Monthly Economic Update · Monthly Economic Update April 2016 2 US: Twisting and turning The latest...

Monthly Economic Update April 2016

1

Monthly Economic Update Easy does it…for now

Financial markets have responded positively to the latest stimulus efforts by

the major central banks – the European Central Bank’s (ECB) multi-pronged

efforts to stimulate the Eurozone economy, and the Federal Reserve’s (Fed)

more cautious approach to tightening. But there are still plenty of pitfalls

ahead – China’s macroeconomic and financial difficulties, the Brexit vote and

US Presidential Elections all have the potential to upset risk sentiment – with

little left in Central Bank arsenals to provide any more offsetting support.

Markets have taken comfort from the lowering of the Fed’s tightening intentions as given

by their so-called “dot diagram”. This, despite repeated comments from Fed Chair, Janet

Yellen, that these dots do not represent a plan, a pre-commitment, or even that this is

formal ‘forward guidance’ (it isn’t).

Indeed, with one FOMC member already looking for immediate tightening, we are

surveying the data for evidence to support a more aggressive tightening profile than our

current forecast for one hike in 2016. Such evidence will include financial conditions as

well as the familiar domestic indicators of inflation, wages, and activity.

In Europe, there is little immediate need for the ECB to follow with more stimulus as

sentiment remains positive and inflation is showing signs of bottoming out, albeit it is

unlikely to hit the 2% target anytime soon. But there are many risks to the outlook, not

least from Greece, Brexit and the ongoing refugee crisis. Expect monetary policy to

remain loose for a long time to come, although “helicopter money” seems unlikely.

In the UK, the Brexit referendum campaigning is becoming more fraught, with the

electorate still unsure as to what it all means. Opinion polls remain close and this is

starting to hurt sentiment and economic activity, and the Bank of England is becoming

more vocal in pointing out the near-term risks. We still assume that the UK will vote to

stay, but we don’t have a high degree of confidence in this call.

The data on China has been rather mixed, with stronger investment and housing data

counterbalancing weaker industrial production. Greater stability in the People’s Bank of

China’s CNY policy should support growth, although political clouds are starting to gather

as questions are raised about the stability of President Xi’s administration.

There are many challenges facing the Japanese economy, not least a likely downtrend in

core inflation through 2016. Recent comments from PM Abe suggest that fiscal policy

may not pick up the mantle, placing further pressure on the Bank of Japan to act in April.

This year, we struggle to see EUR/USD decisively breaking out of 1.05-1.15 range as

transatlantic policy divergence has a diminishing marginal impact on FX. This is

supported by our view that the Fed is increasingly sensitive to financial conditions and

would be wary of allowing a stronger dollar to strengthen much more than the 8-10%

seen over recent years.

The positive sentiment going into, and in the weeks after, the recent ECB/Fed meetings

has helped boost risk assets and Central European yields have benefited. Our call is for

long dated core yields to remain contained, but we remain watchful of risk factors, not

least from oil, Brexit and China – all of which could prompt changes in our forecasts.

FINANCIAL MARKETS RESEARCH

research.ing.com SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES & ANALYST CERTIFICATION

Global Economics

30 March 2016

Mark Cliffe Head of Global Markets Research

Rob Carnell

Tim Condon

Padhraic Garvey

James Knightley

James Smith

Chris Turner

Peter Vanden Houte

GDP growth (% YoY)

Source: Macrobond, ING

10Y bond yields (%)


FX


-12

-10

-8

-6

-4

-2

0

2

4

6

-12

-10

-8

-6

-4

-2

0

2

4

6

00 02 04 06 08 10 12 14 16

Japan

Eurozone

US

Forecasts

0

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

00 02 04 06 08 10 12 14 16

US

Japan

Eurozone

Forecasts

60

80

100

120

1400.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

00 02 04 06 08 10 12 14 16EUR/USD (eop) USD/JPY (eop)

Forecasts

FINANCIAL MARKETS RESEARCH


2

US: Twisting and turning The latest turn in the US story has been driven by the Federal Reserve’s (Fed’s) latest

rate setting meeting. Although activity data has been coming in on a more positive trend,

and core inflation data has been nosing higher, the Fed left rates unchanged, and

markets instead focussed on a substantial reduction on what has come to be known as

the Fed’s “dot diagram”.

The dots represent the views of all 17 Federal Open Market Committee (FOMC)

participants, voters and non-voters, and prior to the latest meeting, have suggested an

entirely improbable and aggressive tightening by the FOMC over the coming years, with

100bp of tightening implied by the median of these dots by end 2016 and again in 2017.

As the Fed did not hike rates in March, it was almost inevitable that at least one of the

implied hikes would be removed from this diagram. In the event, two of the hikes in 2016

were removed. Chair Yellen noted that with rates already so close to zero, the Fed’s

ability to respond to negative shocks with easing was constrained and that this warranted

caution (the slower path for implied tightening) over 2016. This is undoubtedly the case,

but it was also the case in December last year, or earlier. Moreover, the Fed projection is

still more aggressive than market expectations, even though the lower projection seems

to have provided a big boost to risk sentiment.

