Issuu

The Divergence Theme

Jonathan Basile Head of Business Cycle Research AIG Global Economics 212-770-5228 jonathan.basile@aig.com March 19, 2015

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Factor 1: The Oil Price Shock The supply-side decline in oil prices boosts global growth, with asymmetric effects across countries.  It represents a massive shift in wealth and income from producers to consumers of oil even as economies have become less “oil-intensive”.  A floor for oil prices will emerge, as layoffs and investment curtailment take place. Crude Oil Futures ($/barrel)

Sources: EIA; AIG Global Economics 2

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Market Impact: The USD rises as oil prices decline

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

… And deflation fears set in

Sources: Haver; AIG Global Economics 4

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Factor 2: The ECB’s QE ECB picks up QE baton from Fed

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Market impact: Competitive devaluation Euro

Yen

CHF

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

… And massive rally in sovereign bonds

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Factor 3: The Fed’s Lift-Off Strong employment report…

… Prompted a re-thinking of the Fed’s policy moves

Sources: Haver, Bloomberg, AIG Global Economics

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Market impact: Inflation Expectations Bouncing off Lows

Market-based inflation expectations Core inflation: More stable

Sources: Haver; AIG Global Economics

Sources: Haver; AIG Global Economics 9

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

… And the flattening of Yield Curves: 2 Year-10 Year Yield Spread US Treasuries

UK Gilts

German Bunds

Japanese JGBs

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Global monetary policy is coalescing around three blocks: The Americas… Latin America (Latam): Can’t afford to fight the Fed:  Portfolio-flow financed current account deficits in some countries limit the central bank’s ability to cut rates, as does moderate level of dollarization across the financial system.  Some Latam countries have either started to raise policy rates, or will have to over 2015 in line with rising shortterm and long-term rates in the US, as preventing capital outflows becomes more important than maintaining currency competitiveness.

Currencies (vs US$) are adjusting to the weaker outlook

Foreign currency debt means following the Fed

Sources: Oxford Economics, Fitch, Haver, AIG Global Economics

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

… Emerging Europe Emerging Europe: Can’t afford to fight the ECB  Poland’s central bank rate cut is linked to the potential gains of the currency and ensuing financial stability risks (i.e., bond bubble).  Russia has started an easing cycle, following the aggressive tightening (650bps) in December, as the ruble has stabilized.  Turkey is more influenced by USD financing. It faces adverse dynamics of high inflation, a large current account deficit, dependence on confidence-driven capital flows and, therefore, a volatile currency.

Currencies reacting to the ECB

Currencies (vs US$) lose ground

Sources: Oxford Economics, Fitch, Haver, AIG Global Economics

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

… And Non-Japan Asia Non-Japan Asia: An eye on the BoJ and the Fed; dovish central banks amidst intensified dis-inflation and restrictive fiscal policies.  China: Looser monetary conditions are aimed at countering the tightening caused by capital outflows.  South Korea, Indonesia, Singapore and Thailand are all seeing more dis-inflation with faster pass-through effect of lower gasoline prices, against the backdrop of modest domestic demand.  Thailand’s baht and the Philippines’s peso are regional outperformers on strong current account position and FDI inflows.  India: The switch to inflation targeting makes aggressive cuts less likely. Currencies (vs US$) are adjusting to the weaker outlook

Foreign currency debt means following the Fed

Sources: Haver, AIG Global Economics

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

The outcome: Developed economies outperform emerging markets Volatility in the currency markets, capital outflow pressures and broken growth models are factors that will continue to weigh on EM growth.

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

The US lead-dog to global growth  US GDP growth of close to 3% in 2015 should turn out to be the best year of expansion since the end of the Great Recession.  The main reason: broad-based acceleration in private domestic demand dominated by households. Stronger domestic demand will widen the trade gap as import growth outpaces export growth for the first time in five years.  We expect both disposable income and consumer spending to post the strongest annual growth since 2009. A tighter labor market should benefit households through strong job gains and moderately faster wage growth.

