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September 30, 2015 Issue No: 15/21 Global Economics Weekly Economics Research A secular increase in the equity risk premium Increasing consensus that ‘excess saving’ has contributed to lower equilibrium interest rates There is an increasing consensus that global ‘excess saving’ has contributed to a reduction in equilibrium real interest rates, with the ‘secular stagnation’ thesis the most recent (and extreme) expression of this view. While economists and policymakers dispute the extent and duration of the decline, few now question that a decline has taken place or that excess saving has played a causal role. Global equity yields have risen significantly since 2000 A key implication of the excess saving account is a decline in yields of all assets, including but not restricted to government bond yields. Yet, since the turn of the century, the global economy has also been characterised by a rise in the yields on quoted equity, a feature for which the standard excess saving story cannot easily account. A separate explanation – complementary to the excess saving narrative – is that there has been a secular increase in the global ex ante equity risk premium (ERP), which has simultaneously pushed risk-free yield curves lower and earnings yields on risky equity higher. Kevin Daly +44(20)7774-5908 [email protected] Goldman Sachs International Noah Weisberger (212) 357-6261 [email protected] Goldman, Sachs & Co. Aleksandar Timcenko (212) 357-7628 [email protected] Goldman, Sachs & Co. Sharon Yin (212) 855-0684 [email protected] Goldman, Sachs & Co. An increase in the global ERP has contributed to lower rates Applying a sign restrictions approach to explore the relative importance of ‘excess savings’ and ‘risk premium’ shocks, we find that an increase in the global propensity to save relative to the propensity to invest was the predominant force affecting global real bond yields between the mid-1980s and 2000 but that an increase in the global equity risk premium has accounted for more of the decline in real bond yields since 2000. Relative to bonds, the long-term returns implied by current global equity valuations are high In addition to aiding our understanding of the decline in equilibrium real interest rates, this analysis has important forward-looking implications for financial markets. While expected real returns on the government bonds of developed economies are exceptionally low, the expected returns implied by current global equity valuations remain relatively high. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. The Goldman Sachs Group, Inc. Global Investment Research September 30, 2015 Global Economics Weekly A secular increase in the equity risk premium ‘Excess saving’ has contributed to lower equilibrium interest rates Earlier today, we published a Global Economics Paper in which we discussed the implications of the divergence in global bond and equity yields that has taken place since the turn of the century.1 There is a large body of opinion that excess saving – or, more precisely, an increase in the global propensity to save relative to the propensity to invest – has lowered global equilibrium real interest rates in the past 25 years. Ben Bernanke (2005), former chairman of the US Federal Reserve, was the first to suggest that an emerging-world ‘savings glut’ was responsible for the decline in real long-term government bond yields witnessed in developed economies from the early 1990s onwards (Exhibit 1 plots 10-year real, ex ante government bond yields for the US, Japan, UK and a Euro area composite from 1975 onwards 2 ). Initially viewed as a largely benign development, this savings glut is now considered by many to have played an instrumental role in facilitating the credit boom that preceded the 2007/08 global financial crisis. Exhibit 1: Long-term real bond yields have been falling since the mid-1980s Real ex ante 10-year government bond yields (%) 7.0 US 6.0 Euro area 5.0 Japan UK 4.0 3.0 2.0 1.0 0.0 -1.0 75 78 81 84 87 90 93 96 99 02 05 08 11 14 Source: Goldman Sachs Global Investment Research In the years since the crisis, short- and long-term real interest rates have fallen further, and the idea that excess saving has resulted in a secular decline in interest rates has become more widespread. Former US Treasury Secretary Lawrence Summers (2014) has argued that the global economy has entered a period of secular stagnation, in which too much 1 “A Secular Increase in the Equity Risk Premium”, Global Economics Paper No. 226, September 30, 2015. 