morgan the global macro analyst macro surprises for 2014

8/13/2019 Morgan the Global Macro Analyst Macro Surprises for 2014

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For important disclosures, refer to theDisclosur es Section, loc ated at the end ofthis report.

M O R G A N S T A N L E Y R E S E A R C H

Global

December 18, 2013

The Global Macro Analyst

Macro Surprises for 2014It is ironic, but in a world where so many questions are stilllargely unanswered, investors, economists and strategistsseem to hold very similar views at the moment. But wherecould this strong consensus be wrong? To help answerthat question, we continue a Morgan Stanley traditionintroduced nearly three decades ago by our legendaryformer US strategist Byron Wienwith a few twists. Thesurprises we list today would surprise the consensus andmarketsand us as well since these are not our basecase, even though we do have them firmly on our radar.So what could challenge the consensus in 2014? Howabout:

Forward guidance fails and many DM central bankslose credibility

The shale revolution goes global A spat at the Fed on the role of forward guidance

splits the FOMC

Spain learns to love deflation and Germanyinflationwhile Italy is Japanified In Asia, the transition towards more sustainable

models of growth fails; China hard-landing fearsreturnwhile North Korea sees a regime change

Brazil takes a turn for orthodoxy after its elections,and reforms in Mexico hit speed bumps

Moscow becomes the New Brussels while Turkeyscentral bank returns to conventional monetary policy

Will these surprises pan out? We dont know, but theywould certainly change the landscape in 2014 if they do.

As Monty Python has famously said nobody expects the

Spanish Inquisition.

SpotlightFed Focus: The Fed Dream Team?Stanley Fischer, the possible next vice-chairman of theFederal Reserve Board, comes with a resume that cannotbe topped. A Yellen-Fischer-led Fed would likely work as aworld-class institution if all goes according to plan. Perhapsmore importantly for Yellen, what signal is the

Administration trying to send? p 7

Global Economics ForecastsReal GDP (%) CPI inflat ion (%)

2013E 2014E 2015E 2013E 2014E 2015E

Global Economy 2.9 3.4 3.7 3.2 3.3 3.2

G10 1.1 1.8 2.0 1.4 1.6 1.5

Emerging Markets 4.7 5.0 5.3 5.0 5.0 4.7Source: Morgan Stanley Research forecasts

The Morgan Stanley Global Economics View .........

Global Macro WatchGlobal: Global GDP Nowcast: 4Q Update .................. p 1Euro Area: No Specific Measures Yet ........................ p 1Spain: Regional Finances No Longer a Problem? ... p 11Japan: Abenomics, Labour and Wages: Thousand MileJourney in a Blizzard.................................................... p 11UK: Autumn Statement: Finally, Some Better FiscalNews ........................................................................... p 12EM: The Double Deficit Club & the Safe-Haven Club.. p 1China: Modest Easing in Growth Momentum.............. p 1

Asia Pac if ic : Asias Boom-Bust-Adjustment Cycles ... p 1Indonesia: Policy Rate Kept on Hold .............. ............ p 1Latin America: Latam Transitions .............................. p 1

Global Economics Team

Coordinators of this publication

Joachim Fels [email protected]

+44 (0)20 7425 6138

Manoj [email protected] +44 (0)20 7425 3805

Patryk Drozdzik [email protected]

+44 (0)20 7425 7483

Sung Woen Kang [email protected]

+44 (0)20 7425 8995

Philipp Erfurth [email protected]

+44 (0)20 7677 0528
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December 18, 2013The Global Macro Analyst

Macro Surprises for 2014Joachim Fels & Manoj Pradhan, with contributions from theentire Morgan Stanley Global Economics Team.

Over the past couple of weeks, Morgan Stanleys economicsteam has been busy marketing our 2014 Global MacroOutlook (December 2, 2013) and the accompanying regionaloutlooks around the globe. One of our key takeaways fromthe many client meetings, conferences and calls is that mostinvestors, economists and strategists hold very similar viewsabout what 2014 will bring and how to position for it. In fact,we cannot remember a year in the recent decade when the

groupthink has been so strong in the international financialcommunity. Most investors are aware of this and so manykeep asking where could the consensus be wrong?

To help answer this question, we continue a Morgan Stanleytradition introduced nearly three decades ago by ourlegendary former US strategist Byron Wien. Each year, Byron(now at Blackstone) publishes his Ten Surprises for theupcoming year. He defines a surprise as an event that theaverage investor believes to have only at most a one in threechance of happening, while Byron believes that it has at leasta 50% likelihood of coming true. For our purposes, we arebending Byrons rules. First, reflecting the many thinkers onour team and many regions and countries we cover, we havecompiled more than ten surprises from our economists aroundthe globe. Second, these surprises do NOT represent ourbase case. Rather, the events we describe would come as asurprise to us as well. However, we do believe that theydepict plausible scenarios that would represent a meaningfulsurprise to the prevailing consensus.

Global

Forward Guidance FailsMany of the major DM central banks (possibly including theBoJ in the future) have moved towards a regime of forwardguidance, which has become an important policy tool for asmooth transition from QE towards more conventional policy.One central bank proves unsuccessful in upholding credibleforward guidance on interest rates, and this failure istranslated around the world to other central banks as well.Forward guidance then increasingly becomes viewed as merecheap talk and investors lose confidence in central bankscredibility to both support growth and deal with inflation whenthey need to.

Shale Gas & Oil Revoluti on Goes GlobalWhile the US and Canada shale gas revolution took off forgood, it was held back in other parts of the globe by variousfactors including political, geological and environmentalconcerns. But no more. The successful exploration in the USthat reduces its external dependence on energy and supportsits manufacturing renaissance, high energy prices despitesubpar global growth recovery, geo-political developmentsand bold energy reforms, inspire EM economies to give shalegas and oil a proper go andthey score. Mexicos energyreforms and Poland and Ukraines exploitation of its shale gas

reserves (Europes biggest and third biggest reserves,respectively) provide strong results. In China too, liberalisationpolicies attract involvement of foreign multinationals withnecessary know-how. Finally, lifting restrictions on fracking inthe UK and the more attractive tax regime of the industry in

Australia keep DM involved as well. Meanwhile, global crudeprice breaks below its range as supply continues to outpacedemand. Global energy prices react as they should. Theymove lower and give the global economy a positive supplyshock. Energy importers prosper while new shale gasproducers see rapid development of this new sector of theireconomy.

Trade Agreement, Anyone?With steep domestic economic challenges, policy-makersseek to create growth via the international stage, giving apush to agreements such as the TTIP (Trans-Atlantic Tradeand Investment Partnership between the US and EU) andTPP (Trans-Pacific Partnership beefed up to 12 countriesincluding the US, Japan and S. Korea). The effect? Tradebarriers tumble, investment sees a further liberalisation pushand transaction costs are decreased as bureaucracy and redtape are reduced. The improved cooperation leads to moresolid pick-up in trade and more sustainable growth in theglobal economy.

Bubble TroubleHousing price and asset price bubbles build up in variouseconomies on the back of prolonged accommodative monetarypolicy (e.g., NZ, UK, Canada, Sweden and Australia). Centralbanks are hesitant to pull the tightening trigger too soon, andcontinue to depend heavily on macro-prudential measures as asubstitute to monetary policy. These tools fail to rein in thebuild-up of bubble prices and central banks tighten policy ratesin a panic, only to find that it is too late. The boom gives way toa bust, with a sharp reversal in prices, and financial instabilityderails confidence and economic growth.
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Y=ALK , Capex: Check, but What about Labou r?Though the US manufacturing renaissance progresses in2014, a shortage of skilled labour (thanks to a deep recessionand years of outsourcing) throws a spanner in the works. USfirms struggle to fill jobs due to a lack of proficient laboursupply. Competition for skilled workers leads to upwardpressures on wages, which, in turn, hurts competitiveness.Meanwhile in the EU, due to the lack of decisive policy action,long-term youth unemployment stays at record highs, withyoung jobseekers lacking the experience and skills to drive aneconomic recovery. Not just in the European periphery butalso in countries like the UK, long-term youth unemploymentremains at multiples of pre-crisis levels. In both the US and

the EU, this skills gap shortage acts as a road block on theway to a sustainable recovery.

EM: Show ing Poli cy-Makers the Yellow CardIn EM, a dangerous cocktail of economic policies andoutcomes cause a serious hangover. Necessary fiscal andmonetary tightening measures and other macro adjustments,execution of unpopular structural reforms, a subpar andvolatile recovery, currency depreciation and rising divergencebetween slowing EMs and reaccelerating DMs all play a role.

