MACRO HIGHLIGHTS & STRATEGY US Federal Funds Target Rate (%) DECEMBER …... · 2020. 6. 25. · DECEMBER 14 TH 2015 OUR ROUNDUP: The markets could turn more volatile between now

PRIVATE BANKING

EDMOND DE ROTHSCHILD | B. JACQUIER, F. LÉONET, L. TURK 1/13

MACRO HIGHLIGHTS & STRATEGY DECEMBER 14TH 2015

OUR ROUNDUP:

The markets could turn more volatile between now and year’s end. China is unshackling the yuan from the dollar. US capital investment is not going to increase anytime soon. The SNB should have lowered its deposit rate. In the end the news was wrong: Japan avoided recession.

MARKETS

THE ENDGAME NEARS

On Wednesday 16 December the US Federal Reserve (Fed) is expected to raise its key lending rate

by 25 basis points to 0.50% (see chart below). Investors have been waiting eagerly for this moment all

year, the end of a game that has seen considerable seesawing, and it is finally coming—in the closing days

of 2015.

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US Federal Funds Target Rate (%)

So many investors the world over are expecting the Fed to act that the move should not cause any panic in

the markets. In her latest statements the Fed chair, Janet Yellen, has expressed confidence about the US

MACRO HIGHLIGHTS & STRATEGY | DEC. 14TH 2015

2/13 EDMOND DE ROTHSCHILD | B. JACQUIER, F. LÉONET, L. TURK

economy and labour market. However, our own scenario (in which the Fed might continue tightening its

monetary policy faster than the consensus anticipates) leads us to conclude that volatility could

increase sharply between now and the year’s end. The nervousness already began last week, which

saw a plunge of more than 13% in the oil price following inaction by the Organisation of Petroleum

Exporting Countries (OPEC). The VIX “fear index”, which measures volatility in the US stockmarket, surged

74%, from 15 to 25 points—well above the long-term average (20).

Oil price index (in USD) Volatility index (VIX)

The investment environment is unfriendly, especially with year-to-date returns struggling to stay above the

water-line. The chances of the Fed issuing a dovish statement are slim, if not nil. If the US central bank

announces a faster-than-expected pace of hikes in its federal funds rate, investors will be disappointed. On

the other hand, if it decides not to tighten at all to take account of falling stock prices, as it did in

September, this will also be regarded as cause for concern. We need to be ready because, if our analysis

is correct, bond yields could go up, equities could slide further, the dollar could flex its muscles, gold could

run into resistance… and the year will be over (see the 16 November issue of Macro Highlights & Strategy).

CHINA

THE YUAN IS BEING CUT LOOSE FROM THE DOLLAR

As we expected (see the 1 December issue of Macro Highlights & Strategy), shortly before the yuan was

included in the IMF’s basket of global reserve currencies in late November it started dropping vs the US dollar

(see chart on next page). Unsurprisingly, as soon as the Chinese currency received its membership

card political pressure on Beijing to shield it from undue volatility subsided.



Moreover the People’s Bank of China (PBoC) advised international investors that it was composing a

basket of 13 currencies, weighted by their trade ties to China, to serve as its new benchmark. The US

dollar reportedly accounts for 26.4% of this basket, followed by the euro (21.4%) and the yen (14.7%). This

marks the start of a gradual drift away from the yuan’s dollar peg and towards an exchange-rate

mechanism that better reflects China’s economic reality, in this case its trade ties. In a more

roundabout way the new benchmark to some extent takes Beijing off the hook as it won’t need to respond

so much to the imminent rise in US interest rates. This move will boost the US dollar and, if the peg to it

had been maintained, would have forced the PBoC to intervene heavily in the forex market.

New information on changes in China’s exchange-rate policy is bound to come. In the present

circumstances, however, it is doubtful that the yuan will appreciate much. The forthcoming hike in the US

federal funds rate and increasing volatility in financial markets will probably combine to maintain downside

pressure instead.

UNITED STATES

GOOD CAPITAL INVESTMENT IS HARD TO FIND

US GDP is set to grow above trend in 2016. But while this will mainly be thanks to robust consumption and a

booming real estate market, business spending—an essential driver of healthy expansion—will create drag.

