the global economic review & outlook december 2009 · 2009. 12. 3. · sharp declines in global...

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JULY 2009

THE GLOBAL ECONOMIC REVIEW & OUTLOOK

DECEMBER 2009

Rebalancing the Global Economy »

The Chinese Need to Consume »More and the US Less

Some Emerging Market Currencies »Appear Undervalued

Americans Probably Face Higher »Taxes in the Future

Lower UK Interest Rates Have Not »Translated Into Increased Lending

A Tale of Two Europes »

Australia is the First Major Economy »to Hike Rates

Peoples’ Bank of China Needs to »Rein in Bank Lending

1

The global economy appears to be back on the road to recovery after suffering its worst recession in the post-war era. Emerging markets in Asia and Latin America, some of which managed to avoid an outright recession, are already experiencing an acceleration of economic growth. In the industrialized world, both the German and Japanese economies expanded for the first time in a year during the second quarter. Even the United States, where the financial crisis began, is poised for positive economic growth.

However, much of this growth is being driven by massive fiscal and monetary stimulus which cannot be sustained indefinitely. At some point, private demand in the form of consumer spending and business investment will need to materialize. The question is where will this demand come from? In recent years, the global economy has been heavily reliant on US households to drive consumption

REBALANCING THE GLOBAL ECONOMY

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1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-4

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1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

WorldIndustrialized EconomiesEmerging and Developing Economies

Actual Forecast

Yea

r-o

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-Yea

r Pe

rcen

t C

han

ge

Real Gross Domestic Product

Emerging Markets are Leading the Global Recovery

The Chinese Need to Consume More and Americans Less

Most emerging markets had little direct involvement in the global credit crisis that has consumed the industrialized world over the past year. This may explain why developing countries as a whole have avoided an outright decline in economic activity. The diver-gence in performance is of grow-ing importance since developing countries comprised nearly 45% of world GDP in 2008.

Rebalancing global growth such that the US consumes less and ex-ports more, while Asia consumes more and exports less would seem to make sense. Indeed, consumer spending in China amounts to only 35% of GDP or roughly half that of America, where it is 70%. It is therefore not surprising that the country with the largest trade deficit is the United States and that with the largest trade surplus is China.

Sources: National Statistics Office and The Bureau of Economic Analysis

Sources: International Monetary Fund and Payden & Rygel Estimates

1989 1991 1993 1995 1997 1999 2001 2003 2005 200734

36

38

40

42

44

46

48

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52

Perc

en

t

66

66.5

67

67.5

68

68.5

69

69.5

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70.5

Perce

nt

Chinese Consumer Spending as a Share of GDP (Left)US Consumer Spending as a Share of GDP (Right)

2

growth. In fact, although Americans comprise less than 5% of the world’s population, they have accounted for 25% to 30% of world consumption over the past decade. We may be reaching the limits of this US-centric global growth model. American consumers are facing considerable headwinds in terms of household balance sheets and the labor market. This suggests the trajectory of both US and global economic growth may be lower than would otherwise be the case.

That is, unless the decline in consumer spending in the United States is replaced by an increase in consumer or business spending elsewhere. After the United States, the region that would be most effected by the fall in US consumption would

probably be Asia since exports account for an average of 40% of GDP across the region. Rebalancing global growth such that the US consumes less and exports more, while Asia consumes more and exports less would seem to make sense. A revaluation of some of the larger emerging market currencies could help facilitate the rebalancing process. Several currencies in Asia and Latin America appear undervalued on a long-term purchasing power parity basis. These currencies may undergo a secular strengthening trend and move to a permanently higher level (that is, if their countries allow this). By contrast, the G-7 economies are all in the same boat and the dollar looks fairly valued and in some cases undervalued versus these currencies.

