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Economic Research Week in Focus 24 February 2017 Germany: Housing overpriced but boom continues House prices in Germany keep on rising. According to our new model, they are now overpriced by around 10%. Only a marked rise in interest rates would be likely to end this boom and such a move is nowhere in sight. House prices should therefore continue to climb for the time being. This does not pose a great danger for the economy at present as the building sector is not yet over-inflated and the rise in private debt has been limited so far. However, the longer the boom lasts, the greater the risk that major imbalances will emerge whose correction would hit the German economy hard. Page 2 The Week in Focus in 100 seconds Please follow this link for video summary. CHART: German property prices are climbing sky high BulwienGesa house price index: from 1975 to 1999; house price index of the Federal Statistical Office: from 2000 until Q3 2016; estimates based on the IMX: Q4 2016, index: 2000 = 100; percentage changes on the year 10 135 125 115 5 105 95 85 0 75 65 55 -5 1975 45 1980 1985 1990 1995 change on the year in % (lhs) 2000 2005 2010 2015 house price index (rhs) Source: BulwienGesa AG, Federal Statistical Office, Immobilienscout24, Commerzbank Research Outlook for the week of 27 February to 3 March 2017 Economic data: Euro zone inflation in February may well see a two before the decimal point for the first time in four years. While this could drive inflation expectations further up, it is likely that the inflation rate will soon fall again as underlying inflation pressure remains weak. Page 7 Bond market: The long-end of the curve is increasingly impacted by the Bundesbank’s sizeable €QE purchases in the one-year maturity sector. Moreover, investors remain nervous regarding political risks in France and Italy, while ample redemptions need to be reinvested. We therefore continue to expect Bund yields to trend downward amid a steeper curve. Page 10 FX market: Strong support in polls for the eurosceptic French presidential candidate Marine Le Pen continues to weigh on the euro. Speculation that strong US inflation will prompt higher rates continues to support the USD. Page 11 Equity market: High DAX valuations, notably inflated P/B ratios, have increased the importance of selective stock-picking. We favour companies with credible restructuring plans; that have a high share of sales in the USA and whose earnings react positively to a stronger dollar. Page 12 Commodity market: In the week ahead, the price of a barrel of Brent oil should remain range-bound around USD 55. Survey-based estimates of OPEC production are expected to confirm that the agreed output cuts have been largely implemented. Further support should come from upbeat sentiment indicators. Page 13 Chief economist: Dr Jörg Krämer +49 69 136 23650 [email protected] For important disclosure information please see pages 16 and 17. Editor: Peter Dixon research.commerzbank.com / Bloomberg: CBKR / Research APP available +44 20 7475 4806 [email protected] Economic Research | Week in Focus Germany: Housing overpriced but boom continues Dr Marco Wagner Tel. +49 69 136 84335 House prices in Germany keep on rising. According to our new model, they are now overpriced by around 10%. Only a marked rise in interest rates would be likely to end this boom and such a move is nowhere in sight. House prices should therefore continue to climb for the time being. This does not pose a great danger for the economy at present as the building sector is not yet over-inflated and the rise in private debt has been limited so far. However, the longer the boom lasts, the greater the risk that major imbalances will emerge whose correction would hit the German economy hard. The housing boom is in full swing In Germany, prices for residential property are on an apparently unstoppable uptrend. House prices in the third quarter of 2016 – the latest data published by the German Federal Statistical Office – were more than 6% above year-ago levels (see chart on title page). This is the sharpest price rise in 25 years. In the final quarter of 2016, the increase was likely to have been at a similar pace, on the basis of data from the Internet Portal Immobilienscout24. Housing is overvalued by 10% … In view of these figures, an increasing number of people are warning that a bubble is developing on the housing market. And indeed, our newly developed model (see box, page 4) does show that since 2011, German house prices have been rising at a faster rate than is justified on the basis of private household incomes; interest rates; building costs and demographic trends. While the beginning of the upturn was initially a correction to the previous undervaluation of residential property in Germany, since the beginning of 2015 house prices have increasingly been above the “fair” level determined by our model (chart 1) and latest estimates put the degree of overvaluation at about 10%. … unlike in earlier booms Consequently, the current boom differs from earlier periods when house prices rose strongly in that, according to our model, there has not been a similar degree of overvaluation. At the end of the 1970s and again at the end of the 1980s, house prices rose largely in line with the “fair“ house price (chart 2). The strong economy at that time boosted private household incomes and stimulated the labour market. At the beginning of the 1990s, a demographic component was added when there was a rise in the percentage of the population aged between 25 and 44 years, who typically start a family and look to buy their own home (chart 3, page 3). These factors fuelled the demand for home ownership despite relatively high interest rates and caused house prices to soar. The price correction between the mid-1990s and mid-2000s was also explained by the fundamental data; unemployment was climbing, real household incomes came under pressure and the demographics turned negative from the property market perspective. CHART 1: House prices are overvalued by 10% … CHART 2: … unlike in earlier boom phases Actual prices for residential property