Download Where lies north?

Where lies north? 16 May 2016
Economics
Where lies north?
DBS Group Research
16 May 2016
• Market gyrations have thrown everyone off course. Moms and Pops,
hedge fund managers and central bankers alike have lost their bearings
• Although the world frets over slow growth, Europe and Japan are doing vastly better than 1-2 years ago; the US no worse
• China is the only major economy in the world today pursuing a substantial package of reform and structural change. Ironically, it’s China
that everyone seems most concerned about
• No central bank in the world can control headline inflation today
because it is driven by still-low oil prices. But better growth has led
to steadily rising core inflation. Core CPI inflation in the US is already
above the Fed’s medium-term target
• If you’re worried about slow growth today, get used to it. It’s not going back up in the medium-term. It’s going down
The market gyrations of the first quarter threw everyone for a loop. Central banks,
multi-lateral agencies, hedge funds, analysts – all questioned their bearings when
markets crashed in the first 6 weeks of Jan/Feb – the S&P 500 by 12%, the Eurostoxx
by 19%, the Topix by 22%. In the US, those who weren’t surprised by the fall were
surprised by the rebound. One way or the other, everyone missed it. One way or
the other, everyone was left dazed or confused or both.
Of course there had to be a lot of questions to begin with. A 12% drop in the stock
market in 6 weeks isn’t unheard of – in the US, such has occurred 20 times since
WWII. What’s different is that only once before (in March 2009) did the market
rebound as quickly as it fell. It’s the 1-2 punch that speaks: A 12% drop in 6 weeks;
S&P 500 – drops of 12% or more in a 6-week period
% drop
46
50
54
58
62
66
70
74
78
82
86
90
94
98
02
06
10
14
18
0
-5
-10
Eisenhower
recession
-15
-20
-25
End-war
recession
60-61
recession
1st oil
crisis
2nd oil
crisis
EU debt
crisis
Asian
flu
69-70
recession
-30
2016
jitters
Housing
recession
Dotcom
Black
Monday
Subprime
David Carbon • (65) 6878-9548 • [email protected]
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Where lies north? 16 May 2016
a 12% rebound in 6 weeks. Twice in 70 years. Surely that occurs only when the
questions are many and the answers few.
Take but a couple: US growth dropped to 0.5% (QoQ, saar) in the first quarter while
housing soared and jobless claims dropped to their lowest in history. Square that
circle. The BoJ and ECB both eased monetary policy significantly and it backfired
on their currencies. Square that one. Got a theory? Good luck. Even the hedge
fund wizards that can bet in any direction they want at the drop of a hat had their
worst quarter in years. They’re as confused as Mom and Pop and the central bankers – mere mortal institutions are pulling their money accordingly.
There’s lots of humble pie to go around and most of the big questions have yet to be
answered. Consider a few and the serious minds grappling with them in more detail:
1. The Fed’s ‘tight’ financial market conditions
Few fell harder for the market’s head-fake in Q1 than the Fed. No sooner had it
pulled the trigger on lift-off than it was warning of ‘tight financial market conditions’ that obliged a re-think. Inflation was no longer the risk forcing the Fed to
choose between gradual hikes today or rapid hikes tomorrow. A new three-part
risk threatened the recovery, Yellen told Congress on 10-February: a jump in the
dollar, rising yields on ‘high-yield’ (junk) bonds and a fall in the stock market. And
the Fed went into neutral.
In fact, financial markets were anything but tight. On the currency front, the Fed’s
dollar-majors index showed a tiny 1% appreciation between mid-December when
the Fed hiked rates and late-January. By the time Yellen testified before Congress,
it was weaker, not stronger, than it was in December. It has continued to weaken
since February and is today 5% weaker than on January first.
Nomenclature
Economic regions referred
to in this report adhere to
the following abbreviations:
Junk bonds? Yes, yields rose by 100 basis points between mid-December and 10-February (when Yellen testified). But why was the Fed focussing on junk bonds of all
things? Mortgage rates had fallen by 40 basis points over the same time frame and
they are far more important to the economy. At 13.7 trillion dollars, the mortgage
market is 10.5x larger than the junk bond market. A 1% rise in junk bond yields
meant risky companies would have to pay $13bn more each year for their loans.
But the 40bps drop in mortgage rates provided $55bn of relief to home buyers.
That’s 4.2 dollars of gain for every dollar of pain. From an interest rate perspective,
financial market conditions had become looser than they were in December, not
tighter. And like the dollar, bond yields have continued to fall. Today, junk bond
yields are 150 basis points lower than they were at the start of the year. Mortgage
rates are 45bps lower. The latter are now at their lowest since WWII (2.69%).
