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Capital Daily %2819th Mar 2015%29 .pdf



Original filename: Capital Daily %2819th Mar 2015%29.pdf
Title: The World is our Oyster Second Quarter 2000
Author: CAPITAL ECONOMICS

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th

19 March 2015

UK election may cause more market turbulence than the Budget


How will the markets fare leading up to Fed tightening? (see Chart of the Day)



US FOMC likely to have dropped “patient” from its latest statement



Swiss National Bank and Norges Bank set to cut rates (08.30 GMT & 09.00 GMT)

Key Market Themes
The initial response in the Gilt market to Wednesday’s
UK budget has been muted. This is probably because
the Chancellor has largely maintained his existing
programme of fiscal austerity (see UK section below).
Admittedly, the Treasury will rely more heavily on longterm bonds for its financing needs. But the shift in its
funding strategy is not very significant – according to the
debt and reserves management report, the value of gilts
with a maturity of 7-15 years will increase from 20% to
21% of total issuance in the next financial year.
We suspect the outcome of May’s general election may
have a much bigger impact on gilts, UK equities and
sterling. After all, it could result in a fragile coalition
and lead to either a disruptive referendum on the UK’s
EU membership or the higher taxation of profits and
wealth, which could trigger capital outflows. (For more
on our reaction to the Budget, see our forthcoming UK
Economics Focus.) (Kevin Ferriter)

What to watch for today: US
Although the trade deficit widened in Q4, we estimate
that the overall current account deficit (12.30 GMT) fell
to around $98.0bn, or 2.2% of GDP, from $100.3bn
(2.3%) in Q3, as the primary income surplus probably
rose slightly.
Meanwhile, after falling over the past few months, we
expect that the Philly Fed manufacturing index (14.00
GMT) stabilised in March – we have pencilled in a slight
rise to 8.0. (Adam Collins)

With the labour market still evidently on fire in
February, we expect the FOMC statement (18.00 GMT
Wednesday, after publication of this Capital Daily) to
omit the language that the Fed can be “patient” in
beginning to normalise monetary policy. Even with
headline inflation below zero, we then anticipate a first
hike in June, with the FOMC pushing the target range
for the fed funds rate to 1.00-1.25% by the end of this
year and 2.75-3.00% by end-2016. (Paul Ashworth)

Canada
No major data or events scheduled for today.

Continental Europe
We see the Swiss National Bank (SNB) cutting its
deposit rate from -0.75% to -1.00% (08.30 GMT).
Admittedly, the franc has softened a bit after it surged in
January following the shock abandonment of the cap.
But, at CHF 1.06 per euro, it remains much too high for
comfort. Elsewhere, faced with an economic slowdown
and mounting disinflationary pressures, we expect the
Norges Bank to cut its main policy rate (09.00 GMT) by
25bp to 1.00% and suspect that further cuts will follow.
Meanwhile, the ECB’s third Targeted Longer-Term
Refinancing Operation (10.15 GMT) will, unlike the first
two, which offered unconditional funds for the first two
years, limit borrowing to three times banks’ net new
lending since last April. As overall bank lending has
fallen since then and uptake at the first two TLTROs was
low, we doubt that banks will borrow much this time.

SELECTED DATA AND EVENTS
GMT
th

Wed 18

NZ GDP (Q4, Production)

Thu 19th

Swi SNB Interest Rate Announcement
Nor Norges Bank Interest Rate Announcement

q/q/(y/y)

21.45

Previous*

Median*

+1.0%(+3.2%) +0.8%(+3.4%)

CE Forecasts*
+0.9%(+3.5%)

08.30

-0.75%

-0.75%

-1.00%

09.00

1.25%

1.00%

1.00%

EZ ECB Monthly Bulletin

09.00

-

-

-

EZ Hourly Labour Costs (Q4)

10.00

(+1.3%)

-

(+1.0%)