An early World Cup exit for Brazils football team andelections in many, including all core Double Deficit Club EMeconomies, act as a catalyst for heightened popularawareness about slowing growth prospects and other socialproblems. The result is social unrest which hurts economicactivity in the short term. Policy-makers respond with populistmeasures which go against the need for structural reforms tohelp these economies transition from their broken growthmodels to newer, sustainable ones.

A Sharper EM Adjustment, bu t wi th a Silver Lining (Finally) As US growth and capex surprise to the upside, EMeconomies get none of the benefits from better US growth(since they are better equipped to cater to consumer, notinvestment demand). Higher US Treasury yields and astronger US dollar create 2013-like effects in the EM world,pushing a sharper adjustment onto asset prices and economicgrowth. However, this time round, policy-makers finally findreligion, and respond with structural reforms that find enoughbuy-in from global investors aided by the significantadjustment to asset prices. Economic and asset marketprospects in EM finally improve for the right reasons.

United States

A Spat at the FedVice chairman Stanley Fischer draws a battle line in the sand,arguing forward guidance is ineffective and should beabandoned. Chairwoman Yellen tries to enforce conformity infavour of forward guidance. Nevertheless, Fischersintellectual gravitas draws enough support to split the FOMC.The Fed drops details of forward guidance and simply statespolicy accommodation will remain in place until the outlookfor the labor market has improved substantially in a context ofprice stability. Confused financial market participants price inearlier tightening and rates jump.

More Aggressive Housing PolicyNewly installed Federal Housing Finance Agency (FHFA)director Mel Watt paves the way for the Presidents plan toopen up refinancing for millions of families by streamliningthe process for mortgages not guaranteed by the government.

A new wave of refinancing ensues, freeing up a substantialamount of disposable income.

Republican SweepSince 2010, a divided US Congress has slowed passage oflegislation to a near glacial pace. The steady stream ofpartisan gridlock is only periodically interrupted by artificialfunding crises, the product of prior makeshift eleventh hourdeals. To reset the course, Republicans pour endless hoursand funds into divided senate races until Election Day inNovember 2014. They net the 6 seats needed to controlCongress, the President is forced to the table with fewerbargaining chips, and the elusive budget grand bargainbecomes reality. Strong legislation and the removal of policyuncertainty comfort consumers, businesses and financialmarkets.

Europe

Political Backlash: More Regional than EuropeanWhile investors get increasingly worried about the EuropeanParliament elections and the rise of anti-European or anti-euro parties, the real trouble is starting to brew at the regionallevel within individual European countries. In the context ofthe Scottish independence vote in September 2014 and theplanned Catalan referendum in November 2014, it becomesincreasingly clear that Member States will use the full force ofthe EU treaty, which says that any region leaving a countrywould also find itself outside of the European Union andwould need to reapply for entry, to limit potential devolution ofnational power up to and including full regional independence.


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Italy Turns Out to Be the Next Japanand Bon d YieldsFall SharplySigns of Japanification take hold in Italy more than anywhereelse in the eurozone. Just like in Japan over the past decadeand a half, outright deflation happens and affects inflationexpectations, and Italys poor demographic prospectscontribute to entrench the declining trend in consumer prices.But, like the Japanese economy at that time, the Italiancurrent account is now in surplus, and its bond market muchmore owned by domestic investors than before. Thus, withstructurally low growth and negative inflation, yields on Italiangovernment bonds fall sharply as long as perception of aEuropean policy backstop remains in place

Spain Learns to Lo ve Deflation , Germany Learns to Lo veInflation. No Fun in Italy Though .The whole of southern Europe sees outright declines inconsumer prices. But this happens just as a result of economicweakness and wide spare capacity in Italy, which struggles toshoulder its debts as consumers and firms postpone spending inexpectations of further falls in prices. This makes nominal GDPshrink even more. Yet Spain sees a drop in consumer prices as aresult of rising productivity and falling wages courtesy of thelabour market reforms. In turn, this regained competitivenesssupports GDP growth and lowers the debt burden through theexport channel but also thanks to domestic spending, given thatproduct market reforms now make the balance-sheet adjustmentfeeding through into lower consumer prices. Yet, this is short-lived and doesn't trigger expectations of further drops in prices.

And, to round-up the good rebalancing within the eurozone,wage growth and rising house prices boost the Germanconsumers purchasing power, which does actually spend!

Cyprus Lifts Capital Controls before IcelandWith all capital controls in Cyprus being removed and thecountry resuming its full effective membership of the euro,doomsayers, who were praising Iceland to be lucky for notbeing restricted by being a member of the European Union orthe Single Currency, will have another opportunity toreconsider their views. The same goes for those who werecommenting that the difference between Ireland and Icelandwas one letter and six months as Irelands exit from thebailout programme will prove highly successful.

EMU-Outs Stifled by Tigh ter Macro-Prudential Polic iesIn our baseline, the UK and Sweden will grow four to fivetimes as fast as the euro area. One factor that is supportingconsumer spending in both countries is a strong performanceof the housing market. In Sweden, the strength of the housingmarket and the accompanying increase in mortgage debthave already become a concern both from a monetary and

macro prudential policy point of view. In the UK, the housingmarket is already becoming a concern on the macro-prudential policy side, despite only small increases inmortgage debt. But with macro-prudential policies which arenow applied in both countries still largely being untested, theyhave a bigger-than-expected impact, causing housingmarkets to come to a grinding halt or even to go into reverse,thus opening the door for more monetary policy stimulus.

Japan

Wage Inflation Triggers Productivity Boo stWages accelerate to 2%Y quickly, in the face of labourshortages. Moreover, wage acceleration starts in small business,

where shortages are worst. In addition, pressure from the Abegovernment on large companies leads to increases of basewages in the spring wage round, and small firms are forced tofollow doubling the pressure on the small firms. A shakeoutbegins among small firms, and this shakeout reallocates labourto better uses. Although the wage pressure starts a politicalbacklash for more small business support, the tight labour marketallows a change of labour laws, to allow more flexiblemanagement of hiring/firing. Better incentives for business andlabour improve skill levels and justify the higher wages. Thehigher wage inflation gives BoJ more confidence in its inflationforecast, and it postpones new easing measures, leading tochanged expectations for both yen/dollar and JGB yields. The

yen stabilises towards our end-2014 level of 109/US$, but doesnot weaken further. JGB yields rise more in line with our bearcase, particularly at the long end of the curve. However, thefaster move from deflation to inflation improves tax revenue, andcontains fiscal pressures. Equity markets may be concernedabout higher input costs, but managements that actively raiseproductivity will be rewarded with higher stock prices.

Aust ral ia

Macro-Prudential Housing Restriction: Aussie Does a Kiw i Australia introduces macro-prudential restrictions on housingfinance, following New Zealands lead for only the second time ineconomic history (we concede that they helped pioneer inflationtargeting). The RBNZ could fly solo into its 10/80 rule (no morethan 10% of loans above 80% LVR from October 2013) given its

joint mandate as central bank and prudential regulator, but theRBA will need to work with its counterparts at APRA. RBAGovernor Stevens last week flagged that macro-prudentialpolicies have been discussed, although there was no active planto deploy them right now. If Australia indeed goes macro-prudential in 2014, we expect that investor mortgages would betargeted, with loans for new construction likely exempted, asrecently announced across the Tasman.


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As ia

Asi an Grow th Mo dels Tran si tion Fail sIn China, reforms do not get started in earnest, the governmentcontinues to rely on credit-fuelled investment-driven growthwhich lacks productivity dynamic, thus increasing the financialstability risks. In India and Indonesia, election outcomes bringweaker governments, which fail to address the challenge oflifting productivity while the rise in US dollar and US real ratesaccelerates. A combination of these developments brings amajor downside surprise to GDP growth in the region.

China Fast-Tracks ReformsPolicy-makers accelerate the pace of rolling out reform

measures and the initial impact starts to surface towards late1H14. In particular, the early initiation of service sectorderegulation induced more private sector investment andboosted consumption of service. With the help of a globalrebound and domestic demand strengthening, overcapacityhas largely been absorbed while local government financevehicle (LGFV) related liability undergoes more restructuring.

