Deutsche Bank Markets ResearchGlobal Cross-Discipline Date 20 June 2013 Peter Hooper Chief Economist (+1) 212 250-7352
[email protected] Michael Spencer Chief Economist (+852) 2203 8303
[email protected] World Outlook Fed Policy Tapers Global Markets The June FOMC communication confirmed recent Fedspeak suggesting that a reduction in asset purchases is likely this year if the US economy evolves in line with our (and the Fed’s) expectations. With renewed focus on eventual Fed exit, rates have risen sharply and risk assets have weakened. These and other market reactions to the Fed’s policy shift are the focus of our World Outlook this quarter. Consistent with this recent guidance and our forecast, we anticipate an initial taper of QE3 in September, with purchases ending by mid 2014, and very possibly sooner with faster progress in reducing unemployment. Rate hikes should commence by mid-2015, and the Fed will not be selling assets on exit. Market adjustment to this policy shift will not occur without significant disruption and pain, as rates rise further amid heightened volatility. Those markets that have shown signs of becoming frothy during the Fed’s prolonged period of extraordinary monetary ease should be most vulnerable to this move. Ultimately, however, we expect the rise in rates to be contained, and improved growth prospects should support risk assets, including equities. We continue to see 2013 as a transition year for the global economy, with growth approaching potential by year-end. We have marked down slightly our global growth forecasts for this year and next in light of recent underperformance, most notably in EM economies. Our outlook for AEs remains largely intact, with the exception of a significant upgrade of prospects in Japan. To be sure, a more disorderly market response to the start of a Fed exit from QE is possible and represents the most significant risk to our outlook over the year ahead. If rates rise more sharply than we anticipate, or equities react adversely, the negative market response could well spillover to growth prospects. Such a reaction could cause the Fed to delay or reduce the pace of its tapering. Any setback would be less painful than the recent crisis, as balance sheets and global imbalances have improved significantly since that time. Economic Forecast Summary GDP growth ,% 2013F 2014F 1.4 2.2 2.2 3.2 2.0 0.6 -0.6 1.0 6.3 7.3 7.9 8.8 5.5 6.5 2.7 3.6 2.8 3.3 2.8 3.6 2.4 3.1 1.2 4.9 3.0 2.1 5.8 3.9 CPI inflation,% 2013F 2014F 1.5 2.1 1.7 2.3 -0.1 2.3 1.5 1.5 3.3 4.1 2.6 3.5 5.4 5.7 5.1 4.9 6.8 6.0 8.3 8.4 6.4 5.6 1.5 4.5 3.0 2.0 5.0 3.5 G7 US Japan Euroland EM Asia China India EMEA Russia Latam Brazil Advanced economies EM economies Global Source: DB Research 2011 1.5 1.8 -0.5 1.5 7.5 9.3 7.5 4.9 4.3 4.3 2.7 1.4 6.4 3.8 2012 1.4 2.2 1.9 -0.5 6.1 7.8 5.1 2.8 3.4 2.8 0.9 1.2 4.8 2.9 2011 2.6 3.1 -0.3 2.7 6.0 5.4 9.5 6.4 8.4 8.4 6.6 2.6 6.5 4.5 2012 1.9 2.1 0.0 2.5 3.8 2.6 7.5 5.0 5.1 7.8 5.4 1.9 4.8 3.3 _______________________________________________________________________________________________________________ Deutsche Bank Securities Inc. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013. 20 June 2013 World Outlook: Fed Policy Tapers Global Markets Table of Contents Global Overview Fed Policy Tapers Global Markets US Why taper? Why now? Europe An unconvincing calm Japan Recovery has started in Q1 2013 Asia (ex Japan) A slightly delayed recovery Latin America Tested by shifting flows and strong dollar outlook Global Asset Allocation Growth versus stimulus—The Fed’s taper US Equity Strategy Attractive long-term S&P 500 outlook as economy returns to normal European Equities Strategy The domestic cyclical strategy Rate Outlook Rates to sell-off beyond the peak of monetary stimulus and fiscal tightening Credit Strategy Credit in the face of QE tapering US MBS & Securitization Outlook Fed exit and MBS FX Strategy Rotation within a USD trend Commodities Hazards from new supply, Fed exit and a turn in the US dollar Geopolitics More internationalization of the Syrian Civil War Forecast table Key Economic Indicators Interest Rates Exchange Rates Long-term Forecasts Contacts 3 10 15 23 25 27 29 33 35 37 40 43 44 47 49 51 52 53 54 55 Page 2 Deutsche Bank Securities Inc. 20 June 2013 World Outlook: Fed Policy Tapers Global Markets Global Overview: Fed Policy Tapers Global Markets Introduction1 When last we updated our view in March, we emphasized the importance of central bank liquidity for global asset prices and the ongoing global economic recovery. Recent market developments have underscored this fact. As indications of Fed tapering have intensified, market volatility and rates have risen, and global risk assets have weakened. The outlook for monetary policy will continue to be a focal point for the economy and financial markets in the quarter ahead, and will thus be a common theme in our outlook. In this quarter’s overview, we begin by outlining recent developments in the global economy and our baseline outlook for the year ahead. We then present our expectations about Fed tapering and eventual exit from its unprecedented accommodation, and discuss our baseline scenario for the economy and markets consistent with these expectations. We also summarize our strategists’ views for how equities, rates, credit, FX, and commodities will react to this policy shift. Given the uncertainty about the economic conditions on which a taper is contingent, and on the market response to a slower pace of purchases, we also present the risks to our baseline view as we see them. unadjusted for a further contraction in the Euro area and marginally reduced our forecast for US growth this year, on the back of slightly slower growth in the first half than anticipated. In aggregate, these adjustments caused us to markdown global growth prospects for this year and next by 0.2 and 0.1 pp, respectively. Figure 1: Growth returning to trend 10 8 6 4 2 0 -2 -4 -6 2000 World Advanced economies Emerging economies Trend: World Trend: Advanced economies Trend: Emerging economies 2002 2004 2006 2008 2010 % yoy Real GDP grow th Forecasts Economic outlook Global growth outlook has weakened slightly As we move into the second half of the year, we continue to see 2013 as a year of transition, with global growth expected to rise closer to potential by year-end (Figure 1). However, growth in the first half of the year has underperformed our prior expectations, particularly in Emerging Market economies, causing us to downgrade slightly our global GDP growth forecasts for this year and next (Figure 2). The downward revisions to growth in EMs were relatively broad-based, with India, Russia and Brazil experiencing the largest downgrades. Growth in China this year was also revised lower by several tenths of a percent. These revisions led to a downward adjustment to 2013 EM growth of 0.6 pp in aggregate. On the other hand, the 2013 growth forecast for advanced economies has been upgraded slightly. In response to the bold policy initiatives of the Abe government, our Japanese growth forecast for this year was increased substantially. Elsewhere in advanced economies, we left our forecast 2012 2014 Source: IMF, Haver Analytics, DB Research Figure 2: Global GDP growth forecast & revision (% yoy) Forecast level Jun’13 WO 2012 2013F 2014F G7 US Japan EA EM Asia China India EMEA Russia Latam Brazil Advanced economies EM economies Global Source: DB Research Forecast change since Mar’13 WO 2012 2013F 2014F 0.0 0.0 -0.1 0.1 0.2 0.0 1.0 0.0 0.0 0.0 0.0 0.0 0.1 0.0 0.1 -0.1 0.6 0.0 -0.5 -0.3 -1.4 -0.7 -1.5 -0.7 -0.9 0.1 -0.6 -0.2 0.0 0.0 0.0 0.0 -0.2 -0.1 -0.7 -0.3 -0.9 -0.4 -1.1 0.0 -0.3 -0.1 1.4 2.2 1.9 -0.5 6.1 7.8 5.1 2.8 3.4 2.8 0.9 1.2 4.8 2.9 1.4 2.2 2.0 -0.6 6.3 7.9 5.5 2.7 2.8 2.8 2.4 1.2 4.9 3.0 2.2 3.2 0.6 1.0 7.3 8.8 6.5 3.6 3.3 3.6 3.1 2.1 5.8 3.9 The Authors are grateful to Stefan B. Schneider and Oliver Rakau for their production editing of this report. We also wish to thank especially Manjuri Das, Siddhartha Chanda, Kuhumita Bhattacharya, Baqar Zaidi and Moumita Paul, employees of Infosys Ltd., a third party provider to Deutsche Bank offshore research support services, for their assistance. 