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April 1, 2011
Contents
Global Data Watch Economic Research note
Tracking the global economic
• Global industrial activity poised to slow sharply in coming months ... impact of Japan’s earthquake 11
EM food inflation to push higher
• ... led by a double-digit drop in Japan over March and April into midyear 13
US: first-half income growth and a
• Sustained US job growth is the key for this downshift to be temporary simple twist of fate 15
Euro area debt crisis: gauging the
• ECB to tighten next week while Fed still expected to stay on hold for 17
optimal exit path
more than a year Understanding the supply shock to
Japan’s economy 19
Fundamental lifts meet temporary drags Israel: BoI steps up tightening
21
pace into second half of cycle
The March data flow is validating our view of a building tension between Iceland: export-led growth holds
fundamental lifts and temporary drags. Releases thus far raise our comfort level the key 23
about the underlying health and resiliency of the global expansion. However, they Global Economic Outlook Summary 4
also are underscoring the impact of material drags this quarter—particularly on Global Central Bank Watch 6
industrial production and consumer spending. If we are right, these drags will be The J.P. Morgan View: Markets 7
narrowly based and short-lived. As such, the rocky road expected over the coming
Selected recent research from
months should be followed by a rebound in the second half of the year. J.P. Morgan Economics
10
This week’s key March releases lay to rest doubts about the fundamental support Data Watches
coming from business spending and hiring. Rebounding from a weak January, US United States 27
private payroll gains averaged 188,000 monthly gains last quarter. Alongside a Euro area 35
continued upward trajectory in the workweek, increases in hours and private Japan 41
sector labor income look set to be strong this quarter. Meanwhile, Euro area Canada 47
surveys slipped in March to still elevated levels and continue to signal a broaden- Mexico 49
Brazil 51
ing regional expansion—particularly in the core countries outside Germany. In
Andeans 53
Asia, a rise in China’s PMI survey and healthy Korean trade flows underscore the
United Kingdom 55
solid position of regional growth on the eve of the Japanese earthquake.
Sweden 59
Russia 61
However, in the aftermath of Japan’s tragic natural disasters, Asian regional
Turkey 63
performance is set to deteriorate. We are more downbeat this week about the size
of the economic shock hitting Japan and have further revised down our 1H11 Australia and New Zealand 65
growth forecast. The Japanese economy is expected to contract in both quarters China, Hong Kong, and Taiwan 69
with industrial activity dropping a huge 16% over March and April (see “Under- Korea 73
standing the supply shock to Japan’s economy” in this GDW). This week, two ASEAN 75
industry surveys covering the post-quake period collapsed. As negative as their India 79
results appear, they probably understated weakness due to the low reporting rate Regional Data Calendars 84
by the hardest-hit firms (see “Tracking the global economic impact of Japan’s
Our latest Special Report, “India: heading for an
earthquake” in this GDW).
accidental soft landing,” was
published on April 1, 2011 and is available on
The impact on the rest of the Asian region is likely to vary widely. This week’s
our website.
March trade report shows little immediate impact on the Korean economy. Korean
J.P. Morgan global PMI excluding Japan US: consumption and private payrolls Bruce Kasman
DI, sa %q/q, saar 000s, mo. avg. (1-212) 834-5515
Cons. bruce.c.kasman@jpmorgan.com
62 4 (with 1Q 400 JPMorgan Chase Bank NA
Output
60 forecast) David Hensley
2 200 (1-212) 834-5516
58 david.hensley@jpmorgan.com
New JPMorgan Chase Bank NA
56 0 0
orders
Joseph Lupton
54 Private payrolls (1-212) 834-5735
-2 -200
joseph.p.lupton@jpmorgan.com
52 JPMorgan Chase Bank NA
Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 -4 -400
06 08 10 www.morganmarkets.com
JPMorgan Chase Bank NA, New York Economic Research
Bruce Kasman (1-212) 834-5515 Joseph Lupton (1-212) 834-5735 Global Data Watch
bruce.c.kasman@jpmorgan.com joseph.p.lupton@jpmorgan.com April 1, 2011
David Hensley (1-212) 834-5516
david.hensley@jpmorgan.com
Japan manufacturing PMI and industrial output covery in the affected areas, the financing of the fiscal
DI, sa %3m, saar stimulus measures is important for the outlook of the
PMI Mfg output
70 60
broader economy as well as for the impact on the JGB mar-
ket. While some portion of the supplementary budget will
40 be financed by a tax increase, it will take time before a tax
60
20 rate hike plan is decided. As a result, the stimulus will ini-
50 0 tially be financed by debt issuance—including short-term
bill financing—and will thus prove to be more stimulative
Adjusted -20
40 Mar PMI for economic activity in 2Q and 3Q.
-40
30 -60 EMU fiscal stress on slow simmer
2007 2008 2009 2010 2011
The EMU sovereign credit crisis continued to simmer but
non-oil imports rose smartly last month, while exports to Japan not boil over this week, with markets appearing to have
remained firm in the days after the shock. The impact of supply discounted much of the news out this week. According to
disruptions and weaker Japanese demand should be more the Central Bank of Ireland’s bank stress test, Ireland’s
apparent this month and felt most strongly in the ASEAN banking system will require €24 billion in additional capi-
manufacturing centers. Accordingly, we lowered growth esti- tal. Capital will be provided by the National Pensions Re-
mates for Taiwan, Malaysia, and Thailand this week. serve Fund, the EU/IMF facility, subordinated bond hold-
ers, and private capital markets. Some market stress was
The other temporary drag on global growth comes from rising relieved as it is now clear that senior bank creditors will not
oil prices, which are taking a bite out of global consumption be impacted by restructuring. However, it remains unclear
spending as we move through the first quarter. This is evident how Irish banks will be funded in the medium term. There
in the US where consumption gains slowed to about a 1.5% has been much speculation this week about the ECB creat-
annualized pace. Global auto sales also appear to be moving ing a medium-term facility for banks that have a chronic
lower at the end of the quarter. This consumption drag will be funding need. Nothing has been announced yet; we may
reinforced by Japan’s demand shock. Our forecast incorpo- get more information at next week’s ECB meeting. As ex-
rates a softening in global consumption into midyear but pected, the Portuguese debt and deficit numbers were re-
energy prices are threatening to move above forecast levels. vised up this week, and the president announced that the
There is growing concern that disappointment from consum- election will take place on June 5. With bond yields con-
ers will magnify a projected slowing in industrial activity. The tinuing to climb, it seems only a matter of time before the
March global PMI survey provides some hints of this vulner- Portuguese ask for external help. There is some uncertainty
ability as new orders appear to be weakening while output about whether this is possible during the interregnum. Our
gains remain strong. view is that if Portugal needs help, a bridge loan will be put
in place until a new government has the authority to re-
Japan ramping up fiscal stimulus quest a full bailout.
