Economic Research Week in Focus Fed rate hikes: How vulnerable are Emerging Markets? With the Fed set to raise interest rates, there are concerns that this could cause difficulties for emerging markets. But we see only a remote risk of a rerun of the 1997 crisis, as EM no longer hold such high levels of foreign currency debt. But private domestic currency debt has risen sharply and financing conditions could deteriorate once the Fed raises rates. The growth advantage enjoyed by EM over the developed economies is likely to narrow further and most currencies will probably depreciate against the US dollar. Page 2 20 March 2015 The Week in Focus in 100 seconds Please follow this link for a video summary. BRICS: Private sector more vulnerable than government BRICS countries (Brazil, Russia, India, China, South Africa), debt in per cent of GDP 200 180 160 140 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Public Debt Private Debt Source: BIS, Global Insight, Commerzbank Research ECB: Fragmentation remains in place. Contrary to ECB President Draghi’s view that differences in lending rates across the euro countries have decreased “significantly”, ECB data shows fragmentation in lending rates is currently higher than three years ago Page 5 Product Idea: MinMaxPlus Note in US$. This product allows investors to benefit from our view that the Fed will raise rates faster than the markets currently expect. Performance will be enhanced by the further weakness of the euro. Page 6 Outlook for the week of 23 to 27 March Economic data: We look for the German Ifo business climate to have moved higher in March. More importantly the manufacturing PMI is likely to break out of its recent sideways trend. Page 9 Bond market: The spectacular rally on euro area bond markets is losing steam. In the medium-term, peripheral yields will drop further although a period of stronger price volatility appears to be on the cards. Page 12 FX market: For the first time, the Fed has hinted that the recent appreciation of the USD is too rapid for comfort. However, the FX market ignored this warning, suggesting that it will take more than words to rattle the market, and EUR-USD is likely to retreat further. Page 13 Equity market: The outperformance of the DAX versus the S&P500 should lose momentum in the coming months as the P/E valuation gap has narrowed sharply. Page 14 Commodity market: Rising US crude oil stocks should continue to weigh on oil prices whilst gold could regain a bit of its shine as the downside pressure from a strong US dollar is easing and demand from China and India appears to be picking up. Page 15 Chief economist: Dr Jörg Krämer +49 69 136 23650 [email protected] For important disclosure information please see pages 18 and 19. research.commerzbank.com / Bloomberg: CBKR / Research APP available Editor: Peter Dixon +44 20 7475 4806 [email protected] Economic Research | Week in Focus Dr Jörg Krämer Tel. +49 69 136 23650 Fed rate hikes: How vulnerable are Emerging Markets? With the Fed set to raise interest rates sooner rather than later there are concerns that this could cause difficulties for emerging markets (EM). But we see only a very remote risk of a crisis like in 1997/98, as emerging markets no longer hold such high levels of foreign currency debt. But corporate debt in domestic currency has risen sharply and financing conditions could deteriorate considerably once the Fed raises interest rates. The growth advantage enjoyed by EM over the developed economies is likely to narrow further and most currencies will probably depreciate against the US dollar. The Fed and EM: 1997 and 2013 EM have experienced difficulties several times in the past when the US central bank tightened monetary policy. A dramatic example is the Asia crisis of the 1990s. When the Fed raised its key interest rate from 3.0% to 6.0% in 1994 and 1995, higher US rates eventually put pressure on EM currencies in 1997. In Asia especially, many central banks had to abandon their peg to the US dollar. It became difficult to refinance high levels of foreign currency denominated debt. Drastic savings programmes and a sharp decline in economic activity were the result. When the Fed indicated in May 2013 that its asset purchases were coming to an end, EM did not slide into a 1997/98-style crisis, but their currencies did depreciate sharply. The first Fed rate hike, which is likely in June or September, will put these countries to the test again. But they can rely on two advantages for now: Advantage 1: Balanced current accounts, flexible exchange rates Ahead of the Asian crisis, the crisis-hit countries were posting current account deficits around 4% of GDP (chart 1). In contrast, since the shock of 1997, emerging markets as a group have reported current account surpluses, allowing them to build up currency reserves in the event of future crises. Excluding China, with its high current account surplus, the current account balances of other countries show only a slight deficit. This improvement has essentially been possible because most EM no longer have fixed exchange rates and therefore have no incentive to borrow abroad at favourable rates, protected by supposedly fixed exchange rates, which enabled them to live beyond their means. Advantage 2: Sustainable external debt A second advantage for EM countries is that their external debt is now at sustainable levels. According to the World Bank, developing countries held debt of around USD 5.5 billion in foreign currency at the end of 2013. This is only just under a quarter of aggregate income. Debt servicing came to only 10% of export revenues, a marked improvement on the 21% recorded in 2000. Mirroring the sustainable external debt position, domestic banks dominate the supply of capital to the private sector in most EM. In the case of BRICS, the share of domestic banks in CHART 1: Current accounts are roughly balanced Current account balances in % of GDP. 1997 crisis countries: Indonesia, Malaysia, South Korea, Philippines, Thailand. EM: Emerging Markets 10 55 8 6 50 4 2 45 0 40 -2 -4 35 1990 1993 1996 1999 2002 1997er crisis countries Source: IMF, Commerzbank Research 2 Gross public debt of all Emerging Markets, in % of GDP 60 12 -6 CHART 2: … and public debt levels are stable 2005 2008 2011 EM 2014 30 2000 2002 2004 2006 2008 2010 2012 2014 Source: IMF, Commerzbank Research 20 March 2015 Economic Research | Week in Focus private credit supply fluctuates between 75% (Russia and China) and over 90% (Brazil, South Africa, India, see chart 3). The advantage of this