Last week was relatively light on important economic data and some of the data continues to be distorted by special factors, in particular adverse weather in the US and the Lunar New Year in China. But it certainly was not a boring week as the conflict over Crimea continued, concern over Chinese growth further spoilt sentiment on markets for risky assets and we revised our forecast for euro–dollar. Reading the tea leaves of the data I am still convinced that prospects for the global economy are positive. We do not expect the Crimea conflict to evolve into a full military conflict or to lead to Iran-style sanctions that would impact energy supply. In addition, we also think that China’s growth rate will not fall dramatically.
Crimea votes for Russian annexation, as expected
The Crimean referendum on Sunday resulted in an overwhelming majority (almost 97%) voting for Russian annexation. This result was expected. As my colleague Arjen van Dijkhuizen wrote early today (please see ‘Russian Roulette’, Global Daily Insight), if Russia does not de-escalate, the EU and US will likely announce further sanctions today. These will likely entail travel bans and asset freezes of individuals. The impact on cross-border trade or financial flows would still be limited. Although developments are still highly in flux, our baseline scenario assumes that Crimea will stick to its self-declared independence (comparable to Georgia’s breakaway regions). Russia may delay full annexation to avoid more sanctions, but will keep dominating Crimea. Although there is a risk that sanctions could be sharpened further going forward, a full energy blockade ‘Iran-style’ is not likely as it is in no one’s interest. The EU relies on Russian energy, while it would also seriously hit Russia’s tax revenues. It would also put upward pressure on oil prices. In the absence of military escalation or Iran-style sanctions, the fall-out for the global economy is likely to be limited.
Output growth in Europe unmoved, the periphery impresses
Industrial production in the eurozone fell 0.2% mom in January, but the yoy rate strengthened from 1.2% to 2.1%. In the UK, the yoy rate of output growth rose from 1.9% in December to 2.9% in January. Employment growth in the eurozone amounted to 0.1% in Q4. On a yoy basis, employment was still down 0.5%. At least as interesting as the eurozone data are the trends in individual countries. What is coming through, loud and clear, is the turn-around in Spain and Portugal. These economies have gone through significant austerity but also structural reform. Industrial production in Spain and Portugal was up by 1.4% and 4.6%, respectively in January, while they had registered declines of 2.5% and 2.8%, respectively in August last year. This improvement is reflected in the employment data as well. Spain’s employment was still 0.5% down yoy in Q4, but this was a big improvement on the drop of 4.2% registered in Q1 last year. Employment in Portugal is actually turning up. Q4 employment was up 0.5% yoy in Q4, after a 5.2% drop was seen in Q1. That is a significant improvement. Talking to various people, my impression is that many people don’t seem to realise what is going on or they are not appreciating the success. I suppose people cannot be blamed for being sceptical after so many years of downturn and, in some cases, disappointments and broken promises.
US data, still not a clear picture
When weather affects economic data, it is hard to assess when these effects ease. Last week saw an unwelcome drop in sentiment among small businesses in the US in March. But perhaps that was still weather related. Early indications of consumer confidence for March also show a drop. On the other hand, February retail sales exceeded expectations, though previous data was revised down, somewhat. Perhaps the most accurate data at this point in time is the weekly jobless claims data. Claims fell to their lowest level of the year in the week of 8 March. This seems to suggest that the labour market is leaving the weather behind and the economy is continuing its strengthening trend.
China’s data disappointed last week. Industrial production growth over January and February taken together was up 8.6% yoy, down from 9.7% in December and the lowest level since 2009. Retail sales growth over this period eased from 13.1% to 11.8%. The statisticians in China always have a hard time at the start of the year as the Lunar New Year jumps around from year to year. I rarely comment on Chinese monetary aggregates, but the growth of base money shows how jumpy things can be in Chinese statistics at the start of the year. M0 growth weakened to +3.3% yoy in February, after it had almost exploded in January when the growth rate stood at 22.5%. The two months together showed stronger growth that last year.
The bottom line for China’s economy
I am not overly concerned that Chinese growth will decelerate sharply this year. Recent weak data must not be over-interpreted. The quarterly Manpower survey for China, which is a gauge of hiring intentions, was up by a reasonable degree. The same actually apples to many other Asian economies. But there are more decisive reasons not to be overly concerned. The Chinese government has announced a growth target of 7.5% for the year as a whole. While Prime Minister Li has said that a slightly lower rate would be acceptable as long as income growth and employment growth are satisfactory, he added he was thinking of a lower bound of perhaps 7.2%. Nobody will lose sleep over that. I think that the policymakers have the means to prop up growth should that be required.
The debt issue
China’s corporate sector is highly indebted. Total corporate debt exceeds 150% of GDP, which is very high for a country in China’s stage of development and the sophistication of its financial system. There is little doubt that China needs to embark on a deleveraging process. However, as my colleague Maritza Cabezas wrote last week (‘China’s high debt woes’, Macro Focus, 13 March 2014), we think China’s deleveraging process will occur against a more favourable background than in the West. In the West, we associate deleveraging with poor growth. We must, however, not lose sight of the fact that our economies got themselves in trouble and we were forced to reduce leverage. That process made a bad situation worse. Working your way out of debt in a shrinking economy is not easy and it hurts. The situation in China is different, they are trying to reduce leverage against a backdrop of growth. That is a lot easier. Even more so, it is essential for China’s leaders to keep growth going at a decent clip in order to prevent the painful process many Western economies went through. If growth slows too much, the process will become much more painful. As the policymakers have the means to stimulate the economy, we believe they will not hesitate eventually and they will be successful.
Revised dollar forecast
We revised our dollar forecast last week. While many of our FX forecasts had turned out well last year, we have struggled with euro-dollar. So we did some soul searching last week and drew a couple of conclusions. Why did the dollar not strengthen against the euro as we had expected? Different factors have an impact on the FX market. And different currencies respond to different forces. What makes things really complicated is that forces that dominate at some stage seem to lose that dominance later. The dollar is a currency that benefits usually from two factors: a cyclical improvement, driving up rate expectations and risk aversion in financial markets. Our call for a cyclical improvement last year was spot on and it should have had an upward effect on the dollar against the euro. That did not happen for two reasons. First, dollar-positive sentiment was spoilt by the deadlock of the debt ceiling. Second, we probably underestimated the effect of strengthening risk appetite, which was dollar negative and euro positive in this instance as for a large part it reflected dissipating worries on the future of the euro. So where do we stand now? We think that risk appetite in Europe will continue to rise as the economies in the likes of Spain and Portugal are turning convincingly. That should limit any upward effect from a further strengthening of growth in the US and building rate-hike expectations. We have therefore revised our forecast. In the near future, we see only a moderate fall in EUR/USD. As time progresses, we still expect the dollar to strengthen, but later and by less than previously anticipated (see the FX note in today’s Macro Weekly).