Fears o f Chinese Hard Land ing Make a ComebackPolicy-makers inadvertently missed the opportunity to adjustcountercyclical policies while they paid too much attention onlong-term planning. As a result, domestic demand growth slowsdown sharply in 1H14. Financial conditions remain tight, whichweighs further on manufacturing sector investment. Meanwhile,reform implementation comes to a stall, as downside risks froma widespread deleveraging process loom large.

A Nor th Korean Regime ChangeFollowing the surprising execution of Jang Sung-taek, theleading political figure and uncle of Kim Jung-un who wasbelieved to be the second person in charge and the de factocountry leader during the transition from Kim Jung-il to KimJung-un, the stability of the North Korea regime becomes highlyquestionable. Execution of such a senior official was unseensince the 1950s. Our base case remains that the North Koreanregime will be kept intact and that Kim Jung-un may evenreplace his aides by younger politicians who can bringinnovations and reforms to the country. Yet, we cannot rule outthe possibility of increasing unrest in the Korean peninsula. Thiswould take a toll on both consumer and business sentiment inSouth Korea and derail the recovery that we are expecting in2014. A change in the North Korean regime could possibly seean influx of refugees, posing substantial financial burden on theSouth Korean government.

Latin America

Brazil Takes a Turn for OrthodoxyNo sooner is the October 2014 presidential election over thanthe central bank restarts its hiking cycle with an aim at finallydenting labour market dynamics and slowing wage growth.We are surprised to find that the fiscal and quasi-fiscalauthorities are not far behind as fiscal consolidation takesplace to avoid a sovereign rating downgrade that appeared inthe cards. 2014 ends on a challenging note for consumers,but hope emerges that on the other side of such painfulmedicine, Brazil's growth profile might improve with the helpof a series of structural reforms.

Brazil's Labou r Markets Start to UnravelWhile not our central case, a crisis of confidence triggers a sell-off in the currency, which leads to a material pick-up in inflation.The hit to disposable income and consumer spending leads tohigher unemployment. In order to control inflationary pressuresthe central bank tightens monetary policy aggressively, whichsoftens domestic demand even further and raises concernsover Brazil's fiscal and debt dynamics.

Mexico Los es a Year and Maybe MoreWhile we are firmly in the camp that Mexico's Moment comesto fruition in 2014, the anti-reform proponents could gainground in the first months of 2014 just as enabling legislationis scheduled for congressional passage. (Surprising as thatwould be for us, there are some grounds 2014 is the 20thanniversary of both NAFTA and the Zapatista uprising).Legislative delays prove temporary, but they cut intoadvances for the year. A late start is compounded by a seriesof regulatory delays as neither Mexicos state-owned oilcompany nor the new regulatory bodies are ready for a bravenew world in the oil and gas industry.

Chile Reaffirms OrthodoxyEven before the new administration takes office in March, itsurprises those concerned with its campaign initiatives byinstead announcing a strong cabinet from the center. Once inoffice, it unveils an aggressive strategy for the electricitysector, allowing mining and industry to gradually regain someof its lost competitiveness, while at the same time tacklingshortcomings on education and health care, succeeding in thedual challenge of strengthening the current business-friendlymodel and addressing calls for a more inclusive society. Moretaxes? Yes, but there is no wavering from the traditionalprudence in fiscal and monetary management.


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Venezuela Regains Favour w ith B ig OilVenezuela revamps the regulatory mix in the oil sector andstarts attracting major FDI commitments from Big Oil. We expectmacro adjustments next year to include a devaluation (with thecurrency moving to Bs$12.00/dollar from Bs$6.30/dollar),legalisation of a parallel flexible foreign exchange system andsome fiscal tightening. But the real surprise (and not our basecase) is the governments more aggressive outreach to theinternational oil companies. After years of oil production andexport declines, potential for Venezuelas macro turnaroundrests on progress in this oil opening.

Argentina Posi tively Resolves Bo nd Stand off withHoldoutsThe move allows Argentina to regain market access andpolicy turns more orthodox. Given the timeline for the legalprocess in US courts, it is likely that the standoff with theholdouts is resolved next year. The debate is whether thisresolution will be positive for Argentina with Argentina curingthe default and regaining access to capital markets ornegative for Argentina with Argentina losing the appeal inthe US Supreme Court and entering technical default. Therealso are encouraging signs that an alternative resolutionthrough an inter-creditor solution may be negotiated early nextyear. A positive resolution would significantly improve the

Argentine outlook both in the near term and the medium termby restoring market access more than a decade after thecountry lost it in the aftermath of the 2001 default.

CEEMEA

Moscow Becomes the New BrusselsIn recent years, Putin has promoted a Russian-led CustomsUnion as a way of strengthening economic and, in time,political ties among the former states of the Soviet Union atheme which we picked up on in last years surprise Back inthe USSR. However, this has not worked well so far: no pick-up in trade, a high cost in subsidies, and a lack of popularappeal, particularly in Ukraine. Meanwhile, the Russians areconcerned that the proposed EU-US Free Trade Agreementmay set standards for the global economy. So, our surprisewould be a change of tack, with a new Russian focus onnegotiating free trade agreements with the US, Europe andglobally ideally from Putins perspective with Moscownegotiating on behalf of the Eurasian Customs Union, asBrussels negotiates on behalf of the EU.

Turkey: The Return of Central Bank OrthodoxyThe commencement of Fed tapering and the associated risein cost of borrowing reignites funding fears, given Turkey'shigh borrowing requirement as well as her debt rollover need.

In order to allay funding concerns, contain currency volatilityand to keep inflows intact, the CBT exhausts all possiblechannels of the current monetary policy. This time the policytraction remains weak and eventually the CBT adopts anorthodox monetary policy which helps TRY to be one of theoutperformers among EM.

South Af rica: Toug her SARB Squeezes CADMost South Africa watchers expect the countrys currentaccount deficit to remain wide in the coming years. However,concerns about the impact of currency weakness and itsassociated pass-through effects on forward-looking inflationoutcomes in the wake of Fed tapering (and/or an earlier-than-expected global recovery) may force the SARB to tightenpolicy much earlier than currently expected. Such a move islikely to cap household and investment spending, which, inturn, enforces a faster closure of the current account gap.While the initial adjustment process is likely to be perceivednegatively by markets, we believe that sentiment shouldchange for the better once the implied macro rebalancing hasrun a fair share of its course.

Czech Republic: Of Deflation and Devaluation Another devaluation in the Czech Republic (CZK), as deflationaryforces turn out to be stronger than the CNB was expecting. Thebackground is that the CNB believes that the onset of deflationwould have serious consequences on the already weak Czech

consumer outlook, and it expects the recent FX devaluation toadd about 1% to CPI next year (which implies a 20-25% pass-through). This FX pass-through assumption strikes us as a bithigh, so another devaluation to push inflation up is a possibility.We would imagine this devaluation to be in the range of 5%versus EUR, possibly larger.

Ukraine Unifies and Looks WestThis year Ukraine authorities created strong expectations ofsigning the Deep and Comprehensive Free Trade Area(DCFTA) with the EU. However, this was followed by the U-turn in the foreign policy and a deal with Russia, details ofwhich have been announced this week. It includes a purchase

of US$15 billion of Ukrainian Eurobonds and a 30% discountof a gas import price, which we think would allow Ukraine tohold the hryvnia and reserves at current levels to thepresidential elections in March 2015. Our surprise would be ifspurred by the current protests, President Yanukovych andthe opposition leaders reach agreement on signing the EUdeal in 2014 and implement an IMF programme, which wouldallow Ukraine to tackle its imbalance without a sharpmovement in the UAH or growing dependence on Russia.


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Spotlight: Fed Focus: The Fed Dream Team?Vincent Reinhart (1 212) 761 3537

In the summer of 1980, the old guard of the Republicanestablishment faced the uncomfortable inevitability of thenomination of Ronald Reagan as their partys candidate forpresident. They doubted Reagan would unseat the incumbent,Jimmy Carter, and wanted policy better anchored in traditionalviews. The solution was to put forward a co-presidency, withReagan at the top of the ticket, focused on domestic policy,and former President Gerald Ford running the internationalportfolio from the office of vice-president.

Despite the backers (reportedly to have included HenryKissinger, Richard Cheney and Alan Greenspan), theproposal lit up the headlines for only two days before flaringout.

The idea failed to gain traction because of concerns about:

The institution. Could the Constitution be interpreted soflexibly as to allow co-presidents?

The signal. Doesnt the desire to break precedent with thenumber two reveal concern about the number one?

The personalities. Would the forced partners have enoughemotional intelligence to share the spotlight, especially whendecisions have to be ratified by a larger group?