The forces currently depressing Japanese activity will
quickly turn to lift around the middle of the year. Just the ECB walks while the Fed will talk
restarting of temporarily shut down production will lead to The tension between lifts and drags on growth is also regis-
a sharp rise in economic activity from its depressed levels tering in the inflation environment. Food and energy prices
in the wake of the disaster. This rebound will be amplified are lifting headline inflation everywhere. However, in the
by the start of a major restoration and reconstruction effort. developed economies wage inflation remains subdued
These efforts will be partly initiated by the private sector nearly everywhere, and there are significant sectoral or re-
but also get a huge boost from government support. gional issues creating financial vulnerabilities. This envi-
ronment complicates monetary policy setting and is push-
Japan’s fiscal response to the earthquake and tsunami will ing policymakers in different directions.
ultimately amount to about ¥10 trillion, or 2% of GDP. The
first installment of this will come in April and amount to There is a sharp distinction at the ECB where the bank’s
about ¥2 trillion for the immediate costs of restoration, balance sheet is being geared toward fostering financial
such as disposal of rubble. A much larger supplementary stability while interest rates will be raised to contain infla-
budget is expected to be announced in July. While the size tion pressure. Next week, the ECB will likely begin nor-
of the spending increase is critical for the speed of the re- malizing policy rates with a 25bp hike. Such a move will
2
JPMorgan Chase Bank NA, New York Economic Research
Bruce Kasman (1-212) 834-5515 Joseph Lupton (1-212) 834-5735 Global Data Watch
bruce.c.kasman@jpmorgan.com joseph.p.lupton@jpmorgan.com April 1, 2011
David Hensley (1-212) 834-5516
david.hensley@jpmorgan.com
Brazil policy rate and core inflation LATAM monetary policy tightening
%p.a. %oya; IPCA trimmed mean smoothed
In the emerging markets, differences of opinion regarding
18 7 monetary policy tools are focused on whether
Selic rate Core inflation
macroprudential measures and other financial market con-
15 6 trols can substitute for traditional monetary policy rate
tightening. Underscoring market concerns about a lack of
12 5 vigilance toward inflation, this week’s release of Brazil’s
1Q11 Inflation Report signaled that the COPOM is inclined
9 4 to adopt a more gradualist approach in its tightening strat-
egy that involves a greater reliance on macroprudential
6 3 measures. The monetary authority has concluded that the
2006 2007 2008 2009 2010 2011
costs of bringing inflation down to 4.5% in 2011 may be
too high and has shifted its focus to fighting only the sec-
ond-order effects of the supply shocks and aiming to guar-
not be beneficial to the periphery, where rising rates will antee inflation convergence to the targeted level by 2012.
slow financial healing and damp growth. But ECB council Against the backdrop of elevated core inflation, rising in-
members have been adamant in highlighting that the central flation expectations, and overheating demand conditions,
bank only has one policy instrument and it thus has to re- this strategy may prove hard to sustain.
spond to conditions in the region as a whole. The central
bank is helping the periphery via enhanced credit support Brazil’s apparent gradualism is not shared throughout Latin
and the collateral requirements, as illustrated this week America. Indeed, during the IADB Annual Meetings in
when the ECB suspended the rating threshold for debt in- Calgary last weekend, the message from other central
struments of the Irish government. banks in the region was much more cautious. After surpris-
ingly stepping up the tightening pace to 50bp last month,
Although there is an active ongoing debate at the FOMC, Chile’s monetary authorities still see inflation risks on the
Fed officials are not likely to use its balance sheet and rate upside and, contrary to Brazil, stated clearly that they will
policy for different objectives. Rhetoric has shifted to em- continue to rely solely on policy rate hikes to tighten, in-
phasize the Fed’s commitment to its medium-term inflation stead of combining this strategy with macroprudential mea-
objectives, but officials are not willing to adjust policy in sures. Peru has been doing a mix of both, and Friday in-
the face of perceived temporary inflation shocks. In addi- creased reserve requirements once again as March CPI in-
tion, they are more likely to see near-term support for de- flation exceeded expectations. Matters are more compli-
mand as critical in an environment in which they perceive cated in Mexico, where inflation has been on the decline
cyclical weakness in labor demand unemployment as a but a narrowing output gap and a likely hike in adminis-
threat to structural supply. Viewing the expansion of its tered gasoline prices next year are lifting inflation expecta-
balance sheets as an extension of traditional policy setting tions. Although we still look for a 4Q11 Banxico hike, the
when interest rate policy is constrained by a lower bound, risks are skewed to a later move.
