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Financial Pacific: Moderate Global Recovery to continue (third party) october 05.2010
 

Financial Pacific: Moderate Global Recovery to continue (third party) october 05.2010

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    Financial Pacific: Moderate Global Recovery to continue (third party) october 05.2010 Financial Pacific: Moderate Global Recovery to continue (third party) october 05.2010 Document Transcript

    • Daniel Kalt, economist, UBS AG Thomas Berner, CFA, economist, thomas.berner@ubs.com, +1 212 713 4108, UBS FS Dominic Schnider, analyst, UBS AG Constantin Vayenas, analyst, UBS AG Wealth Management Research 5 October 2010 Global economy Moderate global recovery to continue Previous reports s Signs of stabilization are mounting in the US after the growth slowdown in 2Q10, and we expect y/y GDP growth to settle at around s 31 August: US economics: Avoiding a US 2.5-3.0% while the Fed seems ready to counteract any deflationary double-dip by a hair's length risks with additional quantitative easing measures. s In the Eurozone, core and peripheral economic performance continue s 4 August: Japan economics: Recovery engine to diverge, while non-Eurozone peripheral countries show strong sputtering momentum. The ECB is likely to stay on hold and is unlikely to remove extraordinary policy measures before early next year. s 22 July: Global economy: This recovery crawls, it doesn't leap s Asian emerging economies are growing at a solid pace, and the somewhat softer current economic indicators are more a mid-cycle- s 9 July: Eurozone economics: The future of the downshift than the beginning of a larger growth downtrend. Japan's euro in jeopardy strong currency and lack of sustainable domestic demand growth should take its toll on economic activity. Growth forecasts for emerging markets in Central/Eastern Europe & Latin America have also shown a general upward drift, although the overall growth rates for 2011 are expected to be below the 2010 spikes. The world economy has recovered from the longest and most severe Fig. 1: World merchandise trade back at pre- recession in post-WWII history. In the US, the semi-official NBER Business crisis levels Cycle Dating Committee recently declared that the recession that started World trade volume index (1Q2000=100) in January 2008 had ended in June 2009, reaching a trough from which 180 the US economy has since recovered. Indeed, global trade volumes have rebounded steeply from their low point in early 2009, and are now back to 160 Merchandise world trade volume (index, 1Q2000=100) pre-crisis levels (see Fig. 1). Global industrial production is running at solid pace of some 8% y/y (see Fig. 2). Several months ago, we dubbed this a 140 "sugar rush recovery" primarily driven by huge fiscal and monetary policy 120 stimulus measures. 100 80 60 1998 2000 2002 2004 2006 2008 2010 Source: Netherlands Bureau for Economic Policy Analysis This report has been prepared by UBS AG and UBS Financial Services Inc. (UBS FS). Please see important disclaimers and disclosures that begin on page 13.
    • UBS Wealth Management Research 5 October 2010 Global economy We are now at a point where this policy-induced sugar rush is starting to Fig. 2: Global industrial production running at fade and private demand must now kick in to help economic expansion solid pace become self-sustaining. Over the last couple of weeks, however, some of Global IP (% y/y, lh scale) and developed markets the most widely watched leading indicators have started to come down composite leading indicator (rh scale) from their healthy levels, signaling a moderation in global growth as we 10 1.0 approach year-end. Since market participants are still not convinced that a sustainable recovery has taken root, this slowdown was already enough 0.5 5 to fuel speculation about an imminent double-dip recession, sending jitters - through financial markets. 