Itaú BBA - Goodbye 2014, Hello 2015

Global Scenario Review

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Goodbye 2014, Hello 2015

January 16, 2015

Global growth should improve from last year, but not much.

Global Economy
Global growth likely to improve, but not impress

Global growth to improve modestly this year compared with 2014, with the U.S.being the only major bright spot. The emerging markets outlook remains challenging, with growth improving in only a few economies.

The adjustment has started and it won’t be easy

The government has started the process of making the needed adjustments, announcing measures to improve the fiscal picture and reduce lags in regulated prices. We now expect lower growth and higher inflation in 2015.

Better days to come

Indicators available for 4Q14 are still mixed. But for 2015 we expect the economy to accelerate, helped by the ongoing recovery of the U.S. economy, the expansionary fiscal and monetary policies and the implementation of the structural reforms.   

Inflation hits the brakes

Activity is showing some signs of improvement from earlier in the year, but it continues to evolve below trend and confidence remains depressed. Inflation in December decelerated sharply on the back of falling oil prices.  


The economy is recovering on a sequential basis. We expect a 4.7% GDP growth this year, up from an estimated 2.5% expansion in 2014. The central bank cut the policy rate by 25 bps in January and announced another reduction in reserve requirements.      

Gradually slowing

Activity is gradually slowing, even though consumption-related indicators remain very strong. In 2015, the drop in oil prices will have a notable negative impact. We expect the economy to expand by 3.5% this year.

Postponing adjustments

The proximity of the 2015 political change and the potential capital inflows associated with it will likely allow the government to postpone the necessary adjustments. A deal with the holdouts will also be postponed, despite the expiration of the RUFO clause.    

Oil: Where is the bottom?

We believe that the adjustment of oil prices will take a few months, so we are reducing our forecast for prices for the first half. Low oil prices are affecting other commodities through cost deflation, an increase in risk aversion and substitution (from ethanol or natural gas).

Goodbye 2014, Hello 2015

Global growth should improve from last year, but not much. The obvious bright spot is the U.S., with a steady recovery now boosted in the short term by the effects of falling oil prices. Japan and Europe also benefit from cheaper crude, but growth remains sluggish. In Europe, below-target inflation justifies more vigorous actions by the European Central Bank, which would trigger further depreciation of the euro. Political uncertainties in Europe and geopolitical tensions pose risks to the global scenario.

Among emerging economies, China continues to slow down. Oil producers are the biggest losers right now, particularly Russia and Venezuela, which face mounting challenges as oil prices slide.

In Latin America, following a weak performance in 2014, we expect recoveries in Mexico, supported by the economic performance of the U.S., and in Peru, thanks to more expansionary economic policies and a more flexible and open economy. Chile should still face headwinds to faster growth, while in Colombia, which showed strength in 2014, the economy is set to lose momentum.

In Brazil, the government started an adjustment process that is broader than we anticipated, announcing measures to improve the fiscal picture and reduce lags in regulated prices. These are needed and welcome measures. However, the initial condition is worse than expected, requiring an adjustment that is deeper than we anticipated. Hence, we lowered our growth forecast while raising our estimate for inflation in 2015. Given the slowdown in activity and continuing risks of electricity and water shortages in the Southeast, the next months will be challenging.

In Argentina, notwithstanding a more challenging external environment, the government found room to delay adjustments, taking out short-term loans and tightening currency controls. Now the more likely scenario is currency depreciation and monetary contraction after the elections later in the year. A deal with the so-called holdouts will also be postponed, despite the expiration of the RUFO (Rights Upon Future Offers) clause.


Global Economy

Global growth likely to improve, but not impress

• Global growth to improve modestly this year (3.5%) compared with 2014 (3.2%), with the U.S. the only major bright spot.

• The fall in global inflation allows for accommodative monetary policy in major economies, but we still believe that the U.S. Fed will start increasing interest rates in June.

• The political environment in Europe is becoming an important risk factor in the scenario.

• The emerging markets outlook remains challenging, with growth improving in only a few economies. 

We see only a moderate and uneven improvement in global growth this year (3.5%) compared with 2014 (3.2%), with the U.S. economy being the only major bright spot. Europe and Japan are struggling, and China remains in a gradual but bumpy slowdown.