NY Fed President Dudley reaffirmed today the Fed’s com-
mitment to complete its purchases of $600 billion and un- CBRT uneasy with robust growth
derscored that, while the economy is improving, there re- Economic activity in Turkey picked up at a faster pace than
main “several areas of vulnerability and weakness.” anticipated in the year ending 4Q10. Combined with signs
that domestic demand is expanding at a robust pace as the
The BoJ is facing a crisis and is responding to the earth- year begins, the CBRT hiked the reserve requirement ratios
quake and tsunami by easing monetary conditions through by an aggressive 400bp last week. Unless bank lending
several channels. In particular, the BoJ is supporting the slows, further RRR hikes are likely in the coming months.
government’s rescue and rebuilding operation by expanding Traditional policy rate hikes look in the offing following
its balance sheet ¥22.5 trillion ($280 billion). Asset pur- the elections. We see a total of 175bp in hikes in the second
chases will include JGBs, corporate bonds, and equities. Ad- half of the year.
ditionally, the government may examine the possibility of
BoJ debt monetization as one measure to finance the fiscal
package. The BoJ is expected to expand its asset purchase Editor
program at next week’s board meeting. Sandy Batten (1-212) 834-9645 sandy.batten@jpmorgan.com
3
JPMorgan Chase Bank, New York Economic Research
David Hensley (1-212) 834-5516 Joseph Lupton (1-212) 834-5735 Global Data Watch
david.hensley@jpmorgan.com joseph.p.lupton@jpmorgan.com April 1, 2011
Carlton Strong (1-212) 834-5612
carlton.m.strong@jpmorgan.com
Note: For some emerging economies, 2010-2012 quarterly forecasts are not available and/or seasonally adjusted GDP data are estimated by J.P. Morgan.
Bold denotes changes from last edition of Global Data Watch, with arrows showing the direction of changes. Underline indicates beginning of J.P. Morgan forecasts.
4
JPMorgan Chase Bank, New York Economic Research
David Hensley (1-212) 834-5516 Joseph Lupton (1-212) 834-5735 Global Data Watch
david.hensley@jpmorgan.com joseph.p.lupton@jpmorgan.com April 1, 2011
Carlton Strong (1-212) 834-5612
carlton.m.strong@jpmorgan.com
Memo: Global industrial production 9.3 6.1 6.7 5.7 7.2 3.9 8.6 10.1 6.7 5.4 5.1
%oya 7.3 6.3 4.9 6.2 7.1 7.1 7.6 6.7
Note: More forecast details for the G-3 and other countries can be found on J.P. Morgan’s Morgan Markets client web site.
5
JPMorgan Chase Bank N.A., New York Economic Research
David Hensley (1-212) 834-5516 Joseph Lupton (1-212) 834-5735 Global Data Watch
david.hensley@jpmorgan.com joseph.p.lupton@jpmorgan.com April 1, 2011
Michael Mulhall (1-212) 834-9123
michael.r.mulhall@jpmorgan.com
The Americas GDP-weighted average 1.38 9 1.47 1.53 1.58 1.59 1.61
United States Federal funds rate 0.125 0 16 Dec 08 (-87.5bp) 27 Apr 11 On hold 0.125 0.125 0.125 0.125 0.125
Canada Overnight funding rate 1.00 0 8 Sep 10 (+25bp) 12 Apr 11 31 May 11 (+25bp) 1.25 1.75 2.00 2.25 2.50
Brazil SELIC overnight rate 11.75 100 2 Mar 11 (+50bp) 20 Apr 11 20 Apr 11 (+50bp) 12.50 12.50 12.50 12.50 12.50
Mexico Repo rate 4.50 0 17 Jul 09 (-25bp) 15 Apr 11 4Q 11 4.50 4.50 5.00 5.00 5.00
Chile Discount rate 4.00 75 17 Mar 11 (+50bp) 12 Apr 11 12 Apr 11 (+25bp) 5.00 6.00 6.50 6.50 6.50
Colombia Repo rate 3.50 25 18 Mar 11 (+25bp) 29 Apr 11 29 Apr 11 (+25bp) 4.25 5.00 5.00 5.00 5.00
Peru Reference rate 3.75 75 10 Mar 11 (+25bp) 7 Apr 11 7 Apr 11 (+25bp) 4.50 4.50 4.50 4.50 4.50
6
JPMorgan Chase Bank, London Economic Research
Jan Loeys (1-212) 834-5874 Global Data Watch
jan.loeys@jpmorgan.com April 1, 2011
The J.P. Morgan View: Markets the signs are not encouraging as we have been lowering our
own growth forecasts in a similar fashion to then. Our six-
Can 2Q survive IP sticker week rolling US Economic Activity Surprise Index turned
negative two weeks ago, and our economists are confirming
shock? that US data are indeed tracking soft versus growth forecasts.
• Economics: Japan IP to contract at 18% pace in 2Q, but
should make up the loss in 2H. US data are tracking a bit Even as 2Q threatens to look ugly, there are sufficient dif-
soft versus forecasts. ferences to keep us net long equities versus bonds. Most
important, we are nearing the second anniversary of the re-
• Portfolio strategy: 2Q11 should not be a repeat of the covery, which is now clearly on more solid footing than a
sell-off in 2Q of last year. But growth data do raise a year ago. In addition, while history frequently repeats itself,
warning. We stay net long equities to bonds, but reduce it is equally so that we constantly learn from experience, in
from aggressive to significant. particular, recent experience. And this tells us that global
• Fixed income: Bonds have largely retraced the March risk markets are extremely robust, having survived car-
flight to safety. Cover shorts in the US, but look for a nage in the Middle East and Japan. Hence, we stay net long
modest further sell-off in Europe. equities versus bonds, but reduce the overweight in re-
sponse to the risk that markets may react negatively to the
• Equities: Move to an overweight in EM vs. DM equities. weaker IP and PMI data over the next two months.
