five macro themes for 2017 - danske...

Five Macro Themes for 2017

Chief Analyst

Allan von Mehren+45 45 12 80 [email protected]

Senior Analyst

Pernille Bomholdt Henneberg+45 45 13 20 21/+44 20 7410 [email protected]

Senior Analyst

Mikael Olai Milhøj+45 45 12 76 [email protected]

Important disclosures and certifications are contained from page 24 of this report.

1 December 2016

Investment Research www.danskebank.com/CI

11

Five Macro Themes for 2017

1. Synchronised recovery

2. Reflation

4. Trump – what policies and when?

3. European policy uncertainty

5. ECB policy - tapering or not?

1. Synchronised recovery

2017 starts with recovery across the regions of the world

33

The global economy is entering 2017 with synchronised recovery

Strongest global recovery since 2013 First synchronised recovery since 2009

% y/yD anske

B ank C o nsensus

D anske

B ank C o nsensus

USA 2.2 2.2 2.8 2.2

Euro area 1.5 1.3 1.5 1.5

Japan 0.8 0.8 0.7 0.7

China 6.6 6.4 6.3 6.0

Global 3.5 3.4 3.6 3.4

2017 2018

We look for global growth at 3.5% in 2017

Source (all charts): Macrobond Financial, Danske Bank Markets

44

Investments to drive recovery as drag from energy investments fades

Investment growth to recover from weak levels US economy hit by falling investments

Drag on the US from oil investments is easing nowInvestments have been the weak link since the crisis


55

In this part of the business cycle equities and US yields increase

Equities move higher in the Blue phase So do US bond yields

Leading indicator

1 2

3 4

100

We are currently in the Blue

phase of the business cycle,

which is characterised by

global growth recovery with negative output gap

Source (both charts): Macrobond Financial, Danske Bank Markets, Bloomberg

2. Reflation

Reflation case is strong in the US – less so in the euro area

77

Reflation case is strong in the US – less so in the euro area

The US can tick all the boxes on the reflation check list currently – the euro area still has slack left

Rise in US inflation towards 2% is persistent. Euro area inflation mainly higher on com-modities. Will fall back to just above 1%

Source (both figures): Macrobond Financial, Danske Bank Markets

88

US output gap almost closed – euro area has more slack

Both US and euro area recovering, but the output gap has closed in the US – not in the euro area

Wage inflation up in US – but not in the euro area

Core inflation to rise in US – stay low in euro area


99

Rising commodity prices pushing up inflation

Change in oil price drives most of short-term change in inflation. To push up inflation in next 6 months

Metal prices rising at strongest pace since 2011. Likely to push up producer prices. Rise driven by recovery of China construction and infrastructure

Source (both charts): Macrobond Financial, Danske Bank Markets

1010

Fed leans towards letting the economy run a bit hot

‘I see benefits to trying to engineer

policy to allow for the strong

possibility of inflation

overshooting its target’

Charles Evans, October 2016

Chicago Federal Reserve

‘The natural next question is to

ask whether it might be possible to

reverse these adverse supply-side

effects by temporarily running a

”high-pressure economy,” with

robust aggregate demand and a

tight labor market’

Fed Chairman, Janet Yellen, October

2016

‘Fed’s 2% inflation target is

not a ceiling’