Here are the reasons why many companies are scaling back their capital investment plans:

1- Encouraged to borrow by the Federal Reserve’s rock-bottom interest rates, corporate America

spent massively on plant and equipment from 2011 onwards (see left-hand chart below). These

investments accounted for 12% of GDP growth in 2012, a rate that has since pulled back to 5-6%

year on year. As a consequence production capacity is very high at present, although it remains



under-utilised. Historically companies do not step up capital investment until the rate of capacity

utilisation exceeds 80% (see right-hand chart below).

2- Earnings growth has been falling in recent quarters (see left-hand chart below), prompting cuts

in capex budgets. Moreover increasing strains in the US labour market will lead to faster wage

growth, squeezing their margins as well as their spending.

Although a good many of the recent cuts in investment budgets have come in the oil and gas industry, where

producers have had to slash their rig numbers as a result of tumbling prices, the general mood among US

manufacturers is also uncertain. The PMI manufacturing index is trending downwards (see left-hand chart

above) and thus does not point to an improvement in capex anytime soon.



SWITZERLAND

A MISSED NOTE IN THE SNB’S INACTION

The Swiss National Bank (SNB) last week decided to leave its monetary policy unchanged. As a

consequence the interest rate on commercial banks’ deposits was not lowered further into negative territory

and remains at -0.75%. We had expected the SNB to show more muscle, in a bid to spur economic

growth, fight deflation and deter upside speculation on the franc. The Swiss monetary authorities probably

want to keep some wiggle room in case the European Central Bank (ECB) opts for more aggressive action,

in which case the franc would appreciate further.

At the risk of appearing impertinent, we believe the SNB’s inaction will harm the Swiss economy, will

prevent the central bank from fulfilling its mandate and will end up being rectified in the coming

quarters. As we have pointed out regularly (see the 9 November issue of Macro Highlights & Strategy),

there are only three ways for the SNB to solve the problems it faces: allow the franc to go up; massively

increase its forex reserves; or further reduce its deposit rate. Since none of these solutions is ideal, the

Swiss central bank will opt for a compromise based on all three.

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2002 2004 2006 2008 2010 2012 2014 2016

SNB Forex Reserves (bns CHF - L.H.S.)

SNB Forex Reserves (%GDP - R.H.S.)

The franc is already about 15% above its fair value based on purchasing power parity. Allowing it to

appreciate further would place a huge burden on Swiss exporters. Meanwhile foreign currency reserves

are reaching dizzying heights. They now amount to CHF 563 billion (see left-hand chart above),

equivalent to 92% of GDP. It is hard to find another country with such a mountain of assets in the vault of

its central bank (see right-hand chart above).

It would therefore make more sense for the SNB to opt for the third solution, i.e. pushing its deposit

rate deeper into negative territory. Admittedly doing so has numerous drawbacks, mainly the risk of

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BoE ECB Fed BoJ SNB

Central Bank Balance Sheet (% GDP)



forming asset bubbles, but as long as Switzerland balks at the idea of creating a sovereign wealth fund

(see the 12 October issue of Macro Highlights & Strategy), it will have no choice but to use the other tools

at its disposal. We should add that the levels of GDP growth and inflation observed in recent quarters

would amply justify a cut in key interest rates. That is, in any case, what the optimal monetary policy

approach advocated by John Taylor suggests (see chart below).

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SNB Target Rate (%)

Optimal Monetary Policy (Taylor Rule)

Under the Taylor rule it is possible to call for a deposit rate as low as -1.75%. Without going that far, a cut

of 25 or 50 basis points (to -1.00% or -1.25%) would not be outlandish.

Another glimpse of how restrictively the SNB is positioning its monetary policy can be had by

comparing Swiss real interest rates and those of other countries. With its deposit rate at -0.75% and

annual inflation at -1.4%, Switzerland has a real 3-month rate of about +0.65%—the highest cost of short-

term money in the developed world (see left-hand chart below). The spread to the same real real rate in the

Euro Zone, Switzerland’s leading trading partner, is particularly striking (see right-hand chart below). For

the record the Swiss 3-month real rate was constantly higher than Euroland’s between early 2009 and end-

2014. During that period the franc appreciated 29%. In January this year, when it introduced a negative

deposit rate, the SNB reversed the trend and thus made the job of stabilising its currency easier. Now, by

refusing to follow the ECB’s lead, it is again making life hard for itself. A further cut in the deposit rate would

have sent a clear signal to the markets by widening the spread to the ECB’s corresponding rate and

making it even more costly to own francs than euros. The franc would have depreciated. In the musical

score it is playing, the Swiss central bank last week missed a beat.