• Credit: Reduction in bail-in risk in Irish senior bank
bonds supports European bank bonds. Very near term, market attention will focus on the start of
US 1Q earnings season. Do note our observation last week
• FX: Dollar and sterling remain our main shorts. that over the first 10 business days of US earnings an-
• Commodities: A considerable draw in US corn invento- nouncement months over the past six quarters, US equities
ries confirms our bullish view. Stay long. rallied at least 2.5%, but then were either flat or down over
the following 10 days. Hence, it is probably worthwhile
Global equities rallied this week to within touching dis- lightening up tactically by selling into further rallies.
tance of the cycle peak reached only a month ago, confirm-
ing that the sell-off was merely a correction. And that in a Asset managers closed on 1Q yesterday, and should be on
month in which global carnage and disaster struck, and average happy-ish with their results. Credit managers
economists had to seriously downgrade growth expecta- have been aggressively long, and that clearly worked. Bond
tions for 2011 (chart, next page). What is happening managers were trading from the short side, and if they held
here? Is complacency setting in, or are the rocks thrown at on through the quarter, they eked a small profit on that as
risk markets really that puny relative to the compelling major government bond markets underperformed cash by
value offered by stocks? 0.5%. FX managers have been consistently negative the US
dollar and bullish EM currencies, and the US dollar is down
As is usually the case, the answer is a bit of both. Every some 3%-4% against G-10 and EM currencies in 1Q. We
investor we see argues that the Japanese earthquake will believe equity managers were generally long Cyclicals
only cause a down-and-up V-shaped move in IP and GDP and underweight Financials and EM. Both Cyclicals and
and that within the year, the Japanese and world economy Financials were flat versus index, while EM net
will be back to where we thought they would be all along. underperformed almost 3%. Hence, unless managers had
And that is also our forecast. What makes us nervous, the timing right, they earned little from these positions.
though, is that in coming months, sticker shock from the Commodity managers are harder to judge, but they clearly
dramatic impact on global and Japanese IP and PMIs might gained from the rally and inflows in the asset class.
lead investors to question whether something more per-
sistent is at work. US consumption is running soft versus Fixed income
production, and oil prices keep rising. Bonds fell for the second week in a row, driven by an-
other upside surprise in Euro area inflation, and gener-
This raises the question whether the second quarter will ally more hawkish commentary from the Fed. Govern-
turn into a repeat of last year when weaker activity data ment yields have now largely retraced the March flight to
raised fears of a double dip and pushed global equities safety. Inflation risks and impending central bank tighten-
down 15%, punctuated by the flash crash in May. So far, ing are the main forces bearing down on bonds. Against
7
JPMorgan Chase Bank, London Economic Research
Nikolaos Panigirtzoglou (44-20) 7777-0386 The J.P. Morgan View: Markets
nikolaos.panigirtzoglou@jpmorgan.com April 1, 2011
that, the coming slowing in activity data as a result of the 2011 global GDP growth forecasts: J.P. Morgan versus consensus
Japanese earthquake may provide near-term support. We %
3.8
keep our shorts where central bank hikes are on the hori-
zon, in the UK and Euro area, looking for a modest further 3.6 J.P. Morgan
sell-off. But we cover our duration short in the US, with
yields toward the higher end of their recent range. 3.4
3.2
Another eventful week for Euro area peripherals saw Por- Consensus
tugal underperform heavily. Ireland’s decision not to seek 3.0
haircuts on senior bank debt bolsters the value argument
2.8
for short-dated peripherals: 1-year Greece yielding 13% is Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 Mar 11
the pick here, though it is not a position for the faint-
hearted. Portugal’s short-dated issuance program postpones old. Mechanically, the gap between DM and EM IP growth
the day when it will need EU/IMF funding. That still seems is set to widen even further in future releases due to the
the most likely outcome, though, especially after Portugal’s collapse in Japanese IP in March. This suggests that this
upward deficit revision widened the credibility gap be- trading model will continue to recommend an overweight
tween Spain (which has been delivering on its fiscal tar- in EM equities for the months ahead.
gets) and the rest. We still look for the semi peripherals
(Spain and Italy) to outperform the high yielders Last week, we highlighted downside risks to equity mar-
(Greece, Ireland, and Portugal) for a little longer. kets beyond mid-April, once the good news in the reporting
season is priced in. These downside risks stem from eco-
Equities nomic data disappointments as captured by our US Eco-
nomic Activity Surprise Index, which moved to negative
EM equities continue to outperform their DM counterparts.
territory two weeks ago. Is this a problem for our EM eq-
They have now recaptured almost half of their previous
uity overweight? Not in our view. More likely, worse DM
13% underperformance between October and early Febru-
can be supportive of an EM overweight. One of the drivers
ary. We took profit on our EM vs. DM equity underweight
of EM underperformance from October to February was a
a month ago (see J.P. Morgan View, Mar 4). We now rec-
narrowing economic growth differential vs. DM. With
ommend investors move to an overweight position, i.e.,
growth indicators softening in DM this growth differen-
long MSCI EM$ vs. MSCI World$.
tial will turn even more supportive for EM equities.
First, the technical backdrop still favors EM equities.
Both survey data and the share of EM in equity mutual Credit
funds/ETFs AUM suggest that both real money and retail Credit markets continued to tighten this week. Retail inves-
investors are still underweight EM in their equity portfo- tors are returning to higher risk credits, with inflows into
lios. Second, signs that policy tightening is having an effect high yield and EM bond funds compared to outflows last
in slowing overheated EM economies is making investors week. The upcoming earnings season is expected to confirm
more comfortable with the idea of a soft landing. In- the strength in corporate fundamentals, keeping us long cor-
deed, today’s release in Chinese PMI boosted the domestic porate credit for the medium term. However, with many
equity market, despite coming out below economists’ ex- uncertainties lingering in the backdrop and a potential for
pectations. This is both a sign of underweight positions and economic data “sticker shock” in coming months, the path
supportive of the idea that modestly weaker economic data toward tighter year-end spreads is uncertain.
are good for EM equities as they boost confidence in the
soft landing scenario. This week’s release of the Irish bank stress test reduces
the likelihood of bail-ins of existing senior bank bond hold-
Third, our EM vs. DM trading model, which uses a com- ers. The announcement yesterday is supportive of senior
bination of two signals, two-month return momentum, and versus subordinated Irish bank bonds as the threat of bur-
relative IP growth, has moved to a positive stance in EM. den sharing remains off the table for senior bonds, but
The MSCI EM index has outperformed MSCI World over not for subordinated bonds. The announcement is also
the past two months. Relative IP growth (i.e., the difference positive for Euro area senior bank bonds more generally,
between the oya rates in EM IP and DM IP) moved to 4.8% which were under threat from a potential bail-in. Stay OW
in the most recent release for January, above the 4% thresh- bank bonds within European HG credit.
