1
Eric Chaney
Chief Economist, AXA Group
Head of Research, AXA IM
Eric.Chaney@axa-im.com
June 2014
(Update 17 June, 2014)
...
2 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM2
The global macro outlook
 Global GDP forecast trimmed...
3 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Central banks: a tentative calendar for exits
 Bank of...
4 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Main macro risks
Short term (3 to 6M):
 Markets challe...
5 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What equity markets say
Equities: supported by risk app...
6 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What our models say
Equities: Risk Appetite Barometer p...
7 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What bond markets say
Bonds boosted by dovish talk; € d...
8 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What bond markets say
Forward curves: hammered by Yelle...
9 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real bond markets say
Inflation futures: stabilisa...
10 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What commodities markets say
Commodities: Chaos in Ira...
11 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What FX markets say
Currencies: € overvalued vs. ¥ and...
12 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
Global trade: roller...
13 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
Inflation/deflation ...
14 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
Divergences within d...
15 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
China: deceleration ...
16 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
 Chinese exports fell from a cliff in February (-45% ...
17 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
US: manufacturing re...
18 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
US: Q1 pothole passe...
19 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
US Consumers: the re...
20
What monetary indicators say
US Fed: money gap positive, money multiplier declining
 The Fed’s obsession: do not repea...
21 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
Japan: losing steam?...
22 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What central banks say
Japan: QE likely to extend into...
23 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
Europe: recovering f...
24 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What real economic indicators say
€-area manufacturing...
25 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What € bond markets say
€-Spreads: convergence at the ...
26
What monetary indicators say
ECB: flat money supply hints at deflation risk
 The ECB is struggling to boost money supp...
27 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What monetary indicators say
ECB: challenged by credit...
28 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Baseline 2014-18: quantitative scenario (1)
Source:IMF...
29 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Baseline 2014-18: quantitative scenario (2)
Source:IMF...
30 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Interest rates 2014-20 scenario: US
Source: Datastream...
31 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Interest rates 2014-20 scenario: EUR
Source: Datastrea...
32 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Interest rates 2014-20 scenario: JP and UK
Source: Dat...
33
AXA IM Research recommendation
Asset allocation - overall
 Equities
Short-term: Overweight
 Worst over for emerging m...
34
AXA IM Research recommendation
Asset allocation – fixed income (UW)
 Government bonds:
Short-term: Underweight
 Fadin...
AXA IM Research recommendation
Asset allocation – equities (OW)
 United States (UW)
+ Growth likely to accelerate
- Eleva...
Theme: Central Banks exit strategies
The shadow of Milton Friedman
 “The quantity of money in the United States fell by o...
Theme: Central Banks exit strategies
Central bankers heard Friedman’s call...
From March 2007 to March 2014, the BoE incre...
38 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
-100
-50
0
50
100
150
5 10 15 20 25 30
Changein10Yinfl...
39 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Theme – Central Banks exit strategies
US Fed: targetin...
40 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Theme – Central Banks exit strategies
ECB: targeting 1...
Theme: Central Banks exit strategies
Unconventional policies raise long term risks
 Risk #1: Fiscal dominance (Japan – US...
42 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Theme - Europe is not out of the woods
What to make of...
43 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Theme - Europe is not out of the woods
Recessions are ...
44 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Theme - Europe is not out of the woods
Asymmetric corr...
45 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Theme: Europe is not out of the woods
€-area imbalance...
46 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Theme: Europe is not out of the woods
€-area imbalance...
47 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Theme: Europe is not out of the woods
€-area imbalance...
48 Eric Chaney, Chief Economist AXA Group, Head of research, AXA IM
Long-term, structural themes
By 2025, China should be ...
49 Eric Chaney, Chief Economist AXA Group, eric.chaney@axa-im.com
Long-term, structural themes
Unbridled credit supply = R...
50 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Long-term, structural themes
The 4 stages of post-WWII...
51 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Long-term, structural themes
Debt: The post WWII US ex...
52 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
The optimal exit path: productivity (and labor force g...
53 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Long-term, structural themes
Could 1970s stagflation c...
54 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Long-term, structural themes
Long term, Fed may tolera...
55 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Long-term, structural themes
Buba- ECB won’t tolerate ...
56 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Long-term, structural themes
ECB not really scared by ...
57 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
What about hyperinflation?
What is hyperinflation?
Phi...
58 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Biography
Eric Chaney
Chief Economist AXA Group
Head o...
Glossary
 Backwardation: situation whereby future commodity prices are lower than spot prices
 Breakeven: expected infla...
60 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM60
Recent research from AXA IM
AXA IM research document...
61 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
Disclaimer
 This document is used for informational p...
Upcoming SlideShare
Loading in …5
×

Eric Chaney's Blue Book, June 19, 2014

310
-1

Published on

Published in: Economy & Finance, Business
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
310
On Slideshare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
2
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Eric Chaney's Blue Book, June 19, 2014

  1. 1. 1 Eric Chaney Chief Economist, AXA Group Head of Research, AXA IM Eric.Chaney@axa-im.com June 2014 (Update 17 June, 2014) Tracking the global recovery  2014 growth forecast cut to 3.3%  US = leading; China = insurance against downside  Emerging markets: regaining market confidence  Central banks: Fed-ECB ever more dovish  Euro area: risk of persistent low inflation
  2. 2. 2 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM2 The global macro outlook  Global GDP forecast trimmed from 3.5 to ≈ 3.3% ; US GDP from 2.8 to 2.2% ► Global trade and the US are recovering from 1Q dip, not fast enough to plug the gap ► China has taken an insurance on GDP growth, with a 7.0% floor ► The emerging markets cycle is lagging behind but should benefit from US growth  Fed: perceived as more dovish under Yellen than under Bernanke ► The new Chair is focused on the labour market, more than on financial stability ► Some FOMC members are ready to let inflation overshoot after having undershot ► Vice chair Stanley Fisher may take a more conservative view  The recovery in Europe is too sluggish to fully offset deflationist forces ► Weak and uneven, the cyclical recovery is nevertheless supportive for equities ► The ECB has delivered an easing package; targeted liquidity injection is the new plan ► Absent QE (unlikely), bank restructuring is a necessary condition to the recovery  Emerging markets: net capital inflows and market sentiment again positive ► Tapering being fully priced, the Fed’s dovish stance is –again- positive for EMs ► Country-specific political risks made things worse. They look less acute now ► The good news: emerging markets have proved resilient to capital flows gyrations
  3. 3. 3 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Central banks: a tentative calendar for exits  Bank of England: end 2014 / early 2015  Federal Reserve: end 2015 / early 2016  European Central Bank: 2017  Bank of Japan: 2018
  4. 4. 4 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Main macro risks Short term (3 to 6M):  Markets challenging the Fed on its very dovish policy stance Yellen’s Fed has become ever more dovish. A rise in inflation may question this stance  Political instability in the Middle East sending crude oil prices through the roof Two conflicts are yet unresolved: Israelis vs. Palestinians and Sunnis vs. Shias  Political instability in Europe caused by votes on independence or EU membership The rise in eurosceptic votes shows that tensions within the EU are building up  Policy mistakes by Chinese policymakers causing an unexpected hard landing China has to reform on several fronts while keeping GDP growth above 7%. Challenging! Medium to long term:  Very low inflation becoming entrenched in the euro area if bank restructuring is too slow Following a large debt build-up, excessively low inflation would raise solvency issues  Further French / German growth and fiscal divergence, markets testing France France is now moving toward supply side reforms – at a snail pace  Ill designed ‘exit strategies’ by big central banks (Fed/BoJ/BoE) Inflating monetary bases to prevent deflation was easy. The opposite won’t be  Mismanagement of the rise of China as regional superpower From India to Japan through Philippines and Vietnam, worries are building up
