Fed Announces QE3 and Extends Policy Guidance; Germany’s Court decision clear the way to tackle the European debt crisis in a more flexible way
FOMC remains far from an exit strategy. FOMC’s decision highlighted the prolonged extent to which the Fed will continue with easy monetary policy
- Bernanke made it clear the Fed’s highly accommodative stance will be appropriate even as economic growth picks up. The FOMC is committed to promoting a stronger recovery and will be careful not to prematurely tighten monetary policy in order to give some time to the economy to show steady growth.
- Effective immediately, the FOMC agreed to purchase $40bn per month of MBS on an open-ended basis. Despite the fact that recent macroeconomic data were not a dead giveaway for QE3, the Fed decided to move forward with additional easing in order to stimulate the economy. As expected, this round of quantitative easing will be slightly different than the previous two rounds, with plans to purchase $40bn per month of mortgage-backed securities (MBS) on an open-ended basis (i.e. until we see substantial improvement in labor market conditions given that inflation is under control). Purchases will amount to $23bn for the rest of September.
- The Fed also extended its policy guidance through at least mid-2015 and will continue Operation Twist through the end of the year. The committee expects that “exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015” rather than late-2014 as announced in the previous meeting. In regards to the appropriate timing of policy firming, we see a dramatic shift from the June meeting in the number of participants expecting the first target rate hike in 2015. The FOMC also decided to continue Operation Twist as scheduled through the end of the year. Ultimately, both policy accommodations will increase long-term securities holdings by about $85bn per month until the end of 2012.
- Committee members downgraded their outlook for 2012 but upgraded growth projections for 2013. Compared to our own baseline scenario, we continue to see a more optimistic outlook from the Fed. On average, the Fed’s projections suggest annual growth between 2.1% and 2.5% for 2013, higher than our expectations for a 1.8% annual rate. Bullish long-term projections remain unchanged from the previous release.
Europe takes additional steps following the road map previously set
- Following the announcement of actions to be taken by the ECB to address the “convertibility risk” (the risk facing by an asset to be re-denominated in a lower currency), this week several events have confirmed the willingness of Member states to tackle the eurozone sovereign debt crisis. What is more the eurozone also showed a more flexible approach to resolve the problem.
- First, the German Constitutional court has backed the permanent European Stability Mechanism (ESM). Yet, the Bundestag must to sanction any potential future increase in the EFSF’s guarantee limit. It (the Bundestag) has to ratify any use of the stability fund. Despite all these caveats the German Court decision makes possible that the ESM will come into force as shortly as October 8). Additionally, it removes one obstacle from the implementation of the ECB’s Outright Monetary Transaction programme (secondary market bond purchase) to address the European crisis.
- Second, the Dutch election results showed an increase pro-European sentiment.
- Additionally following the mandate of the European Council, the European Commission this week presented its formal proposal to create a Single Banking Supervision Mechanism for the Euro Area (SSM for its acronym in English), including a staggered schedule through 2014. Progress in monitoring was established as a prerequisite to allowed the ESM recapitalize banks directly.
- Lastly, the “Troika” released its verdict of Portugal’s economic programme. They concluded that Portugal programme remain broadly on track, allowing the disbursement of the next loan tranche (EUR 3.4bn) in October, subject to the approval of the IMF and the ECOFIN. The positive Troika’s assessment on Portugal’s programme came despite the upward revision in its deficit target to 5 percent in 2012 and to 4.5 percent from 3 percent in 2012. From our point of view, this reflect a more flexible approach from the Troika to resolve the European Crisis, giving more time to peripheral countries to regain sound fiscal target in order to reduce fiscal imbalances while avoiding the negative feedback between fiscal discipline and short-term growth. In this regard, the Troika’s statement said that “it stands ready to support Portugal until full market access is regained." At the same time, the Portuguese government announced an array of measures that will be included in the 2013 budget in order to achieve the new announced targets.
- We are still pending on the assessment of the Eurogroup (meeting today) on recent developments and the way forward after the ECB decision.