The decline in oil price helps consumers across the globe and supports this improvement in growth, but it also creates financial risks that seem concentrated in emerging markets. In particular, oil producers like Venezuela and Russia face strong fiscal pressures. Energy companies are also exposed. Overall, the risk of credit events appears to have increased in emerging economies.

The political environment in Europe is becoming an important risk factor in the scenario. With elections on January 25, Greece is an immediate risk.

The fall in global inflation continues to allow for accommodative monetary policy in major economies. The European Central Bank (ECB) will likely announce a quantitative-easing program in January. The People’s Bank of China (PBoC) is also in an easing mode and it has room to provide additional stimulus if necessary to stabilize short-term growth.

However, we still believe that the U.S. Fed will start increasing interest rates in June 2015. The strong job market will give confidence for the FOMC to start the rate-normalization process. However, with low price and wage inflation, the pace of rate hikes could be gradual.

This scenario is supportive for the USD to continue to strengthen in 2015.

Commodities prices should stabilized during the year. But oil prices will likely remain close to the current low levels in 1H15.

The outlook for emerging markets remains challenging, with growth improving in only a few places. In Latin America, we see a meaningful pickup in Mexico (2014: 2.2%; 2015: 3.5%) and Peru (2014: 2.5%; 2015: 4.7%). Chile (2014: 1.7%; 2015: 2.5%) should continue to grow below potential. Colombia (2014: 4.7%; 2015: 3.5%) will likely decelerate, while Argentina (2014: -2.3%; 2015: -2.0%) remains in recession. In Brazil (2014: 0.1%; 2015: 0.2%) we expect the economy to remain close to stagnated.

U.S. – The end of the zero-interest-rate policy in 2015

Economic growth is strong in the United States, boosted by easy financial conditions and the lower oil prices. U.S. GDP growth was revised up to 5.0% qoq/saar (from 3.9%) in 3Q14 and we expect it to expand 3.0% (previously we had 2.5%) in 4Q14.

The momentum for consumption is robust. Household real disposable income is being boosted by stronger payroll gains, which averaged 264 thousand per month in 2H14. The oil-price drop is reducing energy bills and boosting discretionary spending (see chart). Personal consumption expenditure (PCE) was revised up to 3.2% qoq/saar (from 2.2%) in 3Q14 and will likely accelerate to above 4.0% in 4Q14, remaining at a robust 3.0%-3.5% pace in 1Q15.

We revised our 2014 GDP forecast up to 2.5% (from 2.3%) and to 3.3% (from 3.0%) in 2015. For 2016, we expect 2.5%. 

The labor market will also continue to improve at a solid pace in 2015. We expect the non-farm payroll to add an average of 200 thousand net jobs per month, slightly less than in the 246 thousand in 2014. This should drive the unemployment rate down from 5.6% in December 2014 to 5.0% by the end of 2015.

In our view, this is consistent with the Fed starting to raise rates in June 2015. In December, the FOMC changed its forward guidance from “considerable time” to “patience” before starting to raise rates, in line with our call. The FOMC used the same guidance in January 2004 and started the hiking cycle in June 2004, about the same time frame that we see now. Looking at FOMC members’ projected path for the Fed funds rate, we judge that the committee’s base case remains June 2015.

The risk remains tilted toward a later start of the hiking cycle due to still-low inflation. Most FOMC members foresee raising rates with the core PCE deflator around the current levels (1.4% yoy), but only when they are “reasonably confident” that inflation will converge toward their 2% target. With the improvement in the labor market, this will happen, in our view, by June. But risks to core inflation are slightly on the down side due to the indirect effects of the energy-price deflation, the risk of second-round effects from energy prices on long-term inflation expectations and the lack of wage inflation pressures (average hourly earnings printed -0.2% mom and 1.7% yoy in December).

Our forecast for U.S. Treasury yields remains above the forward markets. However, given the global environment (lower commodities prices and weak economies), the pace of the Fed rate hikes should be slower (25 bps every other meeting) and the term premium should remain lower for longer. Therefore, we reduced our 10-year Treasury forecast to 2.8% (from 3.0%) in end-2015 and to 3.3% (from 3.5%) in end-2016.