  5. 5. 5 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What equity markets say Equities: supported by risk appetite and liquidity Source: MSCI, AXA IM Research  Equity markets have shrugged off concerns about Ukraine, China and oil (so far)  Performances are comparable across regions  The MSCI index has crossed the trend +1s.d. line but valuations are not stretched (yet) and risk appetite is strong  The trend growth rate of real total return is in line with the post-1971 era (2.4%) 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0 2.1 2.2 2.3 Log (MSCI - World Equity Index*, inflation adjusted), 1=1970 *: Total return Red line: real trend (non recursive HP filter, lambda = 10^11) Dotted lines: +/- 1 standard deviation of deviation from mean Deflator interpolated from US PCE deflator As of: 17/06/2014 World US EMU (€) EU ($) EM ($) -40.3% -37.1% -44.3% -46.1% -53.2% Through 2008 30.8% 27.1% 28.7% 36.8% 78.7% Through 2009 12.3% 15.4% 3.3% 4.5% 19.2% Through 2010 -5.0% 2.0% -14.1% -10.5% -18.2% Through 2011 16.2% 16.1% 18.0% 18.7% 18.5% Through 2012 27.4% 32.6% 24.4% 26.0% -2.3% Through 2013 5.5% 6.0% 8.1% 6.2% 5.4% Since 01 Jan 2014 3.2% 3.9% 3.8% 1.4% 1.7% Last four weeks MSCI total return indexes (source MSCI) -3 -2 -1 0 1 2 3 4 5 6 7 8 9 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 MSCI World Equity Index*Annualized real rate of return *: Total return Annualized rate of growth of smoothed (non recursive HP filter, lambda = 10^11) inflation-adjusted total return index. Deflator interpolated from US PCE deflator Long-term average
  6. 6. 6 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What our models say Equities: Risk Appetite Barometer positive  Our in-house ‘Risk Appetite Barometer’ has increased further in June  Its cyclical component (US and € Surprise Gaps) is now firmly in positive territory, led by the US. Also: * The 3M momentum component is rising and is now above zero * The average pair-wise correlation of US stocks is low, a sign that herd behaviour is not a risk * The low vs. high credit quality spread is record high: investors see a recession as highly improbable Rescaled weighted average of four scores (AXA IM surprise gaps, Corporate bond spread of spreads, Average pair-wise correlation of stocks & 3-month equity price momentum) Cyclical risk: first score / Systematic risk: weighted average of the last three scores Sources: Bloomberg, Datastream, Reference document: Market sentiment indicators: less is more – Mathieu L’Hoir – AXA IM Research – May 24th 2012 -1.0 -0.5 0.0 0.5 1.0 -1.0 -0.5 0.0 0.5 1.0 2009 2010 2011 2012 2013 2014 Risk appetite Risk aversion Weekly Risk Appetite Barometer(RAB) Systematic risk appetite Cyclical risk appetite Risk Appetite Barometer (RAB) Latest Data: 17/06/2014
  7. 7. 7 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What bond markets say Bonds boosted by dovish talk; € decoupling from US  Markets see the first Fed hike in mid/late 2015, followed by 25bps hikes every two other FOMC meetings  The ECB rate cuts and announced TLTRO had a small negative impact on Bund yields. Depending on the speed of the restructuring of the banking system, the ECB may have to keep rate at zero until 2017  The long term view: we are at the beginning of a secular bear market for US Treasuries. Once QE is over, markets will reprice the term and inflation premia and reconsider the timing of rate hikes as time passes  In the euro area, a Japanese scenario is a possibility, although not the main case Source: Datastream, AXA IM Research 0 1 2 3 4 5 6 7 8 9 10 11 0 1 2 3 4 5 6 7 8 9 10 11 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 USA Germany US trend Japan Main benchmark 10Y bonds, annual yields% All time lows: US Treasuries: 1.40% on 24 July, 2012 Bunds: 1.15% on 31 May, 2012 JGBs: 0.43% on 13 June, 2003 Latest data: 17 June 2014 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 USA Germany US trend Japan % First hint at 'imminent' tapering
  8. 8. 8 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What bond markets say Forward curves: hammered by Yellen and Draghi  UST curve: Since end 2013, medium-long-term forwards have fallen by up to 70bps, while shorter forwards were stable, as if markets were pricing slower long term growth or a lower duration risk premium  The first speeches of Fed chair Janet Yellen have confirmed that she is on the dovish side re interest rate policy. Yet, markets are trying to assess FOMC decisions, not only the chair’s views  German curve: over the same period, the whole forward curve has eased. Markets have postponed by one year their rate hike expectations. The term premium is still in negative territory: for the markets, a Japanese scenario is not excluded. The ECB may have to diverge from the Fed over 2015-16 Source: Datastream, AXA IM Research -100 -50 0 50 100 150 200 -100 -50 0 50 100 150 200 Average (1999-2012) TP for UST = 70bps US Treasuries German Bunds A proxy for the term premium on 10Y UST and Bunds (basis points, estimated from zero-coupon curves) The term premium is from the Kim-Wright (Fed) model for UST The proxy is a linear function of the 1Y in 7Y forward rate0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 1Y ...in 1Y ...in 2Y ...in 3Y ...in 4Y ...in 5Y ...in 6Y ...in 7Y ...in 8Y ...in 9Y Euro curve, 13-Jun-14 US curve, 13-Jun-14 US curve, 27-Dec-13 Euro curve, 27-Dec-13 US and Germany 1Y forward rates derived from zero coupon curves%
  9. 9. 9 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real bond markets say Inflation futures: stabilisation  Medium term (5Y) expectations have stabilised in the four constituencies we are tracking, with Japan and the euro area at the low end, hovering around 1.2 / 1.3%  Longer term (5Y in 5Y) expectations are broadly stable in the US, between 2.75 and 3.0%, and in the UK, around 3.5%. They have declined to 2.0% in the €-area . If extended, this downward trend would challenge the ability of the ECB to “anchor long-term inflation expectations”.  With Fed, BoE and BoJ sailing in unchartered waters, investors may ask for a higher long term inflation premium, at some point in time. The longer exit strategies are postponed, the higher the premium. Source: Datastream, AXA IM Research -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 UK 5Y in 5Y US 5Y in 5Y EUR 5Y in 5Y Japan 5Y in 5Y Inflation swaps (breakevens), 5Y in 5Y Latest data: 09/06/2014 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 UK 5Y US 5Y EUR 5Y Japan 5Y Inflation swaps (breakevens), 5Y
  10. 10. 10 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What commodities markets say Commodities: Chaos in Iraq may cause a spike  Base metal prices have been declining on trend since early 2011. The deceleration of headline growth in China together with sluggish recoveries in developed economies and ‘end of QE’ headwinds for emerging economies may fuel this downward trend further. Yet, at the moment, they are stable.  Crude oil (Brent): while markets shrugged off tensions between Russia and the West (use of strategic reserves by the US?), they are sensitive to the situation in Iraq. Long forwards indicate convergence toward $100/bbl, once stamped ‘fair price’ by Saudi Arabia... Source: Datastream AXA IM Research 0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 0 1,000 2,000 3,000 4,000 5,000 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Brent, US$/bbl HWWA Index Brent LME index LME Metal Index HWWA Agriculture Raw Materials Index -RHS 60 70 80 90 100 110 120 130 60 70 80 90 100 110 120 130 Crude oil futures, ICE Brent contracts Spot Dec-2014 Dec-2016 Dec-2018 US$/bl Latest data point: 18/06/2014
  11. 11. 11 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What FX markets say Currencies: € overvalued vs. ¥ and $, £ rising fast  Since Mr. Abe election, the JPY has fallen by 30% BoJ is likely to expand further its monetary base  The ECB is concerned by deflation. Followed by action, it is EUR negative. If action fails, deflation is EUR positive  Fed tapering should be USD positive. A stronger than expected recovery in the US too. Source: Federal reserve, ECB, BoE, AXA IM Research Nominal TW rate: Deviation from average(1999-2013) As of: UK £ Euro JP Yen Swiss franc US $ 17/06/2014 -6.2% 2.6% -4.3% 24.5% -9.5% US$ real bilateral rate: Deviation from(1999-2012) As of: US$ /Yen US$ / CHF US$ / UK£ US$ / € 17/06/2014 17% -18% -6% -9% Euro real bilateral rate: Deviation from(1999-2012) As of: € / Yen € / US$ € / UK £ € / CHF 17/06/2014 31% 10% 3% -7% JPY real bilateral rate: Deviation from(1999-2012) As of: JPY/€ JPY/US$ JPY/UK£ JPY/ CHF 17/06/2014 -25% -17% -23% -30% 70 80 90 100 110 120 130 140 150 70 80 90 100 110 120 130 140 150 2007 2008 2009 2010 2011 2012 2013 2014 CHF JPY EUR USD GBP Average 1999- 2012 Nominal trade-weightedexchange rate, 100=average (99-13) 70 80 90 100 110 120 130 140 70 80 90 100 110 120 130 140 2006 2007 2008 2009 2010 2011 2012 2013 2014 € / JPY € / US$ € / UK £ € / CHF Euro bilateral exchange rate, adjusted for inflation trends 100 = average (99-13) StrongeuroWeakeuro
  12. 12. 12 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say Global trade: roller coaster, weak underlying trend  Global trade contracted in 1Q 2014 (-0.8%Q), a payback after an abnormally strong 4Q 2013 (+1.6%Q)  The underlying trend (circa 3.5%) is significantly weaker than the longer trend (6%)  Unless trade sharply rebounds in the coming months, global trade growth will disappoint again in 2014  The elasticity of trade relatively to global growth has fallen from 1.5 before the global financial crisis to less than 1 since then. Is this a structural shift? If it is, growth models based on exports would suffer. Source: CPB, AXA IM Research Volume Price in US$ GlobalTrade 75 85 95 105 115 125 135 145 25 45 65 85 105 125 145 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Volumes (s.a.) Prices / unit values in US$ March 2014 -21% 100 = 2005 Global trade in US$, 2008/06 to 2009/04: -32.5% - 15%
