political risks

The Drive You Demand

Economic & Thematic Research, July 2016

global economic outlook

Union Bancaire Privée, UBP SA ECONOMIC & THEMATIC RESEARCH

Key positives / negatives

Moderate growth trend expected; still downside risks US growth underpinned by consumption; stabilization

expected in EM. Rising political risk and uncertainties on Europe. Low inflation; still excess capacities in industry. Monetary policy will remain accommodative.

Baseline view

Moderate world growth, close to 3%. Growth in DM expected to be below 2% in 2016 and in 2017,

with still downside risks. US growth expected at 1.9%; stabilization expected in EM and in China;

Low growth expected in the eurozone; probable recession in the UK.

Low inflation, but a progressive recovery is expected in DM in 2016-2017.

Monetary policy will remain accommodative. Global easing remains in place and Fed will postpone any rate hike.

Budgetary policy should give limited support in some countries.

World economy: UBP baseline view

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Looser Neutral TighterFed XECB XBoE XBoJ XPBoC XAsia X

Monetary policy

Positive Neutral NegativeUS XEurozone XUK XJapan XChina XAsia X

Growth


Political risks have refuelled risk aversion on markets and challenge our growth outlook, particularly on Europe.

Growth outlook remains positive in the eurozone, underpinned by a very accommodative monetary policy.

Mixed US data have obliged the Fed to postpone its June rate hike. Weak labour data have raised doubts on US growth, but strong retail sales have comforted our baseline scenario.

Inflation is progressively rebuilding in developed countries, as expected in our scenario.

Fed has postponed its June rate hike, but maintained a tightening bias; its stance should progressively diverge from the ECB-BoJ policy.

Asia: Improving domestic growth trend intact. Slow global trade growth. Stable China outlook, poor Japan & better SE Asia. Political risk improving in SE Asia, rising in India. PBOC not likely to loosen policy soon. Inflation a non-issue.

Key data Outlier data points and changes in UBP outlook

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Source: Bloomberg


World growth: around 3%, with downside risks

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GDP y/y % 2015 2016 UBP

2017 UBP

WORLD – MER – on PPP basis*

2.6 3.2

2.4 3.1

2.6 3.2

USA 2.4 1.9 2.2 Japan 0.6 0.5 0.6 Eurozone 1.7 1.4 1.3

United Kingdom 2.3 1.4 -1.0 Switzerland 0.8 0.9 1.2 Brazil -3.8 -4.0 0.8 Russia -3.7 -1.0 1.0

India 7.5 7.6 7.8 China 6.9 6.3 6.3 Developed countries 1.9 1.5 1.5 Emerging countries 4.3 4.3 4.6

Sources: UBP - Economic & Thematic Research, Bloomberg consensus * MER: market exchange rates; PPP: purchasing power parity


Focus on US economy US: growth to rebound in H2-16, but still a moderate cycle

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US growth to stay in a 2%-2.5% range in the coming quarters.

Growth is expected to rebound to 2% in Q2, and to stay above 2.5% in H2-16.

Consumption and services to be the main growth engines. If oil price stabilize, the drag on investment should moderate.

Labor market to stay on a positive trend: payrolls are expected to recover (100k-150k expected) and rising wage pressures to build in the coming quarters.

The US economic cycle is moderate compared to history, due mainly to limited productivity gains.

The US cycle is now more mature compared to other developed countries.


Focus on the Eurozone economy Eurozone: ongoing recovery, but clouded by political uncertainties

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Recovery continues, underpinned by consumption and stronger capex. Public spending could support further growth.

A moderate sequential growth is expected in Q2. Germany continue to lead; Italy and France are

laggards, but the gap is narrowing. Headline inflation should be positive in H2-16,

helped by firmer oil prices. Fiscal policy has turned modestly supportive;

monetary policy should remain accommodative until 2018.

A busy political timetable reduces visibility on growth, despite improving fundamentals.

Cyclical growth exceeds low potential growth; immigration could improve long-term outlook.


Moderate costs on the economy, but rising political uncertainties. Limited impact over the eurozone: -0.25/-0.1 pp per annum over 10 years according to various estimates

(2016: 1.4%; 2017: 1.3%). Most sensible countries to a UK shock: Ireland, Malta, Netherlands, Belgium, Germany, Luxembourg

and some Eastern European countries. Rising political uncertainties and euroscepticism:

Fragmented eurozone and question “who’s next to leave?”. Weak institutional framework. Rising anti-EU protesters to gain in France, Italy and Netherlands. Process of deeper integration stopped (“5 Presidents report”).

Tough negotiations with UK, to avoid fuelling populism in EU. ECB reaction:

To deliver more liquidity Potential further easing if needed; renewed OMT if necessary.

Possible joined central banks action if risks of major FX turmoil; G7 or G20 meeting possible in extreme case.

Impact on UBP scenario: lower GDP growth, lower EUR and rising political risk premium on European assets.

Politics and economic policy changes Eurozone post Brexit

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Weakened European project; far from the initial project of United States of Europe.

Brexit provokes different shocks and could lead to domino effects:

Rising influence of anti-EU protesters, populist and separatist party in local elections (Spain, Italy, Netherlands).

New initiatives of EU referendum, or social protests, in several countries and regions (Scotland, Wales, Ireland, Catalonia, France, Germany...).

EU governments and institutions under critics: incapacity to deal with global and regional problems. No other answer than deeper integration to fragmentation risks.

EU/ Eurozone: no “big bang” expected, but a drawn out process of fragmentation/disintegration: more countries or regions requesting an exit or a special statute.

Political debate could interfere with ECB’s action, its design and its efficiency. The EUR will no longer be an anchor to EMEA and Nordic currencies.