We expect above trend growth in 2015

Shift from producer to consumer

4 3

3.1 2.5

2.3 2.2 2.4 1.6

1 0

-1 -2 -3

Real GDP, YoY % Average growth rate b/t 1Q10 and 3Q14 @ 2.2%

-4 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15F Sources: BEA; BLS; Haver; AIG Global Economics

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

The oil price windfall for the US consumer  Uncertainty about the US growth outlook goes up in the short run because the news is negative for producers. But the drop in gasoline prices from June to present is equivalent to about $200bn in additional income and to a 1.5% tax cut. • But it takes time to harvest the redistribution to consumers because demand for energy in the very short run usually doesn’t change. It takes time (months) for household and business behavior to change from the positive oil price shock. • One way we illustrate this is by looking at US consumer spending on gasoline in dollars (light blue) and volume (dark blue). The negative price effect is more direct on dollars spent (light blue) and it took longer for the volume (dark blue) to get a boost. The price drop has to stick for the volume to move up materially and for more trips to be taken. • Green shoots have emerged: Auto sales have picked up pace and miles traveled have broken through 2007 highs. Americans are paying Less at the Pump…

…And Driving More Places

Sources: Autodata; BEA; Federal Highway Administration; AIG Global Economics 16

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

The oil price windfall for the US consumer (continued) The cumulative effect of the gasoline price drop over the last seven months: The savings have been spent: • Discretionary (green) spending • Nondiscretionary (light blue and red) spending (defined as food/beverages, energy, clothing/footwear, and housing).

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Euro Area: More near-term upside Balance of Risk: Tilting to the upside, with emerging green shoots to the consumer and export sector  The Euro Area (EA) economy has shown more upside momentum recently, despite being constrained by on-going deleveraging in some of the peripheral countries and by the lack of support from fiscal policy on a broader basis.  Consumer spending benefits from lower oil prices and rebounding confidence, especially in countries with lower household debt burdens.  Weak investment remains an entrenching theme across the EA, though drivers differ in each country.  The recent decline in the currency driven by the ECB’s QE has helped the export sector, contributing to continued improvement in the current account.  Headline deflation will more likely stay for most of the year in the region, although core inflation will stabilize with the support of stronger growth.  Winner industries: Autos, consumer discretionary and consumer goods exporters

Real GDP Growth (%, YoY)

Current Account Balance (% of GDP)

5.0

12 9

4.0

3.0

3 2.0

0 -3

1.0

forecasts -6

0.0 GERMANY

FRANCE

ITALY

NETHERLANDS

IRELAND

-1.0 2014

2015

2016

SPAIN

Germany Netherlands Spain

-9 -12 Dec-06

Dec-08

Dec-10

Dec-12

France Italy Ireland Dec-14

Dec-16

Sources: AIG Global Economics Baseline Forecast 18

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Euro Area PMI: Pickup in activity Germany PMI

France PMI

70 60 50 40 30

Italy PMI

20 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Manufacturing

20 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Manufacturing

Manufacturing New Order

Netherlands PMI

Manufacturing New Order

50 45

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Manufacturing

Manufacturing New Order

Manufacturing

Spain PMI

Ireland PMI

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

20 2006 2007

2008

2009 2010

Manufacturing

2011 2012 2013

2014 2015

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Manufacturing New Order

Manufacturing

Manufacturing New Order

Sources: Haver, Markit, AIG Global Economics

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Appendix 1: Global Growth forecasts

World North America United States Europe Euro area Germany France Italy Spain United Kingdom Japan Asia ex Japan China India EMEA Russia Turkey South Africa Latin America Brazil Mexico

PPP weighted share of world GDP (2014) 100.0 17.8 16.3 17.4 12.0 3.4 2.4 1.9 1.4 2.3 4.5 34.2 16.5 6.8 17.6 3.3 1.4 0.6 8.5 2.9 2.0

