Monday, January 31, 2011

GDP x3

Yep, back from hols. We had a great time. Thanks for asking.

Three important fourth-quarter-2010 GDP results were out while I was away: UK, China and the US.

In the United Kingdom, GDP contracted 0.5% in Q4. That was well below market expectations of a small rise. That makes three surprise results on the trot. Q2 and Q3 results were well above expectations. The statistical cynic in me thinks we were simply due a bad number.

The mid-year results were simply too strong given the underlying fundamentals of the UK. It led me to concede that this was the economy I was most wrong on (least right?) in 2010. The Q4 number therefore, somewhat perversely, gives me some comfort that economic fundamentals still matter! I know the theory: every country is supposed to have at least one comparative advantage. The UK’s escapes me for the moment.

Of course the bad UK weather copped most of the blame for the poor result, but also underscores fragile economic conditions in the UK, especially as fiscal austerity measures impact over the course of 2011.

In China, GDP posted an annual rise of 9.8% in Q4 (10.3% in year-on-year terms). Yes folks, it is still a world of two halves out there. Inflation fell back a bit in December to 4.6%, following November’s rise of 5.1%.

Despite this better inflation result, the control thereof remains the key challenge for China in the period ahead. Further tightening appears a near certainty. This will be on three fronts: further increases in benchmark interest rates, the required reserve ratio and further appreciation in the CNY.

Of course further CNY appreciation will also assist in global rebalancing by making China imports cheaper, thereby boosting consumption. Retail sales growth of 14% in the December year was good news, but ideally we want China consumption to be the strongest part of GDP growth for the foreseeable future.

Which brings me to the United States. Fourth quarter annualised growth of 3.2% was both good and not-so-good news. The good news first. 3.2% in the quarter is a good result for a country that is meant to be just “muddling through” (our words) the last half of 2010 and early 2011. It was only back in August that the “double-dipsters” were at their most apoplectic.

The make-up of the result was interesting. Business investment put in another increase in the quarter, although somewhat softer than previous quarters. Exports were strong and imports were weak which made for a positive contribution from net exports. Remember business investment and exports are the two areas we want to see perform well for a better balanced US economy.

Inventories made a big negative contribution in the quarter. That’s not so good for this quarter, but bodes well for production further down the track.

Personal consumption is the part we really need to think about for a minute. Private consumption rose 4.4% (annualised) in the quarter. On the one hand it’s good to see consumers spending a bit, but that is only a short-term consideration. We are more concerned about the medium to long-term outlook.

The first point is this. That growth in consumption was not driven by growth in jobs or incomes. That means it came out of savings. Indeed the personal savings rate dropped from 5.9% in Q3 to 5.4% in Q4.

Now let’s remind ourselves of the genesis of the Global Financial Crisis. A global “savings glut” (Ben Bernanke’s own words) led to low real interest rates which led to over-inflated asset prices. As the bubble inflated, consumers consumed on the back of perceptions of increased wealth. The US had become the world’s borrower and spender of last-resort.

That was never going to go on forever and indeed didn’t. In my view, the US has only just STARTED the deleveraging process. This leaves me wondering if the Q4 rise in consumption is just a “blip” borne out of deleveraging fatigue and a bit of a Christmas spend-up before refocussing on debt repayment again in the New Year. Only time will tell.

If that’s not the case and consumers are spending again, then the message to Timothy Geithner is to use the opportunity to put the accelerator pedal down on fiscal consolidation. It’s called “tough medicine”.

Thursday, January 13, 2011

Portugal debt auction goes well...

Risk assets took heart overnight following the successful sale of Portuguese bonds. Had the auction failed a bailout would not have been avoided and would have been a bad omen for bond auctions in Spain and Italy tonight.

In the end there was “healthy” demand for the Portuguese debt. The 10-year notes were sold at a yield of 6.72%, below the prevailing yield of 6.85%. The yield had been at 7.3% earlier in the week and had only rallied on the back of ECB purchases earlier in the week and comments from China and Japan that they would support sales of European bonds later this month by the European Financial Stability Facility (EFSF) to support the bailout of Ireland.

So far so good then. It remains to be seen if Portugal seeks a bailout – if for no other reason than sourcing cheaper debt via the EFSF rather than raising funds themselves.

Remember all this is simply dealing with the symptoms of a larger problem. The issue is bigger, even than fiscal consolidation and sustainability at the individual country level. It’s actually about fiscal solidarity at the European level.

With the bonds about to be issued by the EFSF, we are seeing the birth of a truly European bond market. A Europe-wide bond market and the lower interest rates and stability that would come with that, at least for the currently troubled peripheral European nations, seems the only pathway to fiscal sustainability and stability for those countries. It might also end up stopping what is currently a peripheral-Europe problem from becoming a core-Europe problem.

Over time that will drive a convergence of fiscal policy. There's nothing like peer pressure and grumpy neighbours to encourgae getting your (fiscal) house in order. This will be helped along by the tougher budget rules, and appropriate penalties for breaking those rules, that is currently being proposed by the ECB and considered by the European Parliament. Go you good things.

Saturday, January 8, 2011

US payroll data doesn't live up to the hype

US December employment data failed to live up the pre-release expectations. Many foecasters had revised up their forecasts for this result on the back of stronger data on unemployment claims and other surveys of employment. Non-farm payrolls rose 103k, below the median market expectation of +150. Private payrolls were up 113k in the month, including +10k in the manufacturing sector. Remember manufcaturing is a key sector to watch given where we thing growth momentum needs to come from.
Offsetting the headline disappointment was upward revisions to previous data with the October gain of 172k revised up to +210k and November from +39k to +71k.

