pivot points for 2013 in the era of dissonance | january 2013
DESCRIPTION
The context of near-zero short-term interest rates from the United States, Europe, the United Kingdom, and Japan provides a huge complication for emerging market countries in terms of the potential interplay of exchange rate movements with growth prospects and inflation pressures. There is nothing like zero interest rate policies (ZIRP) from the major currencies to provide incentives for market participants to seek higher yields elsewhere, including emerging market currencies. The essential policy challenge for emerging market central banks is how to encourage economic growth in these difficult times without fueling inflation on the one hand or creating an environment that would lead to too much currency appreciation that could weaken growth prospects on the other hand.TRANSCRIPT
Pivot Points for 2013 in the Era of Dissonance
Pivot Points for 2013 in the Era of Dissonance The research views expressed herein are those of the author and do not necessarily represent the views of CME Group or its affiliates. All examples in this presentation are hypothetical interpretations of situations and are used for explanation purposes only. This report and the information herein should not be considered investment advice or the results of actual market experience.
Blu Putnam
Chief Economist
CME Group
January 2013
© 2013 CME Group. All rights reserved 3
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only. CME Group assumes no responsibility for any errors or omissions. Although every attempt
has been made to ensure the accuracy of the information within this presentation, CME Group
assumes no responsibility for any errors or omissions. Additionally, all examples in this
presentation are hypothetical situations, used for explanation purposes only, and should not be
considered investment advice or the results of actual market experience.
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2012’s Themes are Old News
China’s growth deceleration has ended
European debt crisis will make some headlines
but the danger of implosion has passed
US avoided the worst of the fiscal cliff and will get
by the debt ceiling, too (very messy, though)
2013 is about Looking Forward to New
Challenges, New Opportunities
4
© 2013 CME Group. All rights reserved
Themes for 2013
Market participants potentially start to embrace
increased risk-taking in search of higher returns
– bad for flight to quality exposures.
Improved investor confidence highlights
unintended consequences of Quantitative Easing
by US, UK, Europe, and Japan – potential for
emerging market currencies
Metals markets may be conflicted, as gold loses
support from the fear factor while copper benefits
from an improved global economic outlook.
Climate volatility may keep Agricultural markets
on edge.
5
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China stabilizing in the 7% real GDP growth area for now, drifting down later in the decade
6
3.59%
6.22%
9.29%
10.42% 10.48%
6.50%
0%
3%
6%
9%
12%
1960s 1970s 1980s 1990s 2000s 2010s
An
nu
al A
vera
ge R
eal
GD
P G
row
th
Source: World Bank Real GDP Index from the Bloomberg Professional (WRGDCHIN). Estimates by CME Economics Research.
China: Real GDP Growth Rates by Decade
Estimate
© 2013 CME Group. All rights reserved
European Bond Markets In Recovery
7
0%
3%
6%
9%
12%
1992 1995 1998 2001 2004 2007 2010 2013
An
nu
al Y
ield
(P
erc
en
t)
Source: Bloomberg Professional (GDBR10 and GSPG10YR)
Spain and Germany:10-Year Government Bond Yields
Spanish Bond
German Bond
Pre-Euro
Debt Debacle
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Euro Has Recovered from Worst of Break-up Fears
8
1.10
1.20
1.30
1.40
1.50
1.60
1.70
USD
/EU
R
Source: Bloomberg Professional (EUR)
US Dollar per Euro
ECB to Markets --Whatever it takes!
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US Tax Rate Uncertainty Resolved (for now)
9
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%1
91
3
19
19
19
25
19
31
19
37
19
43
19
49
19
55
19
61
19
67
19
73
19
79
19
85
19
91
19
97
20
03
20
09
20
15
Pe
rce
nt
Historical Highest US Marginal Income Tax Rate
Clinton
Bush
Source: Tax Policy Center, Urban Institute and Brookings Institute*Note: Income Bracket applied to Highest Tax Rate has changed over time
© 2013 CME Group. All rights reserved
US Fiscal Cliff Avoided – Stocks Rally
10
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US Fiscal Cliff Avoided – Bond Prices Fall
11
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Current Economic Conditions in the United States
The US economy has reeled off 14 straight quarters of real
GDP growth since Q3 2009 averaging about 2.2% growth
per annum.
The unemployment rate has fallen from its peak of 10% to
below 8%, as 1.84 million net new jobs were created in
2012.
US large corporations are flush with very large cash holdings,.
The US banking sector has recapitalized itself since 2008 and
is now comfortably profitable.