Asia-10: CH, HK, TW, KR,
SG, MY, TH, ID, PH, IN
US dollar
Asia-9: A10 less CH
index, increase is appreciation, 3dma
Asia-8: A10 less IN, CH
103
Asean-5: TH, MY, ID, PH, SG
Asean-4: TH, MY, ID, PH
102
Asia Big3: CH, IN, ID
101
G4: US, EU4, JP, A10
100
G3: US, EU4. JP
EU4: GE, FR, IT, UK
99
EU3: GE, FR, IT
98
DXY
97
US Fed :
dollar vs majors
index
96
95
94
15-Dec
4-Jan
24-Jan
13-Feb
4-Mar
24-Mar
13-Apr
3-May
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Where lies north? 16 May 2016
US – junk bond yields and mortgage rates
percent per year, 3dma
percent per year, 3dma (Bberg BUHY Index)
10.2
3.15
Junk bond yields
(LHS)
9.8
3.05
9.4
The housing market
is 10x bigger and
10x more important
than the junk bond
market. What were
officials thinking?
9.0
2.95
8.6
2.85
8.2
7.4
1-Jan
2.75
15Y fixed rate
mortgage (RHS)
7.8
2.65
1-Feb
1-Mar
1-Apr
1-May
Finally, the stock market was down by 12%. But unless there is something actually
broken in financial markets that caused this, this is none of the Fed’s business. The
Fed has three mandates: to promote full employment, guard against inflation and
act as a lender of last resort when financial markets are broken. If officials think
they have a fourth mandate to support the stock market they may as well pack up
their offices and move to Beijing.
The bottom line is clear: financial markets were not tight to begin with and they
have loosened since 10-February. The stock market has fully recovered. Mortgage
rates and junk bond yields are far below where they were year before all the hoopla
began. And the dollar is 4%-5% weaker. Combined, overall financial market conditions are far looser today than they were back in December. If the Fed had work to
do then, it has that much more to do now. Mom and Pop were thrown for a loop in
the first quarter but they stand amongst some pretty illustrious company.
2. Monetary policy backfires in Europe and Japan
If the Fed thinks it
has a mandate to
support the stock
market, it may as
well pack up its offices and move to
Beijing
The Fed isn’t the only central bank getting banged up. The ECB and BoJ both eased
policy very significantly – expanding QE and putting interest rates (further) into
negative territory – only to have it backfire on their currencies. The yen and euro
both strengthened in the aftermath of these moves when all and sundry expected
otherwise.
Lower interest rates and QE have long been impotent when it came to growth and
inflation. The Fed’s QE produced neither in the 8 years since Lehman collapsed; the
BoJ’s balance sheet has expanded by 9 times since Japan’s bubble burst in 1990 and
it’s still hoping for a miracle. Europe? Put it this way: are rates going further into
negative territory because the initial cuts worked?
But QE has had some effect on currencies, not because it added a couple of additional basis points to carry trades but because it signals that rates will stay low for
a long time – it gives a big Green Light to traders to extend their shorts. QE never
put more money into the system – that’s an easy myth to dispel – but it did make
the money already there safer to borrow / bet against.
Lately it hasn’t done even that. When the BoJ announced its negative interest rate
policy on 29Jan, the yen weakened by 2% (to 121 per US dollar). But the move
lasted less than 36 hours. Over the next two weeks, the yen strengthened to 115
and since then it has moved straight to 108. In all, the yen has strengthened by 9%
since the BoJ put rates below zero.
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Where lies north? 16 May 2016
Same for the euro. On March 9 – the day before the ECB unloaded a ‘Bazooka’ of
deeper and broader QE, and put interest rates further into negative territory, one
euro would buy you a dollar and ten cents. But the Bazooka didn’t kill the euro. Instead it made a Bee-line for $1.15, strengthening by 4.5% in 5 short weeks. Friday,
a euro still bought you a buck-fourteen.
Given the history, nobody expected QE to work wonders. But nobody expected it to
backfire either. And while there is no shortage of after-the-fact explanations making the rounds today, that’s pretty much the point – they’re after the fact. Nobody
bet on it – analysts, fund managers, traders, least of all the ECB and the BoJ – it just
happened. Little wonder the two central banks held their fire in March and April.
What if policy backfired again? Mom and Pop might be puzzled but Kuroda and
Draghi are probably downright perplexed.
Yen
Euro
per USD (decrease = yen appreciation)
USD per euro (incr = euro appreciation)
122
1.16
Jan28
120
1.15
118
1.14
1.13
116
1.12
114
1.11
112
1.10
110
1.09
108
106
01-Jan
Mar9
1.08
27-Jan
22-Feb
19-Mar
14-Apr
10-May
1.07
01-Jan
27-Jan
22-Feb
19-Mar
14-Apr
10-May
3. The euro – a longer view
Forecasting is tricky business, especially in the short-run. But when it comes to currencies, even the long-run outlook is tough to discern. Take a look at the euro in
the chart below. Since the collapse of Lehman Bros in September 2008, it has made
7 moves against the dollar averaging 20% each time. Why?
