Global Economic Perspective

Transcription

1 Investment Team Update December 214 PERSPECTIVE FROM THE FRANKLIN TEMPLETON FIXED INCOME GROUP Christopher Molumphy Michael Materasso Roger Bayston Michael Hasenstab John Beck IN THIS ISSUE: Federal Reserve Points Cautiously towards Rate Rise Winners and Losers from Oil Price Decline European Outlook Federal Reserve Points Cautiously towards Rate Rise With 321, jobs added, the initial US nonfarm payroll report for November was much stronger than markets expected and brought job growth in 214 close to levels last seen in the late 199s. Added to upward revisions in September and October jobs data, the nonfarm payrolls data reinforce the view that whatever is occurring in the rest of the world, the US economy appears to remain firmly on track to record reasonably strong growth in the months ahead. And while fourth-quarter gross domestic product (GDP) growth for the United States is expected to be lower than the third-quarter rate of 5.%, there is renewed optimism that the country s economic expansion is being put on a sustainable footing. Perhaps even better than the raw jobs numbers were signs that wages, long stagnant, might finally be moving upwards. According to US Bureau of Labor Statistics figures, average hourly earnings rose.4% in November over the previous month and 2.1% from a year earlier, though such rises are still modest. Combined with an unemployment rate that remained stuck at 5.8% and a historically low labour force participation rate, these results were taken as indicating some remaining slack in the labour market. However, combined with low inflation and falling energy prices, a brightening jobs picture may have helped lead to a small rebound in US consumer spending in October after a flat September. Corporate data have also been relatively upbeat. US manufacturing output recorded its largest increase in nine months in November, and industrial production surpassed its pre-recession peak. As for forward indicators, the November Institute for Supply Management purchasing managers index (PMI) readings for the manufacturing and nonmanufacturing sectors alike remained well above the 5 mark that separates expansion from contraction. New orders have been strong, while nonresidential fixed investment grew at an annualised pace of over 7% in the third quarter, according to the US Bureau of Economic Analysis. One important factor in America s revival is the fall in oil prices. International Monetary Fund (IMF) Managing Director Christine Lagarde said that lower energy prices could help accelerate US growth to 3.5% next year from a projected 3.1% in 214. Although cracks have begun to appear in the US high-yield bond market in which energy sector-related issues have grown in recent years and now make up a sizable part of the noninvestment-grade universe, and although energy-related capital spending could be expected to slide, falling oil prices are thought to be overwhelmingly good for the US economy because they typically stimulate consumer spending and hold down inflation. The lower costs could support economic growth by helping boost corporate earnings and, if they last, might lessen the pressure on the US Federal Reserve (Fed) to raise interest rates at anything more than a very gradual pace.

2 Chart 1: US Recovery Real GDP (Quarter-Over-Quarter) 6% 4% 2% % -2% -4% 9/9 9/1 9/11 9/12 9/13 9/14 9/15 Source: US Bureau of Economic Analysis, data through 3/9/14; as at 25/11/14. Estimates from Bloomberg survey of 87 economists forecasts, surveyed from 7/11/14 12/11/14; reported on 13/11/14.There is no assurance that any projection, estimate or forecast will be realised. Chart 2: US Oil Prices November 213 November Actual Estimate Moving Average 5 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Source: New York Mercantile Exchange, crude oil price per barrel; as at 3/11/14. Nonetheless, while the Federal Open Market Committee (FOMC) under Chair Janet Yellen is considered dominated by policy doves, the improving jobs picture has pleaded for normalisation of interest-rate policy after six years of close to zero base rates. Indeed, in early December, FOMC Vice Chair Stanley Fischer opined that, even allowing for low inflation, short-term rates were too far below normal at a time when the US labour market was normalising rapidly. Thus, while inflation