0 -0.5 2002 2003 2004 2005 2006 2007 2008 2009 2010 We don't share this gloomy perspective on the world economy. Our base -1.0 -5 case is still for a continuation of what we would describe as a choppy, sub- -1.5 par economic recovery. Job creation in the US and Europe should continue – Global industrial production (% y/y) -10 albeit at a relatively slow pace – and build the basis for consumer spending DM composite leading indicator (rh scale) -2.0 to continue expanding moderately. Overall, we expect world GDP to expand -15 -2.5 at 4.1% this year and 3.7% in 2011. Source: ThomsonReuters EcoWin, UBS WMR Of course, there are significant differences across and even within regions, as we highlight in the sections below. Many Asian emerging economies have recovered very quickly from the global slump and are today producing at substantially higher output levels than at the mid-2008 cyclical peak. Fig. 3: Moderate but sustainable growth Inflationary pressures have emerged, and central banks – most prominently Real GDP y/y growth and its main components in China – have started to tighten monetary policies. On the other hand, Japan is fighting against the deflationary forces stemming from the strong JPY appreciation. In Europe, the divergence between strong core economies (with Germany at the forefront) and weak peripheral economies is becoming increasingly evident. Against this backdrop, central banks in developed economies are unlikely to start hiking rates before the middle of next year. They will likely make any withdrawal of extraordinary policy measures highly dependent on further improvements in macroeconomic developments. Some may even consider embarking on a further round of quantitative easing – as signaled by the US Fed in its latest Federal Open Market Committee (FOMC) state- ment – if deflationary forces become entrenched. Source: Thomson Datastream, UBS WMR US: Signs of stabilization are mounting After a significant growth slowdown in 2Q10, signs are mounting that growth stabilized in 3Q10. Housing indicators point to an end of the nega- tive payback after the expiration of the housing tax credit in April. Business and consumer confidence statistics are still mixed, but at least suggest a halt to the erosion experienced in the last few months. Initial jobless claims are retreating after the worrisome surge in August. We continue to expect real GDP growth of 1.5% q/q annualized in 3Q10 and 2.5% in 4Q10, after 1.7% in 2Q10. Such a scenario implies no additional quantitative easing (QE2) by the Fed, but we now expect a Fed rate hike to come in September 2011 rather than June 2011. Growth is stabilizing at a very modest rate The noticeable growth deceleration to 1.7% q/q annualized in 2Q10, after 3.7% in 1Q10 and 5% in 4Q09, seems to have run its course. While the most recent data is still mixed, we think there is sufficient evidence for growth stabilization at a very moderate rate. Global economy - 2
    • UBS Wealth Management Research 5 October 2010 Global economy First, one of the most important growth barometers, the ISM Manufactur- Fig. 4: Stable but very low inflation ing PMI, is still at a robust level. At 54.4 in September, it is consistent with Headline and core CPI inflation solid real GDP growth. While its counterpart, the ISM Non-manufacturing Composite index, fell in August, the non-manufacturing index tends to lag and thus may simply reflect the earlier slide in the ISM Manufacturing PMI. Furthermore, initial jobless claims, one of the timeliest economic indicators, reversed its sharp August rise in the first three releases in September. Thus, this suggests that private payroll growth can continue at a pace close to 100,000 per month. Based on this recent data, we feel confident that real GDP growth is unlikely to deteriorate further. In fact, we think that our real GDP growth forecast of 1.5% q/q annualized in 3Q10 might be too conservative. Looking further ahead, we reiterate our forecast for 2.5% growth in 4Q10 and 2.7% for 2011. The improvement in the growth pace will likely be driven by some pick-up in private consumption and investment. Source: Thomson Datastream, UBS WMR Inflation is too low for comfort Headline and core CPI inflation have fallen to levels clearly below the Fed's long-term mandate. In its long-term outlook, the Fed has consistently fo- cused on reaching inflation of 1.7-2%. In contrast, core CPI has stabilized at 0.9% y/y. While we don't expect inflation to slide further, the current low rate might become a policy driver in its own right. In fact, in its Septem- ber statement, the FOMC explicitly stated low inflation as an economic cir- cumstance that could be addressed by additional quantitative easing. We forecast core inflation to trend sideways until the end of the year and to gradually edge higher in 2011. Fed on