Research Dept. News
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Monthly Report, num 353 - January 2012
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International review
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United States
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The United States: the winds of improvement
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The United States ends 2011 in a more robust state than expected.
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The US economy is affirming its growth and continuing what, in principle, appeared to be an upswing limited to the third quarter. The latest indicators suggest that fourth quarter growth might exceed 0.7% quarter-on-quarter, clearly above what was expected a month ago, which would leave growth for the whole of 2011 at 1.8%. However, this does not mean that the crisis has been averted. In 2012, this moderate improvement in the prospects for domestic demand will be reduced by the European crisis and the expected withdrawal of fiscal policy, so that growth is not expected to go much beyond 2.0%, a rate that is not enough to bring about an end to the weak labour and housing market.
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Growth will be modest in 2012, affected by the European crisis.
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The good tone expected for the fourth quarter is based equally on the robustness of capital goods investment in addition to an upward stock cycle and private consumption that, judging by the latest indicators, will maintain the good tone of the third quarter. Another positive factor to take into account for 2012 might be less of a fiscal withdrawal than expected. The heads of agreement reached by the Senate to extend the lower tax rate on wages and unemployment insurance, should it be approved by Congress, would avert the threat posed to the development of employment and private consumption by such measures coming to an end.
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Consumer confidence improves.
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However, this improved outlook is likely to be sullied by the European crisis. Europe's banks hold 3.3% of the total gross debt of the US economy, 1.8 trillion dollars combining that of households, firms and the public sector. Should the European crisis continue for some time, this would result in tougher financing terms for this debt which could deduct up to 0.8% points from growth in 2012, a probability that pushes the 2012 forecast down.
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The good performance shown by private consumption was mainly reflected in the sharp rise in consumer confidence. In November, the Conference Board Consumer Confidence index saw its highest monthly increase of the last 15 years, going from 40.9 to 56.0 points. Although this level is still more consistent with recession than expansion, such improvement confirms that the recovery is becoming more firmly established. A good example of this is the good performance by retail sales. Excluding the volatile automobiles and petrol, retail trade was up 5.6% year-on-year in November, with a slight slowdown in the indicator due to, in part, the upwardly revised figures for October and September. Nevertheless, during the first half of 2012 the push from private consumption will be limited by the trend in household income, still growing less than consumption.
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The labour market is still weak, with a slow recovery.
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This necessary improvement in income will depend on the trend in the labour market, which is the true touchstone for this crisis. The weakness in the labour market has been closely linked to the bursting of the real estate bubble but some figures suggest that employment might recover faster than housing. To date, the recovery in the labour market has been partly hindered by the high rate of under-employment; i.e. workers who are involuntarily working part-time. This is the case because, when the demand for labour increases, these under-employed workers recover the hours they had lost, delaying the hiring of new employees. The share of under-employed workers is still very high, with 8.4 million workers stating that they are working part-time due to a lack of demand. Of the 8.75 million jobs lost during the crisis, only 2.5 million have been regained in the last 21 months.
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The recovery might start with a reduction in under-employment.
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However, things might be starting to change. In November, the figures for hours worked reached 33.6 hours a week on average, close to the pre-crisis level (33.8) and leaving behind the minimum of 33.0 hours that had prevailed between June and October 2009. Historically, an increase in hours worked per week precedes a reduction in under-employment so that, should this pattern continue, we might start to see some reduction in under-employment over the coming months. This would result in an effective recovery of the labour market, which would start to be seen in the second half of 2012. The road is still plagued with difficulties, however. In November, unemployment fell to 8.6% but this improvement was largely due to a smaller labour force and all the evidence suggests that it won't move very far from 9.0% throughout 2012. The two million jobs lost in the construction industry, whose workers are difficult to relocate, the high number of discouraged workers and the proportion of long-term unemployed continue to weigh heavy on its recovery.
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Industry has plenty of room to improve but moderates its recovery.
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The housing market is still afflicted by excessive supply, boosted by mortgage foreclosures. Consequently, prices have yet to touch bottom. The drop in the Case-Shiller index for second-hand housing, which in September was sharper than in August, points to the recovery still being some time off (the second half of 2013, according to our forecasts). The improvement in construction activity is based on low base levels. The 685,000 new homes started in November, in annual terms, represent a rise of 24.3% year-on-year, which will mean that the sector will contribute to growth, but the reality is that these levels are still less than half the typical levels in the period 1995-2000, prior to the bubble.
