Global Themes: Macroeconomics, Geopolitics and Markets June 2016

Transcription

1 Global Themes: Macroeconomics, Geopolitics and Markets June 2016 Introduction Thanos Papasavvas, CFA Co-Founder & CIO The best that can be said as the UK runs up to its momentous Brexit vote and as China still teeters on the brink of a hard or a soft landing, is that the global economy is uncertain. Yet we maintain our positive outlook on global markets and expect both US and Chinese growth to surprise to the upside versus market expectations. Chinese data has improved slightly supported by an improved trade position and the weakness of its currency. Indeed, whether or not China has a hard or a soft landing is moot; China is an emerging economy with all the challenges that invokes; it is still growing rapidly both in GDP and in trade terms. For the US, the major risks seem political. The Federal Reserve will ensure that monetary policy does not adversely impact the US economy and in particular financial asset prices and consumer sentiment. Yet the increasing prospect of a Trump administration, especially after Paul Ryan's endorsement last week, would raise volatility in markets in 2017 as well as inadvertently increase the value of the US dollar on the back of global uncertainty and safe haven flows. Trump's rhetoric will have unintended consequences for trade, particularly through existing arrangement such as the Trans-Pacific Partnership or evolving ones such as the Transatlantic Trade and Investment Partnership. Furthermore, verbal intervention both from policy makers and politicians is likely to have the opposite effects on currency markets than those intended by Mr Trump which could make 2017 a year of heightened currency volatility and a stronger US dollar. A Clinton victory on the other hand would see the US dollar decline in 2017 as uncertainty subsides and global markets and economies benefit from the continuation of the current geoeconomic and geopolitical policies. The question is whether a Clinton victory could turn the tide of anti-establishment and anti-globalisation rhetoric that is also prevalent on this side of the pond. Indeed, Europe s situation is deeply uncertain. Europe's fragile economic and political equilibrium has been overly dependent on a balancing act performed by one person, German Chancellor Angela Merkel. A British departure, or indeed Merkel's departure in due course, would cause Germany and Europe to face complex realpolitik challenges of a kind that confronted Otto von Bismarck's departure, its legendary chancellor in the 1870s and 1880s. The best outcome for European stability would lie in the UK to remain inside the EU. A British exit would hasten the breakdown of the EU in its current form. 1

2 Given the importance of this potential development for the UK as well as for the other member states, we have attached in a separate document our own geopolitical analysis by Jack Harding who has analysed the geopolitics of Brexit and the implications for the future of European security focusing in particular on the UK, France and Germany. But is the UK likely to exit? My view has been that the UK is likely to stay in the European Union after the 23 June vote and have thus backed a contrarian positive outlook for sterling since its lows in March, when disquiet about a British exit was at its height. From the point of view of world trade, Britain s interest would appear to lie firmly in staying within the EU. International trade and international trade finance are growing extremely slowly. Even on a cautiously optimistic basis, both indicators are unlikely to rise at more than a fraction of pre-crisis rates of 15%-20% annually. This would therefore not be a propitious moment to cut loose from the EU in favour of a new focus on non- European markets. On the assumption that the UK stays in the EU, by 2020 sales to the EU, on our estimates, will still represent the largest component of the country s total exports, at 42%. The share of exports to the larger emerging market economies Brazil, Russia, India, China and South Africa will still be fairly modest at 11%, while that with Anglophone countries, led by the US, is expected to be 15%. Should the UK vote to leave, sterling volatility would rise to new highs but the currency would not drop cataclysmically. The UK and its European partners would have an interest in reaching an amicable resolution threatening neither the economic stability of the UK nor the delicate balance of the entire EU. 2

3 Value of UK trade (USD) Year on Year change (%) Billions Trade Outlook UK The UK government has targeted export-led growth since it was first elected in 2010 with a goal of reaching a total value for UK exports of 1tn by Equant Analytics data suggests that the value of exports, in constant prices, will have risen to just 400bn by 2020 compared to 365bn in This of course has to be seen against a backdrop of slowing global trade but it does point to the under-performance of UK exports since the UK government s targets were first set in 2012 The period since 2008 has been challenging for trade in every country and this volatility can be seen clearly by looking just at the UK s trade with the EU in Figure 1 below which shows that, in nominal terms, trade with the EU has increased at an annualized rate of 3% since The chart also shows the fastest rate of trade growth was in the five years after the introduction of the Euro to 2006 and subsequently a slow-down in growth of trade after the rapid growth post financial crisis. Figure 1: UK Exports to EU, USDm and Y-O-Y change UK exports to Europe, USD bn UK exports to Europe, Y-O-Y change (%) The EU may be the UK's largest trading partner, but trade growth with the EU is the slowest of all other export partners over the period At a rate of annualized growth of 3% it has grown at less than a third of the rate of growth of exports to the BRICS, for example as illustrated in Figure 2. 3

