macro markets themes for 2016 -...

Goldman Sachs Global Investment Research 1

Macro Markets Themes for 2016

Francesco Garzarelli Co-Head of Global Macro-Markets Research

and of European Economics

[email protected]

+44(20)7774-5078 02 March 2016 Goldman Sachs International

Investors should consider this research as only a single factor in making investment decisions. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to

www.gs.com/research/hedge.html.

The Goldman Sachs Group, Inc.

Goldman Sachs Research


A Look Back at 2015


Source: Haver Analytics, Goldman Sachs Global Investment Research

US Dollar Strengthens in Trade-Weighted Terms

Trade-weighted currency indices

USD, JPY and EUR, Indexed at May-2014 = 100

Ratio of narrow money base to nominal GDP Q4-2007 = 100

85

90

95

100

105

110

115

120

125

130

May-14 Aug-14 Oct-14 Jan-15 Mar-15 Jun-15 Aug-15 Nov-15 Jan-16

USD TWI

JPY TWI

EUR TWI

Index

A Look-back at 2015

‘Divergence Between, Convergence Within’

50

100

150

200

250

300

350

400

450

2007 2008 2009 2010 2011 2012 2013 2014 2015

US

Japan

Euro Area

Index

Monetary Policy Divergence Extends

Bank lending rates to companies in respective countries

Bank Lending Rates in Euro Area Converging

-600

-400

-200

0

200

400

600

800

1000

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

EUR bn

Germany

Italy

Spain

France

Target 2 Imbalances Still High

Target2 balances in the Euro Area Banking System

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Germany

France

Italy

Spain

%


Source: Bloomberg, Haver Analytics, Goldman Sachs Global Investment Research

...Reinforcing Expectations of

Protracted ‘Low-flation’

Weighted average contribution of energy prices

to headline CPI in G4 vs WTI

A Look-back at 2015

Lower Crude Oil Prices Pull CPI Inflation Down

Lower Energy Prices Is Subtracting

More Than 1% from Headline CPI...

30

45

60

75

90

105

120

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2010 2011 2012 2013 2014 2015 2016

Weighted average contribution of energycomponent to headline CPI in G4 (LHS)

WTI (RHS)

% $/bbl

-1.00

-0.50

0.00

0.50

1.00

1.50

1.25

1.75

2.25

2.75

3.25

3.75

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

UST 10 Year Nominal Yield(LHS)

10 Year TIPS (RHS)

%%

Oil Price'Crash'

US 10-year nominal yield and 10-year TIPS

Goldman Sachs Global Investment Research 5 Source: US NOAA, Bloomberg , Haver Analytics, Goldman Sachs Global Investment Research

A Look-back at 2015

Four Global Unanticipated ‘Shocks’

25

30

35

40

45

50

55

60

65

70

Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15

Greek Government

Bond Strip Pr ice

Price

6.0

6.2

6.4

6.6

6.8

7.0

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

USD/CNY

FWD

GS Forecast

USD/CNY

Greece’s Confrontation with the ‘Troika’

A ‘Rational Bubble’ in German Bunds China’s FX Depreciation

10-year Bund Yield: Actual vs Model ‘Fair Value’

Greek Government Bond Strip Price

USD/CNY: Spot, Forwards and GS Forecasts

A Particularly Strong ‘El Nino’

Sep-Nov US Temperatures vs 1900-2000 Average

50.0

52.5

55.0

57.5

1895 1915 1935 1955 1975 1995 2015

Temperature: Sep-Nov

Average Sep-Nov. Temperature 1900-2000

Degrees F.

-2.0

-1.8

-1.5

-1.3

-1.0

-0.8

-0.5

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Aug-14 Nov-14 Feb-15 May-15 Aug-15

DEM 10-yr yield

Sudoku Misvaluation

% Std. Dev .


Where Are We Now?


Source: Consensus Economics, Haver Analytics, Goldman Sachs Global Investment Research

Headline CPI Inflation

Below Target in 2016...