and “fair” house prices (Box, page 4), Index 2010 = 100 Actual prices for residential property and “fair” house prices (Box, page 4), Index 2010 = 100 130 130 125 120 120 110 115 100 110 90 105 80 100 70 95 60 90 2005 2007 2009 2011 actual house prices 2013 2015 2017 "fair" house prices Source: Statistical Office, German Bundesbank, Commerzbank Research 2 50 1975 1985 actual house prices 1995 2005 2015 "fair" house prices Source: Statistical Office, German Bundesbank, Commerzbank Research 24 February 2017 Economic Research | Week in Focus “Fair” prices continue to rise … For a good ten years, “fair“ prices have been rising. However, an average growth rate of 1½% in the past three years means that their rise is much more modest than in earlier boom phases. This is partly due of course to much lower consumer price inflation, but also because private income is rising at a much slower pace than in the 1970s and 1980s. Furthermore, until recently – and unlike in the first half of the 1990s – the percentage of 25 to 44 year olds in the total population has decreased. Moreover, the pace is set to change very little this year and next. Although the percentage of 25 to 44 year olds is likely to increase somewhat in the next few years (chart 3), real interest rates are barely likely to fall (chart 4) and the inflation rate will probably only pick up slowly at best. … and the overvaluation of prices is increasing At 4½% per year, house prices in the past three years have risen at a much stronger rate than was justified according to the model. Favourable financing costs alone cannot explain this; low real interest rates are incorporated in the model’s calculation of “fair” prices so this is already factored into their rise. Not considered in the model, however, is the wide uncertainty in Germany about the long-term consequences of the prolonged low-interest phase resulting from the ECB’s liquidity flood, particularly with regard to pension provision and the long-term inflation outlook. Many view the general outlook for European Monetary Union with some scepticism, which has allowed “concrete gold” to gain favour with investors. Since a solution to the problems of EMU and a move by the ECB towards a less expansionary monetary policy will not happen in the next couple of years, whilst a further rise in “fair” prices is likely, the property boom in Germany can be expected to continue in the near term. But what if the bubble bursts? The boom would end at some point if the situation in the euro zone improved significantly, thus alleviating German concerns. A more likely trigger, however, is higher real interest rates which would reduce the “fair” price via rising financing costs and act as a dampener on the economy (and thus income and the labour market). If the boom were to end quickly, the consequences for the overall economy would be limited. Like in the last two episodes, house prices would be unlikely to slump, but would more likely fall slightly at worst. The debt of private households has only risen moderately (chart 5, page 4) and CHART 3: Percentage of potential home owners has been on the decline for a long time Percentage of 25 to 44 year olds in total population, in per cent; model forecast from 2017 CHART 4: Real interest rates bottoming out Effective interest rates for housing loans to private households with an initial fixed interest rate for 10 years, deflated by consumer price inflation (excluding energy), in per cent 33 9 32 8 31 7 30 6 29 5 28 4 27 3 26 2 25 1 24 1975 1980 1985 1990 1995 2000 2005 2010 2015 0 1975 1980 1985 1990 1995 2000 2005 2010 2015 Source: Federal Statistical Office, Commerzbank Research 24 February 2017 Source: Statistical Office, German Bundesbank, Commerzbank Research 3 Economic Research | Week in Focus CHART 5: Loans for house purchases rising moderately CHART 6: Building investment is still below-average Existing volumes of loans for house purchases (all tenors) to private households, percentage change on year, and in relation to disposable income Investment in housing in per cent of GDP; black line: mean since 1975 10 66 8 64 7.5 7.0 6 62 6.5 4 60 2 0 -2 2003 8.0 2005 2007 2009 2011 in % on the year (lhs) 2013 6.0 58 5.5 56 5.0 2015 in % of income (rhs) Source: German Bundesbank, Commerzbank Research 4.5 1975 1980 1985 1990 1995 2000 2005 2010 2015 Source: Federal Statistical Office, Commerzbank Research most housing loans have a long fixed interest rate. 97% of current residential property loans have an original maturity of five years or more. Consequently, high interest rates would only slowly increase the interest burden and there would be far fewer emergency sales than in Spain, for example, at the end of the housing boom. Furthermore, building investment is at a belowaverage level (chart 6) which suggests there is no risk of a slump and job losses on the scale of Spain or the USA. That said, the longer the current boom lasts, the larger the risks that substantial imbalances will develop whose correction would greatly harm the economy. The gap between actual and “fair” prices will continue to widen, increasing the risk of a big correction in prices. What’s more, the building sector, in which capacity utilisation is already very high, is likely to begin to expand capacity at some point amid the continued high demand. Consequently, if – in several years’ time – the property boom were to end abruptly, this could result in huge job cuts. Lastly, the marked upward trend in private household debt since 2010 is set to continue and if prices then slumped, this could lead to problems for borrowers and the banks financing them. Box: Estimating the "fair" level of house prices To quantify the level of tension on the German property market, we have developed a model – based on studies from the ECB and BIS – to help us arrive at an estimate of the "fair" level of 1 house prices. Temporary deviations from this level imply an over- or undervaluation of German residential property. The "fair" value is calculated from the long-term correlation between real property prices and the following economic fundamentals: • real disposable per-capita income; • real construction costs; • real interest rates; • the rate of unemployment and • the share of those aged 25 to 45 in the overall population. Real house prices and the explanatory variables follow an I(1) process, with the Akaike information criterion suggesting a three-period lag. Moreover, a Johansen trace test implies two cointegrating relationships (rk=2). Based on a Chow break-point test there was nothing to indicate a structural break in the time series, implying that the estimate can easily be run over the entire 1975 to 2016 period. Based on these features, estimates from a vector error correction model seem appropriate where both the long-term (cointegration) and near-term correlations of the variables are taken into account. 