4 Year on Year change (%) Figure 2: UK regional trade growth (%), compared with Exports to Rest of World Exports to Anglophones Exports to BRICS Exports to EU Exports to World CAGR CAGR This is not to suggest that trade with the EU is unimportant. In 2015 the value of trade with the EU was worth some $250 billion, or 44% of the value of the UK s total trade with the world. In comparison, trade with the BRICS was worth just under $53 billion, or just over 9% of UK s overall trade. Furthermore, whilst trade growth with Europe is not showing much sign of growth, trade with the BRICS is likely to grow, from its value now to $62 billion by 2020, or an annualized growth between 2015 and 2020 of 3.3%. This compares to an annualized growth in exports to the EU of just 0.5% over the same period. Figure 3: UK exports to EU and BRICS, (YOY %) UK exports to Europe, (YOY %) UK exports to BRICS (YOY %) Trade with the Anglophones, the US, Australia, Canada and New Zealand follows a similar path to that of the EU, however, suggesting that the slower growth in trade with the EU is about slower trade growth between developed nations and not one that is specific to the UK s trade with the EU. Trade with Anglophones was 4

5 Year on Year change (%) Value of trade (USD) Billions some 14.7% of the UK s total export trade in 2015 so it is smaller than the value of exports to the EU as can be seen in figure 4 below, and is forecast to grow by approximately 1% by 2020 annually as in figure 2 above. Figure 4: UK exports to the EU and Anglophones, (USD) UK exports to Europe (USD) UK exports to Anglophones (USD) Trade with the rest of the world includes the European Free Trade Area, Japan and South Korea as well as many large emerging economies such as Indonesia and Mexico and the whole of the Middle East and North Africa. It represents 31% of UK s total exports but interestingly, is much more volatile than trade with the EU. Figure 5: UK exports to EU and Rest of World, (YOY %) UK exports to Europe, (YOY %) UK exports to RoW (YOU %) 5

6 There are three main highlights from this analysis: The UK's 1tn target for exports set by the UK Government in 2012 to be reached by 2020 was always over ambitious as there is little sign that trade will grow quickly over the next five years. The fastest growth will be with the BRICS countries, by an annualized rate of 3.4%. Trade elsewhere is likely to grow more slowly, but since the BRICS represent the smallest share of UK trade, this does not in the end make a large contribution to the overall growth in UK trade. The slower growth in trade with the EU is about slower trade growth between developed nations in general and not one that is specific to the UK's trade with the EU. It is likely that the increase in trade with the BRICS will have a substitution effect: exports to the BRICS will increase as a proportion of UK exports while exports to the EU will decline proportionately. This is illustrated in Figures 6 and 7 FIGURE 6: Share of UK exports by global grouping, 2015 (%) Figure 7: Share of UK exports by global grouping, 2020 (%) UK exports to EU UK exports to BRICS UK exports to Anglophones UK exports to Rest of World UK exports to EU UK exports to BRICS UK exports to Anglophones UK exports to Rest of World The figures show that by 2020 it is likely that trade with the EU will have fallen back to 42% versus 44% now and trade with BRICS will account for 11% of UK s exports compared to 10% now. These are hardly seismic shifts in the structure of UK trade: the UK, irrespective of the outcome of the referendum, will remain dependent on the EU for its trade for the foreseeable future. 6