William Dudley, November 2016

Fed Vice-chairman

Source: Federal Reserve, Bloomberg

1111

The Fed taking a dovish twist in 2017 – we look for only two hikes

2016 2017

Hawkish Lacker Lacker Richmond

George George Kansas city

Mester Mester Cleveland

Rosengren Rosengren Boston

Harker Harker Philadelphia

Neutral Lockhart Lockhart Atlanta

Williams Williams San Francisco

Powell (B) Powell (B) Board

S. Fischer (B) S. Fischer (B) Board, Vice chair

Dovish Kashkari Kashkari Minneapolis

Kaplan Kaplan Dallas

Yellen (B) Yellen (B) Chairman

Tarullo (B) Tarullo (B) Board

Evans Evans Chicago

Dudley Dudley New York

Bullard Bullard St. Louis

Brainard (B) Brainard (B) Board

Vacant Vacant (B) Vacant (B) Board

Vacant (B) Vacant (B) Board

Voting member (B) Board Member

7 out of 10 voters in 2017 will be

doves – only one hawk left with voting rights

Source: Federal Reserve, Danske Bank Markets

3. European policy uncertainty

EU-sceptic parties to acquire power, not control – the recovery

continues with political uncertainty

1313

Time for anti-establishment parties to gain power: EU-sceptic parties have gained in polls

Political uncertainty the main euro theme in 2017

• EU-sceptic parties are likely to acquiresome power in 2017 after having gained inopinion polls, but we do not expect them totake control of the euro area.

• It is hard to imagine further euro areaintegration in coming years, but we believethe UK will be the only country to leave theEU, while the euro will not lose anymembers.

• The growing EU scepticism has so far hadlimited economic impact, but more actualpower to anti-establishment parties couldresult in postponed investments andconsumption decisions. On the other hand,it could boost fiscal spending, but at thesame time threaten fiscal sustainability.

0% 10% 20% 30% 40%

DK: Danish People's Party

SE: Sweden Democrats

UK: UK Independence Party

IE: Sinn Fein

PT: Left Bloc

GR: Golden Dawn

GR: Syriza

FI: Finland's Finns Party

AT: Austrian Freedom Party

BE: Vlaams Belang

NL: Dutch Freedom Party

SP: Podemos

IT: Five Star

FR: Front national

DE: Alternative for Germany

Latest polls (Oct-Nov) Last national election EP 2014 EP 2009

Source: Danske Bank Markets

1414Source: Danske Bank Markets

Italian referendum – market reaction dependent on political path

‘ YES’

Initial positive market reaction

Renzi continues growth reforms. Work on new

electoral law

Weak support for Renzi’s government

Care-taker government and snap election

Referendum on Italy’s constitutional reform

Renzi steps down

New government/coalition serving as placeholder until election in 2018

Renzi stays PM

Election in 2018based on revised Italicum

Renzi gets second term with more government

power

Focus on new electoral law. No reform progress

Negative market reaction. Uncertainty about Italy’s future in the euro / EU

Positive market reaction. No/little uncertainty about Italy’s future in euro / EU

The Five Star Movement emerges into power

Strong support for Renzi government

Initial negative market reaction

President Mattarella accepts Renzi’s

resignation

President Mattarella rejects Renzi’s

resignation

Snap election in H1 2017based on current Italicum

Snap election in H2 2017based on revised Italicum

Coalition government

Strong reform progress. Work on new electoral law

‘NO’

Renzi is not likely to take part in new government

Within the next week, the first major political event in the euro area will take

place with the Italian constitutional referendum

• In our base case, the Italians vote ‘No’ and PM Renzi steps down but without it resulting in ‘Italexit’ or a major sell-off in Italian government bonds

• There is broad political support in favour of changing the new electoral law – ‘Italicum’ – into being less beneficial for a single party like the anti-establishment Five Star Movement (M5S) before calling snap elections

• A revised electoral law makes a coalition government most likely, which should limit M5S power given its opposition to forming coalitions

1515

French presidential election – are opinion polls unreliable?