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With regard to investment, improvements in corporate earnings and tax breaks for investment, which might also be extended to 2012, contributed to a strong advance in the third quarter that will probably moderate gradually. The question here is one of sustainability. Perhaps because of this, the improvement in the business sentiment indices of the Institute of Supply Management (ISM) for manufacturers and services is much more timid that the growth in investment spending in the third quarter. The manufacturing ISM for November rose by 50.8 to 52.7 points, while the services index went from 53.8 to 56.2 points. Levels that, although better, are still consistent with modest economic growth. Along the same lines, although industry still has a long way to improve, its rate of recovery is tending to subside. Proof of this is the trend in industrial production, which dropped back slightly in November, as well as the slowdown in the improvement in production capacity utilization, which has been slower throughout 2011 than in 2010.
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The CPI rises 3.4% and core inflation by 2.2%, but it should ease in 2012.
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The persistence of low growth and commodity prices whose trend is nothing like the one seen in the first half of 2011 should make inflation ease throughout 2012. However, in November the consumer price index (CPI) saw a minimal slowdown, with a year-on-year rise of 3.4% (3.5% in October) while, for its part, core inflation, which excludes energy and food prices, halted its downward slide of the last few months to post an increase of 2.2% year-on-year, slightly higher than the 2.1% of October. The contribution to inflation of rent attributed to housing moderated in November but was replaced by other components, such as clothing and healthcare.
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Japan sees a decline in 2011, while it expects 2012 to be a year of expansion.
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The correction in the foreign sector's trade imbalance continues. The trade balance of goods and services for October was 43.5 billion dollars, 24.4 billion excluding oil and its derivatives, the lowest figure since June. However, in October the improvements were more because of weak imports than increased exports that, after two months of rises, suffered from weaker global demand. The foreign sector's contribution to growth will therefore be limited in 2012, so the US economy will have to continue to look to its domestic demand for support.
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Japan
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Japan: worse than expected
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But growth will suffer from weak global demand.
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Japan significantly revised downwards its growth for the first three quarters of 2011, particularly the first quarter. This reveals that the consequences of the earthquake in March and of the Fukushima nuclear crisis were more severe than had initially been thought, so we believe that the economy will decline by close to 0.6% for 2011 as a whole. The recovery should gain in strength in 2012, with growth coming close to 2.5%. This strength will be based on low base levels, as the declines of 2011, added to those of 2009, will mean that the economy will still be clearly below its production potential for the next two years.
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Given its dependence on exports, which provided five sixths of the economy's total growth in the third quarter, the recovery will be hindered by the slowdown in world demand. Exporters blame the strong yen and have lowered their expectations, as shown by the Tankan business sentiment index published by the Bank of Japan. Similarly, the 3.5% drop in exports month-on-month in October points to more modest rises in the fourth quarter.
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Public indebtedness is high and deflation continues.
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Another difficulty lies in the indebtedness of the country's public coffers. In this respect, after several extraordinary reconstruction budgets, public expenditure was already showing signs of exhaustion in the third quarter. On the positive side, industrial production grew by 2.2% month-on-month after September's bad figures.
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The CPI also fell in October to 0.2% year-on-year, while the core CPI, the general index without energy or food, fell to 1.1% year-on-year, indicating that deflation continues.
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China
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China: the priority is to go on growing
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The possibility of lower economic growth has become the main risk for China's economy. For 2012 we predict 8.4% growth, which represents a slowdown although it is still consistent with a soft landing scenario. In the summer, inflation was the greatest hazard; one month ago there was talk of a fine adjustment but, at the end of the last meeting of the economic authorities, it was established that the main aim of economic policy must be to maintain fast growth in a tough, complicated international environment.
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Exports continue to fall behind, affected by the European crisis and Asia's lower demand.
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Inflation fell sharply in November, with the CPI posting a rise of 4.2% year-on-year, when in July this had reached 6.5%. The CPI for food, which in China accounts for half the general index, slowed up even more to 8.8%, clearly lower than the 14.8% for July. Similarly, business indicators continue to decelerate, pointing to a moderation in growth consistent with a soft landing. Industrial production advanced by 12.4% year-on-year, the slowest pace since April 2009, and electricity production and retail sales moved along the same lines.
