Friday, February 21, 2014

While I was away...

I’ve been out of the office (and the country) for a couple of weeks.  Yes it was a holiday and we had a great time - thanks for asking.  But I was keeping an eye on things and there were a few developments worthy of brief mention by way of catch-up…

The “Fragile 5”
We are seeing a discernible improvement in trade balance data out of some of the so-called “Fragile Five”.  Recall our story has been that in those countries (India, Brazil, Indonesia, South Africa and Turkey) currency depreciation and higher interest rates (leading to lower domestic demand) would see an improvement in trade and eventually current account balances.   We have not been disappointed; trade balances are clearly on the improve in India, Indonesia and South Africa and current account balances have turned the corner in India and Indonesia.

That leaves Turkey and Brazil yet to show some improvement.  Some great analysis by our Head of Investment Strategy Keith Poore suggests the recent currency depreciation in four of the five (India, Indonesia, South Africa and Brazil) has been sufficient for their current account deficits to fall to a more sustainable  -3% of GDP, but Turkish Lira still has further to go.  In terms of Brazil that analysis suggests their lack of improvement to date may reflect the J-curve effect. 

We are far from out of the woods yet, but events so far confirm for us that with more flexible exchange rate regimes, we are not seeing a repeat of the Asian Financial Crisis.  And while we took a hit on our 2013 & 2014 emerging economy growth forecasts last year the medium term growth story remains compelling.


Bad weather in America
Recent labour market and production data (manufacturing PMI, industrial production) has been soft.  Much of the softness seems to be related to the bad weather.  I think the weakness is also inventory related.  At the end of last year we saw a significant boost to growth from inventory building.  That won’t last in fact we expect inventories will be a drag on GDP growth in the first half of this year.  That said we expect domestic demand to continue to track around a 3.0% annualised pace.  In that respect weaker data will reflect volatility rather than a change in view on the fundamental strength of the US economy.  I know it’s not fashionable to talk about it anymore but the next thing to worry about in America is inflation.  For those signals we will be watching labour market data closely in the period ahead, especially wages unit labour costs.  We still believe it’s the labour market where signs of generalised inflation pressures will emerge first. 

China data "mixed"
It’s always safest not to read too much into China data in the early part of the year.  That said some of the recent news (lending, export and imports) has been generally better than expected while other news (PMIs) has been somewhat disappointing.  At this point I’m still happy with my forecast that we will see a further modest decline in GDP growth this year to around 7.5% (compared with 7.7% in 2013) reflecting stronger export growth which will likely prove insufficient to offset a further decline in investment.  The good news is that inflation remains benign (despite being higher than expected in January).  That means there is room for the PBoC to move in need.  Low inflation along with money supply growth now coming into line with target (13.2% in January y/y vs. target of 13%) should see the central bank shifting from a tightening bias (liquidity) to a more neutral stance over time. 

GDP growth in Japan and the Euro area
Euro area GDP was stronger than expected at +0.3% q/q.  While there is little in the way of detail at this point, it appears the upward surprise was in business investment.  That’s good news.  We continue to believe that stronger business investment is a necessary condition for rebuilding a more robust growth environment.  Let’s hope it continues.  But with inflation still low, this level of growth will still not be sufficient for the ECB to completely dismiss the risk of deflation.  We still think the ECB does more, but exactly what “more” is remains moot.

Fourth quarter Japan GDP growth also came in at +0.3% q/q, but that was below expectations of an increase of around +0.7% q/q.  The surprise was the weakness in net exports with a hefty rise in imports acting as a drag on growth.  There were signs of domestic demand picking up ahead of the April 1st increase in the consumption.  We expect this will strengthen over the next few months before the tax increase takes effect.  Demand will slow sharply after the tax increase with the decline in real incomes likely to be a drag on growth over time.  I remain less optimistic than some on the success of “Abenomics” and future growth prospects for Japan and believe the BoJ will be easing further around mid-year.   

Strong NZ growth spilling over into the labour market
In New Zealand activity data has continue to paint the picture of robust growth.  While the 1.2% q/q increase in December quarter retail sales failed to meet consensus expectations, it’s still strong enough to support our expectations of q/q growth of around 1.0% in the last quarter of 2013.  The really good news is the extent to which the stronger growth is spilling over into a more consistent performance in the labour market with strong employment growth continuing into the end of last year and a further decline in the unemployment rate despite an increase in the participation.   Wages are still relatively subdued but our view that the declining trend in unit labour costs has bottomed-out was supporting with a small tick-up in the annual rate of change at the end of the year.  While that’s no cause for panic, it is another sign that the time is right for the RBNZ to get on with the tightening cycle.

Back to more regular posts next week.