Fig 1 December Fed Dot Diagram

Fig 2 March Fed Dot Diagram

Source: Federal Reserve, Bloomberg Source: Federal Reserve, Bloomberg

LR Implied fed funds rate is the furthest Fed contract – in this case, Feb 2019

It is a puzzle to us why markets pay much attention to this dot diagram, since even the

Fed has pointed out that it is not a formal piece of ‘forward guidance’. We are more

puzzled still when it merely moves in the direction of what markets were in any case

expecting, yet causes such a big reaction.

Indeed, the more interesting story for the outlook for US rates, in our opinion, is the fact

that there is now a dissenter at the Fed. Esther L George, FOMC voter and President of

the Kansas City Fed, now thinks that the Fed target range should already have been

raised to 50-75bp. Furthermore, if you ignore the dot-diagram, then the reasonably

upbeat Fed statement, the dissenting view, and the subsequent press conference all

seemed to tell an entirely different story – one that noted the improvements in activity and

the labour market, and also the increase in inflation. What seems to have been

overlooked in all of this was that Fed Chair Yellen described the April meeting as a “live”

one, and re-iterated this by describing a rate hike in April as a “live” possibility.

0

1

2

3

4

5

December Meeting

Dec implied Fed fund rate

Latest median

2015 2016 2017 2018 LR

%

0

1

2

3

4

5

March Meeting

Dec implied Fed fund rate

Latest median

2016 2017 2018 LR

%

The Fed has provided a nice

boost to markets with its

more dovish rate projections

Only two rate hikes are now

projected by Fed materials in

2016

This puts the Fed back in

touch with reality – it does

not really alter our

expectations

The dot diagram is not formal

forward guidance – it never

was

Little attention is being paid

to the fact that there is now a

dissenter who wants to hike

rates now


3

So whilst a month ago, we were looking for an excuse to remove our remaining 2016 rate

hike and wondering about the possibility of recession, instead we had to acknowledge the

better run of data in February. The run of data through March has retained this strength,

and the pressure on our forecast is now to see whether we need to bring forward the

3Q16 hike to 2Q16, and possibly restore the 4Q16 hike too.

The hurdle for further Fed tightening is not a low one, as Yellen points out. But it is not

insurmountable either. A decent activity picture will certainly help, and we see this as a

necessary condition to a rate hike. But it is not sufficient on its own. In contrast, were we

to see some convincing evidence that wages were beginning to accelerate, and also that

inflation was pushing up towards the Fed’s target, either of these might on their own be

sufficient to lead to a rate hike, and together, would be almost irresistible. Coupled with

this, financial conditions will play a role. Figure 3 shows our own measure of financial

conditions (a complicated mix including exchange rate indices, interest rates, and equity

market). Looser conditions clearly make it easier for the Fed to increase policy rates.

Fig 3 US Financial Conditions

Fig 4 Wages and hours fail to break higher

Source: ING Source: Macrobond

With only a six week period between the March meeting and the April one, we see some

scope for wages to pick up again, but probably not sufficiently to push into a new range.

An hourly wages growth rate of 2.4% or 2.5% YoY is about as high as we believe we are

likely to get before the 27 April FOMC meeting. Likewise, headline inflation is now

struggling to stay elevated as the year on year comparisons have to deal with the short-

lived February – July 2015 oil-related pick-up in gasoline prices. That said, the recent

firming in crude oil/gasoline will help offset these negative base effects.

As a result, an April hike, whilst “live” is probably not a strong contender in our view,

though the April meeting could be used to flag the possibility of a June hike, without pre-

committing. For now though, we are happy to leave just one hike in for 2016 in the third

quarter. US data is choppy, and who is to say we will not have the usual mid-year soft-

patch that has seemed to become the norm. Moreover, with plenty of political noise both

within the US (Presidential Elections) and outside (Brexit vote, China), there is scope for

a further deterioration in risk sentiment and a tightening in financial conditions – so

pencilling in more tightening without supportive evidence seems highly speculative.

Consequently, we would not be at all surprised if, over the next few weeks, the post-dot-

diagram eurphoria wore off, equities struggle to find new reasons to go up, and bond

yields settle back to a higher level again in anticipation of the Fed’s ultimate return to

monetary tightening.

Rob Carnell, London

0.00

0.25

0.50

0.75

1.00

Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16

Estimated Fed tolerance range

Trend (since Jul. 2014)

ING US Financial Conditions Index

ING US Financial Conditions Index (normalised Jul 2014 = 0)

Dec FOMC rate hike

33.2

33.4

33.6

33.8

34

34.2

34.4

34.6

34.8

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

07 08 09 10 11 12 13 14 15

Average hourly earnings, lhs

Average hourly earnings - production and supervisory,lhs

YoY% hours

The balance of risks to our

forecast is that we may have

to bring forward tightening,

and maybe add some too

Inflation and wages pressure

will be important in any

decision to hike rates, as will

financial conditions

There is not much time

before the April meeting, but

it might be enough to flag a

forthcoming hike in June

Our preference is to keep

with our one 3Q16 hike, but

to watch for excuses to shift

this up or add to it


4

Eurozone: ECB - all done?

