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THINK Economic and Financial Analysising.com/THINK
Follow us@ING_Economics17 November 2017
Why markets are still underestimating the FedOur answers to this month’s big questions
Economic and Financial Analysis
Our top sixthemes this
month
Economic and Financial Analysis
Follow us@ING_Economics
What the 19th congress could mean for China
#1
#2
#3
#4
#5
#6
Shaking up the Fed: What vacancies and voter rotations mean for rates
What’s in store for oil and petro-currencies in 2018
Will the Italian election end in a hung parliament?
Global Economics and Strategy Team
November 2017
The latest on the Eurozone economy
NAFTA: What now for the “worst trade deal ever”?
Economic and Financial Analysis 2
There are a series of Fed vacancies that still need filling
Powell hired, but what about the other Fed vacancies?
Jerome PowellChair nominee
V
Vice ChairMid-2018 Vacancy*
Board of Governors
V VV
Brainard Quarles
Janet YellenCurrent chair
William DudleyOutgoing NYFed President
Stan FischerEx. Vice Chair
Outgoing
Regional Presidents (2018 voters)
V
NY Fed* Cleveland RichmondAtlantaS. Francisco
V = Vacancy
Markets may have shrugged off the upcoming change at the top of the Fed, but they remain complacent about the risks of faster rate rises next year
Assuming Chair Yellen steps down in February, that will leave 4 out of 7 Fed Board positions vacant.
With Trump facing mid-terms next year, it is unlikely he’ll want to see clear hawks appointed that could threaten his 3% growth target.
Until Trump has made his decisions and the full 2018 voter mix becomes clear, it is perhaps not surprising that markets continue to treat the Fed's latest "dot diagram" cautiously.
*William Dudley is currently filling in as Fed Vice Chair, meaning the First Vice President of the NY Fed is currently the alternate member.
Image sources: Federal Reserve, Shutterstock
Economic and Financial Analysis 3
One hike priced in. We expect two, and the risk is more rather than less
Markets are still underestimating the Fed’s 2018 plans
Neel KashkariMinneapolis Fed
Charles EvansChicago Fed
Loretta MesterCleveland Fed
John WilliamsSan Francisco Fed
Two doves out
Two hawks in
Annual regional Fed voter rotation
The combination of upside risks to growth and mounting inflationary pressures, as well as a hawkish rotation in the make-up of Fed voters, suggests that markets are too cautious in only pricing in one hike next year.
As part of the annual Fed voter rotation, two of the most dovish members will be replaced by two hawks – John Williams and Loretta Mester
Williams is in favour of three hikes next year, and Mester has hinted she'd like the Fed to go 'a little stronger‘ even than that.
Until Trump gets new governors onto the Fed board, this means the group of voters will be both smaller and more hawkish, faced with an economy that is performing well and that may have more fuel thrown on the fire with tax cuts.
We're expecting a December rate hike, and these various factors mean there is upside risk to our call for two further rate rises next year.
Image source: Federal Reserve
Economic and Financial Analysis 4
NAFTA: What now for the “worst trade deal ever”?
-80
-60
-40
-20
0
90 92 94 96 98 00 02 04 06 08 10 12 14 16
$ B
illio
ns
Mexico
Canada
US trade balance with Canada and Mexico ($bn)President Trump threatened to rip-up NAFTA arguing the US has not benefitted – jobs have been lost and the US’ trade deficit has ballooned.
Negotiations need to be completed swiftly (aim of 1Q 2018) – Mexican election in July, US mid-terms next November
Up for debate are rules of origin changes, 5Y sunset clause, “Buy American” government procurement, national minimum content rules
Will Mexico & Canada reluctantly agree to a watered down version of Trump’s original demands?