The practicalities. Who speaks for the institution, attendsinternational meetings and directs staff?

The co-presidency idea failed for the same reason thatinvestors head for the door when boards of directorsannounce the novel solution of co-CEOs. An i nsti tu tionneeds a leader, and a leader speaks with one voic e.

Other than that, we think i t is great news that the Adm inis tration may nominate Stanley Fischer to be vic e-chairman o f the Federal Reserve Board. Fischer has beenaround the inner circle of international economic policy-

making for three decades. If he was not at a major meeting inperson, one of his students from his long tenure at MITprobably was. The most relevant experience for the job as

vice-chairman was his eight years of service as FirstManaging Director of the International Monetary Fund. Heeffectively ran the institution for the Clinton Treasury frombelow an MD who was either headed for retirement (MichelCamdessus) or viewed by it as inadequate (Horst Kohler).When you add his service at the World Bank and as governorof the Bank of Israel, Fischer has a resume that is hard to betopped.

As for the content of that career, Fischer is eminentlypractical. Even though he has written textbooks on

macroeconomics, he has not rotely applied lessons from theirpages. He has expressed scepticism about forwardinterest rate guidance and quantitative easing. Indeed, hewondered out loud about interventions at the latest JacksonHole Economic Symposium, questioning several acts of faithin the policy-making canon, including the benefits ofinternational capital mobility.

A Yell en-Fischer -led Fed would likely wo rk as a world-class institution if all goes according to plan. But in Fischersnomination, Janet Yellen has to wonder about the signal.What is the Administration revealing about her role? How willit be taken by her colleagues on the Federal Open MarketCommittee and at international meetings? Who will Fed staffbe straining to please? And how soon will observers talkabout her tenure as four and done?

We think that the Administration needs to clarify its intent, if itsintent really is to nominate Fischer. Part of that can be done inpreparing Fischers way for Senate confirmation to explain theworkability of the arrangement and the viability of hiscandidacy. With the fifty-vote rule in place, the White Housesproblem will not be with Senate Republicans. Rather, advisorswill have to convince Senators to the Presidents left that aformer Citicorp official carrying the baggage of eight years ofIMF policy decisions will serve in a supporting position to thechairwoman they so dearly wanted.

See US Economics: Fed Focus: The Fed Dream Team? , December 12, 2013.
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The Morgan Stanley Global Economics ViewOur Core Global Views Key Macro Risk EventsFive key transitions: 2014 will mark year five of a post-crisis global economic expansionand the transition to a sounder, safer and more sustainable second half of this expansion.For this to be achieved though, policy-makers around the globe will have to master fivetransitions in the US, euro area, Japan, China and EM . In our base case, these transitionswill eventually be accomplished and we expect global GDP growth to accelerate to 3.4%Yin 2014, from just below 3%Y in 2013.

Continued accommodation by central banks: The transitioning to a better second halfof this expansion will require ongoing support from central banks. With global inflationlikely to remain low for longer, we forecast continued accommodation by DM centralbanks. However, we expect 13 EM central banks to hike rates in 2014.

Eurozone not out of the wood s yet: The Japanification of the euro area is a serious risk,but can still be avoided if policy-makers heed lessons from Japans past. We think thatresolution of the euro area sovereign and banking crisis requires both a fiscal union anda banking union coupled with the ECB being willing and able to be the lender of last resortto governments . While the ECB has taken a decisive step towards fulfilling this role,progress on fiscal and banking union remains painfully slow and full of setbacks.

Fiscal dominance and financial repression: Dont expect DM central banks to t ightensoon they are locked into a regime of fiscal dominance , where increases in the realinterest rate worsen government debt sustainability. Part of the solution to highgovernment debt levels can be imposing artificially low, or even negative, real returns oncaptive investor groups financial repression .

EM growth m odel broken needs structural reform: EM economies face external andinternal challenges that render the old, export-led model of growth defunct . Weak DMconsumers, onshoring of DM manufacturing and risks to external funding all work againstEMs externally.

December 18, 2014US FOMC meeting- Tapering start 15% probability

January 15, 2014Deadline for expiration of US continuing resolution

January 30, 2014US FOMC meeting- Tapering start 25% probability

February 7, 2014Next soft US debt ceiling deadline, extraordinarymeasures to avoid default until summer

March 1, 2014ECB expected to assume supervisory tasks withinSingle Supervisory Mechanism

March 20, 2014US FOMC meeting- Tapering start 35% probability

March, 2014Turkey Local elections

Apr il , 2014Indonesia Parliamentary elections

May, 2014India General elections

May, 2014European Parliament elections

EM Regional Themes Chart of the WeekE M growth has stabilised but important t ransitions are needed to progress recoverytowards a more sustainable one and/or improve macro-stability.

Asi a ex-Japan: China needs to focus on pro-market reforms, economic rebalancing anddeleveraging which might come at the expense of short-term performance but will improvemedium-term outlook. India needs higher real rates and more friendly investmentenvironment to alleviate the macro-stability risks. Koreas growth needs to be moreconsumption driven. Indonesia needs higher rates and lower REER.

Latin America: While there is unlikely to be near-term unravelling in Brazil, we also dontexpect a major policy shift necessary to fix the structural challenges before electionseither. Mexico and Colombia will need to implement proposed reforms, while Chilespolitical transition could be accompanied by greater focus on inequality issues. Peru isshifting to a new lower normal on the back of lower mining investment.

CEEMEA: Russias mild cyclical rebound will need stronger investment while Turkeyneeds to tighten monetary policy to ease external balance sheet concerns. Polandsgrowth is on the mend and rebalancing towards greater contributions from domesticdemand. S. Africa CAD will involve a painful adjustment for the domestic economy.

5 Key Transitions t o Sustainable Growt h

Five Tricky, Tough and Testing Transitions

SSSGrowth

USQE -->

ForwardGuidance

SSS = Sounder, Safer,more Sustainable

For our global forecasts, see 2014 Global Macro Outlook: Five Key Transitions , December 2, 2013.For our cross-asset views, see Global Debates Playbook: The Alpha Games: Catching Fire , December 6, 2013.
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Key Forecast ProfileGlobal Economics TeamQuarterly Annual

2013 2014 2015 2013E 2014E 2015E

Real GDP (%Q, SAA R) 1Q 2Q 3QE 4QE 1QE 2QE 3QE 4QE 1QE 2QE 3QE 4QE

Global** 2.5 3.5 4.0 3.4 3.3 2.8 3.6 3.7 3.3 3.8 3.7 3.5 2.9 3.4 3.7

G10 1.1 2.2 2.3 1.6 2.3 1.3 1.9 2.1 2.0 2.1 2.1 1.8 1.1 1.8 2.0

US 1.1 2.5 3.6 1.9* 3.3 2.8 2.5 2.8 2.6 2.7 2.6 2.7 1.6 2.6 2.7

Euro Area -0.9 1.1 0.3 0.5 0.2 0.4 1.1 1.2 1.2 1.2 1.2 1.2 -0.5 0.5 1.1

Japan 4.3 3.8 1.9 2.3 3.3 -3.0 0.7 1.5 1.1 1.7 2.8 -1.1 1.8 1.3 1.1

UK 1.5 2.7 3.2 2.8 2.4 2.0 2.4 2.0 2.4 2.4 1.6 2.4 1.4 2.5 2.2

EM (%Y) 4.9 4.5 5.1 4.5 4.8 4.8 4.8 5.1 4.8 5.0 5.1 5.3 4.7 5.0 5.3

China (%Y) 7.7 7.5 7.8 7.4 7.5 7.3 7.0 7.1 7.2 7.6 7.4 7.4 7.6 7.2 7.4India (%Y) 4.8 4.4 4.8 4.8 5.0 5.0 5.2 5.3 5.5 6.1 6.3 6.3 4.7 5.1 6.0

Brazil (%Y) 1.9 3.3 2.0 2.0 2.1 1.3 2.0 2.3 1.9 1.4 1.2 1.5 2.3 1.9 1.5

Russia (%Y) 1.6 1.2 1.2 1.9 2.4 3.2 2.6 2.0 2.9 3.9 4.9 5.9 1.6 2.7 2.6

Consumer price inflation (%Y)

