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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] 1 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 2 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. 3 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 4 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 5 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”). 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