The unemployment rate dropped from 9.8% to 9.4%. On the surface that's a pretty good result, but it was largely the result of a drop in the participation rate. That most likely reflects disenfranchised job-seekers giving up the search for work and therefore dropping out of the labour force, so this should not be read as an indicator of any strengthening of momentum in the labour market.

The picture therefore remains one of subdued labour market activity reflecting the subdued pace of economic growth in the US.

Thursday, January 6, 2011

India inflation and monetary policy

A just completed IMF mission to India has warned of the risk of higher inflation and the likelihood of further interest rate hikes. India is growing at a strong clip - a China-like 8.9% for the year to September - with little slack in the economy. While inflation has cooled from recent highs, it remains at an elevated 9.7% for the year to October 2010.


India entered the Global Financial Crisis from a position of near over-heating and already relatively tight monetary conditions. The benchmark interest rate was lowered from a pre-GFC level of 6% to 3.25% by mid 2009. From that low point, interest rates were raised 6 times during 2010, rising to 5.25%.

The Reserve Bank of India should be applauded for its actions thus far, but we agree with the IMF assertion that there is more work for them to do yet. Remember inflation and the containment thereof will be the key emerging market theme this year.

Wednesday, January 5, 2011

Macro themes for 2011

For those of you who either haven’t read the December issue of QSO, or have read it but forgotten it already, here’s a summary of the key macro themes for 2011:

1) After posting what looks like 4.5%+ growth in 2010, we expect global growth of 4% in 2011. This will, again, be driven by strong growth in emerging markets while the key developed markets will continue to struggle under the weight of continued household deleveraging and weak job growth (US) and fiscal belt-tightening (Europe). Growth then builds again in 2012, making 2011, not a double-dip, but definitely a post-dip-blip.

2) Growth in the US will remain subdued thanks to the headwinds of continued deleveraging at the household level, soft jobs growth and a housing market that is still struggling to form a base. Having said all that we have raised our 2011 US GDP forecast from 2.5% to 3.0% on the back of cuts to payroll taxes, stronger business investment and exports. This is however, still not robust growth for this stage of a recovery. Consumption won’t gain any robust traction until households are more comfortable with their balance sheets, which could be still 2-3 years away.

3) Structural issues will remain a key focus for Europe. Sovereign debt will continue to be the catalyst for further concern in this region. More precisely, government financing requirements of around 20% of GDP in 2011 will be the immediate challenge. This is not as high as the funding requirements of other governments, but Europe is a different case. For example Japan, with a funding requirement of 58% of GDP, runs a current account surplus and has significant foreign assets, making them less reliant on global capital markets. The US, with a funding requirement of 25% of GDP, runs a current account deficit making them reliant on foreign capital. However, the status of the USD as a preferred reserve currency means there will continue to be strong demand for their public securities. There is considerable economic diversity across Europe, with questionable commitment to improved governance across the region. With that comes concern about the degree of commitment to the survival of the Euro. It will be another challenging year for Europe. At the very least, we expect to see another “shock and awe” strategy play out (Shock and Awe II?) as the European Financial Stability Facility is beefed up.

4) Inflation will be the primary concern in emerging markets in 2011. This will further highlight the difference in economic challenges between developed and emerging economies. For developed markets the challenge will be weak growth and inflation that is too low, while in emerging markets, the challenge will be over heating and rising inflation. This will be most evident in China. China raised benchmark interest rates on Christmas Day, and we expect to see further increases in 2011. A stronger Yuan and further increases in the required reserve ratio can also be expected. We fully support actions to keep inflation in check. Going right back to the start of the recovery, we warned that the biggest risk to rising prosperity in emerging markets was any lack of commitment on the part of authorities to tackle inflation. We would rather see lower stable growth than boom and bust cycles.

5) Economic growth in New Zealand undershot even our miserly growth forecasts in the second half of 2010. The recovery will build some momentum in 2011, but this will be partly due to temporary factors such as the Canterbury earthquake rebuild and the Rugby World Cup. Without those, the NZ economy would likely do no better than about 2% growth. However, with potential growth now lower, inflation will become a problem earlier in the cycle, but that’s not something to worry too much about in the first half of the year. When the time comes for withdrawal of the stimulus, the interplay between monetary and fiscal policy will be….let’s call it “interesting”.

US manufacturing

The US manufacturing sector finished 2010 in fine fettle. The Institute of Supply Management (ISM) Performance of Manufacturing Index (PMI) rose to 57.0 in December, up from 56.6 in November.

Manufacturing has to be a key sector in the US recovery, which belies its 11% prportion of the US economy. As we said right at the start of the recovery, growth would have to be driven by productive effort, with producers making things consumers want to buy. And while the US consumer remains in de-leveraging mode, the important consumers are external to the US i.e. exports.

With that in mind, the makeup of the latest PMI result makes for encouraging reading. In particular:

1) the production index hit 60.7 in December, up 5.7 percentage points

2) the trend in New Orders now appears to be on an upward trajectory

3) the export index came in at 54.5 which is down on Novembers 57.0, but still over 50

4) the inventories index fell to 51.8. indicating investories are still building, but at a slower pace.

Furthermore, factory orders rose 0.7% in November, towards the top end of market expectations. Orders for durable goods fell in the month, but orders for capital goods rose. We expect business investment to remain strong into 2011 as firms build productive capacity, an important precursor to strong productive sector recovery.

Sure this all falls someway short of a robust recovery, but the signs are positive. We continue to believe that this is the beginning of a resurgence in US manufacturing that will see its share of the US econony beging to rise after decades of decline.