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Monthly Economic Update April 2016
1
Monthly Economic Update Easy does it…for now
Financial markets have responded positively to the latest stimulus efforts by
the major central banks – the European Central Bank’s (ECB) multi-pronged
efforts to stimulate the Eurozone economy, and the Federal Reserve’s (Fed)
more cautious approach to tightening. But there are still plenty of pitfalls
ahead – China’s macroeconomic and financial difficulties, the Brexit vote and
US Presidential Elections all have the potential to upset risk sentiment – with
little left in Central Bank arsenals to provide any more offsetting support.
Markets have taken comfort from the lowering of the Fed’s tightening intentions as given
by their so-called “dot diagram”. This, despite repeated comments from Fed Chair, Janet
Yellen, that these dots do not represent a plan, a pre-commitment, or even that this is
formal ‘forward guidance’ (it isn’t).
Indeed, with one FOMC member already looking for immediate tightening, we are
surveying the data for evidence to support a more aggressive tightening profile than our
current forecast for one hike in 2016. Such evidence will include financial conditions as
well as the familiar domestic indicators of inflation, wages, and activity.
In Europe, there is little immediate need for the ECB to follow with more stimulus as
sentiment remains positive and inflation is showing signs of bottoming out, albeit it is
unlikely to hit the 2% target anytime soon. But there are many risks to the outlook, not
least from Greece, Brexit and the ongoing refugee crisis. Expect monetary policy to
remain loose for a long time to come, although “helicopter money” seems unlikely.
In the UK, the Brexit referendum campaigning is becoming more fraught, with the
electorate still unsure as to what it all means. Opinion polls remain close and this is
starting to hurt sentiment and economic activity, and the Bank of England is becoming
more vocal in pointing out the near-term risks. We still assume that the UK will vote to
stay, but we don’t have a high degree of confidence in this call.
The data on China has been rather mixed, with stronger investment and housing data
counterbalancing weaker industrial production. Greater stability in the People’s Bank of
China’s CNY policy should support growth, although political clouds are starting to gather
as questions are raised about the stability of President Xi’s administration.
There are many challenges facing the Japanese economy, not least a likely downtrend in
core inflation through 2016. Recent comments from PM Abe suggest that fiscal policy
may not pick up the mantle, placing further pressure on the Bank of Japan to act in April.
This year, we struggle to see EUR/USD decisively breaking out of 1.05-1.15 range as
transatlantic policy divergence has a diminishing marginal impact on FX. This is
supported by our view that the Fed is increasingly sensitive to financial conditions and
would be wary of allowing a stronger dollar to strengthen much more than the 8-10%
seen over recent years.
The positive sentiment going into, and in the weeks after, the recent ECB/Fed meetings
has helped boost risk assets and Central European yields have benefited. Our call is for
long dated core yields to remain contained, but we remain watchful of risk factors, not
least from oil, Brexit and China – all of which could prompt changes in our forecasts.
FINANCIAL MARKETS RESEARCH
research.ing.com SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES & ANALYST CERTIFICATION
Global Economics
30 March 2016
Mark Cliffe Head of Global Markets Research
Rob Carnell
Tim Condon
Padhraic Garvey
James Knightley
James Smith
Chris Turner
Peter Vanden Houte
GDP growth (% YoY)
Source: Macrobond, ING
10Y bond yields (%)
Source: Macrobond, ING
FX
Source: Macrobond, ING
-12
-10
-8
-6
-4
-2
0
2
4
6
-12
-10
-8
-6
-4
-2
0
2
4
6
00 02 04 06 08 10 12 14 16
Japan
Eurozone
US
Forecasts
0
1
2
3
4
5
6
7
0
1
2
3
4
5
6
7
00 02 04 06 08 10 12 14 16
US
Japan
Eurozone
Forecasts
60
80
100
120
1400.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
00 02 04 06 08 10 12 14 16EUR/USD (eop) USD/JPY (eop)
Forecasts
FINANCIAL MARKETS RESEARCH
Monthly Economic Update April 2016
2
US: Twisting and turning The latest turn in the US story has been driven by the Federal Reserve’s (Fed’s) latest
rate setting meeting. Although activity data has been coming in on a more positive trend,
and core inflation data has been nosing higher, the Fed left rates unchanged, and
markets instead focussed on a substantial reduction on what has come to be known as
the Fed’s “dot diagram”.
The dots represent the views of all 17 Federal Open Market Committee (FOMC)
participants, voters and non-voters, and prior to the latest meeting, have suggested an
entirely improbable and aggressive tightening by the FOMC over the coming years, with
100bp of tightening implied by the median of these dots by end 2016 and again in 2017.
As the Fed did not hike rates in March, it was almost inevitable that at least one of the
implied hikes would be removed from this diagram. In the event, two of the hikes in 2016
were removed. Chair Yellen noted that with rates already so close to zero, the Fed’s
ability to respond to negative shocks with easing was constrained and that this warranted
caution (the slower path for implied tightening) over 2016. This is undoubtedly the case,
but it was also the case in December last year, or earlier. Moreover, the Fed projection is
still more aggressive than market expectations, even though the lower projection seems
to have provided a big boost to risk sentiment.