EZ Third ECB TLTRO Allotment

10.15

€130bn

-

€20bn

US Current Account (Q4)

12.30

-$100.3bn

-$104.1bn

-$98.0bn

US Initial Jobless Claims (14th Mar)

12.30

289,000

293,000

-

US Philly Fed Index (Mar)

14.00

+5.2

+7.0

+8.0

14.00

+0.2%

+0.2%

+0.3%

US Index of Leading Indicators (Feb)
*m/m(y/y) unless otherwise stated; p = provisional

Capital Daily 1

Chart of the Day
The US FOMC is likely to have judged on Wednesday
(after the publication of this edition of the Capital Daily)
that it can no longer be patient in beginning to
normalise the stance of monetary policy. If so, we think
it is most likely that the Committee will raise its target
th
for the federal funds rate for the first time on 17 June,
which is almost exactly three months away. (See US
section.) What sort of reaction can we expect to see in
the financial markets in the meantime?
While not necessarily a guide to the future, the past may
provide some insight. In the last quarter of a century,
there have been three major US monetary tightening
cycles, which we define as occasions when the federal
funds rate was increased by at least one percentage
point in total. These began in February 1994, June 1999
and June 2004. The Chart below shows the returns in
the three months leading up to the first increase in the
federal funds rate in 1) the trade-weighted value of the
US dollar against other major currencies; 2) the S&P
500; 3) 7-10yr US Treasuries; and 4) 7-10-year US BBBrated corporate bonds.
CHART: RETURNS FROM US DOLLAR, EQUITIES & BONDS
IN THE 3 MONTHS LEADING UP TO THE START OF THE LAST
THREE MAJOR FED TIGHTENING CYCLES (%)
8
6
4
2
0
-2
-4
-6
-8

8

1994

6

1999

4

2004

2
0
-2
-4
-6

Dollar
Major
TWI

S&P
500

7-10yr US
Treasuries

7-10yr US
BBB-Rated
Corp. Bonds

Sources – Thomson Datastream, CE

Two things stand out. First, the dollar and the stock
market rose each time. Second, bonds fared poorly on
the last two occasions, with little to choose between the
returns from those issued by the US government and
those issued by US BBB-rated corporations.
We doubt things will be dramatically different this time
around. Our expectation is that the dollar will continue
to be supported by the stark contrast in the prospects for
interest rates in the US and elsewhere; we anticipate that
the stock market will hold up quite well, although a
squeeze on profit margins is likely to weigh on its
performance; and we foresee a further increase in bond
yields as investors recalibrate their expectations for
monetary policy. (For more, see our Global Markets
Focus, “How will the outlook for monetary policy affect
th
the markets?”, 19 December, 2014.) (John Higgins)

The European Council meeting, beginning today, is set
to focus on employment policies rather than Greece.
But representatives of the newly-renamed Brussels
Group (previously the Troika) will remain in Athens
conducting “technical talks” about reform and austerity
measures. With the talks unlikely to result in the
disbursement of bailout money at this stage, Greece will
remain dependent on domestic sources such as its
agricultural and pension funds to make scheduled
repayments to the IMF this week. (Jennifer McKeown)
January’s euro-zone trade data (released on
Wednesday) suggested the region’s exports are still not
benefitting substantially from the weakness of the euro.
Admittedly, the non-seasonally-adjusted trade surplus
rose to €7.9bn – its strongest January outturn since the
single currency’s creation. But this was only because the
5.6% y/y fall in imports outpaced the 0.4% decline in
exports. (Jack Allen)
Sweden’s Riksbank followed up its recent hints of more
policy action by cutting its repo rate from
-0.1% to -0.25% at Wednesday’s unscheduled meeting
of the executive board. The key prompt seemed to be
the recent strength of the krona, which has risen by 5%
against the euro over the last month. The Riksbank said
that it expects the repo rate to remain at -0.25%, but
reiterated that it was prepared to loosen policy again.
Further rises in the krona against the euro as the ECB’s
QE programme progresses may prompt both further rate
cuts and bigger asset purchases.
Iceland’s central bank left its main interest rates on hold
at its scheduled meeting on Wednesday as it waits to
judge the outcome of the ongoing wage negotiations.
The seven-day collateralised lending rate was left at
5.25% and the rate on seven-day term deposits, which it
has recently started referring to as its key interest rate,
was left at 4.50%. But with labour market tensions
growing and domestic demand strong, we think that the
next move in interest rates will be up. (Jessica Hinds)