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2000 2002 2004 2006 2008 2010 2012 2014 2016

EUR Real 3-month Yield (%)

CHF Real 3-month Yield (%)

EUR/CHF Exchange Rate (L.H.S.)

Until the SNB lowers its cost of money further, it will be forced to intervene in the forex market to slow the

franc’s appreciation. Sadly the ECB is printing money far too fast (at the rate of €60 billion a month) for the

Swiss central bank to have any sustainable impact (see chart below).

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Central Banks Balance Sheet Differential (bn EUR)

EUR/CHF Exchange Rate (R.H.S.)

As investors we can rest assured that, as long as real interest rates remain so high in Switzerland,

exposure to franc appreciation will be a good bet.

JAPAN

THE RECESSION THAT WASN’T

The second estimate of Japan’s Q3 GDP marks a good opportunity to point out the problem of

trying to analyse “raw” or only half-baked economic data. According to the revised figures, the

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BoJ ECB Fed BoE SNB

Real Central Bank Target Rates



Japanese economy grew 1.0% quarter over quarter (see chart below) vs an initial estimate of -0.8%. Thus

Japan has managed to avoid its fifth recession in less than eight years, exactly as we anticipated.

Contributions to Japan’s GDP growth (% QoQa)

How are such errors possible? National number-crunching agencies try to publish GDP data as quickly

as they can and, to do so, they fill in missing numbers that, statistically speaking, are significant. The

resulting first estimate of GDP growth is then revised at least twice in the following months, as more and

more information from all sectors of the economy become available. It is quite common for the first and

second estimates to be revised by a wide margin. To draw the right conclusions about the health of the

economy, one has to watch statistics over an extended period. Investors tend to forget this.

The good news in Japan’s case is that growth turned up in Q3. Business investment was much

stronger than expected and inventory drawdowns had less of an impact than forecasters thought

they would. These two factors, added to consumer spending, created robust domestic demand capable of

keeping the economy in expansion mode.

Actually there is scope for sustainable growth, with the Abe government goading companies to

invest and raise salaries. Yet these vital components of the third “arrow” of Abenomics are not being

implemented as they should. Despite record profits thanks to yen weakness, Japanese firms are dragging their

feet. They are reluctant to use their earnings to increase capex and pay their employees more until they can be

certain that it is possible to pass on the higher costs through their sales prices. They do not want to take a

cut in their margins. But they will only recover their pricing power when everyone is convinced that inflation

is back for good. The BoJ policy committee could be prompted to step up monetary stimulus to ensure this.

The labour ministry has just announced that the average monthly salary in companies with over 100 employees

had increased 1.9 %, the biggest rise since 1999. Unfortunately, at the same time prices of food and imported

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12-Q4 13-Q1 13-Q2 13-Q3 13-Q4 14-Q1 14-Q2 14-Q3 14-Q4 15-Q1 15-Q2 15-Q3

Private Consumption

Public Spending

Capex

Inventories

Trade Balance

GDP

%QoQa %QoQa



goods increased even more quickly. In the end Japanese consumers’ purchasing power failed to improve

(see left-hand chart below).

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Real Japan Wages (%YoY)

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Japan Unemployment Rate (%)

Real wages could grow eventually if strains appear in the labour market. With a jobless rate of 3.1%,

Japan has full employment (see right-hand chart below). There will soon be an imbalance in the supply-

demand equatio. Some sectors of the economy are unable to recruit qualified employees without offering

higher pay. For less skilled workers, whose ranks exceed vacancies, the government has planned a 2%

regulatory increase in the minimum wage, hoping to boost the incomes of poorer households.

Everything is being done to underpin consumption … and put paid to recession once and for all!



ECONOMIC FORECASTS

Contributions to global GDP growth

Comments The GDP growth rates shown above are actual for 2013 and 2014 and projections for 2015. Each country’s weighting is based on its GDP in US dollars as calculated by the World Bank. Contributions to global expansion are calculated by multiplying the GDP growth of each country by its weight. The sum of the

contributions works out to 3.6% for 2016, a good estimate of next year’s global GDP growth.