  13. 13. 13 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say Inflation/deflation balance: deflation has an edge  Japan, the UK and a handful of emerging economies are operating above recent trends, by a small margin. China is close to potential, Brazil below trend.  Most of Europe is at or below trend, but the UK, which is now on a fast track  Short term, risks are still tilted toward disinflation  Bear in mind that the global component of inflation explains 70% of local inflation (*) Source: Datastream, AXA IM Research (*): More precisely, the share of inflation variance explained by a measure of global inflation is 71%, on average, for Oecd economies. This share ranges from 60% for Germany to 68% for the US and 89% for France. Source: Ciccarelli and Mojon, Global Inflation in The Review of Economics and Statistics, 2010. Trend GDP is estimated with a non-recursive HP filter, with lambda set at 10,000 (industrialised) or 5,000 (emerging) -4 -3 -2 -1 0 1 2 3 -4 -3 -2 -1 0 1 2 3 Japan Hungary Malaysia UK US Denmark Australia Canada Indonesia Germany Turkey China Sweden Korea Romania Switzerland Chile Mexico France Belgium Russia* Taiwan Argentina* Italy Poland India Portugal Ireland* Spain Brazil Thailand Netherlands Greece Output Gaps, 1Q 2014 (* = 4Q 2013) Actual minus trend GDP as % of trend GDP Operating above trend Operating close to trend Risk of deflationOperating below trend 1.0% < OG -1.0% < OG < 1.0% -2.5% < OG < -1.0% OG < -2.5% -3.8
  14. 14. 14 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say Divergences within developed economies stabilised Source: National Accounts, AXA IM Research  Since the bottom of the 2009 recession, recoveries in the developed world have been heterogeneous.  Canada, Switzerland and Sweden, all wide open economies, are doing better than others.  Among larger developed economies, the US is leading, followed by Germany. The UK is catching up  Japan has overtook France, where unemployment is still rising. Yet, mind the payback in 2Q  Along larger economies, Italy remains the most worrying case, with GDP still 9% below the 2008 peak 86 88 90 92 94 96 98 100 102 104 106 108 110 86 88 90 92 94 96 98 100 102 104 106 108 110 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Canada US Germany France Japan UK Italy Real GDP index 100 = average 3 quarters around peak 74 76 78 80 82 84 86 88 90 92 94 96 98 100 102 104 106 108 110 76 78 80 82 84 86 88 90 92 94 96 98 100 102 104 106 108 110 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Sweden Switzerland Belgium Netherlands Ireland Spain Portugal Greece Real GDP index 100 = average 3 quarters around peak
  15. 15. 15 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say China: deceleration under control; PBC role critical  China’s GDP decelerated further in 1Q (1.4%Q vs. 1.7% in 4Q 2014), hit by weak exports. Industrial production growth has landed just below 9%  Thanks to the targeted stimulus decided by the government, the 7.0% floor for GDP looks credible. We have cut our 2014 forecast to 7.2%.  Financial jitters are likely, as PBC raises the ante to force banks to clean their balance sheet. Yet, liquidity is controlled by PBC and a credit hard landing is unlikely, in the short term at least  Car sales are growing robustly (16%Y on trend), testimony of a re- balancing toward consumer demand. Source: NBS, Datastream, AXA IM Research 50 100 200 50 100 200 2006 2007 2008 2009 2010 2011 2012 2013 2014 Smoothed series Raw series China: vehicles production (volume index - log scale) 2 4 6 8 10 12 14 16 18 2 4 6 8 10 12 14 16 18 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Real YoY Real GDP quarterly annualised (SAAR) Trend growth (HP) China - actual and trend real GDP growth 0 5 10 15 20 25 35 40 45 50 55 60 65 2006 2007 2008 2009 2010 2011 2012 2013 2014 China: NBS PMI and industrial value added 12M % change PMI index Long term relationship between growth and PMI Output % = -28 + 0.8*PMI Breakeven around 35 PMI at 50 consistent with circa 10% growth in the long run IP growth, May 2014 PMI, April 2014
  16. 16. 16 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM  Chinese exports fell from a cliff in February (-45% MoM), without any ‘economic’ rationale. Imports fell much less (-22%), thus generating a trade deficit (=China exporting growth). Since then, exports have recovered faster than imports; yet the current trend is puzzlingly flattish.  This is why a limited fiscal stimulus was decided, together with a cut in the reserve requirement rate  The message from the PBC was loud and clear: with financial liberalization coming, RMB/USD will no more be a one-way bet. Note that the currency is now back on the 2.5% p.a. appreciation line. Source: NBS, Datastream, AXA IM Research What real economic indicators say China: sluggish exports, RMB stabilised 11 12 13 14 15 16 17 18 19 11 12 13 14 15 16 17 18 19 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Average annual rate: +6% 100 yuan = … US $ 2.5 to 5% per annum 21July,2005 25July,2008 21June,2010 End of the 5% p.a. de facto FX policy New leadership Trading range widened to +/- 2.0% Latest data: May - 2014 -20 0 20 40 60 80 100 120 140 160 180 200 220 -20 0 20 40 60 80 100 120 140 160 180 200 220 2006 2007 2008 2009 2010 2011 2012 2013 2014 USD Bn USD Bn Exports (monthly, USD Bn) Imports (monthly, USD Bn) Trade balance (smoothed) China: Trade flows ?
  17. 17. 17 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say US: manufacturing recovering; GDP forecast cut  The May ISM index (speed component) was up but still 2% below its 4Q 2013 average. The Surprise Gap (acceleration component) rose significantly, hinting at a likely acceleration of the US economy  GDP growth is likely to accelerate during the year, thanks to a more benign fiscal drag (-0.75% vs. -1.75% in 2013), more confident consumers and companies likely to spend more on equipment goods  Yet, a part of the production lost in 1Q will not be recouped. even a strong rebound in 2Q (say 4%) wouldn’t save the year. We have cut our GDP forecast from 2.8% to 2.2%. Source: ISM, Fed, AXA IM Research -4.0 -3.5 -3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 -4.0 -3.5 -3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Surprise Gap, smoothed Surprise Gap (Production - previous orders), normalised Production component March 2009 US Surprise Gap: Current production minus new orders 3 months ago Source: ISM (ex-Napm) survey Recession warning Recovery signal US Surprise Gap Index February 2010 May 2011 August 2013 December 2007 June 2012 Dec. 2011 Feb. 2013 October 2008 February 2014 July 2009 May 2014 -20 -10 0 10 20 30 40 50 60 70 80 90 100 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Production (lhs) Aggregate hours (lhs) Index - 100 = 2007 US Manufacturing production 3M / 3M annualised rate, % Production growth (rhs)
  18. 18. 18 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say US: Q1 pothole passed, fundamentals improving  Corporate investment (x-structures) is growing slower than in the first phase of the recovery(2.5% on trend vs. 10% in 2010-11), despite improving fundamentals. It is likely to accelerate in the course of the year.  More worrying and uncertain is the outlook for housing investment, which contributes to explain why the Fed wants to check bond yields and mortgage rates.  As growth accelerates, the participation rate will rise, thus slowing the unemployment decline. Interestingly, the perceived unemployment rate is not declining as fast as the measured one. In its forward guidance, the Fed will assess the labour market through a broader set of variables than the sole unemployment rate. Source: BEA, , Department of Commerce, Conference Board, AXA IM Research 45 50 55 60 65 70 75 80 85 90 95 100 105 110 115 120 125 130 135 45 50 55 60 65 70 75 80 85 90 95 100 105 110 115 120 125 130 135 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Corp. Invest., equipment softwares and intangibles (10%) Private consumption (68%) GDP (100%) Gov't spending (19%) Residential investment (3%) Volume indexes; 100 = average (2001-2007) US GDP and demand components 1 2 3 4 5 6 7 8 9 10 11 1 2 3 4 5 6 7 8 9 10 11 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 'Perceived' unemployment rate Actual unemployment rate Actual: extrapolated trend 'Perceived': extrapolated trend 10.8% 7.8% Subjective unemployment = 5.8+ 0.06 * (balance of opinion on current jobs - Conference Board) OLS, 1978-2013, R2=0.83 10.0%
  19. 19. 19 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say US Consumers: the return of wealth  As long as the personal saving rate rises, consumer spending could not but disappoint. This is what happened until 3Q 2010. As wealth rises and net debt declines, the savings rate may decline –again.  Based on 1Q net wealth data, the personal savings rate could fall by another 1 pp during the year, thereby boosting consumer spending  The stabilisation of the debt/income ratio (at end-2002 level) is consistent with the wealth-based analysis Source: BEA, AXA IM Research. Latest data: 1Q 2014 (NIPAs revised from 1929) 0 2 4 6 8 10 12 14 40 50 60 70 80 90 100 110 120 130 140 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Household total credit market debt Debt trend Gross saving rate (smoothed) Gross saving rate Debt, % of disposable income Saving, % of disposable income Debt trend (1975-1999) Debt overhang: between 9% and -7%% of income, as of Mar. 2014 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 CORRELATION = - 0.71 Personal gross savings rate, % of personal disposable income (left hand scale) Ratio Net wealth / annual disposable income (right hand scale) Consistent with 3.0% savings rate