2 We have directly-observed 10-year (constant maturity) inflation-linked government bond yields for the UK from 1986Q1, for the US from 1997Q2, for the Euro area from 2003Q1 and for Japan from 2004Q2. Given a longer sample for the UK, which includes periods of significant volatility in bond yields and inflation, it is possible to estimate a more robust relationship between real yields, nominal yields and inflation for this economy. We therefore apply the estimated coefficients from this relationship to the nominal bond yields and inflation rates of other economies, making an adjustment for the difference between UK RPI and CPI inflation. An additional advantage of this approach is that it helps to ensure cross-country comparability. Goldman Sachs Global Investment Research 2 September 30, 2015 Global Economics Weekly saving is chasing too few investment opportunities, driving the equilibrium real interest rate below zero and curtailing the effectiveness of monetary policy in the process. While there are differences between the savings glut and secular stagnation theses, a common implication of both is that excess saving has resulted in a generalised decline in yields across all assets, including but not restricted to real government bond yields (sometimes referred to as real ‘risk-free’ rates). Yet, in the years before and since the 2007/08 crisis, the global economy has also been characterised by rising yields on quoted equity, a feature for which the standard excess saving story cannot easily account (Exhibit 2 plots an estimate of the 10-year global real ex ante government bond yield and the earnings yield on global equities – including advanced and emerging markets – adjusted for changes in leverage from 1975 onwards3). We argue not that the excess saving story is wrong but that, in failing to account for the rise in the earnings yield on quoted equity from the early 2000s onwards, it is incomplete. Exhibit 2: Bond and equity yields have diverged since the turn of the century Global earnings yield and G4 real ex ante 10-year government bond yields (%) 13.0 11.0 Earnings Yield (E/V, Global) Real 10yr Bond Yield (G4) 9.0 7.0 5.0 3.0 1.0 -1.0 75 78 81 84 87 90 93 96 99 02 05 08 11 14 Source: Goldman Sachs Global Investment Research A separate explanation – which is complementary to the excess saving story – is that there has been a secular increase in the global ex ante equity risk premium (ERP) since the turn of the century, which has simultaneously pushed risk-free yield curves lower and earnings yields on risky equities higher. 4 Global ERP has increased significantly since turn of century The main purpose of our analysis is to document the behaviour of real government bond yields and the earnings yields of quoted equities, and to assess what the behaviour of both implies about the relative importance of ‘excess savings’ shocks (which would tend to push both bond and equity yields lower) and ‘risk premium’ shocks (which would tend to push bond and equity yields in opposite directions). 3 For a detailed discussion of the derivation of these series, please refer to Global Economics Paper. 4 The divergence between global equity and bond yields and what it implies for the global ERP was discussed in a previous Global Paper (“The savings glut, the return on capital and the rise in risk aversion”, Daly and Broadbent, Goldman Sachs Global Economics Paper No. 185, May 27, 2009) and in a speech by Broadbent (2014). Goldman Sachs Global Investment Research 3 September 30, 2015 Global Economics Weekly To explore the relative importance of excess savings and risk premium shocks in driving real government bond yields and the earnings yields of quoted equities, we use a sign restrictions approach. Exhibit 3 – which plots our measures of the global earnings yield against G4 real bond yields over time – provides a visual representation of this analysis in its simplest form. An increase in the global propensity to save relative to the propensity to