Economic Activity GDP 2014GDP 2015

Economist Estimates

GDP 2016Economist Estimates

Country

WeightsContribution 2016

United States 2.4% 2.5% 2.5% 23.2% 0.58%

Canada 2.4% 1.2% 1.9% 2.0% 0.04%

Euro Area 0.9% 1.5% 1.7% 14.5% 0.25%

United Kingdom 2.6% 2.4% 2.3% 4.0% 0.09%

Switzerland 1.9% 0.9% 1.2% 0.8% 0.01%

Russia 0.5% -3.8% 0.0% 1.9% 0.00%

Japan 0.2% 0.6% 1.1% 4.9% 0.05%

China 7.4% 6.9% 6.5% 17.8% 1.16%

India 4.7% 7.4% 7.4% 3.6% 0.26%

Brazil 0.1% -3.0% -1.3% 2.1% -0.03%

Mexico 2.1% 2.4% 2.8% 1.6% 0.04%

Others 4.4% 3.3% 4.7% 23.6% 1.10%

WORLD 3.4% 3.1% 3.6% 100% 3.6%

Source : Bloomberg Momentum (vs Last Estimates) Performance (Over \ Under)



RETURNS ON FINANCIAL ASSETS

Major benchmarks and currencies

Markets Performances

(local currencies)

Last

Price1-Week (%) 1-Month (%) Year-to-Date (%) Last Year (%)

Equities

World (MSCI) 393 -3.5% -3.4% -3.5% 4.8%

United States (S&P 500) 2'012 -3.7% -2.8% -0.3% 13.7%

Euro Area (DJ EuroStoxx) 339 -3.7% -5.9% 8.5% 5.0%

United Kingdom (FTSE 100) 5'989 -4.6% -5.1% -5.7% 1.0%

Switzerland (SMI) 8'538 -3.4% -4.3% -2.5% 12.9%

Japan (NIKKEI) 18'883 -1.4% -2.3% 12.0% 9.0%

Emerging (MSCI) 774 -4.7% -7.1% -17.1% -2.0%

Bonds (Bloomberg/EFFAS)

United States (7-10 Yr) 2.18% 1.1% 1.8% 3.1% 8.9%

Euro Area (7-10 Yr) 1.48% 1.1% 0.5% 1.8% 14.0%

Germany (7-10 Yr) 0.58% 1.2% 0.7% 1.6% 12.0%

United Kingdom (7-10 Yr) 1.84% 0.8% 2.0% 1.7% 11.7%

Switzerland (7-10 Yr) -0.20% -0.2% -0.6% 5.0% 7.2%

Japan (7-10 Yr) 0.30% 0.1% 0.2% 1.0% 5.0%

Emerging (5-10 Yr) 5.14% -0.9% -1.2% 1.5% 7.7%

United States (IG Corp.) 3.47% 0.3% 0.7% 0.0% 7.6%

Euro Area (IG Corp.) 1.16% 0.4% 0.2% -0.2% 8.1%

Emerging (IG Corp.) 4.64% -0.7% -1.5% -2.0% 5.7%

United States (HY Corp.) 8.84% -2.2% -3.6% -3.1% 1.6%

Euro Area (HY Corp.) 4.95% -1.4% -1.8% 1.0% 5.5%

Emerging (HY Corp.) 10.51% -2.1% -3.2% 4.0% -2.6%

United States (Convert. Barclays) 45 -2.5% -2.9% -2.4% 7.7%

Euro Area (Convert. Exane) 7'395 -1.5% -2.6% 6.1% 4.5%

Real Estate

World (MSCI) 185 -2.0% -0.5% -1.7% 15.2%

United States (MSCI) 194 -2.1% -0.1% 0.6% 28.1%

Euro Area (MSCI) 204 -1.8% -4.7% 12.8% 19.1%

United Kingdom (FTSE) 6'577 -0.1% 0.3% 9.2% 19.7%

Switzerland (DBRB) 3'507 -1.1% -2.0% 2.2% 14.6%

Japan (MSCI) 267 -1.7% -2.1% -0.1% -6.3%

Emerging (MSCI) 93 -7.0% -6.6% -12.9% -3.4%

Hedge Funds (Dow Jones)