1 Deutsche Bank Securities Inc. Page 3 20 June 2013 World Outlook: Fed Policy Tapers Global Markets US growth remains on track The concerns of a sequester-induced mid-year slump in the US have not (yet) materialized, as employment growth and consumer spending have proven resilient to tax increases and lower government spending. As a result, our outlook for the US economy has remained broadly intact. Entering this year, we anticipated that the fiscal drag resulting from the expiration of the payroll tax reduction and sequester-related spending cuts would weigh on US growth in H1, but that continued improvements in consumer balance sheets and a strong rebound in housing activity would overcome this drag and push growth toward potential by year-end. Rapid house and equity price appreciation have continued to support consumer balance sheets and, along with a resilient labor market, have supported consumer spending. And housing market prospects, as indicated by low inventory, rising demand, continued price appreciation, and buoyant homebuilder sentiment, are supportive of a strengthening housing recovery in H2. Government policy concerns related to budget negotiations and the debt ceiling have thus far proven to be a non-issue for markets and the economy, and we anticipate that this will continue. As such, the rebound in US growth remains on track, with a disorderly market reaction to Fed tapering as the most significant risk going forward. We discuss the prospects for Fed tapering in more detail in the last section of this overview. Growth outlook upgraded in Japan Our outlook for Japan this year has been revised up meaningfully in response to the bold policy initiatives of the Abe administration, while we left our forecast for 2014 unrevised. The initial market reaction to this policy announcement was substantial, as the yen depreciated significantly, stock values rose, and inflation expectations moved up. And crucial to the ultimate goals of these policies, there is early evidence that these market reactions are spilling over to the real economy. First quarter growth came in well ahead of expectations and business and consumer confidence have risen. However, the unveiling of the third pillar of “Abenomics” – structural reforms – was met with market skepticism due to what was perceived as an underwhelming proposal that lacked sufficient scope and detail. This reaction brought about sharp reversals in previous trends, as the yen and stock prices have experienced significant corrections, and volatility has risen. We anticipate that these corrections will prove transitory, and financial conditions should remain supportive of growth in Japan going forward. Growth is still expected to take a significant hit from the VAT hike next year, but we have left our 2014 growth forecast unrevised. Euro area growth unrevised this year, slight upgrade to 2014 We left our forecast for Euro area growth this year unchanged at -0.6% and upgraded 2014 growth by 0.1pp. Although early growth indicators were generally disappointing this year, recent indicators have been more mixed. Industrial production figures improved meaningfully in Germany and France, but continued weakness for Spain and Italy is evident. On the other hand, PMIs have been broadly disappointing more recently and point to downside risks to near-term growth prospects. We continue to believe that growth should improve in H2, helped in part by improving external demand and slowing fiscal austerity. The ECB has maintained their dovish bias and in theory kept all policy tools on the table. The ECB returned to conventional policy easing in May rather than opt for more contentious unconventional measures (e.g. negative deposit rates, purchasing SME securities), but the recent dataflow has in our view tipped the balance of risks away from further conventional easing. In particular, the trend acceleration in the PMI in recent months should give the ECB hope that the forecast of a H2 recovery remains intact. We now no longer see a final quarter point rate cut as a baseline and see the refi rate remaining at 0.5% over the next 12 months at least and the deposit rate remaining at zero. A final rate cut should be considered a risk scenario if the data reweaken. Emerging market growth outlook downgraded EM growth forecasts for this year have been marked down broadly. A disappointing start to the year in EM growth was due primarily to below-expectation export performance, which resulted from lower global growth, particularly in the US and Euro area. Poor export performance was found across EM Asia and Latam. Lower than expected growth and inflation has led to tighter than optimal policy in China and India. And although we remain above consensus in our outlook for China, we have reduced our GDP growth forecasts by 0.3 and 0.1pp for 2013 and 2014, respectively. In Latam, downward revisions were led by Argentina, Brazil, and Venezuela, while revisions to Colombia, Peru, and Chile were smaller. With this backdrop, we marked down 2013 growth expectations for Brazil, Russia, India, and China by 0.9, 1.5, 1.4, and 0.3pp, respectively, while 2014 growth expectations were generally reduced by a smaller amount, except for Brazil. More recently, rising bond yields in AE, intensifying discussions of Fed tapering, and the implications of these actions for EM capital flows, have led to rapidly rising rates and falling EM currencies. Moreover, expectations of further dollar appreciation could put additional pressure on growth prospects for EM commodity exporters. While dissipating inflation pressures could in theory provide additional room for Deutsche Bank Securities Inc. Page 4 20 June 2013 World Outlook: Fed Policy Tapers Global Markets policy accommodation in these countries to support growth if judged necessary, further concerns about the potential reversal in capital flows during a Fed’s policy downshift may caution them against more policy easing. Growth outlook above consensus Our world growth outlook remains above the consensus forecasts of private economists this year, but slightly below the IMF’s most recent projections (Figure 3). For the US, we are slightly above consensus surveys and the IMF in 2013 and 2014, while our forecast is below consensus and the IMF for the Euro area this year, and generally consistent with other forecasts for 2014. Figure 3: Consensus Forecasts GDP growth, % World DB (Mar) DB (June) Bloomberg (Jun Survey) Consensus (Apr Survey) IMF (Apr) DB (Mar) DB (June) Bloomberg (Jun Survey) Consensus (Apr Survey) IMF (Apr) DB (Mar) DB (June) Bloomberg (Jun Survey) Consensus (Apr Survey) IMF (Apr) 2012 2.9 2.9 2.9 2.9 2.9 2.2 2.2 2.2 2.2 2.2 -0.6 -0.5 -0.5 -0.5 -0.5 2013F 3.2 3.0 2.2 2.6 3.3 2.3 2.2 1.9 2.1 1.9 -0.6 -0.6 -0.6 -0.4 -0.3 2014F 4.0 3.9 3.0 3.2 4.0 3.2 3.2 2.7 2.7 3.0 1.0 1.0 1.0 0.9 1.1 Figure 4: Inflation forecast & revision (% yoy) Forecast level Jun’13 WO 2012 2013F 2014F G7 US Japan EA EM Asia China India EMEA Russia Latam Brazil Advanced economies EM economies Global Source: DB Research Forecast change since Mar’13 WO 2012 2013F 2014F 0.0 -0.2 0.0 0.0 0.0 0.0 0.0 -0.2 -0.1 0.0 0.0 0.0 0.0 0.0 -0.3 -0.9 -0.1 -0.1 -0.6 -0.4 -1.1 -0.2 0.3 0.0 0.4 -0.3 -0.5 -0.3 -0.2 -0.3 0.3 -0.1 -0.1 0.0 -0.7 -0.2 -0.1 0.2 0.2 -0.2 -0.1 -0.1 1.9 2.1 0.0 2.5 3.8 2.6 7.5 5.0 5.1 7.8 5.4 1.9 4.8 3.3 1.5 1.7 -0.1 1.5 3.3 2.6 5.4 5.1 6.8 8.3 6.4 1.5 4.5 3.0 2.1 2.3 2.3 1.5 4.1 3.5 5.7 4.9 6.0 8.4 5.6 2.0 5.0 3.5 Outlook for Fed tapering: Expectations and impact The discussions about Fed tapering will continue to figure prominently in the upcoming months, as we gain further clarity on both the economic outlook and how the Fed expects to manage its exit. This section presents our views for how this process will proceed and how markets and the economy will