The document discusses the challenges facing the global economy in 2011, including a peak in US economic growth, rising fiscal deficits, and the risk of downgrades of treasury debt. It highlights the need for ambitious reforms in Europe to address the sovereign debt crisis and warns that the end of quantitative easing may lead to increased turbulence in financial markets. The situation in Japan is further complicated by a significant national debt and the aftermath of the recent disaster, which may delay necessary structural reforms.

1. The Global Economy
Monthly letter from Swedbank’s Economic Research Department
by Cecilia Hermansson No. 4 • 9 May 2011
How will the US finance its growing fiscal deficit this year
when the Federal Reserve ends QE2?
• It appears that global economic growth has already peaked. Preliminary first-
quarter GDP growth in the US was weaker than expected. The earthquake led to a
weak first half-year in Japan. Eventually the euro zone will also be more affected
by higher inflation and interest rates, a strong euro and budget consolidation.
China's growth was stronger than expected, but overheating has to be avoided,
increasing the likelihood of slightly slower growth in the rest of the year.
• The sovereign debt crisis in the West is threatening growth and financial stability.
The biggest problems are in Europe and the US. It is important that the rescue
packages in the euro zone are combined with ambitious reform efforts. Portugal’s
casual attitude could create greater resistance for support among taxpayers in
northern Europe. A restructuring could be necessary in debt-strapped countries,
but more time is needed as it is important to not lose the momentum in carrying
out the necessary reforms for increased competitiveness.
• The prospects of a downgrade of Treasury debt could force US politicians to agree
on a revised debt ceiling, a budget for 2012 and a medium-term plan to reduce
government debt. This year's growing budget deficit, in contrast, has received far
too little attention. When the Federal Reserve phases out QE2, there are
questions who will finance the deficit. Interest among households, banks and
foreign players is low or shrinking. As a result, some form of extension (by any
name other than QE3) is likely in order to avoid turbulence, a weaker dollar and/or
significantly higher interest rates.
Growth – but the peak has been reached forecast relative to other analysts of 3% could be at
risk as well.
The global economy is still in a recovery phase, but
the rebound is now slowing and, as in previous Weak demand is keeping the US service sector
recoveries, differs between countries. We are from growing as desired. The Purchasing
maintaining our projection that global GDP growth Managers’ Index (PMI) for the service sector nearly
will fall from 4.7% last year to 4% this year. fell to levels that would indicate stagnation. The
manufacturing sector, on the other hand, has
Preliminary GDP growth in the US was weaker than
recovered strongly, but accounts for only 10% of
expected, at an adjusted annual rate of 1.8% in the
the economy.
first quarter, partly due to the cold weather and
significantly higher energy and food prices. Gas Productivity growth, which reached nearly 7% after
prices have especially affected household the recession, has slowed during the last year to
consumption. It is important in understanding the 1.3% and on an annualised basis was 1.6% in the
decline that imports increased markedly, while first quarter. Employment increases somewhat
export and investment growth slowed and public faster and according to data in April with 244 000,
investment contributed negatively to growth. If this but the improvements are still slow and the
continues, there is a risk that even our modest unemployment is still at 9%.
Ekonomiska sekretariatet, Swedbank AB (publ), 105 34 Stockholm, tfn 08-5859 1000
E-mail: ek.sekr@swedbank.se www.swedbank.se Ansvarig utgivare: Cecilia Hermansson, 08-5859 7720.
Magnus Alvesson, 08-5859 3341, Jörgen Kennemar, 08-5859 7730

2. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 4 • 9 May 2011
Unit labour costs are now rising for the first time China's GDP growth was stronger than expected
since 2008, which could make it harder for during the first quarter at nearly 10% on an
companies to stay competitive going forward. annualised basis (9.7%). The fact that inflation has
Lending is working better, but many small and risen to more than 5% concerns the administration.
midsize companies are waiting for demand to Credit growth has now returned to a level of around
improve before investing and taking on new debt. 15-20% from before the global recession and
The housing market is still weak and the mortgage financial crisis. Reserve requirements and interest
market is shrinking. rates have been raised. The question is whether
this will be enough to mitigate the signs of
In Europe, there are distinct differences in activity overheating.