hold, but very close call Although our outlook incorporates a slight pick-up in growth after the re- cent growth moderation, the economy is still fragile, and the risks to our forecast are skewed more prominently to the downside. Our scenario im- plies that the Fed will not have to expand the size of its balance sheet again, but the possibility of renewed liquidity injections by the Fed remains on the table, which is consistent with more prominent downside than upside risk. In its August statement, the FOMC announced that it would keep its balance sheet at roughly USD 2.3trn. Since its mortgage backed securities (MBS) are maturing, this directly implies that the Fed will have to buy about USD 20bn in Treasuries per month to keep its balance sheet from shrinking. The FOMC's 21 September statement reiterated that it would keep its bal- ance sheet from shrinking. It also opened the door for additional quantita- tive easing (QE2) should the economy need it: “The Committee will con- tinue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.” Fed Chairman Ben Bernanke stated a few weeks ago that “further significant weakening” of economic data would be a criterion for additional quantitative easing. We haven’t seen that so far, and given our outlook for a growth pick-up in 4Q10, we don’t expect to see it. Thus, we think that QE2 will not materialize. However, as pointed out above, the very low inflation rate suggests that the Fed will now be even more cautious than before about becoming too restrictive too soon. We thus expect the first fed funds rate hike to come in September rather than June 2011. Thomas Berner Global economy - 3
    • UBS Wealth Management Research 5 October 2010 Global economy Europe: Economic fragmentation Fig. 5: Business sentiment: Mind the gap Business sentiment indices for various EMU countries Europe will increasingly feel the strain of strongly divergent economic de- velopments among its core and more peripheral economies. Back in 2008, the steep slump in global trade and investment spending affected all Euro- pean economies simultaneously, and they initially staged a more or less syn- chronized rebound from the Great Recession's trough starting in mid-2009. Coming out of this initial rebound in economic activity, the aftermath of the financial crisis and the ongoing government debt crisis have led to frag- mented economic and political developments. Gap widens between core and peripheral economies Within the Eurozone, the competitive core economies have recently posted very solid growth numbers. Germany's real GDP expanded an impressive 2.2% q/q in 2Q 2010, which translates into 9% annualized growth for the quarter. The Netherlands posted 0.9% q/q growth (3.6% annualized). At the same time, Greece's GDP contracted by 1.5% q/q in 2Q 2010, bringing the y/y rate to -3.5%. Ireland's GDP declined by 1.2% q/q in the second Source: ThomsonReuters EcoWin, UBS WMR quarter, and its GDP has fallen 14% since its peak in 2007. Other economic indicators also point to growing divergences within the Eurozone. EMU business sentiment indicators show that a wide gap has opened up since mid-2009 between the strongest economy (Germany) and Fig. 6: Consumer sentiment: Germans upbeat the weakest (Greece), while France and Spain fall somewhere in between Consumer confidence indices for various EMU coun- (see Fig. 5). A similar picture emerges when looking at consumer confidence tries (see Fig. 6), where Germans have become much more upbeat as of late, while sentiment among French, Italian and Spanish consumers is lagging behind. Overall, we expect German GDP to expand by 3.3% this year and 2.2% next year. The latest figures show that German growth is increasingly driv- en by domestic components, such as investment spending and to a lesser extent private consumption, which bodes well for the sustainability of the recovery. Ireland, Greece and Spain lie at the other end of the spectrum, having already experienced a big contraction in economic output last year and expecting either flat growth or further contraction this year. We see moderate growth near long-term averages for Italy and France, the two remaining big players in the Eurozone. In sum, we expect Eurozone GDP to grow by 1.7% this year and 1.9% Source: ThomsonReuters EcoWin, UBS WMR next year. After all, one should not forget that Germany, Italy and France make up 65% of Eurozone GDP; Greece contributes only 2.6% of overall EMU GDP, and Ireland and Portugal 1.8% each. While labor markets will also develop differently depending on each country's growth performance, overall Eurozone unemployment is unlikely to fall very quickly from current levels of around 10%. Global economy - 4
