ECB: the only game in town? - J. Safra Sarasin€¦ · vices sector fell sharply in August,...

Cross-Asset Weekly 06 September 2019

1 | Cross-Asset Weekly

ECB: the only game in town?

With euro area growth and inflation remaining depressed, Mario Draghi is likely to announce a significant easing package when the ECB Governing Council meets next week. Loose monetary and financial conditions should keep the risk of a region-wide recession low. But the economy is unlikely to rebound meaningfully as long asgovernments shy away from boosting spending.

US corporate profits were expanding at a modest 1.7% yoy in Q2 2019. Coming on theheels of substantial downward revisions of corporate profits by the BEA for 2016-2018, earnings growth will fail to impress markets in 2019. Our analysis of wage pressureshints that US corporate profit margins are not materially at risk. With subdued profitgrowth, investors’ attention should focus on liquidity trends and Fed policy, which willplay a bigger role for US equities going into Q4 2019.

The large “counter-cyclical factor” used by the People’s Bank indicates that policymak-ers wish to avoid an abrupt devaluation of the renminbi, but raises the risk of a policymisstep. We doubt the authorities will repeat the mistakes made in 2015, but fears ofa competitive devaluation are unlikely to disappear quickly.

This week’s highlights

European Macro 2The case for more policy support

US Equity 3Watch the Fed, and then US corporate profits

China Economics 5PBoC is resisting renminbi depreciation, but risks remain

Economic Calendar 6Week of 09/09 – 13/09/2019

Contacts

Dr. Karsten Junius, CFA Chief Economist [email protected] +41 58 317 32 79

Raphael Olszyna-Marzys International Economist [email protected] +41 58 317 32 69

Cédric Spahr, CFA Equity Strategist [email protected] +41 58 317 31 28

Alex Rohner Fixed Income Strategist [email protected] +41 58 317 32 24

David Rees Emerging Market Strategist [email protected] +41 58 317 51 36

Kunal Singh, CFA Emerging Market Credit Analyst [email protected] +41 58 317 31 21

Thilina Hewage, CFA Emerging Market Credit Analyst [email protected] +65 6230 66 61

Walid Bellaha Emerging Market Credit Analyst [email protected] +41 58 317 51 57



European Macro

The case for more policy support

With euro area growth and inflation remaining depressed, Mario Draghi is likely to announce a significant easing package next week. Loose monetary and financial conditions should keep the risk of a recession low. But the economy is unlikely to rebound meaningfully as long as governments shy away from boosting spending.

The ECB is set to deliver a comprehensive easing package when it meets next week. We expect a cut of 10bps in the depo rate to -0.5%, the introduction of a tiered deposit rate, a new QE program of €45 of monthly purchases (€30bn of sovereign bonds) to last for a year and new forward guidance that will push any rate hike well into the fu-ture. But given the lack of consensus on the benefits of further bond purchases, there is a good chance that the details of the QE program will be released later this year.

Euro area GDP seems on track to grow at a modest 0.2% q/q in Q3, unchanged from last quarter (Exhibit 1). We continue to see a wide gap between indicators related to external and domestic demand, which remains reasonably resilient given the strength of the labour market. Loose financial conditions are helping too. The pace of real mon-ey supply and credit expansion has actually picked up over the past year and corporate credit spreads remain low. These conditions are typically associated with stronger growth, and surely not with a downturn. Exhibit 2 shows two models of recession. The first one uses monetary and credit aggregates, corporate credit spreads and the slope of the yield curve. The second model includes the expectations component of the Ger-man manufacturing IFO but excludes credit spreads. Interestingly, neither of the mod-els flags a risk of a euro area recession over the next 6 months.

Still, there is a strong case for more policy action, partly to provide insurance against the damage US trade policy is doing to business sentiment. More fundamentally, Ger-man manufacturing is likely to remain under pressure as consumers shun diesel cars. The uncertainty over Brexit is set to persist well into next year, further depressing UK business investment and the demand for German capital goods. There are already clear signs that manufacturing woes are spreading to the broader economy: euro area em-ployment intentions have deteriorated and optimism about the coming year in the ser-vices sector fell sharply in August, according to the latest PMI survey. As the ECB ad-mits itself, it will need a helping hand from fiscal policy to reflate the economy.

