Itaú BBA - Advanced economies improving, emerging economies adjusting

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Advanced economies improving, emerging economies adjusting

September 11, 2013

The performance of emerging markets is different. Most economies suffered a slowdown in growth and are affected by the prospect of QE tapering in the U.S.

Global Economy
QE Tapering about to Start
Our baseline scenario is of a steady increase in the U.S. rates in the next couple of years. The Eurozone has exit its recession and growth in China has stabilized.

Brazil
Fuel for Inflation
We incorporated in our scenario an adjustment in fuel prices before the end of 2013. We have maintained our forecasts for the Selic rate at 9.75% p.a. at the end of both this year and next year.  

Mexico
The Economy Offers a Negative Surprise
The economy performed in 1H13 was much worse than expected and the core inflation reached a new record low. The central bank reduced the monetary policy rate by 25 bps (to 3.75%).

Chile
Reversal Signs
Chile’s economy posted weak growth in 2Q13, but the number’s breakdown shows strong final demand growth. In addition, the first indicators available for 3Q13 came in strong.

Peru
A Wider Current Account Deficit
The current account deficit reached 5.0% of GDP, due mostly to lower copper and gold prices. The economy is slowing down, but the pickup in public investment is a buffer for the deceleration of private investment.

Colombia
Investment Remains Weak
Consumption has recovered, but investment remains weak. The central bank opened the way for additional monetary easing. We now forecast a 25-bp rate cut in the September meeting.

Argentina
Looking to the Supreme Court
The U.S. Court of Appeals issued a negative ruling against Argentina recently. The Argentine government is appealing to the U.S. Supreme Court and launching a new debt swap for all holdouts. The risk of a rerouting of payments to restructured bonds remains.

Commodities
Lower Grain Surplus, Higher Geopolitical Risk
We revised our year-end forecast for soybean prices upward, due to less-favorable weather since mid-August. Escalating conflict in Syria lifts crude-oil prices, but we expect the impact to be temporary.

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Advanced economies improving, emerging economies adjusting

The global economy is recovering. The U.S. is showing signs a moderate recovery and Europe is emerging from recession. In China, after a decelerating first half, growth is now maintaining the current levels.

Commodity prices have recovered, supported by the gradual reacceleration of global industry (metals), the adverse weather in the U.S. (grains) and geopolitical tension in Syria (oil).

The performance of emerging markets is different. Most economies suffered a slowdown in growth and are affected by the prospect of QE tapering in the U.S., which should start in September. Their currencies depreciate; the higher the current-account deficit, the stronger the depreciation.

In Latin America, Mexico is the exemplary case of deceleration; we now forecast growth at just 1.3% this year. The central bank surprisingly cut the interest rates, even with the devaluation of the peso in recent weeks, as core inflation hit a record low. Deceleration is less pronounced in Colombia and Chile, but the central banks also show an easing bias, given the low inflation. We expect rate cuts in both countries this year. Peru is also slowing down, and the central bank has been easing monetary conditions by reducing reserve requirements.

Brazil does not have the same flexibility. Despite the prospect of negative growth in the third quarter, the central bank needs to continue to raise interest rates in order to contain the inflationary effects of FX depreciation. The probable increase in fuel prices in the domestic market complicates the job. The central bank intensified currency intervention in order to reverse (successfully, so far) the rapid depreciation trend of the real observed in August.

In Argentina, the central bank has been allowing sharper currency devaluation as a way to avoid the peso from detaching from other currencies in the region (particularly the Brazilian real). The political and economic environment remains uncertain. The U.S. Court of Appeals issued a negative decision for the country in the case of the holdouts of the restructured external debt, and the government suffered a defeat in the primaries for the mid-term elections in October.

Global Economy
QE Tapering about to Start

•           The Fed is about to start reducing the pace of its monetary stimulus. We expect QE tapering to start in September. If delayed, it will be only for a short period.

•           Our baseline scenario is of a steady increase in the U.S. rates in the next couple of years as the Fed slowly normalizes its monetary policy.

•           The euro zone has exited its recession and growth in China improved in 3Q13 after the slowdown seen in 1H13.

•           Asset prices in emerging markets remain sensitive to upward movements in the U.S. interest rates, but the extent depends on domestic fundamentals.

