The Federal Reserve has announced that it is cutting the fed funds target rate 100bp to 0-0.25% with immediate effect on the basis that Covid-19 is disrupting global economic activity and has significantly affected global financial condition. It has promised to keep rates there “until it is confident that the economy has weathered recent events”. We had expected such an outcome, but thought they would wait until the scheduled Wednesday time slot. However, with the news flow on the virus getting worse and the economic disruption set to intensify, the Fed clearly thought it prudent to get out ahead of the market open tomorrow. The supply crunch in manufacturing, the panic in the financial sector and the collapse in airline travel, hotel stays and leisure activities means we could see a quarterly contraction of the scale reached during the height of the financial crisis, especially with the prospect of some city lockdowns. We are pencilling in an 8% annualised 2Q20 GDP decline relative to the -4.4% figure experienced in 1Q09 and -8.4% in 4Q08.

The Fed has also announced it is formally restarting QE by promising to buy US$500bn of Treasuries and US$200bn of mortgage backed securities “over coming months”. We also expected then to restart QE, but anticipated that they would begin with around US$75bn per month. By giving a more general end-target they have more flexibility to front load or respond to any market dislocation as necessary.

Read more @ ING Economics

Fannie Mae: Mortgage Lenders' Demand Expectations for Purchase and Refinance Mortgages Hit New Survey Highs as Mortgage Rates Move Lower

Lenders' Profit Margin Outlook Also Hits High on Strong Consumer Demand

(From March 12, 2020, edited by Chaganomics)

WASHINGTON, DC – Mortgage lenders’ profit margin outlook for the next three months reached a new survey high based on data collected in the first half of February, according to Fannie Mae's Q1 2020 Mortgage Lender Sentiment Survey®. This quarter, 51% of lenders believe profit margins will increase compared to the prior quarter, while 44% believe profits will remain the same and 4% believe profits will decrease. The increased optimism supplements prior quarter MLSS results revealing already-strong lender expectations of profitability. Strong consumer demand for both purchase and refinance mortgages continued to drive lenders' expectations of increased profitability, with operational efficiency cited by lenders as the second most common reason for the optimistic outlook. "The mortgage industry has had a strong start in 2020, consistent with our forecast and the February Home Purchase Sentiment Index® released on Monday," said Fannie Mae Senior Vice President and Chief Economist Doug Duncan. "Lenders' expectations of consumer demand for purchase and refinance mortgages hit survey highs this quarter, with many lenders pointing to favorable interest rates as the engine driving the demand. The first quarter survey data, which were collected during the first two weeks of February, do not reflect the potential impact of the decline in the 10-year Treasury rate seen in recent weeks. Mortgage spreads have since widened. Given capacity constraints and continued interest rate volatility, we expect mortgage rates to continue to decline and spreads to continue to be wider throughout 2020." "Past experience from 2012 and 2016 suggests that mortgage spreads generally take a few months to compress," continued Duncan. "We anticipate similar rate dynamics this time, depending on the path of the underlying Treasury rate. Although uncertainty around coronavirus may have a dampening effect on housing market sentiment, for now we expect the continued low interest rate environment will help bolster mortgage volume, particularly refinances, as well as lender profitability, consistent with lenders' expectations."

Continue reading the survey here

Despite the threats from trade wars the black swan event was coronavirus, which has upended markets and decimated supply chains. Below, excellent example of market dynamics. - CH

+
A local gasoline wholesaler says we’re quickly going to see prices at the pump fall in central Virginia as crude prices crash due to the Russia-Saudi Arabia oil war. Palmyra resident and Virginia Fuels President John Zehler sees $1.50-a-gallon gas prices by the end of the month. With WTI crude — the oil from which U.S. gasoline is manufactured — running $32-to-$34-a-barrel, Zehler calculates it’s about 75-cents a gallon for crude. Add approximately 70-to-75-cents for transportation, refining, taxes, and margins, Zehler says we’re looking at roughly $1.50 retail. And because the prices are crashing so quickly, he says we’ll see prices at the pump fall quickly. Zehler says retailers want to run larger margins, but they’ll be pulled down initially by the big box stores… such as Sheetz, Wawa, Kroger, Costco, Walmart, etc. - WINA Virginia

Chris Robinson, managing director of agriculture and commodities at TJM in Chicago, is advising clients to take advantage of crude's plunge to lock in diesel prices. “At the end of the day, that's the silver lining to being an energy trader/farmer,” he said. - Bloomberg

New Oil Order

From Goldman: We believe the OPEC and Russia oil price war unequivocally started this weekend when Saudi Arabia aggressively cut the relative price at which it sells its crude by the most in at least 20 years. This completely changes the outlook for the oil and gas markets, in our view, and brings back the playbook of the New Oil Order, with low cost producers increasing supply from their spare capacity to force higher cost producers to reduce output.
In fact, the prognosis for the oil market is even more dire than in November 2014, when such a price war last started, as it comes to a head with the significant collapse in oil demand due to the coronavirus. This is the equivalent of a 1Q09 demand shock amid a 2Q15 OPEC production surge for a likely 1Q16 price outcome. As a result, we are cutting our 2Q and 3Q20 Brent price forecasts to $30/bbl with possible dips in prices to operational stress levels and well-head cash costs near $20/bbl.

