Contributors Not counting chickens - Institutional Money · Not counting chickens 05 April 2016...
Transcript of Contributors Not counting chickens - Institutional Money · Not counting chickens 05 April 2016...
Not counting chickens05 April 2016
After a sluggish start to the year, the first signs that industrial activity may be stabilising have
emerged as JP Morgan's global manufacturing PMI edged up to 50.5 in March, from 50.0 in
February. The improvement in the month was led by the output and new orders components,
which increased by 0.9 and 0.8 index points respectively, to 51.2; while the employment and export
orders components both remained in contractionary territory (see Chart 1). Declining employment
was likely a consequence of the lagged effects of earlier output weakness, together with the
natural reaction of industrial firms to weak earnings. Falling export orders in the presence of rising
output and new orders suggests that the lift in demand was primarily being satisfied by domestic
producers.
The pick-up in global manufacturing sentiment is encouraging, but it is too early to tell if a turning
point in activity has been reached. Sentiment can be volatile from month to month and does not
always reflect genuine changes in the underlying trend in activity. For example, China was one of
the biggest improvers in the month, which could reflect the benefits of recent policy stimulus but
may also be related to the timing of the Chinese New Year. Certainly, the rest of Asia was a mixed
bag; sentiment in Taiwan, Indonesia and Vietnam improved, but it deteriorated in South Korea,
Malaysia and Japan. The drop in Japanese activity was especially large and highlights growing
question marks over the future of Abenomics. Elsewhere, European manufacturing sentiment
picked up slightly, led by Ireland, the Netherlands, Italy and Germany. The weaker sentiment
readings recorded in Greece, France and the UK may be due to elevated political risk. Meanwhile,
it is hard to get an accurate read on the trend in US manufacturing sentiment. The Markit PMI
increased only slightly and remains close to a multi-year low, though it is still at a level consistent
with mild growth in production. The more widely-followed ISM Index increased more strongly, albeit
from a lower base, led by a surge in new orders. Although it will take time before it is clear which
is providing the more reliable signal, we are doubtful that elevated new orders can be sustained,
given the softness in manufacturing fundamentals.
Contributors
Authors:
Jeremy Lawson
Govinda Finn
James McCann
Alex Wolf
Editors:
James McCann
Stephanie Kelly
Chart Editors:
Carolina Martinez
Alessandro Amaro
Contact:
Jeremy Lawson,
Chief [email protected]
Who's afraid of the external wolf?
After a soft Q4, in which the Bureau of Economic Analysis (BEA) now estimates that the economy grew at a 1.4% seasonally
adjusted annualised rate (saar), Q1 is likely to be even weaker. After a big drop in March, light vehicle sales were down in the
first quarter as a whole, leaving personal spending on track to grow just 1.5%; well down on last year’s pace and the
weakest outturn since Q1 2014 (see Chart 2). Sluggish consumption growth is a problem because there are few other drivers of
growth to be found. Net exports will weigh on growth again in Q1, while the trend in non-structures capex spending remains flat,
though investment in structures is growing at a healthy clip. March did see a healthy rise in the manufacturing ISM, led by a surge
in new orders, but the Markit PMI edged up more modestly and the combination of soft consumption, weak external demand and
elevated inventories suggest that new orders will drop back gain in the coming months. As has been the case for some time, the
healthiest economic signals are coming from the labour market. Nonfarm payrolls continued to increase at an above-200k pace in
March, while the upward trend in the employment-to-population rate was maintained, propelled by another increase in labour force
participation (see Chart 3). The only disappointment was that implied trend productivity growth remains anaemic.
Despite the continued strong performance of the labour market, Federal Reserve (Fed) chair Janet Yellen gave a wide-ranging
policy speech last week, which revealed that she has become more concerned about downside risks from the global
economy and financial markets, justifying a more accommodative path for interest rates. She also elaborated on the rationale for
the Fed’s cautious view on core inflation, observing that short-term developments can be volatile. With further pass-through from
earlier dollar appreciation likely and some measures of inflation expectations running low, medium-term inflation risks are tilted to
the downside. Yellen also chose not to push back against the market’s dovish expectations for Fed policy, instead pointing out
how lower market rates had helped shield the economy from recent shocks. She then went on to argue that the current stance
of monetary policy was sufficiently accommodative because the neutral real interest rate (that which is neither expansionary nor
contractionary) – which the Fed currently estimates is close to zero – remains above the actual real rate – which is -1.25% once core
PCE inflation is subtracted from the federal funds rate. This implies that the economy should continue to growth modestly above
potential, ensuring further progress on the Fed’s employment and inflation goals. Further out, her view is that that the neutral rate
will gradually rise over time to around 1%, allowing the Fed to lift rates while still maintaining a modestly accommodative stance. If
neutral real rates do not increase, the terminal fed funds rate will naturally be much lower.