Auto sales are booming
Housing is finally entered a recovery phase in 2012
12
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US Labor Market Improving Slowly
13
0.00%
3.25%
6.50%
9.75%
13.00%
1987 1990 1993 1996 1999 2002 2005 2008 2011 2014
Civ
ilian
Un
em
plo
yme
nt
Pe
rce
nta
ge R
ate
Source: St. Louis Federal Reserve Bank FRED Database (UNRATE)
US Unemployment Rate
Unemployment Headed Back Below 6.5% in 2014?
© 2013 CME Group. All rights reserved
US Auto Sales Are Back to 15 Million Units per Year
14
0
5
10
15
20
25
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012
Mill
ion
s o
f U
nit
s o
f C
ars
and
Lig
ht
Tru
cks,
A
nn
ual
Rat
e
Source: Federal Reserve Bank of St. Louis FRED Database (ALTSALES)
US Auto Sales
On the Road to Recovery
© 2013 CME Group. All rights reserved
US Home Prices Finally Stabilized ….
15
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
1988 1992 1996 2000 2004 2008 2012
Year
ove
r Ye
ar P
erc
en
tage
Ch
ange
Source: Case-Shiller index from the St. Louis Federal Reserve Bank FRED Database (SPCS10RSA , SPCS20RSA)
US Case-Shiller Home Price Percent Change
Home Prices Finally Stabilize in 2012
© 2013 CME Group. All rights reserved
Leading to a Recovery in Single-Family New Home Sales …
16
-50%
-25%
0%
25%
50%
2002 2004 2006 2008 2010 2012
Year
-ove
r-Ye
ar P
erc
en
tage
Ch
ange
Source: St. Louis Federal Reserve "Fred" Database (HSN1F)
New Single-Family Home Sales in US
© 2013 CME Group. All rights reserved
And a Rebound in Housing Starts from a Very Low Base
17
0
500
1000
1500
2000
2500
30001
96
0
19
64
19
68
19
72
19
76
19
80
19
84
19
88
19
92
19
96
20
00
20
04
20
08
20
12
Tho
usa
nd
s o
f H
ou
sin
g St
arts
, An
nu
al R
ate
Source: Federal Reserve Bank of St. Louis FRED Database (HOUST)
US Housing Starts
Housing Starts Show Lifein 2012 -- From a Very Low Base
© 2013 CME Group. All rights reserved
US Real GDP Growth in the last 14 quarters has been comparable to pre-crisis growth.
18
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
2004 2005 2006 2007 2008 2009 2010 2011 2012
An
nu
aliz
ed
Re
al G
DP
Gro
wth
, Qu
arte
rly
Dat
a
US Real GDP Growth by Quarter
2.5% Average Annual Real GDP Growth, Q1/2004-Q4/2007, with support from solid growth overseas.
2.2% Average Annual Real GDP Growth, Q3/2009 - Q4/2012, with headwinds from a slowing China and stagnant Europe.
© 2013 CME Group. All rights reserved
2013 -- Back to the Quantitative Easing Debate
Evaluating Why QE Did Not Help Create Jobs:
“Essential concepts necessary to consider when
evaluating the efficacy of quantitative easing,”
Review of Financial Economics, 2013, (Bluford H.
Putnam)
Unintended Consequences of QE: “Ultra easy
monetary policy and the law of unintended
consequences,” Federal Reserve Bank of Dallas
Globalization and Monetary Policy Institute, 2012,
Working Paper no. 126 (William R. White).
19
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US & Japan are the Two Countries Most Concerned about Raising Economic Growth
20
4.19%
3.24%
3.23%
3.43%
1.55%
9.22%
4.46%
4.64%
1.13%
0.74%
0% 2% 4% 6% 8% 10%
1960s
1970s
1980s
1990s
2000s
Source: World Bank Real GDP Dataprovided through the Bloomberg Professional
US and Japan Real GDP Growth by Decade
Japan:AverageAnnual RealGDP GrowthRate ByDecade
US: AverageAnnual RealGDP GrowthRate ByDecade
© 2013 CME Group. All rights reserved
Japan’s Population Growth Rate Peaked in 1971, the US in 1991
21
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
An
nu
al P
erc
en
tage
Ch
ange
in P
op
ula
tio
n
Source: US Census Bureau: International Database
US & Japan Population Growth: 1951-2011
United States
Japan
United States
Japan
© 2013 CME Group. All rights reserved
Population Pyramids
The next charts represent a country’s age
profile in 5 year segments, with the
children at the base, the working age
population in the middle, and the retirees
at the top. Men are in blue on the left, and
women in red on the right.
Source: US Census Bureau: International
Database.