react. How is Fed tapering and the exit process likely to proceed? The June FOMC meeting results confirmed that the Fed intends to commence tapering this year; we think that is most likely to happen in September if the US economy evolves in line with our baseline expectations (employment gains average 175-200k per month and the inflation slowdown proves transitory). We expect the initial taper to entail cutting MBS and Treasury purchases equally by about one-fourth to one-third. Further cuts will ensue at subsequent meetings, assuming economic reactions are not strongly negative. Assuming a relatively benign economic response, QE is likely to be cut to zero by June 2014 as Chairman Bernanke indicated at the post-June meeting press conference. Indeed, given that Bernanke has tied the end of QE to achievement of a 7% rate of unemployment that is likely to be improved upon going forward, the unemployment forecast of our US economics team suggests that the end of QE could come sooner in 2014 H1. That forecast says that the Fed still see the unemployment rate at 7% by Q1, which would point to a March termination date for QE. The Fed has said it will update its exit guidance in the months ahead; based on what they have told us so far, we can expect it to: US EA Source: IMF, Consensus Economics, Bloomberg Finance LP, DB Research Global Inflation falling While we continue to expect consumer price inflation to rise from this year to next, inflation has generally been below our expectations so far this year, helped by a slowdown in commodity price inflation and weak global growth that remains below potential (Figure 4). This has caused us to reduce inflation forecasts for this year and next across both EM economies and AEs. Deutsche Bank Securities Inc. Page 5 government bond yields rose broadly. Moreover. . Following Bernanke’s testimony to the JEC in late May. expectations for further reductions beyond the first Figure 5: Bond yields have risen substantially… US 6 5 4 3 2 1 0 Dec-12 Jan-13 Feb-13 Mar-13 A pr-13 May-13 Jun-13 Source: Haver Analytics. leading to sharp increases in real rates. We expect this to be achieved by around 2020 via natural runoff as assets mature or are prepaid. Alternatively. it could still begin by September at a slower pace or be delayed until later in the year. a more rapid pace of rate increase. While many of these movements are indeed substantial. which reinforced the real possibility of a start to tapering of asset purchases this year. while equities weakened. particularly in light of recently subdued volatility. we would anticipate deviations from our base case timeline if the trajectory of the economy does not match our outlook for the US economy (which is quite similar to the Fed’s). employment gains. because of the endogeneity of the market and economic response to a reduction in purchases. a strong recovery in growth. the pace of tapering will be slower than we expect. DB Research …but remain low compared to history 9 8 7 6 5 4 3 2 1 0 2004 2005 2007 2008 2009 2010 2011 2012 2013 US Spain % Germany Japan Italy UK Germany Japan Italy UK Spain % 10 year government yield (end 2012 . A further weakening of employment growth or core inflation from recently reduced rates would likely put off the start date even further. If employment gains fail to move up from the average monthly pace of about 150k in recent months or core inflation fails to begin to recover.present) 19-Jun Page 6 Deutsche Bank Securities Inc. What will induce deviations from that expected process? Given the conditionality of the Fed’s QE program on economic data. How are markets likely to react to the Fed’s tapering and exit process? Markets have already moved significantly in response to Fed communication on possible tapering in the months ahead. So long as these key macro variables are on track currently and prospectively (our base case). . and or substantial rise in core inflation and longer-term inflation expectations would induce a more aggressive exit process. they are less striking when viewed in a more historical context (Figures 5-7). inflation expectations declined. and even the reintroduction of large-scale asset sales into the picture. we would not expect the Fed’s tapering to be put off by potential and actual disruption in financial markets stemming from the shift in policy.present) 19-Jun 10 year government yield (end 2004 . with a more rapid pace of tapering. phase must forecast how the market and economy will react to the taper. These market dynamics accelerated in response to the June FOMC statement and Bernanke press conference.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Stabilize its balance sheet for another 6-12 months after QE ends Use term deposits and repos to reduce excess reserves shortly before raising rates Raise rates by early-mid 2015 Not engage in asset sales until after the balance sheet has been normalized to its precrisis trend level. In the US. 0 1.0 -0.0 0.0 2.0 Dec-12 Jan-13 Feb-13 Mar-13 A pr-13 May-13 0.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Figure 6: US inflation expectations have fallen… 3.0 2. the tapering has been interpreted in the context of a more general Fed exit.5 -1.0 Dec-12 Jan-13 Feb-13 Mar-13 A pr-13 May-13 Jun-13 Source: Haver Analytics.0 % 5 yr-5yr breakeven inflation expectation 2. and there has been a significant shift forward in expectations about the eventual timing and pace of the Fed’s policy rate hikes (Figure 8). DB Research …but remain well below normal % 10 year bond yields Nominal Inflation-indexed 19-Jun 6 5 4 3 19-Jun % Nominal Inflation-indexed 2 1 0 -1 -2 2004 2005 2007 2008 2009 2010 2011 2012 2013 Despite the fact that Bernanke and the Fed have endeavored to disconnect the taper decision from subsequent balance sheet reduction and policy rate hikes.3 1.0 5 yr-5yr breakeven inflation expectation % 19-Jun 2. Indeed.5 1.5 0. Figure 8: Implied Fed funds rate path 400 bps 350 Current 300 250 200 150 100 50 0 2013 Source: DB Research Implied fed rate May 21.8 …but remain within historical range 3.5 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Haver Analytics.5 1.5 2. Page 7 .0 2. 2013 2015 2017 2019 2021 2023 2025 Deutsche Bank Securities Inc. DB Research Figure 7: US real yields have moved into positive territory… 10 year bond yields 3. a tapering in September appears already to have been fully priced into the Treasury curve.5 19-Jun 2.5 2. 2013 May 02. In the commodity space. In all likelihood. in the wake of talk of tapering. . Equities should benefit from the macro fundamentals underlying the Fed’s exit. especially if those expectations were prompted by a stronger than expected pickup in growth and inflation expectations that was seen as prompting more aggressive Fed action. especially in high yield and EM will be hit especially Deutsche Bank Securities Inc. especially those with high debt or external deficits will feel the impact.5% by year end. especially the yen and currencies of commodity exporting countries. including residential investment. A downtrend in employment growth or significant further decline in core inflation with inflation expectations drifting lower would halt and possibly even reverse tapering. as investors that have reached for yield continue to rotate out of these investments. Even in the face of stronger US growth. the setback would not be recessioninducing. Where is pain in the markets likely to be most intense? Investors that have reached aggressively for yield. The rise in Treasury yields could quickly be reversed by a large-scale flight to safety. EM credit and equities could drop sharply.15 and the yen to 115 by the end of next year. We expect these assets will continue to be affected negatively. and bond yields up by 50-100 bps. especially oil and possibly grains. indeed.