Euro vs US dollar
Jan08=100, monthly avg, increase=appreciation
106
The euro has made
7 moves since 2008
averaging 20% each
time. Why are we
still talking about
a 2% move in the
RMB?
+17%
102
+18%
98
+13%
94
90
86
-24%
82
GFC
74
-18%
-22%
78
EU debt crisis
7 moves since 2008: avg 20%
-29%
70
08
09
10
11
12
13
14
15
16
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Where lies north? 16 May 2016
Did “policy divergences” account for seven 20% moves, as consensus has driven
moves over the past year? Probably not. Did fundamental growth outlooks swap
places seven times since 2008? Probably not. What then account for so many huge
moves in such a short space of time?
Mom and Pop’s guess is probably as good as anyone’s. No strategist, no central
banker, no hedge fund manager can look back and explain those moves, even afterthe-fact. If you can’t explain the past, how can you hope to forecast the future?
Sometimes the best one can do is to identify the factors that consensus seems to
believe are pushing the needle this way or that – like ‘policy divergences’ today –
and guesstimate how long you think consensus will continue to think what it does.
Rocket science it isn’t. The compass needle spins again.
4. How weak is global growth?
Everyone seems to think global growth is going to heck in a hand basket. The Fed
is still essentially at zero. The ECB and BoJ have pushed interest rates into negative territory. And the IMF and OECD are urging governments to use “all available
means” to stimulate economies. Sounds like a crisis. Is it?
No. The US remains on track for 2% growth this year, virtually unchanged from the
2.1% averaged for the past five years. Consensus expects Japan will grow by 1.2%
over the next 4 quarters. That’s 1.5 times the 0.8% growth registered over the 4
quarters of 2015 and infinitely better than that registered in 2014 (chart below).
Europe grew by 2.1% (QoQ, saar) in the first quarter of the year and is thus running ahead of consensus’ expectations for full year growth of 1.6%. Even the 1.6%
is better than last year’s 1.4%, which was better than 2014’s 0.9% – all of which is
hugely better than 2012/13 (chart below).
Are things getting better or worse? Sure looks like the compass is pointed North.
Why does the whole world seem to think the opposite?
Japan – GDP growth
Eurozone – GDP growth
% growth over 4 quarters ending Dec
% growth over 4 quarters ending Dec
2.0
1.6
1.2
1.2
1.6
1.5
0.8
0.8
1.0
0.4
0.5
0.0
0.0
-0.4
-0.5
-0.8
-1.0
-1.2
-0.9
2014
1.7
1.0
0.5
-1.0
-1.5
2015
2016f
2012
2013
2014
2015
2016f
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Where lies north? 16 May 2016
5. Maybe it’s China?
Maybe people think China is still headed south. They’ve worried for four years now
about a hard landing. Does one still lurk? Wouldn’t appear so. In any event, a hard
landing now would have to be the softest one in history, wouldn’t it?.
The risks in China
have nothing to do
with the PMI. The
real risk is whether
structural reforms
get implemented or
shoved aside
Cyclically, China is probably still slowing, and that could continue for another year
or two. If it is still slowing, it hardly comes as a surprise. The government cut investment very sharply several years ago and private consumption – the chosen (but
unlikely) driver of future growth – was never going to take up the slack in the shortrun. The economy was always going to slow a little more than the government had
hoped. The government was always going to have to ante up a bit of stimulus. And
the newspapers were always going to shout “crisis looms and the government is going back to its bad old ways.”
This is cyclical hoopla – no more, no less and mostly irrelevant in the broader scheme
of things. Cycles occur in all countries; always have, always will. What matters is
not whether the manufacturing sector PMI drops by another tenth of a point this
month. In 5 years’ time, today’s cyclical drop will be but a blip on an upward-sloping line of structural growth. At least that’s the hope.
Plainly, what matters is whether that upward-sloping line of structural growth continues to move Northward or takes a right turn to the East. The latter is what matters to global growth. The latter is the risk to the global economy. The latter is
what markets and analysts and media and investors should all be paying attention
to. And it all hinges on whether the government is effectively pursuing the reforms
necessary to keep long-term growth as strong as it can possibly be. Is it?
The record is spotty. For the past two years, most of the effort has been placed on
the internationalization of the RMB and opening up the capital account. By most
accounts, these reforms have been implemented much more quickly than most
imagined 5 years ago. And the fact that capital has flowed out of China over the
past year neither surprises nor makes this reform any less successful. Open means
open. If some capital moves out after being locked up for 65 years, it’s not a bad
thing [1]. Moreover, to the extent outflows force officials to pursue consistent, sustainable policies that’s an additional plus.
