Global daily insight 05 january

Daily Insight

Group Economics Macro & Financial Markets Research

5 January 2016

‘Happy’ New Year!

Nick Kounis

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Head of Macro and Financial Markets Research Tel: +31 20 343 5616

hurting investor sentiment  

arjen.van.dijkhuizen @nl.abnamro.com

US ISM index falls further below 50, but eurozone PMI rises as EUR/USD effect leaves its mark – global manufacturing lacklustre

Senior Economist Tel: + 31 20 628 8052

China wobbles partly reflect manufacturing data, though other parts of the economy are more resilient; further CNY weakness ahead

nick.kounis @nl.abnamro.com Arjen van Dijkhuizen

2016 starts off on the wrong foot with China, geopolitics and weak data

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German inflation disappoints, raising further questions about the credibility of the ECB’s goal

What a start to 2016!

The first working day of the year began in a rather dramatic fashion. Colleagues wished each other a ‘Happy New Year’ against the background of sliding equity markets. The collapse in China’s equity market (see below) combined with geopolitical tensions (this time the ending of diplomatic ties between Saudi Arabia and Iran) and weak global manufacturing data proved to be a powerful cocktail undermining investor risk appetite.

The S&P 500 was down more than 2% and the Euro Stoxx more than 3%, while US and German 10y government bond yields fell by around 6bp. Safe haven demand also supported the yen.

Our base scenario sees global growth regaining its footing in 2016 and China experiencing a soft landing. We also think that global policymakers have the flexibility to support demand given very subdued inflationary pressures.

China’s stock markets start 2016 with a crash and a trading halt After the rollercoaster ride seen in 2015, China’s stock markets started 2016 with a crash on Monday, as the leading indices lost 7.5%-9%. According to new trading rules introduced as of 1 January, trading was first suspended for 15 minutes after the CSI 300 index lost 5%. After the resumption of trading, this index lost another 2%, triggering the closure of the stock markets for the day. These ‘circuit breakers’ had been introduced in the hectic summer months of 2015.

The latest stock market rout looks to have been triggered by a combination of factors.

First, the weaker than expected manufacturing PMI published by Caixin. Second, anticipation regarding the ending of a temporary ban of share sales introduced last year.

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Daily Insight – ‘Happy’ New Year – 5 January 2016

Third, the introduction of the new regime with ‘circuit breakers’ may have caused market jitters as well. Finally, the ongoing depreciation of the Chinese yuan versus the US dollar will also have affected market sentiment.

China December PMI data confirm divergence between industry and services We think that the focus on manufacturing exaggerates the weakness in the economy.

Indeed, the December PMI data for China published in the past few days confirmed the ongoing divergence between manufacturing and services. The two manufacturing PMIs, published by NBS and Caixin, came in somewhat below market expectations. Caixin’s manufacturing PMI fell back to a three-month low of 48.2 (November: 48.6), after having risen in the past two months, whereas markets had expected an increase to 48.9. The official NBS index for manufacturing rose marginally to 49.7 (November: 49.6, consensus expectation: 49.8), but remained below the neutral 50 mark for the fifth consecutive month. By contrast, NBS’s non-manufacturing PMI jumped by 0.8 points to 54.4, the highest level since August 2014. Caixin’s services PMI will be published on Wednesday.

We expect China’s economic slowdown to remain gradual, with growth easing from 7% in 2015 to 6.5% in 2016 and 6.0% in 2017, assuming the authorities remain committed to add stimulus to prevent a hard landing.

China PMIs show ongoing divergence industry/services Indices (50 = ‘neutral mark’ )

60 58 56 54 52 50 48 46 11

12 13 Caixin Manufacturing PMI NBS Manufacturing PMI

14 15 16 Caixin Services PMI NBS Non-manufacturing PMI

Source: Thomson Reuters Datastream

More CNY weakness versus the US dollar ahead China’s weak export performance and the ongoing real effective appreciation of the yuan have triggered changes in the exchange rate regime. After allowing the yuan to weaken versus the US dollar in August, in December a new currency index was presented, which should better capture external competitiveness. This may well indicate that China’s exchange rate policy is shifting from a de facto crawling peg versus the US dollar to a system in which the yuan is managed more broadly against a currency basket.

This shift makes sense, as a peg to the US dollar does not really look optimal for several reasons (see our China Watch, Year ends with better data, weaker yuan published and FX Watch, CNY index implies weaker CNY? published in December 2015 for more information). Since October, the yuan has depreciated by almost 3.5% versus the US dollar.

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Daily Insight – ‘Happy’ New Year – 5 January 2016

We expect the authorities to allow a further yuan weakening versus the US dollar, also to support exports and re-inflate the economy and taking into account ongoing monetary policy divergence between China and the US. However, we still do not expect the authorities to allow a very large depreciation, as that could trigger an acceleration of capital outflows.

Global manufacturing lackluster The weakness in China’s manufacturing sector was mirrored by poor data in the US. The ISM manufacturing index fell to 48.2 in December from 48.6 in November. The Markit PMI is at higher levels, but the trend is the same, with the index falling to 51.2 from 52.8. The strength of the dollar seems to be playing a role here, which impacts the export sector with a lag. Similarly, it is probably no coincidence that the eurozone manufacturing sector is outperforming, with the PMI rising to 53.2 from 52.8. The big picture for global manufacturing seems to be one of very weak growth. The global manufacturing PMI in October and November hovered around the 51-mark, and this seems to have continued in December, though services are generally stronger.

We think that global economic growth will firm in 2016, but will still be sub-trend. The US and eurozone economies will likely continue to recover. Meanwhile, emerging markets are likely to stabilise and should benefit from weaker currencies and stronger DM demand.

Although China’s economy should continue to gradually slow, its drag on the rest of the world economy should ease as last year’s collapse in imports abates.

German inflation raises ECB questions A final element at the start of 2016, which seemed very familiar, was subdued European inflation. Indeed, German inflation fell to 0.2% yoy in December, from 0.3% in November, which confounded expectations for a bounce. Although energy price deflation eased as expected, this seems to have been more than offset by a slowdown in food price inflation.

The fall seen in German inflation may not be repeated in data published for the eurozone today, as other countries may see a rise (early Spanish data pointed in this direction).

However, it does suggest that headline inflation will remain very low for a long time.

The argument that this is just energy and food prices does not really stack up given that core inflation also stands at less than half the ECB’s price stability goal. In addition, had it not been for the fall in oil prices, eurozone domestic demand and hence underlying inflationary pressures may have been weaker still. The bottom line is that the credibility of the ECB’s inflation goal is under threat. We expect to see further monetary easing in the coming months.

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Daily Insight – ‘Happy’ New Year – 5 January 2016

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