5.0

5.1

0.8

1.9

2.9

3.5

Emerg- GS

Emerg - CE

Adv - GS

Adv- CE

World - GS

World - CE %

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

USA UK Euro Area Japan

2016 2017 2018 2019%

Consensus Economics, GS Forecasts for World,

Advanced and Emerging Economies in 2016 GS CPI forecasts for USA, UK, Euro Area, Japan

...And in the Years Ahead

in Several Advanced Economies

2% inflation target

Where Are We Now

Inflation Outlook Still Clouded


Source: Goldman Sachs Global Investment Research

We Expect a 'Managed' CNY Depreciation

GS Current Activity Indicator and GS Market Based China

Growth Risk Factor

A Bumpy Deceleration is Underway in China

USD/CNY: Spot, Forwards and GS Forecasts

6.0

6.2

6.4

6.6

6.8

7.0

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

USD/CNY Spot

FWD

GS Forecast

USD/CNY

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

2008 2009 2010 2011 2012 2013 2014 2015 2016

China CAI

Market-based China Growth Risk Factor

%

Where Are We Now

China Slowing, Policy Easing

85

90

95

100

105

110

115

120

125

2012 2013 2014 2015

EM FX Real TWI

CNY Real TWI

Index

33%

CNY Has Appreciated vs EM Peers

China Real Trade Weighted Exchange Rate

vs Other EM Majors


Source: Haver Analytics, Bloomberg, Goldman Sachs Global Investment

Research

Where Are We Now

Bonds as Stretched as in Early 2015...

-4

-2

0

2

4

1991 1996 2001 2006 2011 2016

10-year Bund Misvaluation

+/- 1 Std. Dev

+/-1 2 Std. Dev

Cheap

Expensive

Std.Dev

German Bunds: Model Over/Undervaluation

US Treasuries: Model Over/Undervaluation

1

2

3

4

5

2009 2010 2012 2013 2015 2016

US 10-yr yield

Sudoku 'Fair' Value

Current Market Pricing

GS Forecast

%

US Treasuries: Actual and Model ‘Fair Value’

0

1

2

3

4

2009 2010 2012 2013 2015 2016

DEM 10-yr yieldSudoku 'Fair' ValueCurrent Market PricingGS Forecast

%

German Bunds: Actual and Model ‘Fair Value’

QE + forward guidance

QE + forward guidance

On current

consensus

macro forecasts,

a 2SD even on

TY10 is at 1.75% -4

-2

0

2

4

1991 1996 2001 2006 2011 2016

10-year UST Misvaluation

+/- 1 Std. Dev

+/-1 2 Std. Dev

Cheap

Expensive

Std.Dev


-0.3

0.7

1.7

2.7

3.7

4.7

t-4 t-2 t t+2 t+4 t+6 t+8 t+10 t+12 t+14 t+16 t+18 t+20 t+22 t+24Months (t = Month of rate hike)

2004

1999

1993

1988

25 Feb 2016

Source: Federal Reserve, Haver Analytics, Goldman Sachs Global Investment Research

Expectations on the ‘Neutral Rate’ (R*)

Usually Rise as Fed Hikes

5-yr- 5-yr ‘risk neutral’ US $ rates

estimated by Adrian, Crump and Moench (2013)

Term Premium Drops 2 Quarters After the

First Hike, But From Much Higher Levels

5-yr- 5-yr ‘term premium’ on US $ rates

estimated by Adrian, Crump and Moench (2013)

Where Are We Now

Low ‘Neutral’ Rate, No Premium in Bonds

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

t-4 t-2 t t+2 t+4 t+6 t+8 t+10 t+12 t+14 t+16 t+18 t+20 t+22 t+24Months (t = Month of rate hike)

2004

1999

1993

1988

25 Feb 2016



Yields in G-4 Have Co-Moved

Since Start of Year

10-Year bond yields in US, Germany, UK and Japan

But JGBs have Been in the Driving Seat

Cumulative rate shocks for yields of 10-year USTs, German

Bunds, UK Gilts and JGBs, computed using Rigobon (2003)

methodology

Where Are We Now

Japan in the Driving Seat for Rate Rally

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16

US

UK

Japan

Germany

Cumulativestandard errors

-0.1

0.1

0.3

0.5

0.7

1.2

1.4

1.6

1.8

2.0

2.2

2.4

Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16

UK

US

Japan (RHS)

Germany (RHS)