China is the only
major economy in the
world today pursuing
significant structural
reforms. Ironically,
it’s China that everyone seems most
worried about
Elsewhere, progress has been less impressive. “Hukou” (migration / residency) reform is running slowly although in fairness migration / urbanization is among the
most complex and risky reforms on the table. Western investors would also like to
see faster closure of state-owned enterprises and reduction of excess capacity. But
the government has never claimed to be in a hurry on this score because the higher
unemployment implied by plant closures is another problem in and of itself. While
slow, few would argue that progress is not being made.
A goods and services tax is to be fully implemented and expanded to the construction, real estate, financial and consumer services industries starting May 1. China’s
GST / VAT will go a long way towards putting fiscal policy on par with developed
countries. Income tax is notoriously hard to monitor / collect in less developed
countries and the GST will provide a stable and efficient source of revenue for the
government. The government has also announced deeper regulation / reform of
the shadow banking sector. Capital adequacy ratios are being raised and tougher
definitions of risk assets are being employed.
In short, things are moving in the right direction. One always wishes reform and
structural change happened more quickly but these longings aren’t limited to China. They apply to the rest of the world too, probably more so. When push comes
to shove, is any other country in the world pursuing reform and structural change
than China is today? The US isn’t. Europe isn’t. Japan isn’t. Only China seems to be
eating the bitter medicine necessary to ensure that growth doesn’t fall more than
it inevitably will.
Ironically, it’s China that everyone seems to be most concerned about.
6
Where lies north? 16 May 2016
6. Is inflation headed North or South?
If the G3 is pointed in the right direction, and China is pointed in the right direction, then maybe all the global angst is about inflation? Or, rather, deflation. If so,
it shouldn’t be. There isn’t a central bank in the world that can control headline
inflation right now because headline inflation is being driven by low oil prices and
they are being driven by (still) surging supply, not falling demand. Oil demand is a
sideshow that, for the record, continues to grow at 2.5%-3% pace. Instead of trying to offset / defeat low oil prices with ever more QE and negative interest rates
– a futile endeavor that only sews confusion and fear in the marketplace – central
banks should bask in the boost they bring to household balance sheets and/or consumption.
No central bank in
the world can control headline inflation today because
it is being driven by
oil prices and they
are being driven by
supply, not demand.
Meanwhile, core
inflation has risen by
a lot
Lower oil prices since mid-2014 have brought about a transfer of wealth to oilconsuming nations from producing ones amounting to some 4 trillion US dollars,
half a trillion more than the Fed’s QE1, 2 and 3 combined. It’s as if the Fed’s 6-year
QE program was rolled out all over again, except this time it went global and this
time it went straight into consumers’ pockets instead of to the banks, which, most
readers will know, put the money not into the economy but straight back into the
Fed’s basement in the form of excess reserves. Why central banks today are trying
to lift oil prices and undo this transfer is a question that begs to be answered. Mom
and Pop and more than a few analysts are really – really – confused by this one.
But back to inflation. Once upon a time, central banks focussed on core (ex-food
and energy) inflation because that reflected underlying demand conditions and
that was something they could influence. And what about core inflation today? Is
it going up? Or down?
Not surprisingly, given the better growth coming out of Europe and Japan and the
ongoing recovery in the US, core inflation rates have risen by a lot. In Europe, core
CPI inflation has risen to 1% YoY from 0.6% over the past 9 months. In Japan, it
has more than doubled over the past year, rising to 1.1% from 0.4% (charts below).
But it’s US core inflation that has really taken off (chart top of next page). Core
CPI quietly passed the Fed’s 2% target back in November and now sits at 2.2% YoY.
Core PCE inflation – the Fed’s favored gauge – is rising in tandem and is now 1.6%.
The average of the two – 1.9% – is one tick shy of the Fed’s medium-term goal.
Back in December the Fed said it wanted to start normalizing rates to avoid having
to move abruptly later on. But the Fed hasn’t budged since then and inflation has
risen substantially. Three points remain: growth is at potential; inflation is one tick
shy of target and the Fed is essentially still at zero. Which seems out of place?
Eurozone – core CPI inflation
Japan – core CPI inflation
% YoY
% YoY, ex-fresh food & energy
1.8
1.5
1.6
1.1%
1.0
1.4
0.5
1.2
1%
0.0
1.0
-0.5
0.8
-1.0
0.6
0.4
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
-1.5
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
7
Where lies north? 16 May 2016
US - core inflation
%YoY
2.6
Mar12
Mar16
2.4
2.2
2.0
CPI
1.8
1.6
1.4
1.2
Feb16
PCE
1.0
0.8
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
7. What if global growth is already at potential?
Central banks push interest rates into negative territory. The IMF and OECD clamor
for governments to lift growth by all available means. But what if growth today is
already at potential? What if this is it?