funding structure is that financing does not immediately become more expensive if the domestic currency depreciates sharply (e.g. due to higher Fed rates). But domestic private sector debt has risen significantly Balanced current accounts, flexible exchange rates and sustainable external debt levels suggest that higher US interest rates are unlikely to push emerging markets into a crisis like in 1997/98. This is even more true as public debt has merely grown in line with GDP in the past few years (chart 2, p.2), something that many euro zone countries can only dream of. But the disadvantage for many emerging economies is that private sector debt (companies/consumers) has risen in recent years at a much sharper rate than GDP (see chart on front page). China is a prominent example (chart 4). The debt ratio of Chinese companies and private households soared by 50 percentage points to 180% of GDP in the five years to Q2 2014 (newer figures are not available). In particular, so-called shadow banks have contributed to this process since they have provided a significant amount of finance to Chinese companies, which have thus bypassed the banks. The sharp rise in private debt is not an argument for a balance of payments crisis like in 1997/98, because it has been incurred predominantly in domestic currency. However, higher debt leaves many businesses more vulnerable in the event that local central banks will have to follow the Fed’s lead and raise interest rates (or least prevent them from being cut as far as lower inflation rates would warrant). Interest rates in the emerging markets could also rise if international investors shift funds from EM to the US, which would require action to offset capital outflows as investors seek higher returns elsewhere. All in all, financing conditions in the EM space are likely to deteriorate, which will weigh on economic growth. Monetary policy is barely expansionary EM monetary policy is in any case no longer as expansionary as it has been in previous years. 1 This can be demonstrated by a Taylor rate (chart 5, page 4). This appropriate key interest rate with respect to capacity utilisation and inflation has fallen in the past few quarters, largely because inflation rates in many emerging economies have dropped sharply on the back of declining oil prices. The Taylor rate is thus now almost at the level of actual key interest rates, which have only fallen a little recently. CHART 3: Domestic banks are dominant Share of domestic banks of private sector credit, in %. Data for Q2 2014. Horizontal line: unweighted average for 14 developing countries CHART 4: China – Strong rise in private debt Private-sector debt in % of nominal GDP and rise of private debt ratio between 2009 and 2014 in percentage points 60 95 50 2009-14 debt growth 100 90 85 80 75 70 65 60 CH 40 TR 30 20 RU 10 0 MX -10 Brazil South Africa India 2014 Russia Average Source: BIS, Commerzbank Research China -20 KR 0 HU 40 80 120 160 200 Private Debt/GDP Source: BIS, Commerzbank Research 1 We have estimated capacity utilisation using a Hodrick-Prescott filter. As many central banks do not have an explicit inflation target, we have similarly calculated an underlying inflation trend using the HodrickPrescott filter and interpreted this as the inflation target. We have calculated two versions of the rule. In one, we use the Consumer Price Index as the inflation yardstick, in the other, the GDP deflator. Chart 5 (p.4) compares the average result of the two versions with the actual trend in EM key interest rates, in which aggregate values represent GDP-weighted averages of the individual countries. In our calculations, we have drawn on a BIS study (see http://www.bis.org/publ/arpdf/ar2014_5_de.pdf, page 109). 20 March 2015 3 Economic Research | Week in Focus Based on the Taylor rate, monetary policy is barely expansionary any more. Consequently, a decade of cheap money across EM has now come to an end (if we disregard central and eastern European countries that are focused on ECB monetary policy, and which has supplemented its zero-interest-policy with broad-based asset purchases). Growth edge of EM diminishes … The less expansionary stance of monetary policy across the emerging markets has recently played a role in the slowdown of economic growth. While EM GDP was still expanding at a rate of 7.5% in 2010, which is 6.5 percentage points above the rate in the industrial countries (chart 6), the growth advantage was only 2.6 percentage points in 2014. If financing conditions worsen due to higher US key interest rates, the EM growth edge should narrow further. This applies particularly to China, where economic growth should slow further this year to 6.5%. China is not only suffering under its high debt level but also from the fact that house prices, after rising sharply in recent years, are now falling. Furthermore, the commodities sector in particular is struggling with overcapacity. Mexico on the other hand is one of the few emerging markets, which could expand its growth edge since it has tight links to the US economy. … which will weigh on company earnings and EM currencies A narrowing of the EM growth advantage argues against strongly rising company earnings in the euro zone. DAX-listed companies generate almost a fifth of their earnings in Asian EM alone. If growth slows there, the DAX will continue to be less driven by company earnings and more by a rise in the price/earnings ratio, which is likely to rise given the ECB’s zero-interest rate policy. With a few exceptions (such as the Mexican peso) EM currencies are likely to depreciate versus the US dollar. Unlike before, the Chinese renminbi should not appreciate against the US dollar until at least the end of next year. Central European currencies should – largely in line with the euro – either depreciate against the dollar (Zloty) or even underperform somewhat (Forint). CHART 5: EM is almost at “Taylor level” Key interest rate and Taylor rate of EM, in percent, for details see footnote on page 3. Gap in economic growth between EM and industrial countries, in percentage points. IMF forecast for 2015. 