Raphael Olszyna-Marzys International Economist [email protected] +41 58 317 32 69

The ECB is set to announce a comprehen-sive easing package next week

The probability of a euro area recession over the next 6 months is low

But there are clear signs that the pain in the manufacturing sector is spreading. Fis-cal policy will have to play a bigger role

Exhibit 1: ‘Nowcast’ model points to 0.2% growth in Q3 Exhibit 2: Probability of a euro area recession remains low

Source: Datastream, J. Safra Sarasin, 05.09.2019 Source: Datastream, J. Safra Sarasin, 05.09.2019

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Eurozone GDP (% QoQ) Median of 7 activity indicators regressed on GDP

0

20

40

60

80

100

1980 1985 1990 1995 2000 2005 2010 2015 2020Euro area recession Model 1 Model 2

Probability of a recession 6-month ahead (%)



US Equity

Watch the Fed, and then US corporate profits

US corporate profits were expanding at a modest 1.7% yoy in Q2 2019. Coming on the heels of substantial downward revisions of corporate profits by the BEA for 2016-2018, earnings growth will fail to impress markets in 2019. Our analysis of wage pressures hints that US corporate profit margins are not materially at risk. With subdued profit growth, investors’ attention should focus on liquidity trends and Fed policy, which will play a bigger role for US equities going into Q4 2019.

We delve into the US corporate profit cycle this week and its outlook for Q4 2019. The US Bureau of Economic Analysis (BEA) released at the end of August corporate profits figures for Q2 2019. Q2 corporate profits were higher than in Q1, yet up only 1.7% compared with Q2 2018. Investors should take note firstly that the yearly growth rate of corporate profits seems to be petering out (Exhibit 1). Such figures come on the heels of a large adjustment of profit estimates carried out by the BEA for the period 2016-2018. The revision resulted in a large reduction of estimated US corporate profits over the past three years. This materially reduced the profit boom initially registered in US statistics over the period 2017-2018. This change is all the more puzzling that the Trump tax cuts were implemented in January 2018. As things stand, the US tax reform delivered a far smaller boost to US corporate profits. This information dovetail nicely with similarly lowered payrolls estimates from the Bureau of Labour Statistics (BLS). We can summarize our initial take by saying that the US economy’s performance since mid-2016 was far less impressive than initially assumed when it comes to profitability.

Corporate profits lead corporate investments by two years and employment growth by 12 to 18 months, which means that the outlook for US corporate profits influences not only the stock market in the short term but also employment eventually. Corporate prof-it margins have remained steady since 2016, yet showed some signs of erosion when it comes to the nonfinancial corporate sector (Exhibit 2). We do not witness impending signs of doom for US corporate profits. Profit margins have remained at elevated levels since 2009 and all the caveats about future margin compression have proved ill-advised. US companies have proven apt at managing costs at the aggregate level. Globalization still exerts a powerful influence on the US economy and we find scarce evidence that the workforce is achieving breakthroughs in wage negotiations. Barring a genuine recession, we do not anticipate margin compression in coming quarters.

Cédric Spahr, CFA Equity Strategist [email protected] +41 58 317 31 28

US corporate profits are expanding less briskly than previously estimated

US corporate profit margins have remained steady

Exhibit 1: US corporate earnings are contracting at an annual rate of -4.5% yoy in Q2 2019 in the nonfinancial corporate sector

Exhibit 2: US corporate profit as a share of GDP are holding up,set might erode slightly in the nonfinancial sector


-75

-50

-25

0

25

50

75

1990 1995 2000 2005 2010 2015

US corporate profits after tax, yoy in %

US nonfinancial corporate profits after tax, yoy in % 0

2

4

6

8

10

12

1950 1960 1970 1980 1990 2000 2010

US corporate profits after tax in % of GDP

US nonfinancial corporate profits after tax in % of GDP



Even if official figures suggest that the US economy is close to full employment, the bargaining power of US employees remains modest when it comes to achieving wage gains. Lingering risks of skill obsolescence and offshoring probably explain this lack of bargaining power. The employment cost index (ECI), a broad gauge of wages and sala-ries in the US private sector, was growing at 3% yoy in Q2. With labour productivity ris-ing by 1.8% yoy, we end up with unit labour costs increasing a still moderate 1.2% yoy. Other measures of wage pressure, such as the ratio of employee compensation to gross value added (GVA; Exhibit 3) as well as a declining ratio of productivity to real wages in the nonfinancial corporate sector send a less favourable signal for company profits (Exhibit 4). Wage pressure seems to be building up slowly in the nonfinancial corporate sector, yet do not threaten US corporate profitability in 2019 yet.