As discussed back in detail in February, (see “Global growth: what is potential and
where is it headed?”, 28Feb16) it just may be. According to the UN’s latest (2015)
population projections, working age population growth (WAPG) throughout much
of the world has slowed far more sharply than most seem to realize [2]. This is fundamentally important because GDP growth is nothing but the sum of productivity
growth and the growth in the number of people going to work every day. A drop
in WAPG means potential GDP growth – that which can be aspired to / sustained
over the medium-term – has fallen more sharply than many realize.
Take Japan. Many are surprised to discover that total population growth there
has already fallen below zero; indeed it fell to -0.2% in 2015. But almost everyone
is surprised to learn that the working age population is shrinking five times more
rapidly – by a full 1% per year (chart below).
Japan – population growth
US – population growth
% per year
% per year
1.20
1.80
Working age
0.80
Working age
1.60
Total
Total
1.40
1.20
0.40
1.00
0.00
0.80
0.60
-0.40
0.40
-0.80
0.20
0.00
-1.20
75
80
85
90
95
00
05
10
15
20
25
30
75
80
85
90
95
00
05
10
15
20
25
30
8
Where lies north? 16 May 2016
Similarly for Europe. Most are aware that population growth has been slowing for
years. But few realize that WAPG there is already zero. In the US, baby boomers
began retiring 5-6 years ago. WAPG in the US is falling like a rock. Fifteen years
ago, it was 1.4% per year. Today it’s 0.4%.
Japan’s potential
growth rate is about
0.5%. Europe’s is
about 1.5%. Both
regions are thus
growing at potential.
Why are their central
banks pushing interest rates further into
negative territory?
The implications for potential GDP growth are straightforward – it is one to 1.5
points lower today than it was 10 years ago. If you used to think of US potential
growth being around 3%, today it’s 2%. If you used to think of Europe’s potential
being 2.5%, today it’s 1.5%. And so on. These are large proportionate drops.
But let’s sharpen the pencil a bit. It’s normal – or at least it used to be – to think of
productivity growth in a high-income country (like Japan or Europe or the US) maxing out at about 1.5% per year. In fact, worryingly, it has been lower than that for
the past 20 years. But assume for the sake of argument that the G3 can get back on
that 1.5% productivity growth track and stay there. Put this together with WAPG
in the US, Japan and Europe and what do you get?
Take Japan first. Start with 1.5% productivity growth and add working age population growth – negative 1% – to that. Potential growth comes to 0.5% per year – exactly what Japan grew by in 2015 and just about the 0.6% full-year average growth
that consensus expects in 2016.
Now Europe. Add 0% WAPG to an assumed 1.5% productivity growth rate and potential GDP growth comes to 1.5% – one tick higher what Europe actually did grow
by in 2015 and one tick lower than what consensus expects in 2016.
The US? WAPG of 0.4% added to productivity growth of 1.5% give you potential
GDP of 1.9%. That is two ticks slower than the 2.1% growth averaged for the past
5 years and a single tick slower than what consensus expects this year.
In all three cases – the US, Japan, Europe – economies already seem to be growing
at their potential rates. And in all cases productivity growth is generously assumed
to be 1.5% per year. If that cannot be reached / maintained, then potential growth
is even slower than the 1.9%, 1.5% and 0.5% estimates for the US, Europe and Japan respectively.
Two questions are immediately begged: First, if these key economies are already
growing at their potential rates, is it any surprise that monetary policies have failed
to lift growth higher? Or that a ‘pivot’ to fiscal policy would likely prove no more
effective? [3] Second: if these economies are already running at potential, why are
central banks extending QE and pushing interest rates ever further into negative
territory? Do they not accept the UN estimates? Do they believe monetary policy
can raise productivity growth? Or is there some other explanation?
The only answer we can offer is our usual one. Central bankers continue to pursue monetary policies because that is their job. Like any earnest employee or civil
servant or inventor, you don’t quit when at first you don’t succeed. You try again.
And again. No one gets paid to throw up their arms and say ‘it’s no use’. Just like
everyone else, central bankers get paid to show up on Monday morning and do the
best they can.
True North
The world is in a panic over ‘slow’ growth. Markets don’t know whether to go up
or down. Moms and Pops, hedge funds and central bankers are equally chagrined.