12 25 10 20 8 15 6 10 4 2 5 0 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 key interest rate Source: BIS, Commerzbank Research 4 CHART 6: Growth advantage is diminishing Taylor rate 0 -2 1980 1985 1990 1995 Emerging economies 2000 2005 2010 2015 Emerging Asia Source: IMF, Commerzbank Research 20 March 2015 Economic Research | Week in Focus Dr Michael Schubert Tel. +49 69 136 23700 ECB: Fragmentation remains in place At the last press conference, ECB President Draghi emphasised that the differences between lending rates across the euro countries had decreased “significantly”. But ECB data shows that the so-called fragmentation of lending rates is currently higher than three years ago. The backdrop of Mario Draghi’s statement is the frequently voiced criticism that the ECB’s QE programme helps the financial markets but does little to support the real economy. Whilst government bond yields of the euro countries have converged considerably in recent years, such a trend has not been seen for a long time in lending rates, which are much more important to the real economy. And this situation has not fundamentally changed. The central bank measures the dispersion of 2 lending rates by means of the coefficient of variation of 75 different rates for new lending to businesses and private households, broken down by loan volume, rate fixation and whether loans are uncollateralised or collateralised. In 2013, Draghi had already proposed to compare the current levels of the coefficients with those in H1 2012. In the summer of 2012, government bond yields of the peripheral countries started to fall sharply in the wake of Draghi’s “whatever-ittakes” announcement, and it thus makes sense to check to what extent the differences between lending rates have diminished since then. Contrary to Draghi’s statement, around three quarters of the coefficients of variation are currently higher than in H1 2012, and in a quarter of cases they are even at all-time highs (chart 7). Whilst lending rates in the euro periphery have indeed come down since last spring, rates in the core countries have also fallen to a similar extent, and so the dispersion of lending rates across the euro countries has barely changed. This leads us to assume that while lower lending rates may help the real economy, the effect will probably be smaller than the significant convergence in euro government bond yields suggests. The still-hesitant decline in peripheral lending rates shows that the balance sheet adjustments are only progressing slowly. Whilst, for example, the positive development of the ECB’s Bank Lending Survey or the decline in non-performing loans in Spain demonstrate that progress is being made, the balance sheet adjustments are far from over – and this is something the ECB continues to emphasise at each press conference. CHART 7: Euro zone: Fragmentation mostly greater than in H1 2012 Number of cases in which the variation coefficients calculated by the ECB for lending rates (new loans) in the individual euro countries were higher/lower/unchanged compared to H1 2012 25 22 20 18 14 15 10 7 7 5 5 1 0 corporates higher 1 corporates, collateralized lower 0 households unchanged Source: ECB, Commerzbank Research 2 Standard deviation of lending rates in the individual euro countries at a given point in time, divided by the average rate in the euro zone. 20 March 2015 5 Economic Research | Week in Focus Markus Koch +49 69 136 87685 Product idea: MinMaxPlus Note in US$: 3-month US$ Libor: race to the top! With the Fed’s patient stance abandoned this week, the kick-off in the next rate hike cycle looms ahead for this summer. Judging US$ Libor forwards by our own metrics, markets persistently underestimate the pace of US money market rate hikes. What is more, the US dollar still possesses decent scope to firm against the euro to sub-parity levels. To express the view of a steep 3-month US$ Libor trajectory compounded by US dollar gains, we recommend investing in a MinMaxPlus note, denominated in US$. A modest rise in the note’s index suffices to print maximum coupons fairly soon on account of the double lever. While coupon risks are limited to 1% during the 5-year term, the performance may be further enhanced if the euro slides to the levels we expect. The FOMC has finally abandoned its “patient” stance ahead of the next policy normalisation cycle. Despite some marginal downward adjustments in growth and employment projections, the door for the next hiking campaign – to be kicked off this summer – remains open. More importantly, though, we expect US Fed funds to be raised quickly with an ongoing strengthening 3 of the US dollar not altering our assessment. Based on various measures of past Fed rate 4 cycles and also relative to the dot plot , the current Fed funds and US$-Libor forward strips are way too flat, in our view. At the same time, we look for the US dollar to firm against the euro to below parity, long term, as a result of divergent monetary policies. Investors willing to enhance long-term FX exposure may benefit from more favourable entry levels amid the current EURUSD stabilisation. To capture the value inherent in our view of swift Fed rate hikes coupled with EUR-USD sliding Plus into sub-parity territory in the long term, we recommend investors to invest in a MinMax note in US$ with a 5-year term. Given a still tame forward strip (versus our own forecast of a steep curve), the coupon cap subsidises the floor at 1% coupled with a double leverage. As a result, the structure will generate minimum coupons of 1% p.a. or 3-month US$ Libor (reference index), featured with a twofold leverage, depending on the annual in advance fixings. If the index is fixed above a level of 0.5% at any annual coupon period, the floor will be exceeded fairly rapidly due to the double lever. The maximum coupons will be paid once the index is fixed above 1.6% – a level we envisage for the start of year 2 i.e. Q1 2016. This may mean a coupon increase to the maximum level of 3.20% (cap, see box below) already from year 2, ensued by similar coupons through maturity, based on our long-term Libor forecasts. Comparing forecast- versus forward-based coupons currently yields c. 2.75% versus c. 2.5% on average, respectively. This is simply a result of our expectation of the index outpacing the forward strip. In a worst case scenario, the index would be fixed below the 0.5% threshold to which, however, we attribute only a low probability. Plus Finally, investors may enhance the MinMax performance given the note’s exposure in US dollar. If our sub-parity US dollar forecast over a 5-year horizon is realised, the performance pick-up may reach c. 10% in total (and vice versa if the euro were to gain versus the US dollar). Plus MinMax Note in US$ (indicative) Issuer A- (average) Type: Note Maturity: 5 years Currency: US$ (non quanto) Minimum lot: US$1m Redemption: 100% Reference index: 3m US$ Libor Coupon: 2 * 3m US$ Libor, floored at 1% Coupon cap: 