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1
Global Economic Prospects
October 2014
Christopher J Probyn
Chief Economist
2
Global
• We expected 2014 to be “a year of improvement”
• But that has not happened:
–The US had a bad first quarter
–Japan had a bad second quarter
–The Eurozone lost momentum prematurely
• Now it seems that 2014 will be “more of the same”
• Real improvement will have to wait until 2015…
• … With geopolitical events skewing the risks to the downside
3
'70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14-1
0
1
2
3
4
5
6
7
Pe
rce
nt
Sources: IMF, SSgA Economics Team
World GDP Growth
World GDP, % chg y/ySSgA Economics Team Forecast
Average Historical Growth Rate (3.6%)
Global Global
4
Global Developing Economies
'10 '11 '12 '13 '14 '153
3.5
4
4.5
5
5.5
6
6.5
7
7.5
8
Pe
rce
nt
Forecast
Sources: Oxford Economics & SSgA Economics
Developing Economies GDP Growth with Forecast
Developing Economies GDP (ppp weights), % chg y/y
5
Global Advanced Economies
'10 '11 '12 '13 '14 '151.2
1.4
1.6
1.8
2
2.2
2.4
2.6
2.8
3
3.2
Pe
rce
nt
Sources: Oxford Economics & SSgA Economics
Advanced Economies GDP Growth with Forecast
Advanced Economy GDP (ppp weights), % chg y/y
6
US
• Fiscal drag was so much smaller in 2014 than 2013 that growth
was expected to accelerate quite markedly
• Unfortunately, all the “kick” from the reduction of fiscal drag was
offset by the first-quarter contraction
• So, this year will look a lot like last year
• But there are grounds for optimism about next year
7
Global US
'07 '08 '09 '10 '11 '12 '13 '14 '15-3
-2
-1
0
1
2
3
4
Pe
rce
nt
Forecast
Sources: Oxford Economics, SSgA Economics Team
US GDP Growth with Forecast
US Real GDP, % chg y/y
8
US
• Fiscal drag will be reduced further
–This should add about 0.5 percentage point to GDP growth in 2015
• Private-sector fundamentals appear solid
–Consumer fundamentals are generally strong
–Housing has picked up
–Capital spending has revived
– International trade is recovering
• Recent data have been strong
–Employment and unemployment insurance claims
–Manufacturing and non-manufacturing ISM
–Consumer confidence
–Light vehicle sales
9
US
'06 '07 '08 '09 '10 '11 '12 '13 '148
9
10
11
12
13
14
15
16
17
18
Mill
ion
s
Sources: Dept of Commerce & NBER
US Vehicles Sales
US Light Vehicle Sales, number of units at annual rateRecession Periods - United States
10
US
• Recent data suggest that the pick-up in the second quarter is
continuing into the third
• Indeed, we expect growth to average around 3.0% over the next
six quarters
• This also seems to be in line with Fed thinking, and explains the
ongoing reduction of monetary accommodation
• Tapering will end in October
• And policy rates will begin rising around mid-2015
• The exact timing and pace of tightening will be data dependent
11
US
• We do not see any real danger in this approach:
–There is no sign of wage inflation
–There is some slack left in the labor market
(Latest research suggests “true” unemployment is around 7.0% not 6.1%)
–The unemployment rate fell to around 4.0% in both 2000 and 2007 without
much impact on inflation
• Hence, the Fed should continue to focus on growth and not
worry about inflation
12
US
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '141
1.5
2
2.5
3
3.5
4
4.5
Pe
rce
nt
Source: BLS
US ECI, Wages and Salaries
US Employment Cost Index, Wages and Salaries, % y/y
13
Japan
• In 2013, the government embarked on aggressive policy
stimulus to speed up growth and end deflation:
–Fiscal package
–BoJ adoption of a formal 2.0% inflation target
–Large quantitative easing program
–Proposed structural reforms
• Financial markets adjusted rapidly, with the yen depreciating
and the Nikkei soaring, and growth and inflation accelerated
• A casual glance suggested that Abenomics was working, but…
–The pick-up of inflation reflected the effects of the lower exchange rate,
which are temporary rather than permanent