- Financial markets have reacted positively to recent announcements. Peripheral spreads have narrowed significantly. Beside, several financial and corporates firms took advantage of the improving financial condition issuing debt: BBVA, Santander, Gas Natural, Iberdrola, among others. Additionally, Ireland tested the financial markets again. It sold EUR 0.5bn in a 3-month Treasury Bills at an average yield of 0.7%, down from 1.8 percent in the previous auction. The bit-to-cover was high 3x. - Moody's threat this week to downgrade the US government's credit rating unless lawmakers are able to reduce the percentage of debt to gross domestic product during budget negotiations next year. In a statement, the rating agency said that the rating would likely be cut to Aa1 if negotiations fail to produce such policies. Plans that produce a stabilization and then downward trend in the ratio over the medium term will likely lead to an affirmation of the rating. Looking back of last year Standard & Poor´s downgrade to AA+.
Chinese data suggested the growth slowdown has not yet bottomed out. In the Eurozone the data still show that conditions in peripheral countries continue to remain difficult, while France and Germay are being more resilent
- In Asia, China's August activity indicators confirm the ongoing slowdown. Industrial production growth slowed to 8.9% y/y (consensus: 9.0%; BBVA: 8.4%), fixed asset investment moderated to 20.2% ytd (consensus: 20.4%; BBVA: 20.6%), import growth fell by -2.6% (consensus: 3.5%; BBVA: -3.0%), and export growth remained sluggish at 2.7% y/y (consensus: 2.9% y/y; BBVA: 0.5% y/y). Encouragingly, retail sales growth stabilized at 13.2% y/y (consensus: 13.2%; BBVA: 13.1%), and there are signs that property investment and government infrastructure spending are picking up. On Wednesday, China State Council unveiled a package of policy initiatives to support exports. The new measures include: accelerating tax rebates for exporters, expanding coverage of export credit and insurance, simplifying procedures for exports and imports, encouraging imports of advanced equipment and helping domestic exporters in settling trade disputes with other countries. Although details of these policy initiatives have not yet been released, we expect them to be implemented soon in order to support the economy’s growth momentum.
- Regarding the US, the buying trend about U.S products seems to end, due to the trade deficit widened in July for the first time in four months as the global economic slowdown reduced demand for American-made goods. The gap grew 0.2% to $42bon, smaller than projected, from a revised $41.9bn in June. The consensus forecast called for a $44bn deficit. Exports fell by the most since April, outpacing a decline in imports that reflected cheaper petroleum
- In the Eurozone, industrial production rose a sharp 0.6% in the euro area in July after a 0.6% contraction the previous month. In France, industrial production was also better than expected in July, increasing by 0.2%. Then, Eurozone figures benefited from the better-than-expected performance in France and the strong reading of Germany (+1.3% m/m) published last week. In this context, conditions in peripheral countries continue to remain difficult while France and Germany would be more resilient to the crisis.
- Regarding Latam, in Mexico the industrial production increased 0.5% m/m in July, in line with expectations. With this result in terms of annual growth rates, the industry expanded 4.5%. The contribution of the manufacturing and construction was more balanced than previous month, contributing 0.3 and 0.2 pps to growth respectively. Based on available information, economic activity in Q3 continued to show good growth, even better than expected at the beginning of the quarter. However, some signs of moderation persist, as the slower pace of expansion in leading indicators for Mexican manufacturing, as the U.S. ISM, or the slower expansion of industrial employment in August. We maintain the GDP growth forecast of 3.7% for the year. In Brazil, after one year of practical stagnation, high-frequency indicators started to suggest that economic activity is finally rebounding following the sharp reduction of interest rates and the introduction of tax-incentives to some specific sectors. Particularly, retail sales grew 1.4%m/m in July. This was the second robust expansion in a row (in June retail sales had expanded by 1.6%m/m). Other high frequency indicators (such as capacity utilization in the manufacturing industry, hours worked in production, corrugated paper shipment, steel production, vehicles production, vehicles sales and business confidence) support the view that activity started to rebound more solidly in July/August.