Overall, it was hard to detect any urgency in the speech about lifting interest rates. April is almost certainly off the table,
meaning that a rate rise will not come into play until at least June. For now, we maintain our view that two rate hikes are still possible,
but external and financial risks will need to dampen, alongside an improvement in domestic growth indicators. A healthier labour
market is clearly a necessary, but not sufficient, condition for tighter monetary policy.
Author: Jeremy Lawson 2 05 April 2016
Weekly Economic Briefing www.standardlifeinvestments.com
Getting defensive
The Office for National Statistics has, as usual, revised up GDP estimates. Growth is now believed to have risen 2.3% last year,
with household consumption contributing 1.7 percentage points (ppts) of this increase. Investment played a supporting role, adding
0.7 ppts to growth, although it seems likely that firms will be more cautious over coming months as political uncertainty around the
EU referendum builds. Indeed, the latest Deloitte CFO survey reported that the referendum is now seen as the biggest risk
to large companies. When we add broader economic and financial concerns, the share of CFOs who rate the uncertainty facing
their business as above normal has jumped to 83%. Unsurprisingly, this has weighed on risk appetite, with respondents favouring
more defensive balance sheet strategies, such as reducing costs and increasing cashflows (see Chart 4). We have to be a little
cautious interpreting these data. While large corporates are an important part of the economy, smaller companies account for a
larger aggregate share of economic activity. Moreover, SMEs might be less directly sensitive to the UK’s relationship with the EU.
However, it seems fair to assume that investment and hiring will be weaker over the first half of the year as the vote approaches.
Given the softness in global trade and attempts, albeit slightly watered down, to tighten the fiscal purse strings, the onus is even
more on household spending to support short-term growth. Thus far, the resilient UK consumer looks to be up to the job, helped
by a boost in incomes on account of low inflation. However, this does not provide a sustainable growth mix in the longer term. The
hope is that any pause in businesses investment proves temporary, in order to broaden an increasingly imbalanced upturn. This
imbalance is also being reflected in current account dynamics. These provided a nasty surprise at the end of last year, with
the current account deficit widening to a record 7% of GDP. This is being financed by huge capital inflows, particularly in the
form of portfolio investments. Political uncertainty has created concern that the market could be less willing to finance the current
account shortfall. Indeed, sterling has weakened by 7% in trade-weighted terms since the turn of the year and the cost of insurance
against a more pronounced depreciation has increased to levels above those seen during the financial crisis.
Policy setting is becoming increasingly difficult in the current environment. At home, we have seen signs of growth moderating
while the global backdrop remains rocky, illustrated by wild swings in financial markets. Meanwhile, inflation is running well below
target, albeit largely on account of weak commodity prices. While the Bank of England believes that spare capacity is almost
exhausted, this has yet to translate into material domestic inflationary pressure. Finally, there are tentative signs that credit growth
is starting to accelerate, creating concerns that financial imbalances may be building (see Chart 5). At present, the Bank is using
macroprudential tools to tackle concerns over financial stability. Last week, it announced an increase in the capital that banks
must hold relative to risk-weighted assets. This gives it the scope to allow monetary policy to help cushion some of the short-
term headwinds. However, questions remain over the efficacy of this dual policy approach over the longer term.
Author: James McCann 3 05 April 2016
Weekly Economic Briefing www.standardlifeinvestments.com
Staying cautious
The European Central Bank (ECB) has made its move. Last month, it announced a package of easing measures that comfortably
exceeded market expectations on most counts. Asset purchases will be broader and more aggressive, while the central bank
has redoubled its credit easing efforts. Markets were admittedly disappointed that President Draghi signalled a reluctance to cut
rates much further, although we were more relaxed with this reticence, given our scepticism over the efficacy of negative interest
rates. The central bank will now be keenly watching the data to see how large an impact the deteriorating global and
financial backdrop will have had on domestic activity. At first glance, the latest array of survey data might give it some heart.
Following a weak run, the Eurozone manufacturing PMI rebounded a little to 51.6, supported by an improvement in most member
states. Similarly, the German IFO survey regained a little of its lost ground, helped by an improvement in current conditions and
expectations. However, these tentative improvements still left most survey data signalling weaker growth than that seen through
much of 2015. Therefore, while the ECB might take some encouragement from signs of stabilisation in global manufacturing, it will
want to see a much more marked reacceleration before it becomes more optimistic.
The central bank is likely to have reacted to the latest inflation data with a similar degree of caution. The closely-followed core
measure of price growth provided a rare upside surprise, rising to 1% year-on-year (y/y) in March from 0.8% y/y in February.
