent weeks. We also remain fairly confident the liquidity heretofore provided by the Fed s monthly asset purchases will be largely replaced by similar, massive new stimulus measures by the Bank of Japan this year and that emerging markets are also likely to benefit from the improvement in growth that is underway throughout the developed world. In particular, the recent drop in the value of their currencies against the US dollar offers an important advantage to countries like South Korea and Mexico that have significant exports to the United States. China remains something of an uncertain factor. At least some of the volatility seen in recent weeks reflects concerns that the country s growth is flagging. Structural reforms in China also make the situation there difficult to read. Led by a set of newly selected leaders, the world s second-largest economy is in the midst of a monumental makeover of its economic model. The aims of the reforms include developing the domestic Chinese economy and lessening dependence on exports. Highly delicate financial-sector reform is also underway, involving the liberalization of deposit interest rates and the uncovering of the true level of leverage carried by Chinese local governments and other economic actors. The country s interest rates have long been artificially suppressed in an effort to promote large fixed investments, which are often undertaken by state-owned enterprises. Interest rates have been rising, possibly dampening growth somewhat, but also having the welcome effect of reining in unsustainable credit growth. Although financial-market liberalization could lead to greater business-cycle volatility in the years ahead, we do not see the risk of an economic hard landing in the short term. While parts of the financial system seem to be creaking as a result of the government s reform drive, periodic surges in the interbank market have given the authorities plenty of advance warning of eventual difficulties. And as they have already proven, the authorities seem to possess the willingness and capacity to intervene to help head off a crisis in the financial sector. Additionally, we think China s state-owned banks, where they have been poorly managed, have enough assets to cover much of any potential damage. EUROPEAN OUTLOOK Forward indicators, including surveys of activity in Europe s manufacturing and nonmanufacturing sectors and consumer confidence, continue to suggest the region s recovery is gaining some traction. The UK remains in the vanguard, with its economy growing at an annualized rate of 2.8% in the final quarter of 201. Many observers doubt whether such a level of growth can be maintained, although there is hope that growth can be prolonged should business investment and exports take over as the leading drivers of growth from household consumption. The UK should also benefit from the turnaround in the eurozone, although prospects for UK exports (and for European exports overall) have

4 been clouded by the rapid decline in the yen over the past year and uncertainty about the slowing pace of growth in China and other emerging markets. In addition, some signs of contagion from emerging-market worries could be seen in the heavy drop in the value of the Hungarian forint at the end of January. The Polish zloty and Czech koruna have also stumbled. Chart : Annualized UK GDP growth (%) Q12 2Q12 Q12 Q12 1Q1 2Q1 Q1 Q1 Source: Office for National Statistics, 1/28/1. Nonetheless, reasonably strong UK growth appears to remain the order of the day. Combined with substantial improvements in the unemployment figure plus a fall in inflation, it has been testing the Bank of England s credibility. Unlike the European Central Bank (ECB), the Bank of England has undertaken large-scale asset purchases (expanding its balance sheet threefold since 2008) and provided forward guidance to the effect that interest rates will remain low until unemployment has fallen to 7% so long as inflationary pressures remained in check. But UK unemployment has been falling much faster than predicted (to 7.1% in December, the lowest level since early 2009), while consumer price inflation in the same month was in line with the Bank of England s target of 2%, and well down from its peak of.2% in Large eurozone countries such as France, Spain and Italy would probably like to have the Bank of England s problems (although probably not the UK s large current account deficit). In those countries, unemployment has remained much higher and growth much lower. Of the three, Spain seems the most firmly set on improvement, thanks to a series of structural reforms since But Spain and much of the rest of the eurozone are facing excessively low inflation. Eurozone inflation recently fell significantly below market forecasts, with consumer prices rising at an annual rate of just 0.7% in January, well below the ECB s target of 2% The weakness in domestic demand caused by austerity policies and the lack of wage growth no doubt largely explain the general absence of inflation in the eurozone. Hit by rising taxes, many of the region s corporations and households have long been more interested in deleveraging than in contracting new credits. Matters have not been helped by the eagerness with which banks have repaid funds loaned to them by the ECB as part of the central bank s long-term refinancing operations. Various emerging markets, either through their own slowing growth or through currency devaluations, may also be contributing to the exceptionally low levels of inflation in Europe. ECB President Mario Draghi has repeatedly stressed he does not think the eurozone risks entering an extended period of falling prices, and it may well be that inflation will pick up as the European economy grows more solidly. Some signs of loan expansion should contribute to this trend. Indeed, a closer look at the January consumer price figures for the eurozone showed that core inflation (stripping out volatile items like food and energy) had a slight uptick compared to the previous month, while producer prices also rose. But even should there be solid arguments for dismissing talk of Japanese-style deflation, there are grounds for fearing that persistently low inflation will make it hard for the weaker European countries to both reduce public debts to a sustainable level and produce a durable improvement in economic competitiveness. Understandably, the ECB has therefore come under increasing pressure to remedy the current situation. Unlike inflation, European capital markets have been well behaved. Yields for peripheral European government bonds over German Bunds have recently either continued to drop or have stabilized. Improvements in sentiment mean there has even been increased interest in Greek debt. In addition, Eurostat released figures showing eurozone government debt as a percentage of GDP had dropped in the third quarter of 201 for the first time in six years, with declines in each of the monetary bloc s three largest economies (France, Germany and Italy).