And we’re supposed to point the way? Alas, this is our job and we too must do the
best we can. Here’s what we think:
Short-term
Short-term cyclical growth is doing better in the US, Japan and Europe. In the US
we expect another year of 2% growth this year – not significantly different from
the 2.1% averaged over the past five years. We see no reason for that to change
in 2017, absent market panic over further Fed hikes that we expect will number 5
9
Where lies north? In the US, growth is
at potential, core inflation is already 2%
and the Fed is still
essentially at zero.
Which seems out of
place?
16 May 2016
to 6 by the end of next year. First quarter growth, while slow, was typical of other
first quarters in recent years, pulled down in this instance by random swings in inventories and net exports that happened to coincide this year. Consumption – the
driver of all things – continues to expand at a 2.8% on-year pace in real terms, virtually unchanged from the 2.9% averaged for the past two years. Business investment continues to be the weakest part of the economy; housing is once again the
bright spot. The latter has contributed 5 times more to GDP growth over the past
6 quarters than its weight in the economy. The lowest mortgage rates since WWII
(currently 2.69% for a 15Y fixed-rate mortgage) account for the strength in housing
as well as the continued rise in home prices, which are now only 2-3 months away
from reaching their pre-crisis peaks on the West Coast and 6-7 months away from
doing the same nationally.
In Europe and Japan, things are looking up, not down. First quarter Eurozone
growth hit 2.1% (QoQ, saar) and is thus on track to better last year’s 1.4% expansion, in turn up sharply from than the 0.9% registered in 2014 and the zero growth
environment of 2012/13. Japan’s growth will average 1.2% over the coming 4 quarters if consensus and DBS are correct – orders of magnitude better than the 0.5%
full-year average growth registered in 2015 and the Zero tallied in 2014.
In Asia we expect 5.8% growth this year. That is down from 5.9% last year and the
6.4% averaged in the three previous years. But the half a point decline over three
years ago is modest and gradual given the cyclical and structural slowdown in China. Perhaps 90% of the overall slowdown there owes to structural factors and has
been intentionally engineered. The modest amount of additional stimulus in recent
months to support growth neither surprises nor reflects a return to ‘the bad old
days’. China fully accepts / anticipates – as do we – that recovery will be “L-shaped”
rather than V-shaped in order that it may continue to clean up short-term cyclical excesses (over capacity, bad debts etc) and pursue long-term structural reforms.
The latter are key to keeping medium-term growth as high as it can possibly be –
though it will still slow – and readers are reminded once again that few if any other
countries in the world are pursuing structural reforms on a par with China today.
If you’re worried
about slow growth
today, get used to
it. It’s going down
in the medium-term,
not up
Reflecting the better growth in Europe and Japan and the 6th year of recovery in
the US, core inflation in the G3 is now rising. It has nearly doubled in Europe over
the past year and more than doubled in Japan (charts on page 7). In the US, core
CPI inflation has risen sharply over the past six months and is now, at 2.2% YoY, two
ticks above the Fed’s medium-term target (chart p8). Core PCE inflation is following
close behind. Had the Fed not fallen hook, line and sinker for the drop in the stock
market in January/February – a move now fully reversed – it would likely have raised
interest rates for a second time in March and have done so again this coming June.
With growth at potential, core inflation nearly at its medium-term target and wage
growth having accelerated to 2.5% YoY from 2% six months ago, the Fed appears
to have fallen behind the curve. Several officials have stated that it remains reasonable to expect two additional hikes this year and that is indeed what we expect.
Longer-term
Except for a possible short-lived return to 7% growth in China, we do not envision
an acceleration in global growth going forward. Working-age population has fallen more rapidly than most seem to appreciate and, if the UN is correct, it will continue to fall throughout most of the world over the next 10-20 years. This means
growth in the US, Europe and Japan – which may be running at potential – would
slow further in coming years rather than rise.
The same holds for Asia. Except for short-term cyclical ups and downs, growth will
slow continuously / persistently in the years ahead. This will owe partially to continued slowing in working-age population growth, as in the G3. But in Asia the bigger
force driving slower growth will be rising incomes. When incomes go up, productivity growth – hence GDP growth – goes down. ‘Twas ever thus. Japan grew fast in
the 50s and 60s. But when incomes went up the fast growth passed to Singapore
10
Where lies north? In Asia, growth is
slowing mainly because incomes are rising. That’s unequivocally a good thing,
not a bad thing.
16 May 2016
and Hong Kong. Then to Korea and Taiwan; and on to Malaysia, Thailand China,
and so on. No wants slower growth but it’s important to remember that growth
slows when things go right, not just when things go wrong. To the extent growth
slows due to rising incomes, as will be the case in Asia, it is unequivocally a good
thing, not a bad thing.