3.2% Fixings: Annually, in advance Payment: Annually, in arrears Basis: Act/360, mod. following, adjusted 3 4 6 Taylor & Co.: Where are we heading? in Ahead of the Curve, 12 March 2015. Policymakers’ weighted-average projections on the appropriate pace of policy firming (18 March) 20 March 2015 Economic Research | Week in Focus Major publications from 13 – 19 March 2015 Economic Insight: Euro area – the different types of euro sceptics In a number of euro countries, parties with anti-euro agendas are successfully chasing more votes. However, many of them are not so much lamenting the single currency itself, but rather their view that its overvaluation places major restrictions on national economic policy. Criticism could ease given the expected continuing weakness of the euro and the increasingly "flexible" interpretation of the stability pact. In almost all countries, a clear majority of the population also takes a positive view of the euro and the EU, with a marked improvement in sentiment evident here in the last two years. more Economic Briefing: UK – The fudge it Budget Today’s budget presentation was an unashamedly political event. Voter giveaways such as an end to the double-taxation of saving and higher personal tax thresholds are to be paid for by higher corporate taxes, notably on banks. We continue to question whether the UK can deliver a budget surplus on a three to four year horizon. However, public finances are (slowly) improving and the UK’s gross funding needs are lower relative to GDP than for all major economies bar Germany. more Economic Insight: France & Italy – A reform overview In France and Italy, it has become difficult to see through the thicket of reforms. We give an overview and show that these reforms are unlikely to bring a breakthrough – although a number of them are going in the right direction. more EM Outlook: Q2 15 – Central Bankers of the world, unite! A major challenge for EM central banks is how to reconcile domestic rate cuts with the pressure posed by Fed rate hikes. While the EM sovereign credit space is better placed to deal with tighter US monetary policy (given the lack of supply facing sustainable demand), EM FX/rates will face continued volatility and curve steepening. more Credit Note: EU Banks – (When) will the zero-risk weight for sovereign exposure end? The regulator’s aim seems clear – sovereign exposure on banks’ balance sheets should no longer be considered risk free and thus exempt from capital charges. The ESRB proposes various policy options. However we expect it will take several years to find political agreement on this matter before the rules are implemented with a generous transitional period. Therefore no reaction from market participants should be expected in the near term. The longer-term impact could be, first, stronger diversification of banks’ sovereign exposures and, second, penalisation for holding lower rated or stressed sovereign debt, affecting mainly peripheral banks but also some German banks. more FX Hotspot: The Hare and the Hedgehog The FOMC reacted more strongly to the 9-month USD-appreciation trend. This was a strong signal to the FX market not to push too hard for USD strength. more FX Hotspot: Forward Misguidance With confusing and hawkish talk, Riksbank Governor Stefan Ingves had talked down EUR-SEK during recent weeks. Today his colleagues in the Executive Board had to take measures to counter the effect of his words. With such a communication policy, an efficient forward guidance is impossible. Uncertainty about the Riksbank’s strategy prevails. This has two consequences: (1) Implied SEK volatilities should trade at elevated levels. And (2) Riksbank has to take stronger measures to reach the desired results. This increases the risk that the strategy will finally fail. more 20 March 2015 7 Economic Research | Week in Focus Preview – The week of 23 to 27 March 2015 Time Region Indicator Period Forecast Survey Last Monday, 23 March 2015 14:00 15:00 USA EUR Existing home sales Consumer confidence, preliminary Feb Mar SAAR, mn sa 4.88 -6.5 4.94 -5.8 4.82 -6.7 PMI, manufacturing PMI, services PMI, manufacturing PMI, services PMI, manufacturing PMI, services CPI Mar Mar Mar Mar Mar Mar Feb CPI CPI ex food, energy New home sales Business confidence Feb Feb Feb Mar sa sa sa sa sa sa mom yoy mom, sa mom, sa SAAR, k sa 49.0 52.0 51.5 54.5 51.5 53.0 0.3 0.1 0.2 0.2 460 -8.0 – – 51.5 55.0 51.5 53.9 0.4 0.1 0.2 0.1 475 – 47.6 53.4 51.1 54.7 51.0 53.7 -0.9 0.3 -0.7 0.2 481 -8.2 Mar Mar Feb Feb sa sa mom, sa mom, sa 99.0 107.0 -1.5 -0.5 – 107.2 0.6 0.5 99.0 106.8 2.8 0.0 GfK consumer confidence M3 money supply Loans to the private sector Retail sales Apr Feb Feb Feb Initial claims CPI Unemployment rate 21 Mar Feb Feb sa yoy yoy mom, sa yoy k, sa yoy sa 10.0 4.0 0.0 0.2 3.9 290 2.3 3.5 9.9 4.4 – 0.3 4.0 – 2.3 3.5 9.7 4.1 -0.1 -0.7 4.8 291 2.4 3.6 Mar Q4 SAAR 92 2.3 – 2.4 92 2.2(p) Tuesday, 24 March 2015 8:00 FRA 8:30 GER 9:00 EUR 9:30 GBR • 12:30 USA • 14:00 BEL Wednesday, 25 March 2015 7:45 9:00 • 12:30 FRA GER USA Business climate (Insee) Ifo business climate Durable goods orders Durable goods orders ex transport Thursday, 26 March 2015 7:00 9:00 GER EUR 9:30 GBR 12:30 23:30 USA JPN Friday, 27 March 2015 7:45 12:30 FRA USA Consumer confidence GDP, real (3rd estimate) Source: Bloomberg. Commerzbank Economic Research; *Time GMT (subtract 4 hours for EDST. add 1 hour for CET). # = Possible release; mom/qoq/yoy: change to previous period in percent. AR = annual rate. sa = seasonal adjusted. wda = working days adjusted; • = data of highest importance for markets 8 20 March 2015 Economic Research | Week in Focus Dr Ralph Solveen Tel. +49 69 136 22322 Economic data preview: Germany: Just a matter of sentiment? In March, the ongoing decline in the euro is likely to have sent the Ifo business climate higher again. But will the German manufacturing PMI now finally rise as well? If, contrary to our expectations, it were to remain stuck in the sideways trend started last autumn, some economic optimists will likely rethink their 2%+ growth forecasts for this year. US order intake is likely to have slipped. An ever-growing number of analysts are now looking for the German economy to grow by more than 2%. This also seems to be justified by the Ifo business climate which has been on the rise since last autumn. However, this ignores the fact that businesses have so far been less positive when asked about their trends in orders, production or employment. The purchasing managers’ index (PMI), which is calculated