Markets Roundup. Markets eyeing falling oil prices and Japanese yen. 17 November 2014 Research

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1 Markets Roundup 17 November 214 Research CONTENTS Market Movers 2 Economics Weekly Calendar 7 Central Bank Policies 8 Forecast Table 9 Interest Rates (3M 1yr) 1 Gov t Bond Yields (2yr 1yr) 11 Interest Rate & Bond Futures 12 Equities, Currencies & Commodities 13 DATA RELEASES United States 17/11 Industrial production 18/11 Producer prices 18/11 NAHB housing index 19/11 Housing starts/permits 19/11 Fed minutes 2/11 Consumer prices 2/11 Existing home sales Eurozone 18/11 ZEW index (Ger) 2/11 PMI business surveys United Kingdom 18/11 Consumer prices 19/11 BoE minutes 2/11 Retail sales 21/11 Public finances Markets eyeing falling oil prices and Japanese yen The decline in oil prices will benefit oil importing nations via lower inflation rates, but it hurts oil exporting nations (p.1 p.6). The Chart of the Week shows Brent and WTI oil prices. The depreciation of the Japanese yen - caused by the Bank of Japan s expansion of its monetary easing programme - may raise some eyebrows in the region (and maybe also outside the region). Last week, Chinese data confirmed that growth of the world s second largest economy is slowing. This adds to concerns that also global growth will weaken and it increased concerns of especially emerging market economies that the weakening value of the yen will contribute to even more difficult times ahead. Currencies are probably going to attract more attention. But there is more that raised our awareness about a more fragile situation in emerging markets. The Fed s plan to tighten monetary policy next year has been an important reason for the appreciation of the US dollar. A dollar appreciation historically has been a bad signal for emerging markets as they funded themselves with foreign currencies, mostly via the USD. And as there was plenty of cash in the system, the global liquidity injections since 29 resulted in an increase of leverage. For example, private sector debt as a percentage of GDP in Emerging Asia rose to levels last seen at the end of the 199s. Indeed, that was when the East Asian financial crisis occurred. That period was also featured by declining oil prices, which contributed to the Russian crisis in So far, we have only used the word emerging markets, but it should be clear that not all emerging market countries will suffer equally from adverse developments. The ones with savings deficits (i.e. have a current account deficit, such as Brasil and Indonesia) and that are most dependent on commodity exports (e.g. Russia) are most vulnerable. Chart of the Week: EMs under pressure from lower oil prices? USD per barrel RESEARCH Duncan de Vries Erwin Langewis E: nibc.research@nibc.com WTI oil prices Brent oil prices Source: Macrobond Important disclosures appear on the final page of this document

2 MARKET MOVERS: REVIEW & PREVIEW United States Falling commodity prices will not only affect oil exporting nations such as we discussed on the front page, but it will also affect commodity importing nations. The decline in commodity prices is effectively an indirect tax cut and it shows that deflation is not per definition bad news. Indeed, we anticipate official inflation rates to fall a bit further the coming months. And the retail sector will likely benefit from this development. Indeed, retail sales excluding autos and gasoline rose.6% on the month in October and the retail sales report suggests that real consumer spending will accelerate in Q4. Yet, as the domestic economy is still relatively strong, domestic price pressures in the US are building. For example, the past weeks we finally got some evidence of rising wage growth. The employment cost index and also the compensation per employee hour picked-up recently. And given that unit labour costs also rose, this suggests that core inflation will eventually rise as well. These developments probably are starting to worry Fed officials. As long as the rise in wage growth continues, policy makers at the Federal Reserve will likely look through the dip in inflation rates caused by falling commodity prices. Domestic price pressures are rising % change on a year ago % change on a year ago Core CPI inflation (LS) Unit labour costs (2 quarters advanced, RS) But as long as inflation rates remain at modest levels and medium-term (market-based) inflation expectations are below longer-run average levels, we don t expect the Fed to strike a very hawkish tone soon. In fact, the current situation in which the unemployment rate (5.8%) is moving close to the socalled natural rate (5.2%-5.5%), but official inflation rates (CPI and PCE inflation) remain at subdued levels (and may thus fall further the coming months), will likely intensify the debate between the two camps within the Fed s FOMC: one camp will prefer sooner tightening actions and the other camp prefers no tightening actions anytime soon. Overall, we remain confident with our expectation that the first rate hike could come in mid-215. And we were therefore happy to see that the Fed s Dudley said that the market expectations that expect us to lift off some time around the middle or later next year are reasonable expectations. The Fed seems willing to raise rates, but Dudley reiterated that the timing and pace of rate hikes depends on how the economy performs. In our view, the Fed should have already raised rates with an economy that expanded on average almost 4% in nominal terms the past 5 quarters. The chart also shows that the Fed s own labour market conditions index - based on 19 monthly labour market indicators - has improved for a very long period of time as only in the and periods the index improved one month longer. Keeping rates at % is absolutely unnecessary and stimulates speculation and overinvestments. This is bad news for economic growth prospects and makes a higher interest rate more damaging for the economy compared to a situation in which interest rate levels would have moved in tandem with economic growth. Labour market improves for a long time Average monthly change (percentage) Fed labour market conditions index In addition, and which was actually a more interesting comment from Dudley, it is also going to depend a bit on how the financial markets react to our tightening. If the first move in rates leads to very violent reactions in financial markets, we would probably want to slow down, he argued. It was another comment that fits in the message the central bank has given to financial markets. The Markets Roundup 2 17 November 214

