Policy Prop for BBB (Bumpy, Below-par and Brittle) expansion

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This post is a guest contribution by Joachim Fels of Morgan Stanley.

The more things change… A lot has changed in the four months since our last global economic forecast update (see Global Forecast Snapshots: Outlook 2012: Policy Make or Break, November 28, 2011).  US policy-makers finally agreed to extend the fiscal stimulus until end-2012. The ECB responded to the euro area debt crisis by flooding the banking system with more than €1 trillion of cheap three-year loans, thus making ‘LTRO’ the most frequently used acronym in investor conversations around the globe.  Encouraged by falling inflation and worried about global recession risks, other central banks eased or ‘untightened’ policy in various forms, ranging from more subtle ones like dovish talk (the Fed in particular) and reserve ratio cuts (China, India) to blunter instruments such as rate cuts (ECB, Brazil, Indonesia and several more) and additional outright QE (BoE, BoJ).  Encouraged by this second instalment of the ‘Great Global Monetary Easing’ (or GME2), stocks have rallied, risk premia in European peripheral government bond markets have eased, and credit spreads came in. Unsurprisingly, on the back of all of this, investor sentiment has swung from ‘winter depression’ back in November to ‘spring feelings’ now.

…the more they stay the same: And still, our baseline scenario for the global economy in 2012-13 has hardly changed since those dark November days. The reason is that we had assumed significant policy responses around the globe to help arrest recession and systemic risks, and policy responses is what we got.  However, we were nervous about our base case policy assumptions and thus worried a lot about a much darker bear case scenario where further policy mistakes would plunge the world back into recession.  Luckily, these worries haven’t materialised, and to the extent that investors had similar fears, the risk rally simply reflects a collective sigh of relief because ‘bad stuff’ that could have happened didn’t. In short, by coming to the rescue once again, policy-makers, and central banks in particular, cut off the tail risks and helped the world economy to keep stumbling along rather than falling hard.

Main scenario remains BBB expansion… Our framework for looking at the world economy remains unchanged: Post-bubble economic expansions are different. Hence, ever since the credit bubble burst and policy-makers came to the rescue to prevent another Great Depression, we have been looking for only a Bumpy, Below-par and Brittle global economic expansion, particularly in the advanced economies. Three years after the Great Recession, strong headwinds to growth continue to emanate from ongoing consumer deleveraging in the US and other former bubble economies, and from banking sector and public sector deleveraging in Europe. The recent rise in oil prices on supply concerns is an additional near-term drag. Partly offsetting these headwinds are tailwinds from ongoing global monetary policy support, which has kept real interest rates in negative territory and asset markets supported, and from generally very healthy non-financial corporate balance sheets.  Reflecting these opposing forces, we look for global GDP to grow by 3.7% this year (marginally up from our 3.5% forecast last November) and 4.0% (from 3.9%) in 2013, about in line with the long-term average growth rate, but about 1-1.5 percentage points slower than the previous expansion during the credit boom.

…propped up by ongoing policy support: Without ongoing monetary policy support, the BBB global expansion would long have faltered, as it did in the euro area, which is now in recession following ECB tightening last year which aggravated the debt crisis.  Looking ahead, we think that the recent and prospective monetary easing will continue to prop up demand and keep global recession risks at bay. On our forecasts, virtually all of the major central banks, and many others, have some more easing in the pipeline this year. During the second quarter of this year, we expect the Fed to extend its Operation Twist and add (sterilised) MBS purchases, the ECB to cut rates one more time, the Bank of England to announce £25 billion additional QE, China to cut official policy rates by 25bp, India to begin embarking on rate cuts, and Brazil to deliver another (final) 75bp rate cut. Many other central banks both in DM and EM will likely follow suit with further easing.  Thus, GME2 should continue to reign supreme in the near future.  Only later in 2012 and in 2013 do we expect the easing trend to fizzle out and anticipate a few central banks to start undoing some of the easing. This is more likely to occur in EM rather than DM, as we expect EM inflation to trough out at still slightly elevated levels later this year, while DM inflation (provided the oil price roughly follows the futures path as we assume) should ease slightly throughout 2012-13.

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The HARPEX Index is superior to the Baltic Dry Index!