Such price levels will start creating acute financial stress and declining production from shale as well as other high cost producers. Specifically, we assume legacy production decline rates outside of core-OPEC, Russia and shale increase by 3% to 5% to return to their 2016 highs. In the case of shale, we assume a negligible response in 2Q but with production falling sequentially in 3Q by 75 kb/d and with declines increasing to 250 kb/d qoq in 4Q20. This will not, however, prevent a 3Q20 surplus of 1.2 mb/d and inventories peaking above their 2016 highs and Brent spot prices staying at $30/bbl on average. In fact the negative feedback loop of lower oil prices on energy exporting economies could exacerbate the decline in oil demand. At that point, the fundamental rebalancing could require oil prices falling to operational stress levels for high cost producers with well-head cash costs near $20/bbl.

From the NY Times: Saudi Arabia slashed its export oil prices over the weekend in what is likely to be the start of a price war aimed at Russia but with potentially devastating repercussions for Russia’s ally Venezuela, Saudi Arabia’s enemy Iran and even American oil companies. Story Link

The Global Macroeconomic Impacts of COVID-19: Seven Scenarios from the Centre for Applied Macroeconomic Analysis, the Australian National University.

Abstract: The outbreak of Coronavirus named COVID-19 world has disrupted the Chinese economy and is spreading globally. The evolution of the disease and its economic impact is highly uncertain which makes it difficult for policymakers to formulate an appropriate macroeconomic policy response. In order to better understand possible economic outcomes, this paper explores seven different scenarios of how COVID-19 might evolve in the coming year using a modelling technique developed by Lee and McKibbin (2003) and extended by McKibbin and Sidorenko (2006). It examines the impacts of different scenarios on macroeconomic outcomes and financial markets in a global hybrid DSGE/CGE general equilibrium model.

The scenarios in this paper demonstrate that even a contained outbreak could significantly impact the global economy in the short run. These scenarios demonstrate the scale of costs that might be avoided by greater investment in public health systems in all economies but particularly in less developed economies where health care systems are less developed and population density is high.

Find Seven Scenarios. CAMA Working Paper 19/2020. February 2020. Warwick McKibbin. Australian National University. The Brookings Institution. COVID REPORT (https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2020-03/19_2020_mckibbin_fernando_0.pdf)

The Spanish flu (1918-20): The global impact of the largest influenza pandemic in history by Max Roser

In the last 150 years the world has seen an unprecedented improvement in health. The visualization shows that in many countries life expectancy, which measures the average age of death, doubled from around 40 years or less to more than 80 years. This was not just an achievement across these countries; life expectancy has doubled in all regions of the world. What also stands out is how abrupt and damning negative health events can be. Most striking is the large, sudden decline of life expectancy in 1918, caused by an unusually deadly influenza pandemic that became known as the ‘Spanish flu’.

But it was named as such because Spain was neutral in the First World War (1914-18), which meant it was free to report on the severity of the pandemic, while countries that were fighting tried to suppress reports on how the influenza impacted their population to maintain morale and not appear weakened in the eyes of the enemies.

OurWorldInData.org

Overview
US Economics Analyst From Goldman Sachs

Last week we revised down our US growth forecast to incorporate larger negative spillover effects from the slowdown in China caused by the coronavirus. Our previous estimate accounted for three channels of impact: a hit to US goods exports to China, a decline in tourist arrivals from China, and modest supply chain disruptions affecting US retailers.

Over the last week the situation has proven worse than we expected in two respects. First, economic activity in China has remained even weaker than we had anticipated, and our China Economics team cut its forecast for Q1 GDP growth sharply. Second, it has become clear that the new coronavirus is especially infectious as outbreaks have occurred in many additional countries, including the first reported cases of community spread in the US.

We are therefore revising down our US growth forecasts further to incorporate a hit to GDP from two additional channels. First, we now account for supply chain disruptions affecting US producers. While shortages of intermediate goods should remain modest in the US if Chinese production continues to recover, some US producers are likely to exhaust their inventories.

Second, we now account for direct effects of US outbreaks on consumer spending. This channel is highly uncertain because it depends on the extent and duration of any outbreaks and how strongly businesses and consumers pull back from normal economic activity. To estimate the magnitude, we combine a top-down estimate of GDP changes during past pandemics with a bottom-up estimate of potential declines in the categories of consumption likely to be hit hardest.

Accounting for these additional effects, we now forecast US growth of 0.9% in Q1, 0% in Q2, 1% in Q3, and 2.25% in Q4, with the virus shaving about 1pp off of Q4/Q4 growth in 2020. While the US economy avoids recession in our baseline forecast, the downside risks have clearly grown.

Following a statement from Chair Powell on Friday afternoon, a Fed cut in March appears nearly certain. We have made a further adjustment to our Fed call and now project a 50bp rate cut by March 18 followed by another 50bp of easing in Q2, which we are penciling in as 25bp cuts in April and June, for a total of 100bp.

We thought it was pertinent to update our reader base on the state on global commodity flow. 

- Chaganomics 

Financial

G7 Finance Ministers and central bankers hold a conference call on the impact of the coronavirus this Tuesday. We think this could ultimately lead to the Fed cutting rates 100bp through the first half of this year, 10-year US Treasury yields dipping to 0.75% and EUR/USD trading up to 1.15

Energy

Oil markets were part of the broader bounce higher in markets yesterday, with expectations of action from central banks in response to the anticipated effects of the Covid-19 outbreak. US Fed Chairman, Jerome Powell, said late last week that the Fed would use necessary tools to support the economy if needed. Easing from central banks may offer some respite to markets, but ultimately what markets need to see is a peaking in the outbreaks outside China, or at least signs of peaking, to suggest that the worst is behind us.

In China, there are signs already that we are seeing a return to normality. New cases of Covid-19 have dropped dramatically, while if we look at refinery activity, last week, independent refiners in the country increased run rates, suggesting that we are starting to see a recovery in fuel demand. Although admittedly run rates are still well below the levels they were prior to the Lunar New Year holidays.