3 central bank has made clear that the institute has created a new mandate for itself apart from maximum employment and price stability: protecting the markets from falling sharply. And the central bank has a reason for that: only rising asset prices have improved net debt levels. Imagine what happens when asset prices tumble This week s agenda will focus on the Fed s FOMC minutes and consumer price inflation (CPI) data. The discussion about the potential removal of the considerable time phrase in the Fed s FOMC statement will be watched most closely by us. We still expect this forward guidance to be removed in December and that the minutes of the late October meeting will signal a more hawkish stance. This week s minutes should therefore give strong signals whether this remains our base case scenario. And a removal of the considerable time phrase in December would mean that a rate hike in mid-215 becomes increasingly likely. The annual consumer price inflation rate is expected to tick-down a bit and we anticipate it to slow further the coming months, due to falling oil prices. Accordingly, core inflation (excluding food and energy) may actually have risen in October. Furthermore, housing market data (housing starts, building permits, existing home sales) will probably confirm that activity is only slowly rising. And as house price appreciation is slowing, a marginal improvement in activity is probably the best we can hope for. In Japan, Abe may announce snap elections and announce the delay of the planned tax hike for next year after the economy fell in recession. On Thursday, the Chinese flash PMI will attract attention. Eurozone Eurozone central bankers keep on doing their bit on influencing financial markets and making their own positions regarding unconventional policy known to the public. As such, we noted that only a few days after the ECB meeting that was held on 6 November and where ECB president Mario Draghi tried to convince market participants that the ECB is preparing solutions to combat deflation and boasted that all ECB governing council members signed off his prepared remarks, it took only a few days until Jens Weidmann, German Bundesbank president and governing council member, dismissed the idea that the ECB needs to do public sector QE. Weidmann indicated that one should not compare the ECB with the Fed or the BoJ and said that risks for deflation are limited. Moreover, he said that Germany does not need additional economic stimulus, because monetary policy is already too expansive for Germany. However, as Weidmann was speaking in Germany (in Bavaria) his comments may have had only the intention to sooth domestic worries over money printing central bankers. The third quarter GDP figures that were published last Friday for eurozone member countries revealed that the eurozone economic aggregate expanded by.2%, which was slightly better than the expected.1%. However, Weidmann s idea that monetary policy may be too expansive for Germany or that it does not need economic stimulus may not be shared by everyone. The German economy grew by just.1% last quarter, only wiping out a comparable decrease in economic activity in the second quarter of this year. Accordingly, the German economy has been stagnating at best lately and considering that German business surveys have been trending lower recently, it may be the case that the economy may not show that much strength either in the last few months of this year. Compared to the same quarter a year earlier, the German economy expanded by 1.1% (see the chart). Fortunately for the Germans, unemployment is relatively modest in their country and as such a few quarters of stagnation will not rock the boat. However, Germany s fellow eurozone members are generally not that lucky and as such market commentators were curious how France and the eurozone periphery fared last quarter. German GDP growth % change on a year ago Real GDP growth Germany Markets Roundup 3 17 November 214