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Like many analysts and economists I have been an avid follower of the Baltic Dry Index (BDI) as a so-called leading indicator of global economic activity. However, I have come to the conclusion that the BDI as such is of no further use to me. The massive growth in demand for commodities from especially China from 2005 to 2008 led to a significant increase in capacity as the number of ships built surged through until the 2010 crisis that resulted in a major change in supply from relatively inelastic to highly elastic. Furthermore, it means that changes in the Baltic Dry Index occur in what is essentially a downtrend or, put differently, in a bear market.

However, I have discovered an indicator that is far superior to the BDI. The HARPEX Index was developed by Harper Petersen, a global leading chartering agent. The Index is calculated by using the actual time charter rates for seven classes of ships. This index therefore measures the rates of moving mostly finished goods globally and is an excellent indicator of global consumer activity. Unfortunately the historical data on the website only date back to 2009. (http://www.harperpetersen.com/harpex/harpexVP.do)

In the graph below I depicted the HARPEX Index against my GDP-weighted Major Economies Manufacturing PMI as well as the Markit Eurozone PMI, with both the PMIs leading by two months. In the graph it is evident that the HARPEX Index should be rated highly as a coinciding indicator in any economic forecasting model. The value of manufacturing PMIs as leading indicator comes to the fore as it is evident that the GDP-weighted manufacturing PMI of the major economies leads the HARPEX Index by two months. The bottoming and subsequent rise of the PMIs in January this year indicated that the HARPEX Index would rise through end March.  It has indeed risen from $376 at the end of February to $393 currently. The slight weakening of the major economies’ PMI in February indicates that freight rates in April are likely to go nowhere and even decline.

Sources: Harper Petersen; CFLP; Li & Fung; Markit; ISM; Plexus Asset Management.

The value of the HARPEX Index can be seen in the following graph. During the great financial crisis in 2008/2009 the HARPEX Index fell to $300 and remained relatively unchanged until February 2010. The global manufacturing sector started to expand in August 2009 when the GDP-weighted Major Economies Manufacturing PMI rose above the 50 level in August 2009. It therefore took six months of global expansion to take up the slack in the container shipping industry. Thereafter the PMI and the HARPEX Index moved in the same direction, with the PMI leading by approximately two months.

Sources: Harper Petersen; CFLP; Li & Fung; Markit; ISM; Plexus Asset Management.

The current level of the HARPEX Index is indicative of how weak the global manufacturing sector really is. This sector is still in a much better shape than in 2009 as the HARPEX Index is still 30% higher than the presumably $300 absolute minimum level at which ships can operate. In my opinion any further strength in the global manufacturing sector is likely to have an immediate impact on global containerized freight rates as the sector is not recovering from a deep recession as it did in 2009.

In a recent article I presented you with a graph of my calculated PMI seasonal factors of the CFLP Manufacturing for China against the Baltic Dry Index, which  not only explained the weakness in the BDI but also the shorter-term movements in the BDI. I argued that January/February would also mean a seasonal low for the Baltic Dry Index and a major reversal would be evident in March and April.

Sources: CFLP; Li & Fung; I-Net Bridge; Plexus Asset Management.

The BDI subsequently made a low of 647 on 3 February and is currently at 897. Although the BDI is up 38.6% it is still a far cry from what it should normally have been in light of the usually strong seasonal period. It is therefore an indication of the underlying weakness of China’s manufacturing sector.

Although I argue that changes in the Baltic Dry Index occur in a bear market due to the underlying fundamental factors, the BDI should not be discarded in total as it does give an indication of the underlying strength of China’s manufacturing sector. I regard the HARPEX Index as a better coincident indicator of global economic activity.

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Figuring out ECRI’s recession call

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I am writing this post in response to the article “Why Our Recession Call Stands” of March 15, 2012 by Lak­sh­man Achuthan and Anir­van Banerji of the Economic Cycle Research Institute (ECRI).

ECRI said: “How about forward-looking indi­ca­tors? We find that year-over-year growth in ECRI’s Weekly Lead­ing Index (WLI) remains in a cycli­cal down­turn (top line in chart) and, as of early March, is near its worst read­ing since July 2009. Close observers of this index might be under­stand­ably sur­prised by this per­sis­tent weak­ness, since the WLI’s smoothed annu­al­ized growth rate, which is much bet­ter known, has turned decid­edly less neg­a­tive in recent months. The unusual diver­gence between these two mea­sures of growth under­scores a wide­spread sea­sonal adjust­ment prob­lem that econ­o­mists have known about for some time.”

