Pivot Points for 2013 in the Era of Dissonance | January 2013
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Pivot Points for 2013 in the Era of Dissonance | January 2013

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The context of near-zero short-term interest rates from the United States, Europe, the United Kingdom, and Japan provides a huge complication for emerging market countries in terms of the potential ...

The context of near-zero short-term interest rates from the United States, Europe, the United Kingdom, and Japan provides a huge complication for emerging market countries in terms of the potential interplay of exchange rate movements with growth prospects and inflation pressures. There is nothing like zero interest rate policies (ZIRP) from the major currencies to provide incentives for market participants to seek higher yields elsewhere, including emerging market currencies. The essential policy challenge for emerging market central banks is how to encourage economic growth in these difficult times without fueling inflation on the one hand or creating an environment that would lead to too much currency appreciation that could weaken growth prospects on the other hand.

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    Pivot Points for 2013 in the Era of Dissonance | January 2013 Pivot Points for 2013 in the Era of Dissonance | January 2013 Presentation Transcript

    • Pivot Points for 2013 in theEra of Dissonance
    • Pivot Points for 2013 in theEra of DissonanceThe research views expressed herein are those of the author and do notnecessarily represent the views of CME Group or its affiliates.All examples in this presentation are hypothetical interpretations of situationsand are used for explanation purposes only.This report and the information herein should not be considered investmentadvice or the results of actual market experience.Blu PutnamChief EconomistCME GroupJanuary 2013
    • Risk DisclosuresFutures trading is not suitable for all investors, and involves the risk of loss. Futures are aleveraged investment, and because only a percentage of a contract’s value is required to trade,it is possible to lose more than the amount of money deposited for a futures position. Therefore,traders should only use funds that they can afford to lose without affecting their lifestyles. Andonly a portion of those funds should be devoted to any one trade because they cannot expect toprofit on every trade.The Globe Logo, CME®, Chicago Mercantile Exchange®, and Globex® are trademarks ofChicago Mercantile Exchange Inc. CBOT® and the Chicago Board of Trade® are trademarks ofthe Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange, andClearPort are trademarks of New York Mercantile Exchange, Inc. COMEX is a trademark ofCommodity Exchange, Inc. CME Group is a trademark of CME Group Inc. All other trademarksare the property of their respective owners.The information within this presentation has been compiled by CME Group for general purposesonly. CME Group assumes no responsibility for any errors or omissions. Although every attempthas been made to ensure the accuracy of the information within this presentation, CME Groupassumes no responsibility for any errors or omissions. Additionally, all examples in thispresentation are hypothetical situations, used for explanation purposes only, and should not beconsidered investment advice or the results of actual market experience.All matters pertaining to rules and specifications herein are made subject to and are supersededby official CME, CBOT, NYMEX and CME Group rules. Current rules should be consulted in allcases concerning contract specifications.© 2013 CME Group. All rights reserved 3