Europe – ECB to launch QE in January political risks come to the forefront

We see signs that activity stabilized toward the end of 2014, after decelerating for most of the year. Survey data stopped declining and remain at a level that indicates moderate growth. For instance, the composite Purchasing Managers’ Index (PMI) came at 51.4 in December, up slightly from the 51.1 recorded in the preceding month. The euro-zone overall economic sentiment indicator was unchanged at 100.7 and the German IFO survey rose to 105.5 from 104.7.

Growth will likely pick up in the beginning of the year, as the confidence shock due to the Russia/Ukraine crisis wears off and the effect of lower oil prices comes through. While the economic situation in Russia is deteriorating, the main channel through which it affected the euro area was consumer and business confidence – and there are clearer signs it has now worn off. Additionally, the large decline in oil prices is positive for the region, as the fall in energy prices provides a boost to households’ real wages.

We maintain our GDP-growth forecasts at 0.8%, 1.0% and 1.4%, respectively, in 2014, 2015 and 2016.

The effect of oil prices on inflation is also bringing a stronger sense of urgency to the ECB, which we expect to announce a government-bond purchases program in January. Comments by the central bank’s voting members suggest that most of them are not willing to wait to assess the full effect of the decline. Headline inflation has turned negative to -0.2% yoy in December from 0.3% yoy previously, and will likely continue at these levels in the coming months. ECB members see increased risks that the fall will affect core inflation through second-round effects and destabilize long-term expectations as market-based inflation expectations continue to fall.

The effect of the asset-purchasing program on economic activity is limited. In an environment of near-zero (short-term and long-term) interest rates in the Eurozone, transmission of the balance sheet expansion should take place mainly through currency depreciation.

In anticipation of capital inflows due to the Eurozone QE, monetary authorities in Switzerland, a trading partner of the bloc, surprised the market by withdrawing its currency floor. This led to a sharp appreciation of the franc (by approximately 15% during the day). The Swiss central bank also reduced deposit rates by 50bps, taking the target range to between -1.25% and -0.25%. The strengthening exchange rate will likely decrease inflation and negatively impact economic activity, notwithstanding the fact that interest rates went deeper into negative territory.  

Greece is a new short-term risk in the scenario. The country is going into an early election on January 25 and the leftist party Syriza, which defends a haircut on the Greek debt and a reversal of some of the implemented reforms, is the favorite to win. The troika strongly opposes both, and the negotiations for the continuation of the international-community financial support to Greece look tense. But both sides have reasons to agree to a deal. While a haircut to the Troika debt is unlikely, further maturity extensions and lower interest rates will likely be agreed on, whatever party comes to power.

Contagion to other euro-zone-periphery countries has been limited – but Greece raises the issue of political risks in Europe. Extremist parties are receiving broader support in France, Italy, Spain and the UK (see graph). With elections this year in the last two countries, we will probably see continued worries about electoral developments. The terrorist attacks in Paris also underscore that security issues might become more pronounced in European countries. If we come to see other similar episodes, market reactions may become more exacerbated ahead.

Japan – Not yet a solid recovery

Japan is seen to be finally recovering from the slump that followed the VAT hike in April, but in a bumpy way. Industrial production and retail sales surprisingly declined, respectively, 0.6% and 0.3% mom in November. However, both remain up on average for 4Q14 when compared with 3Q14 (industrial production: 1.4% qoq; retails sales: 0.9%).

For a more solid recovery, the country needs to see stronger wage growth. Since Abenomics began, even with a tighter labor market, nominal wages didn’t pick up, affecting households’ real income. To confirm the virtuous-cycle scenario from a more depreciated yen, real wages have to gain strength in the first half of 2015 and improve domestic consumption.

Prime Minister Abe’s reelection could give a new boost in this direction and, more generally, to the structural reforms agenda. The government coalition maintained the supermajority on congress and is likely to accelerate labor-market reforms, resume the Trans-Pacific Partnership negotiations and work on revitalizing regional economies. The government announced a JPY 3.2 trillion (USD 26 billion or 0.7% of GDP) stimulus package, which we expect to provide a moderate impulse to the Japanese economy.