Policy changes and impact on scenario Fragmented EU/Eurozone

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Rising anti-EU sentiment across Europe


A matured growth after sustained recovery, driven by domestic demand and structural reforms.

Economic performance still above the EU average, but some slowdown ahead (GDP 2016: 2.7%; 2017:2.5%-2%) with eroding confidence.

Main priorities: To continue labor reforms to reduce structural

unemployment (estimated at 16%-18%) To meet fiscal target (EU: 2.5% in 2017) and stop

regular rise of the public debt (100% of GDP). Probable next economic policy:

Less fiscal austerity and increasing vulnerability Reforms on the backseat, particularly on labor.

Rising political uncertainties: Minority government and political stalemate. Unstable large coalition and low visibility on policy.

Policy changes and impact on scenario Spain: slowdown in sight and risk of a minority government

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Spanish Congress seat projection


Large potential costs on economy and low visibility; rising political uncertainties.

Economics:

Possible shock on consumer confidence, labor and decisions on capex, falling FDI.

Negative to flat sequential growth expected in H216; 2016 outlook revised down from 1.7% to 1.4%

No visibility on 2017 outlook, but a recession looks highly probable: -1%, but a large range of alternative GDP scenarios from -3% to 1%, according to economic and political developments.

Inflation: a rebound from 0% to 2% after currency depreciation: a rebound above 2% in 2017.

BoE: to ease from 0.50% to 0%; extended QE or additional special liquidity measures if needed.

Fiscal policy: public debt under close watch by rating agencies; fiscal spending to support domestic activity in the short run and relaxed fiscal policy.

Policy changes and impact on scenario UK: weak outlook post Brexit

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Medium-term consequences:

2 years or more to adapt and negotiate

Remaining EU passports for corporate implies still a UK participation to EU budget.

Shrinking size of the economy if final Brexit (-3% according to IMF): loosing attractiveness; need for flexible economy and currency to remain competitive. Back to “stop & go” policy.

Large current account deficit needs a flexible currency, or more attractive yields or to constrain domestic demand.


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Rising political uncertainties:

Tough or smooth negotiations with EU on free trade, free capital flows and EU passports for corporate.

UK two-party political system is challenged. Possible split within Conservative and Labor party.

Next PM : a political leader or an ad interim PM ?

A Bremain Scottish referendum; breaking united UK

A 2nd referendum ?


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How UK could leave the EU

Source: Credit Suisse


Headline GDP numbers slowing, but from a 7% base Credit growth of 20% hasn’t boosted growth. PMI

services has turned up from end-2016 but don’t suggest acceleration in H2. Exporters in a slump

Industrial deflation is ebbing and CPI is stable at 2%. Property in T1 cities up 30%y/y; dampening policy in force

Governance concerns, MSCI rejection and unease about heavy corporate debt maturities in H2 suggest policy will also focus on bank stability and default management

Greater overall emphasis on fiscal / infrastructure and less on rate cuts, even with 1% real rates

FX policy is stable, but CNH isn’t tracking DXY this month. Reserves depletion has stopped.

CNH / CNY spread and financial stress indicators are back to pre-Aug 2015 levels.

Size of move depends on capital inflow

Looser fiscal, lower CNY basket with focus on debt-service Focus on China

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GDP surprised in Q1, but was exceptional with no investment. Without stimulus, little reason to expect H2 GDP acceleration

Sales tax withdrawn until 2019, ahead of Upper House elections on 10 July. High corporate profitability / poor capex.

Services companies reported a small upturn in April/May. Manufacturing in a slump. Corporates increased hiring. Outlook perceived as poor

Supplementary earthquake budget may be followed by a second (JPY5-10trn) package. Widely expected after 10 July

Inflation back down to zero. Real wages perceived as falling. Stronger yen cutting costs. BOJ has confessed the 2% inflation objective has not been met

Monetary policy is confused. Negative rates have hurt equities and USDJPY. Likely waiting for Brexit result and US Fed on 27 July. Next BOJ meeting on 29 July.

USDJPY at the mercy of risk flows and Fed speeches

Policy on hold, confusing the markets Focus on Japan

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Source: UBS

Sources: Bloomberg

Source: UBS


Supplementary budget (2nd of the year): Proposed JPY5-10trn in size compared to initial FY2016 budget

JPY58trn. Potential announcement after upper house elections on 10 July 2016. Concerns about fiscal stability after delaying the sales tax Upper house election / change of constitution:

50% delegates up for re-election. LDP needs 46 seats to gain an upper house majority. Key event: a 2/3rds majority giving control of both houses and the opportunity to change the post-1945 constitution

More BOJ stimulus:

Negative rates / depreciation haven’t boosted data. Consumers expect 2%+ inflation, so perceived real wages are declining. Europe-style broad asset purchases are the only option left other than monetisation & fiscal.

New ‘third arrow’ initiatives:

Direct wage subsidies to consumers via payroll

Impact on Outlook: Limited medium-term for growth. Lower JPY, slightly higher CPI.

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Source: Bloomberg

Source: Bloomberg

Politics and economic policy changes Japan: upper house elections in sight


Monetary policy To remain on an accommodative mode

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Accommodative policy to continue to support growth locally and address risks.

Limits on efficiency of monetary policy acting alone. Monetary policy to face short-term risks: more

liquidity delivered to banks The Fed will postpone its rate hike, even if the

tightening bias remains in its communication. The BoE should cut key rates to 0%. The ECB and BoJ monetary policy will maintain an

easing bias: The BoJ is expected to act in parallel with more

budgetary supports. The ECB should wait before launching new

measures. Central banks in emerging countries are expected to

maintain an easing bias.

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