Global Daily – Low risk of contagion

by: Georgette Boele , Aline Schuiling , Peter de Bruin

140131-Global-Daily-Insight.pdf ()
  • Investors continue to put pressure on emerging market currencies, but risk of contagion relatively low
  • Stable German inflation signals decline in today’s eurozone reading
  • Tightening of credit standards by eurozone banks diminishes
  • US GDP grows above trend for second quarter in a row

Investors continue to press emerging market currencies…

Sentiment regarding emerging market currencies remained weak on Thursday. Investors are increasing the pressure on currencies that are not freely floating such as the Russian rouble. The Russian central bank has communicated that it will defend the currency beyond its corridor and it has sufficient foreign exchange reserves to do so. However, the market will likely test its commitment. Moreover, investors have increased expectations that emerging market central banks, that have recently not hiked interest rates, will feel forced to do so soon to defend their currencies. Early rate hikes are, for example, expected in Poland and Hungary.

…but risk of contagion is relatively low

Fear of contagion dominates news headlines, but risk indicators don’t signal an aggressive wave of risk aversion. For starters, the 1-month volatility in USD/JPY has edged higher, but it is still far away from the peaks seen in previous risk aversion waves. In addition, the movements in major currencies has remained relatively small. USD/JPY has moved lower and we have experienced large intraday volatility, but overall the move has been small. Moreover, Emerging Market sovereign spreads (with exception of a few countries) and liquidity spreads remain at low levels. Furthermore, gold prices and safe haven bonds have received support but not to the extent that we would experience in a major risk aversion wave.

German inflation lower than expected

Germany’s HICP inflation rate stabilised at 1.2% yoy in January, whereas the consensus was for a small rise on the back of an upward base effect in package holidays and health-care costs. This makes us comfortable about our forecast for today’s eurozone headline HICP inflation rate, of a decline to 0.7% in January from 0.8% in December (consensus is for a rise to 0.9%).

Eurozone banks tighten credit standards slightly

The ECB’s Bank Lending Survey (BLS) showed that the net percentage of banks reporting a tightening of credit standards on loans to companies fell further in 2013Q4, to 2 from 5 in 2013Q3. For Q1 2014 banks expect a further reduction in net tightening, to zero. The main reasons for continued tightening of lending criteria were the outlook for general economic activity and industry or firm-specific developments, although banks became significantly less pessimistic on these issues. The cost of funding and balance-sheet constraints played a minor role. Corporate demand for loans by companies is still weak, but less so than in Q3. Poor investment spending was the main culprit here. All in all, the BLS suggests that lending to enterprises should gradually become less negative as the eurozone economy gains momentum in the quarters ahead.

US 2013Q4 GDP: Second quarter of above trend growth…

Real GDP rose by 3.2% qoq saar in 2013Q4. This followed upon a 4.1% increase in Q3, was in line with the consensus forecast and put growth above the potential growth rate for the second quarter in a row. Looking at the details of the report, there were some encouraging signs, though the report was not unambiguously positive. Consumer spending growth accelerated to 3.3% (was 2.0%), the strongest reading since 2010Q4. This suggests that households have shrugged off the effects of the tax rises, while benefiting from firm gains in net worth. Moreover, there was a sharp pickup in investment in durable equipment from 0.2% to 6.9%. Despite these impressive gains, final domestic demand rose by just 1.4% in Q4, down from 2.3% in Q3. Net exports contributed 1.3 pp to growth in Q4, while inventories added 0.4 pp. Both of these categories can be volatile, though. Moreover, there was a 4.9% drop in federal government outlays, which partly reflected the government shutdown. Finally, both residential and investment in structures declined, suggesting that construction activity slowed.

…which should mark the beginning of a trend

Overall, we view the sharp gains in consumption and investment as encouraging signs that the economy will continue to grow above its trend growth rate (estimated at 2.5%) this year. Indeed, consumption should benefit from a sharply reduced fiscal drag, a strengthening labour market, and the firm gains in net worth that we saw last year. Meanwhile historically high profit margins should continue to underpin investment. Finally, the demand-supply situation for the housing market, despite higher mortgage rates, remains positive, suggesting that it should not take long before residential investment picks up again.