Hedge Funds Industry 554 n.a. 0.5% -0.1% 4.1%

Distressed 738 n.a. -0.3% -3.9% 2.6%

Event Driven 608 n.a. 0.1% -3.9% 1.6%

Fixed Income 302 n.a. -0.2% 0.4% 4.4%

Global Macro 891 n.a. 1.3% 0.9% 3.1%

Long/Short 678 n.a. 1.7% 3.7% 5.5%

Managed Futures (CTA's) 312 n.a. -2.5% -2.4% 18.4%

Market Neutral 268 n.a. -0.6% 1.1% -1.2%

Multi-Strategy 519 n.a. 0.1% 3.4% 6.1%

Short Bias 31 n.a. -5.6% 1.0% -5.6%

Commodities

Commodities (CRB) 376 -2.9% -3.0% -16.1% -11.9%

Gold (Troy Ounce) 1'068 -0.8% -1.6% -10.1% -1.1%

Oil (Brent, Barrel) 37 -11.2% -17.0% -33.1% -49.7%

Currencies

USD 97.8 -0.9% -1.2% 8.3% 12.8%

EUR 1.10 1.2% 2.6% -9.4% -12.0%

GBP 1.52 0.8% -0.2% -2.6% -5.9%

CHF 0.99 1.5% 2.5% 0.9% -10.2%

JPY 121.3 1.7% 1.5% -1.3% -12.1%

Source : Bloomberg Momentum (1-week / 1-month / 3-month) Performance (Negative \ Positive)



EDMOND DE ROTHSCHILD (SUISSE) SA

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Disclaimer

This brochure was prepared by Edmond de Rothschild (Suisse) S.A., 18 rue de Hesse, 1204 Geneva, Switzerland. Edmond de

Rothschild (Europe), located at 20 boulevard Emmanuel Servais, 2535 Luxembourg, Grand Duchy of Luxembourg, and subject

to the supervision of the Luxembourg Commission de Surveillance du Secteur Financier (CSSF), and Edmond de Rothschild

(France), a société anonyme (public limited company) governed by an executive board and a supervisory board with capital of

EUR 83,075,820 and with its registered office at 47 rue du Faubourg Saint Honoré, 75008 Paris, subject to the supervision of

the French Autorité de Contrôle Prudentielle et de Résolution (ACPR), limit themselves to making this brochure available to

clients at their offices and branch offices.

The figures, comments, analyses and investment research contained in this brochure reflect the opinion of Edmond de

Rothschild (Suisse) S.A. on market trends, formed on the basis of its own expertise and the economic analyses and the

information in its possession at this time. The figures, comments, analyses and investment research contained in this brochure

may no longer be current or relevant when the investor reads this brochure owing to its date of publication or changes in the

markets.

Each analyst mentioned in this document certifies that the views expressed about the evaluated companies and securities

reflect the analyst's personal opinion. Their remuneration is not tied directly or indirectly to the specific recommendations and

opinions expressed in this document. Details on the rating methodology used by Edmond de Rothschild (Suisse) S.A. are

available free of charge on request.

Neither Edmond de Rothschild (Suisse) S.A., Edmond de Rothschild (Europe) nor Edmond de Rothschild (France) may be held

liable for a decision to buy, sell or hold based on the aforementioned commentaries and analyses under any circumstances.

Furthermore, neither Edmond de Rothschild (Suisse) S.A., Edmond de Rothschild (Europe) nor Edmond de Rothschild

(France) may be held liable for harm incurred by an investor as a result of the contents or availability of this brochure.

This brochure is intended solely to provide general, preliminary information for the investors consulting it and should not be

used as a basis for any decision to buy, sell or hold.

Edmond de Rothschild (Suisse) S.A. recommends that each investor obtain the different regulatory descriptions of each

financial product before any investment in order to analyse the risk and form his or her own independent opinion, with the

assistance of advisers specialising in these matters if necessary, so as to ensure that the investment is appropriate to his or her

financial and tax situation.

Past performance and volatility are not a reliable guide to future performance and volatility, and may vary over time.

This information may not be used or reproduced in whole or in part.

Copyright © EDMOND DE ROTHSCHILD (Suisse) S.A. – All rights reserved



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MACRO HIGHLIGHTS & STRATEGY US Federal Funds Target Rate (%) DECEMBER …... · 2020. 6. 25. · DECEMBER 14 TH 2015 OUR ROUNDUP: The markets could turn more volatile between now