Growth, Capital Markets, Currency The impact of the Euro Crisis May 23, 2012 Kathleen Stephansen Managing Director Senior Investment Strategist and Global Head of Sovereign Research
The Global Economy
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Global growth should withstand the mild recession in Europe and is set to reach 3-3.5% this year, down from 3.8% in 2011 Global Growth (quarterly year-on-year % change PPP-basis) Projection
The EA conundrum: will renewed fiscal restraint restore confidence or deepen the recession?
Source: Credit Suisse; Global Insights; AIG Asset Management;
Emerging Asia continues to lead the global expansion
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Emerging Markets (EM) contribute the most to global growth, with Non-Japan Asia (NJA) leading the charge Real GDP (shares, growth, contribution) Shares of World GDP (2011 PPP) %
Region
2012 E Growth %
2013E Contribution ppt
Growth %
Contribution ppt
Global
100
3-3.5
3.3
3.7
3.7
US Europe Japan Canada
2.3 0 1.5 2.2
0.4 0.0 0.1 0 0.5
2.5 0.5 1.5 2.5
Subtotal
19.1 18.6 5.6 1.8 45.1
0.5 0.1 0.1 0.0 0.7
Non-Japan Asia China Latin America EMEA Subtotal
27.2 14.4 8 10.3 45.6
6.8 8 3.5 3.2
1.8 1.2 0.3 0.3 2.5
7.1 8.6 4 4
1.9 1.2 0.3 0.4 2.7
9.4
3.8
0.4
4
0.4
Others
Global growth levels (Q4:2007=100)
Sources: Credit Suisse; AIG Asset Management
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‌ With the rise of the EM consumer The integration of EM economies implies a rise in income and a shift in the sources of global demand:  EM consumer spending as a share of global consumption has risen steadily over the past decade The composition of growth has shifted, with a sharp rise in the share of EM consumer spending (as a % of world consumption)
Source: IMF; AIG Asset Management
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Strong inflows in EM debt and equities in recent years (apart from 2008), with periods of risk aversion prompting outflows EM Market Funds: Debt and Equity Net Flows (USD bn)
Fixed income flows into EM funds, (USD bn, cumulative flows) sovereign (hard- and local-currency) and corporate debt
Sources: IIF; JP Morgan
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A move to local currency assets and corporate issuance Fund Flows (Mutual / ETFs), cumulative inflows in USD mm, starting from 2005 in EM (Local Debt and Hard Currency (External) Debt)
The East Asian (ex-Japan) local currency bond market has grown by >10x since 1998 to an outstanding volume of $5.7 trillion (2/3 government and 1/3 corporate bonds USD Trillions
Offshore RMB market in Hong Kong
In two years, 8% of China’s trade has become denominated in Renminbi (RMB). In Q1:2012, 25% of foreign direct investment was denominated in RMB, and the offshore market in Hong Kong has reached RMB 600 billion.
Sources: Citi; IIF; HKMA; AMG
Billions of yuan, total CNY deposits
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Recent Developments
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Euro Area (EA) weakness has negatively affected global trade‌ EA: Imports from emerging markets have declined 3.5% per quarter since Q2:11
Global trade has decelerated
Global Growth (year-on-year % change- PPP basis)
China and Korea export growth (3m rolling sum, annual % change) has slowed from 20% y/y in2011 to less than10% currently
Source: Credit Suisse; Eurostat; AIG Asset Management; Institute of International Finance; China and Korea Customs Offices
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... Which, coupled with sluggish growth performance in the US and China, has put a dent on the Q1:2012 risk appetite rally Global Equity markets April monthly returns (%)
EM Equity and Sovereign bond returns (year-to-date April, %): Still positive
Relative performance of EM corporates and equities (JPM CEMBI and MSCI EMF indices, end-2009=100)
Sources: Bloomberg; Barclays; AIG Asset Management; Institute of International Finance (IIF); JP Morgan
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The EA crisis brought an intensification of the risk-off trade in early May Negative sentiment in global asset markets intensified in early May on renewed sovereign-crisis related fears of a potential euro-area exit by Greece and rising concerns over Spanish and Italian funding.
%
Index
May 9
April
March
Feb
YTD 5/9/12
Year 2011
Equities
MSCI EM MSCI Europe S&P 500 MSCI World MSCI Japan Canada S&P/TSX Comp.
