Making Sense of Macroeconomic Uncertainty IIES 2017
Some Key Inflection Points for 2017 and Beyond Rise of populism Growth negative Inflation positive Elevated geopolitical risks Higher inflation Deflation fears fade Various forces conspire to push inflation higher Retreat of globalization For a mix of reasons Slow GDP, competitive parity, protectionism Monetary to fiscal shift Peak monetary stimulus? U.S. transition underway Little global fiscal impulse Source: RBC GAM 2
Manufacturing PMI Global Growth Signal Significantly Improved 56 55 54 53 52 51 50 49 Expansion Global manufacturing accelerates 48 47 Contraction 2012 2013 2014 2015 2016 JP Morgan Global PMI Developed markets PMI Emerging markets PMI Note: PMI refers to Purchasing Managers Index for manufacturing sector, a measure for economic activity. Source: Haver Analytics, RBC GAM 3
Still, There Are Many Reasons for Sluggish Long-run Growth 1 2 3 STRUCTURAL CRISIS-INDUCED NEWER ISSUES Demographics EM Deceleration Less globalization Populism High debt Less business investment Skill decay High policy uncertainty Brexit Some nations running out of economic slack Persists for decades Persists for about a decade; not over yet Temporary, but important Source: RBC GAM 4
Unleashing the Forces of Populism Populism due to Slow growth Financial crises High inequality Policy implications Protectionism Less immigration Higher minimum wage Higher top tax rate Fewer corporate loopholes Economic implications Less economic growth More inflation More focus on distribution of growth Evidence of populist attitudes Brexit U.S. election Various EU nations souring on the union Potential failure of several trade deals Source: RBC GAM 5
Percentage points Trump Economic Effect: Short Term Boost, Long Term Drag 0.8 Effect of Trump policies on U.S. GDP 0.6 0.4 0.2 +0.2 +0.6 +0.4 Negative economic effect in long term 0.0-0.2-0.4-0.6 Positive economic effect in short term -0.3-0.4-0.4-0.2-0.8-0.8-1.0 2017 2018 2019 2020 2021 2022 Cumulative effect on GDP level Effect on annual GDP growth Source: RBC GAM assumptions and calculations 6
How Would a 20% Tariff Increase U.S. Product Prices? iphone: +5% price increase -94% foreign made -But 60% U.S. profit margin softens impact Haircut: negligible effect -cannot import haircuts -minimal equipment costs Clothing: +18% price increase -almost entirely foreign made -Low U.S. profit margin Complications: -Assumes no change to profit margins or domestic substitution -But pain could be worse if other countries reciprocate with their own tariffs Source: Robert Reich, RBC GAM estimates 7
Who is Most Vulnerable to U.S. Protectionism? Exports to U.S. are significant for some countries Mexico Vietnam Canada Malaysia Taiwan Thailand South Korea China Germany Philippines 4 3 4 5 7 8 11 19 20 26 0 5 10 15 20 25 30 Exports to U.S. in 2015 (% of GDP) Source: IMF, Haver Analytics, RBC GAM 8
Who is Most Likely to be Targeted With Protectionist Measures? China Germany Mexico Japan Italy India South Korea France Taiwan Saudi Arabia Canada U.K. Singapore Brazil All other countries U.S. trade deficit with China tops the list Trade surplus - 2-3 - 4-4 - 5-7 4 3 2 6 6 14 13 12-20 -10 0 10 20 70 30 U.S. trade balance (% of total) Note: Cumulative 12 month trade balance to Q3 2016. Source: Census Bureau, Haver Analytics, RBC GAM Trade deficit 64 9
Expect a Hard Brexit Incompatible goals U.K. goal: limit immigration and interference; maintain trade EU insistence: four freedoms are all or nothing British challenges Internal divisions (politically and regionally) Parliamentary veto New & inexperienced U.K. trade negotiators Sequencing: new deal only after exit? EU motivations EU seeks to set example to discourage others All 28 nations have veto power Extract financial hub from London? EU hurt less by hard exit than U.K. Source: RBC GAM 10
U.K. Italy Cyprus Austria Poland Greece France Portugal Spain Ireland Germany Netherlands Better off inside EU? (% of respondents who agreed) Next Populist Risk: Unhappy EU Nations 80 75 70 65 60 55 50 45 40 35 30 Unhappy Anti-EU sentiment is significant Relatively content Nov-2016 Source: European Commission Standard Eurobarometer 86, RBC GAM 11
World real exports (YoY % change) Globalization No Longer Advancing 30 Retreat of globalization? 20 10 0 Era of globalization Retreat of globalization -10-20 -30 2001 2004 2007 2010 2013 2016 Note: Year-over-year % change of 3-month moving average of world real exports. Source: IMF, Credit Suisse, Haver Analytics, RBC GAM 12
CPI (YoY % Change) Inflation Is Now Rising, But Still Low 5 4 3 2 Inflation Is rising but not high in developed world Historical average 1 0-1 -2 2001 2003 2005 2007 2009 2011 2013 2015 2017 Note: CPI of advanced economies. Historical average since 1990. Source: IMF, Haver Analytics, RBC GAM 13
Deflation Fears Gone: Inflation Pointing Higher Deflation fears faded when these reversed Vanishing economic slack Populism is inflationary Central banks printed money End of commodity shock Higher inflation FX swings vary effect across nations 14
Why Wasn t Extreme Monetary Stimulus More Inflationary? Higher risk appetite Lower borrowing costs Increased money supply (2) The new money was low powered (1) Only certain parts of monetary stimulus worked (3) More growth more inflation (inflation happens once economic slack has vanished) 15
Monetary Stimulus May Be Peaking Peak monetary stimulus? Source: RBC GAM Improving growth/inflation Diminishing economic slack Rising yields Fed rate hikes, possible balance sheet decline BoE QE ending this year? ECB QE ending next year? 16
Change in world structural fiscal balance (ppt) A New Era of Fiscal Stimulus? Yes in N.A., Not yet for Rest 2.0 Global fiscal stimulus to be less supportive 1.5 Fiscal boost 1.0 0.5 0.0-0.5-1.0 Fiscal drag 2005 2007 2009 2011 2013 2015 2017 2019 2021 Note: Forecast from IMF World Economic Outlook, October 2016. PPP-based country GDP as share of world total used as weights. Source: IMF, Haver Analytics, RBC GAM 17
Financial Market Implications Short term Macro trend Economic growth has improved EM economies have bottomed Positive for risk assets Stocks, credit spreads Bond selloff may be done for now Monetary to fiscal shift Only a small aggregate effect globally Short-term boost to U.S. equities Higher yields (MP, debt) Long term Rise of populism Pain historically takes a while to build Slower growth hurts earnings growth Higher inflation increases yields Higher uncertainty Retreat of globalization Weaker earnings growth Hurts multinationals most Large markets more resilient Higher inflation Higher nominal yields Eventually hurts P/E ratios, but not at these levels Overall market implications Short term: equities stronger, yields sustain their gains Long term: equities softer, higher yields Source: RBC GAM 18
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