7 Currency Outlook British pound (GBP) - Positive We maintain our positive outlook on the pound which is broadly unchanged since last month at GBP from GBP , and EUR/GBP from We are cautiously optimistic partly on valuation terms which have historically proven very resilient at levels near or below GBP/USD , but also because we believe that should Brexit occur it is in the interests of all parties to reach an amicable resolution which will not threaten the economic stability of the UK nor the delicately balanced economy of the EU. Furthermore, with a probability of Brexit already in the price, a vote to stay in the EU could see sterling rallying back to /$ 1.55 and towards EUR/GBP However, not beyond that due to the poor trade deficit numbers. Indian rupee (INR) - Positive We maintain our positive outlook on the currency, which at INR is marginally off last month's INR levels. The cautious tone in markets towards emerging market currencies, ahead of Brexit and the Fed, kept the currency contained despite the stronger than expected year on year growth rate for Q at 7.9%. India continues to be the fastest growing large economy worldwide and with RBI governor Rajan at the helm we feel confident of the economic trajectory ahead. Furthermore, we believe the currency is protected on any downward pressure from significant reserves accumulated to contain any threat of currency weakness. Euro (EUR) - Neutral We continue to maintain our neutral outlook on the euro against the US dollar, which remained range bound and closed at EUR from EUR since our report last month. Our outlook is driven by the heavy reliance placed in Merkel and the political uncertainty surrounding the project over the medium term, especially if the UK were to leave the EU. The eventual departure of Merkel would challenge the status quo and give more weight to politicians and political parties at the fringes across the EU. It is very timely in fact that for the first time since the Second World War Germany's two main parties (CDU and SPD) have fallen below 50% in the polls. We therefore see a higher risk of the euro weakening due to a loss of confidence in the politics rather than the economics. The rationale for not being outright negative is threefold: 1. The currency has had a significant correction already since its 2014 highs; 2. We don't believe the US Fed will be aggressive thus interest rate differentials versus what is expected by the market will not be in favour of the USD, and 3. Merkel is not expected to depart in the near term after having survived the latest refugee crisis. Brazilian real (BRL) - Neutral We maintain our neutral outlook on the real expecting it to range trade between BRL 3.60 and Over the month it weakened marginally to BRL from BRL on the continuing uncertainty surrounding internal political developments as well as the concerns surrounding the Zika virus and the Olympics. We remain cautiously optimistic for the long term, especially on signs that inflation may have stabilized, but cautious on the speed of the real's appreciation from current levels. We would prefer better levels from which to go positive or structural reasons supporting a change in view. 7

8 Turkish lira (TRY) - Upgrading from Negative to Neutral The lira weakened in line with our expectations last month, from TRY to TRY , following the debacle with ex-pm Davutoglŭ which saw further evidence of President Erdogan's iron grip of the country. However, we are upgrading our view of the currency from Negative to Neutral on the back of the developments since then which have proven that at this point in time the EU needs Turkey more than Turkey needs the EU. Despite the Bundestag's vote to acknowledge the Armenian genocide during the Ottoman rule, Germany's foreign policy driven by Mrs Merkel is unlikely to push for political change in Turkey when so much is at stake nationally and within the EU. We therefore feel that Mr Erdogan is not facing any external threats as evidenced by Mrs Merkel's tacit support for him during last year's elections as well as the tacit acceptance of the latest developments. Chinese yuan (CNY) - Negative The yuan also weakened in line with our expectations, from CNY to CNY over the month. We maintain our negative outlook on the yuan and expect the currency to continue weakening for the remainder of the year, albeit at a slower pace, and turning more positive in This is partly due to the domestic economy, which we believe has 'landed' as well as the structural reforms and signs of stability in trade. As far as the CNY's inclusion into the IMF's SDR basket from the Autumn is concerned, we believe it is a medium term positive alongside the opening of the capital account and the use of CNY within trade finance, but in the near term it is unlikely to have any impact as it takes time for reserve baskets around the world to adjust accordingly. Japanese yen (JPY) - Negative Contrary to our negative outlook, the yen strengthened to Y from Y on a number of factors including the lack of support from the G7 for a concerted effort to weaken the currency, the delay in Abe's tax increase to October 2019 and the US non-farm payroll numbers. We maintain our negative outlook, however, for the remainder of 2016 and into 2017 as domestic monetary policy remains ultra accommodative and unorthodox, US interest rates increase gradually and the global environment improves. Furthermore, our analysis on trade suggests that a weaker yen would help revive the economy through exports as domestically the arrows of Abenomics have disappointed. 8

9 Legal Disclaimer Equant Analytics is a FinTech and Advisory business combining macroeconomic, geopolitical and market data with tailored analytical, risk and trading interfaces. Equant Analytics provides the world s macroeconomic data, which is interpreted to market intelligence and integrated into investment decisions through a proprietary analytical and trading interface. Whilst big data makes information readily available, there is a market gap for businesses, which can offer information, intelligence and a trading interface to their clients in one affordable packaged solution. Equant Analytics Ltd is a private limited company registered in the UK at Companies House, No Any data or information provided in this report is for illustrative purposes only and does not represent investment advice or recommendation. All efforts are made to ensure that data and information are accurate and reliable at the time of delivery. Any divergence of the data from other publicly available sources or from material available on Equant Analytics data platforms is due to rounding or use of alternative methodologies. These are made explicit in the text. 3 rd June