-60%

-40%

-20%

0%

20%

40%

60%

80%

Taiwane

se do

llar

Chinese

renm

inbi

Japa

nese ye

n

South

Korean

won

Hong Kong

dolla

r

Mexica

n peso

Singap

orean d

ollar

UK poun

dEuro

Canadia

n doll

ar

Indian

rupe

e

Aussie

dolla

r

Russian

ruble

Per

cent

Ove

r/Und

er V

alua

tion

Deviations from Purchasing Power Parity

Overvalued

Undervalued

Real GDP ConsumerPrices Policy Rate Policy Bias Currencies

vs. US$2009 2010 2009 2010 2009 2010 2009 2010 2009 2010

World -1.4 3.1 0.6 1.7

US -2.6 1.8 1.6 1.5 0-0.25 1.00 # $

UK -4.2 0.8 1.5 0.8 0.50 0.50 # - 1.66 1.60

Euro Zone -3.9 1.2 0.8 0.8 1.00 1.50 # - 1.52 1.45

Australia 0.8 2.0 1.6 1.5 3.75 4.50 $ $ .92 .90

Canada -2.3 2.5 0.5 0.7 0.25 0.75 # $ 1.05 1.10

Japan -6.0 1.0 -1.0 -0.6 0.10 0.10 # - 90 95

China 8.0 9.0 0.5 1.5 4.77 5.31 # $ 6.82 6.75

Global Economic Forecast

Notes: #= Easing $= Tightening -= On Hold

Some Emerging Market Currencies Appear UndervaluedThe law of one price states that identical goods should cost the same across borders. When a dis-crepancy between price levels develops, a country’s currency should adjust to restore purchas-ing power parity (PPP). At the present time, several currencies in developing Asia appear under-valued on a purchasing power parity basis.

Source: Payden & Rygel Estimates

3

US ECONOMIC OUTLOOK

Economic Growth

Inflation

Interest Rates

Forecast:

Forecast:

Forecast:

The pace of US economic growth was revised down to 2.8% in Q3 2009 compared to the 3.5% rate that was initially reported. This marks the first increase in real GDP in more than a year and the fastest growth rate in two years.

The headline consumer price index (CPI) remained in negative territory, falling 0.2% on a year-over-year basis in October. Core inflation, which excludes food and energy prices, increased by 1.7% over the previous year in October.

The Federal Reserve left its benchmark interest rate unchanged in a range between 0% and 0.25% at the conclusion of its November meeting. The central bank also an-nounced that it would reduce its purchases of Agency debt from $200 billion to $175 billion.

We estimate that real GDP will increase at an annual rate of around 2.5% in Q4 2009. The question will be whether a sustainable rebound in private demand will materialize before the impact of fiscal and monetary stimulus fades in late 2010.

Headline inflation will turn positive again by year-end due to the rebound in global commodity prices. However, core inflation will likely drift lower due to the output gap, the difference between potential and actual economic growth.

We expect the Fed leave its benchmark rate unchanged until the middle of 2010. However, the central bank may choose to exit parts of its credit easing program sooner. The Fed is scheduled to complete its $1.25 trillion in purchases of Agency mortgages by March 2010.

1

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3

FINANCIALS†

STOCKS* BOND YIELDS EXCHANGE RATES

S&P 500 Index +24.07%

Dow Jones Industrial +21.52%

NASDAQ +46.87%

†Current as of November 30, 2009 *Year-to-Date total return in local currency

2-Year 0.66%

10-Year 3.19%

0.67 € / US$

86.41 ¥ / US$

0.61 £ / US$

6.83 Chinese RMB / US$

4

0

10

20

30

40

50

60

70

80

90

100

1930 1940 1950 1960 1970 1980 1990 2000 2010

Perc

ent

-35

-30

-25

-20

-15

-10

-5

0

5

10

Percent o

f GD

P

First Tax Bracket (left) Top Tax Bracket (left) Budget Deficit (right)

US Tax Rates Peak in 1944-45

Higher Tax Rates Likely

Americans Probably Face Higher Taxes in the Future

The 2010 fiscal year budget deficit is expected to reach $1.6 trillion or nearly 11% of GDP

–the largest it’s been since the Second World War. Although a pick up in economic growth

should lead to an increase in tax revenues in the next year, tax rates are likely to have to

rise in order to pay down the budget deficit. During 1944 and 1945 the top rate reached an

all-time high of 94% on incomes above $200,000 ($3 million in 2007 dollars) and the bottom

rate peaked at 23%.