The Republicans: Francois Fillon

Front National: Marine Le Pen

Presidential election

(by universal suffrage in two stages of voting)

Second round run-off

between two top candidate in first round (simple majority sufficient to win)

Socialist candidate

Deeply unpopular, unlikely to enter run-off

First round

(absolute majority necessary to win)

Independent candidateEmmanuel Macron

Unlikely to enter run-off

Polls show Fillon winning run-off against Le Pen with 67% against 33%

Risks to our base case that Marine Le Pen will not become the next French president:

• In the past, voters have united to prevent the far-right from winning, but nothing can be ruled out given the current populist, anti-establishment mood in Europe and the high degree of uncertainty around opinion polls

• With his socially conservative and liberal reform programme, Francois Fillon lacks the broad appeal to both voters on the right and left and may struggle to unite them against Le Pen.


http://www.electograph.com/2016/11/france-presidential-november-2016.html

4. Trump – what policies and when?

Trump’s fiscal easing to support reflation case but his overall

policy remains a risk factor

1717

The political and economic consequences of the Trump presidency

Source: Donald Trump’s speeches, Danske Bank Markets

Donald Trump as US President

Overall political

outlook

Possible regime shifts in US policies but actual policy changes should be more modest than proposed due to likely resistance from Congress even within the Republican party. However, Trump's room for manoeuvre is larger as the Republican party will also control CongressUncertain how he will act as President as he has no political background.

Overall

economic

outlook

Q4 16-Q3 17: The election to be broadly neutral for US growth, which we expect at around 2.25% annualyQ4 17 - 2018: More expansionary fiscal policy to boost GDP growth from late 2017 to nearly 3% annually.2018+: More uncertain, but the negative effects from more protectionism and a tougher immigration policy may outweigh possible positive effects from less regulation, lower taxes and infrastructure spending. Hence structural growth may fall.

Fiscal policyShort to medium term: large tax cuts and infrastructure spending; in sum, fiscal easing of up to 2.2% of annual GDPLong run: worsen public financial sustainability as net debt will rise dramatically.

Trade policy

More protectionist, risking a global trade war.Withdrawal of the US from TPPRenegotitate the NAFTA to get 'a lot better terms', otherwise withdraw from it.No comments on TTIP but given Trump's protectionist stance does not bode well.Tougher line against China.Protectionism will lower US potential growth.

Monetary policy

We expect that the Fed will hike rates in December and twice a year afterwards, i.e. a total of five hikes from now until year-end 2018. We expect Fed to only partly offset Trump's expansionary fiscal policy.Trump to replace Fed chair Yellen in 2018 and likely appoint more hawkish Governors in 2017.

Foreign policy

Trump has more power on foreign policy. Very uncertain how he will act but has hinted at a significant regime shift.Has said that China is the enemy, not Russia. Wants NATO countries to contribute more.

Immigration

Trump has softened his tone but is likely to be substantially more hawkish than previous administrations on immigrants.Will likely take measures to reduce illegal immigration and send criminal immigrants home.Anti-immigration could lower US potential growth.

1818

Trump to boost growth through infrastructure spending and tax

cuts

Higher disposable

income

Higher consumer spending

Firms increase employment

and investments

Personal tax cuts

Increasing infrastructure

spending

Higher employment

Lower corporate

taxes

Higher consumer

saving

Multiplier effect

Estimated multipliers in the range[0.5 ; 2.5] over several quarters

Estimated multipliers in the range[0.3 ; 1.5] over several quarters

We expect the Fed to only

partly offset growth impact

through rate hikes

(tighter monetary policy

lowers multiplier effect)


1919

There is a lag before fiscal policy affects the economy

Biggest growth impact in 2018 due to policy lags

IDEA

DECISION

IMPLEMENTATION

GROWTH IMPACTEarliest from late 2017Infrastructure: Longer policy lag but bigger growth impactTax cuts: Smaller policy lag but smaller growth impact

Takes time for the politicians to pass the necessary legislation – Trump probably needs to make compromises with Republican members of Congress

Comprehensive and permanent economic plan? Smaller and more temporary economic plan?

