Fra BNP Paribas
The page may have turned on 2015, but the new year feels depressingly familiar, with last year’s key macro themes of an ailing China, swooning commodities, emerging-market carnage and a strong USD not just remaining in play, but seemingly turbo-charged.
As baseball legend Yoghi Berra, who passed away last year, famously quipped, “It’s like déjà vu all over again!” China inevitably remains the key driver of the volatility that has seen global equities suffer their worst start to a year since 2008. Weak Chinese PMI surveys have been the proximate cause of the panic.
These have not only confirmed that manufacturing remains under pressure, but called into question the capacity of the all-important service sector to sustain rapid growth. The Caixin services PMI fell to its second-weakest reading (50.2) in its 11-year history in December. Slower growth puts pressure on asset prices, most obviously the currency and equities, to reprice to the more sober macroeconomic outlook. This in turn creates a policy headache for the Chinese authorities.
Aware that their reform programme requires an enhanced role for market forces and the price mechanism, as well as the need to eschew the broad-brush large injections of stimulus used in the past, they are also understandably keen to prevent lumpy, disruptive adjustments in prices. Getting the balance right is difficult, as the authorities have discovered over the past year.
Exiting the long-established de facto peg to the USD is proving especially difficult, with hotmoney outflows and currency weakness positively correlated. In other words, currency weakness simply begets more capital outflows and additional depreciation pressure. Recent developments suggest that having achieved the long-held political ambition of getting the CNY included as an IMF special drawing rights (SDR) reserve currency, the Chinese authorities are now willing to grasp the currency ‘nettle’ and tolerate greater CNY weakness more quickly in the hope of stabilising the capital account.
The sensible move to targeting a trade-weighted basket, rather than just the USD, announced by the People’s Bank of China (PBoC) on its website late last year has seen the pace of depreciation accelerate so far in 2016, with the daily fixing against the USD rising to 6.56 from 6.49 at the end of 2015 and 6.39 around the end of November. However, with forward rates rising in tandem (the 12-month non-deliverable forward spread has held steady at around +2250bp), the accelerated weakness seen in the year to date has done little to staunch depreciation expectations and, presumably, outflow pressure.
Indeed, December’s record fall of more than USD 108bn underscores that the pace of capital flight remains torrid. The clear risk, therefore, remains for more, not less, CNY weakness. As we have long emphasised, CNY depreciation is inherently deflationary and ‘risk off’ for global markets. Exacerbating the global impact of accelerating CNY weakness has been the renewed slump in China’s still richly valued A-share equity markets. Growth and currency jitters have proved a perfect storm for China’s equity markets in the first four working days of the year, with the newly installed 7% circuit breaker already triggered twice.
As with the currency, the risks would seem skewed to the downside, although official intervention to stabilise the market should be expected in the very near term. Like a stronger USD, a weaker CNY pulls down global commodity prices as China’s purchasing power is crimped and global risk appetite is reduced. Despite spiking geopolitical tensions (IranSaudi spat, North Korean nuclear test), the oil price has continued to plunge as inventory data continue to suggest that the required supply adjustment to bring the market back into kilter remains in its infancy.
Once again, short-term risks seem skewed to the downside, despite the speed and scale of the latest drop, which has pushed Brent crude oil down to USD 33/bbl. Other commodities, particularly industrial metals, remain on the back foot, too. The bellwether CRB commodity index, already at 13-year lows, looks destined to test its 2002 low. The other main commodity bellwether, the Bloomberg index (formerly DJ-UBS), has fallen to levels not seen since the Asian crisis in the late 1990s.
Fed ‘lift off’ with the prospect of a slow, but steady drip-feed of rate hikes to come is also buoying the USD, exacerbating depreciation pressure on the CNY (the one-year Sino-US spread has Holiday cheer has quickly evaporated … … as concerns over China have again mushroomed China’s authorities face a delicate task in allowing … … greater price discovery without excessive volatility PBoC now allowing more CNY depreciation … … but risks fuelling more, not fewer, outflows CNY depreciation key to aggressive risk-off mode … … and is deflationary for the rest of the world … Global commodities are hitting fresh 13-year lows Outlook of a drip-feed of Fed rate hikes … narrowed to around 320bp, its lowest since early 2009) and further weighing on global commodities.