2013 3.3 2.2 2.2 0.2 -0.4 0.5 0.3 -1.9 -1.2 1.7 1.5 6.1 7.7 5.0 2.9 1.3 4.1 1.9 2.7 2.5 1.1

2014 3.3 2.4 2.5 1.4 0.9 1.6 0.4 -0.4 1.4 2.6 0.1 6.0 7.4 5.6 2.5 0.5 2.7 1.5 1.2 0.0 2.1

Growth Rates 2015 3.4 3.0 3.1 1.7 1.4 1.7 1.0 0.3 2.1 2.6 1.0 5.9 6.8 5.8 2.2 -3.6 3.6 2.6 1.1 -1.1 3.1

2016 3.8 2.8 2.8 1.9 1.6 1.5 1.5 1.0 2.2 2.5 1.2 5.9 6.5 6.2 3.6 0.2 3.8 3.0 2.7 0.6 4.0

2017 4.0 2.8 2.8 2.0 1.7 1.6 1.5 1.0 2.4 2.6 0.8 5.8 6.3 6.6 4.2 2.0 4.2 3.2 3.6 2.7 4.1

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

Appendix 2: Global Inflation forecasts

World North America United States Europe Euro area Germany France Italy Spain United Kingdom Japan Asia ex Japan China India EMEA Russia Turkey South Africa Latin America Brazil Mexico

PPP weighted share of world GDP (2014) 100.0 17.8 16.3 17.4 12.0 3.4 2.4 1.9 1.4 2.3 4.5 34.2 16.5 6.8 17.6 3.3 1.4 0.6 8.5 2.9 2.0

2013 4.0 1.4 1.5 1.5 1.4 1.6 1.0 1.3 1.5 2.6 0.4 4.3 2.6 9.5 7.8 6.8 7.5 5.8 7.4 6.2 3.8

2014 3.9 1.6 1.6 0.6 0.5 0.9 0.5 0.2 -0.2 1.5 2.8 3.6 2.0 7.3 7.2 7.7 8.9 6.1 10.5 6.3 4.0

2015 3.4 0.7 0.6 0.0 -0.1 0.1 0.0 -0.2 -0.9 0.5 1.2 3.0 2.0 5.5 7.1 9.1 6.0 5.5 11.2 7.0 3.2

2016 3.6 2.5 2.5 1.3 1.1 1.2 1.0 0.7 1.0 1.8 1.0 3.1 1.6 6.4 6.1 6.1 6.5 6.2 8.6 5.6 3.3

2017 3.5 2.5 2.5 1.7 1.5 1.8 1.4 0.9 1.1 2.0 2.0 3.3 2.1 6.3 5.7 5.1 6.1 6.2 6.2 4.9 3.2

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY

American International Group, Inc. (AIG) is a leading international insurance organization serving customers in more than 130 countries.. AIG companies serve commercial, institutional, and individual customers through one of the most extensive worldwide property-casualty networks of any insurer. In addition, AIG companies are leading providers of life insurance and retirement services in the United States. AIG common stock is listed on the New York Stock Exchange and the Tokyo Stock Exchange. Additional information about AIG can be found at www.aig.com | YouTube: www.youtube.com/aig | Twitter: @AIG_LatestNews | LinkedIn: http://www.linkedin.com/company/aig AIG is the marketing name for the worldwide property-casualty, life and retirement, and general insurance operations of American International Group, Inc. For additional information, please visit our website at www.aig.com. All products and services are written or provided by subsidiaries or affiliates of American International Group, Inc. Products or services may not be available in all countries, and coverage is subject to actual policy language. Non-insurance products and services may be provided by independent third parties. Certain property-casualty coverages may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds, and insureds are therefore not protected by such funds.

HIGHLY CONFIDENTIAL - FOR INTERNAL PURPOSES ONLY