  20. 20. 20 What monetary indicators say US Fed: money gap positive, money multiplier declining  The Fed’s obsession: do not repeat the mistakes of 1930  Former chairman Bernanke was the first scholar to demonstrate that Milton Friedman, not JM Keynes, was right about the cause of the 1930 depression: it was the contraction of money supply, not fiscal austerity  When QE3 ends, the monetary base will have increased 5 times compared to pre-Lehman  The test will come when the money multiplier, so far low and stable, starts rising. Then, the Fed will have to shrink its balance sheet accordingly. This is not (yet) part of the official exit strategy of the Fed. Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Source: Federal Reserve Board, AXA IM Research 8.6 8.7 8.8 8.9 9.0 9.1 9.2 9.3 9.4 2 3 4 5 6 7 8 9 10 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 US: Broad money and money multiplier Money multiplier (left hand scale) = M2 / Monetary base, Ln (M2), right hand scale Ratio log (US$ bn) 6% Long termtrend(5.5% p.a.) 0 2,000 4,000 6,000 8,000 10,000 12,000 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 US: Monetary base and broad money Bank reserves (left hand scale) Monetary base (left hand scale) US$ bn US$ bn Monetary base: +$ bn i.e. + Broad money (M2): + 42% M2 (right hand scale) Lehman Bros bankruptcy EndofQEsimulation 3,050 348% Latest data: 01/05/2014
  21. 21. 21 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say Japan: losing steam? Watch Capex  Master piece of Abenomics, the BoJ decision to double its monetary base and reach 2.0% inflation has weakened the yen, boosted equity prices and raised companies as well as consumers’ expectations.  GDP growth took off in 1Q (6.7% annualised growth), as consumers tried to beat the 3pp tax hike. A payback is due in 2Q, but the Tankan-based Surprise Gap is consistent with a re-acceleration in 3Q. Even pricing in a 3.5% GDP dip in 2Q, our 1.7% GDP growth forecast for the full year looks reasonable.  Corporate investment (capex) was re-ignited by Abenomics: capex was up 11.6% in the last 12M. We expect 1.7% GDP growth in 2014, after 1.5% in 2013. Source: MoF, AXA IM Research -15 -10 -5 0 5 10 15 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Manufacturing production, (quarterly growth, %, RHS) Tankan based Surprise Gap (standard deviation, LHS) Japan: Manufacturing production and Tankan based Surprise Gap Tankan based Surprise Gap (Smoothed), LHS) 60 70 80 90 100 110 120 130 140 80 85 90 95 100 105 110 115 120 20012002200320042005200620072008200920102011201220132014 Gov't consumption (20%), LHS Consumption (60%), LHS GDP (100%), LHS Fixed investment (20%), LHS Exports (15%), RHS Japan: GDP and final demand components Volume indexes; 100 = average (2001-2007)
  22. 22. 22 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What central banks say Japan: QE likely to extend into 2015  Abe’s second arrow (fiscal stabilisation – 3pp rise of consumer tax in 2014/04, possibly another 2pp in 2015) and third arrow (reform agenda, including energy and medical sector deregulation, farmland reform, special economic zones “tokku”) is now in place  Therefore, the BoJ is likely to support further the government policy by extending its purchases of assets into 2015 and, probably into 2016. Bond yields will not rise any time soon. Source: Gov. Kuroda at Jackson Hole, 24 August 2014 Beyond 2014: AXA IM estimates 0 50 100 150 200 250 300 2007 2008 2009 2010 2011 2012 2013 2014 BoJ JGB holdings Monetary base Introduction of QQE Bank of Japan balancesheetand QE, in ¥tn End-2013 ¥200tn End-2013 ¥141tn End-2014 ¥270tn End-2014 ¥190tn
  23. 23. 23 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say Europe: recovering from x3 dip caused by x3 deleveraging  € area manufacturing fell again in recession at the end of 2011 and did not recover until 2Q 2013.  A triple-deleveraging (banks, consumers and governments) depressed domestic demand in 2011 and 2012. Southern economies are still hit by a credit crunch. With more neutral fiscal policies and banks on the mend, the recovery, although sluggish, seems sustainable  On balance, Germany, which benefits from robust overseas demand and negative real interest rates, is and will remain the powerhouse of Europe. Spain has bottomed out and could surprise on the upside Source: Datastream, AXA IM Research -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 US China* €-area Manufacturing production 3M/3M, annualized rate % * YoY for China 65 70 75 80 85 90 95 100 105 110 65 70 75 80 85 90 95 100 105 110 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Germany France Italy Spain* Manufacturing production Indexes, 100 = 2007 * Total industrial production
  24. 24. 24 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What real economic indicators say €-area manufacturing: sluggish recovery  The €-area Surprise Gap (SG) has been broadly neutral since the beginning of the year, supporting the scenario of a weak manufacturing recovery  Beneath the surface, companies are incrementally more positive on underlying demand trends  The €-area is more sensitive than the US or Japan to the escalation of the Ukrainian crisis. Source:Ifo,Insee,Istat,INE,CBS,BNB,AXAIMResearch -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 May 2009 April 2008 Euro Area Surprise Gap Index EA Surprise Gap: Current production minus production plans 3 months ago Recession warning Recovery signal December 2008 : -2.4 August 2013 May 2011 Feb 2012 May 2012 May 2014
  25. 25. 25 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What € bond markets say €-Spreads: convergence at the long end? not quite  Consistent euro politics (LTROs + €-Summit + threat of OMTs) have reversed the dynamics of spreads, in favor of Ireland, Spain and Italy, especially for short durations.  5Y in 5Y spreads have been declining on trend since July 2012. They are now fluctuating around 200 bps for Italy and Spain. A significant credit risk and/or a smaller euro club in the longer term are still priced in. This is not deterring yield-chasing investors.  Warning: the German Constitutional Court may cast doubts about the credibility of OMTs, depending on its reaction to the European Court of Justice decision (expected this year) Source: Bloomberg, Datastream, AXA IM research 0 100 200 300 400 500 600 700 800 0 100 200 300 400 500 600 700 800 Spain Italy Belgium France Austria Netherlands 2Y spreads vs. German bonds 25 Nov. 2011 24 Jul. 2012 0 100 200 300 400 500 600 700 800 900 0 100 200 300 400 500 600 700 800 900 Spain Italy Ireland Belgium France Finland Netherlands 5Y in 5Y spreads vs. German bonds
  26. 26. 26 What monetary indicators say ECB: flat money supply hints at deflation risk  The ECB is struggling to boost money supply  M3 is almost flat: +0.8% 3M/3M annualized in April 2014 (0.9% on a 3M vs. 3M previous year basis)  Against its long term trend, M3 is running 20% below. The ECB’s monetary base has fallen below its pre-crisis trend  The purpose of the upcoming TLTRO (targeted LTRO) is to boost credit to companies, thus money supply  ‘Pure’ QE is very unlikely: high political costs vs. low and uncertain reward  The ECB may opt for other assets (ABS for instance); this is unlikely to be large enough to kick start money supply  The most promising channel is the restructuring of the banking system, but this might take years Source: ECB monthly bulletin Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM 8.2 8.4 8.6 8.8 9.0 9.2 9.4 9.6 5 6 7 8 9 10 11 12 13 14 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 € area: M3 and multiplier (M3/monetary base) Money multiplier = M3/monetary base Left hand scale Ln (M3), right hand scale Ratio log (€ bn) Ln(M3) trend 01/1999 to 12/2011 [6.7% p.a.] - 20% (€ 2.5Tn) 0 100 200 300 400 500 600 700 800 900 1,000 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000 01/2001 01/2002 01/2003 01/2004 01/2005 01/2006 01/2007 01/2008 01/2009 01/2010 01/2011 01/2012 01/2013 01/2014 01/2015 Monetary base, left hand Deposit facility, right hand scale € bn € bn
  27. 27. 27 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What monetary indicators say ECB: challenged by credit decline and acting Sources: ECB, AXA IM Research  The endless decline of new loans to companies is a serious cause for concern  With the GDP weighted 10Y average government bond yield at 2.0%, vs. nominal GDP running at 1.8%Y (1Q 2014), monetary policy action aiming at lowering bond yields would be futile  The first wave of TLTROs (in 2014) will have little impact on credit supply, because of its weak conditionality. On the other hand, it will contribute keeping bond yields low by subsidizing banks  After the publication of the stress tests, the restructuring of the banking system will accelerate and the conditionality of the next wave of LTROs will be hardened. If all goes as planned by the ECB (as supervisor and monetary authority), credit supply should start accelerating in the course of 2015. -50 -40 -30 -20 -10 0 10 20 30 40 50 60 70 -50 -40 -30 -20 -10 0 10 20 30 40 50 60 70 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Bns EUR, Monthly flows Loans to non-financial corporations April 2014 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Billions EUR, Monthly flows Loans to households April 2014