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Under this base case timeline for Fed tapering. Corporate credit: Yields have jumped and will likely continue to rise by 25% more than the rise in Treasury yields on average. We see the euro depreciating to 1. How would the Fed respond to market reactions. Mortgages: Spreads have widened 25 bps. Equities: The S&P 500 is about 4% below its mid-May peak. FX: The dollar has declined initially. what controls will it have over both ends of the curve? The Fed will react to how it sees market movements affecting economic prospects. What are the implications for global growth and inflation? Our base-case scenario does not see a significant negative impact on the US economy—we see interest sensitive spending. given the still relatively low levels of investment in durables and structures in the US and given the relatively manageable degree of leverage in most emerging markets. some emerging market economies. It will not hold off tapering or exiting simply because it sees a potentially negative market reaction. The chances of a major failure (of an emerging market or a financial firm) that would roil the markets would rise sharply. The US and global economies could very well be affected negatively in the worse case scenario. and could stabilize around current levels assuming the Fed indicates (but with less than a binding commitment) that they will not sell or repo MBS. We see the S&P 500 moving back into the mid1600s by later this year. It would also elicit more dovish verbal guidance concerning future rate increases and balance sheet management. they believe we could plausibly see 10-year Treasury yields move to 3. The dollar would strengthen even further unless the Fed stepped in or a flight to safety pushed Treasury yields back down. especially against major currencies. as well as a rotation from fixed income into stocks. our strategists see the following: Rates: We see the 10-year Treasury yield moving above 2. though. so long as the underlying momentum in the economy remains intact. in some cases increasingly painfully. relatively unaffected by rising yields. We expect it will eventually strengthen against all currencies. Commodities: Commodity prices have risen modestly on balance since the talk of tapering began. somewhat less so against the euro. declines in metal prices would join into a more general drop in prices. Page 8 Under some conditions. but that we expect to see reversed by year-end. the Fed could delay or reduce the pace of its tapering. and further to 2000 over the next two years. with stocks in some countries down by 5-10% or more. where spreads had declined relatively more in recent years. especially if the equity market dropped sharply and the recovery in the housing market was set back. If the market reaction looks negative enough to keep employment growth from recovering from its recent slower pace (or if core inflation continues to drift lower). a move that may be extended for a time. many have already. While systemic risks are low. Emerging Markets: EMs have taken a larger hit than US markets. and credit and mortgage spreads widen substantially further than in the base case. We expect to see a substantial drop in gold prices and some decline in areas that are dollar-sensitive.5% by year-end and eventually moving back well above 4% as policy rates normalize and the Fed’s balance sheet runs down. with more pain felt in high-yield. How bad could things get in a worse case scenario? Our strategists believe that fixed income markets could sell off substantially faster than we have outlined in our base case if expectations of the eventual pace of Fed rate hikes were increased significantly. it probably will. even if it means pain in the markets. (852) 2203 8305 Matthew Luzzetti (1) 212 250 6161 Torsten Slok. if it does come. (1) 212 250 7352 Thomas Mayer. The prominent role of central bank liquidity for markets and the economy may also be at a transition point. the improvement in the fiscal and external balance positions. A sharp back-up in yields and drop in equities could put a number of EMs and financial firms at risk. Despite this markdown. Similarly. so far this year have caused us to mark down our global growth projections for 2013. Peter Hooper. at least temporarily. (49) 69 910 30800 Michael Spencer. and financial and nonfinancial business balance sheets today compared with six years ago. The Fed will endeavor to be clear enough in its communications/guidance and careful enough in the management of its massive balance sheet to avoid major setbacks. as we expect the Fed to begin reducing the pace of asset purchases this September. (1) 212 250 2155 Deutsche Bank Securities Inc.20 June 2013 World Outlook: Fed Policy Tapers Global Markets hard. we do believe there is a non-trivial probability of a disorderly market reaction to this shift in policy. and our view that 2013 is a year of transition. a disorderly market reaction is the primary risk to our constructive near-term outlook. will most likely be much less painful than the crisis of 200708. Flows into these areas have already seen significant reversals. concern about further accumulation of froth in the markets is a key reason why the Fed will move when the macro data say it is time. the process will not occur without significant disruption and substantial pain in the markets. as well as reduced leverage and increased reserves of major emerging markets since the debt crises of the 1980s and 1990s. The good news is that a setback. means that the potential for downturn in those areas is lessened as well relative to what happened after major Fed policy tightenings in those earlier decades. we continue to see strength in the underlying fundamentals for global growth. if something can go wrong. given the much stronger position of household. in which growth should approach potential by year-end. the underlying strength of the US economy is firm enough to weather the normalization of market yields that is coming – indeed a normalization that will be needed to keep inflation pressures in check in the longer term. however. Although not our base case. However. there is a nontrivial chance that a financial failure could be induced that will cause the markets to tumble. Conclusion Below expectation growth readings and some negative market reaction to Fed tapering. We expect that the Fed will be able to manage this transition without significant market disruption. Page 9 . remains intact. Bottom line: how high are the risks? Most likely. We recognize that neither economic forecasting nor monetary policy making are exacting sciences. That said. Given the distance the Fed has to go in tapering and eventually exiting. most notably for EM economies. especially in those that have shown signs of becoming frothy during the Fed’s prolonged period of extraordinary monetary ease. 9 0 .5 3 .0 5 .8 2 .6 8 .0 7 .0 0 .3 2 . A reduction in the pace of monthly bond purchases should not result in a meaningful tightening of financial conditions—especially as long as the Fed’s balance sheet continues to expand. economic activity should move substantially higher and the pace of real GDP growth is due to accelerate above 3% by yearend.0 8 .2 .0 .4 3 .1 2 .3 2 .4 1 .0 5 .6 4 .4 2 .0 2014F % y oy 3 . allowing the program to be cut to zero by the end of Q1 2014.3 2 .2 Q 1F 3 .7 5 . the impact on overall housing affordability will be modest.0 0 .8 1 .0 .4 9 . The projected USD25 billion reduction would be divided between USD10 billion in mortgages (to USD30 billion per month) and USD15 billion in treasuries (to USD30 billion per month).4 2 .1 .7 3 .0 6 .6 3 .0 .8 3 .5 7 .0 0 .0 0 .3 2012 % y oy 2 .2 2 .0 0 .6 5 . but it would not be so large so that policymakers could not ramp purchases back up should the economy meaningfully falter in the quarters ahead.0 6 . Housing activity—one of the key drivers of growth in the coming quarters—should not be impinged by higher rates because the latter would be occurring against the backdrop of improving job and income prospects.2 3 .1 Q 3F 3 .0 9 .9 2 .9 0 .9 1 .4 0 .0 0 .9 1 . Given our expectation of the unemployment rate falling to 7. policymakers will have to make it