eurozone crisis intensifies, but economy muddling through december 2010
TRANSCRIPT
Eurozone crisis intensifies, but economy muddling through
December 2010
- 2 -Economic Outlook – December 2010
Europe Crisis stage is back, but to
date, contagion has not spread beyond Eurozone
German economy powering ahead as weak Euro boosts exports
UK outlook improving: mixed growth and high inflation
Asia Japan stimulus measures cool
Yen, light a fire under equities
China policy looks to slow economy, growth remains strong
Exchange rates matter a lot in this region
Canada Economic growth slowed
substantially in Q2
Bank of Canada expected to hit the pause button over next 6 months
C$ fortunes tied to global outlook, most specifically China
Headwinds remain, but global expansion still underway
Emerging Markets India’s economy still strong
Brazil to grow 7.5%-8% this year, strongest in 25 years
EM will continue to be a powerful growth engine
Currencies undervalued
- 3 -Economic Outlook – December 2010
European Bailout Breakdown
Amount AmountProgram (€ B) ($US B) Purpose
European Financial Stabilization Fund 60 70
Immediate loans intended to help any member of the eurozone struggling to finance its debt due to high interest rates demanded by capital markets
European Financial Stabilization Facility 440 570
Government-backed loans intended to improve market confidence guaranteed by EMU members and implicitly by ECB. To be drawn if and when needed.
IMF - Special Purpose Loans 250 284Government-backed loans intended to improve market confidence guaranteed by IMF. To be drawn if and when needed.
Total 750 924
Source: The Guardian, Bank of America Merrill Lynch, Reuters
Economic Headwinds European Banking Crisis
- 4 -Economic Outlook – December 2010
European Banks - Ireland, Spain & Portugal CDS 5-Year Spreads
0
200
400
600
800
1000
1200
1400
1600
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11
Basis
Poin
ts
Santander BBVA Banco Espirito SantoBanco Comercial Portugues Allied Irish Bank of Ireland
Source: Bloomberg
Europe's "PIIGS" - Bank Stock PerformanceRBC Piggybank Index Relative to MSCI World
0.08
0.09
0.10
0.11
0.12
0.13
0.14
0.15
0.16
0.17
Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
Source: RBC CM
Economic Headwinds European Banking Crisis
RBC Capital Markets Piggybank Index tracks the share prices of major banks in Spain, Portugal and Greece. It shows markets consider banks of peripheral European economies to be at least as vulnerable today as at the peak of the financial crisis of 2008/09.
Will it stop with Ireland, or is Portugal next, and then Spain? Aggregate GDP for the economies already in crisis (Greece & Ireland) is only 2.9% of Eurozone total, but Portugal would add another 1.3% and Spain a further 7.3%. Cost of insuring near-sovereign debt shows fear of serial correlation as the failure of Irish banks lifts CDS spreads for Portuguese banks (with a lag). Is Spain next?
- 5 -Economic Outlook – December 2010
Swap SpreadsUnited States & Eurozone
0
50
100
150
200
250
300
350
400
Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11
Basis
Poin
ts
U.S. (3-month Libor-OIS Spread) Eurozone (3-month Euribor-OIS Spread)
Source: RBC AM, Haver Analytics
So far, the Eurozone banking crisis, itself largely the product of a U.S. banking crisis (but with the necessary precondition of a locally funded real estate
bubble/bust), has had a limited impact elsewhere.
U.S. Yield Curve vs. VIX Volatility-2.0
-1.0
0.0
1.0
2.0
3.01990 1995 2000 2005 2010 2015
%
0
10
20
30
40
50
60
70
%
Recession Periods U.S. 10-2 Spread (Lt, Inv, Adv 30 Months) VIX (Rt)
Source: RBC GAM
Current VIX: 22.2
Stock market volatility has increased as the European banking crisis has intensified, but not by much. VIX levels remain consistent with their normal relationship with the U.S. yield curve.