    • 2012’s Themes are Old News China’s growth deceleration has ended European debt crisis will make some headlines but the danger of implosion has passed US avoided the worst of the fiscal cliff and will get by the debt ceiling, too (very messy, though) 2013 is about Looking Forward to New Challenges, New Opportunities© 2013 CME Group. All rights reserved 4
    • Themes for 2013 Market participants potentially start to embrace increased risk-taking in search of higher returns – bad for flight to quality exposures. Improved investor confidence highlights unintended consequences of Quantitative Easing by US, UK, Europe, and Japan – potential for emerging market currencies Metals markets may be conflicted, as gold loses support from the fear factor while copper benefits from an improved global economic outlook. Climate volatility may keep Agricultural markets on edge.© 2013 CME Group. All rights reserved 5
    • China stabilizing in the 7% real GDP growtharea for now, drifting down later in the decade China: Real GDP Growth Rates by Decade 12% 10.42% 10.48% Annual Average Real GDP Growth 9.29% 9% Estimate 6.22% 6.50% 6% 3.59% 3% 0% 1960s 1970s 1980s 1990s 2000s 2010s Source: World Bank Real GDP Index from the Bloomberg Professional (WRGDCHIN). Estimates by CME Economics Research.© 2013 CME Group. All rights reserved 6
    • European Bond Markets In Recovery Spain and Germany: 10-Year Government Bond Yields 12% Spanish Bond Annual Yield (Percent) Pre- 9% Euro 6% Debt 3% Debacle German Bond 0% 1992 1995 1998 2001 2004 2007 2010 2013 Source: Bloomberg Professional (GDBR10 and GSPG10YR)© 2013 CME Group. All rights reserved 7
    • Euro Has Recovered from Worst ofBreak-up Fears US Dollar per Euro 1.70 1.60 1.50 USD/EUR 1.40 1.30 1.20 ECB to Markets -- 1.10 Whatever it takes! Source: Bloomberg Professional (EUR)© 2013 CME Group. All rights reserved 8
    • US Tax Rate Uncertainty Resolved (for now) Historical Highest US Marginal Income Tax Rate 100% 90% 80% 70% 60% Percent 50% Clinton 40% 30% Bush 20% 10% 0% 1919 1961 2003 1913 1925 1931 1937 1943 1949 1955 1967 1973 1979 1985 1991 1997 2009 2015 Source: Tax Policy Center, Urban Institute and Brookings Institute *Note: Income Bracket applied to Highest Tax Rate has changed over time© 2013 CME Group. All rights reserved 9
    • US Fiscal Cliff Avoided – Stocks Rally© 2013 CME Group. All rights reserved 10
    • US Fiscal Cliff Avoided – Bond Prices Fall© 2013 CME Group. All rights reserved 11
    • Current Economic Conditions in theUnited StatesThe US economy has reeled off 14 straight quarters of real GDP growth since Q3 2009 averaging about 2.2% growth per annum.The unemployment rate has fallen from its peak of 10% to below 8%, as 1.84 million net new jobs were created in 2012.US large corporations are flush with very large cash holdings,.The US banking sector has recapitalized itself since 2008 and is now comfortably profitable.Auto sales are boomingHousing is finally entered a recovery phase in 2012© 2013 CME Group. All rights reserved 12
    • US Labor Market Improving Slowly US Unemployment Rate 13.00% Civilian Unemployment Percentage Rate 9.75% 6.50% 3.25% Unemployment Headed Back Below 6.5% in 2014? 0.00% 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 Source: St. Louis Federal Reserve Bank FRED Database (UNRATE)© 2013 CME Group. All rights reserved 13
    • US Auto Sales Are Back to 15 MillionUnits per Year US Auto Sales 25 Millions of Units of Cars and Light Trucks, 20 Annual Rate 15 10 5 On the Road to Recovery 0 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 Source: Federal Reserve Bank of St. Louis FRED Database (ALTSALES)© 2013 CME Group. All rights reserved 14
    • US Home Prices Finally Stabilized …. US Case-Shiller Home Price Percent Change 20% Year over Year Percentage Change 15% Home Prices Finally 10% Stabilize in 2012 5% 0% -5% -10% -15% -20% 1988 1992 1996 2000 2004 2008 2012 Source: Case-Shiller index from the St. Louis Federal Reserve Bank FRED Database (SPCS10RSA , SPCS20RSA)© 2013 CME Group. All rights reserved 15