large enough so that QE could be removed relatively quickly but not so large as to potentially scare financial markets into thinking the Fed was going to begin the process of removing policy accommodation altogether.H1.4 Q 4F 3 . In terms of size.2 0 . .3 .6 5 .0 .6 .0 .7 0 .9 Page 10 Deutsche Bank Securities Inc. DB Research Q 1F 2 .7 1 .2 7 .4 0 .2 2 .0 . Moreover.2 1 . driven by accelerating private domestic demand should help push long-term interest rates higher. The Fed will reduce both mortgage and treasury securities purchases simultaneously when tapering. However.1 0 .9 2 .0% around yearend and inflation pressures gradually beginning to reaccelerate.0 .8 0 .0 8 .0 . but it would not be so large so that policymakers could not ramp purchases back up should the economy meaningfully falter. allowing the program to be cut to zero by the end of Q1 2014. stronger economic growth.5 7 .2 .9 1 .0 .0 2 .1 2 .5 2 .6 2 .8 1 .4 2 .0 1 .3 1 .4 1 .8 1 .9 1 . P ro d u c tiv it y Source: National authorities.2 3 .0 1 4 .0 .9 1 .6 2013F % y oy 2 .2 3 .0 0 .1 .2 3 . s a a r ) GDP P riv a t e c o n su m p tio n in v e n to rie s) G o v ’t c o n s u m p t i o n E x p orts Im p o r t s C o n t r i b u t i o n (p p ): S t o c k s N e t tra d e In d u s t r i a l p r o d u c t i o n U n e m p lo y m e n t ra te .6 2 .3 6 .0 .2 3 . The USD60 billion in QE could then be reduced by either USD20 or USD30 billion per FOMC meeting.0 .0 1 . a reduction to USD60 billion in QE from USD85 billion at present would be large enough to signal that progress was being made.5 2014 Q 2F 3 .4 2 .0 .8 2 .0 .5 7 .0 .1 3 .5 2 .0 8 .2 2 .8 1 .6 5 .2 2 .9 0 .2 0 .4 3 . Hence.0 4 .0 1 .7 2 .6 2 . In terms of size.9 0 .8 0 .9 1 0 .1 Q 4F 3 .20 June 2013 World Outlook: Fed Policy Tapers Global Markets US: Why taper? Why now? A further improvement in the labor market that coincides with a step-up in second half real GDP growth should allow Fed policymakers to slow down the pace of monetary accommodation.0 6 .5 2 .7 .0 7 .9 0 .2 1 .4 . The USD60 billion in QE could then be reduced by either USD20 or USD30 billion per FOMC meeting.0 6 .2 1 .7 1 4 .0 .0 . a reduction to USD60 billion in QE from USD85 billion at present would be large enough to signal the labor market was making substantial improvement.8 .0 0 .0 .0 0 .3 6 .0 0 .9 3 .7 1 .7 1 .2 2 .9 9 .4 6 .2 0 .4 9 .7 1 .3 3 . The economy has already shown a marked improvement in private domestic demand.7 0 . % P r i c e s & w a g e s (% y o y ) CP I Core C P I P ro d u c e r p ric e s C o m p e n sa tio n p e r e m p l.7 2 .6 2 .1 .8 . given the extraordinarily low levels that interest rates are rising from. A reduction in the pace of monthly bond purchases does not constitute an act of tightening financial conditions—it simply represents a slower pace of easing.4 6 .4 . we expect the Fed to commence tapering asset purchases at the September 1718 policy meeting and terminate them during 2014. as the fiscal drag fades.0 6 .2 2013 Q 2F 2 .7 0 .1 . Tapering does not mean an end to accommodative monetary policy. Figure 1: Macro-economic activity & inflation forecasts E c o n o m ic a c tiv ity (% q o q .4 .2 2 .7 3 .8 Q 3F 3 .9 2 .3 6 .9 0 . In determining the initial size of the reduction.1 1 . real GDP has increased at a 2. there is a fundamental reason why this is occurring—the economy is accelerating in a low productivity environment. but this is accompanied by faster job creation Total private payrolls Real GDP ex-govt minus nonfarm productivity 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 % yoy Estimated range for Q4 2013 Private sector payroll scenarios: (% yoy = implied monthly change) 2. If our forecast for a meaningful acceleration in private domestic demand in the second half of this year proves correct. Figure 2: Productivity typically slows as the expansion matures. which implies average monthly gains of 321k. the employment landscape could materially improve.1% annualized pace. as long as the economic expansion remains intact.0%.0%.1% over the last eleven months. the low end of 1-2% productivity growth over the medium term remains our baseline estimate. and then it subsequently mean-reverts by falling back below trend for an extended period.0%) which is equivalent to our forecasted private payroll gain of 3. it is unlikely for productivity to meaningfully reaccelerate—once the labor recovery is underway. this implies an average monthly private payroll gain of 185k through yearend. While claims provide an important real-time indication that the labor market is potentially on the cusp of a meaningful acceleration.1% year-on-year—is hardly robust enough to foster a dramatic productivity acceleration. Barring a surge in capital investment. the growth rate—currently 4. which is down negligibly from +206k in April but slightly better than the +188k reading at the time of the April 30-May 1 FOMC meeting. The housing sector. However. To be sure. The pattern is similar for private payrolls where the six-month moving average is +199k compared to +212k in April. our baseline assumption has private payroll growth rising toward 3%. Employment will drive the taper.) A more aggressive—yet plausible—productivity assumption would limit the gain to something closer to 2. productivity trends become increasingly tied to capital investment. Nonfarm productivity typically weakens at this stage of the economic cycle. while relatively small in Deutsche Bank Securities Inc. a sustained improvement is becoming increasingly probable. Productivity tends to surge well above trend as the economy initially exits recession. As a result. While the labor market has stumbled through a few false starts.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Based on the likely path of the economy.9% to 2. In terms of the current underlying trend. Low productivity amid accelerating GDP growth will drive a faster pace of hiring. The four-week moving average on initial jobless claims is running below 350k. Even if growth is not quite as strong as we project and productivity posts a moderately stronger recovery. the Fed will reinvest its maturing securities so as to maintain the size of the overall balance sheet at what will likely be USD4 trillion. As we can see in the chart below.0%) for yearend adjusted for productivity (1. Since the end of the recession in mid-2009. This is a key level. This will persist for a couple of quarters. may be largely avoided.5%) would still achieve an impressive 250k per month. Haver Analytics. the labor market will be instrumental in determining the Fed’s course of action. based on historical precedent. If productivity growth remains constant and aggregate demand accelerates. the six-month moving average on nonfarm payrolls is +194k. the fact that initial jobless claims—which have repeatedly proven to be one of the most reliable forecasting tools for nonfarm payrolls—have moved back toward their cyclical lows is an encouraging development for the labor outlook. Consistent with the FOMC’s explicit desire to fulfill the unemployment portion of its dual mandate. If the current pace is maintained.0%. Housing will drive the output acceleration The recovery in the housing sector is an important tenet of our 2013 outlook—and it is also a key reason why we believe a mid-year swoon. nonfarm payrolls have increased by an average of 165k per month. so too does the pace of job creation. the outlook for private sector hiring improves appreciably. before policymakers would then allow the balance sheet to organically shrink.0% = +180k 2.5% = +250k 3.0% = +321k 2007 2008 2009 2010 2011 2012 2013 2014 Source: BEA. The first hike in the fed funds rate is not expected until Q1 2015. (The lower point represents a more conservative estimate. But policymakers would still likely wait a quarter or two before actually raising short term interest rates. consistent with the range of 1. The current pace of private payroll growth is 2. a modest downside miss (2. DB Research The points in the preceding chart