Key for the oil market outlook will be the OPEC+ meeting in Vienna on Thursday and Friday this week. OPEC+ will need to surprise the market with the level of cuts if they want any chance of pushing prices higher. Clearly a lot has changed over the last month, and trimming output by an additional 600Mbbls/d, as recommended by the Joint Technical Committee is not going to be sufficient.

Sticking with the group, and production estimates for OPEC over February are starting to come through. According to a Bloomberg survey, output for the group averaged 27.91MMbbls/d over the month, down 480Mbbls/d MoM, and the lowest monthly output seen since April 2009. Libya, which is exempt from the production cut deal, was the driver behind the decline, with output falling by 640Mbbls/d MoM, reflecting the impact from the ongoing export blockade in the country. This, as mentioned yesterday, is another factor which complicates the decision for OPEC+, given that it is unknown when Libyan output will return to normal.

Finally, given the scale of the sell-off last week, and the fact that we are heading into a key OPEC+ meeting, we could see a bit more short-term strength in the market, with shorts coming in to take profits ahead of the meeting.

Metals

Gold saw a slight recovery yesterday, although gave back much of its gains as the day progressed. Clearly all this talk of central bank easing is constructive for gold prices and underlines the supportive outlook for the gold market. However, markets will need to see action from central banks rather than just expectations of easing and rhetoric. Meanwhile, despite the sell-off seen on Friday, total gold ETF holdings saw inflows of 277koz on Friday- the third-highest daily number since the start of the year, and taking total holdings to 84.7moz.

• ING Economics

The impact of the Covid-19 outbreak on economic prospects is severe Growth was weak but stabilising until the coronavirus Covid-19 hit. Restrictions on movement of people, goods and services, and containment measures such as factory closures have cut manufacturing and domestic demand sharply in China. The impact on the rest of the world through business travel and tourism, supply chains, commodities and lower confidence is growing.

OECD: The impact of the Covid-19 outbreak on economic (Presentation) from chaganomics

Going into the weekend we wanted to share some reading - Chad

Estimating the global economic costs of SARS: https://www.ncbi.nlm.nih.gov/books/NBK92473/

CBO to Bill Frist: A Potential Influenza Pandemic: Possible Macroeconomic Effects and Policy Issues: https://www.cbo.gov/sites/default/files/109th-congress-2005-2006/reports/12-08-birdflu.pdf

Globalization and Disease: The Case of SARS: http://www.sensiblepolicy.com/download//2004/2004_Globalization_and_Disease.pdf

Federal Reserve (San Francisco): Why Is Current Unemployment So Low? https://www.frbsf.org/economic-research/files/wp2020-05.pdf

Federal Reserve (Atlanta): Low-Income Consumers and Payment Choice - https://www.frbatlanta.org/-/media/documents/research/publications/wp/2020/02/20/low-income-consumers-and-payment-choice.pdf

Energy

The sell-off in oil continued yesterday, with worries over Covid-19 growing. The World Health Organization (WHO) reported that the number of new cases outside China exceeded those within China for the first time. The pressure yesterday means that ICE Brent is almost 10% lower over the past week. This should send a clear signal to OPEC+ ahead of their meeting in Vienna late next week. Clearly, it is Russia that needs convincing, with little indication that they back the recommendation from the Joint Technical Committee from a few weeks ago. However the CEO of Gazprom has said that given the level of uncertainty around demand, that OPEC+ should make a decision around quotas at a later stage.

Yesterday, the EIA released its weekly report, which was more constructive than expected. It showed that US crude oil inventories increased by just 452Mbbls, much less than the 2.6MMbbls build the market was expecting, and lower than the 1.3MMbbls build the API reported the previous day. Meanwhile sizeable draws of 2.69MMbbls and 2.12MMbbls were seen in gasoline and distillate fuel oil respectively. The outage at the Baton Rouge refinery was also reflected in the numbers, with refinery run rates in the Gulf Coast down 3.1% over the week.

Metals

Ex-China Covid-19 developments offered renewed support to gold and this strength has continued in early morning trading today. Uncertainty over the virus continues to see investors flocking towards the yellow metal, with gold ETF holdings increasing for 26 consecutive days, with inflows over that time growing by 2.72moz to total 84.43moz currently. Given this uncertainty is likely to linger, along with the prospect for lower rates, it suggests that gold prices are the to remain well supported.

Turning to base metals, LME data showed that copper exchange inventories saw inflows of 61.2kt yesterday (the highest since 2004), taking total stocks to 221kt. Meanwhile turning to aluminium, there are reports that negotiations for 2Q20 Japanese aluminium premia started this week, with one buyer offered  a premium of US$90/t, for the upcoming quarter. This would be up from US$83/t in the current quarter.

Agriculture

There are media reports that the Argentinian government is set to increase the export tax on soybeans from the current 30% to 33% after it temporarily suspended its export registry system. If this is the case, it follows an increase late last year following the arrival of the new president, Alberto Fernandez. The hope is that this will help reduce the country’s fiscal deficit. As of yet, there has been no official confirmation of the tax hike. However, the news did see a brief spike higher in CBOT soybeans.

ING Economics 

• Our panelists expect the coronavirus will significantly hit China’s GDP growth this year, notwithstanding government stimulus. Almost half the panelists surveyed project the virus to subtract 0.5-0.8 percentage points from Chinese growth.

• The impact on the global economy should be milder: Most panelists see a 0.0–0.2 percentage-point reduction in global growth, with the impact likely concentrated in H1. However, risks are skewed to the downside, and the impact could well be larger if the spread of the virus outside China continues.