based on such data, has been moving sideways since last autumn (chart 8). In the Ifo survey, too, responses to the relevant questions not included in the Ifo index came in less favourable than the business climate. For instance, the Ifo PMI we have calculated on this basis, fell markedly in February. We, too, envisage quite decent economic growth in coming quarters. However, businesses’ caution with regard to order intake, production etc. indicates that growth will not be unlimited even with the current euro weakness. One reason could be the weaker global economy which offsets at least some of the positive currency effect and also sent our Early Bird slightly lower in recent months. Against this backdrop, we are looking for an increase in the Ifo (107.0 from 106.8) and the PMI (51.5 from 51.1) but take a rather cautious stance – in line with our overall growth forecast of 1.8%. If the PMI failed to rise once again, this would indicate that the global economy is currently proving more of a drag for German businesses than assumed by many analysts at present. USA: Temporary slack in manufacturing Momentum in US manufacturing has been falling for some months. Non-defence capital goods orders excluding aircraft recently came in only roughly on par with deliveries (chart 9). In addition to the stronger dollar, this may have been helped by the strikes of US West Coast dock workers and the unusually cold weather. Against the backdrop of the booming US labour market, this is unlikely to mean the end of the uptrend but may ultimately only be seen as a dip in orders as in mid-2012. As regards February, however, lower capacity utilisation in manufacturing and the virtually unchanged ISM orders index are pointing to another stagnation in core business. With less airplanes ordered at the same time and demand for defence goods probably also lower, we envisage a 1.5% decline in durable goods orders vs. January (consensus +0.6%). CHART 8: Germany – bullish sentiment, soft hard data? PMI: purchasing managers’ index for manufacturing in Germany; IfoPMI: average of subcomponents of Ifo survey for production, order intake and employment, weighted like PMI 20 60 15 10 55 5 0 50 -5 -10 45 -15 -20 CHART 9: USA – dip in orders Non-defence capital goods excl. airplanes, orders and deliveries, three-month averages in USD bn 75 70 65 60 55 50 2012 2013 Ifo (LS) 2014 Ifo-PMI (LS) Source: Bloomberg, Commerzbank Research 20 March 2015 40 2015 PMI (RS) 45 2008 2009 2010 2011 2012 orders 2013 2014 2015 shipments Source: Global Insight, Commerzbank Research 9 Economic Research | Week in Focus Central Bank Watch (1) Fed At its meeting on Wednesday, the Federal Reserve dropped the assurance that it would be “patient” before starting to normalise interest rates. This means that a rate hike at the meeting after next in June is possible but by no means certain. The Fed wants to raise rates when the labour market has improved further and it is reasonably confident that inflation will move back to the 2% target on a medium-term perspective. At the end of the day, the incoming data will thus determine the way forward. We think it is more likely that these conditions will only be fulfilled in September, because in June the Fed will probably still be influenced by a weaker Q1 and a negative inflation rate. At the same time, Fed officials now expect rate hikes to progress much more slowly. Partly due to the strong dollar, they now forecast slower growth for 2015 and 2016, although they still see above-average growth rates. Moreover, they expect lower inflation pressure than in their December projections. The need for higher rates is further reduced by the lower forecast for the long-term unemployment rate. In the Fed’s opinion, unemployment can now fall for a longer time before inflation kick-starts. However, we still think that the rate hikes priced in by the market are too low. Dr Christoph Balz +49 69 136 24889 CHART 10: Expected interest rate for 3-month funds (USD) 2,5 2,0 1,5 1,0 0,5 0,0 current Jun 15 Sep 15 Dez 15 Mrz 16 Jun 16 Futures 12.03.15 19.03.15 Commerzbank TABLE 1: Consensus forecasts Fed funds rate Q2 15 Q4 15 Q2 16 Consensus 0.25 0.75 1.50 High 0.75 1.50 2.50 Low 0.25 0.25 0.25 Commerzbank 0.25 1.00 2.00 Source: Bloomberg, Commerzbank Research ECB In recent days, ECB officials highlighted that without accompanying government action, latest central bank measures would be less effective in the longer run. ECB president Draghi cautioned that the currency area's vulnerabilities will not disappear simply because the economic cycle is turning. “They stem from the fact that our union remains incomplete along two dimensions. Neither our economies nor our institutions have converged enough," he said. “The current upturn in economic conditions, which the ECB has helped to generate, must be used,” Draghi urged. He called on Europe’s leaders to make a “quantum leap” toward greater sharing of national sovereignty to strengthen the rules governing the 19-member currency bloc. ECB Executive Board member Praet said that monetary stimulus was an “opportunity that the governments have to use”. He stressed that the current recovery is cyclical, not structural. “We have to discuss what the structural problems are”. ECB’s Visco (Italy) said that while QE was justified in the light of the deflation risk in the region, its effects on the exchange rate and on the bond market have overshot expectations in the first week of the plan. Credit costs are likely to fall on QE but “not in an extraordinary way”, he added. Dr Michael Schubert +49 69 136 23700 10 CHART 11: Expected interest rate for 3-month funds (EUR) 0,8 0,6 0,4 0,2 0,0 -0,2 current Jun 15 Futures Sep 15 19.03.15 Dez 15 12.03.15 Mrz 16 Jun 16 Commerzbank TABLE 2: Consensus forecasts ECB minimum bid rate Q2 15 Q4 15 Q2 16 Consensus 0.05 0.05 0.05 High 0.05 0.05 0.05 Low 0.05 0.05 0.05 Commerzbank 0.05 0.05 0.05 Source: Reuters, Bloomberg, Commerzbank Research 20 March 2015 Economic Research | Week in Focus Central Bank Watch (2) BoE (Bank of England) The extent to which the collapse in oil prices is exerting downward pressure on inflation is evident in the import price data, which showed a 3.5% decline between November and January. This is being exacerbated by the upward pressure on sterling, which has risen by more than 2.5% on a tradeweighted basis since the start of the year. These effects appear to be dominating the BoE’s thinking on inflation trends, and recent concerns about the pickup in wage pressure were notably absent from the March MPC minutes