  28. 28. 28 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Baseline 2014-18: quantitative scenario (1) Source:IMF,Datastream,AXAIMResearch As of: 16-Jun-2014 2007 2008 2009 2010 2011 2012 2013 2014f 2015f 2016f 2017f 2018f World GDP (PPP) 5.3 2.7 -0.4 5.2 3.9 3.2 3.0 3.3 3.4 3.3 3.3 3.3 World GDP (market FX rate) 3.9 1.5 -2.1 4.1 3.0 2.5 2.6 3.0 3.1 3.1 3.0 3.0 USA 1.8 -0.3 -2.8 2.5 1.8 2.8 1.8 2.2 2.8 2.8 2.7 2.7 Euro area 3.0 0.3 -4.4 1.9 1.6 -0.6 -0.4 1.1 1.4 1.4 1.4 1.4 UK 3.4 -0.8 -5.2 1.7 1.1 0.3 1.4 3.3 2.7 2.5 2.4 2.4 Japan 2.2 -1.1 -5.5 4.7 -0.4 1.4 1.8 1.7 1.4 1.4 1.4 1.3 China 14.2 9.6 9.2 10.4 9.3 7.7 7.7 7.2 7.0 6.8 6.7 6.5 Rest of Asia 7.6 4.0 5.5 8.7 5.8 5.4 4.8 4.4 4.3 4.2 4.1 4.0 RoW 4.3 2.5 -2.4 4.7 3.9 2.8 2.7 3.0 3.0 3.0 3.0 3.1 Global trade (manuf. goods) 6.5 2.2 -12.5 14.5 6.1 1.9 2.7 3.0 5.1 5.0 5.0 4.9 Inflation US 2.9 3.8 -0.3 1.6 3.1 2.1 1.5 1.8 2.0 2.1 2.1 2.2 Euro area 2.1 3.3 0.3 1.6 2.7 2.5 1.4 0.5 1.4 1.5 1.75 2.0 UK 2.3 3.6 2.2 3.3 4.5 2.8 2.6 1.7 1.8 2.0 2.0 2.0 Japan 0.0 1.4 -1.1 -0.7 -0.4 -0.5 0.0 2.5 2.0 1.9 1.9 1.8 Crude oil (Brent), US$/bbl 72.6 97.3 61.7 79.9 111.6 112 109 110 112 113 116 118 % change 10.6 33.9 -36.6 29.5 39.7 0.4 -2.8 1.0 1.5 1.5 2.0 2.0 Interest rates, FX (end of period) US Fed funds (actual / target)- O/N 4.24 0.16 0.20 0.20 0.15 0.17 0.09 0.10 0.75 1.75 2.75 3.50 10Y Treasuries yield 4.03 2.25 3.84 3.31 1.88 1.80 3.01 2.9 3.5 3.9 4.3 4.6 Euro area EONIA 3.86 2.49 0.39 1.0 0.63 0.13 0.17 0.05 0.05 0.05 0.5 1.0 10Y Bund yield 4.33 2.94 3.38 2.89 1.83 1.43 1.94 1.7 2.1 2.51 2.89 3.2 €1 = …US$ 1.46 1.35 1.46 1.34 1.33 1.33 1.38 1.35 1.34 1.33 1.32 1.31 Japan Overnight call rate 0.47 0.46 0.11 0.0 0.10 0.09 0.10 0.1 0.1 0.1 0.1 0.75 10Y JGB 1.50 1.17 1.28 1.12 0.99 0.79 0.74 0.6 0.6 1.0 1.5 2.0 US$1 = … JPY 110 95 87 85 78 76 105 105 103 101 99 97 €1= … JPY 161 128 127 114 104 115 145 142 138 134 131 127 UK BoE base rate 5.5 2.0 0.50 0.50 0.50 0.50 0.50 0.75 1.25 2.00 2.75 3.50 10Y gilt 4.50 3.09 4.11 3.51 1.98 1.96 3.03 3.0 3.5 4.0 4.3 4.6 €1= … GBP 0.73 0.95 0.89 0.85 0.86 0.81 0.83 0.79 0.75 0.76 0.76 0.77
  29. 29. 29 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Baseline 2014-18: quantitative scenario (2) Source:IMF,Datastream,AXAIMResearch 5.3 2.7 -0.4 5.2 3.9 3.2 3.0 3.3 3.4 3.3 3.3 3.3 -15 -10 -5 0 5 10 15 -6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 2007 2008 2009 2010 2011 2012 2013 2014f 2015f 2016f 2017f 2018f W orld GDP and trade (manufactured), % growth W orld GDP Global trade GDP scale Trade scale 20 40 60 80 100 120 140 -1 0 1 2 3 4 5 2007 2008 2009 2010 2011 2012 2013 2014f 2015f 2016f 2017f 2018f CPI Inflation annual change, % US (left) Euro area (left) Crude oil (Brent, US$/bl) Crude oil (right) 0 1 2 3 4 5 0 1 2 3 4 5 2007 2008 2009 2010 2011 2012 2013 2014f 2015f 2016f 2017f 2018f Policy interest rates, %, end of year Fed funds target ECB (Eonia) BoE base rate 0 1 2 3 4 5 0 1 2 3 4 5 2007 2008 2009 2010 2011 2012 2013 2014f 2015f 2016f 2017f 2018f Benchmark 10Y Bonds yield, %, end of year US Treasuries German Bunds JGBs UK Gilts
  30. 30. 30 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Interest rates 2014-20 scenario: US Source: Datastream, AXA IM Research 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 2014 2015 2016 2017 2018 2019 2020 Fed funds target - O/N 5Y Treasury yield 10Y Treasury yield US rates: baseline scenario  US Fed rate policy: first hike in late 2015, followed by 100bp increases in 2016 and 2017; long-term neutral short term rate: 4.0% (consistent with 2.5% LT potential growth and 2.0% inflation target) Note that this is consistent with Larry Summers statement to the WSJ: “I suspect unless circumstances change fed funds rates may well average less than 3% over the next decade”  US Treasury curve: steady normalization of the term premium, converging toward 120bps, lower than before the crisis because of Fed’s holdings of Treasuries.  Alternative scenario – Other things equal, a terminal rate for the Fed funds target at 3.5% instead of 4% would cut the 10Y yield long term target from 5.2% to 4.5%. 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 2014 2015 2016 2017 2018 2019 2020 Term Premium Average expected 1Y rates 1Y Treasury yield US rates: baseline scenario Term premium
  31. 31. 31 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Interest rates 2014-20 scenario: EUR Source: Datastream, AXA IM Research 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 2014 2015 2016 2017 2018 2019 2020 Refi / Eonia 5Y Bund yield 10Y Bund yield ECB / German rates: baseline scenario  ECB rate policy: first hike in 2017, followed by 50, then 75bps increases in 2018-2020; long term neutral short term rate: 3.3% (consistent with 1.5% LT potential growth and 2.0% inflation target)  German Bund curve: steady normalization of the term premium, converging toward 60bps, lower than before the crisis because German Bunds continue to benefit from a safe haven premium  Alternative scenario (“Japanization”) - The ECB would keep its policy rate close to zero until 2018 and raise it progressively to 3.0%, because of slower potential growth. 10Y Bund yields would converge toward 3.4% in the long term, instead of 3.9% in our current projections, because of a lower terminal rate and also a lower term premium, due to an hypothetical extension of the ECB’s balance sheet. 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 2014 2015 2016 2017 2018 2019 2020 Term Premium Average expected 1Y rates 1Y Bund yield German rates: baseline scenario
  32. 32. 32 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Interest rates 2014-20 scenario: JP and UK Source: Datastream, AXA IM Research  Japan BoJ rate policy: QE extended into 2015 / mid-2016, then tapering; first rate hike in 2017, then gradual rise toward neutral rate (2.5%, consistent with 1.2% LT potential growth and 1.5% inflation)  JGB curve: yields capped below 1.0% by BoJ until 2016, then gradual rise toward 3.0%, which assumes a 50bp term premium, explained by the large size of the BoJ’s holdings of JGBs  UK BoE rate policy: first rate hike toward the end of 2014 or early 2015, then very gradual rise toward neutral rate (4.0%, (consistent with 2.5% LT potential growth and 2.0% inflation target)  Gilts curve: steady normalization of the term premium, converging toward 100bps, lower than before the crisis because of BoE’s holdings of Gilts. If the BoE opted for sales of its portfolio, a higher premium would be warranted 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 2014 2015 2016 2017 2018 2019 2020 O/N = base rate 5Y JGB yield 10Y JGB yield Japan rates: baseline scenario 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 2014 2015 2016 2017 2018 2019 2020 O/N = base rate 5Y Gilt yield 10Y Gilt yield UK rates: baseline scenario
  33. 33. 33 AXA IM Research recommendation Asset allocation - overall  Equities Short-term: Overweight  Worst over for emerging markets  Still ample liquidity but QE effect to fade Long-term: Overweight  The recovery will be spread over years  Risk of recession very low  Valuations: slightly expensive  Government bonds Short-term: Underweight  US economy to pick up  With yields at historical lows, equities win Long-term: Underweight  Expect further rise in long-dated yields (economic healing, term premium, inflation risk)  Credit: Neutral (short and long term)  Tug of war between rising yields and low default rates; quest for yield still intact  Less punitive capital requirements for long-term investors; preference for short duration high yield; valuation clearly less favorable today
  34. 34. 34 AXA IM Research recommendation Asset allocation – fixed income (UW)  Government bonds: Short-term: Underweight  Fading systemic risk in emerging markets  US yield normalisation should resume as growth reaccelerates and early signs of inflation appear Long-term: Underweight  Start of hiking cycle in US is expected by late 2015  Very large monetary base in US/UK imply inflation risk  Valuations are expensive  US curve slope: bear flattening in 2014 and beyond  EU curve slope: short end nailed at zero for 2 to 3 years, long end more likely to rise than to fall  Inflation linked-bonds: Overweight  Long term inflation expectations remain globally well anchored  Preference for US break-evens  Deflationary trends in the €-area = serious headwind Government bonds Short term (3-6M) Medium term (12-24M) United States € area core € area periphery = = UK Japan = Emerging = = Swap spreads Break-even = = – United States – Europe = ▲/▼ Changes of the month
  35. 35. AXA IM Research recommendation Asset allocation – equities (OW)  United States (UW) + Growth likely to accelerate - Elevated valuation; margins already high  Euro area (OW) + Declining systemic risk; attractive valuation + Earnings to rise thanks to margin expansion  United Kingdom (OW) + Cyclical improvement, reasonable valuations - Normalization of monetary policy coming  Japan (neutral) + Improving macro; ample liquidity - Yen depreciation already priced in  Emerging markets (neutral) + Attractive valuation; expect rebound of global trade - Weak economic activity  Switzerland (UW) - Expensive and defensive 35
  36. 36. Theme: Central Banks exit strategies The shadow of Milton Friedman  “The quantity of money in the United States fell by one-third in the course of the contraction. And it fell not because there were no willing borrowers -not because the horse would not drink. It fell because the Federal Reserve System forced or permitted a sharp reduction in the monetary base, because it failed to exercise the responsibilities assigned to it in the Federal Reserve Act to provide liquidity to the banking system. The Great Contraction is tragic testimony to the power of monetary policy -not, as Keynes and so many of his contemporaries believed, evidence of its impotence.” “The Role of Monetary Policy”, Milton Friedman The American Economic Review, Vol. 58, No. 1 (March 1968), p. 3 36 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Source: AXA IM Research – Manolis Davradakis
  37. 37. Theme: Central Banks exit strategies Central bankers heard Friedman’s call... From March 2007 to March 2014, the BoE increased its balance sheet by 408%, the Fed by 386%, the BoJ by 113% and the ECB by 85% 37 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM 0 5 10 15 20 25 30 35 40 45 50 03/2007 08/2007 01/2008 06/2008 11/2008 04/2009 09/2009 02/2010 07/2010 12/2010 05/2011 10/2011 03/2012 08/2012 01/2013 06/2013 11/2013 04/2014 Central banks balance sheets - % of GDP ECB Fed BoJ BoE 0 5 10 15 20 25 30 35 40 45 03/2007 08/2007 01/2008 06/2008 11/2008 04/2009 09/2009 02/2010 07/2010 12/2010 05/2011 10/2011 03/2012 08/2012 01/2013 06/2013 11/2013 04/2014 Monetary base - % of GDP ECB Fed BoJ BoE Source: Central Banks – AXA IM Research