invest will result in a simultaneous decline in both real bond yields and equity earnings yields (i.e., a move in a south-westerly direction in Exhibit 3), while an increase in perceived risk will result in a decline in real bond yields but a rise in equity earnings yields (i.e., a move a south-easterly direction). Exhibit 3: Equity and bond yields both fell between 1985 and 2000, but have moved in opposite directions since 2000 Global earnings yield and real bond yields (1985Q1-2015Q3, actual & 8Q mav) 6 1985 Real bond yield (%) 5 4 2000 3 2 1 2015 0 Equity earnings yield (%) -1 3 4 5 6 7 8 9 10 Source: Goldman Sachs Global Investment Research We start our analysis in 1985.5 Between 1985 and 2000, global real bond yields and equity earnings yields both fell (a south-westerly move), implying that an increase in the global propensity to save relative to the propensity to invest was the predominant force affecting both. However, from 2000 until 2015, bond yields have continued to fall but global equity yields have risen (a south-easterly move), implying that risk premium shocks have predominated. To provide a more quantitative assessment of the underlying shocks, we employ a vector autoregression with sign restrictions to decompose the observed changes in real bond yields into savings shocks (where real bond yields positively co-move with equity yields) and risk premium shocks (where real bond yields negatively co-move with equity yields).6 5 We choose 1985Q1 as the starting point because we are less confident of the reliability of our real bond yield series during the 1970s and early 1980s, when inflation was exceptionally high and volatile. 6 Our methodology proceeds in three steps. First, we estimate a reduced-form Bayesian vector autoregression with quarterly changes in our global real bond and equity yield series. Second, we draw a number of possible structural models with respect to the sign restrictions we place on the impulse responses, and estimate a historical decomposition of real bond and equity yields from each. Finally, we use the median of these historical decompositions of real bond and equity yield movements. Our colleagues in the Asian economics team used a similar approach to quantify supply- and demand-driven changes in oil prices (“The economic impact of the New Oil Order on emerging Asia”, Asia Economics Analyst: 15/02). Goldman Sachs Global Investment Research 4 September 30, 2015 Global Economics Weekly The resulting decomposition is presented in Exhibit 4. Between 1985Q1 and 2000Q1, global real bond yields declined by 2.0pp and we find that virtually all of this decline was due to savings shocks. However, between 2000Q1 and 2015Q3, when global real bond yields declined by a further 3.0pp, we find that only 0.5pp of the decline was due to savings shocks and 2.5pp was due to risk premium shocks. Our estimates imply that, if there had only been savings shocks and no risk premium shocks over the period as a whole, G4 real bond yields would have been 2.5pp higher than they currently are. Exhibit 4: Most of the decline in bond yields since 2000 appears related to a rise in the risk premium A decomposition of global real bond yields into 'saving' and 'risk premium' shocks 1 0 -1 -2 -3 Saving Shocks -4 Risk Premium Shocks Real Bond Yield -5 -6 85 88 91 94 97 00 03 06 09 12 15 Source: Goldman Sachs Global Investment Research Of course, these estimates are dependent on our identification strategy and assume that other factors which do not affect the propensity to save or invest or the equity risk premium but which do affect bond and equity yields have held equal. Both sets of assumptions are open to question. Nevertheless, at the very least, our estimates suggest that a rise in the global ERP has been an important feature of the global economy since the turn of the century that the standard excess saving story neglects. Explaining the rise in the ERP Our analysis till now has primarily been an exercise in accounting – we have not provided a behavioural explanation for the rise in the global ERP since the turn of the century. One explanation for the increase is that emerging market portfolio preferences have played an important role in accounting for the rise in the global ERP and, specifically, that there is some