4 The French economy posted surprisingly.3% growth last quarter, thereby challenging relatively weak business confidence results over the past months: the French PMI was at 48 last month! Nevertheless, also the French economy has been stagnating effectively this year, only growing by.4% over the last four quarters. Moreover, one should not be surprised when the result of +.3% will be downwardly revised at a later stage as the GDP results of France are so much at odds with the recessionary level of its PMI business confidence levels. Moreover, economic growth was driven by inventories and government spending, while business investment, that is in a downward trend since late 211, declined again. In other words, there is not much hope for stronger growth ahead. Interestingly, the two main periphery countries, Spain and Italy are now clearly on separate growth trajectories. Italy has remained in recession last quarter, posting a decrease in real GDP by.1% compared to the previous quarter and a decrease by.4% compared to a year ago (GDP levels are now at early 2 levels). In contrast, the Spanish economy expanded by.5% on the previous quarter and 1.8% compared to a year earlier. This is slightly better than the Greek economy, which expanded by 1.7% over the last 12 months. Clearly, Italy is now the weakest spot in the eurozone. However, it is interesting to note that both Spain and particularly Greece are characterised by deflation in consumer prices. Apparently, deflation is not (always) all that bad! That the eurozone GDP figures were coming in slightly above expectations may have been a relief for the ECB. However, at the same time inflation figures continue to remain very low and in a context of falling oil prices, market participants are now focussing on the prospect for inflation to stay very low or to become negative, which would put further pressure on the ECB to ease monetary policy. Especially as we anticipate the ECB to lower GDP and CPI inflation projections in December. The CPI figures of October were published last week for several member states as well as for the eurozone aggregate. Inflation in the eurozone climbed somewhat to.4% compared to.3% in September. Inflation in Germany remained at.8%, but it has been falling earlier this year and last year Consumer prices Germany and France % change on a year ago Germany France (chart below). This is an interesting development as Germany has also seen its labour market tighten over the last years and wage growth has been picking-up. So far, however, this is not reflected in CPI figures. In France, inflation picked up slightly to.5% from.3% in September and is thereby hardly lower than in Germany, despite its much weaker labour market. The periphery continues to flirt with CPI deflation as Spain, Portugal, Ireland and Slovenia are all posting annual inflation rates around zero percent. Greece, however, is experiencing a quite serious deflation of the price level of consumer goods and services: annual inflation dropped to -1.7%. However, deflation appears to be helpful for Greece as its economy managed to grow as mentioned above. After last week was relatively busy with economic data releases, this week s macroeconomic agenda is relatively quiet. The German ZEW index is scheduled for publication tomorrow. After the slide in the ZEW index this year, it is expected that investor optimism roughly flat lined last month. The eurozone Markit preliminary PMI s for November will be published on Thursday. The eurozone s Markit composite PMI is expected to rise.3 points to 52.4 in November as the manufacturing PMI is foreseen to increase.4 points to 5 and the services PMI to settle at 5, only.1 higher than last month. Accordingly, the PMI data continue to suggest GDP growth of about.2% on a quarterly basis, which is what we are expecting for GDP growth in the fourth quarter as well. Moreover, Draghi will hold speeches today and on Friday. Markets Roundup 4 17 November 214