The ECB surprised financial markets in March, not only by cutting the refi rate to 0% and

the deposit rate to -0.40%, but also by increasing its monthly asset purchase programme

to €80bn from €60bn. On top of that it also included, as we expected, investment grade

non-financial corporate bonds in the eligible assets for purchase. Finally there will be a

number of 4-year TLTROs with very generous conditions.

The striking thing is that ECB President Mario Draghi at first managed to create an

adverse market reaction by suggesting that interest rates would not be lowered any

further and that potential additional easing would be done mainly through non-

conventional measures. This guidance was rectified in the following week by ECB Chief

Economist Peter Praet, who mentioned that rates could still go lower (indeed, but then a

two-tiered deposit rate seems unavoidable in our view). That said, we have a feeling that

barring a relapse into recession, the ECB is basically done and that any additional

measures would be fairly small tweaks to the existing schemes.

However, when thinking about other potential non-conventional measures in the wake of

a new crisis, it is interesting to mention that both Draghi and Praet didn’t shy away from

discussing “helicopter money”. While Draghi mentioned accounting and legal

complexities, Praet clearly stated that all central banks could issue currency and

distribute it to people.

However, there is no need to get too excited, because helicopter money is no free lunch

either. Indeed, if the central bank continues to pursue its mandate of keeping inflation

close to 2% over the medium term and hence helicopter money doesn’t lift money in

circulation permanently, the main impact is that it brings forward in time future

seigniorage income. In other words, people will get a present today, but that will result in

lower ECB dividends in the future (since the helicopter money can be seen as a non-

interest bearing perpetual asset on the ECB’s balance sheet). The key reason why it

could be considered is to kick start the economy and in the hope that this would lead the

economy to a higher growth path.

Of course there is a lot of opposition within the Governing Council against this type of

extreme measures. This is already strong vocal opposition to the current ECB monetary

policy, since negative interest rates are in a way punishing savers and rewarding debtors.

In that regard, we don’t think that helicopter money is feasible in the foreseeable future.

In our view, there is also no need to introduce new measures at the moment. Sentiment

indicators have remained high, though choppy. In March, the PMI indicator increased to

53.7, a 3-month high. In terms of hard data, industrial production surprised in January

with a stronger-than-expected 2.1% MoM increase. On the other hand, the latest terrorist

attacks in Brussels, might temporarily depress consumer confidence. We therefore stick

to our scenario of a subdued, but continuing recovery. While this is not the environment

to see a rapid increase in inflation, the recent increase in oil prices also points to a

gradual bottoming out of headline inflation. That said, with 0.4% in 2016 and 1.5% in

2017, HICP inflation will still remain below the ECB’s target for some time.

ECB strikes again…

…but is now probably done

Helicopter money is not

impossible…

….and would meet heavy

opposition from the ECB’s

hard core

Growth is weak, but not

faltering…

…while inflation is bottoming

out

…but is no free lunch…


5

Fig 5 Uncertainty remains important…

Fig 6 …while money market rates become more

negative

Source: Thomson Reuters DataStream Source: Thomson Reuters DataStream

Of course, there are still plenty of risks around this scenario. That fact that the conclusion

of the first review of the third Greek bail-out programme, originally foreseen for January,

has been delayed until the second half of April at the earliest, shows that Greece is not

out of the woods yet. The confidence in the Greek Prime Minister Tsipras is plunging.

Fortunately Eurogroup President Dijsselbloem suggested that some debt relief might be

in the offing this year.

On top of that, the Brexit referendum might not only lead to more uncertainty in the

coming months. If the UK votes to leave the EU (see below), it is fairly certain that it will

have a negative impact on the Eurozone economy. We forecast a cumulative negative

GDP impact of 0.3% of GDP by the end of 2017, but this effect might be even bigger, if

the divorce turns out to be more acrimonious. (Click here to view our full report)

Finally, it is far from certain whether the recent agreement with Turkey will make the

refugee problem more manageable. More border controls might be put in place in the

Schengen area, hampering trade flows. The recent terrorist attacks in Brussels only

strengthen this trend.

Apart from these “known unknowns” other unexpected shocks might halt the still fragile

economic recovery in Europe. In these circumstances, even if helicopter money remains

unlikely monetary policy will remain very accommodative for years to come. That, and the

continued bond buying by the ECB, will keep bond yields low, though we still expect

some yield curve steepening near the end of this year.

Peter Vanden Houte, Brussels

UK: Feeling the strain of Brexit

The Brexit referendum debate in the UK is becoming more acrimonious. Following a

ministerial resignation, tensions within the Conservative Party are running high, with

reports that Prime Minister David Cameron could face a leadership contest irrespective of

the outcome of the vote. At the same time, the claims and counter claims of the

respective pro and anti-EU campaign groups are adding to a sense of confusion for the

electorate over what Brexit means. Consequently, we are seeing little shift in the opinion

polls which suggest that the outcome is still too close to call. Nonetheless, Prime Minister

David Cameron can seek some comfort from the fact that the bookmakers continue to

back the view that the UK will vote to stay – the best odds on the UK staying in the EU is

4/9 while it is 15/8 for a “leave” vote.