connection between higher saving rates in China and other large emerging markets and higher levels of risk aversion. On this view, the emergence of China and other large emerging economies had two relevant effects on the global economy. Consistent with the excess savings hypothesis, the increase in desired saving from large emerging economies contributed to lower yields on government bonds and other fixed-income assets. In addition, there was an effective shift in the global aversion to risk that reconciles the rise in yields on risky equity and the decline in risk-free interest rates. Goldman Sachs Global Investment Research 5 September 30, 2015 Global Economics Weekly This would help to explain the divergence between government bond yields and equity yields since the early 2000s. But there is also independent evidence of these differing portfolio preferences. In a detailed analysis of the net asset positions of China and India, for example, economists Lane and Schmuckler (2006) show that the net investment positions of both are essentially ‘short equity, long debt’. Particularly following the 1997 Asian crisis, an increasing share of emerging economies’ savings were channelled into foreign exchange reserves held in the shape of developed economy government bonds. As to why emerging market investors display a bias in their portfolio allocation towards government bonds and away from equity, we see two possibilities (which are not mutually exclusive). The first is that emerging market investors are genuinely more risk-averse than advanced economy investors. This would not be surprising – in many models of consumer behaviour, a higher propensity to save goes hand in hand with a higher level of risk aversion. Blanchard and Giavazzi (2005) argue that the relatively high household saving rates of emerging economies reflect a high level of individual risk, related to health costs, retirement and the financing of education that are a result of low levels of social protection. It is plausible that relatively high levels of income uncertainty also account for why those savings have been invested in a relatively risk-averse manner. A second potential explanation for the skew in emerging market portfolios towards fixed income and away from equity is that it is the outcome of restricted investment opportunity – resulting from segmentation in the market for global capital – rather than the outcome of a portfolio preference for debt. Because much of the saving of emerging economies is channelled through government entities, and because these entities are often restricted from making large equity investments in developed economies, there is an effective constraint on the savings of emerging economies being invested in overseas equity. A separate factor that is also likely to have contributed to the dual rise in the global propensity to save and the global ERP has been the impact of population ageing and pensions’ regulation on saving behaviour in advanced economies. There has been an increased focus on the long-term sustainability of private and public pension provision in advanced economies since the turn of the century and a common response to these concerns has been to alter the tax treatment of pensions to encourage increased saving for retirement. At the same time, regulations affecting private pensions saving in advanced economies have tended to skew the investment of those savings away from equity and towards fixed income. Two examples of such regulations include the significantly more favourable treatment of bonds vs. equities under (internationally-agreed) pension solvency rules and the widespread practice of obliging workers to purchase an annuity upon retirement.7 Exhibit 5 displays the direct holding of equities and bonds by European (Euro area and UK) pension and insurance funds as a share of total assets. Both explanations – the increasing importance of relatively risk-averse emerging market investors and the impact of population ageing and pensions’ regulation on saving behaviour in advanced economies – imply that, in effect, the marginal investor became more risk-averse and the increase in the global propensity to save relative to the propensity to invest went hand in hand with a rise in the ex ante global equity risk premium. 