US corporate profits are currently expanding at a subdued pace and we still have good reasons to assume that consensus estimates for 2020 are too elevated. That being said, we keep in mind that earnings growth and the shifts in the Fed balance sheet jointly drive the performance of US equities (Exhibit 5). Since we observed a slight in-crease in Fed Treasuries holdings in the past two weeks, we will monitor any lasting shift in Fed policy closely. The short-term trend in central bank balance sheets por-tends a rebound which has already started this week, probably followed by some pull-back in the second half of September (Exhibit 6).

Exhibit 3: Unit labour costs (ULC) are expanding moderately in the US nonfinancial corporate sector

Exhibit 4: Real wages are growing faster than productivity (outputper hour) in the nonfinancial corporate sector


Wage pressure are moderate and are large-ly offset by rising productivity

Shifts in Fed policy / market liquidity will exert a strong influence on US equities

Exhibit 5: Expansion of Fed balance sheet and earnings growth constitute key drivers of US equity performance

Exhibit 6: The short-term trend in central bank balance sheets foretells some ups and downs for equity markets in September


78

80

82

84

86

88

90

92

94

96

-8

-6

-4

-2

0

2

4

6

8

1990 2000 2010

ULC nonfinancial corporate sector yoy in %

Employee cost index, wages and salaries yoy

Employee compensation as a % of gross value added (GVA)40

45

50

55

60

65

70

75

80

80

85

90

95

100

105

1950 1960 1970 1980 1990 2000 2010

US nonfinancial productivity / real wages

US nonfinancial corporate "EBITDA" margin (rhs)

-150

-100

-50

0

50

100

150

-60

-40

-20

0

20

40

60

2004 2006 2008 2010 2012 2014 2016 2018

Fed: Treasuries held outright, 1Mabsolute change (rhs)S&P 500 yoy in %

S&P 500 - earnings yoy in %

14

14.1

14.2

14.3

14.4

14.5

14.6

1'600

1'800

2'000

2'200

2'400

Sep 2018 Dez 2018 Mrz 2019 Jun 2019 Sep 2019

MSCI WorldFed + ECB + BoJ balance sheets (USD tr, 4W lead, rhs)



China Economics

PBoC is resisting renminbi depreciation, but risks remain

The large “counter-cyclical factor” used by the People’s Bank indicates that poli-cymakers wish to avoid an abrupt devaluation of the renminbi, but raises the risk of a policy misstep. We doubt the authorities will repeat the mistakes made in 2015, but fears of a competitive devaluation are unlikely to disappear quickly.

Last month we argued that the People’s Bank would stop leaning against the surging US-Dollar after trade negotiations failed, and that it would settle at about 7.06/$. (See Exhibit 1, and our Emerging Markets Weekly, “Trade war merry-go-round continues”, 5th August.)

The PBoC set its daily fixes at about 7.08/$ this week, only a shade weaker than our tar-get. But the fixings have been much stronger than the level implied by market exchange rates, meaning that the so-called “counter-cyclical factor” appears to be the largest since the PBoC moved to a market-based mechanism in mid-2015 (Exhibits 2 & 3).

The poorly-communicated policy shift in mid-2015 raised fears of a major devaluation, sparking large capital outflows and pandemonium in global markets (Exhibit 4). The authori-ties have become far more cute since then, and the tough economic and trade backdrop means they can ill afford a repeat performance. However, we already expect the renminbi to weaken to about 7.25/$ in Q4 on account of another failed round of trade negotiations, meaning that fears of a competitive devaluation could emerge again in the future.