• There is still a notable divergence in panelists’ views, reflecting the inherent difficulties in forecasting the duration and extent of the epidemic. • Our panelists judged that South-East Asian countries would suffer the largest economic fallout, due to close economic ties with China and geographical proximity increasing the risk of contagion.

• For this reason, Japan is likely to be the G7 nation hardest hit by the epidemic. However, the recent outbreak in Italy raises the risk of a larger economic impact there and a spread to neighboring European countries.

• The vast majority of panelists do not see the economic impact of coronavirus persisting beyond 2020.


“The global economy will feel the ill effects from China’s economic problems through three principal channels. Chinese tourism and business travel to the rest of the world has already stopped. Major tourism destinations across the globe are feeling the effects, although they are most pronounced throughout Asia. Second, the global manufacturing supply chain is disrupted, as China is at the end of many of those chains. Southeast Asia is especially vulnerable to this disruption, although manufacturers throughout the world, including in the U.S. and Europe, will be affected. Shortages of some goods will likely result this spring. Finally, emerging markets, particularly in Latin America and Africa, will also soon feel the ill-effects of the slump in commodity markets, since China will purchase less oil, copper, soybeans and other commodities.”
- Xu Xiao Chun, economist at Moody’s Analytics



Report from Focus Economics
Edited for Chaganomics by Zermat Research

Preliminary figures revealed that GDP declined yet again on annual basis in the final quarter of 2019—leading to the first full-year economic slump since the 2009 crisis. Industrial-sector output contracted for the fifth quarter running, primarily due to the hammered construction and mining sectors, dragging down overall activity. Moreover, agricultural production cooled in the quarter and although activity in the services sector quickened, the increase was underwhelming, which alludes to softer-than-expected growth in household spending. Turning to 2020, available data suggests a gradually improving scenario. The manufacturing PMI rose in January, albeit remained in contractionary territory. Meanwhile, the services PMI returned to growth for the first time in nine months, which, coupled with strengthening consumer confidence, bodes well for consumption gaining traction.




The economy is expected to recover this year on the back of stronger consumer spending, buttressed by rising real wages and upbeat remittances. Increased effectiveness in executing public spending and investment should also support growth. Depressed business confidence, an uncertain global trade environment and the finances of debt-laden Pemex weigh on the outlook, however. FocusEconomics panelists estimate growth of 0.9% in 2020, which is down 0.1 percentage points from last month’s forecast, and 1.7% in 2021.




Inflation climbed to 3.2% in January (December 2019: 2.8%), thus landing slightly above the midpoint of Banxico’s target range of 2.0%–4.0%. Core inflation, meanwhile, has proved sticky, hovering at 3.5%–4.0% for nearly two years now. Inflation is expected to remain broadly steady going forward, though the sizeable minimum wage hike is an upside risk. FocusEconomics panelists see inflation ending 2020 at 3.4% and 2021 at 3.5%.




At its first meeting of the year on 13 February, Banxico axed the target rate by 25 basis points to 7.00%, coming in line with market expectations and marking the fifth consecutive cut. The decision was unanimous, and was motivated by contained headline inflation and increased economic slack. The vast majority of our panelists see Banxico further loosening policy this year. FocusEconomics analysts expect the target rate to end 2020 at 6.34% and 2021 at 6.04%.




The peso strengthened against the U.S. dollar and hit over one-year highs in recent weeks, buoyed in large part by the signing of the USMCA trade deal by President Trump. On 14 February, the MXN traded at 18.54 per USD, appreciating 1.3% month-on-month. The peso is expected to weaken somewhat ahead, while remaining vulnerable to episodes of volatility and risk aversion. Our panel projects the MXN to end 2020 at 19.65 per USD and 2021 at 19.95 per USD.

Outlook Remains Stable
Growth slipped in the final quarter of 2019 as the French and Italian economies both unexpectedly contracted. More broadly, prolonged weakness in the bloc’s industrial sector amid weak external demand, coupled with policy uncertainties at home, have likely continued to constrain growth. Improved economic sentiment and a stable PMI in January, however, suggest momentum strengthened somewhat at the start of 2020. Meanwhile, in politics, Irish voters head to the polls; Slovenia’s Prime Minister resigned on disputes over healthcare funding; Austria’s conservative People’s Party struck an unprecedented coalition deal with the Greens; Pedro Sánchez was confirmed as Spain’s prime minister; and Italy’s ruling coalition seems to have dodged a government crisis. Moreover, the European Parliament backed Britain’s departure from the European Union, with negotiations now turning to trade talks.

This year, the economy looks set to remain stuck in a low gear. Foreign sales are poised to cool, due to mild global growth and an unsupportive external environment, which will also weigh heavily on investment activity and restrain the industrial recovery. On top of that, interventionist policies in Italy and Spain and trade tensions with the U.S. pose downside risks. Growth is seen at 1.0% in 2020, which is unchanged from last month’s forecast. In 2021, GDP is seen increasing 1.2%

The Eurozone economy slowed sharply in the final quarter of last year, after growth picked up in the third quarter. According to a preliminary estimate released by Eurostat, GDP increased a seasonally-adjusted 0.1% in Q4 from the previous quarter, following Q3’s 0.3% increase. The reading represents the weakest expansion since Q4 2013 and undershot market expectations of a 0.2% increase. Compared with the same quarter of the previous year, seasonally-adjusted GDP expanded 1.0% in Q4, below Q3’s 1.2% increase and marking the slowest growth rate since Q4 2013. Although no details behind the figure are yet available, prolonged weakness in the industrial sector amid global trade tensions, weak demand from key trading partners, and political uncertainty likely hit growth. Additional data showed that Italy’s unexpectedly contracted in Q4, while France’s economy also surprisingly shrunk due to widespread social protests. In contrast, the Spanish economy gained steam; however, a sharp contraction in capital spending and muted private consumption suggest the pick-up will turn out to be temporary. Looking ahead, the economy should gradually gain some strength this year. The manufacturing sector is expected to recover, while private spending will remain solid, benefiting from modest inflation, a relatively low unemployment level and favorable financing conditions. That said, the pace of expansion is expected to be sluggish nonetheless.