  38. 38. 38 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM -100 -50 0 50 100 150 5 10 15 20 25 30 Changein10Yinflationexpectations (swaps),2014/2009 Change in CB balance sheet(% ofGDP), 2014/2007 JP UK USEUR Source: Markit – AXA IM Research Theme: Central Banks exit strategies ... With some impact on inflation expectations
  39. 39. 39 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Theme – Central Banks exit strategies US Fed: targeting 2.0% inflation, or a price level path? Sources: US Dpt of Commerce, AXA IM Research  In January 2012, the FOMC translated its mandatory price stability objective into a more concrete target, namely, a “longer-run goal for inflation” of 2 percent*.  A possible interpretation of the commitment to achieve a 2% inflation rate in the “longer-run” is that the Fed is actually targeting a 2%-sloped price path, instead of a mere 2% rate at any point in time  The average inflation rate observed from 1991until today has been 2.0%, supporting this interpretation  FOMC member Narayana Kocherlatova has recently expressed its interest for this option (May 2014) (*) “The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances.” Board of Governors – Press release January 25, 2012 -1 0 1 2 3 4 5 6 7 8 9 50 60 70 80 90 100 110 120 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 PCE price index (100 = 2009) PCE trend (1991-2013, slope: 1.97%) PCE inflation (average: 1.99%) PCE inflation, smoothed US Personal ConsumptionExpenditure Price Index (The inflationgauge targetedbythe Fed)  Why this matters: if inflation stays below 2% for a significant period of time, the Fed might want to deliver inflation above 2% over a significant period of time, and vice-versa.
  40. 40. 40 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Theme – Central Banks exit strategies ECB: targeting 1.99% inflation, or a price level path? Sources: Eurostat, AXA IM Research  The primary mission of the ECB is to ‘maintain price stability: safeguarding the value of the euro’*  At the outset of the €, the interpretation of the Governing Council (GC) was ‘positive inflation below 2%’  Later on, it became ‘to maintain inflation below, but close to, 2% over the medium term’**  More recently, some members of the GC said that, practically, the target is 2.0%  Since this target is ‘over the medium term’, it is legitimate to ask whether the ECB is actually targeting a 2%-sloped price path, instead of a mere 2% rate at any point in time (see slide on the Fed)  The facts: 1/ average inflation since 1998 (creation of the European Monetary Institute) is 2.00% 2/ the trend over the same period (2008- 2013) has a 2.08% slope  Why this matters: if inflation stays below 2% for a significant period of time, policy makers should aim at delivering a higher than 2% inflation rate during a significant period of time, and vice-versa. (*) in The Mission of the European Central Bank ECB website (**) Jean-Claude Trichet – Foreword to the 2011 edition of ‘The Monetary Policy of the ECB’ -2 -1 0 1 2 3 4 5 6 7 8 60 70 80 90 100 110 120 Eurozone HCPI (2005=100) HCPI trend (1998-2013, slope: 2.08%) HCPI inflation (average: 2.00%) HCPI inflation, smoothed Eurozone HarmonizedConsumer Price Index
  41. 41. Theme: Central Banks exit strategies Unconventional policies raise long term risks  Risk #1: Fiscal dominance (Japan – US – UK) Blowing up balance sheets was politically easy; deflating them won’t be. The risk is monetary policy becoming an instrument of debt management Among QE champions, only the BoE has alluded to sales of assets  Risk #2: Asset price detached from fundamentals (everywhere, including EMs) If ‘low-flation’ has structural causes other than a lack of aggregate demand, liquidity injections may inflate asset prices instead of real demand Bubbling markets? US High Yield, €-periphery bonds, UK housing  Risk #3: Japan-isation (€-area) In highly intermediated regions (€-area) flooding banks with liquidity may delay restructuring and therefore keep the economy in a slow growth, very low inflation and bond yields trap* (*) “Zombie lending and depressed restructuring in Japan”, Ricardo Caballero, Takeo Hoshi and Anil Kashyap, American Economic Review 2008, 98:5, 1943-1977 41 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
  42. 42. 42 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Theme - Europe is not out of the woods What to make of EU elections?  The rise of eurosceptic votes is so a large extent linked to the recessions that have hit most euro zone countries post 2008. Yet, once this factor is controlled, not all countries are equal Ireland Finland Austria Germany Belgium Netherlands Spain France Greece Portugal Italy -35% -30% -25% -20% -15% -10% -5% 0% 5% 10% 15% 0% 10% 20% 30% 40% 50% ChangeinrealGDPpercapita2013/2007 Percentage of eurosceptics MPs elected to European Parliament in 2014 Linear regression: Euroscepticvote = 14.3% - 1.04*GDP loss (R2 = 0.37) Correlation:-61% -20% -10% 0% 10% 20% France NL Austria Greece Italy Germany Ireland Finland Spain Portugal Belgium Shareof eurosceptic vote not explained by GDP change since2007 Sources: EU Parliament, AXA IM Research
  43. 43. 43 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Theme - Europe is not out of the woods Recessions are political bombs  Whatever the reasons for the recessions endured by several euro area countries (GDP previously artificially inflated by a credit bubble or by unsustainable public spending, or fiscal restriction), their amplitude is, in several countries, dramatic enough to fuel anti-euro or nationalistic political reactions.  Which countries are better off, compared to where they stood before EMU? We look at real GDP per capita.  Average growth at or above 1.0% p.a. from 1998 to 2013: * Ireland (2.01%) * Finland (1.47%) * Austria (1.33%) * Germany (1.30%)  Average growth below 1.0%: * Belgium (0.92%) * Netherlands (0.90%) * Spain (0.81%) * France (0.75%) * Greece (0.34%) * Portugal (0.23%) * Italy (-0.14%) Source: Eurostat, AXA IM Research 95 100 105 110 115 120 125 130 135 140 145 150 95 100 105 110 115 120 125 130 135 140 145 150 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Ireland Finland Germany Belgium Netherlands Spain France Greece Portugal Italy Gross domestic product per capitaat constant prices Indexed, 100=1998
  44. 44. 44 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Theme - Europe is not out of the woods Asymmetric correction in imbalances  Pre-2008 current account imbalances within the euro area (German surplus vs. Spanish deficit) could not be corrected through the nominal exchange rate (so long as countries remain in the euro)  The correction had to come from asset prices (stocks, properties and bonds), wages and domestic prices. This is a relative story: higher wage inflation in Germany would have made the adjustment easier  In Ireland and Spain, where excesses came from the private sector, the macro adjustment is largely done via deleveraging and fiscal retrenchment. In Portugal and Greece, where excesses came from government spending ‘austerity’ has been doing the job. All countries have C/A in surplus or at equilibrium  The German and Dutch C/A surpluses are not receding, evidence that macro adjustments are not coordinated. Worth noting: in 2013 H2, external trade contributed negatively to German GDP growth. Source: datastream, AXA IM Research Latest data: 3Q 2013 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 Current account balance: deficit €-area countries Ireland France Spain Portugal Italy Greece % of GDP -4 -2 0 2 4 6 8 10 12 -4 -2 0 2 4 6 8 10 12 Current account balance: surplus €-area countries Netherlands Germany Belgium % of GDP
  45. 45. 45 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Theme: Europe is not out of the woods €-area imbalances: twin deficits watch (1) Greece & Portugal: excess of government spending  Twin deficits dynamics are revealing the root of a country’s macro-imbalance  Because of the rules of the monetary union, government + C/A deficits >> 10% of GDP is risky C/A deficit caused by excessive public spending financed by gov’t debt C/A deficit caused by excessive private spending financed by credit bubble  Greece has dramatically reduced its imbalances, Portugal sails in safer waters Source: IMF, AXA IM Research -15 -10 -5 0 5 -15 -10 -5 0 5 Currentaccountbalance Government balanceGreece 1995 2009 2007Danger zone 2013e 2000 -15 -10 -5 0 5 -15 -10 -5 0 5 Currentaccountbalance Government balancePortugal 1995 2009 2000 Danger zone 2013e 2007
  46. 46. 46 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Theme: Europe is not out of the woods €-area imbalances: twin deficits watch (2) Spain & Ireland: excess of private spending  Twin deficits dynamics are revealing the root of a country’s macro-imbalance  Because of the rules of the monetary union, government + C/A deficits >> 10% of GDP is risky C/A deficit caused by excessive public spending financed by gov’t debt C/A deficit caused by excessive private spending financed by credit bubble Source: IMF, AXA IM Research -15 -10 -5 0 5 -15 -10 -5 0 5 Currentaccountbalance Government balanceSpain 1995 2009 2007 Danger zone 2013e -15 -10 -5 0 5 -15 -10 -5 0 5 Currentaccountbalance Government balanceIreland 1995 2009 2007 Danger zone 2013e [A one-off item sent the government balance to -32% of GDP in 2010) 2000  Spain and Ireland needs C/A surplus to service external debt
  47. 47. 47 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Theme: Europe is not out of the woods €-area imbalances: twin deficits watch (3) France and Italy: imbalances manageable, so far  Twin deficits dynamics are revealing the root of a country’s macro-imbalance  Because of the rules of the monetary union, government + C/A deficits >> 10% of GDP is risky C/A deficit caused by excessive public spending C/A deficit caused by excessive private spending Source: IMF, AXA IM Research -15 -10 -5 0 5 -15 -10 -5 0 5 Currentaccountbalance Government balance Italy 1995 2013e 2007 Danger zone -15 -10 -5 0 5 -15 -10 -5 0 5 Currentaccountbalance Government balance France 1995 2013e 2007 Danger zone 2000  France has reduced its fiscal, not its external, imbalance
