An economic update Craig Botham, Economist May 2017
2016 image of the year Donald and Nigel at Trump towers Source: Splashnews.com. 1
Key issues UK: the election, Brexit and beyond Europe: out of the woods? President Trump policy uncertainty and macro implications What are we missing? Asset allocation Source: Schroders. 2
Synchronised global upswing Developed markets vs. emerging markets PMIs Source: Thomson Datastream, Markit, Schroders Economics Group, 27 March 2017. Thomson Reuters Datastream, Schroders, updated 28 April 2017. 3
Global growth forecasts Forecasts holding up (for once) Source: Thomson Reuters Datastream, Schroders, updated April 2017. 4
UK - The election, Brexit and beyond
UK general election to clear the way for softer Brexit May to gain 100 seat majority and Brexit breathing space 5-poll moving average (% share of popular vote) 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Jun 16 Jul 16 Aug 16 Sep 16 Oct 16 Nov 16 Dec 16 Jan 17 Feb 17 Mar 17 Apr 17 Con Lab UKIP Lib Dem Others GBP: the Brexit barometer GBP/USD 1.60 1.55 1.50 1.45 1.40 1.35 1.30 1.25 1.20 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Source: Schroders Economics Group. 20 April 2017. 6
UK economy deteriorating inflation set to rise further Schroders UK CPI forecast Y/Y 6% 5% 4% 3% 2% 1% 0% -1% -2% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Core Food, Tobacco and Alcholic beverages Energy UK CPI Source: Thomson Datastream, ONS, Schroders Economics Group. 27 March 2017. 7
UK economy deteriorating Consumption drivers under pressure, investment is weak Disposable income vs. savings rate y/y 12% 10% 8% 6% 4% 2% 0% Investment slows as uncertainty rises 4q/4q 15% 10% 5% 0% -5% -10% -15% -2% -4% 06 07 08 09 10 11 12 13 14 15 16 Real household disposable income Savings rate -20% 06 07 08 09 10 11 12 13 14 15 16 17 UK household consumption UK business investment Source: Thomson Datastream, ONS, Schroders Economics Group. 4 April 2017. 8
Deal or no deal? The macro environment to 2019 and beyond Near term: weaker sterling and higher inflation slow consumption Negotiation period: 2017 2019: uncertainty to weigh on activity (capex vulnerable) Low interest rates persist with periodic bouts of GBP weakness 2019: no deal (cliff edge), UK goes to WTO status, stagflation environment as tariffs rise 2019: no deal, but agreement to keep talking (transition period), growth and rates firm If deal struck in 2019, UK growth picks up and rates begin to normalise Ability of economy to grow without inflation depends on trade and migration deal Source: Schroder Economics group, The Times. 9
Beyond Brexit Case study: competitiveness in the UK and Germany UK Q1 2000 Q1 2000 = 100= 100 110 110 Germany Q1 2000 Q1 2000 = 100= 100 130 130 125 125 100 100 120 120 115 115 90 90 110 110 105 105 80 80 100 100 95 95 70 70 2000 2000 2002 2002 2004 2004 2006 2006 2008 2008 2010 2010 2012 2012 2014 2014 2016 2016 Sterling Sterling nominal nominal effective effective exchange exchange rate, rate, 1q MA 1q MA Sterling Sterling real effective real effective exchange exchange rate, rate, 1q MA 1q MA 90 90 2000 2000 2002 2002 2004 2004 2006 2006 2008 2008 2010 2010 2012 2012 2014 2014 2016 2016 Euro Euro nominal nominal effective effective exchange exchange rate, rate, 1q MA 1q MA Germany Germany real effective real effective exchange exchange rate, rate, 1q MA 1q MA Note: All exchange rates are trade weighted, real effective exchange rates based on relative unit labour cost. Source: Thomson Datastream, Schroders Economics Group, 10 March 2017. 10
Eurozone out of the woods?