released earlier this week. Indeed, the Committee noted for the first time that the prospect of lower inflation expectations, on the back of the slowdown in measured inflation, might be one of the factors which helps keep wage growth in check – a feature which is evident in the latest wage data, which once again undershot relative to expectations. The government’s 2015 budget outlook, presented this week, does not appear to have major implications for monetary policy at first glance. But digging deeper into the fiscal data reveals that a very tight squeeze on government outlays is planned for the coming years. This will act as a drag on growth and may prompt the BoE to be correspondingly less aggressive when the monetary tightening process finally begins. CHART 12: Expected interest rate for 3-month funds (GBP) 2,0 1,5 1,0 0,5 0,0 current Jun 15 Sep 15 Dez 15 Mrz 16 Jun 16 Futures 19.03.15 12.03.15 Commerzbank Source: Bloomberg, Commerzbank Research Peter Dixon +44 20 7475 4806 BoJ (Japan) As expected, the BoJ took no new measures at its monetary policy meeting on Tuesday. The bank did not change its forecast for growth, but with regard to inflation it announced downward revisions to both the current situation and the outlook. The Japanese economy has continued its “moderate recovery trend” and is expected to keep following this path, the BoJ said. The core inflation rate excluding fresh food and adjusted for the effects of the VAT hike was moving “in the range of 0 to 0.5%” (previously: “around 0.5%”). It “is likely to be about 0% for the time being”. According to the BoJ, this is due to the decline in energy prices. For this reason this assessment does not mean that the bank is giving up its inflation target of 2%. We remain sceptical that the central bank will reach its inflation target and still see a high probability that the BoJ will ease policy again this year, for example by increasing its purchases of equities. This should push asset prices further upwards and depress the yen, especially versus the US dollar. CHART 13: Expected interest rate for 3-month funds (JPY) 1,0 0,8 0,6 0,4 0,2 0,0 current Jun 15 Sep 15 Dez 15 Mrz 16 Jun 16 Futures 19.03.15 12.03.15 Commerzbank Source: Bloomberg, Commerzbank Research Dr Christoph Balz +49 69 136 24889 20 March 2015 11 Economic Research | Week in Focus Rainer Guntermann Tel. +49 69 136 87506 Bond market preview: Breather but no readjustment The spectacular rally on euro area bond markets is losing steam after ten-year Bund yields fell to new record lows yesterday. The relief following a still cautious Fed pushed yields lower while the ECB’s bond buying is increasingly becoming routine and several market players are standing ready to take profits. Medium-term, peripheral yields will drop further although a period of stronger price volatility appears to be on the cards initially. TABLE 3: Weekly outlook for yields and curves Bunds US Treasuries Yield (10 years) Sideways Moderately higher Curve (2 - 10 years) Neutral Flatter Source: Commerzbank Research The US central bank has lent fresh impetus to the bond market rally. While the Fed has adopted an option to hike rates as early as June and the data dependency arguing for higher term premia, the downward revision to the FOMC members’ interest rate expectations came as a huge relief. This has sent the US Treasury curve around 15 basis points lower, and even after the initial shift, yields hardly rose despite further solid labour market indications (chart 14). In light of the US guidance, ten-year Bund yields dropped to a new record low of 0.17%. Outlook for the Bund future, 23-27 March Economy ↓ Inflation → Monetary policy ↑ Trend → Supply → Risk aversion → Although the ECB’s daily bond purchases of just under €3bn during March are becoming routine, price fluctuations have increased markedly of late. After the significant yield slide in all euro countries, the ECB seems to be left as one of few buyers given that – in anticipation of steady ECB buying – many market players are holding large amounts already. Lately, this has hit peripheral bonds, pushing spreads versus Bunds to pre-QE announcement levels (chart 15). This supply overhang has been helped by recent weeks’ lively issuance activity which will have to be digested in coming days. Moreover, investors on cash markets are holding back in view of the latest considerable intra-day volatility. Next week’s economic data is unlikely to move markets sustainably. While the likely further improvement in business surveys should additionally support the recent rise in inflation expectations, the resulting slight upside pressure on yields would be limited by the increasingly tight budgetary situation in Greece. Ahead of the long Easter weekend and Orthodox Easter on 12 April, the debate about capital controls could intensify further. CHART 14: Relief after the Fed CHART 15: Peripheral rally is losing steam Yield of US Treasuries, in percent 2,4 0,8 185 2,3 0,7 170 2,2 0,6 2,1 0,5 155 2,0 0,4 1,9 0,3 1,8 0,2 110 1,7 0,1 95 0,0 80 Oct-14 1,6 Nov 14 Dez 14 Jan 15 10y (lhs) Source: Bloomberg, Commerzbank Research 12 10y yield spread versus Bunds, in basis points Feb 15 Mrz 15 2y (rhs) 140 125 Nov-14 Dec-14 Jan-15 ITA Feb-15 Mar-15 SPA Source: Bloomberg, Commerzbank Research 20 March 2015 Economic Research | Week in Focus Lutz Karpowitz Tel. +49 69 136 42152 FX market preview: Who’s still listening to the central banks? For the first time, the Fed has hinted that the recent appreciation of the USD is too fast in its opinion. Yet the FX market ignored this warning rather quickly too. The FX market is clearly not easy to unsettle at present with mere words. Even so, this still points to a rather tenacious retreat of EUR-USD. TABLE 4: Expected trading ranges for next week Range Bias Range Bias EUR-USD 1.0400-1.0900 EUR-GBP 0.7100-0.7400 EUR-JPY 126.00-132.00 GBP-USD 1.4450-1.5050 USD-JPY 119.00-123.00 EUR-CHF 1.0350-1.0800 Source: Commerzbank Research How much USD strength is the Fed prepared to take? This question has recently been asked increasingly frequently. Those who had previously assumed that USD strength was not an issue for the Fed have needed to rethink since Wednesday evening. For the first time, the Fed explicitly spoke of the effects of the strong USD on import prices and hence domestic inflation. For the FX market, the message was clear: EUR-USD jumped by about 4 cents to over 1.10. It didn’t last though; already on Thursday morning, EUR-USD was below 1.07 again. The Fed can ultimately learn from this that it is