The Fed is about to start reducing the pace of its monetary stimulus. We expect a tapering of Quantitative Easing (QE) starting in September. If delayed, it will be for a short period and QE tapering will start this year. The scenario remains one of a steady increase in the U.S. rates in the next couple of years as activity picks up and the Fed slowly normalizes its monetary policy. We expect the 10-year U.S. Treasury yields to continue grinding higher, achieving 3.0% and 3.5% at end of 2013 and 2014, respectively.

The recession in the euro area ended. The region’s GDP increased 0.27% in 2Q13 and we believe that it will expand 0.20% in the 3Q13. The euro area is recovering because exports continue to grow and domestic demand has stabilized. We continue to see a moderate pace ahead, but revised our growth forecast to -0.3% from -0.5% in 2013 because of revisions in past GDP figures.

In China, after a slowdown in 1H13, activity data has improved in 3Q13. Policy-makers adopted some small targeted stimulus measures that helped stabilize growth and support a better activity momentum in the 3Q13.  We increased slightly our GDP forecast to 7.6% from 7.5% in 2013 but maintain  7.2% for 2014.

Asset prices in emerging markets remain sensitive to movements in the U.S. interest rates. Policy makers reacted to defend their currencies. Economies with external liabilities and domestic vulnerabilities (weak fiscal position, high inflation and economy slowing down) tend to suffer more.

U.S. – Tapering about to start

Despite the modest outlook for the U.S. in 3Q13, the economy should accelerate, as the fiscal drag diminishes later in the year and into 2014. Our models currently indicate that the economy will likely expand only 1.5% (seasonal adjusted annual rate - SAAR) in 3Q13, down from 2.2% just a month ago. The lower pace in 3Q13 offsets the positive effect from the GDP revision to 2.5% (from 1.7% in the first estimate) in 2Q13. Hence, we kept our GDP forecast at 1.5% for 2013. We believe that the third quarter slowdown will be a blip before better growth at the end of the year takes hold (see graph). We continue to expect GDP to advance 2.5% in 2014.

Moreover, the labor market continues to make progress at a moderate pace, with payroll trend growth at 175k-200k/month, and the unemployment rate down to 7.4%.

It is true that financial conditions have tightened since May, especially after Bernanke hinted that QE tapering could occur later in the year, and, thus, create some downside risks to activity. Higher interest rates might be reducing residential investment. New home sales declined in July. MBA mortgage applications and pending home sales also weakened in the last couple of months, suggesting that housing demand may remain relatively soft in the near term.

However, the recent tightening has not meaningfully changed the outlook, as financial conditions remain accommodative, with very low short-term interest rates.

All in all, the scenario remains for the Fed to start reducing the pace of monetary stimulus, starting with QE tapering in September. We expect the FOMC to reduce the asset purchase program to USD 70 billion per month from USD 85 billion, reducing exclusively Treasury purchases in this first step. In conjunction, the FOMC may decide to give more details about its forward guidance, with the aim of avoiding further tightening of financial conditions.

With the sluggish real GDP in 3Q13 and mixed housing data, the FOMC might delay the tapering to wait for more signs of the expected improvement in the outlook. But this would likely be only for one or two meetings.

Overall, U.S. rates will likely increase in the next couple of years as activity picks up and the Fed slowly normalizes its monetary policy. We expect the 10-year U.S. Treasury yields to continue grinding higher, achieving 3.0% and 3.5% at end of 2013 and 2014, respectively.

Euro area – Recession ends, slow growth ahead

The euro zone’s GDP increased 0.27% qoq in 2Q13. We believe that the economy will expand at a moderate average of 0.20% per quarter in the second half of 2013 and continue to advance next year. We revised our growth forecast to -0.3% from -0.5% in 2013 because of revisions in past GDP figures. We maintain the 0.9% forecast for 2014.

The euro area is recovering because exports continue to grow and domestic demand stabilized. The sum of investments in fixed capital and private and public consumption contributed 0.23% to the GDP growth. This positive contribution came after six quarters of contraction in domestic demand (see graph) as several negative shocks – fiscal austerity, financial tightening, and tail-risks of a euro breakup – are receding. Some one-off factors (like a payback in construction investment in Germany after a long winter) helped in 2Q13, but the underlying growth trend improved. 