National pride may give way to economic pragmatism as the US demands “some candy”
Image source: Shutterstock
Economic and Financial Analysis
$21billion*
Exports to Canadaof US GDP 1.4%
Exports to Mexicoof US GDP1.2%
$525billion*
$545billion*
of Canadian GDP
Exports to US17%
of Mexican GDP
Exports to US29%
$1090 billion
2016
$265billion
1992
*Bilateral trade
Mexico looks most vulnerable from a NAFTA collapse
US-Canada trade could revert to 1988 Canada-US Free Trade Agreement. That would preserves tariff free trade, but still implications in terms of rules of origin and minimum content for products
Canada-Mexico free trade could continue, but Mexico-US trade may have to go to WTO rules
Total NAFTA trilateral trade
Source: Macrobond
Economic and Financial Analysis 6
What the 19th congress could mean for China
2018-2020
• Build a middle-income class
• Coordinate economic growth with education, talent, innovation, the rural economy, regional growth and environmental sustainability.
• Avoid systemic risks
The blueprint
• Deleveraging in the corporate & financial sectors to continue, in turn pushing up interest rates
• Anti-corruption will continue
• This would likely lead to changes in the management of State Owned Enterprises (SOEs)
What we expect
2020-2035
• Increase technological ability, aiming to become one of the most innovative countries
• Raise the proportion of middle class citizens
• Narrow the difference between urban and rural development
• Improve environmental sustainability
The blueprint
• Household robots would be more common
• But we worry there would be overcapacity in the technology sectors
What we expect
2035-2050
• Establish a modern society
• Become an influential country in terms of economic power and role on the international stage
The blueprint
• To be an influential country, the Yuan would have been internationalised with few capital controls. Before then, interest rates would to become market driven.
What we expect
Economic and Financial Analysis 3
The blueprint could be achieved earlier than 2050, but there are hurdles
But we see three risks to China’s blueprint
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2
3
Hurdle 1: A build up of central and local government debts
Technology needs more infrastructure investments but the preparation stage requires the government to spend a lot of money. This will put pressure on gross government debt.
Hurdle 2: Narrowing the wide urban-rural living standards gapGiven the gap between urban and rural livings standards is already wide, this will be a challenge.
Incomes are rising slightly faster in rural areas (8.7% vs. 8.3% in urban centres), but the level of urban disposable income is still 2.8 times that of rural. Likewise, consumption is 2.3x higher, albeit as with incomes, spending is growing more rapidly in rural areas (8.6% annual growth vs. 6.2%).
Hurdle 3: Beware of trade and geopolitical conflictsOther countries would feel the threat in terms of economy size, development of technology, and beefing up military power.
Economic and Financial Analysis
Closing the gap in the Eurozone
8
The Eurozone economy continues to surprise positively and is showing few signs of coming to an abrupt halt, even with some of the political risks on the horizon.
This means that the output gap could be closed sooner than expected, decreasing the need for stimulus in most Eurozone economies.
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
Eurozone output gaps
2017 2018 2019
European Commission Estimates
Source: European Commission
Economic and Financial Analysis
As ECB starts to taper, inflation is still a headache
9
With the Eurozone economy performing well, the ECB has announced it will start to gradually taper asset purchases from January by reducing monthly asset purchases to €30 billion, until September 2018.
But inflation is still low and any pick-up from here is going to be very gradual. That’s why European Central Bank (ECB) President Draghi was at pains to stress that the road to ‘tapering’ of its bond purchases will be a dovish one.
0.0
0.5
1.0
1.5
2.0
2017 2018 2019
ECB staff projections for core inflation
March projections June projections Sept projections
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
19
98
20
00
20
02
20
03
20
05
20
06
20
08
20
10
20
11
20
13
20
14
20
16
20
17
Bill
ion
s
Total ECB assets
Source: ECB, Macrobond
Economic and Financial Analysis
Luigi di Maio(Five Star Movement)
10
The countdown to the Italian election is on…
Italian general election
ING expects the election in
March 2018
Key players and possible coalitions
Matteo Renzi(Democratic Party)
Angelino Alfano(Popular Alternative)
Nicola Frantoianni (?)(Italian Left)
Roberto Speranza (?)(Democrats and Progressives)
Matteo Salvini(Northern League)
Silvio Berlusconi(Forza Italia)
Giorgia Meloni(Brothers of Italy)
Hung Parliament?Based on current opinion polls, none of the coalitions may be able to form a government in isolation, therefore the real game will start right after the election.
