Friday, February 28, 2014

Brazil GDP growth better than expected but challenges remain

Sentiment in emerging markets was given another assist today with better-than-expected fourth quarter of 2013 GDP data out of Brazil.  GDP growth came in at +0.7 for the quarter for annual average growth of 2.3% for 2013 as a whole.  The consensus market expectation was for a number around +0.3%.

Had the number met market expectations (which was below our forecast of +0.5%) I was about to lower my forecasts for 2014.  As it stands I will wait for more partial activity data from early 2014 before making a call.  I am therefore sticking to my expectation of annual average growth of 2.0% for 2014, although acknowledge the risks are biased to the downside.

Today’s GDP result tells us that domestic demand, particularly business investment, is holding up better than expected.  Indeed business investment posted a 0.3% q/q gain in the quarter when the partial data had suggested a further contraction following the -2.0% decline recorded in Q3 was likely.

Also, near full employment is helping support consumption activity in the face of higher interest rates.  But therein lies part of the structural challenge for Brazil.  The labour market remains strong with seasonally adjusted unemployment falling from 5.2% in December to 5.0% in January.  The strong labour market has seen wage growth accelerate with average real wage growth up from 3.2% yoy in December to 3.6% in January.  At the same time, investment as a share of GDP remain at a relatively low 18.4% of GDP which is why we worry about Brazil’s potential rate of GDP growth and inflation.

Annual inflation reached 5.65% in February, up from 5.59% in January.  The increase was in large part due to seasonal factors so the central bank was unlikely to view this negatively. Indeed while the monetary policy committee of the central bank (COPOM) raised the Selic rate by 25bps earlier this week that was a reduction in the pace of tightening as this hike followed 6 successive increases of 50bps.

It therefore appears COPOM is close to the end of the tightening cycle.  But while the impact of higher interest rates on domestic demand is still yet to fully play out, the risks to growth remain based to the downside.

Tuesday, February 25, 2014

It's not just the weather

We’ve hit a soft patch in US activity data, particularly in the manufacturing and the housing & construction sectors.  This is having a flow-on effect into the labour markets with recent payrolls data soft too.  Recent bad weather has been copping most of the blame for the weakness in the data which appears reasonable (although the weather in San Francisco last week was outstandingly good!!!).  To that extent, once the weather improves, a bounce-back in activity can reasonably be expected.

We’re also keeping an eye on inventories.  You may recall I was surprised by the continued strength of inventory accumulation into the end of last year.  That, alongside a surprisingly large contribution from net exports in the fourth quarter, saw GDP come in higher than expected in the second half of last year.  Indeed growth in real final sales (the bit that really matters) was softer than GDP in every quarter of 2013.  For 2013 as a whole annual average growth in real final sales was 1.7% while GDP grew 1.9%.  Both numbers are likely to be revised down at the end of the week when we get the second estimate of Q4 2013 GDP, but the story will remain largely the same.

We think it’s inventory payback time.   We attribute some of the recent weakness in manufacturing data to a reversal in the positive contribution from inventories over 2013.  That means that while we expect some bounce in the activity data when the weather gets better, don’t expect a full reversal.  We think March 2014 quarter GDP growth will be close to 1.0% (seasonally adjusted annual rate) with a result around 2.0% in the June quarter as the drag from inventories continues into the middle of the year.
We expect growth to be stronger in the second half of the year.  For 2014 as a whole we are forecasting GDP growth of 2.8% with real final sales coming in at 3.1%.  So we are going into a period in which real final sales will be stronger than total GDP.  From a monetary policy perspective we think the US Federal Reserve will look through the soft patch in growth, focus on the improving underlying fundamentals and continue to wind its asset purchase program down. 

Monday, February 24, 2014

Keeping an eye on the G20

Despite having been generally disappointed with the outcome of most G20 deliberations since the GFC,  I still check in occasionally.  Why put myself through the angst you might well ask? Because much of the repair to the global economy that still needs to happen is about the necessary rebalancing of global growth and the building of a stronger and more resilient global monetary system.  That needs a co-ordinated approach.  That being the case, a multi-country grouping of the worlds 20 largest economies working alongside the key multi-lateral agencies such as the International Monetary Fund still seems the most logical place to see progress.  

The Communique from the recent Meeting of Finance Ministers in Sydney was in much the same vein as all the others.  It's hard to find a single word to disagree with. A commitment to "develop ambitious but realistic policies to lift collective GDP by 2% above the trajectory implied by current policies over the coming five years" is admirable.  But apart from acknowledging the well-understood structural reform that needs to be progressed to achieve increased investment, a lift to employment and participation,  enhanced trade and greater competition, there is a paucity of detail.  To be fair, there is still hope that the forthcoming Brisbane Action Plan will contain that detail.  Fingers crossed.

I've commented in the past that the challenge with commitments made on the global stage at G20 forums is for the Finance Ministers and Leaders to turn those commitments into policy action at home.  That's where the political reality of implementing what will most likely be unpopular and costly structural reform puts a brake on policy action.

The discussion at this forum that was going to be of most immediate interest was monetary policy and in particular US Federal Reserve wind down of its asset purchase program and the subsequent volatility in emerging markets.  The Communique endorsed the gradual normalisation of monetary policy with the timing conditional on economic growth and price stability. The eventual reduced reliance on easy monetary policy would in time be beneficial to financial stability.  No disagreement from me.

