Rob Carnell

7/31/2019 Rob Carnell

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May 2012 0

Global Economics & Markets

Rob Carnell

Chief International Economist

June 2012


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May 2012 1

Eurozone - what else could go wrong?

Run on banks

AAAs downgraded

Greece leaves euro

EU17 bailout fund not expanded

LTRO impact fades

Portugal debt restructuring

IMF resources not expanded

Fiscal compact fails

Popular backlash againstfiscal austerity

Eurozonedepression


3/32

May 2012 2

Eurozone: Greece - the mad guy in the lift?

Give me the money

Or I shoot the

puppy

Greece realises finallythat it has bargaining

power

But the rest of

Eurozone is playing

tough guy Who is going to blink

first?

Dont let logic blinker

your analysis


4/32

May 2012 3

Presidential and parliamentary elections

2012 2013 2014 2015 2016

US presidentialand senateelection

6 Nov 2012

German federal election

27 Aug 27 Oct 2013

Italian generalelection

Apr 2013

Portuguese parliamentaryelection

2015

Portuguese presidentialelection

2016

Greekpresidential

election

2015

Greek re-runparliamentary

election

17 June 2012

Netherlandssnap

parliamentaryelection

12 Sep 2013

FrenchParliamentary

elections

10-17 June
http://en.wikipedia.org/wiki/File:Flag_of_Portugal.svghttp://en.wikipedia.org/wiki/File:Flag_of_Portugal.svg


5/32

May 2012 4

Greecethe troika plans doomed

To succeed, everythingneeds to go 100% right

Privatisation receipts

Tax implementation, and

co-operation

Public sector spending

cuts

GDP growth returns

and central banks

make up some shortfallwith profit donation

And then it still falls short

of the target

No plan B


6/32

May 2012 5

The logistics of a new currency

Assuming Greek notes were allburned then what can be done?

Each euro note has a serial number

with a letter code so it could work off

this:

X (pictured) = Germany

P = Netherlands

U = France

Y = Greece

But notes have moved across

borders check your wallets &

purses

De La Rue 4 months to print enough

Euro for Greece

Bank runs?

Czechoslovakia style stamping?


7/32May 2012 6

A new Greek drachma: Hello and good-bye

FX performance after failed FX regimes

0

20

40

60

80

100

120

1 51 101 151 201 251 301 351 401 451 501

Days after January 1st of crisis year

Jan1

stofcrisis

year=1

00

0

20

40

60

80

100

120Mexico 1994

Thailand 1997

Indonesia 1997

Korea 1997

Russia 1998

Brazil 1998

Turkey 2000

A Greek exit and a return of the

Drachma is now on the table

The implementation challenge is

huge

On arrival we would expect it to fall

up to 80% against the EUR.

.generally at the lower end of

performances of failed FX regimes


8/32


9/32May 2012 8

Slow motion Euro deposit flight

75

80

85

90

95

100

105

110

115

120

Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12

Jun-2010 = 100

Source: ECB * Excluding deposits held by MFIs and central government

Bank deposits* in selected Eurozone countries

NL

Spain

Italy

Germany

Greece

Ireland

France


10/32May 2012 9

European bailout fund not big enough

Peripheral Eurozone debt maturities Euro bn

0

100

200

300

400

500

600

90%

of which has ended up back ondeposit with the ECB

The BoE has done 325bn of QE

and the Fed has done over $2trn

Scaling up ECB bond buying to

Fed & BoE levels would amountto around1.8trn-2trn more

than the entire Italian bond

market!

Central Bank asset purchases (% of GDP)

0

2

4

6

8

10

12

14

16

18

20

22

24

Bank of England Federal

Reserve

Bank of Japan ECB

LTRO

QE still to come


14/32May 2012 13

Fiscal austerity FOREVER!!

If fiscal policy is going to be so tight

then monetary policy will have to beultra loose to compensate

Low rates and bond yields forever =

currency to depreciate versus emerging

market growth engines

Cyclically adjusted primary balance required for

sustainable debt

-8

-6

-4

-2

0

2

4

6

8

10

12

14

Spain

Germany

FranceItaly

NetherlandsUKUS

Greece

2010

2020-2030

2020-2030 including age related spending

(% of GDP)


15/32May 2012 14

Population demographics bad for Europe

Europe will soon see its

population shrink making

a drive for exports all the

more important

Europes working age

population will fall even

more quickly

meaning the fiscal pain

will be even greater

Growth rates of populations of working age

-40

-20

0

20

40

60

80

100

120

140

160

Europe

NorthAmerica

Asia

Oceana

World

LatinAmerica

Africa

2010-2030

2010-2050

(% change)


16/32May 2012 15

How can we get out of this mess?

