Fed monetary policy amid a global backdrop of negative interest rates Kathy Bostjancic Head of US Macro Investor Services kathybostjancic@oxfordeconomics.com April 2016
Oxford Economics forecast highlights Baseline world GDP forecast for 2016 cut to 2.3% from 2.6% in January slowest pace of global growth since 2009. Forecast for 2017 cut further to 2.7% from 2.9%. Sell-off in global financial markets since start of 2016 a factor; overall financial conditions tightened significantly since mid-2014 despite the rally in financial markets since mid-february. Though near-term growth supported by recent rally in markets and still-healthy US and Eurozone. Slippage in consumer confidence has been modest compared to 2012-13 and 2008-09. Central banks - e.g.. ECB & BoJ - increased use of unconventional policy tools also lends support to near-term growth and the financial markets. Global economy looks likely to avoid recession, but risks lie on the downside OE concerned that financial market slump could create negative credit and confidence shock and negative wealth effects 2
Global forecast summary 3
Oil supply/demand balance not restored until 2017? 2013 2014 2015 2016 2017 2018 2019 2020 Global Demand 91.8 92.7 94.3 95.9 97.0 97.7 98.5 99.3 chg mb/d 1.2 0.9 1.6 1.6 1.0 0.8 0.8 0.7 Global Supply 91.3 93.7 96.3 96.5 96.8 97.4 98.2 99.0 chg mb/d 0.4 2.4 2.6 0.2 0.3 0.6 0.8 0.8 o/w OPEC 36.2 36.2 37.4 38.0 38.1 38.3 38.8 39.4 1.0 0.0 1.2 0.7 0.1 0.2 0.5 0.6 o/w US 11.7 13.5 14.5 14.2 14.2 14.4 14.5 14.6 1.2 1.8 1.0 0.3 0.1 0.2 0.1 0.1 Stock Build 0.6 0.9 2.0 0.6 0.2 0.4 0.4 0.3 Brent Oil Price 108.6 99.0 52.4 32.3 40.2 49.2 58.2 67.2 Source: Oxford Economics/ IEA 4
5 US Outlook
GDP forecast and breakdown for 2016 Non res Residential GDP PCE Investment Investment Exports Imports Inventories 2016 (Annualized %) (Change in Bil. $) Q1 0.8 1.8 1.4 8.6 1.2 1.6 17.0 Q2 2.5 2.7 3.0 7.1 3.8 2.1 14.8 Q3 2.3 2.4 4.0 8.2 2.9 1.7 11.4 Q4 2.4 2.7 3.6 6.2 2.6 2.7 9.5 6
Domestic fundamentals remain quite strong 7
Wage growth should pick up Currently wage growth remains sluggish at 2.2% y/y in February 8
Should support healthy consumer spending growth ~2.5% 9
Housing activity continues to firm 10
Core orders & shipments have slowed sharply 11
Headwinds from strong $ and weak global growth 12
Expansions end by overheating not old age 13
More room for this expansion to run US: GDP output gap estimates % 4 Alternate Gap OE Fed 2 0-2 -4-6 -8-10 -12 2000-2002 - 2004-2006 - 2008-2010 - Q1 Q1 Q1 Q1 Q1 Q1 Source : Oxford Economics/Haver Analytics 2012 - Q1 2014 - Q1 14
CRI model suggests no sign of recession 15
Bond market continues to price in very low rates Expectations of Fed funds rate (%) Market implied rate Fed Dot Plot Oxford Economics Eurodollar futures yield* median rate forecasts forecast Month as of Apr-1-2016 as of Mar-2016 Mar-16 Dec. 2016 0.56 0.88 0.88 Dec. 2017 0.71 1.88 1.63 Dec. 2018 0.89 3.00 2.38 Dec. 2019 1.07 3.25** 3.13 Source: CME group, Federal Reserve, Oxford Economics *Adjusted for estimated risk and term premiums **Long-term forecast 16
Inflation is key focus goal is 2% 17
Inflation expectations move with oil prices 18
Risk premia reduced further 19
Spillover from ECB QE 20
21 China in focus
What is PBoC doing to the RMB? NEER, REER and equilibrium REER Index (2010=100) 140 130 120 NEER REER Fair value trend REER 110 100 90 80 70 60 1995 1999 2003 2007 2011 2015 Source: Oxford Economics, CEIC Data RMB exchange rate RMB/US$ 6.30 6.35 6.40 6.45 6.50 6.55 Dec 12: announcement on more focus on trade weighted exchange rate 6.60 Nov 2015 Dec 2015 Jan 2016 Feb 2016 Source: Oxford Economics, CEIC Data Spot rate Fixing rate CFETS basket End 2014=100 104 103 102 101 100 99 22
Financial outflows have become very large Balance of payments (US$ bn) 2013 2014 2015 FX reserves stock 3,821 3,843 3,330 Change 510 22-513 Valuation changes 78-96 -123 Net FX flow 431 118-389 Current account 148 220 247 Net FDI 218 209 170 Net financial flows 65-311 -806 Source: Oxford Economics, CEIC Data China: Capital flows and balance of payment US$bn 200 100 0-100 Valuation effects -200 Basic balance Net financial capital flows Change headline FX reserves -300 2007 2009 2011 2013 2015 Source : Oxford Economics, CEIC Data 23