0

50

100

150

200

250

300

350

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

EU Economic policy uncertainty index (news based)

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Mar 11 Mar 12 Mar 13 Mar 14 Mar 15 Mar 16

Overnight deposit rate ECB Euribor 3m

The referendum campaign is

becoming bitter, which is

adding to the confusion

amongst the electorate

Greece is not out of the

woods yet…

…while Brexit could be

another headwind…

….and the refugee crisis is

still not resolved

No rate hike likely before

2H18

http://pull.xmr3.com/p/7139-172966-FADF/75394705/2016022316445811_E.pdf


6

We continue to think that the UK will narrowly vote in favour of staying a member of the

European Union on the basis that there is a large proportion of the electorate who are

undecided. As was the case with 2014’s Scottish independence referendum we believe

that most of this group will stick with what they know (opting for the status quo and

staying in the EU) rather than step into the unknown and vote to leave. We also believe

that with business leaders set to become more vocal on the issue in the lead up to the

vote this may focus the mind of the electorate on what it means for them and their

families’ employment and income prospects. This could help sway many undecided in

favour of staying in the EU.

Fig 7 UK business surveys are weakening

Fig 8 Opinion polls remain close

Source: Bloomberg Source: Various polling agencies

Irrespective of this, the referendum does appear to be having an impact on the UK

economy. Business surveys have weakened and consumer confidence has declined,

which may in part reflect the uncertainty that the referendum brings. We therefore

anticipate a slowdown in business investment and employment growth with firms likely to

be reluctant to implement significant expansion plans given the scale of uncertainty Brexit

could cause.

Significantly, after the March monetary policy decision, the Bank of England

acknowledged that the Brexit vote has weighed on sterling and may “also delay some

spending decisions and depress growth of aggregate demand in the near term”. This is

nothing more than stating the obvious, but it could be the first step into what could

become a more concerted campaign to highlight the economic risks.

Our house view remains that if the UK votes to stay in the EU we will see delayed hiring

and investment plans being implemented in 2H16. Given the underlying strength of the

economy and rising medium-term inflation pressures, we still think a November rate hike

is possible. However, should the UK vote to leave the next move is likely to be a rate cut

as policymakers try to shore-up confidence.

James Knightley, London

25

30

35

40

45

50

55

60

65

07 08 09 10 11 12 13 14 15 16

Construction

Services

Manufacturing

20

25

30

35

40

45

50

55

60

65

70

20

25

30

35

40

45

50

55

60

65

70

De

c-1

2

Feb

-13

Apr-

13

Ju

n-1

3

Aug

-13

Oct-

13

De

c-1

3

Feb

-14

Apr-

14

Ju

n-1

4

Aug

-14

Oct-

14

De

c-1

4

Feb

-15

Apr-

15

Ju

n-1

5

Aug

-15

Oct-

15

De

c-1

5

Feb

-16

Remain in EU

Leave the EU

(%) (%)

We still think that the UK will

vote to stay a member of the

EU, but our confidence in

this call is weak

There is evidence to suggest

the uncertainty is dampening

UK activity

The Bank of England is

starting to exert some

influence on the debate

Should the UK stay then a

November rate hike remains

possible.


7

China: Political Clouds Gather

January-February economic data – the statistics bureau releases combined data to

control for Lunar New Year seasonality – were mixed, which makes them an

improvement on the recent trend. On the downside, industrial production growth slowed

to 5.4% from 5.9% in December. The export crash contributed to the slowdown. We

blame the double whammy to export prices and volumes from the 30% fall in global oil

prices in December-January. Retail sales value growth also slowed (to 10.2% from 11.1%

in December).

Fixed asset investment, the other principal spending-side indicator, was the upside.

Growth accelerated to 10.2% from 6.8% in December on across-the-board strength –

infrastructure, real estate and manufacturing. The positive growth of real estate

investment was the first since July 2015. We credit the swing to 10% growth in housing

starts, only the second positive print in 14 months.

The authorities began to ease housing policy in 2014 and by early 2015 it looked like

activity – home prices, home sales and housing starts – were responding. However, sales

and starts flagged in the second half of the year, which from the turnaround in early 2016

(Figure 9), we infer was transitory weakness from the panic in financial markets

associated with PBOC CNY policy uncertainty. We credit steadier policy since the second

week of January and the appearance of better economic data – starting with the January

money and credit data in mid-February – for releasing pent-up demand. We expect

growth to slow as pent-up demand fades. However, we also believe reduced PBOC CNY

policy uncertainty supports our forecast of a solid bounce in housing starts this year,

which we consider necessary for hitting the government’s 10.5% target for fixed asset

investment growth.

It is common knowledge that housing markets in the Tier 1 cities are again overheating

while housing markets in higher Tier cities are struggling. However, while the gaps

between Tier 1 home price inflation and inflation in higher Tier cities are wider than ever,

the inflation paths look similar (Figure 10). Inflation (simple average) in Tier 2 cities

punched into positive territory in December, seven months later than in Tier 1 cities.