Growth booming Eurozone GDP vs. BNB survey and PMIs 6% 6% 4% 4% 2% 2% 0% 0% -2% -2% -4% -4% -6% -6% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Eurozone GDP growth, Y/Y Belgian National Bank survey (standardised) Markit PMI, EZ Composite (standardised) Source: Thomson Datastream, Markit, Belgian National Bank, Eurostat, Schroders Economics Group. Updated 27 March 2017. 12
Inflation is close to its peak Energy base effects have caused inflation to rise, but only temporarily Y/Y 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% 2012 2013 2014 2015 2016 2017 2018 Core Food incl. alcohol & tobacco Energy Headline Source: Thomson Datastream, Eurostat, Schroders Economics Group. Updated 27 March 2017. 13
Eurozone has resisted populist pressure so far A roadmap and guide to upcoming events Country Event risk Date Probability Market impact Hungary Migrant quota rejected in referendum 2 October 2016 High Low Austria Re-run of presidential election with far-right Freedom party winning 4 December 2016 Medium Low Italy Constitutional referendum, leading to Renzi losing his job 4 December 2016 Medium Medium Netherlands General election with the Party for Freedom calling an EU referendum 15 March 2017 High Low UK Article 50 triggered By end of March 2017 High Low France Presidential elections with Front National winning 23 April and 7 May 2017 Low Extreme UK Snap general election with the Conservative party losing its majority 8 June 2017 Low Medium Germany Federal election with Alternative for Deutschland winning 24 September 2017 Very low Extreme Italy 5 Star Movement wins Italian election By May 2018 Medium High Source: Schroders Economics Group. 20 April 2017. 14
Five star have taken the lead in Italy Elections due by May 2018 spell trouble for the eurozone Share of popular votes (10-poll moving average) 36 34 32 30 28 26 24 22 20 Jan 16 Mar 16 May 16 Jul 16 Sep 16 Nov 16 Jan 17 Mar 17 5 Star Movement Democratic party Source: Wikipedia, Schroders Economics Group. Updated 24 March 2017. 15
Structural problems will weigh on Eurozone after the elections No one can keep up with Germany Relative wage costs 1 Germany: soaring trade surplus 2 1 Source: Thomson Reuters Datastream, Schroders, updated 28 April 2017. 2 Source: Thomson Reuters Datastream, Schroders, updated 15 February 2017. 16
US can Trump deliver?
Return of animal spirits in the US Confidence has surged in the US and capex is likely to follow Index 120 Index 120 110 %, y/y 15 110 %, y/y 15 120 120 100 80 60 40 100 80 60 40 105 100 95 90 85 10 5 0-5 -10-15 105 100 95 90 85 10 5 0-5 -10-15 100 80 60 40 20 0 100 80 60 40 20 0 20 20 80-20 80-20 -20-20 03 05 07 09 03 11 05 13 07 15 09 17 11 13 15031705 07 09 03 11 05 13 07 15 09 17 11 13 15 17 Recession Recession Recession Recession US consumer confidence US consumer confidence US non-res private US fixed non-res investment private fixed growth investment growth NFIB small business NFIB optimism,rhs small business optimism,rhs CEO economic CEO outlook economic survey, outlook 1Q lag, survey, rhs 1Q lag, rhs Source: Thomson Datastream, Schroders Economics Group, 23 March 2017. 18
But 4% growth is a long shot Economy has not grown at 4% since 2000 % 10 8 6 4 4% growth 2 0-2 -4-6 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 GDP growth (4q/4q) Source: Thomson Reuters Datastream, Schroders Economic Group, 27 March 2017. 5-year moving average 19
As is the promise to create 25 million jobs Late cycle US has limited labour market capacity Million 30 25 20 15 10 5 0 94 96 98 00 02 04 06 08 10 12 14 16 Source: Bureau of Labour Statistics, Thomson Datastream, Schroders Economics Group. 24 March 2017. 20 Unemployment level, U3 Unemployment level, U6 25m aim
What are we missing? Risks
Is the market complacent? Fed tightens, but volatility falls to new low Source: Thomson Reuters Datastream, Schroders, updated 28 April 2017. 22
US rates could rise considerably further Taylor rule says 3.5% by end 2018 23
Fed rate setters expect 3% Market does not believe the dots 24
Global liquidity could continue to rise Even as the Fed shrinks its balance sheet 25
Central banks stay easy while inflation remains quiescent Wages remain contained despite low unemployment Source: Thomson Reuters Datastream, Schroders, updated 28 April 2017. 26
Asset allocation views Global Market Perspective Q2 2017 Equity + Bonds - Alternatives + Cash 0 By region By Sector By Sector US 0 Government - Commodities + Europe ex UK + US - Gold 0 UK 0 Eurozone Bunds Gilts -- (-) - UK Property EU Property - + Pacific ex Japan (AUS, NZ, HK and Sing.) 0 Inflation-linked 0 Japan 0 (+) Investment grade - Emerging Markets + (0) High Yield 0 Emerging market (USD) 0 Emerging market (LC debt) + (++) Key: +/- market expected to outperform/underperform (maximum ++ minimum ---) 0 indicates a neutral position. The above asset allocation is for illustrative purposes only. Actual client portfolios will vary according to mandate, benchmark, risk profile and the availability and riskiness of individual asset classes in different regions. (Last quarter). Source: Schroders Global Market Perspective, April 2017. 27
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