Labor market conditions in the common currency bloc improved in December, according to data released by Eurostat. The number of unemployed people decreased by 34,000, and the unemployment rate edged down from November’s 7.5% to 7.4% in December. The figure represents the lowest unemployment rate since May 2008. Looking at the countries with data available, five economies saw their unemployment rates inch down in December, including Spain and the Netherlands. In contrast, four economies saw their unemployment rates rise, while the rest of the bloc saw unchanged labor market conditions—including France, Germany and Italy. Despite a large overall improvement in the Eurozone over recent years, disparities in the labor market among core and periphery countries persist. Greece is the economy in the Eurozone with by far the highest unemployment rate (16.6%, data refers to October), followed by Spain (13.7%). At the other end of the spectrum, Germany (3.2%), the Netherlands (3.2%) and Malta (3.4%) have the lowest unemployment rates. FocusEconomics Consensus Forecast panelists expect the unemployment rate to average 7.5% in 2020, which is unchanged from last month’s forecast. For 2021, the panel expects the unemployment rate to also average 7.5%.


Analysis from Focus Economics

Brazil Survey

What will be the impact of the pension reform?

Pension reform was approved last October, and includes measures such as raising the retirement age and increased workers’ pension contributions in a bid to save close to USD 200 billion over the next decade. The reform has undoubtedly provided a short-term boost to confidence, and raised expectations for progress on other reform fronts going forward. Moreover, the measures are an important step towards strengthening the public finances. However, the majority of panelists polled by FocusEconomics believe that the pension reform alone would not be enough to stabilize the public debt-to-GDP ratio—which, at close to 80%, is extremely high by emerging-market standards. The LatinFocus Consensus Forecast sees the public debt-toGDP ratio peaking in 2021 and declining marginally thereafter, suggesting panelists see further measures going forward to improve the fiscal outlook. “The approval of pension reform was essential to avoid the unsustainable rising trend of public debt. However, it is not enough to stabilize the public debt in the medium to long-run.” Mauricio Nakahodo, economist at Banco MUFG Brasil S.A. “Other measures are necessary to reduce the ratio.” Fernando Honorato Barbosa, chief economist at Banco Bradesco “[…] interest rate cuts were decisive to significantly improve the outlook for the public debt-to-GDP ratio as much as recent [political] developments were.” José Francisco Lima Gonçalves, chief economist at Banco Fator “The spending cap and the pension reform were the most important reforms [to reduce the debt burden]. The others are auxiliary, but not as fundamental as those were.” Sergio Vale, chief economist at MB Associados

Which further steps would reduce public debt?

Panelists frequently mentioned that fiscal and administrative reforms—particularly to address high mandatory expenditure— were key in order to complement the pension reform and put the public debt-to-GDP ratio on a firm downward path. In this regard, the fate of a package of measures presented to Congress in November—which includes the creation of a fiscal council, a fiscal emergency amendment enabling austerity measures, and changes to public-sector pay and conditions—will be important to watch. Most panelists do not see the package being implemented in full, however. “Brazil has roughly 90% of mandatory expenses in its annual budget, so the spending cap has been a burden on discretionary expenditure since 2017, especially public investment. To reduce the public debt/gdp more reforms targetting mandatory expenditure are required, such as: administrative reform and the fiscal emergency reform. The latter also include several measures to states and municipalities, that are also in fiscal difficulties.” Fernando Honorato Barbosa, chief economist at Banco Bradesco “Undoubtedly, administrative reform, which aims to reduce and control mandatory spending, is the biggest challenge and has the greatest weight on public accounts. In addition, tax reform would be of paramount importance to simplify the revenue side and improve the business environment.” Tarciso Gouveia, head of macroeconomic research at Petros.

What is the outlook for the reform agenda?

Panelists unanimously agreed that there will be some further progress on the government’s reform agenda, with tax reform the area mentioned most often by panelists. However, panelists were also clear that there were unlikely to be sweeping changes to the tax system, but rather more moderate tweaks, such as unifying federal taxes. Administrative reform to reduce the public wage burden was also mentioned frequently. However, this could be politically contentious, as demonstrated by the government’s decision to delay such a reform late last year for fear of public unrest. “A modest tax reform that focuses on simplification of some revenue streams appears possible, given strong support from Congressional leaders.” Jeffrey Lamoureux, head of country risk for the Americas at Fitch Solutions “The agenda is very complicated, but at least the value added tax should be somehow created.” José Francisco Lima Gonçalves, chief economist at Banco Fator.

“Both administrative and the fiscal emergency reforms have a significant approval probability, with some adjustments to the content – but should still have a positive effect on spending reduction over the next 10 years. We think a deep tax reform is unlikely, but the unification of federal taxes has significant probability of approval. Central Bank autonomy has a high probability of approval this year, as well as some privatizations.” Fernando Honorato Barbosa, chief economist at Banco Bradesco “In the case of administrative reform, it is more likely to be approved some reform focused on new public servants. And we expect a minor version of tax reform concentrated on the unification of a few federal taxes and some harmonization on the rates, and some changes to income tax.” Mauricio Nakahodo, economist at Banco MUFG Brasil S.A.