    • UBS Wealth Management Research 5 October 2010 Global economy European Central Bank (ECB) on hold for the time being We expect inflation to remain well below the ECB's 2% ceiling this year and next. Against this backdrop, and in light of the continuing fragility of the European banking system, the ECB announced at its September meeting that full allotment of its repo operations will continue until January 2011, i.e. further steps to exit extraordinary policy measures are unlikely before early next year. If the economic recovery continues as implied by our base case, we expect a first rate hike in the middle of next year. UK: Can a weak GBP counterbalance fiscal austerity? Fig. 7: Weak GBP continues to support exports The UK economy surprised on the positive side with a strong 2Q10 GDP. UK sterling real effective exchange rate Solid growth in Europe should combine with a weak GBP to continue sup- porting British exports. The real effective exchange rate of the GBP – i.e. the trade-weighted, inflation-adjusted exchange rate versus major trade part- ners – has depreciated some 20% since early 2008, rendering UK exports much more competitive globally. Inflation is expected to remain high in the short term as a result of the VAT hike and recent commodity price increases. In the medium term, however, we see inflation gradually falling back to the Bank of England's target rate. Against this backdrop, the Bank of England (BoE) will have to strike a bal- ance between fiscal austerity and an economic recovery that may call ul- tra-low policy rates into question. We think the Monetary Policy Committee (MPC) will try to muddle through the middle. We have delayed our rate hike call from Q1 2011 to Q3 2011, but a hike will depend on a sustained recov- Source: ThomsonReuters EcoWin, UBS WMR ery in leading indicators such as the PMI. If the economy were to weaken, the MPC would likely implement another round of quantitative easing. Nordics and Switzerland: Strong momentum Fig. 8: Switzerland is outperforming The Nordic economies of Sweden, Finland and Norway have all weathered Real GDP, Index 1Q2005 = 100 the financial market crisis relatively unscathed. The same holds for the Swiss economy, which has delivered an astonishing outperformance compared with its neighbors. Government finances in the Nordics and Switzerland are not deeply in the red, they had no real estate or credit bubbles, and their banking systems are in solid shape. Therefore, these economies have re- covered quickly from last year's recession and are showing strong econom- ic momentum. While both the Norwegian and the Swedish central banks have already started their hiking cycles, the Swiss National Bank has not yet increased policy rates, as it wanted to prevent the CHF from raising even more against the EUR. We think the Norges Bank and the Riksbank will continue hiking rates, and that the SNB will also have to raise rates sooner or later, given the Swiss domestic economy's very strong momentum and the looming risks of a real estate bubble. Source: ThomsonReuters EcoWin, UBS WMR Daniel Kalt Global economy - 5
    • UBS Wealth Management Research 5 October 2010 Global economy Asia: Rising gravity Fig. 9: GDP growth in Asia, Europe and the US Values are seasonally adjusted and annualized versus Second attempt at decoupling Asian growth the previous period Asia's growth held up remarkably well compared to the weakness wit- nessed in the US. In the second quarter of 2010, most Asian countries 15 13 grew at or above trend. In that sense, Asia's largest economy – China – 11 was lagging behind, growing slightly below trend (8.5-9%) after above- 9 trend growth in the first quarter. Policy tightening aimed at slowing eco- 7 nomic activity has been very effective. Besides this exception, the percep- 5 tion has started to emerge again that the region will be able to decouple 3 from macroeconomic trends in the US. We think investors should be careful 1 when making early judgments. (1) Hong Kong Philippines India Indonesia China South Korea Thailand Europe Singapore * Japan US