Global economy Research Department ARC Research Team Tel: 966 11 211 9370, devassyp@alrajhi-capital.com Global economy and markets The global economic data was largely positive over the last one month with the US registering robust growth in Q3 2014, although its real-time economic indicators have largely been mixed. On the other hand, indicators in the Eurozone point to a slowdown, whereas they were slightly disappointing in China, as the powerhouse seems to be stuck in a period of slowing growth. Meanwhile, Indian growth looks appealing in the coming years as its industrial growth revives and exports pick up, while the current account deficit remains in the manageable territory. Monetary policies look divergent across the Atlantic as the market expects a policy rate hike by the Fed in Q2 2015, whereas the ECB is preparing for QE this week. Meanwhile, a rate hike is also expected in the UK within one year. Sovereign yields in the US as well as Germany declined with the German bund 10-yr yield touching a record low, amid declining commodities prices dampening the outlook for inflation almost everywhere. Oil prices fell further as markets continue to be concerned by oversupply and weak global demand. Gold prices continued to trend lower amid a strong US dollar and tumbling crude prices. Global economic data: The US government released its third estimate for the Q3 2014 GDP growth at 5% revised up from 3.9%, mainly due to the upbeat consumer spending and business investment. Besides the upward revision in Q3 real GDP growth, job market data, ISM indices and other indicators were lower as compared to the prior months. However, more than 200k additions in non-farm payroll in each of the last twelve months and a multi-year low unemployment rate point to a positive outlook for the economy. On the other hand, manufacturing activity remained weak in China, as the country s industrial output and manufacturing PMIs moderated in December, whereas better than expected December trade figures gave the government some reprieve. Meanwhile, activity in the UK production and construction sector slowed unexpectedly in November; however a bounce back in factory output and narrowing trade deficit suggest the economy could weather troubles in their biggest trading partner, the Eurozone. The Eurozone fell into deflation for the first time since October 2009, making it certain that the European Central Bank (ECB) will boost up the supply of cheap credit in the currency bloc despite German opposition. Monetary policy and markets: Although most central banks stayed put during their respective policy meetings last month, the strong Q3 2014 revised real GDP data in the US boosted the interest rate hike expectations from the Fed. However, a subdued inflation scenario could complicate the central bank s aim to raise interest rates this year. On the other hand, deflation in the Eurozone is sparking the ECB to fast track its QE plan. The ECB is a step closer to implement QE measures at its upcoming meeting this week after the European Court of Justice gave its ruling approving the ECB s Outright Monetary Transactions (OMT) program. Meanwhile, global bond yields were mainly lower on expectations of an expanded quantitative easing in Europe and rising deflationary risks. Commodity markets: The OPEC s November 2014 decision to leave its oil production target unchanged, caused the non-reversal of significant price depreciation, following which the prices have broken below the ~US$ barrel level. Crude oil prices are now near their six-year lows and have been a major factor in driving down inflation almost everywhere. The EIA in its latest report projects crude oil production in the US will increase to 9.3mbpd in 2015, which would translate into the highest US production since 1970. Moreover, the EIA projected a largely stable OPEC supply in 2014 and 2015. Meanwhile, a declining crude oil and a strengthening US dollar are putting pressure on gold prices that moved lower during Q4 2014. Gold closed on December 31 at US$1,184.1 down 2.3% on the quarter and 1.5% in 2014. The correction in the precious metal price has happened owing to tepid physical demand in 2014 and reduced interest in gold ETPs. Further, an economic slowdown in China and import restrictions in India hurt the yellow metal purchases in 2014. Disclosures Please refer to the important disclosures at the back of this report. 1
Global economic data United States The US Department of Commerce reported in its final GDP estimate that the US economy grew at its quickest pace in 11 years in Q3 2014 at 5.0%, higher than the agency s previous 3.9% estimate. This advance followed a Q2 where the economy expanded at 4.6%. The US has now experienced the two strongest back-to-back quarters of growth since 2003. The government s final upward revision was largely driven by better growth in sales to domestic purchasers, which expanded at an annualized rate of 4.1% in the third quarter (previously estimated at 3.2%). Consumer spending, which accounts for about two-thirds of the US GDP, grew at a 3.2% annual rate instead of the previously reported 2.2% pace, which is also the fastest since Q4 2013. Growth in business investment was raised to 8.9% from 7.1% previously. Spending on residential construction as well as government outlays were also revised higher. However, export growth and imports were revised downward. Figure 1 Recent growth trend in US 6 % QoQ annualized 5 4 3 2 1 0-1 -2-3 Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 Q1-14 Q2-14 Q3-14 Consumption Investment Net-exports Government Real GDP growth Source: BEA, Al Rajhi Capital Real time indicators remain mixed Real time indicators: Economic indicators in the US have been mixed in the last one month. The most recent ones, the job market data slightly topped market expectations as the economy added 252k jobs in December, with the unemployment rate at 5.6%, the lowest since 2008. However, the