Cosa ci riserva il 28? Scenari e previsioni per l anno in corso Keith Wade Capo Economista
The US economy today A re-assessment of risk De-leveraging Financial sector Real economy Historical precedents not encouraging how do we get down?
International rescue The A-team Team leader We must do all that is necessary Aide 1 Is this the biggest problem? Aide 2 They got themselves into this mess
International rescue Conditions for success i.e. avoiding a Japan style slump Speed and scale of response Size and nature of the problem Risks Mitigating factors A white knight?
Chances of success the scale of the crisis Large in absolute terms, less threatening as share of GDP Billions USD$ % 1 9 8 7 6 5 4 3 2 1 US Savings and loan (1986-95) Japan banking crisis (199-99) Asia banking crisisus Subprime crisis (1998-99) (27 - present) 4 35 3 25 2 15 1 5 Bank losses Other financials Percent of GDP, rhs Source: World Bank, IMF staff estimate All costs are real 27 dollars. Asia includes Indonesia, Korea, the Philippines, and Thailand
The nature of the problem the transmission mechanism is blocked Surveys show banks are tightening credit US C&I loan surveys corporates Net % 1 8 6 4 2-2 -4 9929496982468 US Household loan survey - mortgages Net % Net % 1 8 6 4 2-2 -4 992949698246 8 US Real estate 1 8 6 4 2-2 -4 9929496982468 Large & medium firms Small firms All Subprime Prime Commercial real estate loans Source: US Federal Reserve senior loan officer survey, Thomson Datastream
The transmission mechanism is blocked The Fed is getting less bang for its buck Interbank spreads Impact of 1bps Fed easing on mortgage rates % bps 1,2 1,,8,6,4,2, -,2 -,4 -,6 apr7 lug7 ott7 gen8 apr8 US (3M Interbank over Feds funds target rate) Euro area (3M interbank rate over ECB repo rate UK (3M Interbank rate over UK base rate) Source: Thomson Datastream Current cycle based on the period from 17/9/7 to 7/4/8-1 -2-3 -4-5 -6-7 -8-9 -1 1-year 1-year treasury ARM Current cycle (Freddie 2-3 cycle MAC) 1995-96 cycle 199-92 cycle Average last 3 cycles 3-year fixed rate mortage
Risk factors 1 the scale of imbalances US faces significant funding gap and house price adjustment US current account deficit USD billions 9 8 7 6 5 4 3 2 1-1 88284 8688992 949698 246 US annual current account balance US house price-income ratio 4.2 4. 3.8 3.6 3.4 3.2 3. 2.8 2.6 8 828486 889 9294 9698 2 46 8 Pre-bubble average Net private inflows Median price/ income Source: Thomson Datastream
Risk factors 2 the response from inflation Food and oil drive a wedge between headline and core inflation rates % 6 5 4 3 2 1-1 88 89 9 91 92 93 94 95 96 97 98 99 1 2 3 4 5 6 7 8 Gap, % G7 Headline CPI, y/y% G7 core CPI, y/y% Source: Thomson Datastream
Risk factors 2 the response from inflation Sub-trend growth should deliver lower core inflation % % 2. 1.5 1..5. -.5-1. -1.5-2. Growth above 3% Inflation rising Growth below 3% Inflation falling 88 89 9 91 92 93 94 95 96 97 98 99 1 2 3 4 5 6 7 8 9 8 6 4 2-2 Core CPI, 12 month change of y/y% US GDP, y/y%, 4 quarter lag, rhs Baseline forecast Source: Thomson Datastream, Schroders
Positives - strength of global economy A more balanced world - contribution to 27 global GDP growth % 1.2 1..8 EM ex China Eurozone China US.6.4.2 Japan UK. EM ex China: Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela, China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan, Thailand, South Africa, Russia, Czech Rep., Hungary, Poland, Slovakia, Romania, Turkey, Ukraine Source: Consensus Economics
World GDP growth: slowdown? What slowdown? Emerging Markets now account for half global growth y/y% 5 4 Asia crisis Last US recession Baseline forecasts 3 2 1 96 97 98 99 1 2 3 4 5 6 7 8 9 Growth contribution from emerging markets Growth contribution from the OECD countries Source: IMF, Consensus Economics, Schroders
Sovereign Wealth Funds the white knight? Commodity prices and the global savings glut fuel the Sovereign Wealth Funds China s FX reserves USD Billion 18 16 14 12 1 8 6 4 2 97 99 1 3 5 7 Country Name Source of funds United Arab Emirates Singapore Norway Kuwait Abu Dhabi Investment Authority Government of Singapore Investment Corporation Government Pension Fund - global Kuwait Investment Authority Current size US$bn Natural resources 522-9 FX reserves/ fiscal surplus 2-438 Natural resources 329 Natural resources 213 Russia Stabilisation Fund Natural resources 148 China Central Investment Company FX reserves 68 Source: Thomson Datastream, Peterson Institute for International Economics, Nov. 7