7 Under IAS19 (International Accounting Standard 19), a set of accounting rules concerning employee benefits set by the International Accounting Standards Board that took effect in 2013, the assumed discount rate for future liabilities and the assumed long-term expected return on assets held by company pension funds are both fixed to current bond yields (government and other highly rated). In other words, the ERP is implicitly fixed by accounting rules to zero, which means that, from a solvency perspective, investing in equities comes with costs – in terms of higher volatility – but has no associated benefits for pension funds. Goldman Sachs Global Investment Research 6 September 30, 2015 Global Economics Weekly Exhibit 5: European pension and insurance companies have switched from equities to bonds Pension and insurance funds direct holding of equities and bonds (% total assets) 40.0 35.0 30.0 25.0 20.0 Direct holdings in equities 15.0 Direct holdings in bonds 10.0 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 Source: Goldman Sachs Global Investment Research, ONS, Eurostat A third potential explanation for the divergence between global bond and equity yields (and the implied rise in the global ERP) since the turn of the century is that it reflects a reduction in expected long-run global growth.8 Consensus long-run (10-year) real global growth expectations are broadly unchanged from where they stood in 2000 – having risen on the back of BRICs-related optimism, before falling back again (Exhibit 6). But long-run expectations of growth in advanced economies have fallen from 2.6% to 1.9% over this period and it may be that investors’ expectations of long-run real earnings growth have fallen by more. If they have declined materially, this would have tended to push equity yields higher (all else equal). That said, the change in growth expectations would need to have been very large for this to be the primary explanation for the rise in equity yields. In standard equity valuation models, future earnings are discounted at the real risk-free rate. Given that real bond yields have fallen by 3.0 percentage points since the turn of the century, this implies that the expected long-run growth of earnings would have to have fallen by 3.0pp over this period just to offset the effect of declining bond yields, and that expected growth would have had to have fallen by a further 3.2pp (6.2pp in total) to have accounted for the rise in equity yields that has actually taken place. These are large numbers and there is little evidence from surveys that growth expectations have fallen to anything like this degree. Therefore, while it seems likely that reduced growth expectations have played some role in the rise in equity yields (particularly in recent years), we nevertheless place less weight on this explanation relative to the previous two. 8 A change in the central expectation of long-run real growth should – in theory – have no effect on the ERP, because it affects neither investors’ preferences nor the perceived degree of risk. In the standard Gordon relationship (ERP = dy + Eg – rby), a reduction in expected growth (Eg) should be matched by a rise in the dividend yield (dy). However, in measures of the ERP that assume that long-run real growth is either fixed or broadly stable, an increase in the dividend yield will be (wrongly) interpreted as a rise in the ERP rather than a reduction in expected growth. Goldman Sachs Global Investment Research 7 September 30, 2015 Global Economics Weekly Exhibit 6: Long-term real global growth expectations rose between 2001 and 2010, and are now broadly unchanged from 2000 levels Rolling Consensus forecasts for average global and G6 growth over the next 10 years 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 Global 0.5 G6 0.0 98 01 04 07 10 13 16 Source: Consensus Economics, Goldman Sachs Global Investment Research Financial market implications In addition to aiding our understanding of the decline in equilibrium real interest rates, this analysis has important forward-looking implications for financial markets. Although we view the excess saving and rising risk premium accounts as largely complementary to each other in economic terms, they have contrasting implications for financial