How will the 2020 budget impact the economy?

In December, Congress approved the 2020 budget. The government assumes GDP growth of 2.3% and inflation of 3.5%—both figures which are slightly above our panelists’ forecasts—and sets a primary deficit target of 1.6%. The panel had mixed views on the economic impact of the budget, ranging from contractionary to broadly neutral. “The 2020 budget is less restrictive than the previous years. The expenses are still restricted by the spending cap, but the restriction is smaller in the margin.” Fernando Honorato Barbosa, chief economist at Banco Bradesco “2020 will be another year of budget constraint due to the need for fiscal adjustment. This is a year of local elections and we might see some higher expenditures during the first half, but as compared to past election years, the situation is also tough at regional level meaning moderate expenditures.” Mauricio Nakahodo, economist at Banco MUFG Brasil S.A. “As we have been seeing lately, it will be a drag for economic growth”. Flávio Serrano, chief economist at Haitong “The public budget, while conservative, should make room for investment resources as fiscal dynamics improve, particularly with regard to the primary surplus that is expected to be much better in 2020.” Tarciso Gouveia, head of macroeconomic research at Petros “Moderate fiscal consolidation will be somewhat of a drag on aggregate demand. On the other hand, fiscal consolidation can be a positive driver for private confidence and, thus, investments. All in all, the effect should be roughly neutral.” Luis Suzigan, senior economist at LCA Consultores.

Will Brazil receive a rating upgrade this year?

Virtually all panelists expect Brazil to receive a credit rating upgrade this year in response to the improved fiscal and growth outlook. While some panelists see positive economic repercussions from an upgrade, others see no significant change, and some pointed out that the credit rating will remain below investment grade—an important threshold for decisively boosting capital inflows. “We should witness portfolio capital flows and a strengthening of the real (R$) in the short term.” Tarciso Gouveia, head of macroeconomic research at Petros “We think the BRL would strengthen against the USD [in the case of a rating upgrade], helping maintain the inflation rate at a low level, even under a solid rebound of economic activity.” Helcio Takeda, head of research at Pezco Economics “Very little [impact] – already priced into bond markets.” William Jackson, chief emerging markets economist at Capital Economics “Somewhat limited [impact], there’s a lot of uncertainty in the political and economic areas.” César Carrasquero, executive director of treasury & finance at Banesco “It will be positive, but not as positive as gaining back the investment grade, which we consider may happen only after 2022.” Sergio Vale, chief economist at MB Associados.

How will the stock market evolve in 2020?

In 2019, the Brazilian stock market reached an all-time high on investor optimism over economic reforms and lower interest rates. For 2020 panelists are broadly optimistic on the outlook for Brazilian stocks, with most seeing further price gains. “According to our scenario, we expect at least 16% [gains]. Alongside our macroeconomic scenario, there is still plenty of room for advancing multiples of companies. In addition, we should watch a new round of IPOs throughout 2020.” Tarciso Gouveia, head of macroeconomic research at Petros “[Stock prices should rise] linked to our expectation of more solid GDP growth this and next year.” Mauricio Nakahodo, economist at Banco MUFG Brasil S.A. “Most fundamental drivers of stock prices are already counted in. The low interest rates, less weak economic activity. Further relevant gains depend on inflows of capital. I don’t expect too much of this.” José Francisco Lima Gonçalves, chief economist at Banco Fator.

Focus Economics 

Focus Economics 

The outlook remains stable.
Available economic indicators show growth momentum remains weak. Industrial production was subdued in October, as the trade war with the U.S eroded manufacturing activities. This trend is expected to continue in the coming months as corroborated by a new drop in exports in November. Moreover, mounting economic uncertainty is postponing investment plans, especially among foreign firms. The main silver lining has been the rebound in the manufacturing PMI in November. Meanwhile, on 13 December, President Trump agreed to a limited trade deal with China, effectively barring a fresh round of tariffs due on 15 December. As part of the deal, U.S. officials stated that China will purchase more U.S. agricultural products, while the U.S. will remove some existing tariffs in return. At the time of writing, however, Chinese authorities have not yet confirmed whether the two sides have reached an agreement.

Next year, the economy will continue to moderate amid a long-lasting trade rift with the United States. Moreover, the property sector is expected to suffer from tight financing, which will weigh on overall economic growth. Although supportive fiscal and monetary policies are expected to cushion the slowdown, the scale of the measures will be limited. FocusEconomics panelists see the economy growing 5.9% in 2020, which is unchanged from last month’s forecast, before decelerating to 5.7% in 2021. Inflation soared from October’s 3.8% to 4.5% in November, a near eight-year high. The African swine fever outbreak continues to push up prices not only for pork but also for substitute products such as beef and lamb. Conversely, non-food inflation remains subdued, reflecting weak economic growth. Looking forward, inflation will inch down on this year’s high base effect. FocusEconomics panelists forecast that inflation will average 2.7% in 2020, which is up 0.2 percentage points from last month’s estimate, and 2.3% in 2021.

On 18 November, the Central Bank slashed its seven-day reserve repo rate by 5 basis points (bp) to 2.50%, while, on 20 November, the Bank cut the one-year loan prime rate by 5 bp to 4.15%. These actions followed a similar move with the medium-term lending facility on 5 November, and should lower borrowing costs especially for small-to-medium-sized firms. Panelists project the one-year deposit and lending rates to close 2020 at 1.48% and 4.33%, respectively, and 2021 at 1.50% and 4.35%.