8
JPMorgan Chase Bank, London Economic Research
Jan Loeys (1-212) 834-5874 Global Data Watch
jan.loeys@jpmorgan.com April 1, 2011
In contrast, the US Municipal market has seen little im- Ten-year Government bond yields
provement in recent weeks. Although the yield on Munici- Current Jun 11 Sep 11 Dec 11 Mar 12
pal bonds has stabilized around 4% with spreads approach- United States 3.45 3.60 3.65 3.70 3.90
ing February lows, retail investors continued to withdraw Euro area 3.37 3.50 3.55 3.65 3.75
funds from their Muni bond funds for the fifth consecutive United Kingdom 3.72 3.90 4.00 4.15 4.20
month. Moreover, heavy expected supply remains the main Japan 1.28 1.15 1.30 1.35 1.40
threat. Overall, $17 billion was issued in March, much less GBI-EM 7.00 7.30
than the $30 billion anticipated. This means that funding Credit markets
needs and supply are pushed out to coming months, keep- Current YTD Return
ing investors wary of jumping in currently. We remain de- US high grade (bp over UST) 136 0.7%
fensive tax-exempt Municipal bonds. Euro high grade (bp over Euro gov) 156 -0.8%
USD high yield (bp vs. UST) 513 4.2%
Foreign exchange Euro high yield (bp over Euro gov) 522 2.9%
EMBIG (bp vs. UST) 292 1.0%
The secular bull market in bonds is clearly over as the
EM Corporates (bp vs. UST) 271 1.8%
world’s second-most important central bank (ECB) pre-
pares to tighten next week, and the most important one Foreign exchange
(Fed) sounds collectively less dovish. Although this bond Current Jun 11 Sep 11 Dec 11 Mar 12
sell-off has been tame by historical standards—global rates EUR/USD 1.42 1.43 1.45 1.48 1.48
have moved up only 20bp this quarter compared to +50bp USD/JPY 84.1 80 79 78 78
moves when the ECB and/or Fed is tightening—the trend GBP/USD 1.61 1.57 1.59 1.64 1.66
for the rest of the year seems negative. The path for curren- Commodities - quarterly average
cies is more debatable. As always occurs when the US Current 2Q11 3Q11 4Q11 1Q12
bond market has sold off during this decade-long bear mar- Brent ($/bbl) 119 118 108 108 110
ket in the dollar, hopes (or fears) of a trend change emerge.
Gold ($/oz) 1430 1450 1475 1500 1500
The rates fixation is legitimate, but it still looks premature.
Copper($/m ton) 9413 9450 9750 10000 9750
Even though the US money market is the fourth most
Corn ($/Bu) 7.34 7.00 6.75 6.10 6.20
dovishly priced in the world, US activity data are softening
Source: J.P. Morgan, Bloomberg, Datastream
and the Fed remains a few quarters from hiking. And since
actual rate spreads matter as much for deficit countries like
the US as shifts in rate expectations, the dollar is very far
lower-than-expected US inventories, further highlighting
from turning. At best today’s payrolls can correct some of
the extent of the tight supply picture resulting from last
the dollar’s recent, excessive weakness that the US fiscal
year’s extreme weather. The USDA also announced a
disarray has been driving. Dollar forecasts are still bear-
much-expected increase in the amount of land dedicated to
ish, and trades split across several regional themes.
growing corn and wheat for the next season. This balances
the more bullish inventory picture, and we thus keep our
On trades, exploit the yen collapse to take profits on a short
price forecasts unchanged and remain bullish grains
JPY/KRW put spread opened in the 2011 Outlook (Nov 23,
over the next few months.
2010) and a short 1-month USD/JPY put opened after BoJ
intervention on March 18. Also take profits on a short
Copper is down almost 5% this week as a further hike in
AUD vs. BRL vol swap now that USD/BRL is beginning to
China’s reserve ratio, a slightly weaker-than-expected Chi-
slip. Sell NZD/CAD to increase exposure to oil currencies
nese PMI, and uncertainty around the impact from the
and position for a possible bumper Canadian employment
Japanese earthquake raised fears of a slowdown in demand.
report next week, and stay short sterling within Europe
Our view remains that China will be able to bring its
(vs. EUR and NOK). There is no running theme among
economy under control without adversely effecting de-
these trades, but rarely this year have regional dynamics
mand. The impact of the Japanese earthquake is less clear
been so diverse.
but we believe that there is likely to be a significant near-
term negative impact on the supply chain, especially in
Commodities Asia. However, the rebound in growth, as reconstruction
Commodities are up around 2% this week as oil and ag- gets under way later this year, should bring us back at least
riculture produced strong gains, offsetting a 3% fall in base to where we were before the disaster. We thus remain
metals. Corn rallied sharply after the USDA reported bullish copper on a medium-term view.