Since bottoming in April 2015 deflation in Tier 3 and 4 cities has been narrowing by an

average of 0.5ppt each month, a trend that would put inflation in positive territory this

month. The similar home price inflation paths increase our confidence that the positive

association between home sales, home prices and housing starts remains intact.

In late March two documents appeared that raise questions about the stability of Xi

administration. The first, entitled “A Thousand Yes-Men Cannot Equal One Honest

Advisor” appeared on the website of the Central Committee for Discipline Inspection. The

second was an open letter from a group calling themselves “loyal Party members” calling

for President Xi to resign.

The post on the CDDI website in particular supports the conjecture that something has

changed, that erstwhile Xi supporters now are worried. The head of the CDDI is Wang

Qishan, who is thought to be a close ally of the President; his position makes him the

point man for the President’s anti-corruption campaign. Through allegory it warns against

creating a cult of personality. It also says that “The fundamental attitude of our Party

toward criticism is to consider things as they stand, seek the truth in facts, and distinguish

right from wrong…” which could be interpreted as a direct counter to President Xi’s recent

admonition that Party members not “irresponsibly discuss the Center” and description of

the media as the “tongue and throat” of the Party.

Mixed January-February

economic data

Fixed asset investment was

the bright spot

A rise in the political noise

level...

…raises doubts about the Xi

administration’s stability.

Home price inflation differs

by city tier

Housing is recovering, at last


8

In the letter the loyal party members tell President Xi they “have no choice but to point out

that, precisely due to your gathering of all power into your own hands and making

decisions directly, we are now facing unprecedented problems and crises in all political,

economic, ideological, and cultural spheres.”

In the economic sphere, his “direct involvement in the development of micro- and

macroeconomic policy has created instability in the stock market and the property

market.” His supply-side reforms have resulted in large numbers laid off. The One Belt,

One Road has “put a huge amount of foreign exchange reserves into chaotic countries

and regions with no return.” Finally, the “excessive consumption of foreign exchange

reserves, and renminbi devaluation cycles, has made everyone’s confidence decline, has

brought the national economy to the verge of collapse. People want change.” The

message is almost Trumpian.

We believe the authorities have already hit upon quick fixes to some of the economic

shortcomings. Since the second week of January the PBOC’s CNY policy has been more

predictable with, in Governor Zhou’s phraseology, enhanced reference to a basket of

currencies. Less CNY policy uncertainty has contributed to firmer stock prices – the

Shanghai Composite stock index is up 13% from its low in late January, though for the

year it’s still down 17% – and curbed the drain on foreign reserves from hot money

outflows. We also think it contributed to releasing pent-up housing demand.

We expect President Xi to stay his course. We also think the authorities recognize the

virtues of the PBOC’s CNY policy and will stay the course as well. Despite Governor

Zhou’s admonition that the PBOC sets the USDCNY reference rate “with reference” to a

basket and is not a basket peg, our forecasts continue to assume it is.

Fig 9 China: Housing Indicators (%YoY)

Fig 10 China: New Home Prices by City Tier (%YoY)

Source: Bloomberg, ING Bank Source: Bloomberg, ING Bank

Tim Condon, Singapore

Japan: More stimulus coming

Although one of the major headwinds facing Japanese policymakers, namely global

turmoil has died down recently, a number of other challenges remain ever-present.

Domestic growth remains weak, spring wage negotiations have disappointed and most

importantly (at least as far as the BoJ is concerned), core inflation looks set to trend

downwards and further below the 2% target. Pressure for more stimulus appears to be

building, although exactly what form this easing will take is still up for discussion.

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

2014 2015 2016 ytd

Prices Sales Starts

-10

-5

0

5

10

15

20

25

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Tier-1 Tier-2 Tier-3 and up

Japanese policymakers face

a number of challenges

Not a basket case

Numerous shortcomings…

…including economic ones

Economic quick fixes


9

At the moment, it doesn’t look like this boost is going to come from fiscal policy. Perhaps

the biggest outcome of this week’s budget was the announcement that the sales tax hike,

planned for April 2017, will go ahead barring a Lehman-style event. There had been

reports that the government was looking to postpone this in advance of this summer’s

Upper House elections. From an economic perspective, the policy is likely to be growth-

negative, as the effect is likely to mirror the 2014 tax change which caused a significant

frontloading of demand, followed by technical recession.

Fig 11 Core CPI has reached its peak

Fig 12 Frontloading effect of 2014 sales tax hike

Source: Macrobond Source: Macrobond, ING

The other interesting development in the budget was PM Abe’s hint that he will use the

G7 meeting in Japan at the end of May to push for coordinated action to boost global

growth. This would most likely take the form of a boost to public investment, as was

recently suggested by the OECD. Ultimately though, this may be difficult to agree upon,

particularly in a US election year.

