Itaú BBA - Slowdown in emerging economies, recovery in the U.S.

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Slowdown in emerging economies, recovery in the U.S.

August 9, 2013

In Latin America, slowdown in economic activity along with low inflation figures makes room for a more-expansionary monetary policy bias.

Global Economy
Still a Growth Recovery
The U.S.’s growth recovery looks less strong at the moment. This is unlikely to preclude the Fed from starting to taper QE in September, but it indicates a cautious approach. China and emerging economies in general continue to decelerate.

Brazil
Lower Growth and Less Room to Maneuver
Lower confidence levels point to lower economic growth. Room for countercyclical policies is limited. We expect a more depreciated exchange rate this year and in 2014.  

Mexico
Currently Slowing, But Rebound in Sight
We have revised our growth forecast for 2013, as the economy remains weak. We expect a rebound during the second half of this year due to stronger growth in the United States. In 2014, economic reforms will likely help to boost growth.

Chile
Slower Growth
The economy posted a below-expectation growth during the first half of the year and inflation remains below the target.

Peru
Slowdown Ahead
Falling business confidence points to lower investment growth ahead. The Central Bank has been easing monetary conditions through macroprudential measures.

Colombia
Slow Growth and No Rate Hikes in Sight
Recent data suggest that the economy is not rebounding in the second half of this year. Amid below-potential growth and below-center-target inflation, it is unlikely that the Central Bank will deliver a tightening cycle next year.

Argentina
Thawing Out
As the price-freeze agreement loses effectiveness, inflation is rising. Domestic interest rates are rising and the central bank has accelerated the depreciation of the peso. International reserves have stopped declining.

Commodities
Favorable Weather Reduces Grain Prices
We have made downward revisions to our 2013 year-end forecasts for corn, soybeans and wheat due to favorable weather in the United States. Improvements in refining and distribution capacity of crude oil in the U.S. are consistent with a smaller WTI discount to Brent.  

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Slowdown in emerging economies, recovery in the U.S.

Economic activity in the developed world has been improving. The U.S. recovery continues, despite lower-than-expected GDP growth in the first half of the year. The euro zone is stabilizing after a long recession. In contrast, China and emerging economies continue to cool.

Growth in the U.S. is still modest this year. This should not prevent the Fed from starting to reduce the pace of quantitative stimuli in September, but suggests that it will do it cautiously. Therefore, new leaps in long-term Treasury yields seem unlikely. In this scenario, the specific fundamentals of each emerging country should now play a greater role in determining their asset prices.

In Latin America, slowdown in economic activity along with low inflation figures makes room for a more-expansionary monetary policy bias. We withdrew our forecast of interest-rate hikes in Colombia. In Peru, the central bank has been loosening monetary conditions through macroprudential measures. These actions improve the prospect of growth rebounding ahead.

In Mexico, we don’t expect rates to go down, but the North American recovery and the advance of structural reforms tend to benefit the economy from the second half of this year onward.

There is less room for countercyclical policies in Brazil. The more-depreciated exchange rate and expectations anchored at high levels pose risks to inflation. Thus, despite the deterioration in business and consumer confidence, the central bank will probably continue to hike the interest rate and fiscal policy tends to be less stimulative at the margin. We lowered our GDP growth forecasts for 2013 and 2014.

In Argentina, inflation picked up again with the end of price-freeze agreements, revealing the brief effect of that measure. The central bank has been allowing a faster depreciation of the official exchange rate and reserves stopped falling. Even with improved growth in the first half, we maintain our growth forecasts unchanged.

Global Economy
Still a Growth Recovery
 

•           The U.S.’s growth recovery looks less strong at the moment. This is unlikely to preclude the Fed from starting to taper QE in September, but it indicates a cautious approach.

•           The euro zone’s economy is stabilizing after a prolonged recession.

•           China and emerging economies in general continue to decelerate.

•           Asset prices in emerging markets will remain sensitive to movements in interest rates in the U.S., but risks of another generalized sell-off are lower and domestic fundamentals should play an increasing role.