David Rees Emerging Market Strategist [email protected] +41 58 317 51 36

PBoC did not stand in the way of a strong US-Dollar in August…

…but has begun to resist further weaknessby using a large “counter-cyclical factor”

Fears of renminbi devaluation may emerge again if trade talks fail in October, even if they are misplaced

Exhibit 1: The US-Dollar has been surging in recent months Exhibit 2: The PBoC fixes are stronger than the market rate…

Exhibit 3: …pointing to a large “counter-cyclical factor” Exhibit 4: Change to the fixing mechanism sparked panic in 2015

Source: Bloomberg, Datastream, J. Safra Sarasin, 06.09.2019

6.1

6.3

6.5

6.7

6.9

7.1

88

90

92

94

96

98

100

Sep-17 Jan-18 May-18 Sep-18 Jan-19 May-19 Sep-19

DXY Index (LHS)

CNY vs. US$ (RHS)

US$ Stronger

6.0

6.2

6.4

6.6

6.8

7.0

7.22015 2016 2017 2018 2019

CNY vs. US$ (Inv.)

CNY Daily Fix vs. US$ (Inv.)

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

2015 2016 2017 2018 2019

Difference Between Daily Fix and Previous Day's Closing RMB vs US$

Daily fix set stronger than implied by previous market close

PBoC switched to market-based fixing mechanism

5.7

5.9

6.1

6.3

6.5

6.7

6.936000

38000

40000

42000

44000

46000

48000

50000

52000

54000

56000

Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16

MSCI Emerging Markets (Lcu, LHS)

CNY vs. US$ (Inv., RHS)



Economic Calendar

Week of 09/09 – 13/09/2019

Country Time Item Date Unit Consensus

Forecast Prev.

Monday, 09.09.2019 CN 00:00 New Yuan Loans Aug CNY bn 12001060.0

00:00 Money Supply M1 Aug yoy +3.7% +3.1%00:00 Money Supply M2 Aug yoy +8.2% +8.1%

JP 01:50 GDP SA, final 2Q qoq +0.3% +0.4%UK 10:30 Monthly GDP Jul 3m/3M -0.1% -0.2%

10:30 Industrial Production Jul mom 0.0% -0.1%10:30 Industrial Production Jul yoy -1.0% -0.6%

Tuesday, 10.09.2019 JP 08:00 Machine Tool Orders, prel. Aug P yoy -33.0%UK 10:30 Average Weekly Earnings Jul 3m/yoy +3.7% +3.7%

10:30 ILO Unemployment Rate Jul 3Mths +3.9% +3.9%US 16:00 JOLTS Job Openings Jul 7348

Wednesday, 11.09.2019 US 14:30 PPI Ex Food and Energy Aug mom +0.2% -0.1%

14:30 PPI Ex Food, Energy, Trade Aug mom +0.2% -0.1%

Thursday, 12.09.2019 EMU 11:00 Industrial Production SA Jul mom +0.1% -1.6%

11:00 Industrial Production WDA Jul yoy -1.3% -2.6%13:45 ECB Main Refinancing Rate Sep 12 % 0.0% 0.0%13:45 ECB Deposit Facility Rate Sep 12 % -0.5% -0.4%

JP 01:50 Core Machine Orders Jul mom -9.0%+13.9%01:50 Core Machine Orders Jul yoy -4.1%+12.5%

US 14:30 CPI Aug mom +0.1% +0.3%14:30 CPI Ex Food and Energy Aug mom +0.2% +0.3%14:30 CPI Aug yoy +1.7% +1.8%14:30 CPI Ex Food and Energy Aug yoy +2.3% +2.2%14:30 Initial Jobless Claims Sep 7 1 000 - 217

Friday, 13.09.2019 US 14:30 Retail Sales Advance Aug mom +0.2% +0.7%

14:30 Retail Sales Ex Auto Aug mom +0.1% +1.0%14:30 Retail Sales Ex Auto and Gas Aug mom +0.3% +0.9%16:00 U. of Mich. Sentiment, prel. Sep index 90.2 89.816:00 U. of Mich. Current Conditions, prel. Sep index 105.316:00 U. of Mich. Expectations, prel. Sep index 79.9

Source: National Statistical Offices and Central Banks, J. Safra Sarasin


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ECB: the only game in town? - J. Safra Sarasin€¦ · vices sector fell sharply in August,...

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