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The foreign sector, once the bastion of economic expansion, continues to weaken. November's trade surplus fell to 14.5 billion dollars, a little more than half the average of 2008, prior to the crisis in world trade, and with exports that continued to fall behind compared with the economy as a whole. By geographical area, the slowdown in exports to the rest of Asia is particularly significant, accounting for half the total and whose year-on-year growth of 13.4% is the lowest since the 2009 crisis in trade flows. The European crisis is also having an effect on Chinese exports. Exports to Europe rose by a meagre 6.9% year-on-year while those for the United States grew by 21.5%.
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Residential construction shows signs of exhaustion and constitutes a risk to growth.
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With a private consumption that still accounts for less than 40% of gross domestic product (GDP) and a foreign sector that is losing its drive, the supports for growth are limited to investment. Of particular note within this area of investment is the housing sector. Construction accounts for 13% of GDP and absorbs close to 40% of the steel consumed by China, the world's largest importer. Real estate operations have fallen sharply over the last few months due to monetary restrictions and there are signs of a hangover in prices. These are particularly falling in Wenzhou, in the province of Zhejiang, one of the most dynamic in the country, and are perhaps acting as an early indicator. Another clue to this exhaustion in real estate might be the price of iron, one of the commodities that have fallen the most over the last few months. The bad practices of local authorities, monopolizing land and selling it to the highest bidder in order to sort out their debt, as well as interest rates that are below the rise in the CPI have all led to price rises.
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The land acquired by developers and the large number of vacant properties point to the existence of excess supply, although we should remember that it's difficult to compare the housing situation in China with other economies, given the significant growth in incomes and migratory flows to urban areas. An abrupt end to real estate expansion could push growth down but if, as stated by the conclusion from the authorities' meeting, the main priority is now to maintain growth, we should expect expansionary monetary policies to continue, helping to minimize the risk to housing.
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Brazil
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Brazil: a hard landing or just downtime?
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Brazil's economy stalls in the third quarter.
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Brazil's economy stalled in the third quarter, advancing by 0.0% compared with the previous quarter. In year-on-year terms growth was 2.2%, the worst figure since the start of the recovery at the end of 2009. Although we already expected the moderating tone to become more accentuated, we did not anticipate such a marked halt, forcing us to revise our central forecast scenario downwards, both for 2011 and 2012. In both cases we have placed the expected rate of growth at around 3.0%. With a view to 2013, we expect activity to pick up in line with the improved tone expected for the world economy and given the impending football world cup.
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Brazil's economic growth is still being supported by strong domestic expenditure although this is losing steam somewhat. After growing by an average of 6.1% year-on-year for nine consecutive quarters, consumption halved its growth (+3.0% year-on-year) in the third quarter of 2011. Imports also dropped off and went from a 14% increase year-on-year in the second quarter to 6% in the third. Investment and public consumption slowed down less, advancing 1.4% and 2.4% (year-on-year) respectively. Exports were able to maintain their position better than the rest of the items and grew by 4.3%, benefitting from a weaker real.
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Macroeconomic indicators continue to point to weakness.
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In spite of the standstill reflected by the data for the third quarter, Brazil's government continues to forecast growth in GDP of around 3.5% in 2011. Nonetheless, and although the confidence of Brazilian consumers in their economy remains historically high and picked up again in November, most leading indicators for activity do not provide much support for this prediction as they are pointing to weak growth for the last quarter of the year. To begin with, industrial production dropped markedly in October (-2.7% compared with the same month in 2010). That same month, retail sales surprised many with a fall of 0.5% compared with September, in spite of the robustness of employment. On the other hand, although it's true that the purchasing managers' index (PMI) improved for the second month in a row in November, thanks to the good performance by services, the manufacturer index remains at levels indicative of a decline, despite a slight upswing that took it to 48.7 points.
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Monetary policy will remain countercyclical in 2012.
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Given this scenario and with prices also tending to ease, we predict that, in 2012, the central bank of Brazil will introduce further interest rate cuts and the government will continue to implement both fiscal and macroprudential stimuli, such as relaxing reserve requirements for credit. This countercyclical tone of economic policies is not without its risks, given that inflation has yet to fall back down to its target range and the real's recent weakness is not helping to ease pressure on prices. However, the fear of a rough landing is currently stronger than the spectre of inflation.
