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2014, n°4
14 February

This week….
Deflation is threatening US and Europe
US retail sales declined 0.4% ...
United States

Retail sales declined 0.4% in January, the

building materials outlets, gasoline stations

most since June ...
Fed policy makers are on guard to keep such

finances, fell to 94 in February from 96.8 a

disinflation from morphing into...
Euro area

The euro-area economy expanded more

Italian Prime Minister Enrico Letta resigned,

than forecast in the final ...
When Europe’s leaders set out in June 2012

grease to the wheels of financial markets,

to break the vicious circle betwee...
Other countries

UK: the market forecasts interest rates will

from a year earlier. The economy expanded

remain on hold u...
China: the Chinese government is tar-

Investors are increasingly concerned that

geting export growth of about 7.5% in 20...
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Macroeconomic commentary


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Analysis of the macro economic news

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Macroeconomic commentary

  1. 1. MACRO COMMENTARY 2014, n°4 14 February This week…. Deflation is threatening US and Europe US retail sales declined 0.4% in January Euro area GDP grew more than forecasts to 0.3% in Q4, but down minus 0.4% in 2013 Italian Prime minister resigned Chinese economy would grow 7.4% in 2014 Macroeconomic analysis  United States  Euro Area  Other countries
  2. 2. United States Retail sales declined 0.4% in January, the building materials outlets, gasoline stations most since June 2012 amid bad weather and and grocery chains. uneven progress in the labor market, signaling the economy was off to a slow start in 2014. Slower employment and wage growth the last two months, along with colder than normal temperatures, caused American shoppers to pull back after the strongest consumer spending pace in three years in the final quarter of 2013. It’s not looking good for consumer spending. Even if you have some modest improvement in the pace of employment growth, that’s not enough to generate a huge improvement in income. The expiration of emergency jobless benefits probably also played a role in holding back sales. Federal benefits for the long-term unemployed expired on Dec. 28, shutting off aid to more than a million people. Legislation to extend the program for three months, at a cost of $6.4 billion, is stalled in the Senate. More than 3.6 million people have been without work for 27 weeks or longer, according to the Labor Department. After the drop in retail sales, Goldman Sachs cut its tracking estimate for first-quarter growth to 1.9% from 2.3%, Credit Suisse lowered to 1.6% from 2.6%, and Morgan Stanley reduced its projection The budget deficit arrowed by 37% in the first four months of the fiscal year compared with a year earlier as spending declined and a stronger economy helped increase revenue. Outlays exceeded receipts by $184 billion from October through January compared with a $290.4 billion shortfall in the same period a year earlier. The nation’s deficit as a share of the economy will shrink to a seven-year low in the 12 months ending Sept. 30, according to projections earlier this month by the Congressional Budget Office, which predicted a $10 billion deficit for January. An unemployment rate that fell to 6.6% last month from 7.9% a year earlier is helping boost government revenue and contain spending. Revenue rose 8.2% from October through January to $960.6 billion from the same period a year earlier, while outlays dropped 2.8% to $ 1.14 trillion in the fiscal year to date. The CBO said Feb. 4 that the fiscal 2014 deficit will narrow to $514 billion, or 3% of from $680 billion last year. The projected gap is down from 9.8% of GDP in 2009, the widest in records dating back to 1974. to 0.9% from 1.9%. The drop in sales was Five years into the economic expansion, broad-based, with nine of 13 major catego- inflation shows little sign of picking up as ries showing declines last month, led by prices rise more slowly for goods and ser- auto dealers, sporting goods stores and ap- vices from automobiles to medical care, parel outlets. Auto sales slumped 2.1% at complicating the Federal Reserve’s drive to automobile dealers, the most since October guide the economy away from the precipice 2012. Cars and light trucks sold at a 15.2 of deflation. The personal consumption ex- million annualized pace in January, slowing penditures price index, minus food and en- from a 15.3 million rate in December that ergy costs, rose 1.2% in 2013, matching had helped cap the best year for the indus- 2009 as the smallest gain since 1955. The try since 2007. Spending decreased 0.9% at slowdown has been broad-based, with dura- clothing chains and 1.5% at department ble goods such as autos, nondurables like stores. Retailers showing an improvement in clothing and services including health care January sales included electronics stores, all playing a role. 2 - Research 2012—Jean Paul Poggi