In the absence of any fiscal boost, expectations are likely to build ahead of April’s Bank of

Japan meeting. However, with negative rates still unpopular, the policy board may be

wary of cutting rates again just yet (note that some members discussed removing the

policy at the last meeting, according to the Summary of Opinions). Although we wouldn’t

rule out a rate cut (and incidentally, this is likely to be the favoured tool in the longer

term), we think that the BoJ may for now opt to increase purchases of risk assets.

In this regard, the most likely candidates are either exchange traded funds (ETFs) or

corporate bonds. The BoJ’s scope to expand purchases of existing ETFs is fairly limited,

given that it now owns well over half the market. This was reflected in their decision to

jump-start creation of new ETFs back in December, when they committed to buying

assets based on firms that invest in physical/human capital. In our opinion, the BoJ has a

greater ability to boost corporate bond purchases. Although the BoJ technically buys such

bonds now, it is simply to maintain holdings at a certain level (¥3.2 trillion) following pre-

Abenomics asset purchases. Based on a quick calculation using Bloomberg data, we

estimate that there is around ¥9 trillion of eligible corporate bonds in issue, not held by

the BoJ. Thus any increase in purchases would likely amount to around ¥2-3 trillion per

year.

Of course, the main point is that the size of the market is small so the economic impact

could be limited (and many would contest that the market has already been distorted by

current purchases). However, if the BoJ felt under pressure, but didn’t want to cut rates,

this may be their favoured tool, particularly now that the ECB has gone down this route.

James Smith, London

-30

-25

-20

-15

-10

-5

0

5

10-1.0

-0.5

0.0

0.5

1.0

1.5

Jan12

May12

Sep12

Jan13

May13

Sep13

Jan14

May14

Sep14

Jan15

May15

Sep15

Jan16

BoJ Core CPI (YoY%, lhs) - 7M lag

Nominal Effective Exch. Rate (YoY%, rhs)

-40% -30% -20% -10% 0% 10% 20% 30%

Motor Vehicles

Food & Beverages

Fuel

Fabrics, Apparel& Accessories

General Merchandise

Machinery & Equipment

April 2014 (Post)

March 2014 (Pre)

Retail SalesMoM% Change

Data seasonally adjusted by ING

The April 2017 sales tax hike

is still on…

… despite concerns about

the economic impact

Expectations are building

ahead of the BoJ’s April

meeting

With rate cuts unpopular, a

stimulus boost may come

from ETF or corporate bond

purchases

The economic effect could be

fairly limited

Abe may use the G7 meeting

to push for joint action


10

FX: Dollar strength in abeyance

Benign conditions continue. These have been helped by another dovish turn from the

Fed, helping to cement recent trading ranges for the $/Majors. Going forward we struggle

to see EUR/USD breaking decisively out of a 1.05-1.15 range this year and foresee a

much more neutral environment for the dollar. This should be more constructive for risk-

sensitive currencies, especially those that are cheap and offer risk-adjusted carry.

Fig 13 EUR/USD range solidifies, volatility falls

Fig 14 Carry Trade starting to recover

Source: Bloomberg Source: Bloomberg, Basket comprises BRL/IDR/ZAR funded out of USD/EUR/JPY. 1 January 2015 = 100.

This month we are further dialling back on our call for dollar strength this summer. While

acknowledging that a less dovish Fed could briefly push EUR/USD down to 1.05 this

summer, we prefer to market a more neutral EUR/USD story – and one in which

transatlantic monetary policy divergence is having a diminishing marginal impact. This is

probably a function of extreme EUR/USD undervaluation and the large rate spreads

required to offset the Eurozone’s 3% current account surplus.

At the same time we would argue that the Fed is increasingly sensitive to US financial

conditions and will be reluctant to pursue a tightening cycle that would generate the kind

of 8-10% appreciation in the real trade-weighted dollar seen over recent years.

For USD/JPY, this environment probably means a 110-115 trading range. Like the euro,

the yen is meaningfully undervalued against USD, which puts a limit on its further

weakness. While the announced VAT hike (from April 2017) is likely to translate into

frontloaded consumption, the likely dent to growth thereafter may increase the odds of

further BoJ easing. Yet, with the scale to top up the BoJ QE programme being limited

(see above) and rate cuts having a questionable effect on the currency (recall the

introduction of the three tier interest rate system in January did not prevent JPY strength),

all this points to a limited downside to JPY, particularly when the Fed and the Chair

Yellen appear to err on the side of caution.

Away from the G3, GBP continues to trade on a soft footing. We retain the view that

EUR/GBP should be trading around 0.80 heading into the June Brexit referendum – or

perhaps even higher if non-partisan polls show the Leave campaign gaining traction.

Elsewhere, the further decline in FX volatility is encouraging a return to the carry trade.

This rising tide of risk-adjusted carry has been lifting all ships – despite the ongoing

challenges faced in Brazil and South Africa to name but two. However surveys show

5

6

7

8

9

10

11

12

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

Jan 14 Jul 14 Jan 15 Jul 15 Jan 16

EUR/USD One year EUR/USD implied volatility (RHS %)

80

85

90

95

100

105

Jan 15 Apr 15 Jul 15 Oct 15 Jan 16

Carry Trade Basket*

We struggle to see EUR/USD

breaking decisively out of a

1.05-1.15 range this year

This month we are further

dialling back on our call for

dollar strength this summer

For USD/JPY, this

environment probably means

a 110-115 trading range

This rising tide of risk-

adjusted carry has been

lifting all ships


11

investors still heavily underweight EM and commodity currencies, which warn that recent

trends can extend barring a decidedly more hawkish Fed or Chinese hard-landing.