Swap spreads – an indicator that became prominent in the days surrounding the Lehman bust – suggest an orderly interbank lending market, where faith in counterparties is reasonably solid.
Economic Headwinds Despite Europe’s issues reactions remain muted
- 6 -Economic Outlook – December 2010
Professors Rogoff & Reinhart have shown that sovereign debt levels are largely ignored until they cross the 90% threshold – a level now surpassed by 6 of the G7 nations.
Drawing on over a century of history, the professors show that growth has subsequently slowed by 1.0-1.7% below its long-term norm.
United States Canada France Germany Italy Japan
United Kingdom
2008 71.1 69.8 67.5 66.3 106.1 194.7 52.12009 84.3 81.6 78.1 73.5 115.8 217.6 68.52010 92.7 81.7 84.2 75.3 118.4 225.9 76.72011 99.3 80.5 87.6 76.5 119.7 234.1 81.92012 102.9 78.8 89.4 77.0 119.7 238.7 85.12013 105.4 76.7 90.0 77.0 119.7 243.0 86.12014 107.8 74.3 89.6 76.4 119.4 246.2 85.52015 110.7 71.6 88.4 75.6 118.8 249.2 83.9
Prior Peak 83.2 101.0 77.4 72.5 121.8 217.6 68.2
Anticipated Deficit/GDP -11.8 -4.9 -8.0 -5.0 -5.1 -9.6 -10.2 Ratio for 2010
Source: IMF
Global Gross Debt/GDP Ratios with IMF Forecasts
Economic Headwinds Sovereign debt remains a drag
- 7 -Economic Outlook – December 2010
The U.S. Economy Housing: Renewed weakness after a period of repair
U.S. Housing - New Private Housing Units StartedTotal Starts Including Farm Housing
0.4
0.8
1.2
1.6
2.0
2.4
1980 1985 1990 1995 2000 2005 2010 2015
Milli
on U
nits
Source: Census, Housing Starts
Housing starts still near trough levels, may be headed for a new low…
…and, with the end of home buyers’ tax credit, sales of existing homes have plunged.
United States Housing StatisticsExisting Home Sales
-30
-20
-10
0
10
20
30
40
50
2000 2003 2006 2009 2012 2015
YoY
% C
hang
e Un
its S
oldSource: National Association of Realtors
- 8 -Economic Outlook – December 2010
U.S. Housing - Month's Supply of Homes on the MarketExisting Single Family Homes
2.0
4.0
6.0
8.0
10.0
12.0
14.0
1990 1995 2000 2005 2010 2015
Mon
ths
Source: National Association Of Realtors
Last Plot: 10.1 Mths
U.S. Housing Former "Hot Markets" Percentage Changes in Sales Volumes
-59% -52% -58%-42%
54% 46% 44%
137%
0%
-69%-100%
-50%
0%
50%
100%
150%
200%
250%
300%
Arizona California Florida Nevada Nationwide
% C
hang
e in
Volum
es
Peak-Trough Volume Declines Trough-Current Volume Increases
Source: NAR, Empirical Research Partners
With the stabilizing effect of special incentives removed inventory overhang moved to a new high. This is an important setback on the way to recovery.
Nevertheless, in those areas with the most dramatic price declines, the volume of transactions remains encouraging through Q3 2010.
The U.S. Economy Housing: Renewed weakness after a period of repair
- 9 -Economic Outlook – December 2010
Senior Loan Officer Survey on Bank Lending PracticesU.S. Yield Curve and Willingness to Make Consumer Loans
-2
-1
0
1
2
3
4
5
1990 1995 2000 2005 2010 2015%
-60
-40
-20
0
20
40
60
U.S. Yield Curve (10 yr - Fed Funds %, Adv 18 months) (LHS)Loan Officers Willingness to Make Consumer Installment Loans (RHS)
Source: Federal Reserve, ISI
Senior Loan Officer Survey on Bank Lending PracticesLoan Officers Reporting Tightening Standards
-40
-20
0
20
40
60
80
100
1990 1995 2000 2005 2010 2015
QoQ
% C
hang
e
Mortgage Loans to Individuals Commercial & Industrial Loans
Source: Federal Reserve, Haver Analytics
Lending standards for mortgages are tightening again following a brief period of easing.
