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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
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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
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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.svg7/31/2019 Rob Carnell
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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
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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?
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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
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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
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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
7/31/2019 Rob Carnell
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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)
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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)
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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?
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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
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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
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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
$/bbl
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Impact of fuel shock
oil price inUS$ 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!
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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
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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%
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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
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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 $2.2tr
If the crisis does re-ignite
then the US will not be immune
to Eurozone developments
0
0.1
0.20.3
0.4
0.5
0.6
0.7
0.8
Belg
ium
Fran
ce
Ger
man
yIta
ly
Luxe
mbo
urg
Neth
erla
nds
Aust
ria
Gre
ece
Irelan
d
Portu
gal
Spai
nUK
EUR tr
Ultimate country risk exposure
Country and CDS
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May 2012 24
US fiscal policy tightening set to bite
US growth has been helped by the fact
the government has been quicker to
loosen and slower to tighten fiscal
policy than has the Eurozone
this is beginning to change
Bipartisan politics mean more sun-
setting of stimulus from 2013, and
more fiscal drag
-3
-2
-1
0
1
2
3
4
2009 2010 2011 2012 2013 2014
US Europe
GDP %
Tax-mageddon
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May 2012 25
Debt burden still very heavy
Household debt has fallen
mainly due to debt default
But overall burden still
extremely high
three times average
individual salaries
Likely to weigh on consumer
spending growth for years
The US debt burden*
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
52 56 60 64 68 72 76 80 84 88 92 96 00 04 08
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
Federal & localgovernment debt
Household
Average salary
* debt per person of
working age
($)($)
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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%
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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
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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
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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)
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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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