Next week will be a busy week, in terms of government auctions: On Monday, France will try to get 7bn from the investors in T-bills. On Tuesday Spain and Greece will tender for EUR4.5bn and EUR1.3bn in bills, respectively. On Wednesday Portugal come back to the market issuing 6M EUR1.5bn and 18M EUR1.75bn in T-bills, also Germany will sell 2Y EUR5bn Bund. Finally on Thursday Spain will issue 5Y bonds, at the same time, France will tender for EUR8.5bn in 2, 3 and 5Y. Regarding maturities, Spain has a maturity of EUR9.7bn next week; also, Greece will pay for EUR1.7bn. Next week is empty of important events, just the release of Eurozone PMI.
Calendar: Indicators
Eurozone: Trade balance, s.a. (July, September 17th)
Forecast: €8.9bn Consensus: n.a Previous: €10.5bn
We expect the trade balance to have narrowed in July, as exports are projected to have fallen while imports are likely to remain flat. Despite the expected decline in exports, this does not fully offset the significant rebound observed in June, and thus exports could have grown by around 1% over Q2, while the 3-month moving average (to remove volatility) shows a steady growth rate, albeit at a much slower rate than that observed at the beginning of the year. These figures feed fears that the main driver of the economy is waning as global demand is slowing. However, the decline in imports has deepened in recent months, reflecting the weakness of domestic demand, and therefore we continue to expect net exports to support GDP growth in H2 2012.
Eurozone: Flash PMI Composite (September, September 20th)
Forecast: 46.4 Consensus: 46.6 Previous: 46.3
We expect the composite PMI to have remained broadly stable in September, as observed in previous months, thus remaining clearly in contractionary territory. However, a larger increase in confidence should not be ruled out, as recent positive news in Europe (ECB’s Outright Monetary Transactions) could have lifted the mood of respondents. Our forecast means that the average PMI in Q3 would be roughly equal than in Q2 and, therefore, suggests that GDP in the eurozone as a whole could have been contracted at a similar rate to that observed in Q2 (-0.2% q/q). Similarly, our MICA-BBVA indicator suggests that GDP could fall by -0.3% q/q in the current quarter, although available hard data is still limited. Across components, manufacturing confidence is set to improve slightly again, although prospects for the sector remain gloomy due to slowing global demand, while service sentiment is likely to deteriorate further, reflecting the weakness of domestic demand.
US: Empire State Manufacturing Survey (September, September 17th)
Forecast: -4.00 Consensus: -1.75 Previous: -5.85
Manufacturing data has been anything but encouraging lately, with most indicators suggesting contracting activity. In August, the Empire State Index dropped below zero for the first time since October, reflecting persistent declines in the new orders component. Surprisingly, weak orders have yet to influence a drop in shipments, but we expect that this trend will not last if demand does not rebound soon. Similarly, employment gains in the sector will continue to decelerate if production remains subdued. Ultimately, we do not expect to see a significant rebound in the data throughout the next few months.
US: Existing Home Sales (August, September 19th)
Forecast: 4.57M Consensus: 4.55M Previous: 4.47M
Existing home sales are expected to increase in August to slightly higher levels than seen in the previous two months. Rising home prices have been discouraging homebuyers, however the brief relief in prices in July helped to reverse this trend. July’s increase in pending home sales, which is a leading indicator of existing sales, will likely be reflected in final housing activity for August. However, existing sales will remain limited by falling supply, with the share of distressed properties dwindling. We expect that housing demand will continue to improve gradually while growing on a YoY basis.
Taiwan Export Orders (August, September 20th)
Forecast: -1.5% y/y Consensus: -2.0% y/y Previous: -4.4% y/y
As a forward indicator near-term export prospects in the region, Taiwan’s export orders will be watched to gauge the extent of the ongoing slump in global trade. The economy’s export performance has been very weak in the past two months, as manufacturing PMI dropped to a nine month low (46.1 in August). The recent slowdown in China’s economy evidenced by sluggish activity and trade has further intensified concerns about Taiwan’s export outlook. We expect year-on-year growth of the export orders in August continue to decline, albeit at a slower pace. Orders from the major export partners might show some signs of stabilization, although a meaningful recovery has yet to come.