International rescue Will they succeed? Speed and scale of response + Size and nature of crisis Risks: global imbalances and inflation Mitigating factors : strength of EM + A white knight?: SWF s + Increases/ decreases probability of success + / On balance success is achievable but do not rule out Plan B
Market view
In past cycles, Fed rate cuts have lasted three or four years This suggests US monetary policy will be easing, or easy until 21 Fed funds target rate % 1 9 8 7 6 5 4 3 2 1 27 28 29 21 211 212 Themes Persistent weakness in USD Loose monetary policy in Emerging markets Risk of overheating/ EM currency appreciation Continued flows into commodities Inflation: core v headline tussle The return of fiscal activism Current cycle Jan 21-26 June 1989-1994 Chart shows interest rates from previous cycles pushed forward such that each easing cycle begins at the same point in 27 Source: Thomson Datastream, Schroders
Valuation: Equities are looking attractive Markets trading at bottom of PE range Trailing PE MSCI World (vs. 2 year historical average) Trend PE MSCI World (vs. 2 year historical average) 4 35 3 25 2 15 1 5 88 9 92 94 96 98 2 4 6 8 35 3 25 2 15 1 88 9 92 94 96 98 2 4 6 8 Average +/- s.d. Average +/- s.d. Source: Thomson Datastream, Schroders as at Mar 28
Valuations attractive, interest rates falling buy equities? The economic cycle says otherwise Market performance varies through the economic cycle Asset performance by stage of the cycle Phase/ Asset Statistics Recovery Expansion Slowdown Recession Slowdown Recession Recovery Expansion Equity Excess return* Volatility 8.6 (1%) 13.7 8.8 (83%) 12.4-8.8 (22%) 9.9 (88%) 17.3 14.6 Cash Equity/ Bonds Equity Equity Buy List Asset class: Bond market: Equity market: Size: Style: Sector: Alternatives: Cash Governments US equity Large cap equity Growth/ Quality Energy/ Staples/ Utilities Infrastructure Oil Gold Source: Thomson Datastream, Global Financial Data, Schroders. Data period Jan 195 to February 28 * All risk return figures are in % and annualised from monthly data. Equity, bond & commodity risk return numbers are relative to cash The figures in brackets refer to number of times the equity markets outperformed cash on average during each phase of the cycle since 195 Valuations and rate cuts do not help equities in the slowdown phase
Are we there yet? Equity market performance over cash in the slowdown Performance index of the slowdown phase 18 14 1 96 Cumulative performance of the average slowdown phase Average length 92 88 84 Cumulative performance of the current slowdown phase 1 2 3 4 5 6 7 8 Subsequent months into the slowdown phase Data: S&P 5 TR & 3M T-Bill TR index since 195 Source: Thomson Datastream, Global Financial Data, Schroders
Where next? The recession phase will bring a rotation toward greater risk Slowdown Recession Recovery Expansion Cash Equity/ Bonds Equity Equity Buy List Asset class: Equity market: Size: Sector: Bond market: Alternatives: Equity/ Bonds Emerging markets Small cap Financials/ IT/ Consumer High Yield Convertible bonds Oil The equity market and risk assets turn ahead of the economy Source: Thomson Datastream, Global Financial Data, Schroders * All risk return figures are in % and annualised from monthly data. Equity, bond & commodity risk return numbers are relative to cash The figures in brackets refer to number of times the equity markets outperformed cash on average during each phase of the cycle since 195
Macro and market view Financial crisis now rolling over into real economy : growth weak as consumer de-leverages Challenging environment for monetary policy : high risk of liquidity trap (Japan 199s) Speed of response, strength of world economy and SWF s tip balance of risks in favour of recovery Expect long period of loose money and loose fiscal policy, do not rule out Plan B. While problem in OECD is growth, that in Emerging Markets is inflation Fed policy will exacerbate pressures in EM and commodity markets Underweight risk assets : valuation provides little defence in slowdown Return to equities when the Fed gets ahead of the curve Equities trough ahead of the economy (outperform after the slowdown phase) Economic stability needed to bring visibility on earnings Valuations attractive v. history, cash and bonds
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