Advanced economies are recovering, but we have reduced our U.S. growth forecast.  

The U.S. growth story looks slightly more fragile at the moment. GDP expanded at a seasonally adjusted annualized rate of 1.7% qoq in 2Q13, above our expectation of 1.0%. However, GDP growth was revised down to an average of 1.3% (from 1.6%) in the four quarters up to 1Q13. We lowered our growth forecasts to 1.5% from 1.9% in 2013 but are maintaining 2.5% in 2014.

In our view, weaker growth is unlikely to prevent the Fed from starting to taper QE in September, but it tilts the balance of risks to more monetary accommodation. Indeed, Bernanke has been showing a cautious tone. And there are reasons to be cautious with the labor market and the negative impact of the contractionary fiscal policy in U.S.

This time around, it’s Europe that brings positive surprises. The euro-area economies, including the periphery, are stabilizing. The region might return to growth as early as 2Q13. We increased our GDP forecast to -0.5% from -0.7% in 2013 and to 0.9% from 0.7% in 2014.

With better news coming from Europe rather than the U.S., we revised our forecast for the euro against the dollar to 1.30 at the end of 2013 (previously 1.25).

Meanwhile, the economic slowdown in emerging economies continues.

China’s economy keeps moderating its pace. As a consequence, policy makers adjusted their communication to show support for short-term growth. This reinforces our view that China is decelerating but will not experience a hard landing. However, risks remain on the downside. For now, we maintain our GDP forecasts at 7.5% in 2013 and 7.2% in 2014.

Finally, asset prices in emerging markets will remain sensitive to movements in interest rates in the U.S., but risks of another generalized sell-off are lower. We don’t expect the yields on the 10-year U.S. Treasury to return to the low levels seen at the beginning of the year. However, another surprise spike – like the rise from about 1.60% to 2.75% in May/June – is unlikely, as the U.S. growth story appears less strong. Emerging markets’ fundamentals should play an increasing role in their asset-price movements ahead.

Will Bernanke backtrack from QE tapering given a weaker growth picture?

The outlook for the U.S.’s economy remains positive, but growth momentum is weaker than previously thought. GDP expanded at a seasonally adjusted annualized rate of 1.7% qoq in 2Q13, above our expectation of 1.0%. However, GDP growth was revised down to an average of 1.3% (from 1.6%) in the four quarters up to 1Q13. We lowered our growth forecast to 1.5% from 1.9% in 2013. For 2014, we continue to expect acceleration to 2.5%, as the fiscal drag fades and financial conditions – despite the recent spike in Treasury yields – remain supportive to growth.

In our view, weaker growth is not likely to prevent the start of QE tapering in September, but it tilts the balance of risks to more monetary accommodation.

Indeed there are reasons to be cautious with the labor market and the negative impact of fiscal policy in the U.S. The economy has added a net average of 190 thousand jobs per month in the last 12 months. However, the historical correlation suggests that, with GDP growing at 1.4% yoy over the last four quarters, payroll gains should be south of 100 thousand (see graph). Hence, payroll could decelerate, in a lagged reaction to weaker growth. Moreover, the effects of the contractionary fiscal policy have not yet completely filtered through the economy and could have longer and more intense impacts.

Bernanke has shown a cautious tone. He has been pledging a change in the monetary-policy mix but no tightening in financial conditions. In its last meeting, the FOMC downgraded growth in 1H13 to modest from moderate. The statement also emphasized that financial conditions should remain accommodative for some time.

In sum, although we haven’t changed our base case, we see an increasing risk of looser monetary policy in the short run. The FOMC could choose to wait for more evidence that downside risks have actually faded before starting to taper QE. Alternatively, it could go ahead with tapering in September, but concomitantly soften the forward guidance on interest rates to offset any unintended monetary tightening.