  48. 48. 48 Eric Chaney, Chief Economist AXA Group, Head of research, AXA IM Long-term, structural themes By 2025, China should be as big as the US  … 70% larger than the €-area (vs. 30% smaller today)  … 4 times as large as India (alike today)  … 3.8 times as big as Japan (vs. 50% today) Nominal GDP in US$, trend growth assumptions, % p.a.:  China: 11%  India: 11%  US: 5.1%  €-area: 3.0%  Japan: 2.0% [Implicit real GDP growth assumptions:  China: 5.5%  India: 5.5%  US: 2.5%  €-area: 1.0%  Japan: 0.5%] 75% 51% 31% 21% 17% 16% 15% 12% 12% 8% 0% 10% 20% 30% 40% 50% 60% 70% 80% Euroarea China Japan Germany Brazil France UK India Italy Spain Nominal GDPs in current US$, as % of the US GDP (2Q 2013) Source: National Accounts
  49. 49. 49 Eric Chaney, Chief Economist AXA Group, eric.chaney@axa-im.com Long-term, structural themes Unbridled credit supply = Recipe for financial crisis Source: Schularick-Taylor NBER WP 15512- http://www.nber.org/papers/w15512. Aggregate data for 12 countries: Canada, Australia, Denmark, Germany, Italy, the Netherlands, Norway, Spain, Sweden, US and UK.  12 countries, data reconstructed over 140 years, one conclusion: watch bank assets 1920- 1929 1998-2008
  50. 50. 50 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Long-term, structural themes The 4 stages of post-WWII globalisation  1950-1973: Allegro (ε = 1.6)  US FDI in Europe and Japan  Productivity catch-up  Stable monetary system (until 1971)  1974-1987: Andante (ε = 0.9)  Stagflation, oil price volatility  Beggar-thy-neighbour FX policies  1988-2008: Vivace (ε = 2.2)  Globalisation turns global  Trade barriers fall  China enters the game  2008-?: lower trade elasticity  Temporary (consumer deleveraging)?  Or more structural (rising income in emerging economies shifting demand from manufactures toward services...) Source: WTO 2013 report – AXA IM Research 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 Log (world trade) Log (world GDP) ε T/Y = 0.9 ε T/Y = 2.3ε T/Y = 1.6 ε T/Y = 1.2 ? 1950- 1973 1974- 1987 1988- 2008 Phase I Phase II Phase III Phase IV 2010- 2013
  51. 51. 51 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Long-term, structural themes Debt: The post WWII US example 1946-1956 Debt/GDP reduction: -60 pts Contribution of real growth: -18 pts Contribution of inflation: -17 pts Contribution of primary budget balance: -13 pts Source: BEA, OMB, AXA IM Research – Inflation is measured by the GDP deflator Source: AXA IM estimates, based on the first order approximation of the dynamic equation of the debt. -5.0 0.0 5.0 10.0 15.0 20.0 1941 1944 1947 1950 1953 1956 1959 1962 1965 0 25 50 75 100 125Federal debt, % of GDP GDP growth, smoothed Inflation, smoothed 1946 - 1956 : Average real GDP growth: 3.6% Average inflation: 3.3% GDP, inflation, % Debt 1946:122%
  52. 52. 52 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM The optimal exit path: productivity (and labor force growth) This is how US and Europe deflated the legacy debt burden post WWII (US : innovation; Europe/Japan: catch-up) 1. Obama’s administration highly focused on innovation 2. Innovation: high return in developed economies, low return in developing economies 3. Productivity and moderate inflation: best compromise Long-term, structural themes US: The inflation temptation Simplistic arithmetic but food for thought: 7.0% nominal GDP growth = 3.3% (inflation) + 3.6% (growth) [actual US mix post WWII] = 4.0% (inflation) + 2.9% (growth) [possible post Great Recession path] In both cases, initial debt burden halved in 10 years
  53. 53. 53 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Long-term, structural themes Could 1970s stagflation come back?  Over 1971-1982, US CPI inflation averaged 8% and high inflation turned out to be unemployment-proof. The same happened in Europe, with two notable exceptions: Germany and Switzerland.  With the benefit of hindsight, three main factors explained stagflation: #1. Vietnam war and end of ‘dollar standard’ (15 August 1971). Enters ‘fiat money’, good bye gold. #2. Misguided monetary policies (stripping CPI from ‘transitory components’, illusion of jobs/inflation trade-off) #3. Real wage rigidities (indexation to prices, c.o.l.a. and other scala mobile, please note: no German word for indexation)  Factors #2 and #3 have all but vanished. Hopefully, Fed will be less focused on ‘core inflation’ (reminiscence of Arthur Burns’ stripping habit).  Factor #1 remains: Iraq, Afghanistan vs. Vietnam. Fiat money is here to stay. My personal view: stagflation is a red herring
  54. 54. 54 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Long-term, structural themes Long term, Fed may tolerate mild inflation Source: US Department of Commerce, Federal Reserve, AXA IM Research, latest data December 2009 US inflation (PCEPI) - 1960-2009 0 5 10 15 20 25 30 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 0 5 10 15 20 25 30 Frequency, in % Personal consumption expenditure price index: Mean: 3.7 Median: 3.1 Modes: 2.5; 4.0 Consumer price index: Mean: 4.1 Median: 3.4 Modes: 2.8; 6.8
  55. 55. 55 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Long-term, structural themes Buba- ECB won’t tolerate inflation Source: Destatis - Eurostat, AXA IM Research, latest data December 2009 (German inflation 1960-1997) U (€-area inflation 1998-2009) 0 5 10 15 20 25 30 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 0 5 10 15 20 25 30 Frequency, in % Consumer price index Mean: 3.0 Median: 2.6 Modes: 2.2 ; 5.9
  56. 56. 56 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Long-term, structural themes ECB not really scared by deflation Source: Eurostat, AXA IM Research, latest data November 2013 0 2 4 6 8 10 12 14 0 2 4 6 8 10 12 14 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 Frequency distribution of euro area HICP inflation, 1998-2013 (YoY change of HICP, monthly data) HICP Mean: 1.97 Median: 2.05 Modes: 1.9; 1.1
  57. 57. 57 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM What about hyperinflation? What is hyperinflation? Phillip Cagan defines hyperinflation as CPI increasing more than 50% per month. In theory, hyperinflation is associated with the value of money converging toward zero (debasement of currency). At the limit, money does not buy any tangible good, i.e. real money balances decrease to zero. Practically, hyperinflation may start when the relevant period to measure inflation is a month, not a year. What are the roots of hyperinflation? Hyperinflation is associated with governments deliberately increasing money supply in order to finance unsustainable spending. Because several central banks are deliberately increasing their monetary base by monetizing various assets (including, possibly, government debt), hyperinflation is evoked as a possible outcome. However, increasing money supply is neither a sufficient condition (think of the US in WWII) nor even a necessary condition for hyperinflation. The latter may happen if the utility of the stock of money rises slower than real money balances decrease, in other terms if confidence in money evaporates. I find reasonable to assume that hyperinflation is generally the result of both deliberate fast money supply expansion AND a loss of confidence in institutions such as the central bank or the Treasury. Hyperinflation is a possible outcome in seriously destabilised emerging economies In the current circumstances, and even if the Fed and the ECB monetize government debts (as the BoJ did to fend off deflation), hyperinflation is in my view excluded, at least as long as these central banks are in charge. Yet, emerging economies severely destabilized by BoP crisis leading to large scale defaults may well fall into hyperinflation, which, in our world, turns rapidly into dollar- or euro-ization. Germany: Weimar Republic, 1923
  58. 58. 58 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Biography Eric Chaney Chief Economist AXA Group Head of Research, AXA Investment Managers Member of the Executive Committee, AXA Investment Managers Eric Chaney is chief economist for the AXA Group since 2008. His mission is to provide a vision on the most likely scenarios for the global economy in the medium to long term, as well as an assessment of the main macroeconomic risks, for the group and its main entities. Within AXA Investment Managers, Eric leads the Research and Investment Strategy team and promotes a multidisciplinary approach of Research, directed toward quality and helping investment decision. Eric has launched the AXA IM Symposium (Paris 2010, London 2011 and 2012, Paris 2013) which featured prominent speakers such as Stephen Roach, Francesco Giavazzi, Jacques de Larosière, Charles Goodhart, Sushil Wadhwani, P.O. Gourinchas, Stephen Li Jen, Thomas Huertas, Richard Koo, Tim Tacchi, Thomas Kirkwood. From 2000 to 2008, Eric Chaney was Chief economist for Europe at Morgan Stanley, which he had joined in 1995. Previously, he headed the economic forecasting unit of the French statistical office (INSEE). Before that, he was responsible for global forecasts and analysis at the French Treasury. He has been associate professor at the French School of Administration (ENA). Since 1997, Eric has been a member of the French Economic Council of the Nation, which advises the Minister of finances. He is an independent member of the French Tax Council since 2010. He sits on the Scientific boards of the AXA Research Fund and of the Autorité des marchés financiers (AMF), the French financial market watchdog. A former professor of Mathematics and editor of a mathematical journal of the University of Strasbourg, Eric also holds a Master’s Degree in economics and econometrics from the Paris Graduate School of Economics, Statistics and Finance (ENSAE ParisTech). Eric lives in Paris, is married and has five children.