    • Leading to a Recovery in Single-FamilyNew Home Sales … New Single-Family Home Sales in US 50% Year-over-Year Percentage Change 25% 0% -25% -50% 2002 2004 2006 2008 2010 2012 Source: St. Louis Federal Reserve "Fred" Database (HSN1F)© 2013 CME Group. All rights reserved 16
    • And a Rebound in Housing Starts from aVery Low Base US Housing Starts 3000 Thousands of Housing Starts, Annual Rate 2500 2000 1500 1000 500 Housing Starts Show Life in 2012 -- From a Very Low Base 0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 Source: Federal Reserve Bank of St. Louis FRED Database (HOUST)© 2013 CME Group. All rights reserved 17
    • US Real GDP Growth in the last 14 quartershas been comparable to pre-crisis growth. US Real GDP Growth by Quarter 6% Annualized Real GDP Growth, Quarterly Data 4% 2% 0% -2% 2.5% Average Annual 2.2% Average Annual Real GDP Growth, Real GDP Growth, -4% Q1/2004-Q4/2007, with Q3/2009 - Q4/2012, support from solid with headwinds from -6% growth overseas. a slowing China and stagnant Europe. -8% -10% 2004 2005 2006 2007 2008 2009 2010 2011 2012© 2013 CME Group. All rights reserved 18
    • 2013 -- Back to the Quantitative EasingDebateEvaluating Why QE Did Not Help Create Jobs: “Essential concepts necessary to consider when evaluating the efficacy of quantitative easing,” Review of Financial Economics, 2013, (Bluford H. Putnam)Unintended Consequences of QE: “Ultra easy monetary policy and the law of unintended consequences,” Federal Reserve Bank of Dallas Globalization and Monetary Policy Institute, 2012, Working Paper no. 126 (William R. White).© 2013 CME Group. All rights reserved 19
    • US & Japan are the Two Countries MostConcerned about Raising Economic Growth US and Japan Real GDP Growth by Decade 0.74% 2000s 1.55% Japan: Average 1.13% Annual Real 1990s 3.43% GDP Growth Rate By 4.64% Decade 1980s 3.23% US: Average 4.46% Annual Real 1970s 3.24% GDP Growth Rate By 9.22% Decade 1960s 4.19% 0% 2% 4% 6% 8% 10% Source: World Bank Real GDP Data provided through the Bloomberg Professional© 2013 CME Group. All rights reserved 20
    • Japan’s Population Growth Rate Peakedin 1971, the US in 1991 US & Japan Population Growth: 1951-2011 2.5% Annual Percentage Change in Population 2.0% United States 1.5% 1.0% 0.5% Japan 0.0% -0.5% Source: US Census Bureau: International Database© 2013 CME Group. All rights reserved 21
    • Population PyramidsThe next charts represent a country’s age profile in 5 year segments, with the children at the base, the working age population in the middle, and the retirees at the top. Men are in blue on the left, and women in red on the right.Source: US Census Bureau: International Database.© 2013 CME Group. All rights reserved 22
    • Population Pyramids: Japan United States© 2013 CME Group. All rights reserved 23
    • US Federal Balance Sheet Expansion Assets of the US Federal Reserve ($Billions) Other Assets $254 $447 Wednesday, Mortgage-Backed $948 January 16, Securities $0 2013 Federal Agency Debt $75 Securities $0 Wednesday, September 10, $1,689 2008 US Treasury Securities $480 Total Assets $2,965 $927 $0 $1,000 $2,000 $3,000 $4,000 Source: Federal Reserve Release H.4.1, Table 8.© 2013 CME Group. All rights reserved 24
    • US 10-Year Treasury Inflation-Adjusted Yields How Low Can Inflation-Adjusted 10-Year Treasury Bond Yields Go? 12% 10% Real Percentage Yield: 10-Year Yield minus 8% Year-over-Year Inflation 6% 4% 2% 0% -2% -4% 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 Source: Data from the Bloomberg Professional.© 2013 CME Group. All rights reserved 25
    • Japan Embarks on Currency DepreciationPolicy and Expanded Quantitative Easing© 2013 CME Group. All rights reserved 26