1 We essentially follow the approaches of Gattini, Luca and Paul Hiebert: “Forecasting and assessing euro area house prices through the lens of key fundamentals“, ECB Working Paper 1249, 2010, and Égert, Balázs and Dubravko Mihaljek: “Determinants of house prices in central and eastern Europe”, BIS Working Paper 236, September 2007. 4 24 February 2017 Economic Research | Week in Focus Major publications from 17 – 23 February 2017 Economic Insight US: Changing of the guard – Trump can realign the Fed Donald Trump will soon be able to appoint almost a whole new leadership of the Fed, including the Chair of the Federal Reserve Board. The Republicans in Congress will be keen to select personnel that bind the Fed more tightly to the rules but Trump is unlikely to follow these wishes and the monetary policy course may therefore change less than feared. That said, the new team may well cut back regulation of the financial system quite significantly. more Economic Insight: Euro area loans – Still sluggish Even after two years of government bond purchases by the ECB, lending momentum remains modest in the euro area, and this is unlikely to change much in the coming quarters. For one thing, companies have little demand for credit in light of sluggish investment. For another, the positive effects coming from credit supply should ebb. This is one reason why the ECB will probably reject calls for an exit from its expansionary monetary policy. more EM Briefing: China – Property slowdown looming on the horizon China's nationwide property price slowed in January, as the authorities tightened both property and monetary policies. Clearly, property prices have peaked, and a property slowdown is looming on the horizon. more FX Hotspot: Banxico’s hedge plan to support peso Banxico announced that it will offer up to $20 billion in forex hedges, starting with a first auction of up to $1 billion on March 6. With these new measures that seem to work similar to NDFs (nondeliverable forwards), the Central Bank has beefed up its toolkit to support the peso without using FX-reserves. more FX Insight: The BoJ’s course … We expect that the Bank of Japan will have to taper its bond purchases before year-end. As it is still a long way from reaching its inflation target it will once again have to adjust its monetary policy course, otherwise it risks renewed yen appreciation. more FX Insight: KRW rally overdone The KRW has been one of the best performing EM currencies despite a subdued economic outlook. The outperformance reflects the improvement in EM risk sentiment, positive export data and ongoing political risks. That said, expectations of monetary divergence with the US are likely to put the KRW under renewed pressure. Against this backdrop, we expect USD-KRW to re-test 1,200 by year-end. more FX Hotspot: Why we expect higher EUR-HUF this year The German Ifo recorded another upbeat reading. Our own indicator for German economic activity has also recently risen to its highest since 2012, making it likely that the consensus will have to revise up 2017 GDP forecasts. We see some improvement in CE3 (Poland, Hungary, and Czech Republic) economic prospects too, but there are good reasons to remain cautious. A failure of growth to accelerate strongly would be a reason to expect weaker exchange rates later this year, especially in Hungary. more FX Hotspot: RON – Political crisis weighs on Romanian leu It took the new government only six weeks to stumble into its first political crisis. Its attempt to impede the judiciary’s anti-corruption campaign triggered the largest protests in Romania since the end of communism. Despite plans for a referendum to settle the issue, demonstrations and calls for the government to step down continue. Ongoing uncertainty over the political situation is likely to continue to weigh on the Romanian leu. more 24 February 2017 5 Economic Research | Week in Focus Preview – The week of 27 February to 3 March 2017 Time Region Indicator Period Forecast Survey Last Monday, 27 February 2017 9:00 EUR USA M3 money supply Loans to the private sector Economic sentiment indicator (ESI) Business confidence (industry) Business confidence (services) Durable goods orders Jan Jan Feb Feb Feb Jan yoy yoy sa sa sa mom, sa 4.7 2.1 108.0 1.0 13.0 1.0 – – – – – 2.0 5.0 2.2 107.9 0.8 12.9 -0.5 JPN Durable goods orders ex transport Pending home sales Industrial production Jan Jan Jan mom, sa mom, sa mom, sa 0.2 0.0 0.0 0.5 0.9 0.4 0.5 1.6 0.7 Q4 Q4 Dec Feb Feb qoq SAAR yoy sa sa 0.4 2.0 5.3 54.0 110.0 – 2.1 – 53.0 111.0 0.4 1.9 (p) 5.3 50.3 111.8 51.1 56.0 53.5 -10.0 55.5 55.8 0.6 2.1 0.2 0.2 0.2 57.0 51.1 – – – – – – – 0.3 0.3 0.3 55.8 51.3 55.6 53.0 -26.0 55.5 (p) 55.9 -0.6 1.9 0.3 0.5 0.1 56.0 0.50 17.8 – 17.6 0.50 17.48 10:00 • 13:30 15:00 23:50 Tuesday, 28 February 2017 8:45 13:30 14:00 14:45 15:00 FRA USA GDP, preliminary GDP, real (2nd estimate) Case Shiller house price index Chicago PMI Consumer confidence (conference Board) Wednesday, 1 March 2017 • 1:00 8:15 8:45 8:55 9:00 9:30 # CHN SPA ITA GER EUR GBR GER PMI manufacturing PMI manufacturing PMI manufacturing Unemployed PMI manufacturing, final PMI manufacturing CPI, first state results Feb Feb Feb Feb Feb Feb Feb 15:00 USA Personal income Personal spending PCE excl. food & energy ISM index (manufacturing) Jan Jan Jan Feb sa sa sa mom, k, sa sa sa mom yoy mom, sa mom, sa mom, sa sa Feb % SAAR, mn Unemployment rate CPI, preliminary Jan