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Mexico
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Mexico: watching the peso
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The Mexican economy continues to advance with reasonable expansion.
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A breakdown of GDP for the third quarter revealed stronger domestic expenditure than expected, especially in terms of growth in private consumption, which more than offset the loss of steam in the exports of goods and services (see the graph below). In this way, supported by growing domestic demand and the relative resistance of foreign demand, the Mexican economy is continuing to advance with reasonable expansion, resisting the winds of moderation affecting part of the world's economy. In 2012, these winds are likely to end up forcing a more notable slowdown in Latin America's second economy but it still has some leeway to implement more economic stimuli in order to contain such a slowdown. With a view to 2013, growth should regain its momentum.
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The peso's depreciation might complicate the expansionary shift in monetary policy.
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In any case, the peso's recent depreciation, although boosting activity, might complicate the countercyclical resource of monetary policy. For now, the general and core inflation rates are still within their target ranges and, provided there are no setbacks, should remain there throughout 2012. However, the last minutes of Banxico's Monetary Policy Committee hinted at some concern due to the greater than expected impact on domestic prices of the trend in the exchange rate. Should this be the case, the official interest rate is less likely to be cut over the coming months, something that had become more possible after the minutes for November. Nonetheless, the weakness of the global recovery and an output gap that is still in negative terrain and which will ease the pressure on prices also rule out any restrictive shift in monetary policy.
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In any event, 2012 looks a little more complex than 2011 for the Mexican economy. The main threat continues to come from abroad: a sharper decline in the pace of economic growth or a marked upswing in risk aversion, both at a global level, could result in a bigger slowdown than expected. Nonetheless, the seriousness and orthodoxy of the economic management over the last few years boost confidence in Mexico's economic future and suggest that the expansionary path embarked upon after the crisis will continue.
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Strong and continuing pressures on the financial system
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Looking at the evolution of bank shares in the stock markets, it can be deduced that, over the last few years, they have been especially gripped by the international crisis. Since 2008, when the financial crisis originating in the United States erupted in Europe, bank stocks have performed worse than the average (Eurostoxx Index). There were signs of a recovery at some points in 2009 but, in 2011, the difference between banks' and the average performance has widened, as can be seen in the graph below. The risk premium of the banking sector has also shot up and the sector's Credit Default Swaps (CDS) went above 300 basis points in the summer of 2011. Most of the banks have had their rating downgraded by rating agencies.
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Many events that have occurred regarding the financial system help to explain this trend and the complex perspectives. On the one hand, the economic situation is having a direct effect. A weak macroeconomic environment affects business volumes and, particularly, the flow of credit. Moreover, lasting high unemployment rates influence consumption and the doubtful debt rate. This, together with the trend in property prices, means that doubtful loans related to the real estate sector continue to damage banks' balances, especially in those countries with a real estate bubble. In fact, the stress tests carried out by the European Banking Authority (EBA) are mainly aimed at making credit exposure more transparent, as well as requiring higher levels of capital to cope with deterioration forecasts and potentially risky economic scenarios. In this respect, countries such as Spain and Ireland stood out due to their high exposure to real estate. In Ireland, this situation, together with other factors, led to the country's bail-out and that of its financial system and, in Spain, to an unprecedented restructuring which is still ongoing.
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But the international banking scenario is even more complex since, for the rest of the countries, exposure to sovereign debt has turned out to be a great risk. The levels of public indebtedness in some euro area countries are very high and, given the lack of clear political commitment in the euro area, these are creating doubts and tensions in the financial markets. The risk premium has, therefore, reached historically high figures. In Greece, it has risen to 3,000 basis points and in Portugal it stands at around 1,200 basis points. In Italy and Spain it has often gone way above 400-450 basis points and France is not exempt from this tension either, with levels close to 200 basis points.
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In general, the financial system's exposure to euro area sovereign debt is high. The main problem is the bad perception of solvency, leading to tension in debt markets and real liquidity problems for financial institutions, beyond the rising cost of funding. Because of this, the EBA has also carried out a detailed analysis and is demanding higher levels of capital depending on the deterioration of the sovereign debt on institutions' balance sheets. For example, while French and German institutions were not among those mentioned in the first stress tests on credit exposure, they stand out in the new analysis due to their high sovereign exposure. Consequently, either due to credit exposure or to sovereign exposure, financial systems from most of the European countries are under huge tension.