reflect our private sector GDP forecast (4. BLS. the correlation between private sector employment and productivity-adjusted private GDP is extraordinarily high at 95%. Page 11 . which in the past has been consistent with private sector payroll gains in excess of 200k. Thus. While business fixed investment has been recovering. akin to the experience of the past few years. Of the 2. Rather. DB Research Contrary to what some market participants think. The last comprehensive benchmark revision occurred in July 2009. rising home prices also make it likelier that financial institutions will ease mortgage lending standards. potentially providing an added stimulant to consumer spending beyond what we expect from a recovering labor market. Based on the fact that we have seen a steady pattern of upward revisions to nonfarm payrolls.74 -200 -400 -600 700 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: DB Research 300 400 600 -800 16 22 12 20 8 18 4 0 1960 16 1967 1975 1982 1990 1997 2005 2012 Source: Census. the Bureau of Economic Analysis (BEA) will release the initial snapshot of Q2 real GDP along with comprehensive benchmark revisions that extend back to 1929. as well. We have made a big deal over this upcoming benchmark revision. This is evident in the chart below which compares the level of the federal funds rate versus the housing-wide share of the economy. Furthermore. We are projecting a 10% rise in home prices in 2013.20 June 2013 World Outlook: Fed Policy Tapers Global Markets terms of its direct contribution to GDP. because there will be less fear that the collateral for which the loan is being made will decline in value. which in isolation is pretty substantial. It is noteworthy that every cyclical peak in housing activity has coincided with monetary tightening.0% set in Q4 2011 and Q1 2012. which is unlikely to improve as homebuilders struggle to keep apace of strengthening demand. when we add up all housing-related spending from residential construction to housing rents to the items that go into a home. has a large indirect effect. we arrive at a significantly larger figure. Haver Analytics.) Figure 3: The housing share of the economy is poised to move higher and will not peak until rates rise sharply Federal funds rate (lhs) Total housing expenditures as a share of real GDP (rhs) 20 % % 24 Figure 4: Employment gains are holding steady. This is based on an overall lean inventory-tosales ratio. 3mma. barely above its all-time record low of 17. just as the economy was emerging from recession. because it has the potential to alter investors’ perceptions of both the depth of the last economic downturn and the speed of the recovery. . Rising home prices also provide an upside risk. it is likely to coincide with rising home prices since the latter tend to be highly correlated with a pickup in housing related spending.3%. We believe that a return to more normalized levels of housing activity relative to the size of the economy will be a very important driver of economic growth over the next several years. such as insurance. 800 600 400 200 0 500 Correlation= 0. It is not as small as the roughly 3% share of real GDP that the residential construction sector comprises. thous. more than one-third is expected to be due to either the direct contribution from housing construction or the indirect effect of housing wealth-driven consumption. NAHB. In particular. Rising home values will lift household net wealth. we believe there is a high probability that real GDP growth will be revised modestly higher over the past couple of years.8% real GDP growth we are forecasting through yearend. at least relative to what some market participants’ incorrectly assume. Page 12 Deutsche Bank Securities Inc. a shopworn comment we hear from investors. such as furniture and appliances. which already appears well within reach given that a number of surveys have already crossed this threshold. while the unemployment rate is trending down Initial jobless claims (inverted axis. We calculate that total economy-wide housing spending as a share of GDP is currently 17. To the extent that home price appreciation exceeds our forecast. lhs) Nonfarm payrolls (rhs) 200 Thous. official interest rates went up 425 basis points from their previous low. this potentially creates significant upside risks to our GDP forecast. housing has a substantial weight in the economy. (In the last business cycle. The current reading is pretty depressed. Revisions bear watching On July 31. as well as the costs of maintaining a house. there has never been a peak in the housing cycle that did not correspond with a large cumulative rise in the federal funds rate. If housing’s share of the economy expands. it too remains relatively tame at present (1. DB Research 500 2005 2006 2007 2008 2008 2009 2010 2011 2012 2013 Source:. DB Research Disinflation/deflation risks will subside as the growth outlook improves. it is fairly likely that recent payroll gains will eventually be revised above 200k.0 -3. possibly offsetting a chunk of the ongoing fiscal drag. Figure 7: Inflation will remain tame. because mounting pressures on services and shelter costs are being masked by slack goods Deutsche Bank Securities Inc. Figure 6: Payroll revisions have been consistently higher Difference between current change in nonfarm payrolls and initially reported 300 200 100 0 -100 -200 Thous. Goods prices may provide some buffer against core services in the near term. revisions on balance are positive. The latest round of inflation data contained scant evidence of an imminent acceleration of price pressures. ar Source: BEA.0 -11. There are numerous risks around the forecast.0 Food Energy Core CPI goods Rent of shelter (ROS) Services ex energy & ROS % yoy 6m % chg. Haver Analytics.0 -7. Haver Analytics. which could potentially exert more downward pressure on the economy in the short-term than we are projecting if the fiscal multiplier proves to be Page 13 . the longer-term outlook is unchanged. As a general rule of thumb. Headline inflation remains just above 1.7%).0%. This provides a significant source of stimulus to consumers. Since the economy grows much more often than it declines. Hence.0 -15. While the core inflation trend has been less volatile.0 % History shows that revisions to nonfarm payrolls over the last few years have consistently been in an upward direction. However. Since January 2011. allowing policymakers to maintain aggressive accommodation Average of last 10 cycles Consumer prices: by expenditure category (A pril 2013) 3.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Figure 5: Economic activity will approach 3% growth in the back half of 2013 8 6 4 2 0 -2 -4 Current recession -6 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10111213141516171819202122 "0" represents the recession end date Source: DB Research Real GDP % yoy Forecast inflation—the latter is due to soft import prices. the impressive surge in home values is gaining speed with prices up 12% over the past year according to CoreLogic. DB Research Figure 8: The Fed’s balance sheet is poised to peak in late 2013 and remain elevated for some time 4000 3500 3000 2500 2000 1500 1000 Reserve bank credit outstanding USD bln Current pace of QE through year end Current pace of QE through mid-year -300 1999 2001 2003 2005 2007 2009 2011 2013 Source: BLS. the change in nonfarm payrolls has been revised up 75% of the time with an average upward revision of +65k.0 -13.0 1. but the pressure on service inflation is unlikely to relent as long as economic growth continues—and it will accelerate if faster growth and tighter labor conditions start to generate wage pressures.0 -1. and the producer price index showed little evidence of upstream inflation pressures. -5. the core inflation outlook appears less benign upon closer inspection. On the upside. While inflation pressures may run cooler than we anticipated in the near-term. payroll revisions tend to be upward during economic recoveries/expansions and downward during economic recessions.0 -9. 