Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities in partnership with the Banque de France Paris – March 21, 2016
Financial markets, world economy and monetary policy at a crossroad: a few comments Jorge Sicilia BBVA/Chief Economist
GIC March 2016
Financial tensions trending upwards and repeated episodes of financial turmoil raise concerns Asset performance BBVA Research Financial Stress Index: Emerging markets andin terms of risk/return: Lehman crisis Developed Markets (normalized Index) Source: MSCI & Bloomberg Source: BBVA Research based on Bloomberg data
6 5
Lehman Brothers
4
European sovereign debt crisis Chinese’s concerns
3 2
Bank’s concerns
Tapering talks
1 0 -1 -2 Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Developed
Mar-13
Mar-14
Mar-15
Mar-16
Emerging
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
More so when tensions spread to the banking sector in developed markets
Asset performance in of risk risk/return: Lehman crisis BBVA Research Financial Stress Index, Bankterms credit component: Source: MSCI & Bloomberg
US and EZ (normalized Index) Source: BBVA Research based on Bloomberg data
6 5
Lehman Brothers
4
European sovereign debt crisis
3 2
Tapering talks
Chinese’s concerns
Bank’s concerns
1 0 -1 -2
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Mar-14
Mar-15
Mar-16
US EZ Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
What can we read from recent developments in financial markets? Is it a downward revision of the baseline global outlook?
Not likely, the downside revisions have been mild and indicators are not pointing to a recession
Is it the threat of risk scenarios going forward in this new world?
Very likely! Uncertainty about China and persistent low oil prices raised the risk of second round effects of the current environment that could become self-fulfilling…Together with policy actions and inactions....
Asset performance is radically different under the baseline and the risk scenarios. Changes in probabilities assigned to both scenarios have the potential to generate this market behavior Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Markets are wondering and wandering between two scenarios: Where do we go in terms of risk/return? Asset performance in Bullish Market 2009-2015 terms of risk/return:
?
Source: MSCI & Bloomberg
Bearish Market
Asset performance in terms of risk/return: 2009-2015
Asset performance in terms of risk/return: Lehman crisis
Source: MSCI & Bloomberg
Source: MSCI & Bloomberg
30
70
Equity LatAm (USD) (MSCI index)
60
Equity Euro (MSCI index)
Volatility
20
50
15
Equity US (MSCI index)
10
7-10Y Bonds 7-10Y Bonds US Euro
5
Sov EMs (USD) 0
5
10 Performance
Equity US (MSCI index)
40 Equity Euro (MSCI index)
30
Cred. EMs (USD)
20
Corp US (7-10Y)
Cred. EMs (USD)
Corp Euro (7-10Y)
0
Volatility
25
Equity LatAm (USD) (MSCI index)
15
20
Future 25
10
Corp Euro (7-10Y)
Corp US (7-10Y)
0 -80
-60
-40
7-10Y US
Sov EMs (USD) 7-10Y Euro
-20
0
20
Performance 9/05/08 - 6/03/09
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
How worried should we be about this risk scenario? World GDP growth remains low and fragile Asset performance World GDP(*) quarterly growth, short-term forecasts based onin terms of risk/return: Lehman crisis BBVA-GAIN (QoQ %) Source: MSCI & Bloomberg
Source: BBVA Research and IMF
1,6
Growth forecasts for 2016 are of around 3%, and over 3% in 2017
1,4
1,2
Average 2000-07 1,0
0,8
Average 2011-15
0,6
Annualized rate: 2,6% 0,4 Jun-09
Mar-10
Dec-10
Sep-11
Jun-12
Mar-13
Dec-13
Sep-14
Jun-15
Mar-16
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Risks are higher, and mainly to the downside Slowdown in the US?
