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Stability- no longer what it used to be.pdf

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Quarterly - no. 132 – 2nd quarter 2011 Stability: no longer what it used to be Summary  The market has been looking for better visibility since Lehman’s bankruptcy. At each stage of exit from the crisis, any success in stabilising a particular item was expected to be an important step forward towards an improved economic and financial outlook: from the mess in the banking industry to the sovereign crisis in peripheral Eurozone countries. Alas, the series of issues to fix seems to grow every t
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  Quarterly - no. 132 – 2 nd  quarter 2011  Stability: no longer what it used to be Summary   The market has been looking for better visibility since Lehman’s bankruptcy. At each stage of exit from the crisis, any success in stabilising a particular item was expected to be an important step forward towards an improved economic and financial outlook: from the mess in the banking industry to the sovereign crisis in peripheral Eurozone countries.  Alas, the series of issues to fix seems to grow every time any progress is made. Very recent dramatic events in Japan and the Middle East/North Africa region just make the scenario of a consolidation in global recovery and a return to a more widespread preference for risky assets more uncertain.    Measuring the impact of the events in Japan on the global economy is not an easy task.  A strict accounting approach would reach a limited conclusion: the Japanese economy makes up less than 10% of the total and its contribution to global growth has averaged about 2-3% over the past five years. However, the relationship is likely to be more complex and a more detailed analysis is needed. Global growth will be hit in many different ways: less demand from Japan for the outside world; possible disruptions to the supply of key components imported from Japan; repatriation of capital to the archipelago with a negative impact on the related asset prices; greater demand for oil and gas. The Japanese earthquake, the latest in a series of natural disasters and geopolitical crises, could highlight the current fragility of the international situation and lead to a decline in confidence from households, corporates and investors. If we estimate that GDP growth in Japan for this year will be revised down by 1.5%, the accounting impact on global growth would be minimal (less than 0.2%). But multiplier effects in relation to these different mechanisms need to be taken into account. To what extent? For the moment we do not know.   The oil market has reacted to the recent events in the MENA region: from the coalition’s air strikes in Libya to an even more complex situation in the Gulf countries (especially the GCC army intervention in Bahrain and the spectacular fiscal stimulus plan launched in Saudi Arabia). Uncertainty could last longer than expected with an obvious implications for oil prices, which would stay higher for longer than initially expected. How would the world economy react to a crude oil price above USD100/bl for a number of months? How great would the growth slowdown for advanced countries and acceleration in prices for emerging countries be? Bear in mind that a ratio of oil expenses to global GDP above 4% (the world is around this level currently) has historically been a sign of economic hardship. Contents: Special: Accumulation of issues for the global economy – the new do not erase the old.................................................................................................2   Monetary Policy: From one regime to another..............................................5   US Interest Rates: Questioning Fed policy...................................................7   Eurozone Interest Rates: ECB steps up the pace........................................8   Exchange Rates: USD pressure to ease......................................................9   Energy: Oil prices to correct downwards in Q211.......................................10   Metals: Geopolitical risk premium returns to gold.......................................10   US: Recovery on track despite new headwinds..........................................11   Japan: Recession is coming but strong recovery to follow.........................13   Eurozone: A full-size stress test.................................................................14   France: Slowly but surely...........................................................................16   Germany: Not squaring the circle – yet......................................................17   Italy: Structural weakness...........................................................................18   Greece: The road ahead is still long...........................................................19   Spain: Uncoupling from the rest of the periphery........................................20   Portugal: Balancing act...............................................................................21   Ireland: Trying to turn the page...................................................................22   Scandies: Changing course........................................................................23   UK: Inflation to have the last word..............................................................24    Australia: Reconstruction to boost growth..................................................25   New Zealand: A major setback...................................................................25   Canada: An example to