Feb % yoy 9.6 2.0 – 1.9 9.6 1.8 CPI excl. food, tobacco, and energy, prelim. Initial claims CPI Unemployment rate Feb Feb 25 Jan Jan yoy k, sa yoy % 0.9 245 0.4 3.1 0.9 – 0.3 3.0 0.9 244 0.3 3.1 Jan Feb Feb Feb mom, sa sa sa sa 1.5 55.6 55.8 56.5 – – – 56.5 -0.9 55.6 (p) 54.5 56.5 • CAD BOC interest rate decision # USA Auto sales USA: President Trump speaks before Congress (2 a.m.) Fed releases beige book (19:00) Thursday, 2 March 2017 10:00 EUR 13:30 23:30 USA JPN • Friday, 3 March 2017 # 9:00 9:30 15:00 GER EUR GBR USA Retail sales, volumes PMI services, final PMI services ISM index (non-manufacturing) Source: Bloomberg. Commerzbank Economic Research; *Time GMT (subtract 5 hours for EST. add 1 hour for CET). # = Possible release; mom/qoq/yoy: change to previous period in percent. AR = annual rate. sa = seasonal adjusted. wda = working days adjusted; (p) = preliminary; • = data of highest importance for markets 6 24 February 2017 Economic Research | Week in Focus Christoph Weil Tel. +49 69 136 24041 Economic data preview: Euro zone: Inflation rate reaches ECB target The discussion about the ECB’s exit from its ultra-expansionary monetary policy should continue to gain momentum next week, as the inflation rate in February will probably see a two before the decimal point for the first time in four years. While this could further drive up inflation expectations, it remains to be seen how sustainable the higher inflation expectations will turn out to be. After all, it is likely that the inflation rate will soon fall again, and underlying inflation pressure remains weak for now. In the US, the ISM index for the manufacturing sector should even exceed its high January level. The inflation outlook in the euro area has changed significantly since last autumn. The large jump in the inflation rate from 0.5% in November to 1.8% in January has propelled inflation expectations of companies, consumers and investors sharply upwards (see chart 7). And the rise in the inflation rate to 2.0% that seems to be on the cards for February should drive them up still further (consensus forecast: 1.9%). The ECB may welcome this, but a quick exit from its ultra-expansionary monetary policy is unlikely as weak underlying inflation pressure remains in play. In February, the core rate of inflation – i.e. the year-on-year rate CPI inflation excluding the volatile prices for energy, food, alcohol and tobacco – probably remained at 0.9% (consensus forecast: 0.9%). Even if the ECB’s hopes are fulfilled and the higher inflation expectations are reflected in higher pay deals, it will take one or two years for this to drive the core rate of inflation noticeably upwards. Moreover, the inflation rate will decline again in the coming months, which could dampen inflation expectations a bit. The reason for this is that the sharp rise in energy prices from spring 2016, which is unlikely to be repeated this spring, will then fall out of the year-on-year comparison. On the contrary, we even expect crude oil prices to fall slightly in the course of the year, pushing the inflation rate down to nearly 1% by year-end. USA: Sentiment in manufacturing at a high The uptrend in US industry continues. Although the ISM index already climbed to 56 in January, another increase seems on the cards for February. At least this is what the regional survey of the Philly Fed and the Empire State Index of the New York Fed suggest (chart 8). We forecast a reading of 57.0 (consensus: 55.8). Yet, this means that the surveys overstate the strength of the revival as measured by hard data. While production rose in each of the last five months, total output was only 0.5% higher than a year earlier. CHART 7: Euro zone: Inflation expectations are rising with inflation rate Consumer: Expected price trends over the next 12 months, balance, Manufacturing: Selling price expectations for the months ahead, balance, Consumer price index, y-o-y in % CHART 8: USA – ISM has probably continued rising Regional purchasing managers’ indices for manufacturing (average of the Philly Fed and Empire State indices), ISM index for manufacturing at the national level 15 2 25 60 10 1,5 20 58 1 5 0,5 15 56 10 54 5 0 0 -5 -0,5 -10 -1 2014 2015 Consumer (lhs) 2016 2017 Industry (lhs) Source: Global Insight, EU Commission, Commerzbank Research 24 February 2017 CPI (rhs) 52 0 50 -5 -10 2012 48 2013 2014 regional indices (LS) 2015 2016 2017 ISM index (RS) Source: Global Insight, Commerzbank Research 7 Economic Research | Week in Focus Central Bank Watch (1) Fed According to the minutes of the last FOMC meeting, many meeting participants were of the opinion that another rate hike could be appropriate “fairly soon”. Some even pointed to the upcoming meetings. However, this does not necessarily mean that the Fed will raise rates as early as its next meeting in mid-March. It is likely that it was the hawks among the 12 regional Fed presidents who were pressing for a quick rate move. They often dominate the public debate and also try to steer the discussion at the Fed in their direction. Note that not all meeting participants have voting rights. Votes on monetary policy are the responsibility of the FOMC, where the regional Fed presidents hold 5 seats. In 2017, only one of them is probably a hawk – Patrick Harker from the Philadelphia Fed. The 5 Board members currently on the FOMC prefer to proceed rather cautiously anyway. Therefore, the minutes also show that many “members” (which means the voting FOMC members; the “meeting participants” also include the 7 non-voting Fed presidents) see only a low risk of the economy overheating. They therefore take the view that there is enough time to react to any inflation pressure. This does not point to a quick rate hike. Bernd Weidensteiner +49 69 136 24527 CHART 9: Expected interest rate for 3-month funds (USD) 2,0 1,5 1,0 0,5 current Mrz 17 Jun 17 Sep 17 Dez 17 Mrz 18 Futures 23.02.17 16.02.17 Commerzbank TABLE 1: Consensus forecasts Fed funds rate ((upper bound) Q1 17 Q2 17 Q4 17 Consensus 0.75 1.00 1.25 High 1.00 1.25 1.75 Low 0.75 0.75 0.75 Commerzbank 0.75 1.00 1.25 Source: Bloomberg, Commerzbank Research ECB ECB Executive Board member