Chris Turner, London

Rates: Positive signs

Market sentiment turned decisively positive during the weeks approaching the respective

ECB and FOMC meeting, and in correlation with some recovery in the oil price. Large net

inflows to high yield were followed by impressive net inflows to hard currency emerging

markets. The market friendly ECB outcome was followed by a tolerable FOMC

unchanged decision and a nod in the direction of heeding market angst, in turn rewarded

with the removal of two of the dots for 2016.

The risk-on mood has continued since, with risk asset yields helped not just by a

tendency for spread compression but also by contained core yields. Hence for investors,

2016 has turned into a strong total returns performance YTD, while for issuers the

possibility to issue low coupons remains, into quite a receptive investor base. Investor

interest has been in longer dated issues, where a reasonable yield is attainable and carry

and roll down characteristics are maximised. Central European yields have benefited

generally from the combination of contained core yields, a risk-on mood and contained

risk metrics.

These circumstances are however tenuous. Risk factors include the ongoing possibility

for a downward lurch in the oil / commodity price complex, with likely difficult implications

for high yield / emerging markets. A Brexit is a systemic risk that could also play out in a

few months. Although we think the odds are against a Brexit, elevated risks of a possible

Brexit could cause concern in the intervening period. China could also test some

pressure points in the coming months, and remains a systemic threat too. Or, profit-taking

of strong YTD performances could prompt a bigger change in tone.

For now though the market environment is conducive to both performance and reception

for new issues. Central banks remain supportive and most risk factors are at bay for now.

The call for long dated core rates is for containment at or about current levels in this light.

The medium term outlook is still for a test higher in long yields and steeper curves, but

that requires a sentiment change in the direction of a more sustainably robust macro

prognosis. We like to position for this through 10yr payer swaptions in EUR IRS which

would also perform on any material elevation in volatility.

Padhraic Garvey

Market sentiment has turned

decisively positive

Contained core yields and a

tendency for spread

compression has helped risk

assets

Risk factors remain present,

not least from oil, Brexit and

China

We favour 10yr payer

swaptions in EUR IRS in this

environment


12

Fig 15 ING global forecasts

2014 2015F 2016F 2017F

1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY

United States

GDP (% QoQ, ann) -2.1 4.6 5.0 2.2 2.4 0.6 3.9 2.0 1.4 2.3 1.8 1.9 1.6 2.3 1.9 2.2 2.6 2.1 2.2 2.2

CPI headline (% YoY) 1.4 2.1 1.8 1.1 1.8 -0.1 0.0 0.1 0.4 0.1 1.1 1.1 1.3 1.7 1.3 2.2 2.4 2.2 2.1 2.2

Federal funds (%, eop)1 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.25 0.25 0.25 0.50 0.50 0.50 0.75 0.75 1.00

Fed monthly average asset

purchase total

65.0 45.0 25.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

3-month interest rate (%, eop) 0.30 0.20 0.20 0.20 0.30 0.30 0.15 0.40 0.40 0.65 0.80 0.80 0.85 1.05 1.10 1.30

10-year interest rate (%, eop) 2.71 2.53 2.49 2.17 1.90 2.35 2.03 2.20 1.85 1.90 2.00 2.10 2.20 2.30 2.40 2.40

Fiscal balance (% of GDP) Fiscal Year 2014/15 -2.8 Fiscal Year 2015/16 -2.7 Fiscal Year 2016/7 -2.4 Fiscal Year 2017/18 -2.3

Fiscal thrust (% of GDP) 0.0 0.2 0.2 0.0

Debt held by public (% of GDP) 74.1 74.2 73.8 73.2

Gross public debt/GDP (%) 102.4 102.6 102.2 101.8

Eurozone

GDP (% QoQ, ann) 0.9 0.2 1.2 1.5 0.9 2.2 1.6 1.2 1.4 1.5 1.2 1.2 1.4 1.7 1.3 1.7 1.8 1.8 1.9 1.7

CPI headline (% YoY) 0.7 0.6 0.4 0.2 0.5 -0.3 0.2 0.1 0.2 0.1 0.1 0.2 0.5 0.8 0.4 1.2 1.4 1.6 1.7 1.5

Refi minimum bid rate (%, eop) 0.25 0.15 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.00 0.00 0.00 0.00 0.00 0.00 0.00

3-month interest rate (%, eop) 0.28 0.21 0.08 0.08 0.02 -0.01 -0.04 -0.14 -0.22 -0.26 -0.27 -0.28 -0.28 -0.28 -0.27 -0.25