  59. 59. Glossary  Backwardation: situation whereby future commodity prices are lower than spot prices  Breakeven: expected inflation extracted from inflation-proof bonds (also called linkers)  Contango: situation whereby future commodity prices are higher than spot prices  Convertibility risk: refers to the possibility that a country member of the euro club would leave the club  Credit risk: for a bond, risk of default by the issuer (coupon or principal)  Fair value: econometric estimate of the price of an asset, given economic fundamentals. Despite its name, the ‘fair value’ is not intrinsic, since it is model-dependent  Forward rate: expected future short term interest rate (1Y for instance) derived from the yield curve  Log (MSCI): looking at the logarithm of an economic indicator allows to see whether its growth rate is constant (straight line), accelerating (upward curved or concave) or decelerating (downward curved or convex)  OMT: Outright Monetary Transaction, a name invented by the ECB to qualify potential purchases of government bonds of a country having required financial help from the European Stabilisation Mechanism (ESM). Has never been used.  Risk premium: premium on top of the price of a financial asset asked by investors to compensate for uncertainties about the future (default, liquidity condition, counterparty risk, stock market crash...)  Term (risk) premium: risk premium investors are asking to compensate for the uncertainty on future monetary policy, given the path of short term interest rates that they anticipate. Comes on top of the geometric average of expected rates  Surprise gap: A reversal indicator extracted from business surveys (Ifo, Insee, ISM, Tankan...). As for European surveys, computes the difference between the assessment made by companies on current production growth with the expectations they were expressing three months earlier, on harmonised data (z-score)  Yield curve: curve showing the yields of same nature bonds of various maturities, traditionally from 3M to 10Y.  Zero coupon (yield) curve: for any bond paying annual or semi-annual coupons, it is possible to calculate the price of an equivalent zero-coupon bond. Doing so all along the yield curve gives a fairer idea of market expectations, especially in terms of forward rates.  Z-score: normalised time series: (x-m)/s, where x is the original variable, m its mean and s its standard deviation. The unit is thus 1 standard deviation.  5Y in 5Y: five-year yield in five-year extracted from 10Y and 5Y yields of similar bonds (for instance zero-coupon bonds), considering that the 10Y yield is the geometric average of 5Y and 5Y in 5Y yields. Using both nominal bonds and inflation proof bonds, it is possible to extract 5Y in 5Y inflation expectations. 59 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM
  60. 60. 60 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM60 Recent research from AXA IM AXA IM research documents are available on: http://www.axa-im.com/en/research  The important thing is to participate 28/05/2014 In this article, we start by exploring the broad set of labor market indicators that the Fed is looking at to evaluate the recovery in the job market.  China: continue the economic miracle 22/05/2014 We develop a 2-part report that investigates China's past growth, current problems, and future prospects.  Credit spreads tight, be selective 30/04/2014 Corporate credit fundamentals remain solid and technical supply demand imbalance remains supportive for credit in both the US and EUR IG space. However, returns are getting squeezed and, as we continue to tighten in what sometimes feels like a relentless grind to the bottom, the reality is that returns will be weaker this year than in the past two years.  Japan: one year on, still in midstream 24/04/2014 We review the effects of the "shock and awe" strategy implemented by the government since it took office and lay out our expectations for the short and medium term.  US monetary policy expectations and emerging credit growth 17/04/2014 Credit growth in Emerging Asia is more sensitive to expected changes in US monetary policy, since Emerging Asia receives the lions' share in US portfolio flows.  China: debunking the shadow banking system 03/04/2014 This note on Chinese shadow banking is designed to provide a holistic view of the sector by discussing the structural factors propelling its rise, and how the system functions and what it contributes to China's overall financial reform.  Euro area inflation: trough in sight 26/03/2014 In this article, we dig into recent developments in euro area inflation and lay out our expectations for the coming quarters.  Japanese equities and the yen - An almost 2-for 1 relationship 20/03/2014 The yen has fallen by close to 25% against the US$ since January 2013, with Japanese equities up by 60% over the same period.  Portfolio diversification and the return of leveraged loans 13/03/2014 Having essentially disappeared during the height of the sovereign crisis, leveraged loans are also making a return in Europe as investors warm to the potential return and relative protection they offer in a world of rising rates.  US yield curve: a change on the horizon? 27/02/2014 Our view is that a bear steepening bias will come first, followed by a mild bear flattening to emerge already in the latter part of 2014  Emerging markets turmoil: 1997-98 redux? 20/02/2014 The duration and breadth of the selloff in emerging markets reminded investors of the 1997 Asian crisis, but the resemblance was hastily denied by market consensus. We remain more prudent relative to the consensus.  End of QE: a cross-asset impact assessment 23 July 2013 The first stage of monetary normalisation, QE tapering, should probably start in September, with QE expected to be over by mid-2014.
  61. 61. 61 Eric Chaney, Chief Economist AXA Group, Head of Research, AXA IM Disclaimer  This document is used for informational purposes only and does not constitute, on AXA Investment Managers Paris part, an offer to buy or sell, solicitation or investment advice. It has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of an opinion, based on available data at a specific date.  Due to the subjective and indicative aspect of these analyses, we draw your attention to the fact that the effective evolution of the economic variables and values of the financial markets could be significantly different from the indications (projections, forecast, anticipations and hypothesis) which are communicated in this document.  Furthermore, due to simplification, the information given in this document can only be viewed as subjective. This document may be modified without notice and AXA Investment Managers Paris may, but shall not be obligated, update or otherwise revise this document.  All information in this document is established on data given made public by official providers of economic and market statistics. AXA Investment Managers Paris disclaims any and all liability relating to a decision based on or for reliance on this document.  Furthermore, due to the subjective nature of these analysis and opinions, these data, projections, forecasts, anticipations, hypothesis and/or opinions are not necessary used or followed by AXA IM Paris’ management teams or its affiliates who may act based on their own opinions and as independent departments within the Company.  By accepting this information, the recipients of this document agrees that it will use the information only to evaluate its potential interest in the strategies described herein and for no other purpose and will not divulge any such information to any other party. Any reproduction of this information, in whole or in part, is unless otherwise authorised by AXA IM prohibited.  Editor : AXA INVESTMENT MANAGERS PARIS, a company incorporated under the laws of France, having its registered office located at Cœur Défense Tour B La Défense 4, 100, Esplanade du Général de Gaulle 92400 Courbevoie, registered with the Nanterre Trade and Companies Register under number 353 534 506, a Portfolio Management Company, holder of AMF approval no. GP 92-08, issued on 7 April 1992.

×