9
JPMorgan Chase Bank NA, New York Economic Research
Bruce Kasman (1-212) 834-5515 Joseph Lupton (1-212) 834-5735 Global Data Watch
bruce.c.kasman@jpmorgan.com joseph.p.lupton@jpmorgan.com April 1, 2011
David Hensley (1-212) 834-5516
david.hensley@jpmorgan.com
10
JPMorgan Chase Bank NA, New York Economic Research
David Hensley (1-212) 834-5516 Global Data Watch
david.hensley@jpmorgan.com April 1, 2011
Joseph Lupton (1-212) 834-5735
joseph.p.lupton@jpmorgan.com
The dimensions of these shocks inside and outside Japan EM Asian imports around the Kobe earthquake
will begin to come into focus with the arrival of key March %m/m, sa
data reports. The accompanying calendar highlights the Taiwan
24
most relevant indicators. For Japan, we will track indicators
of both demand and supply, consistent with the dual nature 18
of the shocks affecting the economy. Concerning demand, 12
we will look to data on auto registrations and the broader 6
Korea
measures of retail sales to gauge the hit to consumption. In
fact, the registrations data were reported Friday, showing 0
that vehicle sales plunged nearly 30%m/m to the lowest -6
level in the series dating back to 1980. Later, capital goods -12
shipments data will provide guidance on capex. 1994 1995
11
JPMorgan Chase Bank NA, New York Economic Research
David Hensley (1-212) 834-5516 Tracking the global economic impact of
david.hensley@jpmorgan.com Japan’s earthquake
Joseph Lupton (1-212) 834-5735 April 1, 2011
joseph.p.lupton@jpmorgan.com
Concerning the supply side of the Japanese economy, the Japan manufacturing PMI
monthly business surveys will provide the first clues about DI, sa
how badly output has been hit. This week we received two 55
surveys from Japan that cover the post-quake period. The sur-
50
vey window for the March manufacturing PMI was March 11
to March 25. QUICK conducted a flash manufacturing 45
Tankan on March 28. The PMI, which is a diffusion index, 40 Reported March
fell 6.5pts to 46.4, the lowest level since April 2009. The
35
Tankan, which is a percent balance index, fell 36pts to -20 Adjusted March
(this is equivalent to a decline from 58 to 40 on a DI basis). 30
25
As negative as these results are, they appear to have a posi- 2008 2009 2010 2011
tive bias. Markit received just two thirds the normal re-
sponses. If we assume the remaining one third registered at Japan manufacturing PMI and industrial output
least some decline in output, the adjusted PMI reading would DI, sa %3m, saar
PMI Mfg output
be 31.1, near the low during the 2008/09 recession. In con- 70 60
trast with this month’s experience, Markit says the response
rate for the PMI was relatively stable during the recession, so 40
60
that this bias was not present at that time. 20
50 0
Although they are operating with a great deal of uncer-
Adjusted -20
tainty, our Japan team tentatively is forecasting that indus-
40 Mar PMI
trial production plunged 12%m/m in March. This is ex- -40
pected to be followed by a further 4%m/m decline in April.
30 -60
(The average level of output is expected to be lower in 2007 2008 2009 2010 2011
April than March even though the level of output is as-
sumed to grow throughout the month.) Thereafter, monthly Asian manufacturing PMIs
gains are expected to lift the level of output above the pre- DI
vious (pre-quake) path by year-end. Note that the adjusted
62 Taiwan
March PMI value of 31.1 appears roughly consistent with Korea
our forecast that IP will plummet at a nearly 50% annual 58 China
rate in the three months through August, based on the re-
cent relationship between the PMI and IP growth. 54
12
JPMorgan Chase Bank NA, New York Economic Research
David Hensley (1-212) 834-5516 Global Data Watch
david.hensley@jpmorgan.com April 1, 2011
Joseph Lupton (1-212) 834-5735
joseph.p.lupton@jpmorgan.com
Economic Research Note J.P. Morgan Agricultural CCI and EM food inflation
%oya
EM food inflation to push 100
JPMACCI
16
13
JPMorgan Chase Bank NA, New York Economic Research
David Hensley (1-212) 834-5516 EM food inflation to push higher into midyear
david.hensley@jpmorgan.com April 1, 2011
Joseph Lupton (1-212) 834-5735
joseph.p.lupton@jpmorgan.com
14
JPMorgan Chase Bank, New York Economic Research
Michael Feroli (1-212) 834-5523 Global Data Watch
michael.e.feroli@jpmorgan.com April 1, 2011
Since the beginning of the year, first-quarter real GDP Income and prices
growth projections have been marked down, largely be- %ch, 3-mo annualized
cause real consumer spending growth looks to be expand-
ing at a weaker-than-anticipated pace, perhaps in the 1%- 10
Compensation
2% range. That disappointment in turn seems to be mostly 5
a result of real disposable income growing at an okay but
not stellar 2.5% pace. Nominal disposable income has 0
been growing at a more respectable pace of around 6% or PCE prices
-5
better, thanks in part to the January reduction in Social Se-
curity taxes. However, because headline inflation is being -10
pushed higher by rising food and energy prices, that expan-
-15
sion in nominal income is not translating into as much 2009 2010 2011
growth in real income. In 2Q, those forces should mostly
reverse themselves: although headline inflation should Household sector: taxes paid minus gov't payments received
ease, the boost to nominal income growth from the tax cuts
% of income
will have faded, leaving real income growth tracking in the
2% neighborhood. 12
10
8
Pushes and pulls
6
One reason expectations for growth picked up late last year 4
was because changes in fiscal policy promised more con- 2
sumer income growth in early 2011 and therefore hopefully 0
greater consumer spending growth. The change in fiscal -2
policy referred to is not the Bush-era 2001 and 2003 tax 59 64 69 74 79 84 89 94 99 04 09
cuts: the preservation of those cuts left personal income tax
rates unchanged in 2011 relative to 2010, and thus should wait for next year’s tax refund season. That reduction lifted
have had no major impact on income growth. What did nominal income growth by almost 2%-pts in the first quar-
change was the one-year 2%-pt reduction in Social Secu- ter. (Note, although the reduced Social Security tax rates
rity taxes, which should put $110 billion extra in the wal- hold for all of 2011, the lift to income growth is entirely in
lets of consumers this calendar year. the first quarter).
That boost to income was partly offset by the loss of the So far, the income story looks pretty good. Unfortunately, a
$50 billion lower-income Making Work Pay tax credit. strong increase in inflation means that much of that extra
Even so, households ended up with a $60 billion reduction nominal income growth is simply going into higher prices.
in tax burden. Because that cut in taxes was in payroll Headline PCE inflation is increasing at a 3.5% annual rate
withholding taxes it should immediately show up in con- in 1Q, even as ex.-food and energy core prices are rising at
sumers’ pockets beginning in January, rather than having to less than a 1.5% rate. That extra two percentage points of
15
JPMorgan Chase Bank, New York Economic Research
Michael Feroli (1-212) 834-5523 US: first half income growth and a simple twist
michael.e.feroli@jpmorgan.com of fate
April 1, 2011
inflation due to surging food and energy prices almost ex- Rental income of persons
actly offsets the two-percentage-point lift to nominal in- $ bn
come growth from the tax cuts.