% %


0%

20%

40%

60%

80%

100%

2010 2011 2012 2013 2014 2015 2016

Probability low inflation

Probability medium inflation

Probability high inflation

Source: Bloomberg, Goldman Sachs Global Investment Research

...And Sees Very High Chance of Persistent

Low-flation in the Euro area

Market Still Assigns High Probability

to Moderate Inflation in the US…

Option-implied probability distribution of 5-year inflation by strike

‘clusters’: low inflation (≤1%), medium, and high (≥3%)

Option-implied probability distribution of 5-year inflation by strike

‘clusters’: low inflation (≤1%), medium, and high (≥3%)

0%

20%

40%

60%

80%

100%

2010 2011 2012 2013 2014 2015 2016

Probability low inflation

Probability medium inflation

Probability high inflation

Where Are We Now

The Market Prices Persistent Low-flation

40%

70%



'Market-Implied' Pricing of Core-CPI is

too Low Relative to GS Forecasts

US core CPI (YoY), market implied pricing of core CPI

and GS forecasts

WTI, GS Forecast, Oil Forwards and market implied path

for WTI if Core-CPI has to stay at 2%

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Jan-13 Aug-13 Mar-14 Oct-14 May-15 Dec-15 Jul-16 Feb-17 Sep-17

US Core-CPI (YoY)

GS Forecast

Market Implied Pricing of 'Core-CPI'

%

0

20

40

60

80

100

120

Jan-13 Aug-13 Mar-14 Oct-14 May-15 Dec-15 Jul-16 Feb-17 Sep-17

WTI

GS Forecast

Oil Forwards

Market Price Needed for Core-CPI at 2%

$/bbl

Market Pricing Sub-20 $/bbl Oil Prices

for Core-CPI to stay at 2%

Where Are We Now

Or Discounts ‘Crash Risk’ in Oil Prices



..Compressing Periphery-Core Spreads

Difference between Italy-Germany 30-year government bond

spread and 5-year spread (in asset swaps)

ECB Absorbs Around Half

of Overall Gross Issuance..

Estimated ECB purchases under PSPP for 2016

as percentage of gross bond issuance

Where Are We Now

ECB Gluing EMU Bond Markets Together

0

10

20

30

40

50

60

70

80

90

100

Germany France Italy Spain

ECB purchases 2016/government bond grossissuance 2016

%

median

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Italy-Germany TermStructure of Spreads

%


What to Expect Through 2016


Source: Consensus Economics, Goldman Sachs Global Investment Research

US 2016 Real GDP Growth: GS forecast vs

kernel distribution of consensus projection

Euro area 2016 Real GDP Growth: GS forecast vs

kernel distribution of consensus projection

Distribution of US Growth Expectations

Is Fairly Symmetric Heavy Left Tail in Distribution of Euro

area Growth Forecasts

0.0

0.5

1.0

1.5

2.0

2.0 2.3 2.6 2.9 3.2

Consensus 2016

GS 2016

Density

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1.2 1.3 1.5 1.7 1.9

Consensus 2016

GS 2016

Density

What Will Drive Macro Markets in 2016

Europe Will Beat Its Growth Potential


Source: Goldman Sachs Global Investment Research

...As Is the Case Across Most Economies

US Manufacturing and Services PMI

US Tertiary Activity Continues to Expand

In Face of an Industrial Slowdown...

Global PMIs: Manufacturing and Services


The Services Sector Will Carry the Day

48

50

52

54

56

2011 2012 2013 2014 2015 2016

Global Manufacturing PMI

Global Services PMI

Index48

50

52

54

56

58

60

62

2011 2012 2013 2014 2015 2016

US Manufacturing PMI

US Services PMI

Index


US Government Sector Expected to

Add to US Growth in 2016-18


From the ‘End of Austerity’ (2014-15)’ to

A Synchronous Fiscal Expansion

Contribution of US Government Consumption and Capex

to US Real GDP Growth

Estimates of contribution of fiscal policy

annual real GDP growth in selected countries


The Fiscal Stance Will Turn More Expansionary

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2000 2003 2006 2009 2012 2015

Contribution of US GovernmentSpending to Real GDP Growth

%

GS Forecast

0

20

40

60

80

100

120

140

USA Euro Area Japan China

2015

2016

bp


Source: Japan Ministry of Finance, Haver Analytics, Bloomberg, Goldman Sachs Global Investment Research