Fig 1 December Fed Dot Diagram
Fig 2 March Fed Dot Diagram
Source: Federal Reserve, Bloomberg Source: Federal Reserve, Bloomberg
LR Implied fed funds rate is the furthest Fed contract – in this case, Feb 2019
It is a puzzle to us why markets pay much attention to this dot diagram, since even the
Fed has pointed out that it is not a formal piece of ‘forward guidance’. We are more
puzzled still when it merely moves in the direction of what markets were in any case
expecting, yet causes such a big reaction.
Indeed, the more interesting story for the outlook for US rates, in our opinion, is the fact
that there is now a dissenter at the Fed. Esther L George, FOMC voter and President of
the Kansas City Fed, now thinks that the Fed target range should already have been
raised to 50-75bp. Furthermore, if you ignore the dot-diagram, then the reasonably
upbeat Fed statement, the dissenting view, and the subsequent press conference all
seemed to tell an entirely different story – one that noted the improvements in activity and
the labour market, and also the increase in inflation. What seems to have been
overlooked in all of this was that Fed Chair Yellen described the April meeting as a “live”
one, and re-iterated this by describing a rate hike in April as a “live” possibility.
0
1
2
3
4
5
December Meeting
Dec implied Fed fund rate
Latest median
2015 2016 2017 2018 LR
%
0
1
2
3
4
5
March Meeting
Dec implied Fed fund rate
Latest median
2016 2017 2018 LR
%
The Fed has provided a nice
boost to markets with its
more dovish rate projections
Only two rate hikes are now
projected by Fed materials in
2016
This puts the Fed back in
touch with reality – it does
not really alter our
expectations
The dot diagram is not formal
forward guidance – it never
was
Little attention is being paid
to the fact that there is now a
dissenter who wants to hike
rates now
Monthly Economic Update April 2016
3
So whilst a month ago, we were looking for an excuse to remove our remaining 2016 rate
hike and wondering about the possibility of recession, instead we had to acknowledge the
better run of data in February. The run of data through March has retained this strength,
and the pressure on our forecast is now to see whether we need to bring forward the
3Q16 hike to 2Q16, and possibly restore the 4Q16 hike too.
The hurdle for further Fed tightening is not a low one, as Yellen points out. But it is not
insurmountable either. A decent activity picture will certainly help, and we see this as a
necessary condition to a rate hike. But it is not sufficient on its own. In contrast, were we
to see some convincing evidence that wages were beginning to accelerate, and also that
inflation was pushing up towards the Fed’s target, either of these might on their own be
sufficient to lead to a rate hike, and together, would be almost irresistible. Coupled with
this, financial conditions will play a role. Figure 3 shows our own measure of financial
conditions (a complicated mix including exchange rate indices, interest rates, and equity
market). Looser conditions clearly make it easier for the Fed to increase policy rates.
Fig 3 US Financial Conditions
Fig 4 Wages and hours fail to break higher
Source: ING Source: Macrobond
With only a six week period between the March meeting and the April one, we see some
scope for wages to pick up again, but probably not sufficiently to push into a new range.
An hourly wages growth rate of 2.4% or 2.5% YoY is about as high as we believe we are
likely to get before the 27 April FOMC meeting. Likewise, headline inflation is now
struggling to stay elevated as the year on year comparisons have to deal with the short-
lived February – July 2015 oil-related pick-up in gasoline prices. That said, the recent
firming in crude oil/gasoline will help offset these negative base effects.
As a result, an April hike, whilst “live” is probably not a strong contender in our view,
though the April meeting could be used to flag the possibility of a June hike, without pre-
committing. For now though, we are happy to leave just one hike in for 2016 in the third
quarter. US data is choppy, and who is to say we will not have the usual mid-year soft-
patch that has seemed to become the norm. Moreover, with plenty of political noise both
within the US (Presidential Elections) and outside (Brexit vote, China), there is scope for
a further deterioration in risk sentiment and a tightening in financial conditions – so
pencilling in more tightening without supportive evidence seems highly speculative.
Consequently, we would not be at all surprised if, over the next few weeks, the post-dot-
diagram eurphoria wore off, equities struggle to find new reasons to go up, and bond
yields settle back to a higher level again in anticipation of the Fed’s ultimate return to
monetary tightening.
Rob Carnell, London
0.00
0.25
0.50
0.75
1.00
Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16
Estimated Fed tolerance range
Trend (since Jul. 2014)
ING US Financial Conditions Index
ING US Financial Conditions Index (normalised Jul 2014 = 0)
Dec FOMC rate hike
33.2
33.4
33.6
33.8
34
34.2
34.4
34.6
34.8
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
07 08 09 10 11 12 13 14 15
Average hourly earnings, lhs
Average hourly earnings - production and supervisory,lhs
YoY% hours
The balance of risks to our
forecast is that we may have
to bring forward tightening,
and maybe add some too
Inflation and wages pressure
will be important in any
decision to hike rates, as will
financial conditions
There is not much time
before the April meeting, but
it might be enough to flag a
forthcoming hike in June
Our preference is to keep
with our one 3Q16 hike, but
to watch for excuses to shift
this up or add to it
Monthly Economic Update April 2016
4
Eurozone: ECB - all done?