not easy these days to steer one’s own currency by verbal means. In the global depreciation race, many central banks have already had to experience this. And in this race, it is no longer enough for the Fed to fire a few verbal warning shots. That said, the Fed’s statement shows that it also has a pain threshold and the Fed should refer to it again and again in the coming weeks. Consequently, the EUR-USD trend should continue to point downwards on account of the very different directions of monetary policy on the two sides of the Atlantic, although the USD appreciation will be much slower than in the past few months. Norges Bank faces a few difficulties with its communication at present. It would actually like to support the economy, which could suffer from the lower oil price, by lowering interest rates, but the central bank then failed to act on Thursday. At the same time, interest rates should fall if everything goes as expected. EUR-NOK subsequently took a tumble initially; As the Fed has already shown, it is clearly not easy nowadays to weaken one’s own currency by verbal means. CHART 16: Sizable USD appreciation since July USD, nominal effective exchange rate 105 CHART 17: EUR-NOK: Krone depreciation reversed EUR-NOK, spot price 9,00 8,90 100 8,80 95 8,70 90 85 Jan 14 8,60 Apr 14 Source: Bloomberg 20 March 2015 Jul 14 Okt 14 Jan 15 8,50 15.3 16.3 17.3 18.3 Source: CFTC 13 Economic Research | Week in Focus Andreas Hürkamp Tel. +49 69 136 45925 Equity market preview: DAX outperformance should lose momentum Thanks to the vibrant DAX outperformance, the gap of the DAX P/E to the S&P 500 P/E has improved to minus 1.6 from minus 4.1 since October 2014. In our view the DAX outperformance should lose momentum in the coming months as this P/E valuation gap is already significantly above the 12-year average of minus 2.7. TABLE 5: DAX has outperformed S&P 500 by 20% since the start of the year Earnings 2015e Performance (%) since Index points Growth (%) P/E 2015e Index 28/02 31/12 30/06 current 31/12 current 31/12 current 31/12 DAX 30 11,923 4.6 21.6 21.3 772.8 779.7 9.6 10.2 15.4 12.6 MDAX 20,682 2.9 22.1 23.0 1053 1053 8.6 13.9 19.6 16.1 Euro Stoxx 50 3,669 1.9 16.6 13.6 231.5 242.2 9.0 9.9 15.8 13.0 S&P 500 2,100 -0.2 2.0 7.1 118.1 124.7 1.5 7.6 17.8 16.5 Source: Commerzbank Corporates & Markets, I/B/E/S On Monday the DAX closed at 6,240 – only 26 points below the all-time high of 6,266 on 7 March 2000. Only five months ago – in mid-October 2014 – investors discussed a German recession scenario, and the DAX suffered a correction of more than 15%. The DAX P/E was 4.1 points below the S&P 500 P/E in October – a 10-year low (chart 18). In mid-March, by contrast, Germany has become one of the most sought-after equity markets against the backdrop of the ECB QE programme, the rising Ifo index and the euro depreciation. The gap of the DAX P/E to the S&P 500 P/E has risen from minus 4.1 in October 2014 to minus 1.6 in March 2015 – the 12-year average of this gap is minus 2.7. Relatively robust 2015 earnings expectations for the DAX have worked as a key bull trend for the shrinking P/E gap. The current ranking regarding EPS 2015 revisions now appears as follows: • DAX: analysts have upgraded their expected EPS 2015 for 16 companies over the last quarter, whereas 14 companies suffered negative revisions – ratio 0.88. • MDAX: 24 downgrades to 26 upgrades – ratio 0.92. • Euro Stoxx 50: 31 downgrades to 19 upgrades – ratio 1.63. • DJ Global Titan 50: 42 downgrades to 8 upgrades – ratio 5.25. • US Dow Jones 30: 26 downgrades to 4 upgrades – ratio 6.50. As a consequence, expected FY2015 earnings for the DAX have been relatively robust over the last few months, whereas the Euro Stoxx 50 and the S&P 500 suffered a hefty cut in earnings expectations (chart 19). Thanks to the strong depreciation of the euro over the last year the earnings trend for the DAX should continue to remain more robust than for other equity markets. However, we interpret the relatively low DAX P/E gap of minus 1.6 versus the S&P 500 as a signal that the DAX outperformance should lose momentum in the coming months. CHART 18: DAX P/E to S&P 500 P/E gap has risen strongly DAX forward P/E minus S&P 500 forward P/E, in points CHART 19: DAX EPS 2015 trend relatively robust EPS 2015 for equity markets, indexed, Feb 2013 = 100 110 0 -1 100 -2 90 -3 80 -4 70 12-year average: -2.7 -5 -6 2003 60 Jan-13 2005 2007 2009 Source: Factset, Commerzbank Research 14 2011 2013 2015 DAX Jul-13 Jan-14 FTSE 100 Jul-14 Euro Stoxx 50 Jan-15 S&P 500 Source: I/B/E/S, Commerzbank Research 20 March 2015 Economic Research | Week in Focus Barbara Lambrecht Tel. +49 69 136 22295 Commodities market preview: Descent on gold market is over (for now) Ever-rising US crude oil stocks should continue to weigh on oil prices for now, whereby the price discount of WTI to Brent could actually widen further. Base metal prices should tread water, as sentiment in China’s industrial sector probably barely improved. The gold market should regain a bit of its shine as the downside pressure from a strong US dollar is easing and demand from China and India appears to be picking up somewhat. TABLE 6: Trends in important commodities Per cent change 19 Mar Trend Commodity specific events 1 week 1 week 1 year short-term Brent (USD a barrel) 55.3 -3.2 -8.2 -47.8 Copper (USD per tonne) 5797 -0.8 0.8 -11.5 Gold (USD per troy ounce) 1165 1.0 -3.5 -12.4 Hong Kong gold exports to China (Feb) Source: Bloomberg, Commerzbank Research Oil prices are still under pressure on both sides of the Atlantic. Indeed, US crude oil stocks are marking new record highs week after week, allowing the price WTI to drop to a 6-year low of 42 USD per barrel. In the short term, this inventory build should continue. While the US Energy Information Administration expects lower drilling activity in some shale oil formations to show first signs of slowing in April, the fall in production is still being offset by efficiency gains in other regions. Consequently, supply should remain above moderate refinery demand for seasonal reasons and US crude oil stocks should climb further, which is why the price gap between Brent and WTI could even widen a bit more (chart 20). That said, stocks should sink again in the summer, as crude oil processing in US refineries will pick up considerably as the summer driving season starts and shale oil production begins to slow. This should then drive the sustained recovery of oil prices that we expect. This would presumably only be at risk if sanctions against Iran