average hourly pay slipped 5 cents (0.2%) in December, posting the biggest decline in at least eight years. During the month, manufacturing payroll added 17k, while the services sector took another 52k workers. However, ISM data disappointed in December as both manufacturing and nonmanufacturing PMIs fell to 55.5 and 58.0 from a reading of 58.7 and 59.3 in November. Further, factory orders fell for the fourth straight month in November, signals the economy lost some momentum in the fourth quarter. However, industrial production jumped 1.3% in November after a 0.1% increase in October, easing concerns of a sharp slowdown in Q4 2014. The growth outlook also received a boost from strong automobile sales in December and improved consumer confidence, propelled by favorable labor markets. Moreover, trade deficit in November unexpectedly shrank to US$39bn from US$42.2bn in October with an unexpected fall in imports. Figure 2 Moderation in US ISM PMIs Figure 3 Non-farm payrolls rose to about 3million, highest since 1999 60 Index 3 Thousand % 8.0 58 56 52 300 2 200 1 7.5 7.0 6.5 46 100 6.0 44 0 5.5 ISM manufacturing ISM non-mfg. Nonfarm payroll Unemployment rate-rhs Disclosures Please refer to the important disclosures at the back of this report. 2
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Real indicators remain positive in Eurozone, but deflation piles up pressure on the ECB 58 Index 56 52 46 44 Germany mfg. PMI Italy mfg. PMI Eurozone: Economic data points to slower contraction According to the final PMI reading, the private sector growth in the Eurozone accelerated in December, but missed an earlier flash estimate of 51.7. The composite PMI for the 19-nation region (including Lithuania) rose to a 2-month high of 51.4 in December as compared to 51.1 in November, since both manufacturing and services PMIs posted an increase. Meanwhile, inflation in the Eurozone reached below zero for the first time since October 2009 at -0.2% y-o-y in December from +0.3% y-o-y in November, indicating the need for a fresh injection of funds by the ECB. The main drag came from falling energy prices, which declined by 6.3% y-o-y. Meanwhile, the core inflation rate rose slightly to 0.8% y-o-y from 0.7% y-o-y in the prior month. The region s retail sales rose by 0.6% for the second straight month in November, while unemployment held steady at 11.5% during the month. However, the economic dynamics in the region are different for large economies such as Germany and France on the one hand, and smaller and crisis-affected economies such as Italy, Spain on the other. Economic indicators in the largest economy were only slightly better than the average for the area. In Germany, both the manufacturing and service sector activity grew at a slightly higher rate in December, lifting the composite gauge to 52, while in France, the rate of contraction eased at 49.7, up from 47.9 in November. Citing weak growth prospects and high public debt, S&P cut Italy s long-term credit rating to BBB-. Meanwhile, the unemployment rate in Germany dropped to a record low of 6.5% in December, while it tagged a new high of 13.4% in Italy, underscoring the vast differences within the moribund Eurozone economy. Figure 4 Manufacturing PMI in Germany and Italy Figure 5 Manufacturing PMI in the UK and Japan 58 56 52 Index 60 57 51 Index 46 44 45 Germany mfg. PMI Italy mfg. PMI UK's mfg. PMI Japan mfg. PMI United Kingdom and Japan The final reading for annual GDP growth in the United Kingdom during Q3 2014 was sharply revised down by 0.4% to 2.6% due to revisions to growth figures of the previous quarters, while the q-o-q GDP growth remained unrevised at 0.7%. Moreover, there were new signs pointing to slowdown in momentum of the UK economy. The industrial production shrank by 0.1% on a monthly basis in November. The PMI for services, although still above.0, declined by 2.8 points to 55.8 in December, whereas the PMI for manufacturing and construction edged lower to 52.5 and 57.6, respectively. Meanwhile, the nationwide house price growth slowed further to 7.2% y-o-y in December as compared to 8.5% y-o-y in November. Japan s industrial production and inflation continued to slow in November, while retail sales rose during the month. Further, the country s exports rose lower than estimated, underlining the challenges for the central bank to steer the economy out of recession. Average consumer spending by households with two or more members also declined by 2.5% y-o-y in November, marking the eighth straight monthly decline. The world s third-largest economy remains largely stagnant except its labor market (unemployment unchanged at 3.5% in November), indicating the depth of a slump caused by a national sales tax increase in April 2014. Disclosures Please refer to the important disclosures at the back of this report. 3
China s economy is set to miss 7.5% growth target for 2014 Emerging economies China's factory sector contracted in December for the first time in seven months, suggesting further stimulus is needed to halt a slowdown in the world s second-largest economy. The official manufacturing PMI slipped to.1 in December, providing a soft end to the year that suggests the global powerhouse is likely to miss its 2014 economic growth target of 7.5%. However, there was better news from the country s services sector, which accounts for nearly half of the economy, where the PMI rebounded to.1 from 53.9 reading in November. Job creation in the service sector has been peaking for more than a year. Meanwhile, industrial profits in China fell by 4.2% y-o-y in November, the biggest decline since August 2012. In the face of a risk of short-term slowdown, the Chinese policymakers have introduced an infrastructure stimulus package accounting for 18% of GDP to bolster growth that is in danger of slipping below 7%. World Bank: India to grow at China s pace by FY17 India s economic indicators remained largely positive. The HSBC/Markit