5 United Kingdom All eyes were on the BoE s Inflation Report. As a reminder, interest rate hike expectations have been volatile the past months and at one point in time markets even started to price in a first rate hike as soon as this month. That will unlikely happen. Indeed, that speculation was boosted by Carney s comments in June that interest rates could be raised sooner than markets currently expect. We kept our mid-215 rate hike expectation in place the past months. But rather than that the timing of our rate hike forecast might be too late, it now seems that there are risks that the first increase might come later. The Inflation Report showed that the BoE s Committee sees inflation remaining below 2% for the entire forecast period, based on a first 25bps rate hike only in Q Accordingly, the message from the UK s central bankers was once again that they are in no hurry to raise rates. It all depends on incoming data. And while we see no reason for the BoE to keep rates as low as they are for several reasons (e.g. keeping rates too low gives incentives for speculation and overinvestments, meaning that economic growth potential weakens), the BoE thus clearly disagrees with us. The loss of growth momentum has pushed risks for a first rate hike backwards. Our base case, however, remains a first hike in mid One of the reasons for our unchanged expectation is that the labour market report showed that wage growth rose to % (3m/yoy) in September from.7% previously. With the unemployment rate already below long-run average levels and households having experienced a prolonged period of negative real earnings growth, we expect earnings growth to rise further the coming months. Accordingly, the BoE will unlikely signal that a rate hike is in the cards soon given weakening growth momentum, but as labour market conditions improve and earnings growth rises, we expect debates on the MPC to flare up in the first half of next year. Housing market under pressure Net balance RICS housing market survey price balance RICS housing market survey price balance declined to 2% in October, the lowest level since May 213. Although the index is still at robust levels, the decline since March shows that momentum weakened significantly even though borrowing costs are extraordinary low from a historical perspective. The BoE said in its Inflation Report that recent developments may be partly due to some restrictions in mortgage availability, but also said that easing in demand for housing finance may have been a factor. If even low interest rates cannot boost house prices (indeed, we already showed that also the US housing market is under pressure), we wonder what central banks will do when house prices decline. Doing nothing, and let market forces do the work is an option, but the last years showed that central bankers certainly not have the nerves of a poker player. RICS housing market survey price balance London This week s agenda will focus on consumer price data. The annual price data fell to 1.2% in September, while core inflation was at %. Inflation rates may pick-up slightly in October. Also, retail sales fell in September, but as consumer confidence remains at robust levels, the fall in oil prices supports the real purchasing power of households and labour market conditions continued to improve, we anticipate a small rebound in sales in October. Lastly, the BoE s MPC minutes might show that the committee has become somewhat more dovish recently owing to a weakening in domestic and foreign economic growth momentum. For the short-term, policy makers probably point to the global backdrop, particularly in the eurozone. Moreover, the slowing in house price inflation might get some more attention. For example, the Markets Roundup 5 17 November 214

6 ECONOMIC CALENDAR 17 NOVEMBER 21 NOVEMBER, 214 UNITED STATES Date Time Indicator BN Survey Prior Monday 17 November 14:3 US Empire Manufacturing Nov :15 US Industrial Production MoM Oct.2% % 15:15 US Capacity Utilization Oct 79.3% 79.3% 15:15 US Manufacturing (SIC) Production Oct.3%.5% Tuesday 18 November 14:3 US PPI Final Demand YoY Oct 1.2% 1.6% 14:3 US PPI Ex Food and Energy YoY Oct % 1.6% 16: US NAHB Housing Market Index Nov Wednesday 19 November 14:3 US Housing Starts Oct 125K 117K 14:3 US Housing Starts MoM Oct.8% 6.3% 14:3 US Building Permits Oct 138K 118K 14:3 US Building Permits MoM Oct.6% % 2: US Fed Minutes Oct FOMC Meeting Thursday 2 November 14:3 US CPI MoM Oct -.1%.1% 14:3 US CPI YoY Oct 1.6% 1.7% 14:3 US CPI Ex Food and Energy MoM Oct.1%.1% 14:3 US CPI Ex Food and Energy YoY Oct 1.7% 1.7% 16: US Existing Home Sales Oct 5.15M 5.17M 16: US Existing Home Sales MoM Oct -.4% 2.4% EUROZONE Date Time Indicator BN Survey Prior Monday 17 November 11: EC Trade Balance SA Sep 16.B 15.8B Tuesday 18 November 11: GE ZEW Survey Current Situation Nov : GE ZEW Survey Expectations Nov Wednesday 19 November 1: EC ECB Current Account SA Sep B 11: EC Construction Output MoM Sep -- % 11: EC Construction Output YoY Sep % Thursday 2 November 8: GE PPI MoM Oct -.2%.% 8: GE PPI YoY Oct -% -% 9:3 GE Germany Manufacturing PMI Nov P :3 GE Germany Services PMI Nov P :3 GE Germany Composite PMI Nov P : EC Eurozone Manufacturing PMI Nov P : EC Eurozone Services PMI Nov P : EC Eurozone Composite PMI Nov P : EC Consumer Confidence Nov A UNITED KINGDOM Date Time Indicator BN Survey Prior Tuesday 18 November 1:3 UK CPI MoM Oct.1%.% 1:3 UK CPI YoY Oct 1.3% 1.2% 1:3 UK CPI Core YoY Oct 1.6% % 1:3 UK RPI YoY Oct 2.3% 2.3% 1:3 UK RPI Ex Mort Int.Payments (YoY) Oct 2.3% 2.3% 1:3 UK PPI Input NSA YoY Oct -8.4% -7.4% 1:3 UK PPI Output NSA YoY Oct -.2% -.4% 1:3 UK PPI Output Core NSA YoY Oct.8%.8% Wednesday 19 November 1:3 UK Bank of England Minutes Thursday 2 November 1:3 UK Retail Sales Ex Auto YoY Oct 4.2% 3.1% 1:3 UK Retail Sales Incl. Auto YoY Oct 3.8% 2.7% 12: UK CBI Trends Total Orders Nov : UK CBI Trends Selling Prices Nov -5-3 Friday 21 November 1:3 UK Public Finances (PSNCR) Oct B 1:3 UK PSNB ex Banking Groups Oct 7.9B 11.8B Source: Bloomberg News Weekly snapshot of financial market developments in the United States, euro zone and United Kingdom