–The pick-up of growth reflected the effects of a fiscal stimulus package,
which faded as the year went on
14
Japan
• In 2014, the economy has not done so well:
–The consumption tax (VAT) hike that was enacted on April 1 this year sent
the economy into a tailspin
–And it is having difficulty regaining traction
• While the economy should ultimately prove resilient, and growth
will resume it is unlikely to exceed 0.8% in 2014
• Moreover, with another VAT hike scheduled for October next
year, we expect growth to accelerate to just above 1.0% in 2015
15
Japan
08 09 10 11 12 13-5
-4
-3
-2
-1
0
1
2
3
Pe
rce
nt
AbenomicsBegins
Source: Japan's Cabinet Office
Japan's Real GDP Growth
Japan's Real GDP, sa, quarter over quarter
16
Japan
'08 '09 '10 '11 '12 '13 '14-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
Pe
rce
nt
©FactSet Research Systems
Japanese Inflation
Japan CPI, % chg y/yJapan CPI, excluding food and energy, % chg y/yJapan CPI, excluding fresh food (core), % chg y/y
Official Target
17
Japan
• Will Abenomics work?
• There are two goals:
–Speed up growth
–End deflation
• Success on speeding up the underlying growth rate of the
economy depends on structural reforms… and the commitment
to these remains unclear
• Inflation has accelerated
– But only because of one-off effects
– However, the unemployment rate is at a level where this acceleration
could be sustained… if wages pick-up
18
Eurozone
• In the Eurozone, the recovery is distinctly lackluster
• Indeed, growth stalled in the second quarter, and is only likely to
reach about 0.8% this year and 1.3% next year
• There is continued divergence between members preventing
robust growth for the region as a whole
• The labor market is chronically weak
• Inflation is too low and trending even lower
• The ECB is easing, but private sector credit is still contracting
19
Eurozone
'07 '08 '09 '10 '11 '12 '13 '14 '15-5
-4
-3
-2
-1
0
1
2
3
4
Pe
rce
nt
Forecast
Sources: Oxford Economics, SSgA Economics Team
Eurozone GDP Growth with Forecast
Eurozone Real GDP, % chg y/y
20
Eurozone
'07 '08 '09 '10 '11 '12 '13 '14 '157
8
9
10
11
12
13
14
Pe
rce
nt
Forecast
Sources: Oxford Economics, SSgA Economics Team
Eurozone Unemployment with Forecast
Eurozone Unemployment Rate
21
'06 '07 '08 '09 '10 '11 '12 '13 '14-1.0
0.0
1.0
2.0
3.0
4.0
5.0
Pe
rce
nt
Source: FactSet Research Systems
Eurozone CPI and Core CPI
CPI ex. energy, food, alcohol and tobacco, % chg y/y CPI, % chg y/y ECB Target Rate (2.0%)
Eurozone
22
Eurozone
'06 '07 '08 '09 '10 '11 '12 '13 '14-4
-2
0
2
4
6
8
10
12
14P
erc
en
t
Source: ECB
Eurozone Credit Growth
Eurozone Credit to Private Sector, % chg y/y
23
Eurozone
• In addition, the region has serious structural flaws
• Competitiveness and economic performance are diverging and
the problem seems set to persist
–Nominal exchange rates are locked
– Internal devaluations are not working
–Fiscal transfers to compensate for competitive differences are not part of
the current structure
24
Eurozone
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '1495
100
105
110
115
120
125
130
135
140
Re
-in
de
xe
d: Q
1 1
99
9 =
10
0
Source: Eurostat
GDP Price Deflators: Eurozone Core
Italy GDP Price DeflatorGermany GDP Price Deflator
France GDP Price Deflator
25
Eurozone
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '1470
80
90
100
110
120
130
Ind
ex, Ja
n. 1
99
9 =
10
0
Sources: Bundesbank, INSEE, ISTAT
Industrial Production: Eurozone Core
German Industrial ProductionFrench Industrial Production
Italian Industrial Production
26
Eurozone
• The policy prescriptions employed so far have focused on the
adjustment of the uncompetitive countries through fiscal restraint
and structural reform
• But, it is important that both competitive and uncompetitive
countries adjust:
–While it would be difficult to persuade Germany to boost inflation to
become less competitive, there is a strong argument for boosting its
domestic demand