between countries. In debt-strapped countries,
confidence is low, while it is higher in Germany, the As expected, activity in the Japanese economy fell
Netherlands, Belgium and the Nordic region. We in March after the earthquake, tsunami and nuclear
saw the UK PMI fall from 61.7 in January to 54.6 in disaster. Industrial production declined by 15.3%,
April, and the recovery in British industry has thus household consumption by 8.5% and Nissan’s,
decelerated slightly. Honda’s and Toyota’s production by between 52%
and 63%. Exports shrunk by 7.7%, while imports
It is likely that first-quarter GDP growth in Europe held up better, down only 1.4%.
will surpass that of the US, mainly driven by a
strong recovery in Germany. It is also likely, though, As a result, Japan’s trade surplus is falling
that growth will decline going forward due to higher significantly. It is important that Japanese
inflation and interest rates, a relatively strong euro companies regain their market share at some point.
and the budget consolidation in many countries. The slowdown will continue in coming months. In
Retail sales have been hurt by fiscal austerity. This April the PMI fell to 45.7, indicative of the tough
will be most apparent in bailout countries such as conditions that industry is facing.
Portugal and Greece, where GDP is falling. The
ECB will continue to raise interest rates this year, Purchasing managers index for manufacturing industry
but at a fairly slow pace. 70
65
The European labour market continues to improve.
Unemployment is significantly lower in Germany at 60
7.1% and is benefitting from previous reforms, but 55
in crisis countries many problems still remain. The 50
euro zone average of 9.9% is higher than the 9% USA
45 UK
and the US has generally maintained this Japan
advantage since late 2009. In Spain, one of every 40
Eurozonen
five people in the labour force is unemployed, and 35 Kina
youth unemployment is rising to a new record high 30 Indien
of around 40%. In the bailout countries, Sverige
25
unemployment is likely to increase further. 06 07 08 09 10 11
Unemployment in Europe, the US and Japan (%) Source: Reuters EcoWin
13
12
F ra n ce
G e rm a n y The disaster budget that was unveiled was a
E u ro la n d
modest USD 48.5 billion, compared with an
11
US estimated need of USD 300 billion. The Japanese
10
government does not intend to raise the national
9
debt and instead will slash social spending and
8 pensions. This is a mistake, but credit rating
Procent
S weden
7 agencies are unfortunately driving this process with
6
the threat of downgrades.
5
Even if Japan’s national debt reaches 229% in
4
2011, according to the IMF, the disaster budget will
3
Japan not have a great impact in this regard. Since the
2 country will be in recession during the first half-year,
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
S o u rce : R e u te rs E co W in
the Bank of Japan will have to try to stimulate the
economy. It is likely that the programme in place to
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3. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 4 • 9 May 2011
buy up government and corporate bonds and other Europe. More ambitious stress tests and
financial assets will be expanded. A more capitalisation of the banks will also make it easier to
expansionary monetary policy would be of help, and accept a debt restructuring.
if our prediction of a weaker yen is realised, it would
also be positive for Japan. In the US, more attention will have to be paid to the
fiscal deficit for 2011. In contrast to the euro zone,
Those who feel that the natural disaster will benefit where the deficit is being trimmed, the US deficit
the Japanese economy should think again. this year will reach nearly 11% of GDP. This means
Tremendous assets have been destroyed, and that about USD 1.6 trillion will have to be financed.
there is a risk that Japanese companies will lose How will this be done after quantitative easing is
their position in the global supply chain, which phased out in June?
would impact its trade balance. Although Japan's
debt is financed domestically, there is a risk that the There are five ways to finance the deficit: through
private sector will be burdened by having to households, banks, pension funds and insurance
contribute even more to the needed stimulus. companies, non-US investors and the central bank,
the Federal Reserve. During the first quarter
What Japan needs is structural reform, but the households have reduced their Treasury purchases
disaster could delay well-needed reforms and by USD 20 billion. The banks are net sellers of
instead shift the focus to overcoming the disaster. government bonds, and pension funds and
Japan is at risk of losing time, which its insurance companies have not been buying to a
demographic situation does not allow. There is great extent. International investors are still buying
nothing positive about this disaster, and it would be Treasuries, but their interest is waning. In October-
reasonable if Japan adopted even more expansive February they bought USD 150 billion worth,
economic policies, unlikely as that is. compared with USD 175 billion during the same
period last year.