    • Japan Embarks on Currency DepreciationPolicy and Expanded Quantitative Easing© 2013 CME Group. All rights reserved 27
    • Emerging FX in ZIRP WorldThe central banks in the US, UK, Euro-Zone, and Japan are all committed to extended periods of near-zero short-term interest rate policies (ZIRP).The mature commodity producing countries, such as Australia, and the emerging market nations, from Mexico and Brazil in Latin America to India to China are likely to maintain interest rates between 3% and 6% (or more) above those in the US, UK, Euro-Zone, and Japan.This makes investments in the currency carry trade very attractive, even relative to the substantial risks. However, when market fears (i.e., Europe debt crisis, China slowdown, US fiscal cliff, etc.) dominate, risk-off trading will close these positions down. These carry positions will get reestablished as global market fears calm.© 2013 CME Group. All rights reserved 28
    • Emerging Market Country Short- US Federal Funds term Interest Rate Rate Joint Interest Rate & Exchange Rate Market Volatility Futures FX/USD Spot FX/USD Rate Rate© 2013 CME Group. All rights reserved 29
    • Mexican Peso Traded US Fiscal Cliff Debate Mexican Peso Sold Off on Election Fears of US Fiscal Cliff -- Then Rallied with the Tax Deal 13.4Mexican Pesos per US Dollar 13.2 13.0 12.8 12.6 12.4 1-Oct-12 8-Oct-12 15-Oct-12 22-Oct-12 29-Oct-12 7-Jan-13 28-Jan-13 14-Jan-13 21-Jan-13 5-Nov-12 3-Dec-12 12-Nov-12 19-Nov-12 26-Nov-12 10-Dec-12 17-Dec-12 24-Dec-12 31-Dec-12 Source: Bloomberg Professional (MXN)© 2013 CME Group. All rights reserved 30
    • Brazil Narrowing Rate Spread Over Inflation Brazil: Inflation versus Overnight Rates 30% Year-over-Year Inflation, Percent Annual Rate 25% SELIC Overnight Money Market Rate 20% 15% 10% 5% Inflation 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: CPI (BZPIIPCA) and Overnight Rate (BZSELICA) from the Bloomberg Professional.© 2013 CME Group. All rights reserved 31
    • China & BrazilExchange Rate Paths Comparing Paths of the Renminbi and the Real (Falling line indicates strength versus the US Dollar) 160 RMB per USD & BRL per USD Indexed 140 Chinese RMB - Managed FX to May 2002 = 100 120 100 80 Brazilian Real -- Managed 60 Rates, Volatile FX 40 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Brazilian Real (BRL) and Chinese Renminbi (RMB) from the Bloomberg Professional.© 2013 CME Group. All rights reserved 32
    • Rate Comparisons: Why Yield-Seekers mayconsider the FX Carry Trade in Risk-On Markets Short-Term Interest Rates Euro-Zone Japan United States United Kingdom China Mexico Brazil India Russia 0% 2% 4% 6% 8% 10% Source: Bloomberg Professional (Most liquid overnight rates to 1-month interbank rates)© 2013 CME Group. All rights reserved 33
    • GoldGold benefits from zero rates, which are here for another year in the US, UK, Europe, and Japan.Gold benefits from stronger demand if China and India show solid growth. Both countries should do a little better in 2013 than in 2012. But India is raising taxes on gold imports.Gold benefits from investor fears, which are dissipating.The question for investors is how much demand comes out of the market as fears recede?© 2013 CME Group. All rights reserved 34
    • Gold Price Has Hit Choppy Waters Above$1600/ounce Gold $2,000 $1,600 US Dollars per Ounce $1,200 $800 $400 $0 1992 1995 1998 2001 2004 2007 2010 2013 Source: Bloomberg Professional (GOLDS)© 2013 CME Group. All rights reserved 35
    • CopperCopper demand stems from infrastructure building.China is critical. China slowed infrastructure spending plans in 2011 and 2012, but there are signs that China will start spending again to get the economy moving faster 2013.India is a big buyer of gold jewelry. India’s economic growth slowed in 2012, but may rebound modestly in 2013.Copper is likely to be very volatile, with potential support if a more optimistic global economic outlook gains credence.© 2013 CME Group. All rights reserved 36