We expect growth in Asia will fall by about a tenth (or a tenth-and-a-half) of a percentage point per year for the next 20 years (chart below). Notwithstanding Asia’s
slower growth, the shift in economic gravity from West to East is accelerating. Today, Asia grows by about $1 trillion each year. That is equivalent to adding the GDP
of Germany to the world’s economic map every 3.2 years. Five years from now, Asia
will be adding a Germany every 2.8 years. Even with slower and slower growth, the
time it takes for Asia to put a Germany on the map will grow shorter and shorter,
not longer and longer.
Potential GDP growth – US, JP, EU-4 and Asia-10
% per year
7
6
5
4
Asia-10
3
G4
2
G3
1
0
2015
Worried about a
Brexit? Don’t be
2020
2025
2030
2035
2040
2045
2050
Worried about a Brexit? Don’t be, at least if you live in Asia. Even if the UK were
to fall off the map, Asia would replace it – and add 3 more on top of the one it
replaced – over the next 8 years. Four UKs in 8 years. It’s a lot of growth. So much
that instead of worrying about global growth being too slow, central bankers, analysts and investors might consider the possibility that it’s actually running pretty
darn fast.
Notes:
[1] See “China – when is a trillion not a trillion”, DBS Group Research, 29Jan16.
[2] World Population Prospects, revision 2015, United Nations. http://esa.un.org/
unpd/wpp/
[3] None of this is to say that G3 economies wouldn’t benefit greatly from reform and
restructuring, either in terms of efficiency gains or on equity / social inequality
grounds. Removing trade barriers, reforming tax codes, encouraging female participation in the labor market, etc., would all be expected to bring one-off gains in
output and equality. A one-off gain is not equivalent to a higher rate of growth.
11
Where lies north? 16 May 2016
GDP & inflation forecasts
GDP growth, % YoY
CPI inflation, % YoY
2013
2014
2015
2016f
2017f
2013
2014
2015
2016f
2017f
US
Japan
Eurozone
1.5
1.4
-0.3
2.4
-0.1
0.9
2.4
0.5
1.5
2.1
0.5
1.7
2.4
0.1
1.8
1.5
0.4
1.5
1.6
2.7
0.6
0.1
0.8
0.0
1.4
0.2
0.2
2.2
1.8
0.6
Indonesia
Malaysia
Philippines
Singapore
Thailand
Vietnam
5.6
4.7
7.1
4.4
2.9
5.4
5.0
6.0
6.1
2.9
0.9
6.0
4.8
5.0
5.8
2.0
2.8
6.7
5.2
4.5
6.1
1.5
3.4
6.7
5.4
4.6
6.2
1.9
3.7
6.4
6.4
2.1
2.9
2.4
2.2
6.6
6.4
3.1
4.2
1.0
1.9
4.1
6.4
2.1
1.4
-0.5
-0.9
0.6
4.9
2.5
2.2
-0.2
0.6
1.3
5.4
2.4
3.0
0.4
2.0
2.4
China
Hong Kong
Taiwan
Korea
7.7
3.1
2.2
2.9
7.3
2.5
3.9
3.3
6.9
2.4
0.7
2.6
6.5
2.0
1.4
2.6
6.5
2.5
2.0
2.8
2.6
4.3
0.8
1.3
2.0
4.4
1.2
1.3
1.5
3.0
-0.3
0.7
1.2
2.8
1.1
1.1
1.2
2.5
0.9
1.5
India*
6.9
7.3
7.4
7.6
7.8
9.5
6.0
4.9
5.4
5.7
Source: CEIC and DBS Research
Policy & exchange rate forecasts
Policy interest rates, eop
Exchange rates, eop
current
2Q16
3Q16
4Q16
1Q17
current
2Q16
3Q16
4Q16
1Q17
US
Japan
Eurozone
0.50
0.10
0.00
0.50
0.10
0.00
0.75
0.10
0.00
1.00
0.10
0.00
1.25
0.10
0.00
…
108.7
1.131
…
108
1.10
…
109
1.10
…
110
1.10
…
109
1.10
Indonesia
Malaysia
Philippines
Singapore
Thailand
Vietnam^
6.75
3.25
4.00
n.a.
1.50
6.50
6.75
3.25
4.00
n.a.
1.50
6.50
6.75
3.25
4.00
n.a.
1.50
6.50
6.75
3.25
4.25
n.a.
1.50
6.50
6.75
3.25
4.25
n.a.
1.50
6.50
13,320
4.04
46.5
1.37
35.4
22,340
13,612
4.10
47.9
1.39
36.2
22,217
13,793
4.10
48.4
1.40
36.6
22,217
13,703
4.10
48.2
1.40
36.4
22,217
13,658
4.10
48.1
1.40
36.3
22,217
China*
Hong Kong
Taiwan
Korea
4.35
n.a.
1.50
1.50
3.85
n.a.