Public finances are hurting the outlook in
the West – keep an eye on US deficit There are several reasons why foreign investors
are losing interest. Inflation is becoming a growing
It is obvious that the West is having difficulty
problem in emerging countries, and they are no
sustaining the economic recovery, creating credible
longer propping up the dollar to the same degree to
fiscal policies, implementing structural reforms and
avoid an appreciation of their currencies. Political
designing monetary policies based on these
factors are also having an impact, including China's
challenges. The focus is on growing debt levels,
view that US economic policies are too expansive
which in several cases have become more public
and the Arab countries’ view of US foreign policy.
rather than private. The debt consolidation that has
The Japanese disaster could also play a role. As a
begun or will begin will have to continue for many
result, the dollar has weakened and the price of
years.
gold has reached new highs.
In Europe, the emphasis is on restructuring in a
US budget balance per year, USD trillion
number of countries such as Greece, Ireland and
Portugal, although it is also important to maintain 0,25
USD (thousand billions)
interest in the reform agenda, which suggests that 0,00
any plans to write off debts should be put on hold.
The people and politicians of Portugal seem to lack -0,25
an appreciation of the importance of structural -0,50
reforms, and the package now being offered to the
-0,75
country has to be combined with reforms.
Discussing the possibility of writing off the debts at -1,00
this point creates the wrong incentives. Some form -1,25
of restructuring is likely to be adopted later, but the
countries in crisis first have to demonstrate an -1,50
ambitious approach to reforming old structures and -1,75
becoming more competitive; otherwise taxpayers in 80 85 90 95 00 05 10
northern Europe may be less willing to provide
support. Source: Reuters EcoWin
It is also important to break the link between the
banking system and the sovereign debt crisis in
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4. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 4 • 9 May 2011
The Federal Reserve now has to encourage banks There is probably too little focus on how the huge
and other domestic investors to buy Treasuries. US budget deficit will be financed, but as this
The central bank has been able to utilise QE2 to gradually changes there is also a risk of greater
buy bonds worth USD 600 billion, but this possibility turbulence during the spring/summer.
disappears in July.
Many experts foresee a stronger dollar when the
Some form of extension of the programme will be QE2 ends, but it is just as likely that concerns how
needed. If not, bond rates are likely to rise and/or the US will finance its deficit will further weaken the
the dollar decline. The administration and Fed can dollar. When the ventilator is turned off, many other
live with the latter, but rising interest rates are more markets that have benefited from the US printing
troublesome. presses will also be affected, including the
commodity, equity, bond and emerging markets.
Using the return generated from mortgage bonds to
buy new government bonds does not change the It is never easy to shut off the respirator, especially
Fed’s balance sheet, but it does allow it to buy more if the patient is not yet breathing on his own. For us
bonds. This is a likely path forward for a programme others, our advice is to take a deep breath!
that will be called something other than QE3.
Cecilia Hermansson
Signals from Standard & Poor’s that it may have to
downgrade US credit could force politicians there to
reach an agreement on a new debt ceiling, a leaner
budget for 2012 and a medium-term plan worthy of
its name. On the other hand, it doesn't change
things this year, which is much more precarious
than today's low interest rates would seem to
indicate.
Swedbanks Ekonomiska sekretariat
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tfn 08-5859 7740 Vi tror oss ha använt tillförlitliga källor and bearbetningsrutiner vid utarbetandet av
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Ansvarig utgivare (investerings-)beslut även på annat underlag. Varken Swedbank eller dess anställda eller
Cecilia Hermansson, 08-5859 7720. andra medarbetare skall kunna göras ansvariga för förlust eller skada, direkt eller indirekt,
Magnus Alvesson, 08-5859 3341 på grund av eventuella fel eller brister som redovisas in Swedbanks Månadsbrev.
Jörgen Kennemar, 08-5859 7730
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