The euro area’s economy is stabilizing 

The euro-zone manufacturing purchasing managers’ index (PMI) reached 50.4 in July, crossing the 50 contraction/expansion threshold for the first time since July 2011. The improvement signals a stabilization in industrial production in the region after almost two years of weakness (see graph). Importantly, the gains are broad based. The manufacturing PMIs are close to 50 in the four major economies (Germany = 50.7, France = 49.7, Italy = 50.4, Spain = 49.8) in the euro area.

Several other indicators also point to an economic stabilization, suggesting that the gain is indeed based on better fundamentals. In line with our scenario, exports continue to be an important source of growth in manufacturing. Moreover, although still contracting, domestic demand is starting to stabilize as confidence and financial conditions improve with smaller tail risks and the fiscal drag begins to diminish.

 We increased our forecasts for Eurozone GDP to -0.5% from -0.7% in 2013 and to 0.9% from 0.7% in 2014.

China – Focus on growth stabilization

The Chinese economy continues to moderate. The 2Q13 GDP was 7.5% higher than a year ago, a slower pace than the 7.7% seen in the first quarter.

Policymakers have adjusted their policy communication, emphasizing growth stabilization. In early July, Premier Li Keqiang stated that the government should keep the economy’s performance within a reasonable range and try to avoid the growth rate from slipping below 7% year over year. He also highlighted the need to achieve this year’s official target of 7.5%. At the end of the month, the State Council announced some small, growth-supportive measures (including elimination of taxes on small businesses and expanding projects for railway construction and urban infrastructure). These measures will likely have limited direct impact on boosting aggregate demand in the short term, but are an important indication, which is in line with our view that growth will gradually decelerate but not collapse.

We don’t foresee a hard landing, although risks remain on the downside. We believe that growth over the coming years will gradually slow relative to the past decade as the government attempts to rebalance the economy away from investment- and export-led growth to growth driven by consumption. Despite the government’s efforts to mitigate these problems, the fall in growth could worsen imbalances such as local governments’ indebtedness, real state over-investment, and the risk of a banking crisis due to high leverage and rising non-performing loans.

For now we maintain our GDP forecasts at 7.5% in 2013 and 7.2% in 2014.

Commodities – Favorable climate reduces grain prices

Agricultural prices explain most of the 0.6% drop in the average value of the Itaú Commodity Index (ICI, new methodology) in July. The breakdown by component shows that the agricultural sub-index slumped 10.4%, which was almost completely offset by rebounds in base metals (5.2%) and energy (4.1%).

The ICI agricultural sub-index fell 10.4% in July and we expect lower year-end prices. Rollover of active contracts and favorable weather conditions, which reinforce the prospects of a strong crop, explained the slump in corn and soybean prices in July. We lowered our forecasts for corn, soybeans and wheat at the end of the year and now expect the ICI agricultural sub-index to fall 15.6% yoy in 2013 (previously: -10.9%). We see further downside risks to our forecasts if the USDA doesn’t revise down its estimates for harvested area in corn and soybeans by as much as we expect.

Despite the recovery in July, fundamentals remain weak for metals. The ICI metals sub-index rose 5.2% in July, partially offsetting the fall in the two previous months. Prices were helped by signals from the Chinese government that it will defend the 7.5% growth target for 2013. The stimuli could include investments in railroads (positive for iron ore prices) and smart grids (positive for copper). In our view, the indication doesn’t avert the prospect of gradual deceleration in China and overall weak fundamentals for metals. We maintain our (below-consensus) forecasts for the ICI metals sub-index: -9.7% yoy in 2013, and -7.0% yoy in 2014.

The ICI energy sub-index rose 4.1% in July as supply-increases in ex-OPEC are offset by lower production in OPEC countries, the WTI discount to Brent falls and refineries pass higher prices on to final products. The sub-index in is now around the same high level observed in the first quarter. We believe that these high prices, particularly in crude oil, should persist, as they are consistent with fundamentals. We note that the adjustments in the U.S. market that are leading to the WTI discount to Brent seem permanent, and we now expect a lower discount by year-end (around USD 5/bbl). With this revision, the ICI energy sub-index is now expected to rise 6.6% yoy in 2013 (previously: 5.7%).

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



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