1.38
1.50
3.85
n.a.
1.38
1.25
3.85
n.a.
1.38
1.25
3.85
n.a.
1.38
1.25
6.53
7.76
32.6
1,178
6.54
7.78
33.4
1,173
6.59
7.78
33.8
1,190
6.56
7.78
33.6
1,182
6.55
7.78
33.5
1,177
India
6.50
6.50
6.25
6.25
6.25
66.9
68.6
69.6
69.1
68.8
^ prime rate; * 1-yr lending rate
Market prices
Policy rate
Current
(%)
US
Japan
Eurozone
10Y bond yield
Current
1wk chg
(%)
(bps)
FX
Current
1wk chg
(%)
Index
Equities
Current
1wk chg
(%)
0.50
0.10
0.00
1.71
-0.11
0.12
-4
-1
-2
94.6
108.7
1.131
0.5
-0.4
-0.6
S&P 500
Topix
Eurostoxx
2,047
1,320
2,806
-0.5
1.7
1.5
Indonesia
Malaysia
Philippines
Singapore
Thailand
6.75
3.25
4.00
Ccy policy
1.50
7.73
3.87
4.55
1.95
1.78
-5
-3
-18
-3
0
13320
4.04
46.5
1.372
35.4
0.2
-0.8
1.1
0.0
-0.5
JCI
KLCI
PCI
FSSTI
SET
4,762
1,628
7,437
2,735
1,395
-1.3
-1.3
6.2
0.2
0.3
China
Hong Kong
Taiwan
Korea
4.35
Ccy policy
1.50
1.50
…
1.23
0.81
1.77
…
-10
-2
-1
6.53
7.76
32.7
1179
-0.5
0.0
-0.8
-1.1
S'hai Comp
HSI
TWSE
Kospi
2,827
19,719
8,054
1,965
-3.0
-1.9
-1.1
-0.2
6.50
7.46
3
66.9
-0.4
Sensex
25,490
1.0
India
Source: Bloomberg
12
Where lies north? 16 May 2016
Recent Research
CN: outbound investments intact
5 May 16
SG: the next growth driver
4 Feb 16
JP: perception gap widens
5 May 16
JP: BOJ into uncharted territory
2 Feb 16
2 Feb 16
1 Feb 16
SG: national vs domestic growth
28 Apr 16
IN: investment cycle slows
20 Apr 16
CNH: will capital controls help?
FX: Not just about CNY
ID: the new policy rate
18 Apr 16
IN: RBI to await budget cues
IN: improving liquidity management
15 Apr 16
Rates: Global rates roundup/ chart-pack
29 Jan 16
8 Apr 16
CN: when is a trillion not a trillion?
29 Jan 16
JP: reflation campaign still has a long way to go 8 Apr 16
IN: fading boost from low oil prices
28 Jan 16
CN: what are supply-side structural reforms?
7 Apr 16
TH: consumption the weak link
25 Jan 16
CN: root causes and remedies for overcapacity
6 Apr 16
CN: how to end the vicious cycle
21 Jan 16
Global crude: still spilling onto the floor
20 Jan 16
TW: after the election
19 Jan 16
IN: back at fiscal crossroads
19 Jan 16
CNH: “Taken” – the RMB episode
15 Jan 16
Rates: UST curve: belly’s too big
15 Jan 16
SGD: slipping into neutral 1 Feb 16
US: what is driving core inflation and
when will headline follow? 31 Mar 16
EZ: watching Brexit risks
28 Mar 16
SG budget: balanced and transformative
28 Mar 16
ID: investment eludes
24 Mar 16
Rates: SGS premia compression
21 Mar 16
18 Mar 16
CN: services and manufacturing are codependent
14 Jan 16
JP: rising direct investment in Southeast Asia
SG: a winter budget
14 Mar 16
IN: prepared, not immune
16 Dec 15
Qtrly: Economics-Markets-Strategy 2Q16
10 Mar 16
Qtrly: Economics-Markets-Strategy 1Q16
10 Dec 15
IN: fiscal discipline trumps growth
1 Mar 16
Holiday Heresies 2016
7 Dec 15
Rates: G7 bonds - tantrums brewing
1 Mar 16
ID: manufacturing still a drag
3 Dec 15
Global growth: what is potential and
where is it going?
25 Feb 16
CNH: billion dollar baby
ID: BI easing bias persists
19 Feb 16
EZ: negative rates not a cure
17 Feb 16
US: how strong is consumption?
12 Feb 16
16 Nov 15
EZ: will more QE help?
4 Nov 15
Rates: regional rates rundown
2 Nov 15
FX: monetary policy divergences intact
2 Nov 15
Disclaimer:
The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be
reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or
correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein
does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The
information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement
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of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise)
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13