A steeply positive slope to the yield curve indicates the growing ability/desire by banks to make loans.
Ongoing improvement in U.S. and global lending conditions is essential to our view that a double-dip for North American growth will be avoided.
The U.S. Economy Credit supply
- 10 -Economic Outlook – December 2010
Senior Loan Officer Survey on Bank Lending PracticesBanks Reporting Stronger Demand for Consumer Loans
-60
-40
-20
0
20
40
60
1990 1995 2000 2005 2010 2015
QoQ
% C
hang
eSource: Federal Reserve, Haver Analytics
Senior Loan Officer Survey on Bank Lending PracticesBanks Reporting Stronger Demand for C & I Loans
-80
-60
-40
-20
0
20
40
60
80
1990 1995 2000 2005 2010 2015
QoQ
% C
hang
e
Large and Medium Firms Small Firms
Source: Federal Reserve, Haver Analytics
Following a period of improvement, demand for commercial & industrial loans is once again softening…
…but, importantly, the demand for consumer loans is close to turning positive.
A key element of a sustainable recovery – credit expansion – has been missing as both the supply of funds and borrowing demand moved in reverse. After several quarters of gradual improvement, recent
data shows a loss of forward momentum in both business loans and residential mortgages. This may be transitory – especially if consumers regain confidence – but it must be closely monitored.
The U.S. Economy Credit demand
- 11 -Economic Outlook – December 2010
Some early analysis forecasts that this $600 billion commitment from the Fed will have a positive and meaningful impact on key areas of the economy over the next few years.
Potential Impact of QE2
Size of Program: $600 Billion over 8 months ($75 billion per month)
Impact on : 2011 2012 2013
GDP Level 0.2% 0.8% 1.6%Unemployment Rate -0.1% -0.3% -0.7%CPI 0.7% 0.6% 0.4%
Source: Federal Reserve Board, Deutsche Bank Global Markets Research
Economic stimulus Despite criticism, Fed looks to QE2 to quicken recovery
- 12 -Economic Outlook – December 2010
U.S. ISM Non-Manufacturing Index & the Fed Funds RateFed Funds Inverted and Advanced Six Months
30
35
40
45
50
55
60
65
70
1998 2000 2002 2004 2006 2008 2010 2012
0
1
2
3
4
5
6
7
8
%
ISM Diffusion Index (LHS) Fed Funds Rate (Inverted, Adv 6 Months) (RHS)
Source: Institute for Supply Management
U.S. ISM Manufacturing Index and the Fed Funds Rate Fed Funds Inverted and Advanced Six Months
30
35
40
45
50
55
60
65
70
1998 2000 2002 2004 2006 2008 2010 2012
0
1
2
3
4
5
6
7
8
%
ISM Diffusion Index (LHS) Fed Funds Rate (Inverted, Adv 6 Months) (RHS)
Source: Institute for Supply Management
This month’s unexpected uptick in the ISM and similar gains offshore are welcome signs that the recovery,
although half speed, is durable.
Economic recoveryManufacturing indices continue to respond to low rates
- 13 -Economic Outlook – December 2010
United States ISM Manufacturing Index and Non-Farm Employment
30
35
40
45
50
55
60
65
70
1990 1995 2000 2005 2010 2015
Inde
x Le
vel
-8
-6
-4
-2
0
2
4
6
8
YoY
% C
hang
e
ISM Manufacturing Index (Adv. 12 Months, LHS) Non-Farm Employment (RHS)
Source: Institute for Supply Management, BLS
Employment remains a problem although it is on trend for a positive year/year plot. Improvements closely track manufacturing pick-up and higher consumer spending.