Lautenschläger who has occasionally criticised the ECB’s expansionary measures welcomed the inflation rise but said that it would be too soon for rate move: “it is really important to see a trend, that it is certain that inflation really has come back”. "If inflation rates continue as they were in January, then I would not want to wait until next year [to start tapering]," she said. In the same vein, ECB’s Hansson said that it would not be wise to start exiting from expansionary monetary policy now, as the central bank only decided in December to extend the QE programme. “The central bank should be a factor of stability in this situation of political unrest rather than adding to turbulence.” According to ECB’s Vasiliauskas, “TLTROs are a very good instrument … I would be very flexible regarding that instrument in the future”. (Note that the ECB will offer its last TLTRO in March). He argued that TLTROs cannot be a permanent measure because they “remain an emergency tool” and “a healthy system in normal times should be financed by the markets”. That said, in Vasiliauskas’ view the ECB might reintroduce TLTROs if there were “for example drastic changes in lending”. Any discussion of an exit from QE “would be pretty premature”, he stressed. Dr Michael Schubert +49 69 136 23700 8 CHART 10: Expected interest rate for 3-month funds (EUR) 0,0 -0,1 -0,2 -0,3 -0,4 -0,5 current Mrz 17 Futures Jun 17 23.02.17 Sep 17 16.02.17 Dez 17 Mrz 18 Commerzbank TABLE 2: Consensus forecasts ECB minimum bid rate Q1 17 Q2 17 Q4 17 Consensus 0.0 0.0 0.0 High 0.0 0.0 0.0 Low 0.0 0.0 0.0 Commerzbank 0.0 0.0 0.0 Source: Reuters, Bloomberg, Commerzbank Research 24 February 2017 Economic Research | Week in Focus Central Bank Watch (2) BoE (Bank of England) Although the data tend to be volatile, the market probability assigned to a rate hike by end-2018 continues to drift downwards, with the five-day moving average now showing a probability below 50% for the first time. Indeed, around the turn of the year the markets were even pricing an increase in 2017 as a 50-50 chance. But despite the apparent buoyancy of the economy over the last six months, there are indications that some of the optimism is dissipating in the wake of rising inflation which will take the edge off growth. Indeed, the BoE will likely to have make a decision whether to prioritise slower growth or higher inflation in 2017. Markets increasingly tend towards the former option. The view of the MPC is harder to discern. Governor Carney gave no significant indications following this week’s parliamentary testimony, refusing to confirm whether the BoE remains neutral on the direction of the next rate move. Indeed, one of the issues at the hearing was whether the BoE remains committed to its forward guidance policy. This certainly is an important question, because although the BoE has not formally abandoned the policy, it is not clear at present what signals it is trying to communicate other than that the MPC remains in wait-andsee mode for now. CHART 11: Expected interest rate for 3-month funds (GBP) 1,0 0,8 0,6 0,4 0,2 0,0 current Mrz 17 Jun 17 Sep 17 Dez 17 Mrz 18 Futures 23.02.17 16.02.17 Commerzbank Source: Bloomberg, Commerzbank Research Peter Dixon +44 20 7475 1808 BoC (Canada) The Bank of Canada (BoC) has no reason to change its monetary policy next week. Instead, it will leave the key interest rate at 0.5% and, like in January last year, stress the uncertainty and resulting risks for the economic outlook. Indeed, information is still lacking on the fiscal, tax and trade policy of the new US president. Without this, the BoC will not be able to estimate the consequences for growth and inflation in Canada stemming from the country’s close trade ties with the USA. Furthermore, the substantial excess capacities in the domestic economy pose downsides risks for inflation in the BoC’s view. These risks are being increased by the strong Canadian dollar, which is additionally reducing the competitiveness of Canadian companies and therefore dampening the outlook for the export sector. CHART 12: Expected interest rate for 3-month funds (CAD) 1,5 1,0 0,5 0,0 current Mrz 17 Futures 23.02.17 Jun 17 Sep 17 16.02.17 Dez 17 Mrz 18 Commerzbank Source: Bloomberg, Commerzbank Research Antje Praefcke +49 69 136 43834 24 February 2017 9 Economic Research | Week in Focus Michael Leister Tel. +49 69 136 21264 Bond market preview: Bunds: How to save face at the Eurogroup meeting? The short end of the curve will remain in focus, but the long-end is increasingly impacted by the Bundesbank’s sizeable €QE purchases in the one-year maturity sector. Moreover, investors remain nervous regarding political risks in France and Italy, while ample redemptions need to be reinvested. We therefore continue to expect Bund yields to trend downward amid a steeper curve. TABLE 3: Weekly outlook for yields and curves Bunds US Treasuries Yield (10 years) Sideways Sideways to higher Curve (2 - 10 years) Neutral Neutral Source: Commerzbank Research The continuing improvement in fundamental indicators and new highs in equity markets notwithstanding, the market environment for Bunds could hardly be better at present. The Bundesbank continues making ample use of its option to buy bonds with a yield below the depo rate for its €QE purchases. This has compressed 2y Schatz yields by around 25 basis points since the end of January and driven them to new all-time lows below 0.90% (see chart 13). This is where the present situation differs from the Schatz rally at the end of last year, which was mainly driven by private investors’ demand for German general collateral (GC). Outlook for the Bund future, 27 February – 4 March Economy ↓ Inflation → Monetary policy → Trend → Supply ↑ Risk aversion ↑ The Bundesbank’s purchases have underpinned the steepening trend of the Bund curve. In view of very low two-year yields, the medium and longer maturity segments should also increasingly benefit from the downward pull arising from the Bundesbank purchases. Moreover, political concerns still remain in focus, prompting additional demand for Bunds. The risk premiums of French bonds had widened to new highs before the