The message to the emerging economies was the normalisation of monetary policy might lead to excessive volatility in asset prices and exchange rates but that the primary response to that is to further strengthen and refine domestic (i.e. their own) macroeconomic, structural and financial policy frameworks.  I'm good with that message.

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.

Monday, February 3, 2014

Spotlight on emerging markets

The spotlight has again fallen on structural issues in emerging economies over the past few weeks, particularly those running large current account deficits including India, Indonesia, Brazil, South Africa and Turkey.  This has been sparked by a number of issues including the lead in to the January meeting of the Federal Reserve, renewed concerns about growth and financial stability in China and unrest in two frontier markets; political turmoil in the Ukraine and financial stresses re-emerging in Argentina.

Concerns first emerged in mid-2013 as financial markets contemplated the imminent reduction in the pace of US Federal Reserve asset purchases, the subsequent reduction in global liquidity and the ability of emerging market deficit countries to attract the necessary capital to fund those deficits in an environment of rising developed market interest rates.

So the spotlight is again on the need for structural reform in emerging economies.  Regular readers of this blog understand the need to attend to structural reform is not just an issue in the post-GFC developed economies.  The need is just as great, albeit different, in the key emerging economies.

The objective is a need to rebalance global growth and reduce the structural imbalances that were the genesis of the GFC (the “savings glut”).  To rebalance growth (more precisely final demand) and reduce imbalances the large surplus countries such as Germany, Japan and China, needed to rebalance away from exports to consumption so that the large deficit countries such as the United States, non-Germany Europe and India  could boost competitiveness and grow exports.  Progress has been made in some countries although it remains to be the seen the extent to which these improvements are structural (permanent) or cyclical (temporary).

The emerging economies have just as a big a role to play in reducing imbalances as the developed economies.  That said we don’t need to see an elimination of global imbalances.  Current account deficits are not a bad thing so long as they represent an efficient allocation of savings between surplus and deficit countries.

Current account deficits are the gap between savings and investment.  Emerging markets have high investment needs but typically low wages and low domestic savings.  Developed economies on the other hand typically have higher wages and savings and lesser investment needs so lend their savings to deficit countries, for a return of course.

The issue for us is not so much the deficits themselves but rather the use to which those funds are being put.  It’s the quality of the investment that will ultimately determine the willingness and ability of saver countries to continue to fund those deficits.

Of course structural reform and the benefits that flow from it is a long-term game.  In the near term it’s the commitment to reform that’s important.    In some respects emerging market economies are doing a better job than some of the developed economies.

In the Euro area and the United States it took a sense of crisis to see progress.  We have already seen an ambitious reform program announced in China, although details on implementation remain sketchy.  India has taken action to remove roadblocks to investment.  The Project Monitoring Group has been successful in unlocking investment projects worth an estimated 3.5% of GDP.  Furthermore the Reserve Bank of India has adopted the recommendations of the Urjit Patel Committee which strengthens their commitment to achieving greater stability in prices.  However, we are more concerned about the commitment to reform in Brazil.

As we said last year we don’t see a re-run of the Asian Financial Crisis.  Exchange rates are typically more flexible and have been falling, foreign exchange reserves are higher and external debt is lower.

The bad news is that the lower exchange rate adds to already high inflation in some countries such as India.  We’ve also said at times that the biggest near-term risk for emerging markets is that central banks don’t take the threat of inflation seriously.

On that front central bank action has been appropriate.  The Reserve Bank of India has raised rates 75 bps in 4 months despite decade low growth.   In Brazil the Selic rate has been moving rate higher since April 2013.  Indonesia, South Africa and Turkey have all raised interest rates recently.

Of course higher interest rates are negative for growth.  Indeed when these issues first emerged in mid-2013 we lowered GDP forecasts for the deficit countries in 2013 and 2014 on the expectation of higher interest rates.  I’m still happy with those growth projections, although the risk is that interest rates move higher than we anticipate leading to softer domestic demand.

In India we think growth will be modestly higher this year reflecting growth in exports and higher investment.  We think growth will be higher in export-dependent countries such as South Korea and Taiwan on the back of higher developed world growth.  Brazil, however, is likely to see lower growth in 2014 than in did in 2013.

On the other hand lower domestic demand is also a positive for current account deficits and a reduction in imbalances.  We continue to believe that the current account deficits in the “problem” countries will soon be improving on the back of exchange rate depreciation, higher global growth and lower domestic demand.  India has also taken steps to curtail the imports of gold, although that’s not such good news for South Africa exports.

In China, recent PMI data has slowed again risking another decline in growth this year.  We are still happy with our forecasts of 7.5% this year, down from 7.7% in 2013.  That reflects higher export growth (higher global growth tempered by further exchange rate appreciation) and stability in consumption expenditure which will be offset by the impact of tighter credit conditions on fixed asset investment.

We see little risk of a full-blown financial crisis in China. Post GFC China incurred increased local government debt, a property bubble and growth in unregulated shadow banking.  The leadership is keen to unwind these excesses but at the same time we expect they will protect the lower bound of their growth target of 7.5%.  For us that makes a potential policy mistake the key risk in China, which is not helped by lack of transparency of PBoC actions to rein in credit growth.  The sequencing of the implementation of reforms will also be critical.

Longer term we continue to believe dynamics in emerging markets will see growth continue to exceed that of the developed economies on average.  Demographics, productivity and rising middle classes will continue to contribute to relatively strong growth.  But we also need to see commitment to reform for stability of that growth.