  3. 3. Fed policy makers are on guard to keep such finances, fell to 94 in February from 96.8 a disinflation from morphing into outright month earlier. deflation, a persistent drop in prices that prompts households to delay purchases in anticipation of even lower costs and leads companies to postpone investment and hiring. The five-year breakeven rate, a market gauge of inflation expectations over the next five years based on trading in inflationlinked Treasuries, was at 1.94% this week, down from 2.3% last year at this time. There are indications that disinflationary pressures are becoming more widespread in the economy. A measure of the distribution of inflation by the San Francisco Fed shows that 20.5% of expenditures it tracks had lower prices in December 2013 than a year earlier. That’s almost double the 11.7% it found for the 12 months ended in December 2012. Factory production unexpectedly declined in January by the most since May 2009, adding to evidence severe winter weather weighed on the economy. The 0.8% decrease at manufacturers followed a revised 0.3% gain the prior month that was weaker than initially reported. Total industrial production dropped 0.3% even as utility output climbed the most in almost a year. The drop in manufacturing, which makes up 75% of total production, was broad-based, with declines in the output of business equipment, consumer goods and construction materials. .Capacity utilization, which measures the amount of a factory that is in use, decreased to 78.5% from 78.9%. The number of items with lower prices was 36% of the total in December 2013, compared with 22.2% a year earlier. Pricing is being driven by something other than weakness in demand. Influences on the supply side, such as automakers discounting to gain market share or overseas apparel makers cutting costs, were responsible for about 75% of the slowdown in inflation in four categories: financial services, motor vehicles, clothing and health care. Consumer confidence was stronger than projected in February as Americans grew more upbeat about the economy. The Michigan preliminary index of sentiment held at 81.2 this month. A gauge of the economic outlook improved to the highest level in six months. The reading indicates consumers may pick up the pace of spending after a winter-related slowdown in January. The Michigan sentiment index of expectations six months from now increased to 73 from 71.2 last month. The gauge of current conditions, which measures Americans’ view of their personal 3 - Research 2012—Jean Paul Poggi
  4. 4. Euro area The euro-area economy expanded more Italian Prime Minister Enrico Letta resigned, than forecast in the final quarter of 2013, bowing to pressure from his party and pos- led by Germany and France, easing pressure sibly clearing the way for a new government on the European Central Bank to take action led by Matteo Renzi, his chief rival. Letta, next month to counter low inflation and 47, is the third premier in a row brought to spur growth. GDP rose 0.3% in Q4. For the an early end by Italy’s fragmented parlia- full year 2013, GDP fell 0.4%. The picture did ment. It will now be up to President Giorgio not really change, we still expect persistent Napolitano to appoint a new prime minister very low euro-zone consumer price infla- or dissolve the legislature and call snap elec- tion, ongoing difficulties in building growth tions. The 39-year-old Renzi, who turned momentum and still-tight euro-zone credit the Democratic Party against Letta, said in a conditions. Germany, Europe’s largest econ- speech yesterday that he wants to avoid a omy, fuelled the expansion with 0.4%, while vote. Napolitano will want to avoid early French GDP rose 0.3%. Germany remains elections and likely he will give Renzi the the economic stronghold of the euro zone. mandate. Letta’s resignation ends weeks of Looking ahead, the German economy intra-party friction that brought the 10- should gain further momentum. Filled order month-old government to a near standstill. books and the latest inventory reductions The premier surrendered after Democratic bode well for industrial production in the Party leadership ratified Renzi’s motion to coming months. Italy’s economy grew 0.1% withdraw their support. The Democratic after stagnating in the third quarter, the first Party, known as the PD, favors progressive quarterly increase since 2011. Still, the taxation and has traditionally drawn votes country’s recovery is weak and uncertain. from organized labour and pensioners. The news from the euro area’s periphery While it has the largest number of lawmak- was generally positive, with Spanish and ers in parliament, the PD needs a broad Portuguese GDP up 0.3% and 0.5%, respec- coalition to reach a majority. Under Letta, tively. In Cyprus, the economy shrank that required compromises, notably a more 1%. Greece’s contraction slowed to an an- regressive tax policy characterized by the nual 2.6% in the fourth quarter, based on cancellation of a levy on real estate and an non-seasonally adjusted data. The report increase in the value-added tax. Renzi added to signs that the euro area’s nascent would probably face the same policy pres- recovery is gaining momentum. Factory sures as Letta if he became premier. Deputy output expanded faster than initially esti- Prime Minister Angelino Alfano, leader of mated in January, and economic confidence the second-biggest party in Letta’s coalition, increased for a ninth month, led by the ser- said he was open to backing Renzi as long as vices industry. However, not all the signs are the program was acceptable to his constitu- encouraging. non- ents. The legislature, installed by a general seasonally adjusted trade surplus narrowed election last year, is due to run until 2018. If to 13.9 billion euros in December from 17 a snap vote is bypassed and Renzi takes billion euros a month earlier. Industrial pro- over, he would become the third premier in duction slipped a row to form a government without win- The euro 0.7% area’s and retail sales dropped 1.6% in December from a ning a general election. . month earlier. Inflation remained below half of the ECB’s ceiling in January, driven by falling energy prices. 4 - Research 2012—Jean Paul Poggi