7 CENTRAL BANK POLICIES United States FOMC Policy interest rate: Federal funds target rate Last action: -75/1 bps on 16 December 28 Next Meetings: 17 December, 28 January Policy Outlook: The Fed funds rate has been cut to an unprecedented target range of -.25%. Furthermore, the Fed started to purchase assets and after Operation Twist ended in 212, decided to increase the size of asset purchases per month by a further USD 4bn. A total of USD 15bn of agency MBSs and Treasury securities are purchased per month. The QE programme is expected to end next month, while interest rate hikes are expected in June 215. FOMC minutes: 19 November, 7 January, 28 January Eurozone ECB Policy interest rate: Main refinancing rate Last action: -1 bps on 4 September 214 Next Meetings: 4 December, 22 January Policy Outlook: The ECB lowered its key policy rates by 1bps in September. The refi rate is at.5% (deposit rate at -.2%) and expected to remain at this level for an extended period. No rate hikes are expected before 216 at least. In addition to liquidity injections (TLTROs), the ECB is purchasing private sector assets (ABS and covered bonds). As the central bank is still dovish, there are risks for more actions later this year. United Kingdom - Bank of England Policy interest rate: Repo rate Last action: -5 bps on 5 March 29 Next Meetings: 4 December, 8 January Policy Outlook: Even though inflation rates are expected to remain at elevated levels, we expect the BoE to keep rates unchanged at.5% for the foreseeable future given a still weak economic recovery. The MPC purchased about GBP 375bn of assets. Rate hikes are expected in Q BOE minutes: 19 November, 17 December Markets Roundup 7 17 November 214

8 FORECAST TABLE United States Yearly averages Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 GDP (quarter-on-quarter) (year-on-year) Consumer Price Index (year-on-year) Federal funds rate * yr Treasury yield * Eurozone GDP (quarter-on-quarter) (year-on-year) Consumer Price Inflation (year-on-year) ECB refi rate * Germany GDP (quarter-on-quarter) (year-on-year) ,, Consumer Price Inflation (year-on-year) yr bond yield * Netherlands GDP (quarter-on-quarter) (year-on-year) Consumer Price Inflation (year-on-year) United Kingdom GDP (quarter-on-quarter) (year-on-year) Consumer Price Inflation (year-on-year) BoE bank rate * yr bond yield * *end of period Markets Roundup 8 17 November 214

9 INTEREST RATES (3M 1YR): ACTUALS & CURVE Policy Interest Rates (%) 3m Interest Rates minus Policy Rate (bps) m Interest Rates (%) 12m minus 3m Interest Rates (%) USD Libor Euribor GBP Libor 12m Interest Rates (%) 1 yr Interest Rate Swap Spread (bps) USD Libor Euribor GBP Libor Eurozone United Kingdom Source: Bloomberg Update: 11/17/14 9:39 Markets Roundup 9 17 November 214