latest headlines about an alliance between the moderate candidates Macron and Bayrou provided some relief (chart 14). We doubt, however, that the latter marked a turning point. Instead, the “redenomination risk” connected with Le Pen should still keep risk premiums high, especially as an election in Italy is possible as early as June according to press reports. In turn, the safety premium included in Bund yields should thus remain pronounced for at least three months yet. Moreover, Bunds should increasingly profit from sizeable reinvestment needs, as an aggregate €33bn in redemptions by France and coupon payments by Italy could be parked in safe havens for the time being. We therefore continue to expect curves to steepen and Bund yields to trend lower. CHART 13: QE purchases ensure “rate cut” at short end CHART 14: Turning point for French OATs? Yield of two-year Bunds, ECB deposit rate, in % p.a. Yield premium of 10y French government bonds (OATs) versus corresponding Bunds, on a daily basis, in basis points 85 0,4 0,2 80 0,0 -0,2 75 -0,4 -0,6 70 -0,8 -1,0 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 65 15-Feb 16-Feb 17-Feb 20-Feb 21-Feb 22-Feb 23-Feb ECB depo rate Source: Bloomberg, Commerzbank Research 10 2y Schatz Source: Bloomberg, Commerzbank Research 24 February 2017 Economic Research | Week in Focus Antje Praefcke Tel. +49 69 136 43834 FX market preview: EUR-USD under downside pressure Strong support in polls for the eurosceptic French presidential candidate Marine Le Pen has awakened fears of a breakup of the euro zone and is weighing on the euro. On the back of strong US inflation data the FX market is also speculating about higher interest rates in the US, with the USD gaining slightly as a result. TABLE 4: Expected trading ranges for next week Range Trend Range Trend EUR-USD 1.0400-1.0750 EUR-GBP 0.8300-0.8550 EUR-JPY 117.50-121.00 GBP-USD 1.2350-1.2750 USD-JPY 111.00-115.00 EUR-CHF 1.0550-1.0725 Source: Commerzbank Research Growing support in polls for French presidential candidate Marine Le Pen has exerted strong downside pressure on the euro in February. On a trade-weighted basis, the euro has fallen to its lowest level since March 2016 (see chart 15). The FX market fears an election victory of the eurosceptic candidate, who wants to hold a referendum on France’s EU membership and replace the euro with a basket of national currencies. Political support for the common currency is thus crumbling. With a lack of stimulus from the real economy, the euro remains on the back foot for now. An acceleration of the euro area inflation rate in February to 2.0% will not support the euro. The ECB has already committed to continuing its bond purchases at least until yearend and will not be inclined to start the discussion about an adjustment of its monetary policy, given that critical elections are coming up. This means positive stimuli for the euro will be lacking near-term. At the same time, the dollar has seen gains since early February after various Fed officials had spoken out clearly in favour of a cautious tightening of monetary policy. Support for this came from strong consumer price data in January (chart 16). This inspires hope that the personal consumption expenditure deflator, which is due for release on Wednesday, is gradually moving towards the Fed’s inflation target. The dollar should also continue benefiting from the positive economic environment, as order intake and the second estimate of US GDP growth in Q4 2016 will probably turn out solid. But USD investors beware: At the end of the day, prospects for growth and for the Fed’s interest rate policy strongly depend on the fiscal policy plans of the new US government. And the dollar outlook thus remains fraught with risk as long as more precise information on the tax plans or the planned government expenditure is not available. CHART 15: Trade-weighted EUR exchange rate at its lowest level since March 2016 Multilateral EUR exchange rate index versus the 19 most important trading partners 97 CHART 16: US inflation is approaching the target Consumer price index (CPI) and personal consumption expenditure deflator (PCE), in each case core index excluding energy and food, percentage change on year 2.4 2.2 96 2.0 95 1.8 1.6 94 1.4 93 1.2 92 91 Jan-16 1.0 Jan-14 Apr-16 Jul-16 Source: ECB, Commerzbank Research 24 February 2017 Oct-16 Jan-17 Jul-14 CPI Jan-15 Jul-15 PCE Jan-16 Jul-16 Jan-17 Fed Target Source: BEA, BLS, Commerzbank Research 11 Economic Research | Week in Focus Markus Wallner Tel. +49 69 136 21747 Equity market preview: DAX reaches two-year high Driven partly by a weak euro, the DAX marked a new two-year high this week. On account of current high valuations, selective stock-picking will gain in importance. We still favour companies that harbour hopes of restructuring, have a high share of sales in the USA and whose earnings react positively to a stronger dollar. Furthermore, the price/book value of the stocks should be around the long-term average and earnings should be rising at an above-average rate. This is the case, for example, with Bilfinger, Osram, HeidelbergCement and BMW. TABLE 5: DAX reaches two-year high Earnings 2017e Performance (%) since Index Index points Growth (%) 31/01 01/01 30/06 current 01/01 P/E 2017e current 01/01 current 01/01 DAX 30 11,999 4.0 4.5 24.0 864.1 855.1 7.5 10.8 13.9 13.4 MDAX 23,613 5.1 6.4 19.0 1318 1308 14.0 14.4 17.9 17.0 Euro Stoxx 50 3,339 3.4 1.5 16.6 234.7 233.3 10.1 11.8 14.2 14.1 S&P 500 2,363 3.7 5.5 12.6 129.1 130.4 10.2 11.6 18.3 17.2 Source: Commerzbank Corporates & Markets, I/B/E/S After the price rise of recent weeks, the P/B ratios of 7 for DAX and 9 for MDAX companies are close to their highs of the last 10 years. They are certainly above the average of the last 10 years in the case of 20 DAX and 36 MDAX companies (see chart 17). Six months ago, these figures were considerably lower. At this high valuation level, selection stock-picking becomes even more important. We still prefer companies that have restructuring aspirations, a high share of sales in the USA and earnings that respond positively to a stronger dollar. What’s more, the P/B value of