Sources: Government Accountability Office and the Tax Foundation

ECONOMIC OVERVIEW

Consumption

70%18%

12%

Gov’t Expenditure

InvestmentTotal

$14.26 trn

KEY INDICATORS MAJOR EXPORT PARTNERS** GDP‡ BREAKDOWN

Canada 21.4%

Mexico 11.7%

China 5.6%

Real GDP +2.8% (Annualized Q3 2009)

Inflation -0.2% (Year-over-Year October 2009)

Unemployment rate 10.2% (October 2009)

**2008 Data; Percent of total exports ‡Purchasing Power Parity

5

UK ECONOMIC OUTLOOK

Economic Growth

Inflation

Interest Rates

Forecast:

Forecast:

Forecast:

The rate of contraction in the UK economy moderated from an annual rate of 2.3% in Q2 2009 to 1.2% in Q3. Much of the improvement was accounted for by the tremendous fiscal and monetary stimulus of the past year. The economy remains in fragile condition.

Inflation, as measured by the headline consumer price index (CPI), rose to a year-over-year rate of 1.5% in October, up from 1.1% in September. This marks the fifth consecutive month headline inflation has been below the Bank of England’s (BoE) 2%-target since the recession began.

The BoE maintained its policy rate at 0.5% and signaled that it was in no rush to raise it from that level at its November meeting. The central bank also expanded its quantitative easing program from £175 billion to £200 billion.

The UK economy is expected to recover by early 2010. However, the deleveraging of household and bank balance sheets will act as a restraint on economic activity. The key risk is that the impact of government spending fades before there is a sustained pick-up in private demand.

Sharp declines in global commodity prices, the strength of the British pound, and spare capacity in the economy may cause headline CPI inflation to remain below the BoE’s 2%-target into 2010.

The BoE will likely leave its benchmark rate unchanged until late-2010. However, the central bank may move to mop up some of the liquidity it has pumped into the UK economy early next year if the recent improvement continues.

1

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FINANCIALS†


FTSE-100 Index +22.55% 2-Year 1.18%

10-Year 3.52%

1.64 US$ / £

1.10 € / £

142.05 ¥ / £

11.22 Chinese RMB / £


6

Lower UK Interest Rates Have Not Translated Into Increased Lending

Despite the Bank of England’s moves to reduce interest rates to their lowest levels in history

and adopt less conventional quantitative easing measures, credit to consumers continues to

contract. This is probably due to both the reduced supply of credit from the banking system

as well as reduced demand from households as they struggle to deleverage their balance

sheets.

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

1

2

3

4

5

6

Perc

ent

0

500

1,000

1,500

2,000

Millio

ns o

f Pou

nd

Sterling

Sources: Bank of England and National Statistics Office

Consumer Credit (Right)Bank of England Policy Rate (Left)

Consumption

64%22%

14%

Gov’t Expenditure

InvestmentTotal$2.23

trn

MAJOR EXPORT PARTNERS**

United States 14.2%

Germany 11.1%

France 8.1%

Real GDP -1.2% (Annualized Q3 2009)

Inflation +1.5% (Year-over-Year October 2009)

Unemployment rate 7.8% (September 2009)

GDP‡ BREAKDOWN


ECONOMIC OVERVIEWKEY INDICATORS

Sources: Bank of England and National Statistics Office

7

EURO ZONE ECONOMIC OUTLOOK

Economic Growth

Inflation

Interest Rates

Forecast:

Forecast:

Forecast:

The euro zone economy grew at an annual rate of 1.5% in Q3 2009. This marked the first positive growth in five quarters, but there are still large disparities in economic performance among member countries.

Inflation, as measured by the harmonized consumer price index (CPI), fell by 0.1% in the year to October. This is well below the European Central Bank’s (ECB) 2%-infla-tion ceiling.

The ECB left its policy rate unchanged at 1.0% following its December meeting. The bank will scale back its flagship emergency financing operations next year, as the euro region starts what ECB President Jean-Claude Trichet called an “uneven” recovery.

The euro zone economy has benefited from having had relatively less exposure to the global financial crisis. Though consumer spending and exports appear to be sta-bilizing, rising unemployment and a fragile banking sector remain the key risks to sustainable economic growth.

The headline CPI will turn positive again by year end due to the rebound in global commodity prices. However, deflation risks will persist through much of 2010 due to the output gap, which measures the difference between actual and potential eco-nomic growth.

We expect the central bank to leave its benchmark rate unchanged until mid-2010. But there is some risk that the ECB will begin exiting policies aimed at boosting economic activity.