markets. The standard excess saving account suggests that a glut of savings has driven yields and expected future real returns on all assets lower. By contrast, a higher global ERP implies that, while the expected real returns on government bonds are low, the long-run real returns implied by current global equity valuations remain relatively high. The global ex ante ERP – the expected excess return that a diversified portfolio of global equities provides over G4 real 10-year bond yields – is currently around 6½%, on our estimates. Moreover, this assumes that valuations are held fixed at current levels. Were real bond yields to rise and/or global equity yields to fall over time, this would imply a larger long-run outperformance of real global equity returns over advanced-economy government bonds. These conclusions are consistent with the views of our Equity and Rates strategists: Low bond yields due to reduced term premia: Our Rates strategists have argued that 10-year US and German yields are low mainly because term premia are very depressed, whereas expectations of long-term nominal neutral rates – while lower than they were before the financial crisis – are still tracking at around 3.5-3.75% in the US and 2.5%-2.75% in the Euro area.9 In their view, while part of the decline in term premia at the long end of government bond yield curves is the result of unconventional monetary policies (QE in particular) pursued by the Fed and ongoing in the Euro area and Japan, concerns around deflation in major developed countries have also contributed to its fall. 9 For a discussion of the evolution of government bond term premia, see “Depressed Euro area Term Premium Behind the Wide Transatlantic Yield Gap”, Macro Rates Analyst, September 18, 2014. Goldman Sachs Global Investment Research 8 September 30, 2015 Global Economics Weekly Our Rates strategists also find evidence of investors’ pessimism (another manifestation of high risk aversion) in their empirical work. According to their ‘Sudoku’ model framework – in which they estimate ‘fair value’ levels for government bond yields based on their historical relationship with macro fundamentals – 10-year yields in major markets are trading around 50-75bp lower than historical macro relationships would imply. Looking ahead, they expect longend rates to increase more than priced in the forwards, but they still expect yields to remain below their macro ‘fair values’ for some time, as the term-premium component will likely normalise slowly, as long as the ECB and BoJ continue to remove duration from the market. Significant outperformance of equities relative to government bonds over the next year. Our Equity and Rates strategists’ global asset allocation is currently overweight equities and underweight government bonds on a 12-month horizon, based largely on the view that valuations are significantly more attractive for equities than for government bonds.10 While equities appear more attractively valued than government bonds in general, they find significant variation in valuations across equity markets, with US equity valuations appearing more stretched than Euro area, Japanese and UK equities. On a 12-month basis, our strategists are overweight European and Japanese equities but underweight US equities. Kevin Daly 10 See GOAL: Global Opportunity Asset Locator, July 20, 2015 and GOAL Flash: “China & Commodity Commotion; our views across the asset classes”, August 24, 2015. Goldman Sachs Global Investment Research 9 September 30, 2015 Global Economics Weekly Global economic forecasts Real GDP, %ch yoy Consumer Prices, %ch yoy 2015 G3 USA Euro area Japan Advanced Economies Australia Canada France Germany Italy New Zealand Norway Spain Sweden Switzerland UK Asia China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Taiwan Thailand CEEMEA Czech Republic Hungary Poland Russia South Africa Turkey Latin America Argentina Brazil Chile Mexico Venezuela Regional Aggregates BRICS G7 EU27 G20 Asia ex Japan Central and Eastern Europe Latin America Emerging Markets Advanced Economies World 2016 2017 2018 2.5 1.6 0.6 2.4 1.8 0.8 2.2 1.7 0.8 2.0 1.6 0.9 2.0 1.6 1.2 1.6 0.6 2.3 1.3 3.1 3.3 0.8 2.7 2.0 2.1 1.7 1.9 1.5 2.4 1.4 2.5 3.5 1.2 3.0 3.2 2.0 2.0 1.4 1.3 2.2 2.0 2.2 2.9 1.7 2.8 3.0 1.6 2.4 1.2 1.2 2.5 