Global 3.3 3.2 3.2 3.2 3.1 3.3 3.3 3.1 3.3 3.4 3.6 3.3 3.2 3.3 3.2

G10 1.8 1.7 1.8 1.5 1.3 1.4 1.2 1.2 1.8 1.6 1.7 1.7 1.4 1.6 1.5

US 1.7 1.4 1.6 1.2 1.1 1.7 1.5 1.6 1.5 1.6 1.6 1.6 1.5 1.5 1.6

Euro Area 1.9 1.4 1.3 0.9 0.9 1.1 0.9 1.3 1.2 1.3 1.3 1.2 1.4 1.1 1.3

Japan -0.3 0.0 0.7 1.0 1.2 3.1 2.8 2.8 2.5 0.5 0.5 1.8 0.3 2.4 1.3

UK 2.8 2.7 2.7 2.3 2.4 2.5 2.6 2.5 2.4 2.3 2.3 2.3 2.6 2.5 2.3

EM 4.9 4.6 4.7 4.9 4.8 5.1 5.3 4.9 4.8 5.1 5.3 4.9 5.0 5.0 4.7

China 2.4 2.4 2.8 3.0 2.2 3.4 3.8 3.3 3.4 3.5 3.8 3.6 2.7 3.2 3.6India 10.7 9.5 9.7 10.0 9.2 8.8 7.8 6.9 6.4 6.4 6.2 6.5 10.0 8.2 6.4

Brazil 6.4 6.6 6.1 5.9 5.9 5.8 6.1 6.4 6.2 6.2 6.0 5.9 6.2 6.0 6.1

Russia 7.1 7.2 6.4 6.3 5.7 5.4 4.9 4.8 4.8 4.8 4.9 4.7 6.7 5.2 4.6

Monetary policy rate (% p.a.)

Global 3.1 3.0 2.9 2.9 2.8 2.9 2.9 2.9 2.9 2.9 2.9 3.0 2.9 2.9 3.0

G10 0.6 0.5 0.5 0.5 0.4 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.5 0.3 0.3

US 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15

Euro Area 0.75 0.50 0.50 0.25 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.25 0.10 0.10

Japan 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10

UK 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 0.75 1.00 0.50 0.50 1.00

EM 5.9 5.7 5.7 5.4 5.4 5.5 5.6 5.7 5.7 5.7 5.7 5.9 5.4 5.7 5.9

China 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.25 6.25 6.25 6.00 6.00 6.25

India 7.50 7.25 7.50 7.75 8.00 8.00 7.75 7.50 7.50 7.50 7.50 7.50 7.75 7.50 7.50

Brazil 7.25 8.00 9.00 10.00 10.50 10.50 10.50 10.50 12.00 13.00 13.00 12.00 10.00 10.50 12.00

Russia 5.50 5.50 5.50 5.50 5.50 5.25 5.25 5.00 5.00 4.75 4.75 4.75 5.50 5.00 4.75Note: Global and regional aggregates are GDP-weighted averages, using PPPs. Japan policy rate is a range from 0.00-0.10%, with 0.05% as the midpoint; CPI numbers are period averages. *USGDP forecast for the current quarter is a tracking estimate. **G10+BRICs+KoreaSource: Morgan Stanley Research forecasts


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Global Macro Watch Global GDP Nowcast: 4Q UpdatePhilipp Erfurth (4420) 7677 0528Manoj Pradhan (4420) 7425 3805

Update: 4Q13 Global GDP

2013 4Q

Real GDP (% SAAR) 3.6

As introduced in the 2014 Global Macro Outlook , we use anearly indicator model or nowcast to get an early take onquarterly global activity before the quarter ends.

The indicators used in the model are: OECD Composite Leading Indicators Global Purchasing Managers Surveys (PMIs) CPB World Trade Index

Morgan Stanley Nowcast Model

GDP = constant + 0.26 CLI (lagged) + 0.20 PMI + 0.32 Trade

All coefficients statistically significant at the 5% level; HAC errors used for estimation,S.E of regression =1.0 Given data availability, CPB trade is updated real-time using Korean exports

Acc ur acy o f Nowcasts Deviations o f Nowcasted GDP Growt h from Actual

Source: Morgan Stanley Research

Euro Area: No Specific Measures YetElga Bartsch (44 20) 7425 5434

As ex pec ted , the ECB lef t in terest rates un changed andalso did not announce any other measures after theDecember 5 meeting. The press conference made clear thatno specific measures within the array of possible future policyactions were discussed not even an additional rate cut.Instead, the Council feels that its November cut has beenconfirmed by subsequent market action. While additionalaction was the topic of many questions, Mario Draghi was notwilling to talk about specifics.

The new ECB staff projections brought the inflationforecasts in line with ours a small downward revision forboth 2013 and 2014. Contrary to us, the ECB sees coreinflation moving higher over the forecast horizon though.Somewhat surprisingly, the ECB slightly raised its 2014growth projection to 1.1%Y, making the bank even moreoptimistic on growth than we are, at 0.5%Y. At the same time,the ECB seems to share our cautious view on 4Q, saying thatincoming data point to positive GDP growth, but the bank isno longer talking about an acceleration in growth in the nearterm.

If the ECB was to off er another LTRO, it wil l want to makesure that it is used to fund the real economy, and that itdoes not subsidise carry trades and a recapitalisation of thebanking sector. Hence, there is a risk that any future LTROscould be limited to SME loans. Again, ECB President Draghiwas not to be drawn into a discussion on the specifics. But hestressed that the situation two years ago was very different interms of uncertainty and in terms of funding stresses forbanks.

On balance, we conti nue to expect the ECB to lower therefi r ate again 1Q14 and also see a high outside chance of adepo rate cut. Disappointment on euro area growth looks likea potential trigger. We also believe that the hurdle to full-blown QE is very high a view that seems to be confirmed by

Draghis detailed explanation on why the euro area is differentfrom Japan.

For full details, see ECB Watch: No Specific Measures Yet , December 5, 2013.
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Global Macro Watch Spain: Regional Finances No Longer aProblem?Daniele Antonucci (44 20) 7425 8943

Why look at the local finances With less visibility on thelower levels of public spending, the Spanish regions are a key

and less explored driver of the overall budget outlook,given that they depend on central government willingness andability to extend aid.

and whats the main takeaway: Courtesy of institutionalreforms, the checks on regional deficits are now moreeffective, so overall fiscal risks are more balanced. Yet, someregions are better positioned than others to reduce theirdependence.

Central government deficit tracking well: State budgetexecution has improved, and the fiscal goals are within reach.Even factoring in some slippages at the regional level, butless than before, this years overall budget balance should notovershoot the target by much.

The economy and the banking system: Yet, the budgetdeficit is still quite wide and debt would rise even if thegovernment balance met the target in full. So, the fiscal ratiosshould benefit from growth in their denominator (GDP), andfrom a stronger financial sector.

For full details, see Spain: Regional Finances - No Longer aProblem? December 9, 2013.

Spain: Shrink ing Budg et Deficit, Rising Debt

Public finances (% of GDP)

-12%

-9%

-6%

-3%

0%

3%

6%

2003 2005 2007 2009 2011 2013 20150%

20%

40%

60%

80%

100%

120%

Overall budget balance (lhs) Gov't debt (rhs)

MS forecast

Source: Eurostat, Morgan Stanley Research forecasts

Japan: Abenomics, Labour and Wages:Thousand Mile Journey in a BlizzardRobert Alan Feldman (81 3) 5424 5385

Abenomics in the labour market has fo cused onemployment l aws and female participati on. These areonly the tip of the labour iceberg: A broader analysissuggests ten striking facts.

If recent participation trends continue, aging will cut the labourforce to about 62.3 million by 2020, from 65.7 million in 2012.Productivity growth of 2.5% per year, compared to 1.0% for1990-2008, would be needed to reach 2% real growth.

Even if Abenomics achieves its goal of a 5pp rise ofparticipation for the 20-64 age group, the overall labour forcewill fall to 64.4 million in 2020. Achieving 2% real growthwould require labour productivity to grow by 2.1% per year.

If Abenomics succeeds, high demand for labour will facemodestly reduced supply. If it fails, even modest demand forlabour will face sharply reduced supply. In either case, realwages will rise. We quantify these scenarios.

The major difference between the two scenarios iscorporate profits: If Abenomics succeeds, acceleratedproductivity will allow higher real wages while real profits riseas well. If Abenomics fails, low productivity growth will allow

higher real wages only at the cost of declining real profits.For full details, see J-Insight: Abenomics, Labor and Wages:Thousand Mile Journey in a Blizzard , December 3, 2013.