The ECB surprised financial markets in March, not only by cutting the refi rate to 0% and
the deposit rate to -0.40%, but also by increasing its monthly asset purchase programme
to €80bn from €60bn. On top of that it also included, as we expected, investment grade
non-financial corporate bonds in the eligible assets for purchase. Finally there will be a
number of 4-year TLTROs with very generous conditions.
The striking thing is that ECB President Mario Draghi at first managed to create an
adverse market reaction by suggesting that interest rates would not be lowered any
further and that potential additional easing would be done mainly through non-
conventional measures. This guidance was rectified in the following week by ECB Chief
Economist Peter Praet, who mentioned that rates could still go lower (indeed, but then a
two-tiered deposit rate seems unavoidable in our view). That said, we have a feeling that
barring a relapse into recession, the ECB is basically done and that any additional
measures would be fairly small tweaks to the existing schemes.
However, when thinking about other potential non-conventional measures in the wake of
a new crisis, it is interesting to mention that both Draghi and Praet didn’t shy away from
discussing “helicopter money”. While Draghi mentioned accounting and legal
complexities, Praet clearly stated that all central banks could issue currency and
distribute it to people.
However, there is no need to get too excited, because helicopter money is no free lunch
either. Indeed, if the central bank continues to pursue its mandate of keeping inflation
close to 2% over the medium term and hence helicopter money doesn’t lift money in
circulation permanently, the main impact is that it brings forward in time future
seigniorage income. In other words, people will get a present today, but that will result in
lower ECB dividends in the future (since the helicopter money can be seen as a non-
interest bearing perpetual asset on the ECB’s balance sheet). The key reason why it
could be considered is to kick start the economy and in the hope that this would lead the
economy to a higher growth path.
Of course there is a lot of opposition within the Governing Council against this type of
extreme measures. This is already strong vocal opposition to the current ECB monetary
policy, since negative interest rates are in a way punishing savers and rewarding debtors.
In that regard, we don’t think that helicopter money is feasible in the foreseeable future.
In our view, there is also no need to introduce new measures at the moment. Sentiment
indicators have remained high, though choppy. In March, the PMI indicator increased to
53.7, a 3-month high. In terms of hard data, industrial production surprised in January
with a stronger-than-expected 2.1% MoM increase. On the other hand, the latest terrorist
attacks in Brussels, might temporarily depress consumer confidence. We therefore stick
to our scenario of a subdued, but continuing recovery. While this is not the environment
to see a rapid increase in inflation, the recent increase in oil prices also points to a
gradual bottoming out of headline inflation. That said, with 0.4% in 2016 and 1.5% in
2017, HICP inflation will still remain below the ECB’s target for some time.
ECB strikes again…
…but is now probably done
Helicopter money is not
impossible…
….and would meet heavy
opposition from the ECB’s
hard core
Growth is weak, but not
faltering…
…while inflation is bottoming
out
…but is no free lunch…
Monthly Economic Update April 2016
5
Fig 5 Uncertainty remains important…
Fig 6 …while money market rates become more
negative
Source: Thomson Reuters DataStream Source: Thomson Reuters DataStream
Of course, there are still plenty of risks around this scenario. That fact that the conclusion
of the first review of the third Greek bail-out programme, originally foreseen for January,
has been delayed until the second half of April at the earliest, shows that Greece is not
out of the woods yet. The confidence in the Greek Prime Minister Tsipras is plunging.
Fortunately Eurogroup President Dijsselbloem suggested that some debt relief might be
in the offing this year.
On top of that, the Brexit referendum might not only lead to more uncertainty in the
coming months. If the UK votes to leave the EU (see below), it is fairly certain that it will
have a negative impact on the Eurozone economy. We forecast a cumulative negative
GDP impact of 0.3% of GDP by the end of 2017, but this effect might be even bigger, if
the divorce turns out to be more acrimonious. (Click here to view our full report)
Finally, it is far from certain whether the recent agreement with Turkey will make the
refugee problem more manageable. More border controls might be put in place in the
Schengen area, hampering trade flows. The recent terrorist attacks in Brussels only
strengthen this trend.
Apart from these “known unknowns” other unexpected shocks might halt the still fragile
economic recovery in Europe. In these circumstances, even if helicopter money remains
unlikely monetary policy will remain very accommodative for years to come. That, and the
continued bond buying by the ECB, will keep bond yields low, though we still expect
some yield curve steepening near the end of this year.
Peter Vanden Houte, Brussels
UK: Feeling the strain of Brexit
The Brexit referendum debate in the UK is becoming more acrimonious. Following a
ministerial resignation, tensions within the Conservative Party are running high, with
reports that Prime Minister David Cameron could face a leadership contest irrespective of
the outcome of the vote. At the same time, the claims and counter claims of the
respective pro and anti-EU campaign groups are adding to a sense of confusion for the
electorate over what Brexit means. Consequently, we are seeing little shift in the opinion
polls which suggest that the outcome is still too close to call. Nonetheless, Prime Minister
David Cameron can seek some comfort from the fact that the bookmakers continue to
back the view that the UK will vote to stay – the best odds on the UK staying in the EU is
4/9 while it is 15/8 for a “leave” vote.