1.9 2.1 2.5 1.6 2.6 6.8 2.6 7.5 4.9 4.9 5.6 2.2 2.4 1.6 2.8 6.4 2.8 7.9 5.2 4.6 6.3 2.5 3.3 3.0 2.9 6.1 2.8 7.0 5.7 5.0 6.3 2.8 3.2 2.8 3.2 5.8 2.7 7.1 6.4 5.2 6.5 3.0 3.1 2.8 3.6 3.9 2.8 3.6 -3.3 1.4 2.8 2.8 3.2 3.5 1.0 1.9 3.0 2.6 2.6 3.2 2.8 2.4 3.5 2.5 2.5 3.2 3.1 2.8 3.6 0.0 -2.6 2.2 2.3 -5.2 1.8 -0.4 3.1 3.5 0.2 4.1 1.6 3.8 3.9 2.1 4.5 2.3 3.7 4.0 2.8 5.3 1.9 2.0 3.3 6.1 3.6 -0.2 4.5 2.0 3.2 5.8 2.0 2.2 3.7 6.2 3.3 1.7 5.2 2.2 3.6 5.7 1.9 2.0 3.6 5.8 3.0 3.0 5.3 2.0 3.6 5.7 1.8 1.9 3.6 5.8 2.9 3.4 5.4 2.0 3.7 G3 USA Euro area Japan Advanced Economies Australia Canada France Germany Italy New Zealand Norway Spain Sweden Switzerland UK Asia China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Taiwan Thailand CEEMEA Czech Republic Hungary Poland Russia South Africa Turkey Latin America Argentina Brazil Chile Mexico Venezuela Regional Aggregates BRICS G7 EU27 G20 Asia ex Japan Central and Eastern Europe Latin America Emerging Markets Advanced Economies World 2015 2016 2017 2018 0.2 0.1 0.6 2.0 1.0 0.5 2.3 1.7 2.0 2.4 1.8 1.3 1.8 1.7 0.1 0.1 0.3 0.3 2.2 -0.4 0.1 -1.1 0.0 2.8 1.9 0.6 1.8 0.5 1.4 2.4 0.8 1.3 0.0 1.1 2.8 2.0 1.4 2.5 0.8 1.9 2.6 1.1 2.3 0.8 2.1 2.6 2.0 1.8 2.4 1.3 2.0 2.7 1.0 2.5 1.1 2.2 1.5 3.0 5.2 6.5 2.1 1.5 -0.2 0.8 -0.4 -0.6 2.2 3.0 5.8 6.2 3.1 2.3 1.8 2.0 1.4 1.7 2.0 3.1 6.0 6.1 3.3 3.1 2.3 2.2 1.1 3.2 2.1 3.0 6.0 6.1 3.4 3.0 2.2 2.0 1.0 3.4 0.6 0.2 -0.8 15.0 4.8 7.3 1.5 2.8 1.8 5.5 6.4 7.5 1.4 2.7 2.3 4.0 5.3 7.3 1.6 2.7 2.4 4.0 4.5 7.5 16.1 8.8 4.5 2.8 86.0 21.6 6.3 4.1 3.5 80.9 22.3 5.2 3.2 3.2 63.3 19.0 4.9 3.0 3.0 47.4 4.2 0.3 0.0 2.4 2.5 -0.3 13.3 5.7 0.3 2.9 3.8 1.5 1.1 2.9 3.3 1.9 11.5 5.5 1.5 3.4 3.5 2.1 1.8 3.1 3.4 2.2 9.2 4.8 2.1 3.4 3.6 2.1 1.9 3.1 3.4 2.2 7.3 4.6 2.0 3.3 Source: Goldman Sachs Global Investment Research For a list of the members within groups, please refer to ERWIN. For our latest Bond, Currency and GSDEER forecasts, please refer to the Goldman Sachs 360 website: (https://360.gs.com/gs/portal/research/econ/econmarkets/). Goldman Sachs Global Investment Research 10 September 30, 2015 Global Economics Weekly Global macro and markets charts PMI-implied global growth 8 6 GLI momentum vs. global industrial production* 2 % qoq annl %mom 1 4 0 2 -1 0 -2 Global PMI ModelImplied Growth -2 -4 Global Actual Sequential Growth -3 -6 -8 -4 03 04 05 06 07 08 09 10 11 12 13 14 15 See Global Economics Weekly 12/18 for methodology Source: OECD, Goldman Sachs Global Investment Research Expansion Mar-15 0.03% Apr-15 May-15 0.01% Jan-15 06 07 08 10 110 Europe Risk Slowdown 0.05% 0.10% 0.15% 0.20% 80 US Risks 75 Oct-13 Feb-14 Jun-14 Oct-14 Jan-15 See Global Economics Paper 214 for methodology Source: OECD, Goldman Sachs Global Investment Research See Global Economics Weekly 12/15 for methodology Source: Goldman Sachs Global Investment Research US equity risk premium US equity credit premium 5 US ERP, calculated daily 5.7 May-15 Sep-15 % 4 US ERP, 200 Day Moving Average 5.3 15 China Risk Sept-15 GLI Growth % 13 Index 85 -0.05% 6.1 12 90 -0.04% 6.5 11 Oct-14 Nov-14 -0.06% 0.00% 05 95 Jul-15 Dec-14 -0.03% 03 100 Jun-15 Aug-15 -0.01% -0.02% 02 105 Feb-15 0.00% 01 China, Europe and US risk factors 0.04% 0.02% 00 * Includes OECD countries plus BRICs, Indonesia and South Africa See Global Economics Paper 199 for methodology Source: OECD, Goldman Sachs Global Investment Research GLI ‘Swirlogram’ GLI Acceleration GLI Momentum Global Industrial Production*, 3mma GS Forecast 3 4.5 2 4.1 1 3.7 Credit relatively expensive 1985-1998 average 4.9 0 3.3 2.9 -1 2.5 -2 2.1 1.7 04 05 06 07 08 09 10 11 12 See Global Economics Weekly 02/35 for methodology Source: Goldman Sachs Global Investment Research Goldman Sachs Global Investment Research 13 14 15 2 standard deviations band -3 82 85 88 91 94 97 00 03 06 09 12 15 See Global Economics Weekly 03/25 for methodology Source: Goldman Sachs Global Investment Research 11 September 30, 2015 Global Economics Weekly The world in a nutshell THE GLOBAL ECONOMY OUTLOOK KEY ISSUES UNITED STATES We forecast real GDP growth of 2.5% in 2015 and 2.4% in 2016. On a sequential and annualised basis, we expect growth to pick up to around 2.1% in 2015Q3 and 2.5% in 2015Q4. The US remains the strongest anchor of the global recovery. Positive impulses from investment should add significantly