expectations have remained low (in part because of low oil prices and the strong US dollar), and while wage growth has remained modest, an unlikely drop in core inflation might be needed core personal consumption expenditures prices excluding food and energy prices rose an annualised 1.6% in October to stave off some initially moderate tightening of base rates in the months ahead. In any case, Yellen dismissed low headline inflation as transitory. Instead, backing up our view that the futures markets have heretofore shown themselves to be a little overconfident that the first rate rise will not be seen until near the end of 215, the FOMC s statement of 17 December stated that increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Yet the statement was marked by caution, with the FOMC saying it could be patient in its moves to normalise policy. Just as revealingly, the FOMC s own dots chart, which shows the interest-rate expectations of individual FOMC members, suggested that FOMC members now believe interest rates will be a bit lower at end-215 than they thought when they made their previous forecast in October. The caution displayed in the latest FOMC statement on future policy tightening was most likely designed to reassure investors at a very sensitive time in global markets. Indeed, how delicate prospects are for investors can be seen in the continued performance of longer-dated paper. As we move into a new year, we hope that low inflation, the fallout (however slight) from weakness in the global economy, and an apparent determination by US policymakers to refrain from scaring financial markets should help avoid a disorderly unravelling of the bond market. Winners and Losers from Oil Price Decline Due to an excess of supply rather than a lack of demand, crude oil prices have declined rapidly in recent months. By mid- December, ICE January Brent the international oil benchmark was being quoted at under US$6 a barrel, almost half the price level of mid-june. As the majority of global economies are oil importers, this price decline is likely to add to global growth and that of large emerging-market oil importers like India. Other positive effects for net oil importers include potential improvements in trade and current account balances, as well as fiscal deficits. We believe the oil-assisted drop in inflation should help contain interest rates and provide a boost to investment and consumption. At the same time, the drop in oil prices has bolstered much-needed economic reform in certain economies. In November, both Malaysia and Indonesia moved towards cutting fuel subsidies. India and Egypt have also made similar policy commitments to improve their public finances. This drop in oil prices has placed downward pressure on the currencies of commodity producers, which have suffered major declines in recent weeks. Other currencies have performed comparatively better. The Thai baht, Indian rupee and Philippine peso have lost much less against the US dollar compared to the Russian ruble and Colombian peso, the currencies of two major commodity producers. As an oil producer, Mexico has also seen its currency fall against the US dollar this year; however, this fall has been relatively limited as the United States is one of its largest trading partners. 2

3 Chart 3: Revisions to IMF GDP Growth Projections for Emerging Markets 1% 8% 6% 4% 2% % 12/ 12/2 12/4 12/6 12/8 12/1 12/12 12/14 216E 218E April 211 September 211 April 212 October 212 April 213 April 214 October 214 E: Estimated. Source: Copyright 214, International Monetary Fund, World Economic Outlook, October 214. All Rights Reserved. Emerging Market countries as defined by IMF. As a percent of GDP, historical data as at 3 September 214, IMF Projections through 218. International Monetary Fund staff estimates begin after 3 September 214. There is no assurance that any projection, estimate or forecast will be realised. Chart 4: Changes in Exchange Rates against the US dollar (%) 1 January to 3 November European Outlook As December rolled on, a glut of indifferent or disappointing statistics and stubbornly low inflation seemed to point the way to some form of quantitative easing (QE) for Europe involving the outright purchase of government bonds and other securities on the open market. The market s expectation that the ECB will shortly intervene with further