Market volatility
Emerging Economies Hard choices in a tougher background (Oil prices fall and Flow rebalancing) Source: BBVA Research
Europe “Brexit”, Banking Union
China Hard landing, policy errors
Geopolitical Risks: (and refugees crisis)
Rising
Holding steady
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Overwhelming majority that conditions are deteriorating, to what extent? Asset performance in terms of risk/return: Lehman crisis
From the “fear” approach…
MSCI & Bloomberg ... To theSource: “hope” approach
Lead among others by the BIS (is this view increasingly shared by the IMF?) that alert about the risks given the underlying economic vulnerabilities:
Still shared by G20, central banks and independent observers, but increasingly alert:
• • •
•
High leverage Low productivity No room of maneuver
• •
• •
G20: “the global recovery continues but downside risks and vulnerabilities have risen” IMF: “global recovery has weakened […] higher risks […] urgency of a broad-based response” Fed ” global economic and financial developments continue to pose risks”. ECB ” providing substantial monetary stimulus to counteract heightened risks” Independent observers: “the world need a reality check from financial panic”, A. Posen, PIIE
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Over longer horizons, there are little reasons to expect growth rates higher than “old normal” 3.5%... Economic Growth (annual change, %) 8 6 4 2 0 -2 -4 83 84 85 86 87 88 89 90 80's Expansion
91 92 93
94 95 96 97
98 99 00
90's soft patch 90's soft Expansion
01 02 03 04 05 06 07
Patch and Rebound
00's Expansion
08 09 10 11 12
13 14 15 16 (e) (f)
Crisis and Rebound
Anemic Expansion
The BIG REBALANCING
Source: BBVA Research forecasts
WORLD
GDP, YoY, %
80's expansion
90's soft patch
World
3.8
2.6
DM EM
3.9 3.8
1.7 3.9
90's soft expansion
DM
EM
Patch and rebound
00's expansion
Crisis and rebound
Anemic expansion
3.7
3.7
4.4
3.2
3.3
3.2 4.4
3.5 4.0
2.4 6.6
0.5 5.5
1.7 4.4
Source: BBVA Research, IMF
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
…and probably less considering the high debt levels in a very low inflation environment Outstanding Debt (*) (% GDP) Mature markets
Emerging Markets 150,0
150,0
Households Non-fin corporates Government Financial Corporates
125,0
125,0
100,0
100,0
75,0
75,0
50,0
50,0
25,0
25,0
0,0
0,0
Households Non-fin corporates
Jun-15
Jun-11
Jun-07
Jun-03
Jun-99
Jun-15
Jun-11
Jun-07
Jun-03
Jun-99
Jun-95
Financial Corporates
Jun-95
Government
(*) Source: BIS, IIF
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Financial tensions is already having a toll on economic activity Estimated impact of financial tensions on GDP
Asset performance in Increasing financialLehman tensions (since terms of risk/return: crisis
Transitory and Permanent shock
last summer to now) are already having an impact on GDP growth (transitory shock) mainly in EM while negligible for DM
Source: MSCI & Bloomberg
Source: BBVA Research
Permanent shock
US EZ EM (*)
If sustained at current levels (permanent shock) financial stress might have major impact across the board, especially in EM
(*) estimated impact just for a sample of countries, mainly Latam countries
Transitory shock
-1,5
-1,0
-0,5
0,0
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Volatile financial markets are unwanted Asset performance in Estimated impact of higher volatility* on world GDP Source: BBVA Research
terms of risk/return: Lehman crisis
25.0
Source: MSCI & Bloomberg
20.0
Volatility in financial markets by itself could also have a major impact on growth: assuming a “risk” scenario where volatility spikes (less intense than LB, 30% but more persistent about 2 times its duration-), world GDP growth could be affected by around 1 percentage point
15.0 10.0 5.0 0.0 -5.0 -10.0 08
09
10
11
12 Risk
13
14
15
16
17
18
Base
(*) BBVA Research Global volatility index constructed using analysis component from principal components of financial variables, including 10years bond yields, exchange rates, stock exchange index for developed and emerging markets. For more detail see https://www.bbvaresearch.com/wp-content/uploads/2015/01/GVI_ING.pdf
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Central banks, the art of adjusting their strategy in real time trying to avoid unintended consequences Asset performance in Official interest rates in some developed terms of risk/return: central banks (Refi2009-2015 and depo rates) Source: MSCI & Bloomberg
Source: BBVA Research 6 5 4 3 2 1 0
-1 -2 Mar-07
Sep-08
Mar-10 EZ
BoJ
Sep-11 SW
Mar-13 DEN
Sep-14 SWI
Mar-16
Asset performance in terms risk/return: Lehman crisis Theofcase of negative rates Source: MSCI & Bloomberg
The deeper the central banks go in this direction, the more debate will arise over the unintended consequences of such policies • Uncertainty about how long can they go (in magnitude and duration)? • Impairment of the monetary policy transmission mechanism • Concerns on bank profitability • Global spillovers through exchange rates • Tail risks (of bank runs) • Counterfactual analysis?
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Central banks, the art of adjusting their strategy in real time trying to avoid unintended consequences Asset performance in EZ: Peripheral risk Risk perception in the terms ofand risk/return: 2009-2015 index CDS (bps) premia Banks ITRAXX-
Asset performance in of ECB’s strategy, The welcome shift terms of rates risk/return: Lehman crisis ” from instruments to other,
Source: MSCI & Bloomberg Source: BBVA Research
Source: MSCI & Bloomberg
non/conventional instruments ”.
300
The ECB is increasingly focus on credit easing.
250 200
TLTROs improve financial condition for banks: dissipates funding risks and counterbalances the impact of negative interest rates on banks’ profitability.
150 100 50 0 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16
Senior Bank debt Subordinated bank debt Peripheral risk premiun (avrg ITA SPA POR)
The impact on the amount of credit to the real economy is uncertain.
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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GIC March 2016
Challenges ahead are huge. Important question marks remains open. Asset performance in Monetary policy ammunition and coordination: terms of risk/return: Lehman crisis • Central banks, do they have ammunition left? Source: MSCI & Bloomberg • How could monetary policy be combined with other (most structural) policies? Can we have a design that avoids fiscal dominance? Helicopter money, if it were legal, how could it be designed? • Should central banks consider their international responsibility beyond their domestic mandate? [Rajan proposal]
“Financial repression” • How long can it be maintained? • Combined with digital innovation could it foster financial desintermediation? • Is credit quality endogenous to low interest rates?
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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Financial markets, world economy and monetary policy at a crossroad: a few comments Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities in partnership with the Banque de France Paris – March 21, 2016
Jorge Sicilia, Chief Economist BBVA Research