The last sentence of the above paragraph must be treated with some circumspection. What they call “the unusual divergence” is in my opinion nothing but a mathematical divergence. Let me take you through their calculation of the smoothed annualized growth rate as I figured it out. ECRI calculates a linear smoothed time-weighted index for every week based on weekly WLI values over the past 52 weeks, where each following week carries proportionately more weight than the previous week. The weekly percentage change of the time-weighted index is then calculated and annualized. My calculation of the WLI smoothed annualized growth rate is virtually a perfect fit of that of ECRI with an r-squared of 0.99.

Sources: ECRI; Plexus Asset Management.

It is therefore plain logic that the WLI smoothed annualized growth rate will lead the WLI year-over-year growth rate.

Sources: ECRI; Plexus Asset Management.

It follows that even if the smoothed annualized growth rate starts to fall in coming weeks the year-over-year growth rate will start to turn less negative.

ECRI also commented that “In spite of the efforts of mon­e­tary pol­icy mak­ers, actual U.S. eco­nomic growth has slowed, while WLI growth has barely budged from a two-and-a-half-year low.”

In previous calls ECRI emphasized the smoothed annualized growth rate of the WLI but its focus has clearly changed to the year-on-year growth rate. Will the improved year-on-year growth rate of the WLI in coming weeks change their mind and cause a big hooray about ECRI‘s change in stance or are they hoping or wishing for a major fall in the markets? It would seem the “unusual divergence” ECRI refers to and its change in focus to year-on-year growth from smoothed annualized growth are used to substantiate their call on the economy, whether it may turn out to be right or wrong.

ECRI also said “It is notable that the WLI, which is sen­si­tive to the prices of risk assets that have been sup­ported by mas­sive world­wide liq­uid­ity injec­tions, has hardly been swayed from its reces­sion­ary tra­jec­tory.”

In analyzing the WLI I concentrated on three major assets, namely the S&P 500, US 10-year Government Bond Yield and the Economist Metals Index. My analysis indicates that ECRI again focused on year-on-year growth rather than on smoothed annualized growth rates when they made the statement.

The U.S. stock indices may have a major impact on the calculation of the WLI. This is evident when the year-on-year growth of the S&P 500 Index is compared to that of the WLI. The growth rate of the S&P 500 Index bottomed at zero percent and is on the rise. This should impact positively on the WLI.

Sources: ECRI; I-Net; Plexus Asset Management.

The smoothed annualized growth rate of the S&P 500 Index is clearly exerting upward pressure on the smoothed annualized growth rate of the WLI.

Sources: ECRI; I-Net; Plexus Asset Management.

The prices of materials could have a major impact on the WLI and the Economist Metals Index is probably a good proxy for the prices of materials. The year-on-year growth rate of the Metals Index is currently impacting negatively on the year-on-year-growth rate of the WLI.

Sources: ECRI; I-Net; Plexus Asset Management.

The smoothed annualized growth rate of the Economist Metals Index is clearly exerting upward pressure on the smoothed annualized growth rate of the WLI.

Sources: ECRI; I-Net; Plexus Asset Management.

The U.S. bond market could have a major impact on the WLI and the 10-year Government Bond Yield is probably a good proxy for the U.S. bond market. The year-on-year growth rate of 10-year bond yield index is currently impacting negatively on the year-on-year-growth rate of the WLI.

Sources: ECRI; I-Net; Plexus Asset Management.

The smoothed annualized growth rate of the 10-year bond yield is clearly exerting upward pressure on the smoothed annualized growth rate of the WLI.

Sources: ECRI; I-Net; Plexus Asset Management.

It would seem that the WLI is in fact currently swayed AWAY “… from its reces­sion­ary tra­jec­tory” (ECRI’s quote), especially due to the fact that the smoothed annualized growth rates lead year-on-year growth rates.

ECRI said: “The unusual diver­gence between these two mea­sures of growth under­scores a wide­spread sea­sonal adjust­ment prob­lem that econ­o­mists have known about for some time.”