injections of money could be seen by the seeming lack of a market reaction to recent sovereign ratings downgrades. France s credit rating was downgraded by Fitch in mid-december, but without any immediate effect on the rate at which the country can borrow. But for all of France s problems, its 1-year government bond yields still stood near record lows of about.9% after the December downgrade. Italy too suffered a ratings downgrade in December, with Standard & Poor s lowering the country s credit rating to just a notch above junk status. Symbolising Italy s even more entrenched problems, the country currently pays a higher yield on 1-year bonds than France at just over 2%. However, although Italian yields rose slightly due to the downgrade, the rise was not enough to eradicate the fall in yields over the previous month. Chart 5: European 1-Year Government Yields vs. 1-Year US Treasuries August 212 to November 214 8% 6% -4 4% 2% Source: FactSet, 3 November 214. Earlier this year, investors seemed to make some welcome differentiation between countries with different perspectives. Even allowing for severe drops in some bond markets, emerging-market debt indexes generally seemed resilient given the volatility seen in currencies and stocks. However, by mid- December, panic started to affect investor sentiment towards emerging markets more broadly. This panic was a combination of the negative impacts of lower oil prices on commodity producers, as well as the rising US dollar. The Central Bank of Russia was forced to hike its main interest rate to 17% in an attempt to stave off a collapse of the ruble. Disruption could remain a feature of emerging markets for some time as investors begin to prepare to navigate what we think is a risingrate environment in the United States and to come to terms with the softening of the Chinese economy. Though fundamentally strong economies are not exempt from the short-term destabilising effects of the fall in the price of oil across emerging markets, we believe they should stabilise once panic dissipates and financial assets begin to benefit from fresh liquidity injections from the Bank of Japan and the European Central Bank (ECB). % 8/12 11/12 2/13 5/13 8/13 11/13 2/14 5/14 8/14 11/14 United States Spain Italy Germany Source: Bloomberg, through 3/11/14. The likelihood of further ECB intervention was reinforced by the disappointing take-up of the latest ECB offer of cheap four-year loans to European banks under its targeted longer-term refinancing operation (TLTRO) and by the ECB s own December forecasts for growth and inflation next year, in which the central bank had to pare the already-modest levels it was predicting last September. ECB doves can also point to data such as a slowdown in business activity (as shown by composite PMI indicators for November) and a headline inflation figure that has remained well below the ECB s target of just under 2% as reasons for resorting to steadily more radical ways to boost the eurozone economy. The political and social temperature has also begun to rise and contribute to the case for further stimulus. There have been general strikes in Belgium and Italy, many investors appear fearful that political miscalculation might see the far-left Syriza party elected to government in Greece, and populist left- and 3

4 right-wing parties have been topping opinion polls in both Spain and France. Furthermore, on the European Union s doorstep, fears have grown about the stability of the Russian and Ukrainian economies. QE is not yet a done deal: Opposition from Germany may try to halt it, or at least undermine the size and scope of what the ECB is able to buy. German resolve to resist QE might be hardened by the surprising jump in industrial orders in Germany in October, along with improved business and consumer confidence in November in Europe s largest economy. And questions remain about whether QE violates the European Treaty. Doubters might also argue that the inflation picture has been distorted not only by the fall in oil prices, but also by ongoing efforts in crisis-ridden eurozone member countries to restore competitiveness by lowering costs and wages. On balance, however, with ECB President Mario Draghi apparently ready to override German objections, we believe some form of QE seems likely. A move to buy government bonds would mark an important