Malaysia Taiwan The resilience of Asia's economic growth is based on special factors. US im- ports in 2Q accelerated sharply compared to sub-trend GDP growth. While 1Q 2010 2Q 2010 this is not unusual, the contribution of net exports to GDP activity was ex- ceptionally negative, shaving off considerable US growth. This all coincid- Source: Bloomberg, JP Morgan, UBS WMR ed with strong investment spending, which was a key driver of US growth * In the chart the scale is capped at 15%. Singapore's GDP growth in 1Q 2010 was 45.7% and 24% in 2Q in 2Q. Growth from Europe and non-Asian emerging economies was on the strong side as well. Since we expect some of these parameters to shift downwards, we think Asia's GDP growth is set to moderate towards the Fig. 10: Chinese PMI and import growth from end of 2010. With stalling Asian export growth to China, growth in Asia ex Asia Japan and ex China could drop below 5% in 4Q from growth levels above We expect Chinese imports from Asia to accelerate 10% in 1Q. again 40% This could start to change towards the end of the last quarter of 2010, 65 30% as we expect China's GDP deceleration to stop in 3Q and gain some trac- 60 20% tion in late 4Q. The latest PMI figures for September and August have sur- 55 10% prised versus expectations, including a higher ratio of new orders to fin- 50 0% ished goods inventories. The better-than-expected PMIs have gotten con- -10% 45 firmation from an uptick in electricity production, so we look for China's -20% 40 import demand to accelerate again at the end of 2010. Economic news -30% flow from China for 4Q should therefore be rather a stabilizing factor, in our 35 -40% view, with GDP growth going slightly above 8% in 4Q from levels below 30 -50% May-06 May-07 May-08 May-09 May-10 8% in 3Q. This should give emerging Asia ex Japan and China a helping PMI China (lhs) China: Import growth from Asia (3mavg 3m/3m, rhs) hand in 1H 2011. Source: Bloomberg, UBS WMR Will this be enough to support the view that Asia can decouple from the US? Doubts will remain in investors' minds, but they will recognize where growth still has room to advance structurally and where not. The combi- Fig. 11: Asia's expected growth differential to nation of low regional leverage, negative real interest rates in most Asian the developed world based on IMF forecasts countries, and functioning banking systems are ideal to generate solid do- Values in % mestic demand based on some re-leveraging. Larger and less globally in- 10 tegrated emerging economies like India and Indonesia could stick out. In 9 the absence of another US recession, Asia's economic gravity should gather 8 strength versus the US and Europe and be resilient enough to master most 7 external shocks. Thus, soft economic activity is more likely to be a mid-cy- 6 cle downshift than the beginning of a larger growth downtrend. Japan's 5 4 strong currency and lack of sustainable domestic demand growth should 3 take its toll on economic activity. We expect the country's economy to grow 2 around 1.5% with swings driven by external demand. 1 0 2006 2007 2008 2009 F 2010 F 2011 F 2012 F 2013 F 2014 F 2015 F Developing Asia Asean 5 Newly industrialized Asian economies Source: IMF, UBS WMR Global economy - 6
    • UBS Wealth Management Research 5 October 2010 Global economy Looking for Asia's mid-cycle bottom at the end of 2010 Fig. 12: Real interest rates in Asia A downshift in Asian economic growth should not come as a surprise. In- Nominal interest rates less CPI y/y dustrial activity grew at incredible speed in recent quarters, ranging from 10% to 60% y/y, which cannot realistically be sustained. Given the nature 2% 1% of economic recoveries, we have seen an almost textbook recovery in Asia. 0% Global capital spending has been leading the way, allowing export-oriented -1% Asia to boom. This tailwind will start turning into a headwind for growth -2% in the coming months. -3% -4% The big question now relates to the potential bottom of this business cycle. -5% Hong Kong Philippines Indonesia India China South Korea Thailand Singapore Malaysia We expect 4Q 2010 to mark the trough for industrial production growth, Taiwan followed by an acceleration in 1Q 2011. Monetary policy tightening in Asia has come to a halt, in our view. As in 2008, Asian monetary authorities are Real short-term interest rates likely to keep their economies well supplied