Japan: Ten Strikin g Facts on Labour and Abenomics1: Japans female participation rates are only about 3.5pp lowerthan the advanced county average (once corrected for populationage structure). 2: Japans female participation rates have risen sharply acrossage groups.3: Male participation in Japan is much higher than in mostadvanced countries, despite aging.4: There is ALREADY a labour shortage among non-manufacturing firms, despite the slow recovery.5: Abenomics actually has numerical targets for employmentratios, etc.6: Abenomics labour policy is missing in some crucial elements.7: Even if Abenomics labour goals are reached, the labour forcefalls!8: Even if labour goals are reached, productivity growth mustdouble to hit GDP growth targets.9: Wages will rise, whether Abenomics works or not.10: Failure of Abenomics will push real wages up more than asuccess at the cost of growth and profits.
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Global Macro Watch UK: Autumn Statement: Finally, SomeBetter Fiscal NewsMelanie Baker (44 20) 7425 8607Jonathan Ashworth (44 20) 7425 1820

More pleasant reading: As broadly expected, the OBRsforecasts for GDP were revised up significantly. Largelyflowing from this, the OBR also revised down its deficitforecastsand by more than we had been expecting. Thebigger picture is unchanged though (the deficit figures lookpoor by European standards and austerity is set to remainsomething of a drag on the economy for several years yet).But the prospect of lower deficits while achieving stronger

growth is clearly very welcome. Promised measures to helphousehold finances appeared, and make a modest differenceto our inflation forecasts.

Substantial OBR forecast changes: The OBRs deficitforecast at the end of this parliament (2014-15), for example,is now 13 billion lower at 4.9% of GDP, compared to 5.9% inthe March 2013 forecasts. Note though that this compares to2.1% at the time of the current governments first budget in2010. The OBR no longer forecasts government debt toexceed 100% of GDP on the internationally comparablegeneral government gross debt measure (although it is 2016-17 before this debt metric starts falling).

Fiscally neutral-ish: We expected 1-2 billion of netgiveaways. Net, we got a little less than that. We did get helpfor household finances. Fiscally though, this was offset byvarious revenue-raising measures and government spendingcuts.

For full details, see UK Economics and Interest Rate Strategy: Autumn Statement: Finally, Some Better Fiscal News , December 6, 2013.

UK: Deficit Projections Look Better

PSNB (the deficit), % of GDP

0

1

2

3

4

5

6

7

8

2012-13 2013-14 2014-15 2015-16 2016-17 2017-18

Mar 2013 OBR projections Dec 2013 OBR projections

Royal Mail pension assets transferflattered 2012-13 figures

Source: OBR

EM: The Double Deficit Club and the Safe-Haven ClubManoj Pradhan (44 20) 7425 3805Patryk Drozdzik (44 20) 7425 7483

The two big EM stories in 2014 will likely be: i) Furtheradjustment of asset prices in order to catalyse economicchange; and ii) A focus on which economies change theirmembership, switching from the double deficit club to the safe-haven club , or the other way.

The double deficit club Brazil worries: The double deficitclub hosts Brazil, India, Indonesia, South Africa, Turkey andUkraine, and Mexico and Thailand to a lesser extent, forreasons that go beyond just deficits see Emerging Markets:What if the Tide Goes Out? June 14, 2013).

Whos closest to leaving? Indonesia and India have bothmade progress but are not out of the club yet.

Whos applying for membership? Russia (whose deficits arerapidly deteriorating despite high oil prices) and Thailand (whose easier monetary policy could stimulate demand andkeep its current account deficit under pressure).

Whos staying put? Turkeys double deficits are unlikely todisappear in the foreseeable future, South Africas currentaccount deficit shows how much more work needs to be done,but it is Brazil that concerns us the most. The curiously tightlabour market (since growth has already unwound) has yet tounwind but policy-makers appear to be resisting, therebypushing the starting point for rebalancing further away.

The safe-haven clu b hosts mature EMs (Korea, Taiwan,Chile) and those with sound macro-stability (China, Poland,the Philippines, Colombia, Peru), and is now acceptingapplications from those who are rebalancing or reforming(Mexico has just turned in a strong one with its recent energyreform). India and Indonesia could apply in the future, butmuch needs to be done.

Chinas position: Some ambivalence: China remains a safehaven when EM is under stress from rising real rates.However, the deleveraging process, complicated by financialreforms that add to volatility (see The Global Macro Analyst:Chinas Inherent Reform Tensions , November 20, 2013), willlikely put pressure on financial stability and growth in Chinaand EM as well.

For full details, see Emerging Issues: EM 2014: The DoubleDeficit Club and the Safe Haven Club , December 11, 2013.
https://ny.matrix.ms.com/eqr/article/webapp/8b301352-5e14-11e3-8fae-bcd39d862add?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8b301352-5e14-11e3-8fae-bcd39d862add?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8b301352-5e14-11e3-8fae-bcd39d862add?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8b301352-5e14-11e3-8fae-bcd39d862add?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/c94794ca-b439-411f-ab7f-ea6cc7e34409?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/c94794ca-b439-411f-ab7f-ea6cc7e34409?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/c94794ca-b439-411f-ab7f-ea6cc7e34409?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/c94794ca-b439-411f-ab7f-ea6cc7e34409?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/6a780ac6-520b-11e3-a3a7-ea9f9c74683c?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/6a780ac6-520b-11e3-a3a7-ea9f9c74683c?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/6a780ac6-520b-11e3-a3a7-ea9f9c74683c?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/6a780ac6-520b-11e3-a3a7-ea9f9c74683c?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf9ecf26-61dd-11e3-8123-3166d0d73332?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf9ecf26-61dd-11e3-8123-3166d0d73332?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf9ecf26-61dd-11e3-8123-3166d0d73332?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf9ecf26-61dd-11e3-8123-3166d0d73332?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf9ecf26-61dd-11e3-8123-3166d0d73332?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf9ecf26-61dd-11e3-8123-3166d0d73332?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/6a780ac6-520b-11e3-a3a7-ea9f9c74683c?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/6a780ac6-520b-11e3-a3a7-ea9f9c74683c?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/c94794ca-b439-411f-ab7f-ea6cc7e34409?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/c94794ca-b439-411f-ab7f-ea6cc7e34409?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8b301352-5e14-11e3-8fae-bcd39d862add?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8b301352-5e14-11e3-8fae-bcd39d862add?ch=rpint


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Global Macro Watch China: Modest Easing in Growth MomentumHelen Qiao (852) 2848 6511Yuande Zhu (852) 2239 7820Yin Zhang (852) 2239 7818

Novembers macro data show that overall activity growthmomentum started to abate after stabilising inSeptember-October: Against a less favourable base lastyear, the modest deceleration in growth may be attributed tothe recent tightening in financial conditions. Even so, SOEshad outperformed other firms in both IP and investmentgrowth, probably owing to their better access to fundingthrough the official commercial loan channel when limited

funding sources are available.Meanwhile, financial conditions tightened further: Themoderation in M2 and outstanding TSF growth suggest thatfinancial conditions have tightened further, which is confirmedby higher money market rates and treasury yields. We expectcredit control, exchange rate appreciation, higher interbankinterest rates and the CBRCs ongoing effort to curb interbankactivities to make overall financial conditions tighter towardsyear-end. On the other hand, as the government remainsassured that the annual GDP growth target is certain to bereached, the threshold for potential policy easing is still high(see China Economics: Financial Conditions Tightened

Further , December 11, 2013).Growth outlook and policy implications: Despite themodest slowdown in November, we think that China shouldstill achieve the official growth target of 7.5%Y. So far, wedont think that the combination of a modest slowdown andtame inflation will induce any immediate countercyclical policyfine-turning. However, further deterioration in growthmomentum could test the policy-makers resolve to preventdownside risks.

At t he Central Eco nomic Wor king Conference , whichconcluded on December 13, policy-makers maintained theofficial policy stance, thus making 2014 all about reform and

urbanization. Specific plans on reform implementation includecategorising measures into those that can be fast-tracked,those that need specific changes, and those that can beexplored through pilot programs. On the urbanisation side, thekey priority is for an orderly assimilation of rural migrants whoalready live in cities (see China Economics: 2014 Is All AboutReform and Urbanization , December 16, 2013).

Asia Pacif ic: Asias Boom-Bust -AdjustmentCyclesDerrick Kam (852) 2239 7826Chetan Ahya (852) 2239 7812Jenny Zheng (852) 3963 4015

Focusing on the central role of productivit y: The strongeconomic performance of the Asia ex-Japan region over thepast two decades has had its inevitable ups and downs. Whatis the key factor that drives these cycles and how do theyaffect the regions economic welfare and asset price outlook?