the stocks should be around the long-term average and earnings should have above-average upward momentum. Examples of such stocks are Bilfinger, Osram, HeidelbergCement and BMW. CHART 17: Valuations of DAX companies have risen further Price/book value of DAX companies, in per cent of the peak and average of last ten years 260 220 180 140 100 60 20 EOAN TKA ADS IFX DPW DTE MRK HEN3 FRE BAS SIE HEI PSM FME CON LIN ALV BAYN LHA DB11 BEI MUV2 DAI SAP BMW VNA VOW3 RWE DBK CBK -20 Per cent of average Per cent of peak Source: Datastream, Commerzbank Research 12 24 February 2017 Economic Research | Week in Focus Barbara Lambrecht Tel. +49 69 136 22295 Commodities market preview: Discipline remains high, for now … In the week ahead, the price of a barrel of Brent oil should remain range-bound around USD 55. Survey-based estimates of OPEC production ought to confirm that the agreed output cuts have been largely implemented. Further support should come from upbeat sentiment indicators. The latter are likely to also push forward the timing of our expected price correction in base metal markets, particularly because some of them such as copper are currently struggling with supply problems. TABLE 6: Trends in important commodities Per cent change in % 23 Feb 1 week Tendency Commodity specific events 1 month 1 year short-term Brent (USD per barrel) 56.6 1.7 2.5 70.1 Copper (USD per tonne) 5977 -0.4 3.1 28.7 Gold (USD per troy oz.) 1239 0.0 1.7 1.1 Cocoa (GBP per tonne) 1611 -1.8 -7.7 -24.2 Estimates of OPEC production (around 28) CHN. Gold imports from Hong Kong (27) ICCO: Quarterly report (around 27) Source: Bloomberg, Commerzbank Research Since the end of November, the price of a barrel of Brent oil has been hovering around USD 55. Of late, volatility has declined further, to the lowest level since the price plunge in 2014. In the week ahead, all should remain calm. In February, OPEC cartel members look set to have stuck to the agreed production cuts for the second month in a row, as the news agencies‘ surveybased estimates of OPEC production should show. This is above all due to Saudi Arabia, which trimmed back its daily output by 500k barrels in January (see chart 18). Thus the largest producer by far in the cartel looks set to have exceeded its contribution in February as well, thus ironing out the weakness of others. Iraq, for instance, only met half of its target in January. Although short-term news is supporting prices, we stick to our expectation of a medium-term correction. This view is corroborated by the fact that the gradual rise in US production should weigh on oil prices, particularly because the market is vulnerable due to record-high net long positions of speculative investors. Around mid-year, we see the price of Brent oil at USD 50 per barrel again. For two weeks, gold prices have been unchanged. The recent strength of the US-dollar has prevented a further recovery. In euro, gold has meanwhile climbed to a 3½-month high. Given severe political uncertainty, demand for gold as a safe haven should remain strong. Weaker demand from China in January, which will be reflected in lower imports from Hong Kong, should be short-lived. The International Cocoa Organization, which will present initial estimates for 2016/17 in its quarterly report, looks set to forecast oversupply in the global cocoa market. This is unlikely to further depress prices, though. In London, these are trading at levels last witnessed in mid-2013, after plunging by 40% since last summer. In New York, prices in US-dollar are even down to the lowest level since 2008 (chart 19). CHART 18: Saudi Arabia ironing out the weakness of others CHART 19: Cocoa prices have already taken a sharp plunge Implementation of agreed production cuts in % in USD per tonne resp. GBP per tonne 140% 4000 3000 120% 3600 2600 100% 3200 80% 60% 2800 40% 2400 20% 2000 2200 1800 0% OPEC-11 Venezuela U.A.E. Saudi Arabia Qatar 24 February 2017 Kuwait Iraq Gabon Ecuador Angola Algeria Source: OPEC, Commerzbank Research 1400 1000 1600 1200 2007 600 2009 2011 2013 in New York, l 2015 2017 in London, r Source: ICE, Bloomberg, Commerzbank Research 13 Economic Research | Week in Focus Commerzbank forecasts TABLE 7: Growth and inflation Real GDP (%) Inflation rate (%) 2016 2017 2018 2016 2017 2018 USA 1.6 2.3 2.3 1.3 2.5 2.5 Japan 1.0 1.0 1.0 -0.1 1.0 1.0 Euro area 1.7 1.8 1.6 0.2 1.3 1.2 - Germany 1.9 1.6 1.5 0.5 1.8 1.6 - France 1.3 1.6 1.7 0.2 0.6 0.8 - Italy 0.8 1.0 1.1 -0.1 0.7 0.9 - Spain 3.3 3.0 2.5 -0.5 1.3 1.4 - Portugal 1.2 1.2 1.1 0.6 1.3 1.5 - Ireland 4.4 3.5 3.0 -0.2 0.8 1.3 - Greece 0.4 2.1 2.3 -0.8 0.7 1.0 United Kingdom 1.8 1.6 1.7 0.7 2.4 2.8 Switzerland 1.5 1.5 1.7 -0.4 0.4 0.8 China 6.7 6.5 6.3 1.8 2.0 2.2 India 6.8 7.3 7.4 5.2 5.3 5.1 Brazil -3.4 0.1 2.0 8.8 5.0 4.9 Russia -0.6 1.3 2.0 8.0 5.5 5.5 World 2.8 3.3 3.4 • Having corrected its imbalances, the US economy continues growing at decent rates. • Growth in China is decelerating due, among other things, to high corporate indebtedness and industrial overcapacity. • The ECB’s expansionary monetary policy glosses over the structural problems of the euro zone and allows the economy to grow more strongly. • EMU has survived the sovereign debt crisis, but is gradually evolving into an “Italian-style monetary union” – structural weaknesses are preserved by the loose monetary policy. • The German economy is experiencing a consumption-driven boom; below this glossy surface, however, its competitiveness is gradually eroding. • High unemployment in most EMU countries is keeping inflation low for the time being. • With the Fed having approached its targets, the speed of rate hikes seems set to increase. We expect two hikes in 2017 by 25 bps each. • Mr Trump’s election victory exerts upward pressure on US long-end yields via higher inflation expectations and a looming supply increase. • As euro zone core inflation should stay below ECB expectations, we forecast the ECB will take further measures. • Contrary to the US setting, 10y Bund yields seem unlikely to increase significantly. • The multi-year trend of falling periphery spreads has run out of steam. With ECB support reaching limits and