  5. 5. When Europe’s leaders set out in June 2012 grease to the wheels of financial markets, to break the vicious circle between banks and they are a key part of the portfolios and sovereigns, they left rules for treating banks need to meet liquidity rules. Yet the government bonds untouched, an oversight EU loophole may distort banks’ behaviour that may subvert their drive to prevent a by encouraging them to buy riskier debt recurrence of the debt crisis. Under EU than they might otherwise. In other hand, it rules, banks can rate all debt issued by the is difficult to break the links between banks bloc’s 28 national governments as risk-free, and sovereigns, because banks have to hold avoiding any increase in their capital re- sovereign debt, often under political pres- quirements. This encourages so-called carry sures. European banks outside Italy, whose trades, whereby lenders borrow at low cost 10-year debt offers a 203-basis-point premi- from the European Central Bank and put the um to German debt of similar maturity, held money into state debt that offers higher at least $171 billion of that country’s bonds returns. Twenty months after leaders at the end of September, up from $133 bil- pledged to change this behaviour, banks lion a year earlier, according to BIS data hold more sovereign paper than ever. ECB consolidated by Bloomberg Industries. Of President Mario Draghi said in December that amount, German and French banks that when the Frankfurt-based central bank held $131 billion. Not all peripheral euro offered about 500 billion euros ($680 bil- countries have benefited from this infusion, lion) of new low-cost liquidity two years such as bailout-recipient Portugal, which ago, lenders used it mostly to buy govern- has seen debt held by banks in other EU ment bonds, rather than for lending to stim- states gradually diminish to $20.3 billion in ulate the economy. Domestic euro-area the third quarter, even as the premium in- government debt accounted for 4.3% of vestors demand to hold its 10-year debt total bank assets in December, according instead of comparable German securities to ECB data, up from 3.5% in June 2012. For stands at 322 basis points. A consensus is the ECB, the appeal of state debt is a con- emerging that the EU loophole for sovereign cern as it ponders further stimulus amid debt is problematic. However, nothing is anemic consumer-price growth. Draghi said likely to be done in the near future, espe- before the central bank would offer more cially since strong demand from banks has low-cost liquidity, they will want to make driven down many governments’ borrowing sure that this operation is not going to be costs as the euro zone tries to spur growth. used for subsidizing capital formation by the It could be a different story if the debt crisis banking system under these carry-trade would come back due to a new Greek de- operations. One of the biggest lessons of fault. the current crisis is that there is no risk-free asset, so sovereigns are not risk-free assets. Under Basel rules, large banks are required to measure all significant risks using their own models. For non-significant business units and asset classes that are immaterial in terms of size and perceived risk. Banks buy sovereign debt for a variety of reasons. The bonds serve as collateral, providing 5 - Research 2012—Jean Paul Poggi
  6. 6. Other countries UK: the market forecasts interest rates will from a year earlier. The economy expanded remain on hold until about the Spring of at the fastest pace in four quarters in the next year and then rising to around 2% by three months ended December as a recov- the end of 2016. Carney said this week bor- ery in advanced nations boosted demand rowing costs will need to remain at 0.5% for for the country’s goods. GDP climbed 5.1% some time to safeguard the recovery. A in the period from a year earlier. The timely pledge for borrowing costs to move as in- implementation of fiscal and structural re- vestors predict can’t be a promise because forms will boost investors’ confidence and officials set policy based on their assess- enhance private-sector investment. Inflation ment of the recovery’s progress, Once the risks are rising following subsidy cuts and bank starts raising rates, it will do so gradu- the central bank may be moving closer to an ally. At that point, it will start selling gilts it interest-rate increase after keeping borrow- acquired through its 375 billion-pound ing costs unchanged since