with cheap money to buffer potential negative spillover effects from the developed world. Recent mon- Source: Bloomberg, UBS WMR etary policy tightening in the region barely pushed broad real interest rates to neutral. Thus, monetary conditions remain very loose – probably too loose if the developed world does not see a double dip. US Fed Chairman Fig. 13: Industrial activity level in Asia today Bernanke recently gave clear indications that more unorthodox monetary compared to the level before the financial crisis policy could be used to sustain economic growth. Hence, the probability is Values in % increasing that Asian central banks will find themselves behind the curve in early 2011. 40 35 We initially see industrial production growth accelerating again along with 30 25 solid consumer demand. Since much of the slack in Asia's economy has dis- 20 appeared, the next acceleration in economic activity could generate more 15 price pressure. From a sequence perspective, China should see improve- 10 5 ments towards the end of the year, followed by the rest of emerging 0 Asia. From a swing perspective, Southeast Asia and highly trade-geared (5) economies should witness the strongest activity amplitudes. Over the en- (10) (15) tire year, however, we expect 2011 GDP growth for Asia to be lower than Philippines India Indonesia Singapore South Korea Thailand China * Japan Malaysia Taiwan in 2010. Solid consumption growth in emerging Asian countries will not change this. India should be somewhat isolated from these global industrial Industrial production changes from January 2008 to July 2010 activity swings, as it is going its own domestically oriented growth path. The country is expected to grow around trend growth for the coming quarters. Source: CEIC, UBS WMR * Values for China are interpolated Global economy - 7
    • UBS Wealth Management Research 5 October 2010 Global economy Capital flows – a two-way street Fig. 14: Foreign reserve changes of emerging When investors think about capital flows, they tend to imagine rich coun- Asia countries tries investing abroad. But the net balance of capital flows consists of much Values until June more. It is also about Asian investors who invest in the developed world. 300 105 Detailed and up-to-date data is hard to come by, but we think the incentive Billion USD 250 for Asian investors to send their money abroad has diminished sharply in 100 200 recent months. The attractiveness of the developed world was in its very 150 liquid bond market. But Asian investors now find themselves facing a dif- 100 95 ficult environment: quantitative easing risks lie around the corner for the 50 90 US, Europe has to tackle severe structural issues between north and south, 0 and Japan has been a red flag for most investors in recent years. The con- (50) 85 sequence of a poor return outlook for G3 fixed income markets should (100) (150) 80 motivate the repatriation of wealth and current account proceeds. Capital Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 flows from Asians abroad should thus drop, whereas foreigners' interest in EM Asia: Foreign reserves changes over 3 months (lhs) USDAXJ Index (rhs) Asia should gather strength. To what degree foreign flows come to Asia depends on the de-leveraging magnitude and the shift in portfolio alloca- Source: Bloomberg, UBS WMR tions. USDAXJ Index = equally weighted Asian currency basket versus the USD. A lower value means stronger AXJ currencies In many ways, this is exactly what is needed: Asia should consume or invest its surpluses regionally, and not use them to finance the notorious overcon- sumption in the developed world (especially in the US). Hence, we remain Fig. 15: Forecasted Asian currency appreciation positive on Asian ex Japan currencies continuing their appreciation trajec- versus the USD tory with rather healthy payment surpluses. Mounting price pressure in Asia Total return = spot return + interest rate carry during 2011 is likely to motivate central banks to take a relaxed stance to- 15% wards a firmer currency. Foreign reserve accumulation by emerging Asian central banks slowed sharply in 1H 2010. That said, if the USD comes under 10% renewed pressure and growth in industrial activity decelerates towards the 5% end of 2010, the temptation to stick closer to the USD will again be high. 0% An uptick in foreign reserve accumulation in the coming months should -5% not be viewed as indicative for 2011. The CNY, KRW and MYR offer the best value in terms of risk-reward, in our view. Risk-seeking investors can -10% replace the KRW and MYR with INR and PHP. -15% MYR KRW INR IDR RUB CNY THB EUR TWD JPY SGD PHP Dominic Schnider Expected spot move Interest rate carry Expected total return vs the USD Source: Bloomberg, UBS WMR. see most recent Global Forecasts Global economy - 8