The recent regional vote in Sicily, won by the centre-right candidate, showed how relevant coalitions can be in the Italian framework. Making them consistent at the national level will likely prove a difficult exercise on all fronts
The new electoral law, which will apply to both branches of the Italian parliament, foresees a mixed system. Two-thirds of the seats will be allotted using a proportional system, and a third with a first-past-the-post system, with blocked lists.
Based on the latest opinion polls, the Italian political spectrum remains divided into three groups of similar size. As the new law does not include a majority premium, barring substantial opinion shifts, none of the three groups seem to be in a position to win a majority in the parliament.
Image source: Shutterstock
Economic and Financial Analysis
Bank of England to tread carefully in 2018
11
We don’t rule out a hike next year – but there are a lot of “ifs” in the Bank’s outlook…
Global growth stays
strong
Investment & trade offset
consumer drag
Wage growth & domestic
inflation pressures
build
The Bank of England’s rate hike ingredients
The Bank of England has signalled it is prepared to hike twice more – including one increase in 2018
But there are a lot of “ifs”, not least all the Brexit hurdles to overcome if it is to be as “smooth” as BoE hopes
We’re less confident wage growth & domestically-generated inflation will rise as fast as the Bank hopes. Growth looks set to remain sluggish too.
We don’t rule out a 2018 hike – but it isn’t guaranteed
Economic and Financial Analysis 12
We have revised our ICE Brent forecast for 4Q17 to $57 per barrel and for 2018 to $51 per barrel.
Crude oil: What’s in store for 2018?
Geopolitical risk, positive economic data, and expectations of an extension to the OPEC production cut have seen ICE Brent trade above US$60/bbl for the first time since 2015.
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2
3
Non-OPEC supply will continue to rise despite a slowdown in rig activity. That’s particularly true in the US, which is set to see its highest level on record. In 2018, we see the US increasing its market share in Asia.
IEA expects that growth in oil demand will slow over 2018 to 1.3MMbbls/d. This number is key for the oil market, as it is less than the 1.4MMbbls/d of non-OPEC supply growth forecasted for the year.
OPEC will extend their production cut deal to the end of 2018, however the risk is that the longer the deal continues, the more likely compliance starts to slip.
We are bearish on crude into 2018 on the view that:
The oil market should return to a small surplus over 2018 at US$51/bbl. The key risk to the view is a worsening of the current geopolitical environment.
0
20
40
60
80
100
120
Fiscal breakeven oil price (US$/bbl)
2017
2018
2017 ICE Brent YTD average
Economic and Financial Analysis
Petro-currencies lose their mojo
13
Investors seem to doubt the sustainability of crude’s rally
A problem for petro-currencies?
The correlation between petro-currencies and crude has dropped markedly over the last twelve months.
NOK, in particular, has lagged. This may owe to general fatigue with Scandi currencies where both the SEK and NOK are frequently seen as under-valued.
So what next for petro-currencies?
If crude turns lower it would spell trouble for the CAD and RUB where markets are aggressively pricing future rate hikes.
If crude doesn’t turn lower the market could start to re-price Norges bank tightening cycle.
What about oil importers?
If crude prices stayed bid or pushed higher, we think vulnerable currencies worth highlighting are India and Turkey (struggled to rein in its current account deficit).
Source: ING, Macrobond
Source: ING, Macrobond
Economic and Financial Analysis
Who’s next in line to tighten monetary policy?