4 1 Source: National authorities.3 2 98 1 . so this could occur later this year. % o f G D P T r a d e b a la n c e .5 5 3M 0 . (1) 212 250 0186 Brett Ryan.2 .2 . A potential offset to the fiscal headwinds is the improvement in state and local finances.3 .1 0 0 . The risk to our forecast is that if the labor market does not follow through with the improvement we anticipate.2 -469 .3 .1 0 0 .4 7 12M 0 . Riccadonna.3 9 1 . and as a result the tapering of asset purchases is executed in a less aggressive fashion and over a longer timeframe.5 5 6M 0 .20 June 2013 World Outlook: Fed Policy Tapers Global Markets larger than what forecasters generally anticipated. we anticipate an acceleration in both GDP growth and hiring in the latter half of this year.4 -440 . state and local government is larger than federal. Thus. This was evident in the latest employment report. .3 . State and local expenditures in the GDP accounts have not yet turned positive.5 -486 .2 0 110 1 .1 0 0 .0 2014F .1 0 2 .9 -411 . (1) 212 250 6294 Page 14 Deutsche Bank Securities Inc.6 . U S D b n C u rre n t a c c ou n t.1 0 0 . % of G D P . but they tend to follow the hiring trend fairly closely.1 8 113 1 .1 0 3 . Cu rre n t 0 .5 0 1 . DB Research.2 5 1 .3 .1 0 2 .1 0 2 .7 5 1 .2 F in a n c ia l f o r e c a st s O f f ic i a l 3M ra te 1 0 Y y ie l d USD p er E UR JPY p er USD US D p er G BP spending reductions at the federal level. which showed state and local government hiring rising +11k at the same time that federal employment fell -14k. U S D b n T r a d e b a la n c e .3 .2 . In terms of both employment as well as consumption/investment.8 -535 . as of June 20 Joseph A. then policymakers will be inclined to move more cautiously toward less accommodation.7 -550 . LaVorgna. (1) 212 250 7329 Carl J.8 2013F . improving non-federal tax receipts hold the potential to materially mitigate mandated Figure 9: External balances & financial forecasts 2012 F isc a l b a la n c e .2 6 102 1 . % o f G D P C u rre n t a c c ou n t. In conclusion. and this should be sufficient to push policymakers toward a tapering of asset purchases. 2 1 .5 0 .9 5 . This ‘new fiscal realism’ was evolving in 2012 in Spain and Portugal as the Commission sought to avoid a repeat of the mistakes of the Greek programme of adding austerity on top of austerity.0 2 .1 1 .0 3 .4 3 .5 EM EA P o la n d H u n g a ry C z e c h R e p u b lic R o m a n ia R u s s ia U k ra in e K a z a k h s ta n Is ra e l T u rk e y S o u th A f ric a 2012 2 .8 5 . Fiscal consolidation weighed heavy on growth and the credibility of OMT has permitted some adjustment to the pace of austerity to something more politically sustainable.5 0 .9 7 .5 C PI (% yo y) 2012 2013F 2 .9 1 .2 Figure 1: Macro-economic activity & inflation forecasts: G D P (% yo y) EU E u ro a re a G e rm a n y F ra n c e Ita ly S p a in UK S w eden D e n m a rk N o rw a y S w itz e rla n d 2012 2013F .1 4 .9 5 .3 1 .0 2 .7 2013F 2014F 5 . The ECB has a bias to ease policy via conventional channels – it claims to be technically ready for negative interest rates. we have left unchanged our forecast of 1.1pp of GDP this year and 0.0 1 .4 1 .3 2 .6 0 .8 .5 3 . chances are the markets will have to deal with a new Italian election in 2014.6 2 . improving the efficacy of rate cuts.8 4 .3 3 .2 6 .1 1 .4 1 .5 1 . That is not to say the crisis is over: the euro area remains politically complex.0 .0 .6 5 . There remain vulnerabilities. OMT was a turning point. the Commission has endorsed a softening of austerity in general.4 1 . We are less worried about the impact of rising US rates on private credit extension.2 0 .2 5 . Into 2014.1 3 . stronger fiscal rules.0 1 .0 5 .3 1 .8 3 .2 1 .1 0 .8 6 .1 1 .1 5 . G D P (% yo y) C PI (% yo y) 2012 5 .8 2 .0 .g.8 1 .8 6 .6 1 . Weakness in core economies meant a greater alignment of economic conditions across countries.0 . the pace of economic contraction is slowing. Euro Area: On course for H2 recovery.2 6 . falling Target2 imbalances) aid the pass through of conventional policy.6 2 . Following concerns that the Italian election outcome was a sign that Europe’s social capacity for austerity had reached a peak. and fear of legacy losses continue to cloud banking recovery.6 1 .7 3 .4 1 . if necessary – but following recent firmer data.1 .0 2 . largely on the grounds that most emerging markets in the region have been levering down rather than levering up in recent years. Turkey and Ukraine. Several factors support euro area market and economic sentiment.6 1 . not declined.5 1 .3 5 .4 Source: National authorities.6 2 . Expectations of Fed tapering have precipitated a withdrawal from EMEA asset markets over the last few weeks.0 2 . First.5 1 .5 2 .5 .7 3 .6 2 .5 0 .0 1 . ‘politics’ could be a headwind.2 . look especially exposed on this front given the scale of their current account deficits and reliance on short-term flows to finance them.0 .4 0 .1 3 .7 5 .0 . Second. from a risk of not implementing sufficient mutualisation capacity to absorb legacy bank losses to political incapacity in Italy to move the dial on much needed growth enhancing structural reforms. reforms) and integration (ESM. but the prospects for an end to the contraction around mid-2013 remain good.8 2 .8 3 .5 2013F 2014F 2 .7 0 .5 2 . At the same time.5 .5 2014F 1 .3 1 .0 .3 1 .1 0 .0 .7 0 .4 2014F 1 . in our opinion.3 5 . is consistent with no further easing of monetary policy by the BoE (including no forward guidance). Deutsche Bank Securities Inc.3 1 . buying time for the underlying resolution of the crisis – macro adjustment (deleveraging. banking union.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Europe: An unconvincing calm We remain generally constructive on the euro area economy and the crisis.2 2 .8 2 .0 1 .4 . After recent better than expected PMI data.6 0 .8 1 . etc). However.5 1 . Europe has had a re-think on fiscal policy.1 0 .7 3 .9 0 .1 . We have revised up our view on UK growth this year from 0. the ECB has re-engaged conventional monetary policy by cutting rates and committing to the full allotment liquidity regime until at least mid 2014. DB Research signs of declining fragmentation (e.0 1 .3 4 .. financially fragmented and challenged by low potential growth.4 1 .7 2 .8 2 .3 .5 1 .1 0 . We calculate that the fiscal stance (change in structural primary balance) eased by 0.0 . As long as Fed tapering proceeds in line with a recovering US economy.2 2 .2 3 . we no longer expect a final quarter refi rate cut this summer. we have revised down our view on inflation.2 1 .5 3 . which should bolster confidence in eventual economic recovery.5% to just over 1%. in our view.1 2 .5 1 .2 . however.4 .0 .4 1 .3 2 .1 .7 1 .7 .9 0 . Third.9 .3 5 .2pp in 2014. South Africa.7 5 .1 1 .7 8 .7 .5 2 . A number of countries in the region would be vulnerable to a further pullback in these flows. the effects ought to be manageable for Europe.5 1 .1 0 . The euro area has recorded its longest ever recession (6 quarters). Prospects for a return to economic growth in the euro area in H2 2013 remain good. Likewise. The challenge of stabilizing public debt has increased. we expect the ECB to keep a steady hand on rates.5% and the Page 15 .8% for next year. This combination. We now expect the refi rate to remain at 0.2 .5 0 .8 1 .6 2 .1 .2 . 