    • UBS Wealth Management Research 5 October 2010 Global economy Central/Eastern Europe & Latin America Fig. 16: Emerging markets bounce back Real GDP growth, % y/y change As shown in Fig. 16, economic growth in the emerging economies bounced 11% backed in the first half of 2010 to levels not far from their pre-crisis peaks. 9% A big part of this recovery is that the banking systems in many of these 7% emerging countries remained relatively unscathed during this crisis, unlike 5% the damage done to banks in the US and parts of Europe. To use an analogy: 3% when the average emerging economy opened the lending taps, the credit 1% flowed and people filled their buckets like in the old days. Contrast this with -2% the US, where even very low interest rates did not have the same impact -4% Africa Asia this time round. The US faces the additional problem that the outlook for -6% Central and Eastern europe Middle East the most important financial assets that most people own – their homes -8% Latin America -10% – is uncertain. In many emerging economies, however, real estate prices 04 05 06 07 08 09 10 have remained buoyant, which has encouraged mortgage growth. The big regional exception to this emerging market story has been Central/Eastern Source: UBS Europe, where they had the misfortune of being over-reliant on troubled banks headquartered outside their countries. A strong rebound in 2010 Fig. 17: Forecasts for 2010 real GDP growth The extent to which the economic outlook in the emerging economies has % y/y change, published in the following months: steadily improved over the past year can be gleaned from Fig. 17. It shows the upward revisions to GDP growth across a range of countries. Thus, in Oct 09 Jan 10 Aug 10 Sep 10 Latam October 2009, we expected Brazil to grow by around 4% this year, but Brazil 4.0 4.5 8.2 8.2 we now think that this figure is going to be twice as high. Turkey's GDP Mexico 2.5 2.5 5.1 4.8 number also underwent a massive upward revision. A year ago it looked EMEA as though the country might need help from the IMF, but its economy has Czech Rep. 1.0 1.5 1.5 1.8 managed fine and its growth projection for this year has bounced back Hungary -0.5 -0.1 0.5 0.5 to over 7%. Many emerging economies are booming. Even a struggling Poland 2.0 2.4 3.0 3.3 country like Hungary has seen its growth forecast revised up for this year Russia 2.0 5.6 7.5 7.0 from a contraction to a slightly positive number. South Africa 2.0 2.7 3.3 3.3 Turkey 1.5 2.4 5.5 7.3 Source: UBS Global economy - 9
    • UBS Wealth Management Research 5 October 2010 Global economy What we expect for 2011 Fig. 18: Forecasts for 2011 real GDP Growth In light of the strong 2010 bounce, what is in store for 2011? Here, too, % y/y change, published in the following months: we see a general upward drift in growth forecasts for several economies, although overall growth rates are expected to be below the 2010 spikes. Oct 09 Jan 10 Aug 10 Sep 10 Latam At this point, we do not see this loss of momentum falling back into a dou- Brazil 4.5 4.5 5.4 5.4 ble-dip in any of these markets. Of course, those with the lowest growth Mexico 3.2 3.2 3.7 3.7 projections, like Hungary, have less of a cushion to absorb a sharper global EMEA slowdown if that were to materialize. Czech Rep. 3.0 3.0 2.6 2.6 Hungary 2.0 2.0 2.0 2.0 Poland 3.7 3.7 3.9 3.9 Russia 4.2 4.2 6.0 6.0 South Africa 3.9 3.0 3.5 3.5 Turkey 4.3 4.3 4.3 4.7 Source: UBS No sign of deflation here Fig. 19: Forecasts for 2010 inflation Fig. 19 shows that consumer price inflation expectations have drifted higher % y/y CPI change, published in the following in several countries over the past year. This should come as no surprise: months: Higher growth is not free – it comes at the price of higher inflation. This Oct 09 Jan 10 Aug 10 Sep 10 is also an indication that interest rates in the emerging economies should Latam be higher, and in some cases substantially higher, than those in the United Brazil 4.5 4.5 5.2 5.2 States, Western Europe and Japan. We expect this interest rate differential Mexico 3.5 5.0 4.5 4.4 to continue to grow until the developed economies begin to move away EMEA from their near zero-interest policies. Czech Rep. 2.5 1.2 1.2 1.5 Hungary 4.5 4.3 4.9 4.9 Poland 2.5 2.5 2.5 2.5 Russia 10.0 7.8 5.9 6.1 South Africa 6.5 5.6 5.3 4.4 Turkey 6.5 5.7 8.7 8.7 Source: UBS Global economy - 10