emulate?..............................................................26   Emerging countries: Voice or money..........................................................27   Central Europe: Ongoing adjustments........................................................28   Russia: Closing the output gap...................................................................28   South Africa: One step forward..................................................................29   Turkey: Has the interest rate cycle bottomed?...........................................29   China: Inflationary pressure........................................................................30   India: Battling inflation................................................................................30   Mexico: Calm returns..................................................................................31   Brazil: The hiking continues........................................................................31   Saudi Arabia: To spend or not to spend?...................................................32   Egypt: Inflation and political crisis undermine economic balances.............32   Exchange rate forecasts.............................................................................33   Interest rate forecasts – developed countries.............................................34   Interest rate forecasts – emerging countries..............................................35   Economic forecasts....................................................................................36   Economic forecasts – quarterly breakdown................................................37   Economic forecasts....................................................................................38   Commodities forecasts...............................................................................38      Special: Accumulation of issues for the global economy – the new do not erase the old In the current complex global environment, the search for simple issues, offering clear and immediate translation into portfolio allocation, is no doubt somewhat in vain. Growth prospects are perhaps less of an issue than the return of country risk, the pace of debt reduction or changes in policy. For any investor, It is vital to remain nimble, and liquidity has a value that is no doubt higher than its mere remuneration. Eurozone growth still lagging US growth -6-4-2024607080910(%)GDP US (YoY)GDP EZ (YoY)   Source: Bloomberg, Crédit Agricole CIB Commodity prices leading inflation in emerging countries 0123456789Jan-06Jan-08Jan-10Jan-12%-101030507090110130150USD/blEM CPI (YoY)WTI price YoY (rhs) forecasts   Source: IMF, Bloomberg, Crédit Agricole CIB More cautiousness about emerging markets? 0501001502002503003500102030405060708091011MSCI indexEmerging relative to developed equitiestrend   Source: Bloomberg, Crédit Agricole CIB Only a few months ago, there was the idea in the market that visibility was improving.  Global growth was forecast to come in at 4.5% this year and next. Growth should be driven by the emerging countries, of course (+6.5%), but the US would also come out of it well, with growth at around 3%. Only the Eurozone and Japan were likely to lag behind. The Japanese economy will face a new recession, but its contribution to global growth has been limited in the recent past; so the impact of the former on the latter should be minimal. Europe, with growth expectations in the region of 1.5-2.0% with quite a large divergence between the countries’ performances, also looked like a weak link. That impression, obviously, has been exacerbated by the persistence of sovereign risk. However, it was clear even at the end of last year that in the coming quarters markets would be sensitive to topics other than growth. The search for simple issues, offering a clear, immediate translation in terms of portfolio allocation, is no doubt somewhat in vain.  Above all this is a time of uncertainty and of gambling on future trends and operations. Until recently, the main issues in the market environment, next to the question of growth, have been the pace of debt reduction and the likely changes in policy and regulation. As often happens, tensions have appeared where they were not expected, at least not immediately. Tensions in the Middle East and North Africa (MENA) are not abating. The transition to a more liberal society is still chaotic in both Tunisia and Egypt; in Libya, the current troubles point to a risk of civil war. Bahrain, overshadowed by the Libyan events, is a matter of concern. The other Gulf monarchies and also Iran cannot be indifferent to the request for change expressed by the Bahraini people. It seems likely that, even if there is no disruption to oil output, political uncertainties – in relation to the time needed to come back to more institutional stability – will negatively impact the different markets  and the oil market first of all. Of course, it is impossible to propose any serious quantification of the expected magnitude of the impact. In emerging countries, with a more supportive growth environment and a larger weight given to energy and goods in the consumer basket, the surge in oil prices argues for the prospect of accelerating inflation. This element combined with growing country risk should keep investors cautious vis-à-vis enlarging their exposure to emerging markets. The main point is that the perception of the return to risk ratio in emerging countries is changing. Until recently, a stable political regime (often an undemocratic one) combined with a strong pace of growth was perceived as a positive sign for both quite a high expected return and an acceptably