ECB and BoJ Alleviate ‘Debt Overhang’

7.5

8.0

8.5

9.0

9.5

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

Mar-10 Jan-11 Nov-11 Sep-12 Jul-13 May-14 Mar-15 Jan-16 Nov-16

Average Maturity of JGBs in BoJs Balance Sheet (LHS)

Forecast Average Maturity of JGBs in BoJs BalanceSheet (LHS)

Average Maturity of JGB's at Issuance (RHS)

years years

4

10

16

22

28

34

40

46

52

-10

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

2001 2003 2005 2007 2009 2011 2013 2015 2017

Fiscal Deficit as % of GDP (LHS)

GS projections assuming QQE runs at 80trn Yen/year (RHS)

BoJ Holding of JGB's as % of Total (RHS)

% %

GS Forecast

BoJ on Course to Hold Almost Half of Japan’s

Public Debt

0

2

4

6

8

10

12

14

0

5

10

15

20

25

30

35

Germany France Italy Spain

2017 (LHS)

2016 (LHS)

2015 (LHS)

Average Maturity of ECB Purchases (RHS)

Average Maturity of Stock Outstanding (RHS)

ECB purchases in year X as a % of

stock of bonds in end of year X

years

BoJ QQE Has Afforded Debt Maturity Extension

Outstanding stock of government bonds, ECB purchases and

respective average maturities

ECB QE Alleviates the Public Debt ‘Overhang’

0

50

100

150

200

250

300

350

yr<2 2≤yr<3 3≤yr<4 4≤yr<5 5≤yr<6 6≤yr<7 7≤yr<8 8≤yr<10 10≤yr<1515≤yr<30

33% of Eligible Stock

Debt with Yield Above Deposit Rate

Debt with Yield Below Deposit Rate

Eur Bn

..But Aggravates Bund ‘Scarcity’ Concerns..

Amount of German government bonds eligible for PSPP under current

programme parameters


0

20

40

60

80

100

120

140

-2500

-2000

-1500

-1000

-500

0

500

1000

1500

2000

2500

3000

00 01 03 04 06 07 09 10 12 13 15 16

Global Oil Imbalance

WTI Price (RHS)

kbd $/bbl

Source: IEA, Bloomberg, Haver Analytics, Goldman Sachs Global Investment

Research

WTI Ranging Between US$ 40-50

In the ‘New Oil Order’

Contribution of Energy to Variance of

Headline CPI Variance Set to Decline

Variance of Headline US CPI and Energy Component

(weighted) Global Balance of Oil Demand-Supply and WTI Prices,

Historical and GS Forecasts

The market imbalance estimates are based on IEA data and GS

forecasts, as the WTI price projections.

Decline in the

variance of

headline inflation

attributable to

energy...

0

50

100

150

200

250

300

2004 2006 2008 2010 2012 2014

Variance of EnergyComponent

Variance ofHeadline Inflation

bps


Oil Prices will be ‘Lower for Longer’



Central Banks Will Continue Reflating

“There are adverse global developments [making it difficult to reach] our

objective. Is this a good reason to give up? No, it's not a good reason to

give up. How do you give up? Either accepting a lower objective, which

we don't do; or saying that this objective will be reached in a certain very

large number of years, and we don't do that either. We don't give up”.

Mario Draghi, ECB President,

January 2016




We See US ‘Domestic’ Inflation Accelerating...

Higher Trend in US Service Inflation US Inflation Increase Led by ‘Core’

0

1

2

3

4

2004 2005 2007 2009 2010 2012 2014 2015

Infla tion (yoy)

16%-tile

Trend

84%-tile

%

US CPI Inflation: contribution by component

and GS projections vs market US service inflation trend estimated

using Stock-Watson (2007) procedure

-2.5

-1.0

0.5

2.0

3.5

5.0

Jan-10 Feb-11 Mar-12 Apr-13 May-14 Jun-15 Jul-16 Aug-17 Sep-18

Non energy industrial goods

Energy

Food

Services

Headline

GS CPI Forecast

Market Pricing Implied from Inflation Swaps

%



Oil Price Effects on Market Inflation:

Strong, But Transient

VAR estimate of the impact of a 10% crude oil price ‘shock’

on US 10-year breakeven inflation


...Setting the Fed’s ‘Flight Path’

1.40

1.45

1.50

1.55

1.60

1.65

1.70

-8

-6

-4

-2

0

2

4

0 1 2 3 4 5 6 7 8 9 10 11 12

Impact on Breakeven Inflation in bps (LHS)

Trajectory of Breakeven Inflation (RHS)

bp

Breakeven Inflation Level (set at 1.6% on shock impact)

Following a 10% decline in oil price

%

The Market Prices that the Fed

Will Struggle to Meet Its Inflation Target

US 10-year Inflation Swaps: actual and

estimates of ‘fair value’ based on GS iSwap model

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1yr 2yr 5yr 10yr 15yr 20yr

%

+/- 2 Std dev

+/- 1 Std dev

Current US Inflation Swap

Fair




The Jury Is Still Out in the Euroarea and Japan

Euro area Service Inflation Stable at Low Levels Euro Inflation Below ECB Target

0

1

2

3

2004 2005 2007 2009 2010 2012 2014 2015

Inflation (yoy)

16%-tile

Trend

84%-tile

%%

Euro-Area Service Inflation trend estimated


Euro Area CPI Inflation: contribution by component

and GS projections vs market

-1.0

0.0

1.0

2.0

3.0

4.0

5.0


Non-energy industria l goods

Energy

Food

Services

Headline

GS CPI Forecast

Market Pricing Implied from Inflation Swaps

%

-4.0

-2.0

0.0

2.0

4.0


Non energy industrial goodsEnergyFoodServicesHICP (sum of components)GS CPI ForecastMarket Pricing Implied by Inflation Swaps

%

...And Improving Very Slowly in Japan

Japan CPI Inflation: contribution by component

and GS projections vs market

-4

-3

-2

-1

0

1

2

3

4

2004 2005 2007 2009 2010 2012 2014 2015

Infla tion (yoy)

16%-tile

Trend

84%-tile

%

Around Zero in Japan

Japan Service Inflation trend estimated



Source: Haver Analytics, Bloomberg, Goldman Sachs Global Investment Research


EM Rebalancing Is Underway

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

EM FX vs USD (rolling 2-year return)

Average Valuation signal (FEER/GSDEER)

Overvaluation/depreciation

Note: v aluations are quarterly , and are adjusted f or 2-y ear-ahead (consensus) inf lation dif f erential; CE-4 currencies v aluations/dy namics are measured against the EUR; please see the main paper f or the v aluations relativ e to the

latest spot

Historical EM FX performance vs. “ex ante” valuation signals

EM FX Has Entered Undervalued Territory

-6

-4

-2

0

2

4

6

8

10

12

14

CLP ZAR PEN IDR BRL TWD MXN COP RUB NGN

Oil

Precious meta ls

Base meta ls

Bulk commodities

Commodity exposure (% net exports of GDP)

Greater exposure to oil prices

Greater exposure to metals/bulks

Precious metals: Gold, Silver; Base Metals: Aluminium,

Copper, Nickel, Zinc, Lead; Bulk Commodities: Iron Ore, Coal

Differential Impact of Commodity Price

Slide on Exporters


A Projected 10% Decline in Foreign Official

Sector Ownership of US Treasuries

Source: Federal Reserve Board, US Department of Treasury, IMF COFER, Haver Analytics, Goldman Sachs Global Investment Research

Trend in Net Foreign Purchases of USTs

Negative to the Tune of US$200bn

Foreign official sector holding of US Treasury bills and

bonds as a share of total stock of Treasuries outstanding

Trend component (estimated through a HP filter) of monthly net

purchases of US Treasuries by the foreign official sector

15

20

25

30

35

40

45

2000 2001 2003 2004 2006 2007 2009 2010 2012 2013 2015 2016

Foreign Official sector holding of US Treasuries

as a share of stock outstanding

Pro jections based on past 12-month trend flows

%

-20

-15

-10

-5

0

5

10

15

20

2000 2001 2003 2004 2006 2007 2009 2010 2012 2013 2015

HPF-trend component of monthly

net purchases of US treasuries byforeign officia l sector

USD billions Peak in March 2011


A Further Decline in EM FX Reserves


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