I assume the “wide­spread sea­sonal adjust­ment prob­lem” ECRI refers to is the markets’ reaction to the seasonal adjustments that per se influence the WLI. Surely, similar previous reactions or, put differently, price and yield movements due to adjustments, have been taken into account in all the data series and were included in ECRI’s previous calls?

I am an investment professional and not an economist and regard the WLI and ECRI’s calls on the economy of great value and indispensable. Whether I agree or disagree with their current recession call is not the point, but I urge them to stick to the original interpretation of their WLI and not to be selective in the interpretation that may be viewed as justifying their view on the economy. After all, markets are extremely well informed and their anticipation of future economic trends is nearly perfect, hence the construction of ECRI’s WLI and the great value it offers to non-economists.

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Global PMI Scorecard: Services sector drives acceleration in global growth

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Growth in global economic activity continued to accelerate for the fourth consecutive month in February. Highlights of the February PMIs are as follows:

  • The JP Morgan Global Composite PMI increased to 55.5 from 54.5 In January.
  • The JP Morgan Global Services PMI jumped to a rather robust 56.5 from 55.4 in January.
  • Growth in the global manufacturing sector slowed markedly, mostly as a result of a sharp slowdown in the U.S.
  • After stabilizing in January the Eurozone economy is sliding again as the situation in Italy, Spain and Greece has worsened.
  • Growth in the BRICS countries is accelerating, especially in larger China.
  • Pockets of robust growth are emerging:
    • U.S. non-manufacturing sector
    • India’s manufacturing and services sectors
    • Brazil’s services sector
    • South Africa’s manufacturing sector
    • Saudi Arabia’ overall economy.
 

GDP-weighted Composite PMI

 

Direction

 

Rate of change

CountryFeb-12Jan-12Dec-11
U.S.***56.256.252.7GrowingSame
U.S. BAI***(note 1)60.258.254.9GrowingFaster
Eurozone****48.950.048.3ContractingFrom stalling
Germany*53.253.951.3GrowingSlower
France*50.251.250.0Stalling againSlower
Italy****45.045.344.4ContractingFaster
Spain****42.745.842.5ContractingFaster
U.K.****53.154.952.8GrowingSlower
Japan*51.251.150.1GrowingSlightly faster
Australia47.951.849.3ContractingFrom growing
Emerging Economies
China**50.051.552.6StallingSlower
China S/A**54.253.152.4GrowingFaster
Brazil*55.553.853.2GrowingFaster
India*57.859.654.7Growing/robustSlower
Russia*53.754.453.5GrowingSlower
Hong Kong*52.851.949.7GrowingFaster
UAE*52.052.451.7GrowingSlower
Saudi Arabia*59.660.057.7Growing/robustSlower
JP Morgan Global Composite*  

55.5

 

54.5

 

52.7

 

Growing

 

Faster

Note: ISM Non-manufacturing Business Activity Index used instead of Non-manufacturing PMI
Sources: *Markit; **CFLP, Li & Fung, Plexus Asset Management; ***ISM, Plexus Asset Management; ****Markit, Plexus Asset Management.

Non-Manufacturing/Services PMIDirectionRate of Change
CountryFeb-12Jan-12Dec-11
U.S.*****57.356.852.6GrowingFaster
U.S. BAI***** 62.659.555.5Growing/robustFaster
Eurozone*48.850.448.8ContractingFrom growing
Germany*52.853.752.4GrowingSlower
France*50.052.350.3StallingFrom growing
Italy*44.144.844.5ContractingFaster
Spain*41.946.142.1ContractingMuch faster
Ireland*53.348.348.4GrowingFrom contracting
U.K.*53.856.054.0GrowingSlower
Japan*51.251.050.4GrowingFaster
Australia*46.751.949.0 

ContractingFrom growing
Emerging Economies
Brazil*57.155.054.8Growing/RobustFaster
China**48.452.956.0ContractingFrom growing
China S/A57.656.355.3GrowingFaster
India*56.558.054.2RobustSlower
Russia*55.356.553.8GrowingSlower
JP Morgan Global Services*****56.555.453.0 

GrowingFaster

Sources: Markit*; Li & Fung**; Kagiso***; Plexus Asset Management****; ISM*****.