How the CNY could shake the world World: GDP in FX spillover scenario % difference in level of GDP vs baseline, 2016 Mexico Korea Taiwan Singapore Australia S. Africa Turkey China Thailand Malaysia Philippines Indonesia UK World USA Brazil Russia Hong Kong Chile India Japan Argentina Eurozone 10% USDCNY depreciation -1 0 1 2 3 4 Source : Oxford Economics World: Policy rates in FX spillover scenario absolute difference in policy rates vs baseline, 2016 eop Russia Argentina Turkey Malaysia India Mexico Philippines S. Africa Taiwan Australia Korea Singapore Brazil Indonesia Thailand Chile Japan USA 10% USDCNY depreciation -2 0 2 4 6 8 10 12 Source : Oxford Economics Modest CNY depreciation has recently been associated with sizeable repercussions on global FX markets. We ran two scenarios. In one other currencies move only modestly. In the other the global FX response is in line with the more hefty response displayed during recent episodes of CNY depreciation, and it persists. Simulations show that significant moves in the CNY against the dollar in themselves only have a minor impact on global growth and inflation and China s output does not benefit significantly. But if there is a persistent response from other currencies, the effects on global GDP are more substantial and differentiated: economies with currencies perceived as safe havens see lower growth. 24 24
25 Europe
Euro area forecast in a nutshell Momentum slowing; domestic resilience vs external slowdown Growth slowed in H2 2015, momentum weaker at start of 2016 Domestic indicators still show resilience, but exports struggling since mid-2015 Inflation likely very weak this year, gradual rise in 2017 Oil prices have taken headline inflation to negative territory, will remain close to 0% in 2016 However, nominal rigidities in wages should prevent persistent deflation ECB loosens policy further ECB expands QE programme and cuts interest rates further QE likely to work mainly through keeping euro weak and low bond yields Reform agenda implies a decade long adjustment Monetary policy cannot replace the need for deep structural reforms to address a lack of competitiveness and increase potential growth 26
Downward forecast revisions to 2016 GDP We have lowered our GDP forecasts for this year. Forecasts for 2017 remain broadly stable. GDP forecasts % y/y 2.0 Jan-16 Feb-16 Mar-16 1.8 1.6 1.4 1.2 1.0 2016 2017 Source : Oxford Economics 27
Weaker oil price points to slower rise in inflation Eurozone: CPI Inflation (Bottom-up f'cast model) % y/y / contribution 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 Core Energy Food alcohol and tobacco Headline -1.5 2010 2011 2012 2013 2014 2015 2016 2017 Source : Oxford Economics/Haver Analytics Forecast 28
Draghi deploys arsenal The ECB announced last week a comprehensive package of measures to combat slowdown and lift inflation Cuts to the refinancing rate to 0% and to the deposit rate to -0.4% Expansion of QE to 80bn per month; now includes corporate debt Four new TLTRO programmes with more favourable conditions for banks Barring some massive shock, this represents the end of full-scale measures for the time being. 29
As interest rates go more negative Sweden: Exchange rate, daily Index 18/11/92=100 95 KIX (trade-weighted EER), lhs Repo rate cuts 100 Kronor/euro, rhs 105 110 SKr/euro 7.5 8.0 8.5 9.0 Amount of cash that will take up 1 cubic metre Highest denomination 1m 3 $1bn =?m 3 USA $100 $85,951,413 11.3 Eurozone 500 337,254,479 2.7 UK 50 33,369,372 21.2 China 100 74,147,947.00 88.0 Switzerland Fr. 1,000 Fr. 660,710,581 1.5 Japan 10,000 7,277,596,646 16.1 Source: Oxford Economics 115 9.5 120 10.0 Feb 13 Aug 13 Feb 14 Aug 14 Feb 15 Aug 15 Feb 16 Source : Oxford Economics/Haver Analytics Sweden s Riksbank has just cut its repo rate to -0.5%, the ECB lowered its deposit rate to -0.4% and the BoJ is the first non-european central bank to follow suit. They key impact of negative interest rates seems to be on the exchange rate; but even that is not given, as the Swedish example shows. Moreover, the more countries go negative, the less bang there is for the buck. The feared move to cash has not materialised, for a number of reasons, incl. storage space and costs. A bigger problem is that negative interest rates, unless passed on by banks, threaten to erode banks profits and thus balance sheets, slowing credit growth. 30
Negative interest rate and yield curve 31
Brexit lowers GDP growth moderately 32
Brexit would weigh on the pound & stocks 33
Thank you! Any questions? Kathy Bostjancic: kathybostjancic@oxfordeconomics.com