–This would be an alternative way to lower the country’s trade surplus with
other Eurozone members and thereby reduce the potential for unstable
capital flows
27
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14100
150
200
250
300
350
Eu
ro B
illio
ns (
ch
ain
ed
20
00
)
Source: Eurostat
German Exports vs Household Spending
German Real Exports of Goods & ServicesGerman Real Household Consumption Expenditures
Eurozone
28
Eurozone
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '1420
40
60
80
100
120
140
EU
R B
illio
ns
Source: German Bundesbank
German Trade With Other Eurozone Members
German Merchandise Trade Balance with Other Eurozone Members
29
Financial Markets
• US and Eurozone markets are decoupling because:
– Geopolitical tensions—especially Ukraine—are seen as a greater threat to
Europe than the US
– The Eurozone recovery has stalled, while the US recovery has regained
momentum
– US inflation is 2.0% and stable, while Eurozone inflation is 0.3% and
trending lower
– The ECB has cut interest rates, introduced T-LTROs and is poised to
engage in QE, while the Fed is tapering asset purchases
• This has caused:
– Eurozone equities to weaken relative to the US
– Bunds to rally relative to Treasuries
–EUR/USD to weaken
30
2012 2013 201490
100
110
120
130
140
150
160
Ind
ex: Ja
n 3
, 2
00
8 =
10
0
©FactSet Research Systems
Equities: US, Eurozone
Eurozone MSCI EMU - Price IndexUS S&P 500 - Price Index
Financial Markets
31
Financial Markets
2012 2013 20140.80
1.20
1.60
2.00
2.40
2.80
3.20
Pe
rce
nt
@Factset Research Systems
US and German Bond Yields
10 Year Treasury Note, Yield - United States10 Year Govt. Benchmark Note, Yield - Germany (Left)
32
Category—Title
2012 2013 20141.20
1.25
1.30
1.35
1.40
EU
R/U
SD
Source: Eurostat
Euro-Dollar Exchange Rate
The Euro/Dollar Exchange Rate
Financial Markets
33
Financial Markets
• In 2015:
– US equities are projected to yield a 9.0% total return on earnings growth and
dividend yield. No multiple expansion
– Eurozone equities are projected to yield a 4.0% total return largely on
dividend yield, with little price appreciation
– US bond yields are projected to rise, with the yield on the 10-yr Treasury
hitting 3.30% by the end of the year
– Eurozone bond yields are also projected to rise but by less, with the yield on
the 10-yr Bund hitting 1.25% by the end of the year
– EUR/USD is projected to weaken to 1.18 by the end of the year
Source: SSgA Solutions Group
Thank You
35
Disclosures
The views expressed in this material are the views of Chris Probyn through the period ended October 14, 2014 and are
subject to change based on market and other conditions. All information has been obtained from sources believed to be
reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability
or completeness of, nor liability for, decisions based on such information.
This document contains certain statements that may be deemed to be forward-looking statements. All statements, other
than historical facts, contained within this article that address activities, events or developments that SSgA expects,
believes or anticipates will or may occur in the future are forward-looking statements. These statements are based on
certain assumptions and analyses made by SSgA in light of its experience and perception of historical trends, current
conditions, expected future developments and other factors it believes are appropriate in the circumstances, many of
which are detailed herein. Such statements are subject to a number of assumptions, risks, uncertainties, many of which
are beyond SSgA’s control. Readers are cautioned that any such statements are not guarantees of any future
performance and that actual results or developments may differ materially from those projected in the forward-looking
statements.
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Past performance is no guarantee of future results.
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