5 Chart 6: 10-Year Spanish and Italian Government Bond Yield Spreads over German Bonds July 2011 January 201 Basis Points Jul-11 Jan-12 Jul-12 Jan-1 Jul-1 Jan-1 Spain Italy Source: Bloomberg, through 1/1/1. Past performance does not guarantee future results. But the current optimism about Europe may prove misplaced if there is complacency over the lack of inflation and if improved growth causes the movement toward structural reform, which was sparked by the sovereign debt crisis, to grind to a halt. Given that elections to the European parliament will take place in May and that the current European Commission is due to be replaced a few months later, the possibility of policy drift in Europe appears particularly acute. All investments involve risks, including possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging-market countries involve heightened risks related to the same factors, in addition to those associated with these markets smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Such investments could experience significant price volatility in any given year.

6 EUROLAND MACROECONOMIC DATA FINAL OUTPUT Gross Domestic Product (GDP) 1 Q12 1Q1 2Q1 Q1 GDP, Y/Y (%) Private Consumption, Y/Y (%) Gross Fixed Capital Formation, Y/Y (%) ECONOMIC INPUTS 1 SEP 1 OCT 1 NOV 1 DEC 1 Retail Sales, Y/Y (%) Unemployment Rate (%) Industrial Production, Y/Y (%) INFLATION & WAGE PRESSURE Inflation Indicators¹ OCT 1 NOV 1 DEC 1 JAN 1 Consumer Price Index (CPI), Y/Y (%) Core CPI, Y/Y (%) FINANCIAL MARKETS OCT 1 NOV 1 DEC 1 JAN 1 Dow Jones EURO STOXX 0 Price Index EUR, Trailing P/E Ratio ECB Refinance Rate (%) Year Yield German Bunds (%) BALANCE OF PAYMENTS 1 Trade Balance AUG 1 SEP 1 OCT 1 NOV 1 Billion Euro Current Account Balance Q12 1Q1 2Q1 Q1 % GDP JAPAN MACROECONOMIC DATA FINAL OUTPUT Gross Domestic Product (GDP) Q12 1Q1 2Q1 Q1 GDP, Q/Q ar (%) Private Consumption, Q/Q ar (%) Fixed Capital Formation, Q/Q ar (%) ECONOMIC INPUTS SEP 1 OCT 1 NOV 1 DEC 1 Unemployment Rate (%).7 Industrial Production, Y/Y (%) Tertiary Index, Y/Y (%) Corporate Activities 1Q1 2Q1 Q1 Q1 Corporate Profit Growth (%) Tankan Quarterly Survey (index level) INFLATION Inflation Indicators SEP 1 OCT 1 NOV 1 DEC 1 Consumer Price Index (CPI), Y/Y (%) CPI ex-fresh Food, Y/Y (%) FINANCIAL MARKETS 2 OCT 1 NOV 1 DEC 1 JAN 1 Nikkei 22, Trailing P/E Ratio Month Yield JGBs (%) Year Yield JGBs (%) BALANCE OF PAYMENTS Monthly Trade Balance 7 SEP 1 OCT 1 NOV 1 DEC 1 Billion Yen Current Account Balance 9 Q12 1Q1 2Q1 Q1 % GDP 0.9 Abbreviations: Q/Q ar: Quarter-over-quarter annualized rate. Y/Y: Year-over-year. 1. Source: European Union Source: Bloomberg. P/E ratios of Dow Jones EURO STOXX 0 Price Index and Nikkei- 22 Stock Average as calculated by Bloomberg.. Source: European Central Bank.. Source: Economic and Social Research Institute (ESRI), Cabinet Office, Government of Japan.. Source: Ministry of Internal Affairs and Communications, Japan. 6. Source: Ministry of Economy, Trade and Industry, Japan. 7. Source: Ministry of Finance, Japan. 8. Source: Bank of Japan. 9. Source: Bloomberg Indexes. Past performance does not guarantee future results, and results may differ over future time periods. Eurozone Real GDP, Y/Y (%) Q08 Q09 Q10 Q11 Q12 Q1 Source: European Union , as of September 201. Consumer Price Index, Y/Y (%).0 - Jan-09 Jan-10 Jan-11 Jan-12 Jan-1 Jan-1 CPI Core CPI Source: European Union , as of January 201. External Trade Balance, GDP (%) Q10 Q11 Q12 Q1 Source: European Union , as of September 201. Japan Real GDP, Q/Q ar (%) Q08 Q09 Q10 Q11 Q12 Q1 Source: ESRI, Cabinet Office, Government of Japan, as of September 201. Consumer Price Index, Y/Y (%) Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-1 CPI CPI ex Fresh Food Source: Ministry of Internal Affairs and Communications, Japan, as of December 201. Visible Trade Balance, GDP (%) Q10 Q11 Q12 Q1 Source: Ministry of Finance, Japan and Economic and Social Research Institute, Cabinet Office, Government of Japan, as of September 0,