350
16
JPMorgan Chase Bank, London Economic Research
David Mackie (44-20) 7325-5040 Global Data Watch
david.mackie@jpmorgan.com April 1, 2011
17
JPMorgan Chase Bank, London Economic Research
David Mackie (44-20) 7325-5040 Euro area debt crisis: gauging the optimal
david.mackie@jpmorgan.com exit path
April 1, 2011
2. Carmen Reinhart, Kenneth Rogoff, and Miguel Savastano, “Debt Intolerance,” NBER
Working Paper, August 2003.
18
JPMorgan Securities Japan Co., Ltd. Economic Research
Masaaki Kanno (81-3) 6736-1166 Global Data Watch
masaaki.kanno@jpmorgan.com April 1, 2011
Masamichi Adachi (81-3) 6736-1172
masamichi.x.adachi@jpmorgan.com
While agriculture, fisheries, and forestry are the primary Supply-chain bottlenecks are expected to have global im-
industries in the Tohoku region, the area has recently at- plications as well. For example, some plants in the region,
tracted a growing number of manufacturing industries due which produce a special semiconductor in auto engines and
to the development of a highway and shinkansen (bullet have a 40% share of the global market, were damaged criti-
train) network. As a result, firms, employing new technolo- cally and are not expected to reopen until June. Our analyst
gies, have opened new plants in the region, in part to, ironi- says that it will be difficult to find a replacement for this
cally, diversify geographical risk. part in a short time period. It is estimated that auto compa-
nies have at maximum one month’s inventory of this prod-
Supply chain problem uct, but unless supply of the special semiconductors re-
sumes shortly, a part of auto production outside of Japan
The typical new entrants are the auto, electronics, and may be forced to be suspended.
chemical industries. While the relative share of those
manufacturing industries is still low in the region (see “Ja-
pan to recover from disaster, but to take time,” GDW,
Do not underestimate the drag from the
March 18, 2011), there are a number of manufacturing outages
firms that produce key parts or materials without which In addition, power outages have become a much larger
firms cannot produce autos and electronic final products, drag on economic activity, not only in the Tohoku region,
including tablet computers. That’s why almost all the plants but also in the Tokyo metropolitan area, which produces
19
JPMorgan Securities Japan Co., Ltd. Economic Research
Masaaki Kanno (81-3) 6736-1166 Understanding the supply
masaaki.kanno@jpmorgan.com shock to Japan’s economy
Masamichi Adachi (81-3) 6736-1172 April 1, 2011
masamichi.x.adachi@jpmorgan.com
40% of GDP. Although the outages are for a maximum of IP forecast: with and without power outages
three hours a day, they will cause significant damage to Feb11=100
manufacturing, as any disruption in power can cause the 110
shutdown of operations. Unless a stable power supply is No outages
105
assured, their operations will likely remain depressed. In 100
addition, the power company is giving only one day’s no- 95
tice for the planned outages. This has made production With outages in summer
90
planning even more difficult.
85
20
JPMorgan Chase Bank, London Economic Research
Miroslav Plojhar (44-20) 7325-0745 Global Data Watch
miroslav.x.plojhar@jpmorgan.com April 1, 2011
Economic Research Note Israeli real interest rate remains negative despite solid growth
%oya for GDP and %p.a. for BoI rate
Israel: BoI steps up tightening 10
Housing market is not a bubble, yet Housing prices in CPI are lagging growth of house prices
%oya
Beside a potential spillover into CPI, the experience of sev-
25 House prices
eral developed and emerging market countries has showed Housing prices
that inflation targeters should pay close attention to devel- 20 (a quarter of CPI basket)
opments in the housing market. Housing prices and mort- 15
gage credit in Israel did not explode in the mid-2000s as in 10
other countries, thereby limiting the damage from the glo- 5
bal recession. Yet, prices did start to climb in late 2007 and 0
are up 60% since then. We agree with the BoI that the -5
housing market is not in a bubble yet. However, this may -10
change if the double-digit price growth continues. -15
00 02 04 06 08 10
Studying housing market bubbles abroad, the BoI is trying to Housing market reflation is working too well
avoid a mistake of too lax regulation. Last fall, the BoI intro- 2000=100 ILS bn
duced measures designed to reduce loan-to-value ratios. The
experience of housing market bubbles also shows that inter- 160 220
est rates held too low play an important role in the specula- Volume of mortgages 200
tive process, although they are not the most important driver. 140 180
We do not argue that the BoI should target house prices. We House prices 160
120
only think that any central bank behavior should not contrib- 140
ute to overvalued asset prices. Leaving interest rates too low 120
100
for too long is proverbially pouring fuel onto the fire (sec-
100
ond chart).
80 80
00 02 04 06 08 10
Higher rates preferred option...
First, a small FX strengthening is unlikely to have a mate-
Of the main policy options, we think that increasing inter-
rial impact on export performance. Second, a weaker ex-
est rates to neutral or even slightly above will be preferred
port performance, if achieved, may strengthen domestic
to letting the shekel appreciate at faster pace, more macro-
demand for nontradable goods and services, e.g., related to
prudential measures, or reducing government bond hold-
housing, as seen in several developed countries in the past.
ings. Normalizing the level of interest rates should not only
This would be counterproductive in the effort to tame infla-
help to maintain inflation-targeting credibility but also re-
tion pressures in both consumer and house prices. Finally,
strain the housing market boom. Rising interest rates are
theoretical monetary policy considerations meet hard real-
pushing up the currency but only to a limited extent. The
ity when special interest groups are taken into account.
shekel is being driven more by relative undervaluation, the
There is constant, strong pressure from exporters on the
current account surplus, and insufficient investment by Is-
central bank to prevent large shekel gains. As FX hedging
raelis abroad than by capital inflows seeking high carry
activity among exporters is underdeveloped, the BoI is per-
(see “Israel: C/A surplus and strong economy keep pushing
ceived to be the main FX hedger for the whole economy.