change in the ECB s role and have profound political implications for the monetary union, in our view. With eurozone governments already obliged to submit their annual budget plans to the European Commission for assessment, ECB government bond purchases would mark a further step on the road to fiscal integration. Given the rapid changes that can take place in markets and economic conditions, it s often difficult to provide up-to-date materials that address the most current situations. This material is intended to be of general interest only and should not be construed as individual investment advice or an investment recommendation. The views expressed are those of the noted investment managers and their comments, opinions and analysis are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal. Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (FTI) has not independently verified, validated or audited such data. More concretely, a combination of low oil prices, monetary stimulus, some form of fiscal stimulus, and the successful implementation of labour and other structural reforms might mean that late-214 will mark a low point in the fortunes of the eurozone economy. Compilers of a closely watched investor sentiment index for the eurozone, the Sentix, say the economy is now entering a recovery phase after teetering on the edge of recession in the third quarter. By mid-december, oil prices had reached their lowest point in over five and a half years, freeing up spending power for businesses and households, while the decline in the euro down over 1% against the US dollar since the beginning of 214 has helped Europe s exporters. However, any upturn in the eurozone s fortunes could be limited by an uncertain world economy, and the decline in the euro mitigates somewhat the positive effect of the drop in oil prices. As the disappointing TLTRO operations show, demand for loans has remained muted as banks, businesses and households continue to focus on deleveraging. We believe the drop in oil prices and the strengthening US economy may prevent a fullblown recession in the eurozone in 215 with or without QE. But it might be too much to expect anything more than a gradual pickup in the eurozone until the structural reforms being labouriously pushed through in France and Italy begin to make themselves felt. 4

5 EUROLAND MACROECONOMIC DATA Eurozone Real GDP, Y/Y (%) FINAL OUTPUT Gross Domestic Product (GDP) 1 4Q13 1Q14 2Q14 3Q14 GDP, Y/Y (%) Private Consumption, Y/Y (%) Gross Fixed Capital Formation, Y/Y (%) ECONOMIC INPUTS 1 Jul 14 Aug 14 Sep 14 Oct Q9 4Q1 1Q12 2Q13 3Q14 Retail Sales, Y/Y (%) Unemployment Rate (%) Industrial Production, Y/Y (%) INFLATION & WAGE PRESSURE Inflation Indicators¹ Aug 14 Sep 14 Oct 14 Nov 14 Consumer Price Index (CPI), Y/Y (%) Core CPI, Y/Y (%) FINANCIAL MARKETS Aug 14 Sep 14 Oct 14 Nov 14 Dow Jones EURO STOXX Price Index EUR, Trailing P/E Ratio 2 ECB Refinance Rate (%) Year Yield German Bunds (%) BALANCE OF PAYMENTS 1,3 Trade Balance Jul 14 Aug 14 Sep 14 Oct 14 Billion Euro Current Account Balance 4Q13 1Q14 2Q14 3Q14 % GDP JAPAN MACROECONOMIC DATA FINAL OUTPUT Gross Domestic Product (GDP) 4 4Q13 1Q14 2Q14 3Q14 GDP, Q/Q ar (%) Private Consumption, Q/Q ar (%) Fixed Capital Formation, Q/Q ar (%) ECONOMIC INPUTS Jun 14 Jul 14 Aug 14 Sep 14 Unemployment Rate (%) Industrial Production, Y/Y (%) Tertiary Index, Y/Y (%) Corporate Activities 4Q13 1Q14 2Q14 3Q14 Corporate Profit Growth (%) Tankan Quarterly Survey (index level) INFLATION Inflation Indicators 5 Jul 14 Aug 14 Sep 14 Oct 14 Consumer Price Index (CPI), Y/Y (%) CPI ex-fresh Food, Y/Y (%) FINANCIAL MARKETS 2 Aug 14 Sep 14 Oct 14 Nov 14 Nikkei 225, Trailing P/E Ratio Month Yield JGBs (%) Year Yield JGBs (%) BALANCE OF PAYMENTS Monthly Trade Balance 7 Jul 14 Aug 14 Sep 14 Oct 14 Billion Yen Current Account Balance 8 4Q13 1Q14 2Q14 3Q14 % GDP Abbreviations: Q/Q ar: Quarter-over-quarter annualised rate. Y/Y: Year-over-year. JGBs: Japanese Government Bonds. 1. Source: European Union Source: Bloomberg. P/E ratios of Dow Jones EURO STOXX 5 Price Index and Nikkei 225 Stock Average as calculated by Bloomberg. 3. Source: European Central Bank. Due to a discontinued data series, there has been a change in the way the Euroland s current account balance as a % of GDP is calculated. 4. Source: Economic and Social Research Institute, Cabinet Office, Government of Japan. 