Lack of tangible progress on a potential trade deal between China and the United States weighed on the yuan in recent weeks. On 11 December, the yuan traded at 7.04 CNY per USD, a marginal 0.4% month-on-month depreciation. President Trump’s erratic foreign trade policies and a challenging domestic economy will determine the evolution of the yuan further down the road. Our panelists see the yuan ending 2020 at 7.12 CNY per USD and 2021 at 7.07 CNY per USD.

PMI & Beyond
The manufacturing Purchasing Managers’ Index (PMI) published by the National Bureau of Statistics (NBS) and the China Federation of Logistics and Purchasing (CFLP) rose from 49.3% in October to November’s 50.2%. The print was above the 49.5% result expected by market analysts. As a result, the index sits above the 50.0% threshold that separates contraction from expansion in the manufacturing sector for the first time in seven months. November’s improvement reflected a sharp turnaround in new orders, along with stronger growth in the production index. While robust demand boosted suppliers’ delivery times and purchasing activity, job creation was unchanged. Despite remaining well below the 50.0% threshold, export orders gained some ground in November, likely reflecting hopes of a trade agreement between China and the United States. Input prices—a reliable leading indicator for inflation—receded further in the same month. Against this backdrop, Ting Lu, Lisheng Wang and Jing Wang, economists at Nomura, comment that: “The blip of a rise in the official manufacturing PMI certainly looks positive for markets, but we do not think such a rebound suggests a bottoming out of the economy, as strong growth headwinds remain, especially from the cooling property sector and China’s worsening fiscal situation. […] We do not think Beijing will overreact to this reading, as it has already learned the lessons from spring this year when some headline data pointed to a recovery. Amid a deteriorating growth outlook, Beijing will likely to roll out more easing measures despite limited policy room.” Panelists expect GDP to expand 5.9% in 2020, which is unchanged from last month’s estimate. In 2021, the panel foresees lower economic growth of 5.7%.

Industrial Production
Industrial production increased 4.7% year-on-year in October, sharply down from September’s 5.8% expansion and undershooting analysts’ expectations of a 5.4% rise. The reading was led by sizeable decelerations in mining and manufacturing output. The energy sector, however, posted an acceleration in the same month. On a month-on-month seasonally-adjusted terms basis, industrial production increased 0.17% in October, down from the 0.71% expansion in September. Annual average growth in industrial production, meanwhile, inched down from 5.7% in September to 5.6% in October. Against this backdrop, Iris Pang, Greater China economist at ING, comments that: “Industrial production of vehicles (-11.1%YoY) and smartphones (-7.3%YoY) show how the trade war has affected exports as well as local demand. Vehicles and smartphones share two similar features; they are both expensive and demand for new models from consumers is low without an obvious reason to upgrade. As demand is weak, production shrinks as inventory must be sold. It’s not all bad though. Production of integrated circuits grew 23.5%YoY in October and we expect this to remain strong due to the production of 5G parts and products.”

Investment Growth Falls To Record Low
Nominal urban fixed asset investment expanded 5.2% year-to-date in October, below the 5.4% increase in January–September. The reading undershot market expectations of a 5.4% rise and represented the lowest print since the data started in 1998. The reading reflected a slowdown in growth in the tertiary sector as well as a sharper decline in the primary sector. The secondary sector, however, posted an acceleration in the same period. Meanwhile, property investment growth slowed slightly to 10.3%, the lowest rate since the start of the year. In terms of ownership, investment growth in fixed assets of state-owned enterprises accelerated in January-October, while the expansion in investment among private companies softened to a nearly three-year low in the same period. On a month-on-month basis, investment in urban fixed assets rose a seasonally-adjusted 0.40% in October, marginally down from the 0.42% expansion in September. Yi David Wang, head of China economics at Credit Suisse, noted that: “Looking ahead, domestic demand indicators will likely remain tame over the next couple of months. However, we maintain the view that an inflection point to underlying growth momentum will likely occur by December/January in light of our outlook for more supportive policies to come in 2020.”

Exports Contract For Fourth Consecutive Month
In November, exports fell 1.1% over the same month last year, coming in below the 0.8% drop in October. Moreover, the print marked the fourth contraction in a row and contrasted the 0.8% rise that market analysts had expected. Meanwhile, imports rose 0.3% in annual terms in November, contrasting the 6.2% contraction in October and marking the first positive reading in seven months. Moreover, the print was above the 1.4% decline that market analysts had projected. As a result of the expansion in imports, the trade surplus fell to USD 38.7 billion in November 2019 from USD 41.9 billion in November 2018 (October 2019: USD 42.5 billion surplus). The 12-month moving sum of the trade surplus fell to USD 434 billion from USD 438 billion in October. Our panelists forecast that exports will expand 1.5% in 2020 and imports will rise 2.6%, bringing the trade surplus to USD 393 billion. In 2021, FocusEconomics panelists expect exports will expand 2.9%, while imports will rise 3.7%, leaving the trade surplus at USD 388 billion.

Economics Realities of China's Global Influence from chaganomics

A special survey on the Hong Kong political crisis

When will political unrest subside?

“An amicable resolution to the crisis would take compromise on both sides but we see the key issues being that of electoral reform (what the protesters call universal suffrage) and the setting up of an independent commission of inquiry into alleged police brutality. The anti-government movement must also be willing to see their five demands as separate issues, rather than an indivisible package.” - Fitch Solutions

“The authorities will eventually have no choice but to make a meaningful concession.”- Kasikorn Research

What assets will be affected?