10 GOVERNMENT BOND YIELDS (2YR 1YR): ACTUALS & CURVE 2 yr Benchmark govt Bond Yields (%) 1 yr minus 2 yr govt Bond Yields (%) yr Benchmark govt Bond Yields (%) 1 yr Interest Rate Swap Spread (bps) Real govt indexed Bond Yields (%) Estimate of Inflation Expectations (%)* US TIPS 217 (indexed to CPI) FR OATei 217 (indexed to Euro CPI) UK IL Gilts 217 (indexed to RPI) United States (CPI) Eurozone (CPI) United Kingdom (RPI) * Difference between nominal government bond yield and inflation-indexed bond yield ("breakeven inflation") with the same maturity (217) Source: Bloomberg Update: 11/17/14 9:39 Markets Roundup 1 17 November 214

11 INTEREST RATE & BOND FUTURES: MARKET EXPECTATIONS United States: 3m Eurodollar* United States: 1yr treasury yield* Current DEC 14 MAR 15 JUN 15 SEP 15 DEC Current DEC 14 MAR 15 JUN 15 Euro zone: 3m Euribor Euro zone: 1yr govt Bond Yield Current DEC 14 MAR 15 JUN 15 SEP 15 DEC Current DEC 14 MAR 15 JUN 15 United Kingdom: 3m Sterling United Kingdom: 1yr GILT Yield Current DEC 14 MAR 15 JUN 15 SEP Current DEC 14 MAR 15 Current ** Two weeks ago One month ago * Forward interest rates and bond yields implied by futures contracts. Source: Bloomberg Update: 11/17/14 9:39 Markets Roundup November 214

12 EQUITIES, CURRENCIES AND COMMODITIES Major Equity Markets Major Currencies S&P 5 (LS) FTSE Eurotop3 (LS) FTSE1 (RS) EUR/USD (LS) EUR/GBP (RS) USD/GBP (RS) Commodity Prices Oil Price* /7/212 31/7/ DJAIG Index Spot price (USD) Spot price (EUR) Source: Bloomberg; Update: 11/17/14 9:39 * West Texas Intermediate (WTI) Cushing Crude Oil Spot Price Disclaimer Certain statements in this presentation prepared by NIBC Bank N.V. ( NIBC ) are not historical facts but forward-looking statements. Words such as believe, anticipate, estimate, expect, intend, predict, project, could, may, will, plan and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. These statements are largely based on NIBC s current view with respect to future events and financial trends that we believe may affect the economy, the credit market in general and interest rates. By their very nature, forward-looking statements involve uncertainties and are subject to certain risks, including, but not limited to, the risks and uncertainties as addressed in this presentation, and/or changes in general economic conditions, changes in credit spreads or interest rates. The forward-looking statements speak only as of the date of this presentation. NIBC does not undertake any obligation to update or revise forwardlooking statements contained in this presentation, whether as a result of new information, future events or otherwise. The information and opinions presented here have been obtained or derived from public sources believed by NIBC to be reliable at the date of publication of this presentation. No warranty, prediction or representation is made as to their accuracy or completeness and they are subject to change without notice. NIBC does not make any representation, warranty or prediction that the results anticipated by such forward-looking statements will be achieved, and such forward-looking statements represent, in each case, only one of many possible scenarios and should not be viewed as the most likely or standard scenario. NIBC accepts no liability for (direct, indirect or consequential) loss arising from the use of the information and figures presented. This material is not to be relied upon in substitution for the exercise of independent judgment. When preparing this presentation NIBC has not taken into account any customer s, creditor s or investor s objectives, financial resources or other relevant circumstances and the opinions and recommendations herein are not intended to represent recommendations for particular creditors, customers or investors. NIBC is the owner of all works of authorship including, but not limited to, all design, text, sound recordings, images and trademarks in this presentation unless otherwise explicitly stated. The use of NIBC s material, works or trademarks is forbidden without written consent, except were otherwise expressly stated. Furthermore, it is prohibited to forward or publish material made or gathered by NIBC without its prior written consent. Markets Roundup November 214