However, scratching beneath the surface, this increase looks to have been at least partly driven by seasonal effects. Services
inflation jumped to 1.3% y/y (previous: 1.1% y/y) with the early timing of the Easter holidays helping to push the volatile air fares
component sharply higher over the month. Accordingly, the ECB will closely watch how price growth evolves in April, with some
payback from this seasonal factor likely. More generally, the central bank will want to see signs that inflationary pressures
are increasing on a sustained basis over a number of months. Key to this will be the evolution of unit labour costs. While it is
positive that February saw a 13th consecutive decline in the Eurozone unemployment rate, there remains little evidence that slack
has been reduced sufficiently to bolster wage pressures (see Chart 6). The central bank will need to engineer a sustained period
of above-trend growth in order to meet this objective.
Above-trend growth will require a well-functioning financial sector. Perhaps the strongest signal that the ECB can take from the
recent data was the resilience of bank lending data in the wake of a sharp rise in financial stress. Indeed, loans to households
accelerated to 2.2% y/y in February and loans to non-financial firms were up to 0.6% y/y (see Chart 7). Draghi and co. will again
be slightly cautious when interpreting this improvement. There may be lags involved between building stress and tighter credit
conditions. However, if this is sustained, it provides an encouraging signal that the transmission of monetary policy to the real
economy is not being blocked. Moreover, with the ECB offering even more generous funding and incentives to lend under its new
TLTROs, the scope for the financial sector to support growth should increase further.
Author: James McCann 4 05 April 2016
Weekly Economic Briefing www.standardlifeinvestments.com
The mask slips
There is a growing perception that the best of Abenomics may be behind us. Not only has the domestic economy stalled but
overseas demand trends have turned sour. Industrial production slumped 6.2% month-on-month (m/m) in February, the weakest
reading since November 2011, with the deterioration in the inventory-to-shipment ratio firmly pointing to a contraction in industrial
output in the first quarter. The news from the BOJ’s flagship corporate survey provided little reassurance either. Japan’s export-
sensitive large manufacturers reported a significant deterioration in business conditions, with the headline index plunging to +6
from +12 in the previous quarter.
For a better assessment of domestic demand conditions, it is useful to look at the SME sector. Here, the news of late has been
less downbeat. The Shoko Chukin Index pointed to greater resilience in the smaller company sector, rising in March for a second
consecutive month to 48.8. The Tankan too pointed to a less severe downturn in business conditions among smaller companies,
with manufacturers and non-manufacturers experiencing a -4 and -1 point decline respectively. However, the more forward-looking
elements of the survey suggest that these companies may simply be lagging their larger peers. Small enterprises plan to reduce
capex by a disappointing 19.3% y/y in FY2016, while profit expectations fell into negative territory at -5.4% (see Chart 8). Firms
have a habit of revising these measures as the year progresses but, even factoring that in, the outcome is underwhelming. If the
breadth of disappointment in the BOJ’s Tankan Survey is upsetting, the timing is even more galling. We are three years
into to the BOJ’s unprecedented monetary stimulus and the desired virtuous circle has failed to materialise. Yes, both
basic wages and corporate profits have risen but risk-averse household and corporate sectors have saved, rather than spent, rising
incomes. This has raised justifiable concerns about whether monetary policy can dispel Japan’s deflationary mindset. We have
written extensively about the challenges to policy transmission, including weak wealth and credit effects, as well as the impact of
non-price competitiveness concerns on the currency channel. However, we still believe higher inflation remains the best hope
for Japan. Indeed, the fact that the BOJ Tankan shows that proxies of the output gap – such as the production capacity, diffusion
index, and employment conditions – have started treading water, augurs for a further monetary policy response (see Chart 9).
Whether other economies in the region also merit a more aggressive monetary response is a more controversial question.
In Korea, central bank Governor Lee Ju-yeol recently attacked claims from ruling party members that monetary policy should be
eased further to support growth, citing structurally higher inflation and growth. The robust defence is clearly aimed at defusing a
potentially explosive issue ahead of upcoming parliamentary elections. However, the more important consideration for the BOK will
be the composition of growth rather than the level. The Bank appears cautious about stoking further credit growth in the household
sector, fuelled by a strong property market. However, with industrial output growth remaining tepid, averaging just 0.3% m/m in the
first two months of the year, the Bank may be forced to act in the absence of a sustained acceleration in trade.