United StatesReal Consumer Spending and Non-Farm Employment
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
1990 1995 2000 2005 2010 2015Yo
Y %
Cha
nge
Non-Farm Employment Real Personal Consumption
Source: Bureau of Labor Statistics, Bureau of Economic Analysis, Citigroup
Economic recoveryEmployment may be gaining traction
- 14 -Economic Outlook – December 2010
The impact of “QE2” is already considerable, with inflation expectations moving back to the long-term average, and close to optimal levels. By this
measure, the program is already a success.
Implied Long-term Inflation PremiumBreakeven Inflation Rate: Nominal vs. 10-year Real Return Bond
0.0
1.0
2.0
3.0
4.0
5.0
2000 2005 2010 2015
%
Canada U.S. Trailing 5-yr Avg U.S. CPI
Canada: 2.38%
U.S.: 2.12%
2.35%
Source: Bloomberg, RBC Capital Markets, RBC AM
Inflation Outlook
United States Inflation Estimate Dispersion
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Highest Estimate Lowest Estimate Actual Annual CPI High/Low Ranges
Source: Consensus Economics, RBC GAMRanges as at Sept 1/10
- 15 -Economic Outlook – December 2010
EurozoneGerman Ifo and ZEW
75
80
85
90
95
100
105
110
115
1990 1995 2000 2005 2010 2015
Inde
x Le
vel
-150
-100
-50
0
50
100
Index Level
IFO Business Survey (LHS) ZEW Current Economic Conditions (RHS)
Source: IFO, Zentrum fuer europaeischewirtschaftsforschung (zew) mannheim
Current conditions in Germany, Europe’s largest economy, are surprisingly strong despite Eurozone budget pressures and threats to its banking system.
Global Leading IndicatorsJP Morgan Global Purchasing Managers Index
30
35
40
45
50
55
60
65
1998 2000 2002 2004 2006 2008 2010 2012
Inde
x
Source: Wolfe Trahan & Co., Bloomberg
Although below its peak, global PMI rose in its latest plot.
Global EconomiesOffshore economies are performing well
- 16 -Economic Outlook – December 2010
ChinaConsumer Price Index
-4
-2
0
2
4
6
8
10
12
14
2000 2005 2010 2015
YoY
% C
hang
e
Overall CPI CPI Excluding Food
Source: China National Bureau of Statistics
The quality of China’s growth will be a big factor in the sustainability of the world’s recovery. Recent peak in PMI and tightening of monetary
policy has already had an impact on commodity and stock prices.
China Business Climate Index
100
110
120
130
140
150
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012In
dex
Leve
l
Source: China National Bureau of Statistics
Rising domestic inflation has caused a tightening of monetary policy, threatening the pace of growth in this critical emerging market….
…still, confidence remains unbroken.
Global EconomiesChinese inflation a challenge for the world’s growth engine
- 17 -Economic Outlook – December 2010
Implications for the economy
• Headwinds to the recovery remain strong: Eurozone banking, sovereign debt levels, housing, access to credit, employment, exiting the stimulus are all unusual and still important threats. Two years after the fall of Lehman, the world remains an uncertain place.
• Employment, critical to the development of a self-sustaining business cycle expansion, is struggling. Reinforces view that recovery from the bust will be protracted and difficult.
• Sovereign debt has also emerged as a key challenge to achieving normal rates of GDP growth. Even major economies, including the U.S. and U.K. are approaching debt/GDP levels which have in the past limited growth.
• Despite severe headwinds economic data since the summer indicates the economy is moving ahead at a modest but unbroken pace. Unacceptably high levels of unemployment causes Fed to begin QE2, providing additional and unconventional stimulus.
• Deflation has so far proved transitory and should remain so as long as a double dip is avoided. Threat of reflation pushed beyond forecast horizon but cannot be ignored. Uptick in inflation expectations associated with QE2 is an early success for the program.
• Modest recovery/mild inflation remains our base case. Threat of a double-dip is valid, but unlikely. The prospect for a protracted period of sub-par growth has become a comfortable consensus.
- 18 -Economic Outlook – December 2010
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