1. Relax austerity countriesmeant to have deficits less than

3% by 2013, so delay this until

2016

2. Talk down the euro to boost

competitivenessshouldnt be

hard

3. ECB rate cuts, LTRO3,

possible QE will also feed

through into weaker euro but

ECB must be prepared to take

losses

4. Lower oil prices Saudi oil

minister says oil should be

$100/bbl

5. Common Euro-bond?


17/32May 2012 16

Competitiveness still to be addressed

Relative unit labour costs

60

80

100

120

140

160

180

200

00 01 02 03 04 05 06 07 08 09 10 11

GER FRA ITA

SPA NLD BEL

IRE GRE POR

Jan 2001= 100

OECD: Manufacturing Unit labour costs - sa

The likes of

Portugal, Spain,

Italy, and Greece

still have a

mountain to climb

in terms of

competitiveness

but it can be

done

Ireland did it, and

now runs a

current account

surplus


18/32May 2012 17

Shale Gas Race to the bottom

Natural Gas - relative price

0

20

40

60

80

100

120

140

160

180

200

08 09 10 11 12

Europe US Henry Hub

index $ per unit

US Natural Gas prices are their lowest inyearsthanks to the growth of shale gas

production

this has only just taken off in other

regionsthough we can expect a similar price

reduction in time elsewhere

Shale Gas Reserves

US, 862

Other North

America, 1069

South America,

1225Europe, 624

Africa, 1042

Asia, 1404

Australasia, 396

Technically

Recoverable

Resources

Tcf

Recoverable shale gas deposits arewidely distributed


19/32May 2012 18

Oil shock: Israel vs Iran

Prospects for a Middle East clash uncertain Iranian or Hezbollah retaliation?

Oil at $200/bbl? Mining the Straits of

Hormuz?

Crude oil prices

0

20

40

60

80

100

120

140

160

Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12

Brent crude WTI

$/bbl


20/32May 2012 19

Impact of fuel shock

oil price inUS$ pump price($c/gall) average cost 1 car((13 gallons per week ($)) avg annualcost 1 car % median aftertax income 2 cars % median aftertax income100 297 38.94 4050 4.1 8100 8.1110 322 42.22 4390.91 4.4 8781.818 8.8120 347 45.50 4731.82 4.7 9463.636 9.5130 372 48.78 5072.73 5.1 10145.45 10.1140 397 52.05 5413.64 5.4 10827.27 10.8150 422 55.33 5754.55 5.8 11509.09 11.5160 447 58.61 6095.45 6.1 12190.91 12.2170 472 61.89 6436.36 6.4 12872.73 12.9180 497 65.17 6777.27 6.8 13554.55 13.6190 522 68.44 7118.18 7.1 14236.36 14.2200 547 71.72 7459.09 7.5 14918.18 14.9

Potential cost of US Fuel

At current prices - $120-$130/bbl, gasoline consumption is costing a 2 car

household about 9.5-10% of annual income.

At $200/bbl, this increases to about 15%

Of course, if you drive an SUV double all the figures above!


21/32May 2012 20

SPR 30m barrels = about $0.50-$1.00 3m

In recent history, there have

been three instances of an

SPR drawdown

The resulting fall in retailgasoline prices was about

$0.50 - $1.00, though the

counterfactual is unclear

Is few cases, was the

impact sustained for morethan 3m

Moral: Dont overestimate

the price effect of the SPR

SPR Drawdowns

500000

550000

600000

650000

700000

750000

99 00 01 02 03 04 05 06 07 08 09 10 11

0

50

100

150

200

250

300

350

400

450

Strategic petroleum Reserve, lhs

Retail gasoline prices, rhs

low distillatelevels in NE30m b

Hurricane Katrina 11m b

Arab Spring30m b


22/32May 2012 21

EUR/USD the known unknowns

IMPACTLow High

High

Low

PROBABILITY

US elections/

protectionism

Early Fed

tightening

Fed QE3

Greece leaves

EMU

Eurozone breaks up

Iran Conflict

Eurozone

hard-landing

Chinese

hard landing

EUR/USD

Positive factors

Negative factors

0% 15% 30%


23/32May 2012 22

Monetary Shocks policy error?

The Feds proposed first rate hike by no sooner than late 2014 seems difficult

to take seriously

Markets are registering their doubt through Eurodollar and Fed fund futures

contracts Fed taking a chance with inflation bond yield spike later in 2012?