0
50
100
150
200
250
300
350
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
EU Economic policy uncertainty index (news based)
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
Mar 11 Mar 12 Mar 13 Mar 14 Mar 15 Mar 16
Overnight deposit rate ECB Euribor 3m
The referendum campaign is
becoming bitter, which is
adding to the confusion
amongst the electorate
Greece is not out of the
woods yet…
…while Brexit could be
another headwind…
….and the refugee crisis is
still not resolved
No rate hike likely before
2H18
Monthly Economic Update April 2016
6
We continue to think that the UK will narrowly vote in favour of staying a member of the
European Union on the basis that there is a large proportion of the electorate who are
undecided. As was the case with 2014’s Scottish independence referendum we believe
that most of this group will stick with what they know (opting for the status quo and
staying in the EU) rather than step into the unknown and vote to leave. We also believe
that with business leaders set to become more vocal on the issue in the lead up to the
vote this may focus the mind of the electorate on what it means for them and their
families’ employment and income prospects. This could help sway many undecided in
favour of staying in the EU.
Fig 7 UK business surveys are weakening
Fig 8 Opinion polls remain close
Source: Bloomberg Source: Various polling agencies
Irrespective of this, the referendum does appear to be having an impact on the UK
economy. Business surveys have weakened and consumer confidence has declined,
which may in part reflect the uncertainty that the referendum brings. We therefore
anticipate a slowdown in business investment and employment growth with firms likely to
be reluctant to implement significant expansion plans given the scale of uncertainty Brexit
could cause.
Significantly, after the March monetary policy decision, the Bank of England
acknowledged that the Brexit vote has weighed on sterling and may “also delay some
spending decisions and depress growth of aggregate demand in the near term”. This is
nothing more than stating the obvious, but it could be the first step into what could
become a more concerted campaign to highlight the economic risks.
Our house view remains that if the UK votes to stay in the EU we will see delayed hiring
and investment plans being implemented in 2H16. Given the underlying strength of the
economy and rising medium-term inflation pressures, we still think a November rate hike
is possible. However, should the UK vote to leave the next move is likely to be a rate cut
as policymakers try to shore-up confidence.
James Knightley, London
25
30
35
40
45
50
55
60
65
07 08 09 10 11 12 13 14 15 16
Construction
Services
Manufacturing
20
25
30
35
40
45
50
55
60
65
70
20
25
30
35
40
45
50
55
60
65
70
De
c-1
2
Feb
-13
Apr-
13
Ju
n-1
3
Aug
-13
Oct-
13
De
c-1
3
Feb
-14
Apr-
14
Ju
n-1
4
Aug
-14
Oct-
14
De
c-1
4
Feb
-15
Apr-
15
Ju
n-1
5
Aug
-15
Oct-
15
De
c-1
5
Feb
-16
Remain in EU
Leave the EU
(%) (%)
We still think that the UK will
vote to stay a member of the
EU, but our confidence in
this call is weak
There is evidence to suggest
the uncertainty is dampening
UK activity
The Bank of England is
starting to exert some
influence on the debate
Should the UK stay then a
November rate hike remains
possible.
Monthly Economic Update April 2016
7
China: Political Clouds Gather
January-February economic data – the statistics bureau releases combined data to
control for Lunar New Year seasonality – were mixed, which makes them an
improvement on the recent trend. On the downside, industrial production growth slowed
to 5.4% from 5.9% in December. The export crash contributed to the slowdown. We
blame the double whammy to export prices and volumes from the 30% fall in global oil
prices in December-January. Retail sales value growth also slowed (to 10.2% from 11.1%
in December).
Fixed asset investment, the other principal spending-side indicator, was the upside.
Growth accelerated to 10.2% from 6.8% in December on across-the-board strength –
infrastructure, real estate and manufacturing. The positive growth of real estate
investment was the first since July 2015. We credit the swing to 10% growth in housing
starts, only the second positive print in 14 months.
The authorities began to ease housing policy in 2014 and by early 2015 it looked like
activity – home prices, home sales and housing starts – were responding. However, sales
and starts flagged in the second half of the year, which from the turnaround in early 2016
(Figure 9), we infer was transitory weakness from the panic in financial markets
associated with PBOC CNY policy uncertainty. We credit steadier policy since the second
week of January and the appearance of better economic data – starting with the January
money and credit data in mid-February – for releasing pent-up demand. We expect
growth to slow as pent-up demand fades. However, we also believe reduced PBOC CNY
policy uncertainty supports our forecast of a solid bounce in housing starts this year,
which we consider necessary for hitting the government’s 10.5% target for fixed asset
investment growth.
It is common knowledge that housing markets in the Tier 1 cities are again overheating
while housing markets in higher Tier cities are struggling. However, while the gaps
between Tier 1 home price inflation and inflation in higher Tier cities are wider than ever,
the inflation paths look similar (Figure 10). Inflation (simple average) in Tier 2 cities
punched into positive territory in December, seven months later than in Tier 1 cities.
Since bottoming in April 2015 deflation in Tier 3 and 4 cities has been narrowing by an
average of 0.5ppt each month, a trend that would put inflation in positive territory this
month. The similar home price inflation paths increase our confidence that the positive
association between home sales, home prices and housing starts remains intact.