22
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Population Pyramids: Japan United States
23
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US Federal Balance Sheet Expansion
24
$927
$480
$0
$0
$447
$2,965
$1,689
$75
$948
$254
$0 $1,000 $2,000 $3,000 $4,000
Total Assets
US Treasury Securities
Federal Agency DebtSecurities
Mortgage-BackedSecurities
Other Assets
Source: Federal Reserve Release H.4.1, Table 8.
Assets of the US Federal Reserve ($Billions)
Wednesday,January 16,2013
Wednesday,September 10,2008
© 2013 CME Group. All rights reserved
US 10-Year Treasury Inflation-Adjusted Yields
25
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014
Re
al P
erc
en
tage
Yie
ld:
10-
Year
Yie
ld m
inu
s Ye
ar-o
ver-
Year
In
flat
ion
Source: Data from the Bloomberg Professional.
How Low Can Inflation-Adjusted
10-Year Treasury Bond Yields Go?
© 2013 CME Group. All rights reserved
Japan Embarks on Currency Depreciation Policy and Expanded Quantitative Easing
26
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Japan Embarks on Currency Depreciation Policy and Expanded Quantitative Easing
27
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Emerging FX in ZIRP World
The central banks in the US, UK, Euro-Zone, and Japan are all
committed to extended periods of near-zero short-term
interest rate policies (ZIRP).
The mature commodity producing countries, such as
Australia, and the emerging market nations, from Mexico
and Brazil in Latin America to India to China are likely to
maintain interest rates between 3% and 6% (or more) above
those in the US, UK, Euro-Zone, and Japan.
This makes investments in the currency carry trade very
attractive, even relative to the substantial risks. However,
when market fears (i.e., Europe debt crisis, China
slowdown, US fiscal cliff, etc.) dominate, risk-off trading will
close these positions down. These carry positions will get
reestablished as global market fears calm.
28
© 2013 CME Group. All rights reserved 29
Emerging Market
Country Short-
term Interest
Rate
US Federal Funds
Rate
Spot FX/USD RateFutures FX/USD
Rate
Joint Interest Rate & Exchange Rate Market
Volatility
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Mexican Peso Traded US Fiscal Cliff Debate
30
12.4
12.6
12.8
13.0
13.2
13.4
1-O
ct-1
2
8-O
ct-1
2
15-O
ct-1
2
22-O
ct-1
2
29-O
ct-1
2
5-N
ov-1
2
12-N
ov-1
2
19-N
ov-1
2
26-N
ov-1
2
3-D
ec-1
2
10-D
ec-1
2
17-D
ec-1
2
24-D
ec-1
2
31-D
ec-1
2
7-Ja
n-13
14-J
an-1
3
21-J
an-1
3
28-J
an-1
3
Mex
ican
Pes
os p
er U
S D
olla
r
Source: Bloomberg Professional (MXN)
Mexican Peso Sold Off on Election Fears of US Fiscal
Cliff -- Then Rallied with the Tax Deal
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Brazil Narrowing Rate Spread Over Inflation
31
0%
5%
10%
15%
20%
25%
30%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Year
-ove
r-Ye
ar In
flat
ion
, Pe
rce
nt
An
nu
al R
ate
Source: CPI (BZPIIPCA) and Overnight Rate (BZSELICA) from the Bloomberg Professional.
Brazil: Inflation versus Overnight Rates
SELIC Overnight Money Market Rate
Inflation
© 2013 CME Group. All rights reserved
China & Brazil Exchange Rate Paths
32
40
60
80
100
120
140
160
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
RM
B p
er
USD
& B
RL
pe
r U
SD In
de
xed
to M
ay
20
02
= 1
00
Source: Brazilian Real (BRL) and Chinese Renminbi (RMB)from the Bloomberg Professional.
Comparing Paths of the Renminbi and the Real
(Falling line indicates strength versus the US Dollar)
Chinese RMB - Managed FX
Brazilian Real -- Managed Rates, Volatile FX
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Rate Comparisons: Why Yield-Seekers may consider the FX Carry Trade in Risk-On Markets
33
0% 2% 4% 6% 8% 10%
Russia
India
Brazil
Mexico
China
United Kingdom
United States
Japan
Euro-Zone
Source: Bloomberg Professional(Most liquid overnight rates to 1-month interbank rates)
Short-Term Interest Rates
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Gold Gold benefits from zero rates, which are here for
another year in the US, UK, Europe, and Japan.
Gold benefits from stronger demand if China and
India show solid growth. Both countries should
do a little better in 2013 than in 2012. But India is
raising taxes on gold imports.
Gold benefits from investor fears, which are
dissipating.
The question for investors is how much demand
comes out of the market as fears recede?