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The capacity of institutions to generate profits is also being significantly reduced due to business tensions: less revenue and higher costs resulting from greater risk and more expensive financing. Therefore states and central banks have had to adopt new measures to support the financial system.
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Within this already difficult context, numerous regulatory proposals are being planned, aiming to achieve more efficient, better capitalized, less in debt and larger instiutions in the medium term. And this is good for the financial system as a whole, for the economy in general and for customers and citizens. However, higher requirements, constant regulatory changes and the current lack of specific details are generating uncertainty and pressure in the short term.
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Most of the measures that have been proposed/adopted are related to capital. Everything started with the Basel III proposal to increase the level of capital and toughen up its definition but with a long implementation schedule, which in practice markets are anticipating. Moreover, the stress tests and markets have increased demands, up to the 9% of Core Tier 1 required in the last analysis developed by the EBA. And different criteria have been applied by different national supervisors, individually and independently. In Spain, in February 2011, a minimum of 8%-10% for a new concept of capital, namely principal capital, was demanded. In Austria, the application of Basel III has been brought forward to January 2013 and additional buffers of 3 percentage points will be required. In the Netherlands, United Kingdom and Switzerland capital requirements have been increased for systemically important institutions.
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As a result of these proposals, the procyclicality of capital requirements is increasing, as well as uncertainty regarding future levels and definitions, forcing banks to make an additional effort to retain profits and have access to capital markets, thereby restricting their capacity to grant credit.
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Apart from capital, there are regulatory initiatives of all kinds. Among others, changes have been proposed in the accounting of financial assets, as well as adjustments in the calendar of provisions and/or duties on financial transactions. Moreover, in Anglo-Saxon areas, there are plans to separate investment banking from retail banking. In Austria, subsidiaries in Eastern Europe must maintain a ratio of credit over deposits below 110%, forcing them into divestments. And, to give one last example, a strict system was implemented in Denmark to liquidate institutions with private sector involvement, which led to the bankruptcy of two institutions and generated doubts regarding the system.
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In summary, the pressure on the financial system comes from both structural tensions related to business as well as tensions due to the need to comply with new regulatory requirements. As a result, between 2008 and 2010, European states have been forced to restructure or liquidate up to 37 financial institutions in 14 countries. Moreover, European states have allocated 1.1 trillion Euros to grant debt issues by financial institutions and a further 0.5 trillion Euros to recapitalize them, as well as other forms of support. But the situation is clearly not the same for all institutions. Although no-one is free from pressure, depending on the business model and especially their ability to manage and anticipate it, some institutions are handling the situation better and maintaining their ability to grant the flow of credit, a fundamental mission of the financial system to boost the economy.
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This box was prepared by Anna Mialet Rigau Economic Analysis Unit, Research Department, "la Caixa"
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Commodities
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Widespread drops except for oil
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At 107.4 dollars, oil prices are still more reluctant to fall than other commodities.
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The price of crude remained practically unchanged between 22 November and 22 December, dropping a minimal 0.7%, taking it to 107.40 dollars per barrel (Brent quality, for one-month deliveries), 15.9% higher than the start of the year and 14.4% higher than last year's level.
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Oil prices were still reluctant to fall in spite of OPEC announcing that it would not reduce production below 30 million barrels a day. One possible explanation for this resistance, which contrasts particularly with the price of metals, is that its demand is falling at a slower rate than demand for the rest of commodities in general. The persistence of political unrest in oil-producing areas such as North Africa and the Middle East and the tensions in Iran and Russia are also buoying up the price of crude.
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The downward slide continues, including gold.
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Commodities had a markedly downward month. The CRB index fell by 2.2% between 20 November and 22 December, accumulating a 17.8% drop since the annual peak at the beginning of April. Precious metals increased the losses in the general index, a trend that included gold, down 5.1% in the month and which, standing at 1,610.0 dollars per ounce, was 11.8% below the peak reached in August. Base metals continued to suffer from China's weaker demand, with both iron and aluminium falling. However, nickel and copper picked up in reaction to previous falls. Losses also predominated among foods, with the exception of wheat and tea.
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