In late March two documents appeared that raise questions about the stability of Xi
administration. The first, entitled “A Thousand Yes-Men Cannot Equal One Honest
Advisor” appeared on the website of the Central Committee for Discipline Inspection. The
second was an open letter from a group calling themselves “loyal Party members” calling
for President Xi to resign.
The post on the CDDI website in particular supports the conjecture that something has
changed, that erstwhile Xi supporters now are worried. The head of the CDDI is Wang
Qishan, who is thought to be a close ally of the President; his position makes him the
point man for the President’s anti-corruption campaign. Through allegory it warns against
creating a cult of personality. It also says that “The fundamental attitude of our Party
toward criticism is to consider things as they stand, seek the truth in facts, and distinguish
right from wrong…” which could be interpreted as a direct counter to President Xi’s recent
admonition that Party members not “irresponsibly discuss the Center” and description of
the media as the “tongue and throat” of the Party.
Mixed January-February
economic data
Fixed asset investment was
the bright spot
A rise in the political noise
level...
…raises doubts about the Xi
administration’s stability.
Home price inflation differs
by city tier
Housing is recovering, at last
Monthly Economic Update April 2016
8
In the letter the loyal party members tell President Xi they “have no choice but to point out
that, precisely due to your gathering of all power into your own hands and making
decisions directly, we are now facing unprecedented problems and crises in all political,
economic, ideological, and cultural spheres.”
In the economic sphere, his “direct involvement in the development of micro- and
macroeconomic policy has created instability in the stock market and the property
market.” His supply-side reforms have resulted in large numbers laid off. The One Belt,
One Road has “put a huge amount of foreign exchange reserves into chaotic countries
and regions with no return.” Finally, the “excessive consumption of foreign exchange
reserves, and renminbi devaluation cycles, has made everyone’s confidence decline, has
brought the national economy to the verge of collapse. People want change.” The
message is almost Trumpian.
We believe the authorities have already hit upon quick fixes to some of the economic
shortcomings. Since the second week of January the PBOC’s CNY policy has been more
predictable with, in Governor Zhou’s phraseology, enhanced reference to a basket of
currencies. Less CNY policy uncertainty has contributed to firmer stock prices – the
Shanghai Composite stock index is up 13% from its low in late January, though for the
year it’s still down 17% – and curbed the drain on foreign reserves from hot money
outflows. We also think it contributed to releasing pent-up housing demand.
We expect President Xi to stay his course. We also think the authorities recognize the
virtues of the PBOC’s CNY policy and will stay the course as well. Despite Governor
Zhou’s admonition that the PBOC sets the USDCNY reference rate “with reference” to a
basket and is not a basket peg, our forecasts continue to assume it is.
Fig 9 China: Housing Indicators (%YoY)
Fig 10 China: New Home Prices by City Tier (%YoY)
Source: Bloomberg, ING Bank Source: Bloomberg, ING Bank
Tim Condon, Singapore
Japan: More stimulus coming
Although one of the major headwinds facing Japanese policymakers, namely global
turmoil has died down recently, a number of other challenges remain ever-present.
Domestic growth remains weak, spring wage negotiations have disappointed and most
importantly (at least as far as the BoJ is concerned), core inflation looks set to trend
downwards and further below the 2% target. Pressure for more stimulus appears to be
building, although exactly what form this easing will take is still up for discussion.
-20.0
-15.0
-10.0
-5.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
2014 2015 2016 ytd
Prices Sales Starts
-10
-5
0
5
10
15
20
25
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Tier-1 Tier-2 Tier-3 and up
Japanese policymakers face
a number of challenges
Not a basket case
Numerous shortcomings…
…including economic ones
Economic quick fixes
Monthly Economic Update April 2016
9
At the moment, it doesn’t look like this boost is going to come from fiscal policy. Perhaps
the biggest outcome of this week’s budget was the announcement that the sales tax hike,
planned for April 2017, will go ahead barring a Lehman-style event. There had been
reports that the government was looking to postpone this in advance of this summer’s
Upper House elections. From an economic perspective, the policy is likely to be growth-
negative, as the effect is likely to mirror the 2014 tax change which caused a significant
frontloading of demand, followed by technical recession.
Fig 11 Core CPI has reached its peak
Fig 12 Frontloading effect of 2014 sales tax hike
Source: Macrobond Source: Macrobond, ING
The other interesting development in the budget was PM Abe’s hint that he will use the
G7 meeting in Japan at the end of May to push for coordinated action to boost global
growth. This would most likely take the form of a boost to public investment, as was
recently suggested by the OECD. Ultimately though, this may be difficult to agree upon,
particularly in a US election year.
In the absence of any fiscal boost, expectations are likely to build ahead of April’s Bank of
Japan meeting. However, with negative rates still unpopular, the policy board may be
wary of cutting rates again just yet (note that some members discussed removing the
policy at the last meeting, according to the Summary of Opinions). Although we wouldn’t
rule out a rate cut (and incidentally, this is likely to be the favoured tool in the longer
term), we think that the BoJ may for now opt to increase purchases of risk assets.