We maintain our GDP-growth forecasts at 0.2%, 1.2% and 1.6%, respectively, in 2014, 2015 and 2016.

China – waiting for the reaction

Economic activity decelerated, reinforcing our expectation that sequential GDP growth will slow to 6.8% qoq/saar in 4Q14 from 7.8% in the 3Q14. Industrial production growth softened to 7.7% yoy in October and 7.2% in November from 8.0% in September, and the official manufacturing PMI slowed to 50.1 in December from a quarterly average of 51.3 in 3Q14. The shutdown of factories near Beijing to improve air quality before the APEC Summit in November may have played some role, but does not fully explain the slowdown.

December’s industrial production will likely improve, but only due to technicalities (more working days and payback from the temporary shutdown of factories in November). However, the manufacturing PMIs provide no reason to be optimistic about industrial production in the next few months.

In addition, policymakers reiterated after the rate cut in interest rates that there is no need to adopt strong stimuli for the economy and that they won’t change their prudent monetary-policy stance.

Despite the slowdown and falling inflation, we do not expect a policy shift towards a more aggressive pro-growth stance yet. For comparison, the latest material shift came in April 2014, following 6.1% qoq/saar sequential GDP growth in 1Q14, well below the 6.8% we expect for 4Q14.

It is true that the fall in inflation gives room for the government to stimulate the economy if needed. The CPI declined to 1.5% yoy in December from 2.5% in May, and PPI deflation widened to -3.3% yoy from -1.4% in the same period as the combination of overcapacity in key sectors and plummeting commodity prices are pushing prices down. As the fundamentals suggest the economy will slow further, more stimuli will likely take place, but they are still a few months ahead.

In any case, it is important to notice that any stimuli will only aim at stabilizing short-term growth and that the overall policy stance will remain prudent. Despite low inflation, there are other restrictions to launching aggressive stimuli. The credit-to-GDP ratio is already high (206%) and the government is trying to force credit growth (November: 14.8% yoy) to converge towards nominal GDP growth (3Q14: 8.5% yoy)

The scenario in which the government accepts slower growth is consistent with our current forecasts, so we maintain GDP growth at 7.4% for 2014 and 7.0% for 2015. We see an additional slowdown to 6.6% in 2016.

Oil prices: where is the bottom?

The Itaú Commodity Index (ICI) has declined by  16.2% since the end of November, once more driven by lower oil prices. The breakdown by component shows the impact of plummeting crude oil: the ICI-agricultural is down by 1.9%, the ICI-metals are down 7.6%, and the ICI-energy dropped 32.2%.

Brent prices plummeted to USD 50/bbl and are now 55% below the previous equilibrium price (USD 110/bbl). OPEC supply remained fairly stable, showing no reaction to the low oil prices. Indeed, estimates indicate that other OPEC countries stepped in and offset a small decline in Libyan supply.

Oil prices are dragging down other commodities, particularly base metals. First, the fall in energy prices lowers commodities’ production and transportation costs. Second, even though lower oil prices will increase global GDP growth, the sharp decline generates losses to key producing countries, to O&G companies and to banks exposed to these agents. These losses create risks of sizable credit events and are leading investors into a risk-off behavior, affecting other commodities. Finally, ethanol loses competitiveness against gasoline, potentially lowering corn demand for ethanol production in the U.S.

We still believe that Brent prices at USD 70/bbl will eventually balance supply and demand, but the adjustment may take a few months. Therefore we are forecasting average Brent prices in 1H15 at USD 52.5/bbl (previously: USD 70/bbl). We expect prices to recover in the second half of the year, reaching USD 70/bbl by year-end.

We lowered our year-end 2015 ICI forecasts by 1.2 p.p. and the average 2015 by 6.8 p.p. In addition to the change in the average price for the Brent, we reduced sugar and base-metal prices. With these adjustments, our year-end ICI forecast is 17.3% above current levels. Advancing to 2016, we expect the ICI to rise 3.4% yoy.



Please open the attached pdf to read the full report and forecasts.

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