political risks on the rise, we anticipate rising risk premia. • Initially the monetary policies of the Fed and ECB will continue to drift further apart, putting pressure on the EUR-USD exchange rate. The ECB will be forced to reduce the volume of its monthly bond purchases towards year-end 2017, however. That will have a positive effect on EUR short term. • With a view to Brexit negotiations, our working assumption is that ultimately there will be an amicable agreement. However, uncertainty will remain high for a long period so that sterling will not recover for the time being. • Basically, CNY seems set to further depreciate against the dollar over the coming quarters. TABLE 8: Interest rates (end-of-quarter) 23.02.2017 Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 Federal funds rate, upper bound 0.75 0.75 1.00 1.00 1.25 1.25 3-months Libor 1.05 1.00 1.15 1.25 1.40 1.40 2 years* 1.21 1.10 1.30 1.50 1.70 1.90 5 years* 1.90 1.80 2.10 2.30 2.50 2.60 10 years* 2.41 2.50 2.60 2.70 2.80 2.85 Spread 10-2 years 120 140 130 120 110 95 -2 -20 -15 -15 -15 -10 Minimum bid rate -0.40 -0.40 -0.40 -0.40 -0.40 -0.40 3-months Euribor -0.33 -0.30 -0.25 -0.25 -0.25 -0.25 2 years* -0.88 -0.60 -0.65 -0.65 -0.65 -0.60 5 years* -0.53 -0.30 -0.35 -0.35 -0.30 -0.30 10 years* 0.27 0.50 0.25 0.30 0.40 0.50 Spread 10-2 years 115 110 90 95 105 110 Swap-Spread 10 years 47 35 35 35 35 35 Bank Rate 0.25 0.25 0.25 0.25 0.25 0.25 3-months Libor 0.36 0.40 0.40 0.40 0.35 0.35 2 years* 0.10 0.20 0.20 0.20 0.30 0.30 10 years* 1.19 1.70 1.70 1.75 1.80 1.85 USA Swap-Spread 10 years Euro area United Kingdom TABLE 9: Exchange rates (end-of-quarter) 23.02.2017 Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 EUR/USD 1.05 1.05 1.03 1.04 1.04 1.03 USD/JPY 113 112 114 116 118 120 EUR/CHF 1.07 1.06 1.05 1.04 1.00 1.00 EUR/GBP 0.85 0.86 0.86 0.87 0.87 0.87 EUR/SEK 9.49 9.40 9.35 9.30 9.30 9.20 EUR/NOK 8.81 9.05 9.00 8.95 8.95 8.85 EUR/PLN 4.31 4.35 4.40 4.45 4.50 4.55 EUR/HUF 308 310 315 317 320 325 EUR/CZK 27.02 27.00 27.00 25.50 25.00 25.00 AUD/USD 0.77 0.74 0.72 0.73 0.73 0.74 NZD/USD 0.72 0.70 0.68 0.69 0.69 0.70 USD/CAD 1.31 1.35 1.35 1.34 1.34 1.33 USD/CNY 6.88 6.95 7.05 7.10 7.15 7.20 Source: Bloomberg. Commerzbank Economic Research; bold change on last week; * Treasuries, Bunds, Gilts 14 24 February 2017 Economic Research | Week in Focus Research contacts (E-Mail: [email protected]) Chief Economist Dr Jörg Krämer +49 69 136 23650 Economic Research Interest Rate & Credit Research FX & EM Research Commodity Research Dr Jörg Krämer (Head) +49 69 136 23650 Christoph Rieger (Head) +49 69 136 87664 Ulrich Leuchtmann (Head) +49 69 136 23393 Eugen Weinberg (Head) +49 69 136 43417 Dr Ralph Solveen (Deputy Head; Germany) +49 69 136 22322 Michael Leister (Head Rates) +49 69 136 21264 Thu-Lan Nguyen (G10) +49 69 136 82878 Daniel Briesemann +49 69 136 29158 Dr Christoph Balz (USA. Fed) +49 69 136 24889 Rainer Guntermann +49 69 136 87506 Antje Praefcke (G10) +49 69 136 43834 Carsten Fritsch +49 69 136 21006 Peter Dixon (UK. BoE). London +44 20 7475 4806 Peggy Jäger +49 69 136 87508 Esther Reichelt (G10) +49 69 136 41505 Dr Michaela Kuhl +49 69 136 29363 Dr Michael Schubert (ECB) +49 69 136 23700 Markus Koch +49 69 136 87685 Lutz Karpowitz (EM) +49 69 136 42152 Barbara Lambrecht +49 69 136 22295 Eckart Tuchtfeld (German economic policy) +49 69 136 23888 David Schnautz +44 20 7475 4756 Elisabeth Andreae (EM) +49 69 136 24052 Equity Markets Strategy Dr Marco Wagner (Germany, Italy) +49 69 136 84335 Alexandra Bechtel (EM) +49 69 136 41250 Bernd Weidensteiner (USA, Fed) +49 69 136 24527 Ted Packmohr (Head Covered Bonds and Financials) +49 69 136 87571 Christoph Weil (Euro area, France, Switzerland) +49 69 136 24041 Marco Stoeckle (Head Corporate Credit) +49 69 136 82114 Charlie Lay (EM) +65 63 110111 Tatha Ghose (EM) +44 20 7475 8399 You-Na Park (EM) +49 69 136 42155 Hao Zhou (EM) +65 6311 0166 Christoph Dolleschal (Deputy Head Research) +49 69 136 21255 Andreas Hürkamp +49 69 136 45925 Markus Wallner +49 69 136 21747 Technical Analysis Achim Matzke (Head) +49 69 136 29138 Cross Asset Strategy Dr Bernd Meyer (Head) +49 69 136 87788 Other publications (examples) Economic Research: Economic Briefing (up-to-date comment on main indicators and events) Economic Insight (detailed analysis of selected topics) Economic and Market Monitor (chart book presenting our monthly global view) Commodity Research: Commodity Daily (up-to-date comment on commodities markets) Commodity Spotlight (weekly analysis of commodities markets and forecasts) Interest Rate & Credit Research: Ahead of the Curve (flagship publication with analysis and trading strategy for global bond markets European Sunrise (daily comment and trading strategy for euro area bond markets) Rates Radar (ad-hoc topics and trading ideas for bond markets) Covered Bonds Weekly (weekly analysis of the covered bonds markets) Credit Note (trading recommendations for institutional investors) FX Strategy: Daily Currency Briefing (daily comment and forecasts for FX markets) FX Hot Spots (ad hoc analysis of FX market topics) FX Insight (in-depth analyses of selected FX market topics) Equity Markets Strategy: Weekly Equity Monitor (weekly outlook on equity markets and quarterly company reports) Monthly Equity Monitor (monthly outlook on earnings. valuation. and sentiment on equity markets) Digging in Deutschland (thematic research focusing on the German equity market) Emerging Markets: EM Briefing (up-to-date comment of important indicators and events) EM Outlook (quarterly flagship publication with EM economic analysis and strategy recommendation) Cross Asset: Cross Asset Monitor (weekly market overview. incl. sentiment and risk indicators) Cross Asset Outlook (monthly analysis of global financial markets and tactical asset allocation) Cross Asset Feature (special reports on cross-asset themes) To receive these publications, please ask your Commerzbank contact. 24 February 2017 15 Economic Research | Week in Focus In accordance with ESMA MAR requirements this report was completed 24/02/2017 08:41 CET and disseminated 24/02/2017 08:42 CET. 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