FX up” GDW, January 14, 2011).
We expect the Bank of Israel to let the shekel strengthen to
...to a faster rise in the shekel nearer its fundamental value but it is unlikely to let the cur-
A stronger currency would have limited direct impact on rency completely undo more than 10% undervaluation in
inflation. In the past, there was a strong, immediate FX the coming quarters. The strategy of occasional FX inter-
passthrough due to dollarization of services, especially ventions is likely to continue. Regulatory measures to dis-
rents. During 2007-09, however, the rate of passthrough courage nonresident activity in the shekel market, taken
diminished markedly. We do not think it will increase un- two months ago, have so far had only a small effect on the
less the country experiences hyperinflation as in the 1980s. shekel rate. But once the BoI crosses the Rubicon in using
We estimate the current FX passthrough of 10% over 12 capital flow restrictions, more regulatory measures may
months, which is smaller than in similarly sized EMEA EM follow. Finally, it will be easier for the BoI to tighten the
economies due to a less open economy. A stronger cur- interest rate part of monetary conditions within a global
rency should slow inflation also indirectly through its nega- rising rate environment, especially with the likely increase
tive impact on economic growth. There are several caveats. from the ECB next week.
22
JPMorgan Chase Bank, London Economic Research
Nora Szentivanyi (44-20) 7777-3981 Global Data Watch
nora.szentivanyi@jpmorgan.com April 1, 2011
23
JPMorgan Chase Bank, London Economic Research
Nora Szentivanyi (44-20) 7777-3981 Iceland: export-led growth holds the key
nora.szentivanyi@jpmorgan.com April 1, 2011
• The external trade balance has improved markedly. Trade balance and underlying current account in surplus
Iceland’s balance of trade in goods and services moved % of GDP, 12-month sum
to a surplus of 11% of GDP in 2010 from a similar-sized
deficit two years earlier. The improvement owed prima- 15 Underlying current account1
rily to a sharp contraction in imports in 2008-09, and im-
proving terms of trade, while export volumes have risen 0
only modestly. Higher prices for Iceland’s main exports Trade balance (g&s)
(aluminum and marine products) led to a sizable im-
-15
provement in the terms of trade, particularly in 1H10. Current account
• The underlying current account is also in surplus. -30
Iceland’s headline current account has improved signifi- 2005 2006 2007 2008 2009 2010
cantly from pre-crisis levels, but remains in deficit owing 1. C/A ex. accrued interest due to deposit institutions undergoing winding-up proceedings
entirely to a sizable income deficit. Importantly, the re-
Foreign currency reserves have risen
ported income deficit includes accrued interest expenses
due to deposit institutions undergoing winding-up pro- US$ mn
ceedings worth about 9.5% of GDP last year. Because this 6500
does not reflect actual currency flows, but rather accrued
interest on failed banks that will never be paid, it makes
sense to exclude them when analyzing the external bal- 5000
ance. Once the failed banks are settled, the current account
for last year would be in a surplus of nearly 2% of GDP. 3500
• FX reserves are at record highs. Foreign exchange re-
serves have doubled over the past two years on the back 2000
of loans from the IMF, Nordic countries, and Poland; the 2007 2008 2009 2010 2011
CBI’s FX purchases and transactions with commercial
banks, and recovery of loans associated with the banking • Financial stability. The recapitalization of Iceland’s
collapse. Gross FX reserves reached a record high of three major banks is complete, and private sector debt
US$6.2 billion (47% of GDP) at the end of February, relief measures have been finalized following a supreme
while FX reserves net of liabilities reached 20% of GDP. court ruling in November and new legislation. An earlier
The current size of reserves would be sufficient to pay ruling that questioned the legality of FX-linked loans has
interest and principal on external debt through 2015, and led to significant delays in private debt restructuring and
in months of imports is more than adequate. thus in meeting the financial stability condition.
• Inflation has fallen back to target. Disinflation has Capital controls to be relaxed in phases
been rapid, with the headline CPI rate falling from a peak
Icelandic authorities now appear comfortable beginning a
of 18.6%oya in early 2009 to 1.9% in early 2011. This
gradual relaxation of capital account controls, although
has allowed the CBI to cut interest rates to a historic low
only measures to reduce offshore krona positions will be
of 4.25%. Supply shocks should push inflation higher
undertaken in the near future. Further steps in the liberal-
from here, but underlying price pressures should remain
ization strategy will be subject to a number of precondi-
modest as sizable slack persists (we see the output gap
tions and success of the initial steps taken (box, next page).
closing only in late 2013). We see inflation hovering
It is likely that the period of liberalization will span several
close to the 2.5% target, but believe that further rate cuts
years. The revised strategy document targets 2015 for end-
are unlikely due to rising policy rates elsewhere and the
ing the process—a four-year delay from the previous date.
CBI’s interim objective of exchange rate stability.
• Fiscal sustainability is on track. The primary fiscal bal- Nonresidents hold a large share of highly liquid ISK assets
ance improved by 10%-points of GDP between 2008 and of about ISK465 billion or 30% of GDP. Of this, 60% is
2010. The budget foresees a primary balance close to held in government bonds and the remainder in bank de-
zero this year, while a surplus of around 3% is targeted posits. The central bank believes that about 70% of deposi-
for 2012 and 6% by 2015. This, along with the new tors will want to exit their holdings as soon as possible or
Icesave agreement (box, last page), should help to put the might be forced to sell due to Iceland’s low sovereign
public debt ratio on a declining path from next year. credit rating. The first phase of the strategy will thus begin
24
JPMorgan Chase Bank, London Economic Research
Nora Szentivanyi (44-20) 7777-3981 Global Data Watch
nora.szentivanyi@jpmorgan.com April 1, 2011
25
JPMorgan Chase Bank, London Economic Research
Nora Szentivanyi (44-20) 7777-3981 Iceland: export-led growth holds the key
nora.szentivanyi@jpmorgan.com April 1, 2011
26