14
ECB
Fed
BoE
BoJ
BoC
RBA
RBNZ
Riksbank
Norgesbank
Nov 2017
Dec 17
Q
Sept 17Balance sheet unwind starts
2017 2018
Rate hike QQE/balance sheet change
June 18 Dec 18
3Q181Q18
2Q18 4Q18
1Q18 4Q18
3Q18
Dec 18
ING policy rate forecasts
Q
Jan 18Tapering begins
Q
Sept 18End of current QE extension
Q
Oct 17Tapering announced
Economic and Financial Analysis 15
Our global forecasts
EUR/USD EUR/GBP
USD/JPY Oil (Brent Crude)
1M: 0.88 3M: 0.88 6M: 0.88 12M: 0.861M: 1.17 3M: 1.20 6M: 1.22 12M: 1.27
All data sourced from Bloomberg/ING forecasts
1M: 114 3M: 114 6M: 114 12M: 115 4Q17: 57 1Q18: 50 2Q18: 50 4Q18: 52
1.00
1.10
1.20
1.30
1.40
1.50
Jul 11 Jul 12 Jul 13 Jul 14 Jul 15 Jul 16 Jul 17 Jul 18
INGConsensusForwardsEUR/USD
0.65
0.7
0.75
0.8
0.85
0.9
0.95
13 14 15 16 17 18
INGForwardsConsensusEUR/GBP
70
80
90
100
110
120
130
11 12 13 14 15 16 17 18
ING
Forwards
Consensus
USD/JPY
0
20
40
60
80
100
120
140
14 15 16 17 18 19
ING
Consensus
Brent Oil
Economic and Financial Analysis 16
Our global forecasts2017F 2018F
Q1 Q2 Q3 Q4 FY Q1 Q2 Q3 Q4 FY
United States
GDP (% QoQ, ann) 1.2 3.1 3.0 2.8 2.2 2.6 2.5 2.6 2.7 2.7
CPI headline (% YoY) 2.5 1.9 2.0 2.4 2.2 2.3 2.4 2.6 2.3 2.4
Federal funds (%, eop, lower bound) 0.75 1.00 1.00 1.25 1.25 1.50 1.50 1.75
3-month interest rate (%, eop) 1.15 1.30 1.33 1.56 1.57 1.87 1.91 2.08
Eurozone
GDP (% QoQ, ann) 2.2 2.6 2.4 2.2 2.3 1.8 1.7 1.8 1.8 2.0
CPI headline (% YoY) 1.8 1.5 1.4 1.3 1.5 1.2 1.4 1.4 1.5 1.4
Refi minimum bid rate (%, eop) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
3-month interest rate (%, eop) -0.33 -0.33 -0.33 -0.33 -0.33 -0.33 -0.33 -0.33
Japan
GDP (% QoQ, ann) 1.1 2.5 0.9 2.6 1.5 1.5 0.8 1.3 0.0 1.4
CPI headline (% YoY) 0.2 0.4 0.6 0.2 0.4 0.7 0.5 0.7 0.8 0.7
Excess reserve rate (%) 0.0 0.0 0.0 0.0 0.00 0.0 0.0 0.0 0.0 0.0
3-month interest rate (%, eop) 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05
China
GDP (% YoY) 6.9 6.9 6.8 6.7 6.8 6.7 6.6 6.7 6.7 6.7
CPI headline (% YoY) 1.4 1.4 1.6 1.5 1.5 1.5 1.5 1.6 1.7 1.6
PBOC 7-day reverse repo rate (% eop) 2.45 2.45 2.45 2.45 2.45 2.45 2.55 2.55 2.65 2.65
UK
GDP (% QoQ, ann) 1.0 1.2 1.6 1.1 1.5 1.1 1.6 2.1 1.8 1.4
CPI headline (% YoY) 2.1 2.7 2.8 3.0 2.7 2.7 2.3 2.3 2.4 2.4
BoE official bank rate (%, eop) 0.25 0.25 0.25 0.50 0.50 0.50 0.50 0.50 0.50 0.50
BoE Quantitative Easing (£bn) 445 445 445 445 445 445 445 445 445 445
3-month interest rate (%, eop) 0.35 0.35 0.35 0.60 0.60 0.60 0.60 0.60 0.60 0.60
Economic and Financial Analysis17
“USD: Making everyone (else) great again!”
“What we really think of the Bank of England’s rate decision”
“Confused by Yellen’s direction? You’re not alone”
“When caution’s not enough for the euro”
“Brexit battle continues as talks enter round two”
“Normalisation will be a long, uncomfortable journey”
“G10 FX: Careless Central Bank Whispers”
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