5. Source: Ministry of Internal Affairs and Communication, Japan. 6. Source: Ministry of Economy, Trade and Industry, Japan. 7. Source: Ministry of Finance, Japan. For 8. Source: Financial Bank Professional Japan. Use Only / Not For Public Distribution Past performance does not guarantee future results. Source: European Union , as at September 214. Consumer Price Index, Y/Y (%) Nov-9 Nov-1 Nov-11 Nov-12 Nov-13 Nov-14 CPI Core CPI Source: European Union , as at November 214. External Trade Balance, GDP (%) Q11 3Q12 3Q13 3Q14 Source: European Union , as at September 214. Japan Real GDP, Q/Q ar (%) Source: ESRI, Cabinet Office, Government of Japan, as at September 214. Consumer Price Index, Y/Y (%) - - Oct-9 Oct-1 Oct-11 Oct-12 Oct-13 Oct-14 CPI CPI ex Fresh Food Source: Ministry of Internal Affairs and Communications, Japan, as at October 214. Visible Trade Balance, GDP (%) Q11 3Q12 3Q13 3Q14 Source: Ministry of Finance, Japan and Economic and Social Research Institute, Cabinet Office, Government of Japan, as at 3 September

6 US MACROECONOMIC DATA FINAL OUTPUT Gross Domestic Product (GDP) 1 2Q14 3Q14 4Q14E 2 1Q15E 2 Q/Q ar (%) ECONOMIC INPUTS CONSUMPTION/FINAL DEMAND Income/Savings 1 Jul 14 Aug 14 Sep 14 Oct 14 Consumer Spending, Y/Y (%) Personal Income, Y/Y (%) Savings Rate (%) Employment Aug 14 Sep 14 Oct 14 Nov 14 Unemployment Rate (%) Participation Rate (%) Nonfarm Payrolls (in thousands) Jobless Claims, 4-wk average (in thousands) Housing 5 Jul 14 Aug 14 Sep 14 Oct 14 Existing Home Sales (in millions) Y/Y Change (%) INVESTMENT Corporate Earnings 6 2Q14 3Q14 4Q14E 1Q15E Earnings, Y/Y (%) Production & Utilisation 7 Jul 14 Aug 14 Sep 14 Oct 14 Industrial Production, Y/Y (%) Capacity Utilisation (%) Nonresidential Fixed Investment 1 4Q13 1Q14 2Q14 3Q14 Y/Y (%) INFLATION & PRODUCTIVITY Inflation Indicators Jul 14 Aug 14 Sep 14 Oct 14 Personal Consumption Expenditure (PCE), Y/Y (%) 1 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 3 4Q13 1Q14 2Q14 3Q14 Productivity, Q/Q ar (%) Unit Labour Costs, Q/Q ar (%) FINANCIAL MARKETS Valuation Oct 14 Nov 14 Dec 14E Jan 15E P/E S&P Fed Funds Rate 7, BALANCE OF PAYMENTS US Monthly Trade Deficit 1, 9 Jul 14 Aug 14 Sep 14 Oct 14 Billion USD US Current Account Deficit 3Q13 4Q13 1Q14 2Q14 Quarterly (in USD billion) Annualised (% GDP) Abbreviations: Q/Q ar: Quarter-over-quarter annualised rate. Y/Y: Year-over-year. E: Estimate. 1. Source: US Bureau of Economic Analysis, as at 3/11/ Source: Bloomberg Economic Forecasts, as at 3/11/ Source: US Bureau of Labor Statistics, as at 3/11/ Source: US Department of Labor as at 3/11/ Source: Copyright National Association of Realtors. Reprinted with permission. 6. Source: Bloomberg. Corporate Earnings and P/E S&P 5 represented by Bloomberg s calculation of the earnings of S&P 5 Index components, as at 3/11/14. Standard & Poor s, S&P and S&P 5 are registered trademarks of Standard & Poor s Financial Services LLC. 7. Source: US Federal Reserve. At the 16 December 28 meeting, the Federal Reserve cut the main US interest rate to a target rate between zero and.25%. 8. Source: Chicago Board of Trade (3-Day Federal Funds Futures Rate for December 214 and January 215), as at 3/11/ Source: US Census Bureau. 1. Source: Bloomberg Indexes. For Past Financial performance Professional does not guarantee Use Only future / Not results. For Public Distribution Gross Domestic Product (GDP), Q/Q ar (%) 5-5 Source: US Bureau of Economic Analysis, as at September 214. Personal Income & Expenditures, Y/Y (%) Oct-9 Oct-1 Oct-11 Oct-12 Oct-13 Oct-14 Consumer Spending Personal Income Source: US Bureau of Economic Analysis, as at October 214. Nonfarm Payrolls & Unemployment Rate Thousands -1, Nov-9 Feb-11 May-12 Aug-13 Nov-14 Source: US Bureau of Labor Statistics, as at November 214. All figures seasonally adjusted. Consumer Price Index, Y/Y (%) Nonfarm Payrolls Net Change Source: US Bureau of Labor Statistics, as at October 214. Productivity & Unit Labour Costs, Q/Q ar (%) Source: US Bureau of Labor Statistics, as at September 214. US Annualised Trade Deficit, GDP (%) Sources: US Census Bureau and US Bureau of Economic Analysis, as at September Percent Unemployment Rate (right-hand scale) - Oct-9 Oct-1 Oct-11 Oct-12 Oct-13 Oct-14 CPI Core CPI Unit Labour Costs Productivity - 6

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