    • UBS Wealth Management Research 5 October 2010 Global economy The wrong interest rates for the emerging markets Fig. 20: Good news for EM borrowers These very low global interest rates have two major implications for the Yields (in %) on USD-denominated EM sovereign emerging markets. First, emerging market residents can borrow dollars, eu- bonds ro, yen and sterling at rates that have never been seen before. This supports 12 capital inflows into the emerging economies. 11 The second major implication of low global interest rates is that investors in 10 developed countries holding low-yielding cash and bonds in their portfolios 9 are tempted to look further afield for higher yields. This also benefits the 8 emerging markets because their bonds and money markets typically offer 7 higher yields. 6 While these low global rates might be appropriate for developed economies 5 recovering from a deep recession, they are almost certainly wrong for most 4 Nov Jan Mar May Jul Sep Nov Jan Mar May Jul emerging economies, which did not experience a banking crisis and where 08 09 09 09 09 09 09 10 10 10 10 economic growth is continuing at healthy levels. Brazil Indonesia Russia Mexico Fig. 20 shows how much cheaper it has become for a selection of emerging Source: UBS economies to borrow in US dollars over the past year, in this case Brazil, Indonesia, Russia and Mexico. The idea that the average emerging market government could borrow US dollars in the international capital markets for an interest rate of just 5% would have been unthinkable a few years ago. Our records show that over the past 210 years, the United States gov- ernment has had to pay an average yield of 5.6% for long-term borrowing in its own currency. Emerging market residents are therefore in the midst of a boom as far as USD borrowing rates are concerned. The major drawback to these low USD rates are, first, that they could be laying the groundwork for trouble down the road. If money is too cheap, it can result in mispricing and misallocation: Not every new shopping mall or apartment block in Sao Paulo or Shanghai is going to be profitable. The second problem associated with low USD interest rates is that the search for yield in the emerging markets is driving up emerging market currencies. This could undermine their competitiveness and weigh on their economic performance in the medium term. Constantin Vayenas Global economy - 11
    • UBS Wealth Management Research 5 October 2010 Global economy UBS forecasts GDP (real, % yoy) Inflation (in % yoy) 2008 2009 2010 2011 2008 2009 2010 2011 Americas Americas Brazil 5.1 -0.2 8.2 5.4 Brazil 5.9 4.3 5.2 5.2 Canada 0.5 -2.5 3.1 2.8 Canada 2.4 0.3 1.7 2.3 Mexico 1.5 -6.5 4.8 3.7 Mexico 6.5 3.6 4.4 3.7 USA 0.0 -2.6 2.7 2.7 USA 3.8 -0.3 1.7 1.7 Asia-Pacific Asia-Pacific Australia 2.2 1.2 3.4 3.8 Australia 4.4 1.8 3.0 3.1 China 9.6 9.1 10.0 8.7 China 5.9 -0.7 3.0 4.0 India 6.7 7.4 9.0 8.0 India 7.8 6.4 8.6 6.0 Japan -1.2 -5.2 3.2 1.7 Japan 1.4 -1.3 -0.9 -0.3 Rest of Asia 2.8 -0.6 5.3 4.3 Rest of Asia 5.7 1.8 2.7 3.2 Europe Europe Eurozone 0.3 -4.0 1.7 1.9 Eurozone 3.3 0.3 1.6 1.8 Germany 0.7 -4.7 3.3 2.2 Germany 2.8 0.2 1.2 2.0 France 0.1 -2.5 1.7 1.9 France 3.2 0.1 1.8 1.6 Italy -1.3 -5.1 1.1 1.6 Italy 3.5 0.8 1.5 1.9 Spain 0.9 -3.7 0.1 1.0 Spain 2.2 2.7 2.0 1.8 Russia 5.6 -7.8 7.0 6.0 Russia 14.0 11.7 6.1 6.5 Sweden -0.6 -5.1 4.0 2.8 Sweden 3.5 -0.3 1.4 2.3 Switzerland 1.9 -1.9 2.7 2.2 Switzerland 2.4 -0.5 0.7 1.2 UK -0.1 -4.9 1.6 2.3 UK 3.6 2.2 3.1 2.6 World 2.4 -1.1 4.1 3.7 World 5.4 1.3 2.9 3.0 Source: ThomsonReuters EcoWin, UBS WMR Global economy - 12
    • UBS Wealth Management Research 5 October 2010 Global economy Appendix Global Disclaimer Wealth Management Research is published by Wealth Management & Swiss Bank and Wealth Management Americas, Business Divisions of UBS AG (UBS) or an affiliate thereof. In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. 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