were to be lifted at mid-year after an agreement at the current nuclear talks. The near two-month descent in gold prices appears to be coming to an end. This is mainly due to the abrupt end of the dollar rally, removing a negative factor for the gold market for now. In addition, we are seeing stronger physical demand for gold again. Hong Kong’s customs authorities are likely next week to report robust gold exports to China in February. Moreover, Switzerland’s gold exports to India, the world’s largest gold market, were a positive surprise recently. Even so, it is still too early for a sustained price recovery on the gold market in our opinion, as investors are still withdrawing from gold ETFs (chart 21). CHART 20: High price discount for WTI Front-month WTI contract minus front-month Brent contract, USD a barrel 4 0 -4 -8 -12 -16 -20 -24 2011 2012 2013 2014 Source: ICE, Nymex, Bloomberg, Commerzbank Research 20 March 2015 Million ounces, USD a troy ounce 90 1900 80 1700 70 1500 60 1300 50 1100 40 900 30 700 20 500 10 0 300 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 8 -28 2010 CHART 21: Continued outflows from gold ETFs 2015 ETF holdings, left Gold price (US$/oz), right Source: Bloomberg, Commerzbank Research 15 Economic Research | Week in Focus Commerzbank forecasts TABLE 7: Growth and inflation Real GDP (%) Inflation rate (%) 2014 2015 2016 2014 2015 2016 USA Canada 2.4 3.2 2.8 1.6 0.2 2.0 2.5 2.3 2.5 1.9 1.0 2.0 Japan 0.0 0.8 1.3 2.7 0.7 0.7 Euro area 0.9 1.2 1.3 0.4 -0.1 1.2 - Germany 1.6 1.8 1.8 0.9 0.5 2.4 - France 0.4 0.9 0.9 0.5 -0.1 0.7 - Italy -0.4 0.1 0.5 0.2 -0.4 0.7 - Spain 1.4 2.3 2.3 -0.1 -0.7 0.5 - Portugal 1.0 1.5 2.0 -0.4 -0.9 0.5 - Ireland 5.2 3.5 3.5 0.4 0.3 1.4 - Greece 1.0 0.2 2.5 -1.2 -1.5 0.0 United Kingdom 2.6 2.5 2.4 1.5 0.3 1.6 Switzerland 1.9 0.5 0.5 0.0 -1.5 0.0 China 7.4 6.5 6.5 2.0 2.0 2.0 India 7.5 7.9 8.4 5.5 5.0 4.0 Brazil -0.1 -0.3 1.1 6.3 7.3 6.4 Russia 0.6 -3.5 1.6 7.8 14.0 6.7 World 3.1 3.2 3.5 Q4 15 Q1 16 Q2 16 • The US economy has reduced its imbalances and seems set to continue growing at solid rates. • Growth in China is decelerating partly on decreasing house prices. • The recovery in the euro zone will only continue at a slow pace. GDP growth will remain markedly lower than that of the USA. • EMU has survived the sovereign debt crisis, but is gradually evolving into an “Italian-style monetary union”. • The German economy is set to continue outperforming the rest of the euro area – partly because ECB key rates are much too low for Germany. • High unemployment in most countries is keeping inflation low for the time being. In the long term, however, inflation is likely to rise, as central banks have given up some of their independence. TABLE 8: Interest rates (end-of-quarter) 19.03.2015 Q2 15 Q3 15 USA Federal funds rate 0.25 0.25 0.50 1.00 1.50 2.00 3-months Libor 0.27 0.30 0.75 1.25 1.65 2.30 2 years* 0.58 0.75 1.20 1.75 2.30 2.75 5 years* 1.42 1.70 1.95 2.30 2.65 2.95 10 years* 1.93 2.30 2.40 2.50 2.50 2.60 Spread 10-2 years 135 155 120 75 20 -15 9 10 15 15 15 15 Minimum bid rate 0.05 0.05 0.05 0.05 0.05 0.05 3-months Euribor 0.02 0.00 0.00 0.00 0.00 0.00 2 years* -0.23 -0.15 -0.10 -0.10 -0.05 -0.05 5 years* -0.10 0.00 0.00 0.05 0.05 0.15 10 years* 0.19 0.40 0.50 0.60 0.60 0.70 Spread 10-2 years 42 55 60 70 65 75 Swap-Spread 10 years 36 45 45 45 45 40 Bank Rate 0.50 0.50 0.50 0.50 0.75 0.75 3-months Libor 0.56 0.55 0.60 0.75 0.85 1.00 2 years* 0.41 0.60 0.90 1.10 1.30 1.45 10 years* 1.55 1.90 2.00 2.10 2.15 2.20 Swap-Spread 10 years Euro area • Fed interest rate hikes are on the cards from 2015Q3, due to a continuously decreasing US unemployment rate and the expectation that wage growth will gradually rise. • The focus on the Fed’s lift-off will put moderate upward pressure on US$ long-end rates. A return to 2½% for 10y UST yields is only on the cards for year-end 2015, though. The curve is in for a textbook-style flattening in the coming quarters, led by rising short-end rates. • We see a 40% chance that the ECB will increase the monthly volume of purchases of government bonds (QE) significantly in the second half of 2015. • 10y Bund yields are likely remain at their lows in Q1 owing to the ECB’s QE. Thereafter, yields should edge up slowly. The structurally low interest rate environment remains intact for longer. • Risk premiums of peripheral government bonds are set to decline further amid ECB bond purchases. United Kingdom TABLE 9: Exchange rates (end-of-quarter) 19.03.2015 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 EUR/USD 1.07 1.10 1.06 1.04 1.02 1.01 USD/JPY 121 120 122 125 127 129 EUR/CHF 1.06 1.00 0.99 0.98 0.97 0.96 EUR/GBP 0.72 0.74 0.72 0.71 0.70 0.70 EUR/SEK 9.29 9.75 9.80 9.85 9.90 9.95 EUR/NOK 8.62 9.10 9.00 8.90 8.80 8.70 EUR/PLN 4.13 4.15 4.15 4.15 4.15 4.15 EUR/HUF 303 305 310 315 315 315 EUR/CZK 27.43 29.00 29.00 29.00 29.00 29.00 AUD/USD 0.77 0.76 0.74 0.73 0.73 0.74 NZD/USD 0.74 0.73 0.71 0.70 0.69 0.68 USD/CAD USD/CNY 1.27 1.26 1.28 1.30 1.32 1.30 6.20 6.33 6.35 6.35 6.35 6.35 • USD should further profit from the expectations of Fed interest rate normalization. Current USD rates have not priced in the speed of rate hikes that we expect. • The euro is under pressure as a result of the persistent deflation fears in the euro zone and an ECB policy that could even expand government bond purchases. • CEE currencies tend to devalue. • We see the PBoC “allowing” the CNY to remain on the weaker side in H1, following its rate cuts to support the economy and USD strength. Source: Bloomberg. Commerzbank Economic Research; bold change on last week; * Treasuries, Bunds, Gilts, JGBs 16 20 March 2015 Economic Research | Week in Focus Research contacts (E-Mail: [email protected]) Chief Economist Dr Jörg Krämer +49 69 136 23650 Economic Research Interest Rate & Credit Research FX Strategy Commodity Research Dr Jörg Krämer (Head) +49 69 136 23650 Christoph Rieger (Head) +49 69 136 87664 Ulrich Leuchtmann (Head) +49 69 136 23393 Eugen Weinberg (Head) +49 69 136 43417 Dr Ralph Solveen (Deputy Head; Germany) +49 69 136 22322 Alexander Aldinger +49 69 136 89004 Lutz Karpowitz +49 69 136 42152 Daniel Briesemann +49 69 136 29158 Elisabeth Andreae (Scandinavia. Australia) +49 69 136 24052 Rainer Guntermann +49 69 136 87506 Peter Kinsella +44 20 7475 3959 Carsten Fritsch +49 69 136 21006 Dr Christoph Balz (USA. Fed) +49 69 136 24889 Peggy Jäger +49 69 136 87508 Thu-Lan Nguyen +49 69 136 82878 Dr Michaela Kuhl +49 69 136 29363 Peter Dixon (UK. BoE). 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