 

Manufacturing PMI

DirectionRate of Change
CountryFeb-12Jan-12Dec-11
U.S.*****52.454.153.1GrowingSlower
Eurozone*49.048.846.9ContractingSlower
Germany*50.251.048.4StallingFrom growing
France*50.048.548.9StallingFrom contracting
Greece*37.741.042.0ContractingFaster
Italy*47.846.844.3ContractingSlower
Spain*45.045.143.7ContractingFaster
Ireland*49.748.348.6ContractingSlower
U.K.*51.252.049.7GrowingSlower
Japan*50.550.750.2GrowingSlower
Australia*51.3 51.650.2GrowingSlower
Emerging Economies
Brazil*51.450.649.1GrowingFaster
China**51.050.550.3GrowingFaster
China SA****51.951.050.5GrowingFaster
Czech*50.548.449.2GrowingFrom contracting
Poland*50.052.248.8StallingFrom growing
Turkey*49.651.752.0ContractingFrom growing
India*56.657.554.2RobustSlower
Russia*50.750.851.6GrowingSlower
Taiwan*52.748.947.1GrowingFrom contracting
RSA***57.953.249.4RobustFaster
Global****50.8 51.550.3GrowingSlower

Sources: Markit*;.Li & Fung**; Kagiso***; Plexus Asset Management****;.ISM*****.

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Global manufacturing sags again in February: U.S. the culprit!

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After rebounding from contraction in November last year the global manufacturing sector finds itself on the brink of stagnation again. The GDP-weighted manufacturing PMI that I calculate for the major economies fell to 50.8 in February from 51.5 in January, but is still higher than the 50.3 I recorded in December last year.

The U.S. ISM Manufacturing PMI’s fall to 52.4 in February from 54.1 in January contributed 0.6 points to the fall in the GDP-weighted PMI. Excluding the U.S., growth in the manufacturing sector in the rest of the world remained basically unchanged.

Although still indicating contraction at 49.0 the Markit Eurozone Manufacturing PMI shows that the manufacturing sector in the region is stabilizing.

Growth in Greater China is accelerating, with my seasonally adjusted CFLP Manufacturing PMI up to 51.9 from 51.0 in January, while the manufacturing sector in Taiwan is at long last growing again. The growth outlook in the other BRICS countries has turned for the better, with South Africa’s PMI surging to 57.9 from 43.2 in January while Brazil’s PMI rose to 51.4 from 50.6.

 

Manufacturing PMI

DirectionRate of Change
CountryFeb-12Jan-12Dec-11
U.S.*****52.454.153.1GrowingSlower
Eurozone*49.048.846.9ContractingSlower
Germany*50.251.048.4StagnatingFrom growing
France*50.048.548.9StagnatingFrom contracting
Greece*37.741.042.0ContractingFaster
Italy*47.846.844.3ContractingSlower
Spain*45.045.143.7ContractingFaster
Ireland*49.748.348.6ContractingSlower
U.K.*51.252.049.7GrowingSlower
Japan*50.550.750.2GrowingSlower
Australia*51.3 51.650.2GrowingSlower
Emerging Economies
Brazil*51.450.649.1GrowingFaster
China**51.050.550.3GrowingFaster
China SA****51.951.050.5GrowingFaster
Czech*50.548.449.2GrowingFrom contracting
Poland*50.052.248.8StagnatingFrom growing
Turkey*49.651.752.0ContractingFrom growing
India*56.657.554.2RobustSlower
Russia*50.750.851.6GrowingSlower
Taiwan*52.748.947.1GrowingFrom contracting
RSA***57.953.249.4RobustFaster
Global****50.8 51.550.3GrowingSlower

Sources: Markit*; Li & Fung**; Kagiso***; Plexus Hodings****; ISM*****.

Sources: Markit*; Li & Fung**; Kagiso***; Plexus Holdings****; ISM*****.

Sources: Markit*; Li & Fung**; Kagiso***; Plexus Holdings****; ISM*****.

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Roach on U.S. economy, Fed policy, China, Europe

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Stephen Roach, non-executive chairman of Morgan Stanley Asia, discusses the U.S. economy, Federal Reserve monetary policy, China’s economic strategy and the prospects for Europe. He talks with Bloomberg’s Tom Keene at the World Economic Forum in Davos, Switzerland.

Source: Bloomberg, January 26, 2012.

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