“We expect to see some spill-over into the real estate sector. Demand is likely to soften as protests will place a drag on investor confidence, and slowing economic growth will weigh on purchasing power of Hong Kong residents. At the same time, the government seems to be placing emphasis on the housing market to placate protesters, which will likely see a slight increase in housing supply. In her policy address in October, Chief Executive Carrie Lam focused on housing and land policies, proclaiming that these would alleviate ‘issues of greatest public concern.” - Fitch Solutions

 “With less inbound tourism coming from China, the personal financial and insurance services would be affected as the protests persist, although I don’t expect the demand for these services to decline significantly. The institutional activities (such as IPOs) are unlikely affected.” - Oxford Economics

“Real estate seems to be already affected by subdued price growth, in some reported cases heavy discounting by agencies, which in turn affects profitability. As for financial and insurance, I think Hong Kong’s reputation of a financial hub will be left intact.” - Moodys

Outlook deteriorates in Hong Kong
\The economy declined notably in the third quarter, as widespread protests undercut domestic demand. Private consumption and fixed investment nosedived, while exports were also down markedly. Turning to the fourth quarter, economic conditions likely remain anemic. The private sector PMI continued to freefall in November as business activity fell at the sharpest pace on record. Moreover, in October, retail sales plummeted to an all-time low; tourist arrivals continued to tumble; and unemployment ticked up to the highest rate since September 2017— boding poorly for household spending. In politics, an overwhelming majority of pro-democracy candidates were elected in the local district council elections in late November. On 4 December, the IMF concluded its Article IV visit. The Fund recommended a notable increase in fiscal stimulus to counter the downturn, mainly by addressing housing supply and income inequality

The economy is seen recovering next year on a favorable base effect and some support from fiscal stimulus. However, activity is set to remain weak, as political turmoil will likely continue weighing on domestic activity. A further deterioration of the domestic situation and the U.S.-China trade war are the key downside risks. Our panel expects growth of 0.3% in 2020, which is down 0.4 percentage points from last month’s forecast. Moving to 2021, the panel projects the economy to grow 2.4%.

Real Sector
The revised GDP reading confirmed the economy contracted at the sharpest pace since June 2009 in the third quarter, as Hong Kong faced the double whammy of mass protests battering domestic demand and the U.S.-China trade war hampering the external sector. GDP tumbled 2.9% in year-on-year terms, which is unchanged from the preliminary reading, following Q2’s 0.4% expansion. Meanwhile, on a seasonally-adjusted quarter-on-quarter basis, the economy fell an unrevised 3.2% in Q3, which was steeper than Q2’s 0.5%. The fall in year-on-year GDP in the third quarter was mainly driven by a revised 3.4% decline in private consumption (previously reported: -3.5% yoy; Q2: +1.3 yoy), while fixed investment contracted at an unrevised pace of 16.3% in Q3 (Q2: -10.8% yoy). In contrast, government consumption growth accelerated from 4.0% in Q2 to a revised 5.9% (previously reported: 5.3% yoy). On the external front, both exports and imports of goods and services contracted at a sharper pace in Q3 relative to Q2. Muted demand from mainland China weighed on exports, while depressed business and consumer sentiment have suppressed import demand in recent months.

PMI Sinks to 15 year low
The IHS Markit Purchasing Managers’ Index (PMI) slipped to 38.5 in November (October: 39.3), marking the worst reading since April 2003. November’s deterioration came on the back of business activity slumping at the fastest pace since contemporary records began and new business falling at the steepest pace in 11 years. Moreover, headcounts declined slightly and backlogs of work dropped steeply. Needless to say, business sentiment remained the lowest on record in November, as many firms expect lower output in a year from now due to ongoing political unrest. On the price front, input prices fell in November, mainly due to a decrease in staffing costs, while output prices also dipped. Commenting on November’s print, Bernard Aw, an economist at IHS Markit, noted: “The average PMI reading for October and November combined showed the economy on track to see GDP fall by over 5% in the fourth quarter, unless December brings a dramatic recovery.” Going forward, political turmoil and the U.S.-China trade war will continue to undermine Hong Kong’s private sector, which is currently undergoing the worst deterioration since the severe acute respiratory syndrome (SARS) epidemic in 2003. With no clear end in sight to either headwind, business investment will likely continue to markedly contract, which could translate in to a significant spike in unemployment.


Retail Sales
Retail sales by volume plummeted 26.2% year-on-year in October, even more sharply than September’s revised 20.3% freefall (previously reported: -20.4% year-on-year). The knock-on effects from the civil unrest, which has hammered tourist arrivals and caused several major shopping outlets to temporarily close, continued to take its toll. In October, tourist arrivals plunged 43.7% year-on-year, after nosediving 34.2% year-on-year in September. This was despite China’s “Golden Week” holiday that commences in the first week of October each year and brought in roughly 4.7 million tourists from mainland China in the same month last year. The stronger deterioration in sales volume was mainly driven by a more pronounced fall in clothing and footwear; durable goods, notably motor vehicles and electrical goods; and sales of jewelry, watches and clocks. On a seasonally-adjusted, three-month moving average basis, retail sales by volume in the August–October period tumbled 18.5% from the preceding three-month period, down from the 16.7% decline in July–September.

Overall, the annual average variation in retail sales volume fell 8.5% in October after falling 5.9% in September. Going forward, civil unrest seems set to continue to depress the retail and tourism sectors, which will likely bring about a slight fall in employment levels, further suppressing private consumption in turn. FocusEconomics Consensus Forecast panelists expect retail sales to decrease 4.9% in 2020, which is down 3.9 percentage points from last month’s forecast. For 2021, the panel sees retail sales growing 6.5%.

Thank you FocusEconomics