In this regard, the most likely candidates are either exchange traded funds (ETFs) or
corporate bonds. The BoJ’s scope to expand purchases of existing ETFs is fairly limited,
given that it now owns well over half the market. This was reflected in their decision to
jump-start creation of new ETFs back in December, when they committed to buying
assets based on firms that invest in physical/human capital. In our opinion, the BoJ has a
greater ability to boost corporate bond purchases. Although the BoJ technically buys such
bonds now, it is simply to maintain holdings at a certain level (¥3.2 trillion) following pre-
Abenomics asset purchases. Based on a quick calculation using Bloomberg data, we
estimate that there is around ¥9 trillion of eligible corporate bonds in issue, not held by
the BoJ. Thus any increase in purchases would likely amount to around ¥2-3 trillion per
year.
Of course, the main point is that the size of the market is small so the economic impact
could be limited (and many would contest that the market has already been distorted by
current purchases). However, if the BoJ felt under pressure, but didn’t want to cut rates,
this may be their favoured tool, particularly now that the ECB has gone down this route.
James Smith, London
-30
-25
-20
-15
-10
-5
0
5
10-1.0
-0.5
0.0
0.5
1.0
1.5
Jan12
May12
Sep12
Jan13
May13
Sep13
Jan14
May14
Sep14
Jan15
May15
Sep15
Jan16
BoJ Core CPI (YoY%, lhs) - 7M lag
Nominal Effective Exch. Rate (YoY%, rhs)
-40% -30% -20% -10% 0% 10% 20% 30%
Motor Vehicles
Food & Beverages
Fuel
Fabrics, Apparel& Accessories
General Merchandise
Machinery & Equipment
April 2014 (Post)
March 2014 (Pre)
Retail SalesMoM% Change
Data seasonally adjusted by ING
The April 2017 sales tax hike
is still on…
… despite concerns about
the economic impact
Expectations are building
ahead of the BoJ’s April
meeting
With rate cuts unpopular, a
stimulus boost may come
from ETF or corporate bond
purchases
The economic effect could be
fairly limited
Abe may use the G7 meeting
to push for joint action
Monthly Economic Update April 2016
10
FX: Dollar strength in abeyance
Benign conditions continue. These have been helped by another dovish turn from the
Fed, helping to cement recent trading ranges for the $/Majors. Going forward we struggle
to see EUR/USD breaking decisively out of a 1.05-1.15 range this year and foresee a
much more neutral environment for the dollar. This should be more constructive for risk-
sensitive currencies, especially those that are cheap and offer risk-adjusted carry.
Fig 13 EUR/USD range solidifies, volatility falls
Fig 14 Carry Trade starting to recover
Source: Bloomberg Source: Bloomberg, Basket comprises BRL/IDR/ZAR funded out of USD/EUR/JPY. 1 January 2015 = 100.
This month we are further dialling back on our call for dollar strength this summer. While
acknowledging that a less dovish Fed could briefly push EUR/USD down to 1.05 this
summer, we prefer to market a more neutral EUR/USD story – and one in which
transatlantic monetary policy divergence is having a diminishing marginal impact. This is
probably a function of extreme EUR/USD undervaluation and the large rate spreads
required to offset the Eurozone’s 3% current account surplus.
At the same time we would argue that the Fed is increasingly sensitive to US financial
conditions and will be reluctant to pursue a tightening cycle that would generate the kind
of 8-10% appreciation in the real trade-weighted dollar seen over recent years.
For USD/JPY, this environment probably means a 110-115 trading range. Like the euro,
the yen is meaningfully undervalued against USD, which puts a limit on its further
weakness. While the announced VAT hike (from April 2017) is likely to translate into
frontloaded consumption, the likely dent to growth thereafter may increase the odds of
further BoJ easing. Yet, with the scale to top up the BoJ QE programme being limited
(see above) and rate cuts having a questionable effect on the currency (recall the
introduction of the three tier interest rate system in January did not prevent JPY strength),
all this points to a limited downside to JPY, particularly when the Fed and the Chair
Yellen appear to err on the side of caution.
Away from the G3, GBP continues to trade on a soft footing. We retain the view that
EUR/GBP should be trading around 0.80 heading into the June Brexit referendum – or
perhaps even higher if non-partisan polls show the Leave campaign gaining traction.
Elsewhere, the further decline in FX volatility is encouraging a return to the carry trade.
This rising tide of risk-adjusted carry has been lifting all ships – despite the ongoing
challenges faced in Brazil and South Africa to name but two. However surveys show
5
6
7
8
9
10
11
12
1.00
1.05
1.10
1.15
1.20
1.25
1.30
1.35
1.40
1.45
Jan 14 Jul 14 Jan 15 Jul 15 Jan 16
EUR/USD One year EUR/USD implied volatility (RHS %)
80
85
90
95
100
105
Jan 15 Apr 15 Jul 15 Oct 15 Jan 16
Carry Trade Basket*
We struggle to see EUR/USD
breaking decisively out of a
1.05-1.15 range this year
This month we are further
dialling back on our call for
dollar strength this summer
For USD/JPY, this
environment probably means
a 110-115 trading range
This rising tide of risk-
adjusted carry has been
lifting all ships
Monthly Economic Update April 2016
11
investors still heavily underweight EM and commodity currencies, which warn that recent
trends can extend barring a decidedly more hawkish Fed or Chinese hard-landing.