7 US MACROECONOMIC DATA FINAL OUTPUT Gross Domestic Product (GDP) 1 Q1 Q1 1Q1E 2 2Q1E 2 Q/Q ar (%) ECONOMIC INPUTS CONSUMPTION/FINAL DEMAND Income/Savings 1 SEP 1 OCT 1 NOV 1 DEC 1 Consumer Spending, Y/Y (%) Personal Income, Y/Y (%) Savings Rate (%) Employment OCT 1 NOV 1 DEC 1 JAN 1 Unemployment Rate (%) Participation Rate (%) Nonfarm Payrolls (in thousands) Jobless Claims, -wk average (in thousands) Housing SEP 1 OCT 1 NOV 1 DEC 1 Existing Home Sales (in millions) Y/Y Change (%) INVESTMENT Corporate Earnings 6 Q1 Q1E 1Q1E 2Q1E Earnings, Y/Y (%) Production & Utilisation 7 SEP 1 OCT 1 NOV 1 DEC 1 Industrial Production, Y/Y (%) Capacity Utilization (%) Nonresidential Fixed Investment 1 Q12 1Q1 2Q1 Q1 Y/Y (%) INFLATION & PRODUCTIVITY Inflation Indicators SEP 1 OCT 1 NOV 1 DEC 1 Personal Consumption Expenditure (PCE), Y/Y (%) Core PCE, Y/Y (%) Consumer Price Index (CPI), Y/Y (%) Core CPI, Y/Y (%) Producer Price Index (PPI), Y/Y (%) Core Producer Prices, Y/Y (%) Productivity 1Q1 2Q1 Q1 Q1 Productivity, Q/Q ar (%) Unit Labor Costs, Q/Q ar (%) FINANCIAL MARKETS Valuation DEC 1E JAN 1 FEB 1E MAR 1E P/E S&P Fed Funds Rate 7, BALANCE OF PAYMENTS US Monthly Trade Deficit 1,9 SEP 1 OCT 1 NOV 1 DEC 1 Billion USD US Current Account Deficit Q12 1Q1 2Q1 Q1 Quarterly (in USD billion) Annualized (% GDP) Abbreviations: Q/Q ar: Quarter-over-quarter annualized rate. Y/Y: Year-over-year. E: Estimate. 1. Source: US Bureau of Economic Analysis, as of 1/1/1. 2. Source: Bloomberg Economic Forecasts, as of 1/1/1.. Source: US Bureau of Labor Statistics.. Source: US Department of Labor.. Source: Copyright National Association of Realtors. Reprinted with permission. 6. Source: Bloomberg. Corporate Earnings and P/E S&P 00 represented by Bloomberg s calculation of the earnings of S&P 00 Index components, as of 1/1/1. Standard & Poor s, S&P and S&P 00 are registered trademarks of Standard & Poor s Financial Services LLC. 7. Source: US Federal Reserve. At the December 16, 2008 meeting, the Federal Reserve cut the main US interest rate to a target rate between zero and 0.2%. 8. Source: Chicago Board of Trade (0-Day Federal Funds Futures Rate for February 201 and March 201), as of 1/1/1. 9. Source: US Census Bureau. 10. Source: Bloomberg Indexes. Past performance does not guarantee future results, and results may differ over future time periods. Gross Domestic Product (GDP), Q/Q ar (%) Q08 Q09 Q10 Q11 Q12 Q1 Source: US Bureau of Economic Analysis, as of December 201. Personal Income & Expenditures, Y/Y (%) Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-1 Consumer Spending Personal Income Source: US Bureau of Economic Analysis, as of December 201. Nonfarm Payrolls & Unemployment Rate Thousands 1, ,000 0 Jan-09 Apr-10 Jul-11 Oct-12 Jan-1 Nonfarm Payrolls Net Change Unemployment Rate (right-hand scale) Source: US Bureau of Labor Statistics, as of January 201. All figures seasonally adjusted. Consumer Price Index, Y/Y (%) Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-1 CPI Core CPI Source: US Bureau of Labor Statistics, as of December 201. Productivity & Unit Labor Costs, Q/Q ar (%) Q08 Q09 Q10 Q11 Q12 Q1 Unit Labor Costs Productivity Source: US Bureau of Labor Statistics, as of December 201. US Annualized Trade Deficit, GDP (%) Q08 Q09 Q10 Q11 Q12 Q1 Sources: US Census Bureau and US Bureau of Economic Analysis, as of September Percent 7

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