UK
No major data or events scheduled for today.
Chancellor George Osborne stuck to his word on
Wednesday and delivered a fully-funded budget despite
the fact that an election is just around the corner.
Accordingly, the money saved from downward revisions
to expected welfare and debt interest payments has
translated into lower borrowing forecasts, putting the
Chancellor back on track to meet his secondary fiscal
rule to get debt as a share of GDP falling by 2015/16.
The Chancellor will now run a smaller surplus of £7bn
due to scaling back spending cuts, but the big picture is
that the fiscal squeeze is still only halfway through.

Capital Daily 2

The latest labour market figures were a bit
disappointing, with the ILO unemployment rate holding
steady at 5.7% in January, rather than dropping as
expected. And wage growth slowed, with the annual
growth rate of average weekly earnings falling from
2.4% to 1.1%. (Data released on Wednesday.) As
pointed out in the MPC minutes of March’s meeting,
pay growth is still below the rates that are consistent
with inflation returning to its target. And Governor Mark
Carney’s comments that the rise in the pound raises the
risk of a prolonged period of very low inflation were
echoed. Accordingly, an interest rate rise still looks to be
some way off. (Vicky Redwood)

Japan
No major data or events scheduled for today.
The seasonally-adjusted trade deficit widened from
¥412bn in January to ¥639bn in February as a plunge in
export volumes offset another decline in the cost of oil
imports. (Data released on Tuesday after publication of
the last Capital Daily.) Net exports should therefore
become a drag on GDP growth soon. (Marcel Thieliant)

China
No major data or events scheduled for today.

Other Emerging Markets
No major data or events scheduled for today.
The slowdown in annual economic growth in Colombia
in Q4 of last year was relatively broad-based, and with
fiscal policy tightening and export revenues plummeting
in recent months, we expect growth to slow further over
the coming quarters. (Data released on Tuesday after
publication of the last issue of the Capital Daily.) Our
forecast is for a below-consensus expansion of just 2.5%
this year. In contrast, GDP growth in Chile accelerated
in both quarterly and annual terms in the final quarter of
last year, driven by strong government spending and a
sharp pick-up in investment. (Data released on
Wednesday.) Accordingly, the scene is set for a stronger
economic performance this year. (Edward Glossop)

Melanie Debono (+44 (0)20 7811 3911)
melanie.debono@capitaleconomics.com
th

Australia & New Zealand
Our calculations suggest New Zealand’s economy
continued to grow at a healthy pace at the end of last
year, with the 1.0% q/q increase in GDP on the
production measure in Q3 being followed by a 0.9%
increase in Q4 (21.45 GMT Wednesday, after
publication of this Capital Daily). We doubt, however,
that GDP will rise as rapidly this year. (Paul Dales)

Published at 16.12 GMT 18 March 2015
Editor: John Higgins

Capital Economics
Managing Director: Roger Bootle
For a trial of our other services go to our website: www.capitaleconomics.com. Subscribers may make copies of this note for use at
their location, but no further distribution is allowed without specific permission. Disclaimer: while every effort has been made to
ensure that the data quoted and used for the research behind this document is reliable, there is no guarantee that it is correct, and
Capital Economics Limited can accept no liability whatsoever in respect of any errors or omissions. This document is a piece of
economic research and is not intended to constitute investment advice, nor to solicit dealing in securities or investments.

Capital Daily 3


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