low level of risk. Now, it is changing, even if the reasons why are not yet well known. Is it because of the unequal distribution of incomes and excessively high unemployment rate among young people? Is it because the elevated growth momentum forces social change with both winners and losers? In an undemocratic environment, any related tensions are poorly managed and lead to a social crisis. In any case, investors monitoring country risk will have less confidence in autocratic regimes than has been the case in the past, and not just those located in the MENA region. The surge in oil prices is an issue not only for emerging countries; it also challenges the developed economies, which grow at a slower pace . It is key to note that the current upward pressure on oil prices is related to a supply shock (geopolitical tensions and a threat of disruption), not a demand shock. This is taking place at a time of weakness in domestic spending for developed countries. Higher oil prices will weigh on purchasing power. Consumers will not easily decrease their saving ratio to maintain their pace of spending, and indebted governments cannot really decide upon new stimulus measures. At the same Macro Prospects – no. 132 – 2 nd  quarter 2011 2      US: limited pass-through from oil price to core CPI index -3-2-1012345602030405060708091011%-80-60-40-20020406080100120%Core CPI (YoY)Headline CPI (YoY)WTI price (YoY) (rhs)   Source: Bloomberg, Crédit Agricole CIB Eurozone: limited pass-through from oil price to core CPI index -101234502030405060708091011%-80-60-40-20020406080100120%Core CPI (YoY)Headline CPI (YoY)WTI price (YoY) (rhs)   Source: Bloomberg, Crédit Agricole CIB Should central banks look beyond goods and services inflation? -20-15-10-5051015200102030405060708091011%0123456%Case Shiller (20 cities) (YoY)3M T-Bill rate (rhs)   Source: Bloomberg, Crédit Agricole CIB time, accelerating inflation can be an incentive for central banks to begin the normalisation of their official rates from the current very low levels. Such developments are not the best way to consolidate the recovery. In any case, differences exist between the US and Europe: the US is characterised by greater vulnerability to energy prices, an expansionary fiscal policy and core CPI (without the energy and food components) as the central bank’s inflation reference; in Europe, the energy intensity of the economy is weaker, fiscal policy is tightening and the inflation reference of both the ECB and the BoE is the CPI headline index. Ultimately, because of differences in both the sensitivity of the respective economies to oil price developments and the price reference of central banks, it would not be that much of a surprise to see earlier monetary tightening in Europe than in the US. In any case, the unexpected return of country risk and its related impact on the oil price send a double message of less visibility and more vulnerability than were expected some time ago. This does not mean that the themes previously identified and able to challenge a reassuring economic and financial outlook have disappeared. The idea of the more or less inevitable nature of a new set of game rules in the field of economic policy is confirmed if we take our cue from recent history . Economic policy has changed markedly in the wake of every major economic shock, forcing every agent in the business community to adjust their actions and expectations. Thus, after the ‘Great Depression’ Keynesianism imposed itself as the main means of fiscal intervention in the shape of contra-cyclical policies. Similarly, after the ‘Great Inflation’ central bank independence became the norm, and the targeting of inflation the prime objective of monetary policy. It may also be noted that the Great Depression ‘begat’ a greater role from the state in the economy either through more levies and spending, or in the form of more extensive regulation. After the Great Inflation the emphasis was placed squarely on the need to give more weight to market-driven mechanisms and to ease regulatory constraints. What will happen in the wake of the ‘Great Recession’? That is undoubtedly a valid question, but it does not mean that the answers are already to hand. So, let us content ourselves with suggesting a few avenues – there is already no shortage of them!   The first point concerns the ‘market versus state’ debate. In all likelihood, market forces – in the sense of less restrictive regulations – are set to lose ground . If there has to be a substantial state presence, it will be first in the shape of greater efforts to ensure better operation of the markets (regulation and structural policy) in order to achieve greater economic efficiency and to facilitate a higher level of individual and collective well-being. This quest for more efficient public action could also involve more initiatives in favour of improved co-ordination between states, with the idea that intervention is especially effective when it impacts an entire market, which is very often trans-national, if not global, and not simply a part of the market, limited to the space within the borders of a country or a union. Globalised markets require co-ordinated action.   With respect to monetary policy, it is clear that a mix of targeting inflation, measured at the level of goods and services, and independent central banks has not proved to be fully comprehensive insurance against the risk of a very serious crisis. The debate as to whether the accepted definition of inflation should be enlarged to include asset prices will need to be re-opened . More specifically, for emerging countries, exchange rate trends and capital inflows are also constraints that may need to be factored into any monetary policy equation.   