We provide an economic framework that focuses on thecentral role of productivity in driving the business cycles. Weapply this framework to the developments in the region overthe past two decades.

The Asian business cycle can be distinctly characterisedinto three phases:

Boom phase of strong economic growth, which first transitsinto a

Bust phase as the productivity dynamic gets exhaustedbefore moving into an

Adjustment phase, where the economy unwinds the macroexcesses and refocuses on improving productivity.

As productivity improves, the foundations for the next Boomphase will then be put into place.

The developments over the past five years suggest thatthe region is now in the early stages of an Adjustmentphase: During this phase, the relatively elevated macro-stability risks and consequently lesser room for counter-cyclical policies mean greater exposure to any potentialdomestic or external economic shock.

More than before, productivity gro wth wil l have to do theheavy lifting to push th e region out of the Adjustmentphase: In turn, this depends crucially on how quickly policy-makers can and will move to lift productivity from here.

For full details, see Asia Insight: Asias Boom-Bust- Adjustment Cycles , December 5, 2013.
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Global Macro Watch Indonesia: Policy Rate Kept on HoldDeyi Tan (65) 6834 6703Zhixiang Su (65) 6834 6739

Bank Indon esia kept the pol icy rate at 7.50% onDecember 12, in line with consens us; we expected a 25bphike: This follows the surprise 25bp rate hike in November.Cumulatively since June, BI has hiked the benchmark policyrate by 175bp, the FASBI deposit facility rate by 175bp andthe FASBI lending facility rate by 75bp. In the statement, BIstated its belief that the current policy stance is consistentwith ongoing efforts to bring inflation back towards the targetcorridor of 4.5+/-1% in 2014 as well as to reduce the current

account deficit to a more sustainable and sound level.Our thoughts: The policy adjustment so far warrants lessbearishness at the margin. However, we think that Indonesiaremains in a state of disequilibrium. Further policy ratetightening is part of the macro rebalancing process required tobring Indonesia to a more sustainable near-term equilibrium.Indeed, for an economy which is running a CAD in anenvironment of rising real rates in the US, Indonesias realinterest rates would need to rise at an even faster pace inorder to attract liquidity and manage its external imbalances.

Morgan Stanleys US macro team expects rising real rates inthe US and QE tapering in March. In view of this and our

expectations of Indonesias inflation, we think that policy-makers should ideally take the real policy rate to 2% i.e., an8.5% nominal short-term interest rate amid what we thinkwould be a normalised inflation level of 6.5% after the baseeffects from the retail fuel price hike wear out.

However, in terms of what policy-makers would do, we areonly expecting BI to take the policy rate to 8% in 2014, givenBIs more sanguine expectations on inflation (4.5% +/-1pp).

Apart from policy rate tightening, we reiterate our view thatcurrency depreciation is required even at current levels firstto take the real exchange rate from overvalued to fairly valuedterritory, and thereafter to maintain a stable real exchangerate. As a result of such a continued macro rebalancingprocess, the macro slowdown is likely to continue into 2014.

To this point, we believe there still exists a negativeexpectation gap on the growth front. Consensus expects GDPgrowth for 2014 to be similar to 2013 at 5.6%Y. We expect5.1%Y for 2014 and view growth risks as still somewhatskewed to the downside.

For full details, see Indonesia Economics: Policy Rate KeptOn Hold , December 12, 2013.

Latin America: Latam TransitionsGray Newman (1 212) 761 6510

Aft er three consecutive year s arguing that Latin Amer icawould likely see slower (but still above-trend) growth forthe coming year, we are now seeing signs of a modestacceleration: And after years of worrying about the risks tothe region from abroad, the global backdrop appears morebenign in 2014 than we have seen in recent years. We expectLatin America to grow by 2.9%Y in 2014, up from anestimated 2.7%Y this year.

This modest improvement comes as our global team sees2014 as a transit ion year from what has been five years of

post-crisis global expansion that has been bumpy, below-parand brittle to a new phase of sounder, safer and moresustainable growth (see 2014 Global Macro Outlook: FiveKey Transitions , December 2, 2013).

Of course, risks remain to our b ase case of an improvingglobal outlook: Indeed, our global chief economist JoachimFels highlights five transitions whose success is central to ourimproved global outlook, ranging from the USs move fromquantitative easing to credible forward guidance on rates, toJapans path from deflation to (moderate) inflation to Chinasprogress on reform-driven growth.

While I am intrigued by the notion that we may be in the midst

of one of the longest (post-war) global recovery cycles, andwhile our global outlook sounds somewhat reminiscent of thenot too hot, not too cold narrative of the past, I continue toworry that the transitions (which our global team expects to beby and large successful) may bring with them bouts ofturbulence. Those potential bouts of turbulence could easilyobscure the modest recovery under way and, in turn, obscureLatin Americas own transitions.

Indeed, it is the challenge of Latin Americas transitionsthat has prevented us from pro ducing a stronger set ofnumbers for 2014: While the region as a whole is seeing amodest uptick, we do not expect the regions largest economyto join in the upturn. Arthur Carvalho sees Brazilian activityslipping slightly in 2014 and posting 1.9%Y growth afteradvancing by an estimated 2.3%Y this year. Brazils slippageis tied to its inability to transition from its current model achallenge that Arthur thinks is unlikely to be resolved nextyear either. To one extent or the other, each of the majoreconomies in the region faces an important transition in 2014.

For full details of key transitions by country, see Latin America: Latam Transitions: Week Ahead in Latin America , December 6, 2013, and Chile, Peru & Colombia: 2014Outlook: Week Ahead in Latin America , December 13, 2013.
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Inflation Target Monitor & Next Rate MoveGlobal Economics Team. Contact: [email protected]

Inflation targetLatestmonth

12MMS

fcastNext ratedecision

Currentrate

Marketexpects

(bp)

MSexpects

(bp) Risks to our call

US 2.0% PCE Price Index 0.7% 1.5% 18 Dec 0.15 -2 0 -

Euro Area < 2% HICP (u) 0.9% 1.3% 09 Jan 0.25 2 0 ECB could announce additional liquidity measures

Japan 2% CPI (u) 0.7% 0.6% 20 Dec 0.10 0 0 -

UK 2% 2.1% 2.4% 09 Jan 0.50 -1 0 -

Canada 1-3% 1.2% 1.8% 22 Jan 1.00 -1 0 -

Switzerland


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Global Monetary Policy Rate ForecastsCurr ent 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

US 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15Euro Area 0.25 0.25 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10Japan 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10UK 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 0.75 1.00Canada 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00Switzerland 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00Sweden 0.75 0.75 0.75 0.75 0.75 0.75 1.00 1.25 1.50 1.75

Aus tr alia 2.50 2.50 2.50 2.50 2.50 2.50 2.50 2.75 3.00 3.00New Zealand 2.50 2.50 2.50 2.75 3.00 3.25 3.50 3.75 4.00 4.25

Russia 5.50 5.50 5.50 5.25 5.25 5.00 5.00 4.75 4.75 4.75Poland 2.50 2.50 2.50 2.50 2.75 3.25 3.75 4.00 4.00 4.00

Czech Rep. 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.25 0.50Hungary 3.00 3.00 2.60 2.60 2.60 3.25 3.75 4.00 4.25 4.50Romania 4.00 4.00 3.75 3.75 3.75 4.00 4.25 4.50 4.75 5.00Turkey 4.50 4.50 4.50 4.50 5.00 5.50 6.50 6.50 6.50 6.50Israel 1.00 1.00 1.00 1.00 1.25 1.50 1.75 2.25 2.25 2.25S. Africa 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 6.00 7.00Nigeria 12.00 12.00 12.00 12.00 12.00 12.00 11.50 10.50 10.50 10.50Ghana 16.00 16.00 16.00 16.00 16.00 16.00 16.00 16.00 16.00 16.00Kenya 8.50 8.50 8.50 9.50 10.00 10.00 10.00 10.00 10.00 10.00

China 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.25 6.25 6.25India 7.75 7.75 8.00 8.00 7.75 7.50 7.50 7.50 7.50 7.50Hong Kong 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50S. Korea 2.50 2.50 2.50 2.50 2.50 2.75 3.00 3.00 3.25 3.25Taiwan 1.875 1.875 1.875 1.875 2.00 2.125 2.25 2.375 2.375 2.375

Indonesia 7.50 7.50 8.00 8.00 8.00 8.00 8.00 8.00 8.00 8.00Malaysia 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00Thailand 2.25 2.25 2.25 2.25 2.25 2.75 3.00 3.00 3.00 3.00

Brazil 10.00 10.00 10.50 10.50 10.50 10.50 12.00 13.00 13.00 12.00Mexico 3.50 3.50 3.50 3.50 3.50 3.50 3.50 3.50 3.50 4.00Chile 4.50 4.50 4.25 4.25 4.25 4.25 4.25 4.25 4.25 4.25Peru 4.00 4.00 4.00 4.00 4.00 4.00 4.25 4.25 4.25 4.25Colombia 3.25 2.75 2.75 2.75 2.75 3.50 4.00 4.25 4.50 4.50Source: National Central Banks, Morgan Stanley Research forecasts; Note: Japan policy rate takes a mid-range value.