0

1

2

3

4

5

2012 2013 2014 Longer run

% Fed member assessment for appropriate interest rate


24/32May 2012 23

US is not immune to the Eurozone

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

Banking sector Public sector Other to tal

GIIP S Other Euro zo ne UK

EURtr

Exposure of US banks to

Europe through deposits, loans

etc amounts to about $1.8tr

(inc UK)

and exposure through CDS

written amounts to a further $2.2tr

If the crisis does re-ignite

then the US will not be immune

to Eurozone developments

0

0.1

0.20.3

0.4

0.5

0.6

0.7

0.8

Belg

ium

Fran

ce

Ger

man

yIta

ly

Luxe

mbo

urg

Neth

erla

nds

Aust

ria

Gre

ece

Irelan

d

Portu

gal

Spai

nUK

EUR tr

Ultimate country risk exposure

Country and CDS


25/32

May 2012 24

US fiscal policy tightening set to bite

US growth has been helped by the fact

the government has been quicker to

loosen and slower to tighten fiscal

policy than has the Eurozone

this is beginning to change

Bipartisan politics mean more sun-

setting of stimulus from 2013, and

more fiscal drag

-3

-2

-1

0

1

2

3

4

2009 2010 2011 2012 2013 2014

US Europe

GDP %

Tax-mageddon


26/32

May 2012 25

Debt burden still very heavy

Household debt has fallen

mainly due to debt default

But overall burden still

extremely high

three times average

individual salaries

Likely to weigh on consumer

spending growth for years

The US debt burden*

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

52 56 60 64 68 72 76 80 84 88 92 96 00 04 08

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

Federal & localgovernment debt

Household

Average salary

* debt per person of

working age

($)($)


27/32

May 2012 26

China avoiding a hard landing?

Export growth has

been slowing

but some of the

lead indicators for

exports are not too

bad

and in any case,

wasnt China supposed

to be moving to a more

domestically orientedgrowth model?

Exports and Export PMI

25

30

35

40

45

50

55

60

65

70

31/01/2005 31/01/2007 30/01/2009 31/01/2011

-40

-30

-20

-10

0

10

20

30

40

50

60

Export orders PMI

Exports, rhs

index YoY%


28/32

May 2012 27

Key currency attributes in 2012

Very few currencies demonstrate all the attributes of safety, liquidity and return

Return

LiquiditySafety

AUD

CAD

GBP

JPY

NOK

CHF

SEK

USD

NZD

EUR

EMEA

ASIA ex CNY

LATAM

CNY

-6 -4 -2 0 2 4 6

JPY

EUR

AUDSEK

CHF

CAD

NOK

GBP

NZD

Year-to-date vs. USD (% chg)

INR


29/32

May 2012 28

Global FXvaluations to impact returns

Currency pain thresholds

-15 -10 -5 0 5 10 15 20 25 30

UKUS

South KoreaEurozone

MexicoJapan

SwedenHungary

TurkeyIndia

NorwayMalaysia

South AfricaThailand

NZ

IndonesiaSwitzerland

CanadaSingapore

ChinaAustralia

RussiaBrazil

Percent of REER index above/below 10-year average


30/32

May 2012 29

Summary

The best case, is for ongoing, prolonged, low level risk aversion and weakgrowth from the G-10

Assuming no Euro break up: fiscal tightening, credit constraints, and de-

leveraging will weigh on economies and assets for year (decades?) to come

The worst case is for massive economic and market disruption in the event of

Eurozone break up

The rest of the G-10 will not be immune to the fallout

Choosing between a number of binary outcomes (Greece in or out for

example), makes forecasting almost impossible

Adding politics to the arguments makes logic irrelevent

Most of the arguments point to further euro weakness. And also to low(er)

rates and bond yields (for core Europe, and non-Europe)


31/32

May 2012 30

Forecasts

2011 2012 2013 2014

US

GDP 1.7 2.2 2.0 2.3

CPI 3.2 2.1 2.4 2.5

EZ

GDP 1.5 -0.4 0.9 1.2

CPI 2.7 2.4 1.7 1.8EUR/USD 1.30 1.15 1.2 1.25

UK

GDP 0.7 0.2 2.0 2.7

CPI 4.5 2.7 2.0 2.3

GBP/USD 1.55 1.53 1.56 1.56

Japan

GDP -0.7 1.9 1.3 1.2

CPI -0.3 0.2 -0.1 0USD/JPY 77 85 95 110

China

GDP 9.2 8.2 8.4 8.4

CPI 5.4 3.0 3.0 3.0

USD/CNY 6.32 6.24 6.18 6.18All figures annual averages, except for exchange rates, which are year end

Forecast summary


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Rob Carnell