Broadgate: Weekly Briefing 21/01
21 January 2014
U.S. – Negotiators from the US Senate and House of Representatives have agreed on a spending deal worth $1trn which reduces the risk of another government shutdown, at least until October.
The broad spending deal, which is the first the US government has agreed since 2009, details how the country’s budget will be spent and marks another move in the return to regular budgeting by Washington.
It follows a 16-day government shutdown in October last year after a standoff between Republicans and Democrats – who control the House and Senate respectively – led to legislation appropriating funds for fiscal year 2014 not being enacted.
The new deal updates the US’ spending priorities after several years of “continuing resolutions” have kept the government functioning but prevented funds from being reallocated.
Global – The global economy is at a “turning point”, the World Bank has said, as it forecasts stronger growth for 2014. In its annual report on the world economy, the bank said richer countries appeared to be “finally turning a corner” after the financial crisis.
That is expected to support stronger growth in developing economies.
But it warned growth prospects “remained vulnerable” to the impact of the withdrawal of economic stimulus measures in the US. The US Federal Reserve has already begun to wind down its monthly bond-buying programme, previously set at $85bn (£52bn) a month.
There is concern this could push up global interest rates, which could affect the flow of money in and out of developing countries and lead to more volatile international financial markets.
Europe – European shares scaled fresh 5-1/2 year highs on Wednesday, buoyed by strong data and a brighter outlook for the global economy, as well as by easing regulatory concerns about euro zone banks.
Financial stocks provided the biggest boost to the FTSEurofirst 300 index after the European Central Bank said lenders will not be required to adjust sovereign debt portfolios they hold to maturity to reflect current market values.
The biggest gainers, such as Societe Generale and B P Milano, have large exposure to sovereign bonds in the region.
The sector is already up 9.3% this year. It received a boost this week when banking regulators agreed to ease regulation of balance sheets to try to avoid crimping financing for the world’s economy.
“Euro zone banks had good news from Basel at the beginning of the week, and it looks like regulators are lessening the regulatory burden on the banking sector,” Gerard Lane, equity strategist at Shore Capital, said.
Trends – Fund investors poured money into bond portfolios and cash while selling equities in the first full week of 2014, in contrast to the apparent start of the ‘great rotation’ at the beginning of last year.
According to fund flow data provider EPFR Global, bond funds captured a net $5.2bn of new money during the week ending 9 January, while equity funds were hit with a collective redemption of $427m. Money market funds took almost $23bn.
Within the fixed-income space, European bond funds benefited from their largest inflows since late April 2013 while US bond funds took the most money since the middle of November. Furthermore, emerging markets local currency bond funds broke a 14-week outflow streak to capture new money.
EPFR Global says: “In contrast to the first full week of 2013, when record setting flows into EPFR Global-tracked emerging market and global equity funds kicked the ‘great rotation’ narrative into high gear, the new year kicked off with bond funds posting their biggest weekly inflow since early May while equity funds recorded modest net redemptions.”
Commodities – Global demand for energy will grow at a slower pace over the next two decades, a report from the oil giant BP predicts.
BP’s Energy Outlook says energy demand will rise by 41% between now and 2035 – less than the 55% growth seen over the past 23 years. It said increased fuel efficiency in developed economies was behind the predicted slowdown.
But demand from emerging economies is expected to continue to rise strongly.
Some 95% of the growth in global demand will come from developing countries, BP predicts, with China and India alone accounting for half the increase.
In contrast, energy demand in advanced economies in North America and Europe is expected to see only slow growth.
Spotlight on: Outlook for 2014
Anna Stupnytska, macro economist at Goldman Sachs Asset Management, reveals the group’s global outlook for 2014.
The euro area’s expansion is poised to continue in 2014, although growth acceleration is likely to be muted, especially given weak credit growth. The material progress by the peripheral countries in improving competitiveness, and pushing through structural reform, should help reap growth benefits. We expect further rebalancing between the core and periphery to continue gradually, together with slow convergence of financial conditions within the euro area.
At the same time, the European Central Bank will need to ease policy further to combat disinflationary forces. Certainly, Germany could help the process by raising wages faster and tolerating higher inflation, but this seems unlikely.
Japan faces a significant challenge in 2014, as it seeks to consolidate the positive growth impulse of Abenomics against the backdrop of the consumption tax hike. A fiscal package of around ¥5tn should come into force and, despite a volatile growth path, we expect Japan to grow at trend of 1.5% in 2014.
Our growth outlook points to greater divergence in monetary policy cycles, as we expect the Federal Reserve to start tapering in the first half of 2014. Interestingly, Japan’s current efforts to import inflation mean it is exporting disinflation to its trading partners, including Europe. Emerging headwinds.
After a weak 2013, we expect growth and emerging market economies to finally start picking up momentum, despite moderately higher global interest rates. However, in our view, none of the eight growth markets, for which we produce forecasts, will be able to reach their trend growth in 2014.
Progress on post-crisis structural reforms has been disappointing, and the recent sluggish growth has reflected this. Only China and Mexico have delivered good news on this front recently.
Pressures on external funding from rising rates globally, and a slower China, will nevertheless serve as headwinds going forward.
Countries with persistent current account deficits, such as Turkey, South Africa, Brazil, India, and Indonesia, are likely to feel the pressure of tighter financial conditions, especially in light of elevated inflation levels.
Moderately-paced growth in private sector credit should be a welcome support to the cycle, while, domestically, credit growth is showing signs of stabilisation in parts of Asia and Latin America. As the US and Europe accelerate, countries more tightly associated with developed market consumers, such as Korea and Mexico, should also be positioned well.
Equities or bonds?
We believe equities are best positioned to perform well in this stage of the cycle, and developed market equities are favoured. While flows into developed market equities have already been strong, we expect better corporate earnings, particularly in Europe and Japan, to drive the next leg of the equity rally.
The prospect of further easing by the Bank of Japan, coupled with domestic asset allocation shifts into riskier assets, could provide a strong impetus for the Japanese market.
The benign environment for equities should also be supportive for corporate credit spreads, although the upside could be limited by stretched valuations and, for cash bonds, higher sensitivity to the rise in US rates.
For currencies, we expect broad dollar strength, driven by wider interest rate differentials and the dollar’s relative ‘cheapness.’ In fixed income, we expect US rates to move higher overall, particularly for longer-dated instruments.
While global inflation is expected to remain subdued on average, mainly driven by below-target rates in developed markets, intensifying inflationary pressures in some growth and emerging markets will make policy trade-offs more difficult.
Indonesia, Brazil, Russia, and Turkey face the prospects of tighter monetary policy as a result of unemployment being close to potential, and are likely to be more vulnerable. Once a broader growth pick-up becomes more evident, emerging market equities could be well positioned to deliver positive returns, particularly given attractive current valuations relative to developed markets.
The main risks to our views are: US growth weakness, tighter-than-expected US monetary policy, and stress in China’s financial system. In either of the first two cases, equity markets would likely see a material sell-off in the face of either lower earnings, or the diminishing effects of loose monetary policy.
A repricing of monetary policy prospects could create a difficult environment for investors as correlations between stock and bond returns could turn positive, leaving fewer places to take shelter.
Regarding the large amount of leverage in China’s financial system, we will be watching for potential signs of stress in the banking system and real estate market. While the government’s balance sheet remains strong, unintended tightening could be particularly challenging for commodity producers and the broader growth and emerging market universe.
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