to growth in 2015 and beyond. JAPAN We forecast real GDP growth of 0.6% in 2015 and 0.8% in 2016. On a sequential basis, we expect growth to be between 1% and 2% for the rest of the year. Sequential growth moved to negative territory in 2015Q1 for the first time in three quarters. It was last negative in 2014, when Japan had a technical recession following the consumption tax hike. The new BoJ leadership has led to a regime shift in Japanese monetary policy, with much more aggressive, Fed-style easing capabilities. While this potentially offers a way out of more than a decade of deflation, reaching the 2% inflation target remains a tall order. EUROPE For the Euro area as a whole, we forecast growth of 1.6% in 2015 and 1.8% in 2016. The growth outlook at the country level still shows divergent trajectories, with growth below 1% in Italy, but notably above that threshold in Germany, Denmark and Spain. We expect Euro area growth to move higher alongside an increase in consumer expenditure. Support from monetary policy will also contribute to the recovery. Still, the list of adjustments required in parts of the periphery remains long. NON-JAPAN ASIA For Asia ex-Japan, we forecast growth of 6.1% in 2015 and 6.2% in 2016. In China, we forecast real GDP growth of 6.8% in 2015 and 6.4% in 2016. LATIN AMERICA We forecast that real GDP growth in Latin America will be -0.2% in 2015 and 1.7% in 2016. Against a more favourable global backdrop, the divergence between those economies with more challenging (Brazil) and more stable (Mexico) policy outlooks is likely to increase. In Brazil, we forecast real GDP growth of -2.6% in 2015 and -0.4% in 2016. For Mexico we expect 2.3% and 3.5%, respectively. Over the summer, Brazil’s real sector data worsened, credit and financial conditions tightened further, the labour market deteriorated rapidly and political/institutional risk rose. CENTRAL & EASTERN EUROPE, MIDDLE EAST AND AFRICA We forecast growth across the region at 1.0% in 2015 and 3.0% in 2016. The EM differentiation theme is again visible across the region. We forecast solid growth in Poland and Turkey, while growth in Russia and Ukraine are forecast to be negative in 2015. CENTRAL BANK WATCH CURRENT SITUATION NEXT MEETINGS EXPECTATION UNITED STATES: FOMC The fed funds target range is 0-0.25%. The FOMC held policy interest rates unchanged in September. The statement indicated increased concern about global and financial market developments. Fed officials’ funds rate projections indicated a shift toward one interest rate hike this year. Oct. 28 Dec. 16 We still project a December ‘lift-off’ because we expect decent job market news, stable to higher wage and core price inflation, and an improvement in financial conditions. But the risks around this baseline are strongly tilted to the later side. October is very unlikely for both substantive and logistical reasons, while a significant miss on any of the lift-off conditions (jobs, inflation, or financial conditions) would probably push the move into 2016. JAPAN: BoJ Monetary Policy Board The overnight call rate is at 0%-0.1%. The BoJ maintained its overall assessment of Japan’s economy at “has continued to recover moderately,” but cut its export and production assessments to “recently been more or less flat, due mainly to the effect of the slowdown in emerging economies” from “have been picking up, albeit with some fluctuations,” as we expected. Oct. 7 Oct. 30 We expect the BoJ to announce additional easing at the October-end meeting, centred on an extension of the current QQE program. EURO AREA: ECB Governing Council The refi/depo rates are at 0.05%/-0.20%. The ECB began an expanded asset purchase programme that included sovereign debt on March 9, and bonds with a negative yield as low as the deposit rate (-20bp) will be purchased. Total purchases will be made at a rate of €60bn per month. The programme is “intended” to continue until at least September 2016. Oct. 22 Nov. 4 Policy rates on hold until 2017Q3. We expect the ECB to implement its PSPP 'in full' until September 2017. UK: BoE Monetary Policy Committee The BoE policy rate is currently at 0.5%. Oct. 8 Nov. 5 We expect the BoE to keep the policy rate unchanged until 2016Q2. 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