    • BRIC Economies may Improve in 2013, ledby China and Brazil BRIC Real GDP 10% Weighted Average of Annual Real GDP Growth 9.0% Estimate 8% 7.0% 6.1% 6% 5.4% 4% 2% 0% 2010 2011 2012 2013 Source: World Bank Real GDP Data provided through the Bloomberg Professional. Q4/2012 and 2013 estimated by CME Economics Research.© 2013 CME Group. All rights reserved 37
    • Copper Has Become a Risk-On, EmergingMarket Growth Story COMEX Copper Nearby Contract Futures Price $5 US Dollar per Pound of Copper $4 $3 $2 $1 $0 1992 1995 1998 2001 2004 2007 2010 2013 Source: Bloomberg Professional (HG1 <Comdty>)© 2013 CME Group. All rights reserved 38
    • Energy Market Potential Surprises for 2013US economic growth dividend for increased oil/gas supplyMore infrastructure progress in the US than market participants appreciatePossibly less geo-political fears Syria and Egypt do not have oil Iran tensions appear to be lesseningMarket participants may shift from demand focus to supply focus which has possible implications for a narrower Brent- WTI spread and a narrower WTI-Natural gas spread.© 2013 CME Group. All rights reserved 39
    • Natural gas offers a low cost per BTU BTUs per US$1 by US Energy Source 1,400,000 1,200,000BTUs of Energy per 1 US Dollar Coal 1,000,000 800,000 600,000 400,000 Natural Gas 200,000 Oil 0 2001 2003 2005 2007 2009 2011 2013 Source: Bloomberg Professional for prices (USCRWTIC, NGUSHHUB, UNYMM1), CME Economics Research for BTU conversion.© 2013 CME Group. All rights reserved 40
    • Weather VolatilityWeather volatility can easily disturb agricultural marketsQ1/2013 already has seen: Frigid Temperatures in Russia and China Extreme Heat in Australia and New Zealand Continuation of US Midwest Drought (although there is some snow cover now)© 2013 CME Group. All rights reserved 41
    • US Drought Monitor Charts -- SourceThe U.S. Drought Monitor is produced in partnership between the National Drought Mitigation Center at the University of Nebraska-Lincoln, the United States Department of Agriculture, and the National Oceanic and Atmospheric Administration.http://droughtmonitor.unl.edu/© 2013 CME Group. All rights reserved 42
    • The Texas Drought emerged over time in2010-2011© 2013 CME Group. All rights reserved 43
    • In 2012, the US Midwest Drought EmergedVery Quickly© 2013 CME Group. All rights reserved 44
    • Corn and the Drought Corn Spot Price $10 USDA Illinois North Central No.2 Yellow Corn $8 Spot Price per Bushel $6 $4 $2 $0 1997 1999 2001 2003 2005 2007 2009 2011 2013 Source: Bloomberg Professional (CORNILNC)© 2013 CME Group. All rights reserved 45
    • Pivot Points for 2013: Politics & Weather• US Spending and Debt Ceiling Debates (February- April, and possibly beyond)• Formation of New Coalition Government in Italy (February-March)• Development of Midwest US Drought (Spring- Summer)• German Elections (September 2013) – Merkel will probably need a new coalition partner© 2013 CME Group. All rights reserved 46
    • Economic Points to Watch US Unemployment Rate Dips Below 7% China reports Real GDP Growth above 7% in 2013 for two quarters in a row, along with supporting export data Brazil reports Real GDP Growth the first half of the 2013 increasing into the 3%-4% range© 2013 CME Group. All rights reserved 47
    • Confirming Signs We May Be Entering a“Risk-On” Market Environment?•FX: –Yen/$ cross 100 –Brazilian Real cross 2.00 (BRL per USD)•Bonds –JGB 10-Year Yields cross 1% –US 10-Year Treasury Yields cross 2% –Spanish 10-Year Bond Yields remain close or under 5%© 2013 CME Group. All rights reserved 48