With respect to fiscal policy, especially in Europe, placing the emphasis officially on the size of both the budget deficit and public debt did not prevent a sudden increase in sovereign risk. Of course, the determination of some was to comply with the criteria and for others to ensure compliance was lacking. Herein undoubtedly lies some of the explanation for the ongoing doubts about the quality of sovereign risk in the Eurozone periphery. Yet, other factors should have been included in the analysis and would probably have made it easier to see the deterioration looming in the public accounts . We would have needed to know how to integrate fine-grained monitoring of both the external balance and changes in Macro Prospects – no. 132 – 2 nd  quarter 2011 3      Quite large range of sovereign risk within the Eurozone -35-30-25-20-15-10-50    E   U   R   O   Z   O   N   E   G  e  r  m  a  n  y   F  r  a  n  c  e   I   t  a   l  y   S  p  a   i  n   N  e   t   h  e  r   l  a  n   d  s   B  e   l  g   i  u  m   G  r  e  e  c  e   I  r  e   l  a  n   d   P  o  r   t  u  g  a   l government balance (as % of GDP)   Source: Bloomberg, Crédit Agricole CIB UK has strong interest in proper functioning of the Eurozone 0200400600800100012001400GermanyFranceUK(USDbn)Invested assets in the peripheral countries -Sp, Pt, Ir, Gr (2008 figures)   Source: Bloomberg, Crédit Agricole CIB Hervé Goulletquer herve.goulletquer@ca-cib.com +33 1 41 89 88 34  competitiveness at an earlier stage.   In an environment of limited growth prospects (for the advanced countries at least) and reduced room for manoeuvre as regards recovery policy (both fiscal and monetary instruments have been heavily used in recent years), the question of optimising policy mix has become a ‘burning necessity’ . One very recent example illustrates this constraint. The US central bank, faced with a fall in confidence on the part of most economic agents and convinced that no recovery measures would come from the institutions in charge of fiscal policy, decided in November to embark, no doubt by default, on a non-orthodox monetary policy of purchasing government bonds, the effects of which on the rate of growth are somewhat uncertain. The following month, and quite unexpectedly, the White House and Congress reached agreement on a programme of tax cuts and spending increases. Where is the overall consistency, especially when the degree of freedom is so limited? Keeping in mind this inevitable need to adjust the game rules, we now need to look at the sovereign crisis in Europe, which will likely still serve as a backdrop to market movements in the coming months and quarters. In Europe, the rise in sovereign risk among peripherals highlights a number of serious dysfunctions,  and the resolution of the liquidity crisis (guaranteeing the refinancing of government debt) is no more than a partial answer. Here is a simplified presentation of the issues:   The situation of the public accounts is, more often than not, poor, with unsustainable levels of debt.    Although the deployment of austerity plans is an unavoidable solution, the implications in terms of (1) economic acceptability (what are the consequences at an internal level and as regards the operation of the Eurozone of zero or very low economic growth for a certain period and in a certain number of countries?); and (2) political acceptability (government fragility, changes in political balances, with the threat of a rise in ‘extreme’ parties and general discontent among the population) are scary.    The complexity of the web of economic and financial relations inside the Eurozone, and the importance of government bonds in the financial savings of European households, makes the prospect of a sovereign default in a peripheral country a very unattractive outcome , above all because it is difficult, ex ante, to measure the implications. The concern is most definitely that the chain reaction process will lead to a higher level of losses than initially thought.   Solidarity and assistance, alongside a tightening of sound management criteria and close oversight of the public finances and economic policies of member states, should therefore be seen as an essential means of resolving the crisis. But how does one guarantee the support of public opinion in the contributing countries and how can one be certain of the legality of the operations under consideration in European and national law? Europe needs in-depth restructuring – as recent events have shown – and no doubt more than the people and their leaders were envisaging even quite recently. What initiatives will be taken, what will the timetable be, and what new shocks will be needed to force them to move forward? At present, there is no answer to any of these questions. In an environment under reconstruction, one cannot simply extrapolate from yesterday’s trends. Europe and the US will have to recreate at least partially their economic models, and emerging countries will have to push on with assimilating the limitations and opportunities of the culture of macroeconomic stability, while for many of them deepening their understanding of the political and social dialogue. The stakes are huge, and visibility will improve only gradually. We should not allow ourselves to be guided by what can look like trends but which will turn out only to be blips. It is vital to stay nimble, and liquidity has a value that is no doubt higher than its mere remuneration. Macro Prospects – no. 132 – 2 nd  quarter 2011 4  
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