mid-2011. Infla- quantitative-easing program, and that will tion accelerated to 3.2% in December, the precipitate a decline in government debt fastest pace in two years. prices. When you start raising interest rates, rates on all instruments rise, and as you say, the price of government bonds will fall at that point. The London-based central bank increased its growth forecasts this week and now sees expansion of 3.4% this year. Carney said the bank would continue providing emergency stimulus until all the spare capacity in the economy had been used up, changing guidance from a pledge for no rate increase at least until unemployment drops to 7%. Indonesia: the Central Bank kept its key interest rate unchanged to 7.5% for a third straight meeting as a narrowing current-account deficit and slowing inflation reduced the need for tighter monetary policy. The Indonesian economy grew at the slowest pace in four years in 2013 as central bank Governor Agus Martowardojo embarked on a series of rate increases to shore up the rupiah and reduce a record currentaccount gap. With easing import demand, a shrinking deficit and an improving currency, Malaysia: it trimmed its fiscal deficit to 3.9% some analysts are predicting the tightening of GDP in 2013 from 4.5% in 2012, after cycle may be over. The current-account cutting government spending and state sub- deficit narrowed to 1.98% of GDP. Room to sidies to avert a credit-rating downgrade. keep rates on hold has now emerged and Malaysia wants to further reduce the budg- we anticipate that Bank Indonesia will ex- et gap to 3.5% this year and to 3% in 2015, tend this on-hold period for the foreseeable before achieving a balanced budget by future while maintaining a hawkish bias. 2020. Fitch Ratings lowered its outlook on Consumer prices rose 8.22% in January from Malaysia to negative from stable in July, a year earlier. GDP increased 5.7% in the citing public finances. Najib unveiled a plan last quarter 2013, beating estimates. The in 2010 to attract $444 billion of local and central bank also reiterated economic foreign private sector-led investment in growth this year will be at the lower end of Malaysia by the end of this decade, ranging its forecast range of 5.8% to 6.2%. House- from oil storage to a subway in Kuala Lum- hold consumption increased 5.25% in the pur. Foreign direct investment into the fourth quarter from a year earlier. Invest- country climbed more than 24% in 2013 to a ment growth slowed to 4.37%. record 38.8 billion ringgit ($11.7 billion) 6 - Research 2012—Jean Paul Poggi
  7. 7. China: the Chinese government is tar- Investors are increasingly concerned that geting export growth of about 7.5% in 2014. China’s investment through borrowing since The goal, based on the USD value of sales, 2008 may trigger a financial crisis. Liabilities has been distributed to economy-related at nonfinancial companies may increase to ministries and local governments to serve as more than 150% of GDP in 2014, raising an internal guideline for planning. Overseas default risks. The ratio of 139% at the end of shipments rose 7.9% in 2013. The target 2012 was already the highest among the may reflect Ministry of Commerce concerns world’s 10 biggest economies. The govern- last month that trade growth won’t be fast- ment has spent more than $650 billion bail- er than in 2013 amid an unstable global ing out banks by carving out bad loans and recovery. The strength of exports will help injecting capital since the late 1990s, after determine the pace of expansion in the years world’s second biggest economy that ana- caused default risk to balloon. lysts see slowing to a 24-year low of 7.4% this year. Exports grew a faster-thanestimated 10.6% in January from a year earlier. Export figures last year were exaggerated as companies falsified documents to disguise capital flows. A strengthen- ing yuan has put pressure on China’s exporters. The currency has risen about 2.8% against the dollar in the past 12 months, the most among 24 emerging-market currencies of government-directed lending Inflation stayed subdued in January while factory-gate prices extended the longest drop since the 1990s, in a sign of moderating demand in the world’s second-largest economy. The CPI rose 2.5% from a year earlier. The PPI fell 1.6%. The reports may give China’s leaders more room to support economic growth that analysts estimate will be the slowest in 24 years in 2014. tracked by Bloomberg. Bank bad loans increased for the ninth straight quarter to the highest level since the 2008 financial crisis, highlighting pressures on asset quality and profit growth as the world’s second-largest economy slows. Non-performing loans rose by 28.5 billion yuan ($4.7 billion). Bad loans accounted for 1% of total lending. Chinese banks are struggling to keep soured loans in check and extend earnings growth as the slowing economy and government efforts to curb shadow financing make it harder for borrowers to repay debt. Chinese banks added 89 trillion yuan of assets, mostly through loans, in the past five years, equivalent to the entire U.S. banking industry. By comparison, U.S. commercial banks held $14.6 trillion of assets at the end of September, according to the Federal Deposit Insurance Corp. 7 - Research 2012—Jean Paul Poggi