Author: Govinda Finn 5 05 April 2016
Weekly Economic Briefing www.standardlifeinvestments.com
March madness
Emerging markets assets have rallied over recent weeks as risk sentiment rebounds. However, the lack of economic improvement
in many economies leaves open the question as to whether the rally is sustainable and how long it can last. The rally has
been indiscriminate; markets have improved across regions and asset classes, Brazilian equites are up over 30% since January,
Chinese A and H shares are up 13% and 17% respectively, and EM currencies are up 6%. Economic data has been more mixed; on
a positive note EM PMIs generally improved in March to their highest level in a year, following a weak start to 2016. The improvement
was broad, with only Turkey and Russia seeing a decline among the major EM economies. However, other data points to sustained
weakness; industrial production is uniformly soft and trade continues to disappoint. Average industrial production growth rates
(y/y) in Latam, EMEA, and Asia are -4.2%, 1.1%, and 2.6% respectively – the weakest figures since the global financial crisis.
Furthermore, global trade has continued to deteriorate and does not yet appear to be bottoming out. Among the 30 largest EM
economies, only three have positive trade growth this year.
That said, factors other than economic fundamentals combined to boost EM risk sentiment. Dovish remarks by Fed Chair Janet
Yellen signaling gradual rate increases, combined with improving sentiment in China and rising commodity prices, have boosted
flows to EM funds. The Institute of International Finance reported that EM flows turned sharply positive in March, surging to a 21-
month high of $37 billion. Behind much of the improvement in EM is the view that China’s economy has stabilised, following recent
bouts of policy and economic instability. As such, a closer look at China’s data can determine how sustainable it may be. Since
the GFC, China’s economy has been heavily driven by the housing sector. Much of the rapid growth following the crisis was due
to construction activity and much of the weakness over the past two years was due to slowing property investment. Therefore, the
recent rise in property prices, construction, and manufacturing PMIs – after months of declines – were taken as a sign that the
economy is stabilising.
However, we believe it is likely still too early to call for stabilisation for three reasons: property inventories are still very
high, improved housing prices are highly concentrated in three regions, and much of the recent economic activity has been
driven by quasi-fiscal spending. China’s inventories began a healthy correction last year, as new starts continued to contract.
Policies to boost sales began to show dividends, as developers worked through excess supply. This process has largely stopped,
however, as new starts surged in February on the back of price increases. Inventories still have further to fall before reaching healthy
long-term levels. Additionally, price improvements have been highly concentrated in three regions: greater Beijing; Shanghai; and
Shenzhen (see Chart 10). When you strip out the cities that fall in those greater metropolitan areas, average prices are now just
beginning to rise but nowhere near the surge we are seeing in the overall average. Lastly, improved investment has been driven
by SOEs not private firms (see Chart 11), an inherently unsustainable surge considering the weakness among many SOEs. A
rebound based on property exuberance and quasi-fiscal stimulus means it might be more transient than the market wants
to believe.
Author: Alex Wolf 6 05 April 2016
Weekly Economic Briefing www.standardlifeinvestments.com
The document is intended for institutional investors and investment professionals only and should not be distributed to or relied upon by retail clients.
All information, opinions and estimates in this document are those of Standard Life Investments, and constitute our best judgement as of the date indicated andmay be superseded by subsequent market events or other reasons.
The opinions expressed are those of Standard Life Investments as of 04/2016 and are subject to change at any time due to changes in market or economicconditions. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buyor sell any securities or to adopt any strategy.
Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL.Standard Life Investments Limited is authorised and regulated by the Financial Conduct Authority.Standard Life Investments (Hong Kong) Limited is licensed with and regulated by the Securities and Futures Commission in Hong Kong and is a wholly-owned subsidiary of Standard Life Investments Limited.Standard Life Investments Limited (ABN 36 142 665 227) is incorporated in Scotland (No. SC123321) and is exempt from the requirement to hold an Australian financial services licence under paragraph 911A(2)(l) ofthe Corporations Act 2001 (Cth) (the 'Act') in respect of the provision of financial services as defined in Schedule A of the relief instrument no.10/0264 dated 9 April 2010 issued to Standard Life Investments Limitedby the Australian Securities and Investments Commission. These financial services are provided only to wholesale clients as defined in subsection 761G(7) of the Act. Standard Life Investments Limited is authorisedand regulated in the United Kingdom by the Financial Conduct Authority under the laws of the United Kingdom, which differ from Australian laws.Standard Life Investments Limited, a company registered in Ireland (904256) 90 St Stephen’s Green Dublin 2 and is authorised and regulated in the UK by the Financial Conduct Authority.Standard Life Investments (USA) Limited, registered as an Investment Adviser with the US Securities and Exchange Commission.Calls may be monitored and/or recorded to protect both you and us and help with our training.www.standardlifeinvestments.com © 2016 Standard Life, images reproduced under licence