Fed and Eurosy stem Balance Sheet Monitor

Source: Haver Analytics Source: Haver Analytics


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Global GDP and Inflation ForecastsReal GDP (%) CPI infl ation (%)

2012 2013E 2014E 2015E 2012 2013E 2014E 2015E

Global Economy 3.2 2.9 3.4 3.7 3.4 3.2 3.3 3.2

G10 1.5 1.1 1.8 2.0 1.9 1.4 1.6 1.5

US 2.8 1.6 2.6 2.7 2.1 1.5 1.5 1.6

Euro Area -0.6 -0.5 0.5 1.1 2.5 1.4 1.1 1.3

Germany 0.7 0.4 1.4 1.8 2.0 1.5 1.5 1.7

France 0.0 0.2 0.4 1.1 2.0 0.9 1.3 1.3

Italy -2.6 -1.9 0.2 0.8 3.0 1.2 0.5 0.9

Spain -1.6 -1.3 0.6 1.2 1.8 1.8 0.0 1.3

Japan 1.9 1.8 1.3 1.1 -0.1 0.3 2.4 1.3

UK 0.1 1.4 2.5 2.2 2.8 2.6 2.3 2.3

Canada 1.7 1.7 2.4 2.5 1.5 1.2 1.8 1.7

Sweden 0.9 0.6 2.5 3.0 0.9 0.0 0.9 1.8

Australia 3.7 2.6 2.8 2.9 1.8 2.0 2.1 2.5

Emerging Markets 4.9 4.7 5.0 5.3 4.8 5.0 5.0 4.7

CEEMEA 2.7 2.2 3.4 3.7 5.6 5.3 5.0 5.0

Russia 3.4 1.6 2.7 2.6 5.1 6.7 5.2 4.6

Poland 2.0 1.4 3.0 3.2 3.7 1.0 2.0 2.6

Czech Rep -0.9 -1.6 1.5 2.5 3.3 1.4 1.4 2.1

Hungary -1.6 0.9 2.2 1.9 5.7 1.8 1.5 3.2

Ukraine 0.2 -1.2 1.3 2.8 0.6 0.6 2.0 5.3

Kazakhstan 5.0 5.8 6.8 6.3 5.1 6.0 6.1 6.4

Turkey 2.2 3.6 3.9 4.7 8.9 7.6 6.3 6.6

Israel 3.2 3.8 3.0 3.1 1.7 1.6 2.1 1.6

South Africa 2.5 1.8 2.8 3.5 5.7 5.8 5.6 5.5Nigeria 6.5 6.8 7.8 7.5 12.2 8.5 9.0 9.0

Ghana 7.9 7.0 7.5 7.5 9.2 11.4 10.2 9.2

Kenya 4.5 5.0 5.2 5.8 9.7 5.8 8.0 8.1

Asi a ex-Jap an 6.1 6.0 6.0 6.4 4.2 4.3 4.3 4.1

China 7.7 7.6 7.2 7.4 2.6 2.7 3.2 3.6

India 5.1 4.7 5.1 6.0 9.7 10.0 8.2 6.4

Hong Kong 1.5 3.0 2.7 3.0 4.1 4.5 3.6 2.8

Korea 2.0 2.9 3.5 3.7 2.2 1.3 2.5 2.8

Taiwan 1.3 2.0 3.4 3.7 1.9 1.0 1.8 2.0

Singapore 1.3 3.6 3.9 4.0 4.6 2.4 2.5 2.6

Indonesia 6.2 5.7 5.1 5.5 4.3 7.0 7.5 6.5

Malaysia 5.6 4.5 4.7 4.8 1.7 2.1 2.9 3.2

Thailand6.5 3.1 4.0 4.5 3.0 2.2 2.6 2.5

Latin America 2.9 2.7 2.9 3.0 6.2 7.4 7.6 6.7

Brazil 1.0 2.3 1.9 1.5 5.4 6.2 6.0 6.1

Mexico 3.8 1.3 3.3 4.0 4.1 3.7 3.8 3.6

Chile 5.6 4.2 3.9 4.4 3.0 1.8 3.0 3.1

Peru 6.3 4.9 5.4 5.3 3.7 2.7 2.7 2.4

Colombia 4.0 3.9 4.4 5.1 3.2 2.1 3.1 3.2

Argentina 1.9 4.9 3.0 2.0 10.0 10.6 10.4 12.0

Venezuela 5.5 1.9 2.5 2.9 21.1 40.7 44.1 29.2Source: IMF, Morgan Stanley Research forecasts


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Global Economics TeamGlobal Economics

Joachim Fels Global [email protected] +44 (0)20 7425 6138

Manoj Pradhan Global [email protected] +44 (0)20 7425 3805

Patryk Drozdzik Global [email protected] +44 (0)20 7425 7483

Sung Woen Kang Global [email protected] +44 (0)20 7425 8995

Philipp Erfurth Global [email protected] +44 (0)20 7677 0528

Amer icas

Vincent Reinhart US [email protected] +1 212 761 3537

Ted Wieseman US [email protected] +1 212 761 3407

Ellen Zentner US [email protected] +1 212 296 4822

Dane Vrabac US [email protected] +1 212 761 1929

John Abraham US [email protected] +1 212 761 5629

Gray Newman Latam, Brazil [email protected] +1 212 761 6510

Luis Arcentales Chile, Mexico [email protected] +1 212 761 4913

Arthur Carvalho Brazil [email protected] +55 11 3048 6272

Daniel Volberg Peru, Colombia, Argentina, Venezuela [email protected] +1 212 761 0124

Europe & Africa

Elga Bartsch Euro Area, ECB, Germany [email protected] +44 (0)20 7425 5434

Daniele Antonucci Italy, Spain, Greece, Portugal [email protected] +44 (0)20 7425 8943

Olivier Bizimana France, Belgium [email protected] +44 (0)20 7425 6290

Melanie Baker UK [email protected] +44 (0)20 7425 8607

Jonathan Ashworth UK [email protected] +44 (0)20 7425 1820

Marcus Gedai Euro Area, ECB, Germany [email protected] +44 (0)20 7425 9668

Tevfik Aksoy Turkey, Israel [email protected] +44 (0)20 7677 6917Pasquale Diana Poland, Hungary, Czech, Romania [email protected] +44 (0)20 7677 4183

Michael Kafe South Africa, Ghana, Nigeria [email protected] +27 11 587 0806

Andrea Masia South Africa, Nigeria [email protected] +27 11 282 1593

Jacob Nell Russia, Kazakhstan, Ukraine, Belarus [email protected] +7 495 287 2134

Alina Slyusarchuk Russia, Kazakhstan, Ukraine, Georgia [email protected] +44 (0)20 7677 6869

Asi a

Robert Feldman Japan [email protected] +81 3 5424 5385

Takeshi Yamaguchi Japan [email protected] +81 3 5424 5387

Chetan Ahya Asia ex-Japan, India [email protected] +852 2239 7812

Helen Qiao China [email protected] +852 2848 6511

Sharon Lam Korea, Taiwan [email protected] +852 2848 8927

Yuande Zhu China, Hong Kong [email protected] +852 2239 7820

Yin Zhang China [email protected] +852 2239 7818Jason Liu Korea, Taiwan [email protected] +852 2848 6882

Deyi Tan ASEAN [email protected] +65 6834 6703

Zhixiang Su ASEAN [email protected] +65 6834 6739

Derrick Kam Asia ex-Japan, Hong Kong [email protected] +852 2239 7826

Daniel Blake Australia [email protected] +61 2 9770 1579

Upasana Chachra India [email protected] +91 22 6118 2246

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