Chris Turner, London
Rates: Positive signs
Market sentiment turned decisively positive during the weeks approaching the respective
ECB and FOMC meeting, and in correlation with some recovery in the oil price. Large net
inflows to high yield were followed by impressive net inflows to hard currency emerging
markets. The market friendly ECB outcome was followed by a tolerable FOMC
unchanged decision and a nod in the direction of heeding market angst, in turn rewarded
with the removal of two of the dots for 2016.
The risk-on mood has continued since, with risk asset yields helped not just by a
tendency for spread compression but also by contained core yields. Hence for investors,
2016 has turned into a strong total returns performance YTD, while for issuers the
possibility to issue low coupons remains, into quite a receptive investor base. Investor
interest has been in longer dated issues, where a reasonable yield is attainable and carry
and roll down characteristics are maximised. Central European yields have benefited
generally from the combination of contained core yields, a risk-on mood and contained
risk metrics.
These circumstances are however tenuous. Risk factors include the ongoing possibility
for a downward lurch in the oil / commodity price complex, with likely difficult implications
for high yield / emerging markets. A Brexit is a systemic risk that could also play out in a
few months. Although we think the odds are against a Brexit, elevated risks of a possible
Brexit could cause concern in the intervening period. China could also test some
pressure points in the coming months, and remains a systemic threat too. Or, profit-taking
of strong YTD performances could prompt a bigger change in tone.
For now though the market environment is conducive to both performance and reception
for new issues. Central banks remain supportive and most risk factors are at bay for now.
The call for long dated core rates is for containment at or about current levels in this light.
The medium term outlook is still for a test higher in long yields and steeper curves, but
that requires a sentiment change in the direction of a more sustainably robust macro
prognosis. We like to position for this through 10yr payer swaptions in EUR IRS which
would also perform on any material elevation in volatility.
Padhraic Garvey
Market sentiment has turned
decisively positive
Contained core yields and a
tendency for spread
compression has helped risk
assets
Risk factors remain present,
not least from oil, Brexit and
China
We favour 10yr payer
swaptions in EUR IRS in this
environment
Monthly Economic Update April 2016
12
Fig 15 ING global forecasts
2014 2015F 2016F 2017F
1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY
United States
GDP (% QoQ, ann) -2.1 4.6 5.0 2.2 2.4 0.6 3.9 2.0 1.4 2.3 1.8 1.9 1.6 2.3 1.9 2.2 2.6 2.1 2.2 2.2
CPI headline (% YoY) 1.4 2.1 1.8 1.1 1.8 -0.1 0.0 0.1 0.4 0.1 1.1 1.1 1.3 1.7 1.3 2.2 2.4 2.2 2.1 2.2
Federal funds (%, eop)1 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.25 0.25 0.25 0.50 0.50 0.50 0.75 0.75 1.00
Fed monthly average asset
purchase total
65.0 45.0 25.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
3-month interest rate (%, eop) 0.30 0.20 0.20 0.20 0.30 0.30 0.15 0.40 0.40 0.65 0.80 0.80 0.85 1.05 1.10 1.30
10-year interest rate (%, eop) 2.71 2.53 2.49 2.17 1.90 2.35 2.03 2.20 1.85 1.90 2.00 2.10 2.20 2.30 2.40 2.40
Fiscal balance (% of GDP) Fiscal Year 2014/15 -2.8 Fiscal Year 2015/16 -2.7 Fiscal Year 2016/7 -2.4 Fiscal Year 2017/18 -2.3
Fiscal thrust (% of GDP) 0.0 0.2 0.2 0.0
Debt held by public (% of GDP) 74.1 74.2 73.8 73.2
Gross public debt/GDP (%) 102.4 102.6 102.2 101.8
Eurozone
GDP (% QoQ, ann) 0.9 0.2 1.2 1.5 0.9 2.2 1.6 1.2 1.4 1.5 1.2 1.2 1.4 1.7 1.3 1.7 1.8 1.8 1.9 1.7