1

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FINANCIALS†


DJ EURO Stoxx 50 +19.55% 2-Year 1.26%

10-Year 3.16%

1.50 US$ / €

0.91 £ / €

129.65 ¥ / €

10.24 Chinese RMB / €

†Current as of October 31, 2009 *Year-to-Date total return in local currency

8

A Tale of Two Europes: Disparities in Economic Growth

The euro zone economy grew at an annualized rate of 1.5% in Q3 2009. However, the head-

line number masks considerable differences in the economic performance of member coun-

tries. This will complicate the European Central Bank’s task of adopting the correct policy

stance for all of its members as some countries recover more quickly than others.

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4

Euro

Zo

ne

Au

stri

a

Port

ug

al

Ger

man

y

Ital

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Irel

and

Bel

giu

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Net

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Fran

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Spai

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Qu

arte

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arte

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ual

ized

Per

cen

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ang

e

Above Average Performance

Below Average Performance

Source: Eurostat

Consumption

58%21%

21%

Gov’t Expenditure


trn


United Kingdom 13.7%

United States 12.2%

Switzerland 6.2%




GDP‡ BREAKDOWN



9

AUSTRALIA ECONOMIC OUTLOOK

Economic Growth

Inflation

Interest Rates

Forecast:

Forecast:

Forecast:

The Australian economy grew at an annual rate 2.5% in Q2 2009 –its best perfor-mance in the past year. Government stimulus fueled strong gains in consumer spend-ing and a bounce back in business investment.

Headline inflation, as measured by the consumer price index (CPI), slowed to 1.3% year-over-year in September, following a 1.7% rise in August. This was the lowest level in a decade and marks the fifth month that inflation has been below the Reserve Bank’s 2% to 3% target range.

The Reserve Bank of Australia (RBA) raised the overnight cash rate target by 25 basis points for the third consecutive month to 3.75% at their December meeting. The hike came amid increasing signs that Australia managed to avoid the worst of the global financial crisis. The RBA is the first major central bank to increase the cost of borrowing.

The rebound in commodity prices and healthy export growth to China have helped Australia to skirt the global recession. However, the negative wealth effect from de-clines in home values and equity prices suggests growth will be more subdued than it has been in the recent past.

Inflation will be of greater concern once the effects of previous rate cuts and the gov-ernment’s fiscal stimulus measures have fed through into domestic demand. But this seems unlikely before the middle of 2010.

The improving economic outlook reinforces our view that the RBA will continue hiking rates over the coming months. However, the central bank is mindful that con-sumer demand remains weak and will therefore pause its hiking cycle in early 2010 to assess its impact. The central bank is likely to move in small 25 basis point incre-ments.

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FINANCIALS†


All Ordinaries Index +36.26% 2-Year 4.32%

10-Year 5.24%

0.92 US$ / AUD$

0.61 € / AUD$

0.56 £ / AUD$

6.25 Chinese RMB / AUD$


10

Australia is the First Major Economy to Hike Rates

The Reserve Bank of Australia raised its benchmark interest rate by another 25 basis points

in December to 3.75%, making it the first major economy to increase the cost of borrow-

ing. The hike marked the third consecutive month of rate increases. The central bank

stated that solid gains in housing prices over the past few months and a recovery in equity

markets were the primary reasons for hiking the interest rate.

Source: Reserve Bank of Australia and Australian Bureau of Statistics

Central Bank Policy Rate (Right)House Prices (Left)

2005 2006 2007 2008 2009

-5

0

5

10

15

Yea

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ver-

Yea

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rcen

t C

han

ge

3

4

5

6

7

Percent

Source: Statistics Canada


Japan 22.2%

China 14.6%

South Korea 8.2%


Inflation +1.3% (Year-over-Year September 2009)


Consumption

52%30%

18%

Gov’t Expenditure


bn

GDP‡ BREAKDOWN



11

JAPAN ECONOMIC OUTLOOK

Economic Growth

Inflation

Interest Rates

Forecast:

Forecast:

Forecast:

Japanese real GDP grew at an annual rate of 4.8% in Q3 2009, up significantly from a revised Q2 2.7% increase. The rebound was spurred by a rise in exports as well as an increase in household spending associated with recent tax cuts and subsidies.

The headline consumer price index (CPI) fell 2.5% in the year to October 2009. Ja-pan’s deflation has been much more broad based than other countries. Core inflation, excluding food and energy, was down 2.2% over the same time period.