Takes time to implement the policy (projects may not be ‘shovel-ready’ so projects have to be defined and designed first)

Q1 17

Q4 17

Q2 17

Q3 17

Biggest growth impact in 20182018Source: Danske Bank Markets

5. ECB tapering or not?

Premature to price ECB hiking cycle and discuss tapering – we

look for (at least) one QE extension

2121

Inflation above 1.0%, but due to the oil price

ECB set to continue QE as inflation is not on a sustainable path

• We expect the ECB to extend its QE pro-gramme by six months and maintain theEUR80bn monthly purchases as inflationis not on a sustainable path towards 2%.

• Prominent ECB members have expressedconcern about the lack of upward pressureon underlying prices, which together with aconsiderable downward revision to theECB’s core inflation projection shouldconvince enough ECB members that it istoo early to discuss tapering.

• We believe it is premature to price ratehikes from the ECB and see a more than50% likelihood that QE purchases will beextended again next year, which is notconsensus.

Source: ECB, Macrobond Financial, Danske Bank Markets

2222

Core inflation is far from the ECB’s forecast Philips curve: ECB’s wage forecast is hopeful

Lack of upward trend in core inflation is a concern to the ECB

ECB 2016Wages: 1.2%Unemp: 10.1%



Core inflation on a downwardtrend during 2016 – no longersupport from a weakening euro

Source: ECB, Eurostat, Danske Bank Markets Source: ECB, Eurostat, Danske Bank Markets

2323

The market has gone from ‘cut’ to ‘hike’ in 2m

ECB end-of-easing is wrong – QE extension becoming more likely

Trump sell-off has reduced

tapering risks - not increased -

due to:

- Two-sided risk to inflation - and pricing still very, very low - Higher real rates - Periphery spread widening - QE restrictions not binding in the near term - Increased political risk in Europe - Higher protectionism (US repatriation) - (Not weaker effective euro)

6 month EUR80bn extension

(tapering options)

- We expect the ECB to announce a six month QE extension in December - No pre-announcement of QE tapering, but a reiteration that QE will not exist forever - The programme’s end date will remain dependent on the inflation outlook - The first ECB rate hike will not follow until ‘well past the horizon of the QE purchases’ - (Risk of some form of tapering: 1) EUR80 bn will include re-investment of redemptions; 2) 'Tapering' in countries that hit restrictions (Germany, Finland, Portugal & Ireland); 3) Step-down to EUR60bn per month; 4) EUR5bn or EUR10bn reduction per month)

More PSPP flexibility still

needed if core FI rally again (not

really needed at current yield

level)

- Allowing some deviation from Capital Key - but NOT introducing a new buying scheme (enough German Bunds are eligible for a 3-6M extension - but if market rally German/Finnish purchases will be reduced as is already the case with Ireland/Portugal) - IF buying below depo is allowed actual buying will be quite low (ECB will buy Schatz down to -80bp) - Lifting issue/issuer limit is possible, but actual buying in ISINs with holdings above 33% will be quite low. We see risk tilted towards ECB rather reducing longer dated purchases as holdings in longer dated German bonds approach the limit

ECB action in December - extension and minor PSPP tweaks (hawkish wording)

ECB extension (and possible tapering options)

PSPP tweaks (also important for exit strategy)

Source: ECB, Eurostat, Danske Bank Markets

0.3

0.0

0.2 0.3 0.4

-0.2 -0.2 -0.2 -0.3 -0.3 -0.1

0.30.9

1.72.7

3.85.0

6.1

-15

-10

-5

0

5

10

Dec-16 ECB

Mar-17 ECB

Jun-17 ECB

Sep-17 ECB

Dec-17 ECB

Mar-18 ECB

Jun-18 ECB

Sep-18 ECB

Dec-18 ECB

bp

28/11/2016 29/09/2016

ECB dated Eonia swaps (assuming neutral Eonia is 5bp above deposit rate)

2424

Disclosures

This research report has been prepared by Danske Research, a division of Danske Bank A/S (‘Danske Bank’). The authors of this research report are Allan von

Mehren, Chief Analyst, Pernille Bomholdt Henneberg, Senior Analyst, Mikael Olai Milhøj, Senior Analyst.

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