CPI headline (% YoY) 0.7 0.6 0.4 0.2 0.5 -0.3 0.2 0.1 0.2 0.1 0.1 0.2 0.5 0.8 0.4 1.2 1.4 1.6 1.7 1.5
Refi minimum bid rate (%, eop) 0.25 0.15 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.00 0.00 0.00 0.00 0.00 0.00 0.00
3-month interest rate (%, eop) 0.28 0.21 0.08 0.08 0.02 -0.01 -0.04 -0.14 -0.22 -0.26 -0.27 -0.28 -0.28 -0.28 -0.27 -0.25
10-year interest rate (%, eop) 1.70 1.25 0.95 0.54 0.18 0.76 0.59 0.65 0.14 0.25 0.40 0.60 0.70 0.90 1.00 1.10
Fiscal balance (% of GDP) Fiscal Year 2014/15 -2.4 Fiscal Year 2015/16 -2.1 Fiscal Year 2016/17 -1.9 Fiscal Year 2017/18 -1.7
Fiscal thrust (% of GDP) -0.2 0.1 0.2 0.2
Gross public debt/GDP (%) 95.1 93.7 93.4 92.4
Japan
GDP (% QoQ, ann) 4.5 -7.6 -1.1 1.3 -0.1 4.6 -1.4 1.4 -1.1 0.5 0.7 1.5 1.5 1.9 0.6 4.2 -6.2 -0.6 1.3 0.5
CPI headline (% YoY)2 1.6 3.6 3.3 2.7 2.7 2.3 0.5 0.2 0.3 0.8 0.2 0.2 0.3 0.7 0.4 1.3 2.5 2.6 2.5 2.2
Excess reserve rate (%) 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1
BoJ asset purchase total 213 227 249 270 290 310 330 350 370 390 410 430 450 470 485 500
3-month interest rate (%, eop) 0.15 0.15 0.15 0.15 0.17 0.17 0.17 0.17 0.09 0.07 0.05 0.02 0.01 0.01 0.01 0.01
10-year interest rate (%, eop) 0.64 0.56 0.52 0.32 0.39 0.45 0.35 0.26 -0.09 -0.15 -0.07 -0.02 0.02 0.05 0.05 0.05
Fiscal balance (% of GDP) Fiscal Year 2014/15 -7.4 Fiscal Year 2015/16 -7.1 Fiscal Year 2016/17 -6.7 Fiscal Year 2017/18 -6.3
Fiscal thrust (% of GDP) 0.4 -0.8 0.0 0.0
Gross public debt/GDP (%) 211.0 212.0 212.6 213.0
China
GDP (% YoY) 7.4 7.5 7.3 7.3 7.4 7.0 7.0 6.9 6.8 6.9 6.7 6.6 6.5 6.3 6.5 6.7 6.6 6.4 6.4 6.5
CPI headline (% YoY) 2.3 2.2 2.0 1.5 2.0 1.2 1.4 1.7 1.5 1.4 2.3 2.0 1.9 1.8 2.0 2.0 1.8 1.7 2.0 1.9
PBOC 1yr deposit rate (% eop) 3.00 3.00 3.00 2.75 2.50 2.00 1.75 1.50 1.25 1.00 1.00 1.00 1.00 1.00 1.00 1.00
PBOC 1yr best lending rate (% eop) 6.00 6.00 6.00 5.60 5.35 4.85 4.60 4.35 4.10 3.85 3.85 3.85 3.85 3.85 3.85 3.85
7-day repo rate (% eop) 4.19 4.07 2.91 5.07 3.80 3.30 2.39 2.49 2.25 2.00 2.00 2.00 2.00 2.00 2.00 2.00
10-year T-bond yield (%, eop) 4.54 4.09 4.07 3.62 3.60 3.62 3.27 2.86 2.75 2.50 2.50 2.50 2.80 3.00 3.30 3.60
Fiscal balance (% of GDP) Fiscal Year 2014/15 -2.0 Fiscal Year 2015/16 -2.7 Fiscal Year 2016/17 -3.2 -3.0
Fiscal thrust (% of GDP) n/a n/a n/a n/a
Public debt (% GDP), incl. local
govt.
56.6 60.2 64.1 64.1
UK
GDP (% QoQ, ann) 3.6 3.4 2.5 2.5 2.9 1.7 2.4 1.7 1.9 2.2 1.7 1.6 1.9 2.7 1.9 3.0 2.6 2.7 2.7 2.6
CPI headline (% YoY) 1.7 1.7 1.5 0.9 1.5 0.1 0.0 0.0 0.1 0.0 0.3 0.5 0.8 1.5 0.8 2.4 2.9 3.0 2.9 2.8
BoE official bank rate (%, eop) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50 1.75
BoE Quantitative Easing (£bn) 375 375 375 375 375 375 375 375 375 375 375 375 375 375 375 375
3-month interest rate (%, eop) 0.50 0.55 0.66 0.55 0.55 0.58 0.58 0.65 0.60 0.65 0.70 0.90 1.20 1.50 1.70 1.95
10-year interest rate (%, eop) 2.74 2.67 2.42 1.76 1.90 2.00 1.75 2.00 1.40 1.70 2.00 2.20 2.40 2.60 2.70 2.90
Fiscal balance (% of GDP) Fiscal Year 2014/15 -4.9 Fiscal Year 2015/16 -3.9 Fiscal Year 2016/17 -3.1 Fiscal Year 2017/18 -1.8
Fiscal thrust (% of GDP) -0.9 -0.9 -1.5 -0.7
Gross public debt/GDP (%) 80.8 83.0 83.9 81.4
EUR/USD (eop) 1.38 1.36 1.26 1.21 1.05 1.10 1.12 1.09 1.13 1.10 1.10 1.10 1.15 1.17 1.18 1.20
USD/JPY (eop) 103 102 109 120 120 123 120 120 112 112 112 112 112 112 110 110
USD/CNY (eop) 6.21 6.20 6.14 6.21 6.20 6.20 6.36 6.52 6.48 6.50 6.50 6.53 6.53 6.51 6.50 6.50
EUR/GBP (eop) 0.83 0.80 0.78 0.78 0.71 0.71 0.74 0.74 0.79 0.80 0.76 0.76 0.76 0.77 0.78 0.80
Brent Crude ($/bbl, avg) 108 110 103 77 55 64 51 39 35 30 35 40 50 55 60 65
1Lower level of 25bp range
2Includes effect of April 2014 and 2017 consumption tax increases
Source: ING forecasts
Monthly Economic Update April 2016
13
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