Fiscal thrust (% of GDP) -0.2 0.1 0.2 0.2


Japan

GDP (% QoQ, ann) 4.5 -7.6 -1.1 1.3 -0.1 4.6 -1.4 1.4 -1.1 0.5 0.7 1.5 1.5 1.9 0.6 4.2 -6.2 -0.6 1.3 0.5

CPI headline (% YoY)2 1.6 3.6 3.3 2.7 2.7 2.3 0.5 0.2 0.3 0.8 0.2 0.2 0.3 0.7 0.4 1.3 2.5 2.6 2.5 2.2

Excess reserve rate (%) 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1

BoJ asset purchase total 213 227 249 270 290 310 330 350 370 390 410 430 450 470 485 500


10-year interest rate (%, eop) 0.64 0.56 0.52 0.32 0.39 0.45 0.35 0.26 -0.09 -0.15 -0.07 -0.02 0.02 0.05 0.05 0.05


Fiscal thrust (% of GDP) 0.4 -0.8 0.0 0.0


China

GDP (% YoY) 7.4 7.5 7.3 7.3 7.4 7.0 7.0 6.9 6.8 6.9 6.7 6.6 6.5 6.3 6.5 6.7 6.6 6.4 6.4 6.5

CPI headline (% YoY) 2.3 2.2 2.0 1.5 2.0 1.2 1.4 1.7 1.5 1.4 2.3 2.0 1.9 1.8 2.0 2.0 1.8 1.7 2.0 1.9

PBOC 1yr deposit rate (% eop) 3.00 3.00 3.00 2.75 2.50 2.00 1.75 1.50 1.25 1.00 1.00 1.00 1.00 1.00 1.00 1.00

PBOC 1yr best lending rate (% eop) 6.00 6.00 6.00 5.60 5.35 4.85 4.60 4.35 4.10 3.85 3.85 3.85 3.85 3.85 3.85 3.85

7-day repo rate (% eop) 4.19 4.07 2.91 5.07 3.80 3.30 2.39 2.49 2.25 2.00 2.00 2.00 2.00 2.00 2.00 2.00

10-year T-bond yield (%, eop) 4.54 4.09 4.07 3.62 3.60 3.62 3.27 2.86 2.75 2.50 2.50 2.50 2.80 3.00 3.30 3.60

Fiscal balance (% of GDP) Fiscal Year 2014/15 -2.0 Fiscal Year 2015/16 -2.7 Fiscal Year 2016/17 -3.2 -3.0

Fiscal thrust (% of GDP) n/a n/a n/a n/a

Public debt (% GDP), incl. local

govt.

56.6 60.2 64.1 64.1

UK

GDP (% QoQ, ann) 3.6 3.4 2.5 2.5 2.9 1.7 2.4 1.7 1.9 2.2 1.7 1.6 1.9 2.7 1.9 3.0 2.6 2.7 2.7 2.6

CPI headline (% YoY) 1.7 1.7 1.5 0.9 1.5 0.1 0.0 0.0 0.1 0.0 0.3 0.5 0.8 1.5 0.8 2.4 2.9 3.0 2.9 2.8

BoE official bank rate (%, eop) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50 1.75

BoE Quantitative Easing (£bn) 375 375 375 375 375 375 375 375 375 375 375 375 375 375 375 375




Fiscal thrust (% of GDP) -0.9 -0.9 -1.5 -0.7


EUR/USD (eop) 1.38 1.36 1.26 1.21 1.05 1.10 1.12 1.09 1.13 1.10 1.10 1.10 1.15 1.17 1.18 1.20

USD/JPY (eop) 103 102 109 120 120 123 120 120 112 112 112 112 112 112 110 110

USD/CNY (eop) 6.21 6.20 6.14 6.21 6.20 6.20 6.36 6.52 6.48 6.50 6.50 6.53 6.53 6.51 6.50 6.50

EUR/GBP (eop) 0.83 0.80 0.78 0.78 0.71 0.71 0.74 0.74 0.79 0.80 0.76 0.76 0.76 0.77 0.78 0.80

Brent Crude ($/bbl, avg) 108 110 103 77 55 64 51 39 35 30 35 40 50 55 60 65

1Lower level of 25bp range

2Includes effect of April 2014 and 2017 consumption tax increases

Source: ING forecasts


13

Disclosures Appendix ANALYST CERTIFICATION

This publication has been prepared by ING (being the commercial banking business of ING Bank N.V. and certain subsidiary

companies) solely for information purposes. It is not investment advice or an offer or solicitation to purchase or sell any

financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when

published, but ING does not represent that it is accurate or complete. The information contained herein is subject to change

without notice. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this

publication. This publication is not intended as advice as to the appropriateness, or not, of taking any particular action. The

distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose

possession this publication comes should inform themselves about, and observe, such restrictions. Copyright and database

rights protection exists in this publication. All rights are reserved. ING Bank N.V. is incorporated with limited liability in the

Netherlands and is authorised by the Dutch Central Bank.

Monthly Economic Update · Monthly Economic Update April 2016 2 US: Twisting and turning The latest...

Documents

Transcript of Monthly Economic Update · Monthly Economic Update April 2016 2 US: Twisting and turning The latest...