manufacturing PMI rose to the highest level in two years in December at.5, while the services sector PMI eased to 51.1. Employment levels in the Indian services sector increased in December, reversing the trend seen in the previous month. Meanwhile, inflationary pressures from both input and output prices remained modest, bolstering prospects of interest rate cuts this year. ECB a step closer to its bond-buying program US Fed, BoE and BoJ maintain status quo on their monetary policies Global bond yields were mainly lower on expectations of an expanded QE in Europe and rising deflationary risks Central Bank s Monetary Policies Monetary policy The long-feared threat of deflation hit the Eurozone at the end of 2014, reinforcing market expectations that the ECB will soon provide an aggressive monetary stimulus. The ECB Governing Council will be meeting on January 22 for its policy meeting, when it could decide to start printing money for buying large amounts of government bonds to prevent deflation. The likelihood of a start on purchases of government bonds within a week has become clearer following the European Court of Justice s ruling on the ECB s OMT and rumors regarding a EUR0bn assets purchases program. The US Federal Reserve (Fed) made no changes to its monetary policy during its FOMC meeting last month, downplaying market expectations of rise in interest rates within the next couple of meetings, in January and March. The Fed left its key interest rate at the 0-0.25% level to revitalize the US economy from deep recession. Meantime, the Bank of England (BoE) maintained status quo on its interest rate by keeping the bank rate unchanged at 0.5% for the seventh consecutive month, even as inflation dropped to 1.2% in November after 1.5% in October, pointing to weakening demandside and cost pressures in the economy. Moreover, the BoJ also kept its monetary policy unchanged at its final meeting of 2014, in a move to assess the effects of the expanded stimulus program on the Japanese economy. Among emerging economies, the RBI cut its interest rates by 25bps amid signs of cooling inflation, while the PBoC reiterated the decision to maintain its prudent monetary policy. Sovereign bonds and interbank rates Yield for US 10-year Treasury matched the lowest levels since May 2013 as declining commodities prices dampened the outlook for inflation, fueling speculation that the Fed will take a cautious approach to raising interest rates. Moreover, yields on 30-year touched 2.46% last week, the lowest since July 2012, when the yield set a record low of 2.44%. Similarly, German and Japanese sovereign bond yields fell to new historical lows as investors hedged against deflation, while the yield on the 10-year UK government bond fell to the lowest level since 2012. US three-month and one-year rates have risen from their lowest levels in December by 2 basis points and 6 basis points to 0.253% and 0.622%, respectively. Meanwhile, GBP three-month rose by 1 basis point from its lowest levels in 2014. The BoE s decision to maintain status quo on its policy rate at least until early 2016 pulled the 12-month interbank rate by 1.3 bps from its lowest level of 2014. Disclosures Please refer to the important disclosures at the back of this report. 4
Oil prices fell further due to concerns on oversupply and weak global demand In the GCC, interbank rate has eased in Saudi Arabia. The 12-month and 3-month SAIBOR were at 1.05% and 0.87% at the start of December 2014, which have eased down to 1.03% and 0.86%, respectively this week. Meanwhile, in the UAE, the 12- month EIBOR remained unchanged at 1.02%. Commodities Crude oil Crude oil prices remained under pressure across 2014 and have fallen significantly in the past couple of quarters. However, the OPEC s November 2014 decision to leave its oil production target unchanged, caused the non-reversal of significant price depreciation, following which the prices have broken below the ~US$ barrel level. Crude oil prices have been a major factor in driving down inflation in majority of the economies around the world. Amid rising production and weaker global demand, the prices have now declined to almost six-year lows. Moreover, the prices are unlikely to stabilize until the higher cost producers curtail their production and thus reduce the global supply glut. Meanwhile, the EIA in its latest report projects the US crude oil production to increase to 9.3mbpd and 9.5mbpd in 2015 and 2016. If the forecast comes true, it would be the highest production since 1970. Moreover, the EIA projects that the OPEC s total supply will largely remain stable over the next couple of years and will not be able to accommodate the non-opec supply growth. Gold Gold price continued to trend lower amid Gold prices have also moved lower along with low prices of other commodities such as strong US dollar and tumbling crude prices crude oil, during the fourth quarter. Gold closed at US$1,184.1 on December 31, down 2.27% q-o-q and 1.% y-o-y in 2014. However, the precious metal has delivered a 318% return since the beginning of 2000. The long-term rally in gold continues to correct from the highs of US$1,920.7 made in September 2011. During 2014, gold traded in a range between US$1,130 and US$1,390 with the lows coming during the fourth quarter. The sharp correction in the precious metal price has happened due to the tepid physical demand in 2014, reduced interest in gold ETPs and a strengthening US dollar, with the latter trading at its highest level since March 2006. An economic slowdown in China and import restrictions in India also hurt gold purchases by the world s largest consumers in 2014. Further, the subdued inflation outlook in major economies coupled with a change in risk appetite, is turning investors away from defensive exposures like gold. Disclosures Please refer to the important disclosures at the back of this report. 5
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