Recent US data have been mixed and the unusual dichotomy of outright weakness in the ISM manufacturing gauge, but resilience in the service sector, has persisted. Nothing in the recent data fundamentally challenges the view that US GDP growth is, on average, set to continue chugging along at around a 2-2½% annualised rate – above trend in the post-global-financial-crisis world. In fact, the unusually mild winter thus far is likely to have brought forward construction activity, reducing the risk of an anaemic start to the year. The US monthly labour-market report remains the totemic data release short term.
Friday’s report is likely to show another healthy +200k gain in non-farm payrolls in December, while the unemployment rate could tick down to 4.9%, to sit right on the FOMC’s estimate of the maximum sustainable rate. The minutes of the December FOMC meeting showed that Fed Chair Janet Yellen had marshalled a strong consensus for ‘lift off’ followed by a ‘gradual’ rate rise, although, for some participants, the decision was still a close call.
The media focused on the fact that “many participants remained concerned about the downside risks attending to the outlook to inflation”. While the slump in commodity prices since the December meeting will have heightened these uncertainties, we are some way from the tipping point. We still see higher odds (80%) of a March rate hike than the market (about 40%), with inflation data between now and then unlikely to be decisive. In the eurozone, the new year is proceeding as the old one left off, with the economy looking resilient, but inflation (both headline and core) continuing to surprise to the downside.
So far, at least, the eurozone has shrugged off adverse developments in emerging markets. Q3 GDP growth, at 0.3% q/q, was a tad above the bloc’s likely potential growth; Q4 suggests a similar performance. Thanks to the boost from (still falling) oil prices and a more supportive policy mix, with both monetary and fiscal policy now adding thrust, eurozone GDP looks set for robust, above-trend growth of 1.6% this year. This robust growth needs to be seen in the context of sizeable excess capacity, which will intensify global deflationary headwinds, meaning inflation will remain uncomfortably low, ultimately necessitating yet more policy accommodation later this year.
As December’s package of measures was reportedly opposed by five Council members, the hurdle to further action is clearly high, with the improvement in economic conditions likely raising it even more in the short term, Chinese and emerging-market jitters notwithstanding. The publication of the account of the ECB’s December policy meeting on Thursday 14 January will hopefully shed some more light on any differences of opinion on the Governing Council. Beyond that, we think the June and September reviews of the staff projections will be key as serially low inflation forces the ECB to increasingly mark its projections to market.
The next set of inflation projections in March will probably have to be scaled back in light of lower oil prices, but the extension of the time horizon to include 2018 will buy the ECB some breathing space. Coming full circle, a wild card that could prompt the ECB to ease again sooner would be a sharp rise in its nominal effective exchange-rate (NEER) measure, which has not fallen anywhere near as much as EURUSD and which was a key driver of the deposit-rate cut in December.
Emerging-market currencies are necessarily pivotal to this, due to their increased weights in the ECB’s basket, especially China, which has the highest weight by far (almost 18%). While the world is fixated on USDCNY, this suggests EURCNY is actually the key cross on which to focus. Elsewhere in emerging markets, recent developments predictably constitute a witch’s brew, with the usual suspects – the TRL, ZAR, COP, RUB, BRL and MYR – weakening as a consequence.
Mexico’s heavy reliance on oil revenue has ensured that the MXN remains hard hit, too. The currencies of Asia’s commodity importers (the PHP, THB and INR) are outperforming, but are still largely down. Korea’s heavy China exposure has led to the KRW being dragged down vs the USD even as bond yields hit all-time lows. Brazil is still the emerging market most at risk of slipping into outright crisis. We are once again taking the axe to our GDP forecasts and now expect the economy to shrink by 4% in 2016 and stagnate in 2017 (0% growth) as the perfect storm of economic and political crises rages