Although diminished, the negative shocks holding back the euro zone’s economy haven’t disappeared completely. There are still some fiscal adjustments, bank deleveraging and structural problems to be dealt with. Hence we expect positive growth to continue, but in the form of a slow-paced recovery.

Finally, we don’t expect any major change in policy after the German elections on September 22. Angela Merkel remains the favorite to win. It is uncertain whether she will be able to maintain her current coalition with the liberal FDP or will be forced into a grand coalition with the SPD, the main opposition party at the moment. In any case, none of major parties indicate a change in the German approach towards the euro area.

China – Better activity in 3Q13 after the slowdown in 1H13 

July’s and August data showed marginally stronger activity. The highlight was the pick-up in industrial production, edging up from 8.9% yoy in June to 9.7% in July and 10.4% in August (see graph). External trade data were also positive, showing both stronger exports and imports. Fixed-asset investment, loans, M2 and inflation came fairly close to expectations.

The stabilization in activity is occurring as policy-makers have signalled more support to short-term activity. The People’s Bank of China (PBoC) injected enough liquidity to reverse the tightening seen in money-market rates in late June and early July, halting fears that the tightening could further slow down the economy. Other measures aimed to facilitate access to financing by small and medium enterprises. State banks also released funds to some infrastructure projects. Finally, the State Council unveiled specific plans for fostering the environmental protection, energy efficiency and information services and technologies sectors.

Better activity in the developed markets can also help stabilize the country’s exports. The new export orders sub-index in the NBS’s Purchasing Manager’s Index recovered from 47.7 in June to 49.0 in July and then 50.2 in August.

Overall, the policy focus remains on medium- to long-term growth while avoiding short-term volatility. Policymakers have reinforced this message. The governor of the PBoC, Zhou Xiaochuan, has stated that it expects no major changes on monetary stance, saying that “prudent” monetary policy would continue. The premier, Li Keqiang, also expressed confidence that the GDP growth target of 7.5% for this year would be achieved under the current conditions.

All in all, we increased slightly our GDP forecast to 7.6% from 7.5% in 2013 but maintain the 7.2% in 2014. 

Commodities – Lower grain surpluses, higher geopolitical risk

The Itaú Commodity Index (ICI) has risen 3.0% since the beginning of August, driven by prospects of downward revisions to crop forecasts in the U.S., increased geopolitical risk due to Syria and better-than-expected economic data in China. The breakdown by component shows increases in the agricultural (2.8%), base metals (3.9%) and energy (4.0%) sub-indexes.

A new look at past conditions and worse weather suggest lower surpluses for soybeans and corn. Field surveys in the U.S. conducted in mid-August suggested the current official estimates for corn and soybean crops must be revised downward, something we already had in our scenario. However, unfavorable weather conditions in the main producing regions, particularly since mid-August, will probably hurt yields further. Hence we are increasing our year-end forecasts for soybeans to USD 13.2 per bushel from USD 12.5. In addition, weather uncertainty continues to pose upside risks to prices. Corn prices are less affected because the new estimates for global balance still point to a sizable surplus in the current crop year.

We expect metal prices to fall from current levels. Metal prices have risen 3.9% (according to the ICI metals sub-index) since the end of July, driven by restocking and better-than-expected economic indicators from China. But we expect prices to fall from current levels, as the restocking cycle fades and economic indicators show that growth in China is stabilizing, rather than rebounding in the second half of 2013. We maintain our forecasts for the ICI metals sub-index: -9.7% in 2013, and -7.0% in 2014, in line with overall weak fundamentals for metals.

Energy prices have risen 4.0% since the end of July, driven by an increase in geopolitical risk. The supposed use of chemical weapons by the Syrian government led to fears of a military response by the western countries. Syria is not a significant producer of crude oil, but its government is backed by Russia and Iran, generating risk of spillovers through the Middle-East. While the course of action of the western countries (and the reaction of Russia and Iran) is unclear, geopolitical risk will probably continue to maintain crude prices above the fundamentals in the short term. But we believe that the effect of the conflict on prices will fade until the end of the year. Hence, we are maintaining our forecasts for the ICI energy sub-index: 6.6% in 2013 and -0.8% in 2014.

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



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