The Bank of Japan (BoJ) voted in December to leave its policy rate unchanged at 0.1%. The central bank also announced a new program to provide 3 month loans to financial institutions at 0.1%.

Japan’s record ¥15.4 trillion fiscal package has provided a temporary boost to private-sector demand, but the recovery is fragile. The biggest risk is that the new govern-ment led by the Democratic Party of Japan (DPJ) begins unwinding stimulus mea-sures, worsening the effects of a weakening job market.

Continued deflation is the primary threat to economic stability in Japan as the output gap, the difference between potential and current economic growth, widens. Wages will also continue to drop as companies attempt to offset shrinking profit margins.

The BoJ has little choice but to keep interest rates near zero, but may let its emer-gency corporate-debt buying programs expire at year-end as businesses regain access to private funding.

1

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FINANCIALS†


TOPIX -0.56%

Nikkei +7.13%

2-Year .234%

10-Year 1.27%

0.0116 US$ / ¥

0.0077 € / ¥

0.0070 £ / ¥

0.0790 Chinese RMB / ¥


12

Japanese Firms Shifting to Part-Time Employees

Over the past few years, Japanese firms have begun increasingly hiring part-time, rather

than full-time, employees. The global recession has accelerated this trend: part-time em-

ployees have gone from being a rarity in Japan to accounting for one-third of the work-

force. These workers have fewer protections and are not extended the lifetime employment

guarantee that full-time employees enjoy.

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

80

85

90

95

100

105

110

115

Ind

ex

Source: Ministery of Health, Labor

Full-Time Employees Part-Time Employees

Source: Ministry of Health, Labor

Consumption

60%21%

19%

Gov’t Expenditure


trn


United States 20.4%

China 15.3%

South Korea 7.6%


Inflation -2.5% (Year-over-Year August 2009)


GDP‡ BREAKDOWN



13

CHINA ECONOMIC OUTLOOK

Economic Growth

Inflation

Interest Rates

Forecast:

Forecast:

Forecast:

The Chinese economy grew at a year-over-year rate of 8.9% in Q3 2009, which fol-lowed growth of 1.9% in Q2. Massive fiscal stimulus and support for lending have been the key drivers of economic activity.

China is experiencing a temporary deflation due to the decline in international com-modity prices. The headline consumer price index (CPI) fell 0.5% year-over-year in October.

The People’s Bank of China (PBoC) is slowly moving to tighten credit by guiding rates higher in open market operations. It has also reopened its one-year sterilization bill, issuing punitive bills to imprudent banks.

A revival in private demand appears to be underway, suggesting less need for govern-ment intervention in the Chinese economy going forward. The primary risk is the development of an asset bubble if monetary policy is left too loose for too long.

Stronger-than-expected credit growth and the likely deregulation of fuel and utility prices should lift the headline CPI back into positive territory by year end.

If these measures fail to rein in loan growth, the central bank may take more aggres-sive action to stay out in front of any flare up in inflation later this year.

1

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FINANCIALS†


Shanghai Composite +78.06% 2-Year 1.67%

10-Year 3.66%

0.1465 US$ / Chinese RMB

0.0976 € / Chinese RMB

12.6570 ¥ / Chinese RMB

0.0891 £ / Chinese RMB


14

The People’s Bank of China Needs to Rein in Bank Lending

The People’s Bank of China is beginning to discuss tightening credit conditions following a

rapid acceleration in loan growth during the first eight months of the year. Governor Zhou

Xiaochuan said, “There is a difference in guiding inflation expectations when taking steps

to deal with the crisis and during normal times,“ which seems to suggest the bank is search-

ing for an exit strategy.

Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09

20

25

30

35

40

45

50

Ye

ar-

to-Y

ea

r Pe

rce

nt

Ch

an

ge

5.2

5.4

5.6

5.8

6

6.2

6.4

6.6

6.8

7

Perce

nt

Source: Peoples' Bank of China

Commercial Bank Lending (Left)Peoples' Bank of China Policy Rate (Right)

Source: People’s Bank of China

Consumption

39%

46%

15%

Gov’t Expenditure


trn


United States 19.1%

Hong Kong 15.1%

Japan 8.4%



Unemployment rate 4.2% (December 2008)

GDP‡ BREAKDOWN



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the global economic review & outlook december 2009 · 2009. 12. 3. · sharp declines in global...

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