34
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Gold Price Has Hit Choppy Waters Above $1600/ounce
35
$0
$400
$800
$1,200
$1,600
$2,000
1992 1995 1998 2001 2004 2007 2010 2013
US
Do
llars
pe
r O
un
ce
Source: Bloomberg Professional (GOLDS)
Gold
© 2013 CME Group. All rights reserved
Copper
Copper demand stems from infrastructure building.
China is critical. China slowed infrastructure
spending plans in 2011 and 2012, but there are
signs that China will start spending again to get
the economy moving faster 2013.
India is a big buyer of gold jewelry. India’s
economic growth slowed in 2012, but may
rebound modestly in 2013.
Copper is likely to be very volatile, with potential
support if a more optimistic global economic
outlook gains credence.
36
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BRIC Economies may Improve in 2013, led by China and Brazil
37
9.0%
7.0%
5.4%6.1%
0%
2%
4%
6%
8%
10%
2010 2011 2012 2013
We
igh
ted
Ave
rage
of
An
nu
al R
eal
GD
P G
row
th
Source: World Bank Real GDP Data provided through the Bloomberg Professional. Q4/2012 and 2013 estimated by CME Economics Research.
BRIC Real GDP
Estimate
© 2013 CME Group. All rights reserved
Copper Has Become a Risk-On, Emerging Market Growth Story
38
$0
$1
$2
$3
$4
$5
1992 1995 1998 2001 2004 2007 2010 2013
US
Do
llar
pe
r P
ou
nd
of
Co
pp
er
Source: Bloomberg Professional (HG1 <Comdty>)
COMEX Copper Nearby Contract Futures Price
© 2013 CME Group. All rights reserved
Energy Market Potential Surprises for 2013
US economic growth dividend for increased oil/gas supply
More infrastructure progress in the US than market
participants appreciate
Possibly less geo-political fears
Syria and Egypt do not have oil
Iran tensions appear to be lessening
Market participants may shift from demand focus to supply
focus which has possible implications for a narrower Brent-
WTI spread and a narrower WTI-Natural gas spread.
39
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Natural gas offers a low cost per BTU
40
0
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
2001 2003 2005 2007 2009 2011 2013
BTU
's o
f Ene
rgy
per 1
US
Dol
lar
Source: Bloomberg Professional for prices (USCRWTIC, NGUSHHUB, UNYMM1), CME Economics Research for BTU conversion.
BTU's per US$1 by US Energy Source
Coal
Oil
Natural Gas
© 2013 CME Group. All rights reserved
Weather Volatility
Weather volatility can easily disturb agricultural
markets
Q1/2013 already has seen:
Frigid Temperatures in Russia and China
Extreme Heat in Australia and New Zealand
Continuation of US Midwest Drought (although
there is some snow cover now)
41
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US Drought Monitor Charts -- Source
The U.S. Drought Monitor is produced in
partnership between the National Drought
Mitigation Center at the University of
Nebraska-Lincoln, the United States
Department of Agriculture, and the
National Oceanic and Atmospheric
Administration.
http://droughtmonitor.unl.edu/
42
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The Texas Drought emerged over time in 2010-2011
43
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In 2012, the US Midwest Drought Emerged Very Quickly
44
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Corn and the Drought
45
$0
$2
$4
$6
$8
$10
1997 1999 2001 2003 2005 2007 2009 2011 2013
USD
A Il
lin
ois
No
rth
Ce
ntr
al N
o.2
Ye
llo
w C
orn
Sp
ot
Pri
ce p
er
Bu
she
l
Source: Bloomberg Professional (CORNILNC)
Corn Spot Price
© 2013 CME Group. All rights reserved
Pivot Points for 2013: Politics & Weather
•US Spending and Debt Ceiling Debates (February-
April, and possibly beyond)
•Formation of New Coalition Government in Italy
(February-March)
•Development of Midwest US Drought (Spring-
Summer)
•German Elections (September 2013) – Merkel will
probably need a new coalition partner
46
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Economic Points to Watch
US Unemployment Rate Dips Below 7%
China reports Real GDP Growth above 7% in
2013 for two quarters in a row, along with
supporting export data
Brazil reports Real GDP Growth the first half of
the 2013 increasing into the 3%-4% range
47
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Confirming Signs We May Be Entering a “Risk-On” Market Environment?
•FX:
–Yen/$ cross 100
–Brazilian Real cross 2.00 (BRL per USD)
•Bonds
–JGB 10-Year Yields cross 1%
–US 10-Year Treasury Yields cross 2%
–Spanish 10-Year Bond Yields remain
close or under 5%
48