GDUEEGF Index GDDUE15 Index SPX Index GDDUWI Index GDDUJN Index SPTSX Index
-4.6 -4.7 -3.0 -3.9 -4.6 -5.0
-1.2 -2.1 -0.6 -1.1 -3.2 -0.6
-3.3 -0.5 3.3 1.3 1.4 -1.6
6.0 6.4 4.3 4.9 5.0 1.7
7.6 3.4 8.5 6.2 2.8 -1.4
-18.2 -10.5 2.1 -5.0 -14.2 -8.7
Currencies
EUR DXY CAD
USDEUR Curncy DXY Curncy USDCAD Curncy
-2.5 1.7 -1.5
-0.8 -0.3 1.1
0.1 0.3 -0.9
1.8 -0.7 1.3
-0.3 -0.1 1.8
-3.3 1.5 -2.3
Commodities
Brent Oil S&P GSCI Gold
CO1 Comdty SPGCCI Index TR GC1 Comdty
-5.2 -5.4 -4.2
-2.8 -0.5 -0.3
0.2 -2.4 -2.5
10.5 6.1 -1.5
5.4 -0.3 1.7
13.3 -1.2 10.2
Bonds
Emerging Mkts TIPS Gilts Bunds Treasuries Canada
SBGIMS Index SBUSILSI Index SBUKL Index SBDML Index SBUSL Index SBCDL Index
6.2 0.2 1.5 0.8 0.3 0.8
1.5 2.1 0.4 1.0 1.4 0.2
0.2 -1.1 -0.9 0.1 -1.0 -0.4
2.8 -0.4 -1.4 0.1 -0.7 -0.5
0.1 3.0 0.1 2.3 0.5 0.3
8.5 14.0 16.9 9.6 9.6 9.5
Sources: Morgan Stanley; AMG Asset Management
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The ensuing flight to quality‌ 1. Into Bunds: German and Japanese 2-year government note yields (%)
3. Into US Treasuries: 10-year Treasury note yield (%)
2. Into long dated Bunds: The German yield curve has flattened relative to those of the US, UK, and Japan
4. Canada’s government bonds held by foreigners /bonds held by the public*
Sources: Bloomberg; AIG Asset Management; Institute of International Finance (IIF); NBC
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‌Has led to partial reversal of EM capital flows
Net flows to BRIC equity funds
Sources: Credit Suisse; AMG; IIF
Capital Flows to dedicated EM Funds vs. risk appetite
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Uncertainties in the EA put downward pressures on the EURO, with some regional spillover effects EUR-Yen
EUR-USD
EUR-Singapore dollar
EUR-PLN
Sources: Bloomberg; AMG;
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Risks
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Funding flows fail to offset retrenchment in bank financing EA credit to the private sector: Banks are reducing lending to households and businesses
US primary dealer corporate security inventory has fallen sharply
Credit Market Instruments, (Billions of Dollars, SA): Liquidity in many market segments remains impaired
Sources: ECB; Federal Reserve; AMG; IIF
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EA banks are pulling back Cross-border Claims* on developing countries
Cross border lending to EM has declined starting late last year and are set to intensify Growth of international bank lending to EM slowed, driven by declines in EA banks
*Cross-border claims by sector, immediate borrower basis (consolidated claims)
International Bank claims* on developing countries
Sources: IIF; BIS. AMG
*Consolidated foreign claims, ultimate risk basis
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Tighter EM lending conditions Global EM bank lending conditions index (diffusion index – 50=neutral- non-weighted average of responses from 132 banks domiciled in EM and prepared by the IIF)
The recent deterioration in EM lending conditions reflects the tightening of credit standards Europe. Policy responses in both EM and the G4, particularly the ECB mitigated the tightening in Q1:12. By category, trade finance has improved markedly.
Sources: IIF
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Central bank policy accommodation must remain in place The expansion of the G4 central banks’ balance sheets supports the risk rally
Sources: Cumberland Advisors; ECB; Federal Reserve; Bank of England; Bank of Japan
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Conclusions Global growth withstands the retrenchment in EA activity. It reflects the rising EM economic contribution to the global economy, and rising capital inflows into EM, with a commensurate move to local currency assets and corporate issuance. A deepening of the EA crisis poses risks to this dynamic through the trade and more particularly the capital flow channel: - Global trade has weakened. - The retrenchment in bank financing has put downward pressure on funding flows. - The lending pull-back is concentrated in EA banks. - EM lending conditions have turned tighter. Central bank liquidity must offset these deflationary forces. At the very least, central banks should limit contagion stemming from the deteriorating political landscape in Greece or an eventual euro-exit by Greece. In the latter scenario, the ECB should restart its bond-buying program and provide unlimited supply of liquidity, while the EUR500 billion EMS fund would provide additional firewalls that were not in place last year when the crisis last flared up. 20
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