3 0 .3 0 . By improving household confidence in an eventual decline E c o n o m ic a c tiv ity (% q o q .5 1 .5 2001 Our forecasts for euro area GDP growth are unchanged relative to the previous World Outlook: -0.4 3 .3 1 .2 .5 1 .0 0 .6 0 .0 .7 2012 % yoy .1 2014 Q 2F 1 .7 5 .5 1 2 .0 .8 0 .0 .4 Q 3F 0 .0 .0 1 .2 1 .0 -0.0 .8 0 .0 1 .4 .4 4 .0 0 . helping the progress of reform and integration.2 1 . the other part of resolution. This is good for Germany but also for those peripherals becoming more competitive (Spain.6 1 .5 1 .6 1 .0 .4 4 .3 . Deutsche Bank Securities Inc.5 1 . growth should also aid social and political stability.9 1 .2% qoq).7 .0 .9 1 2 .4 1 .5 0 .1 0 .2 0 . Figure 3: Fiscal austerity is slowing 2.3 1 .2 0 .8 0.9 1 .0 0 . signaling some internal capacity to restart investment even in the absence of credit available. but following an extended period of contraction a return to GDP growth will be good news for markets.0 -0. DB Research in unemployment (not forecasted until H2 2014).3 .4 1 .0% in 2014.8 . Should the data re-weaken.5 .4 0 .3 Q 4F 0 . to help circumvent this.2 1 .5 1 .5 -2.20 June 2013 World Outlook: Fed Policy Tapers Global Markets deposit rate at zero.4 1 .1 1 2 .6 2 .2 0 .4 0.4 1 .5 1 .1 2013F % yoy .6 .0 .8 .9 Q 3F 1 .4 0 .4 1 .4 .4 2 .1 0 . The EIB can lend to SMEs but without a capital increase this will cannibalise other lending.7%.2 0 . a conventional policy cut could be back on the table.4 1 .3 1 .0 5 .0 .2 .2 0 .6 .3 .5 1 .6 0 .9 0 .9 .0 .0 . a key part of crisis resolution.2 1 .8 .5 -1.1 1 .9 .3 1 .7 4 .0 .2 0 .2 .2 .2 0 .4 . Our US and China economists anticipate a firm acceleration from 2013 into 2014. helping Europe absorb some of the effects of predicted Fed tapering.6 -0.5 1 .5 2 .0 1 2 .0 % of GDP 'Fiscal Stance' (change in the structural primary budget balance) Positive numbers are a tightening of the fiscal stance Stocks Government GDP Euroarea: GDP growth and contribution to GDP growth (pp) Forecast Q1-12 Q2-12 Q3-12 Q4-12 Q1-13 Q2-13 Q3-13 Q4-13 0. Figure 2: GDP growth forecast in H2 2013 Net trade Investment Private consumption 0. Economic growth will help reduce fiscal deficits and assist economic adjustment.1 . current forecasts for 2013-14) Forecasts Previous forecasts for 2013-2014 2003 2005 2007 2009 2011 2013 Source: Haver Analytics.3 .9 N e t tra d e In d u s t r ia l p r o d u c t io n U n e m p lo y m e n t r a t e .0 Source: Haver Analytics.1 0 .5 0. DB Research Figure 4: Macro-economic activity & inflation forecasts: Euroarea Q 1F .1 .2 2014F % yoy 1 .5 1 .6 .6 0. As exports gain traction.7 3 .4 1 .2 0.0 -1.1 .0 .0 0 .7% to 4.5 .2 0 .4 1 .0 .0 .4 1 .1 3 .7 4 .0 .0 .6 1 2 .3 0 .0 4 .3 1 2 . s a a r ) GDP P riv a te c o n su m p tio n In v e s t m e n t G ov Exp Im p Con ’t c o n s u m p t i o n o rts o rts t r i b u t i o n (p p ): S t o c k s 2013 Q 2F 0 . Germany’s KfW is increasing its lending to banks in the periphery.0 .4 1 .2 -0.4 .9 1 2 . P ro d u c tiv it y Source: National authorities.2 .4 -0.5 1.1 0 .6 . Prospects for a specific ABS support policy from the ECB have faded also.3 0 .7 times) will likely require a flow of bank credit.6 1 . although Page 16 full normalization of the multiplier (the IMF last autumn estimated that the multiplier might be as high as 1.2 1 2 . DB Research Slowing austerity may not in and of itself create recovery but alongside other factors it ought to play a role.2 1 2 . investment spending and domestic demand should get a lift.8 Q 4F 1 .9 5 .6 .3 1 .4 .4 0 .0 .4 2 .6 1 .2 1 .7 .8 0 .6% in 2013 and +1. . The corporate sector is now a modest net lender.0 .4 1 2 . Ireland and Greece).1 0 .5 1 . Over the remainder of 2013.0 -2.9 .8 4 .3 1 .0 1.7 0 . Real global GDP growth excluding the euro area is expected to accelerate from 3.0 Q 1F 1 .4 4 .5 1 .3 4 .4 1 1 .4 2 .5 1 .9 .0 .1 1 .7 2 .0 .4 .9 .7 4 .0 . % P r i c e s & w a g e s (% y o y ) H IC P C o re in fla tio n P ro d u c e r p ric e s C o m p e n sa tio n p e r e m p l. Rising financial markets and economic confidence should also help reduce the fiscal multiplier.8 -1. we anticipate a return to positive economic growth.0 .0 .7 2 . Helping the euro area back into positive GDP will be exports.1 . Portugal.5 1 .1 1 .1 Fiscal stance (incl.1 0 .0 .1 .6 .2 0 .6 1 .8 1 .3 0 .2 0 .0 .2 0 .5 0 .0 1 . 0.1 0 .0 . This may be small in absolute size (quarterly GDP growth rates of c.1 .4 2 .8 5 . DB Research We see the potential for politics to add volatility to this picture in 2014. DB Research Natural change in public debt* (lhs) A bsolute natural increase in debt in 2013 (rhs) % of GDP % of GDP 14 4. The bail-in of depositors in Cyprus reveals a new preference by Europe.3m rolling (lhs) Private domestic demand (rhs) pp of GDP. The PMI inventoryto-orders ratio is the lowest since the return to recession. The effects may be less pervasive in 2014. Certain issues are more positive than generally perceived. If public debt is high and the overlap between domestic taxpayers and holders of large deposits and bank paper is low. Most European banks are expected to be Basel III compliant this year. This is unlikely to provide the comprehensive backstop initially expected. How constrained this backstop will be ought to be clearer at the end of June when the draft mechanism is published. but the uncertain outcome of the AQR/EBA events could undermine bank willingness to extend credit for the time being as well as potentially undermine deposit stability if a fear of harsh treatment a la Cyprus sets in. but the common oversight won’t be complemented with common recapitalization and resolution capabilities until the Single Resolution Mechanism (SRM) is implemented later. Figure 5: Credit impulse supports demand recovery 6 4 2 0 -2 -4 -6 -8 -2 -4 Credit impulse . for example. Figure 6: Public debt stabilization challenge increasing -6 -10 -8 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Haver Analytics. The 2012 EBA stress test arguably cost the euro area economy dearly as banks sought to satisfy high capital requirements via deleveraging. The results of the AQR/EBA stress test will have to be borne nationally. The effects are also set to be concentrated in the still economically fragile periphery. but the fact is Paris has already set its course for reform. the main event over the next year will be the finalization of the bank asset quality review (AQR) by the ECB next spring en route to the ECB becoming the single supervisory for euro area banks in mid-2014. French President Hollande may have assailed the European commission for making prescriptive reform recommendations to France.0 3. The European banking system has come quite some way in satisfying new more demanding capital targets. Nevertheless. This means either bail-out.0 12 10 8 6 4 2 0 -2 Netherlands From a crisis resolution perspective. or bail-in. which potentially undermines financial sector stability (cost of bank Deutsche Bank Securities Inc. Firms have destocked sharply since the lapse back into recession in 2011. The Single Supervisory Mechanism (SSM) is a step towards an improved stability architecture for the euro area. Common recapitalization – still under negotiation – is likely to remain constrained. yoy % yoy 6 4 2 0 funding could rise). The conclusion of the AQR will coincide with a new European Banking Association (EBA) stress test. The ECB Bank Lending Survey reported the first rise in demand for loans for inventories and working capital in Q1 for six quarters. as long as there are minimal spillover costs for the stability of the euro area banking system. and vice versa. but a similar dynamic could play out and restrain what will only be at best a nascent economic recovery. risking a re-ignition of the sovereign/banks negative feedback loop.change relative to 6months ago Source: Haver Analytics.0 2. Moreover. demand for credit remains low.5 3. a recent opinion poll found three quarters of French want Hollande to press ahead with reforms and are willing to make personal sacrifices for their Page 17 Greece Spain Italy France .5 0. an inventory rebuild it likely to kick in. Portugal Belgium Ireland Finland Germany Note: (Excess of debt -stabilizing primary deficit over actual primary balance) .20 June 2013 World Outlook: Fed Policy Tapers Global Markets Bank liquidity has improved because of the impact of OMT on markets (Cyprus was not a source of much or lasting disruption). a bail-in may be favoured.5 2. The intention is to use the implementation of the common bank supervisor to flush out once-and-for all legacy bank losses and avoid bank ‘zombification’.0 0. which potentially stresses the sovereign. Once businesses are more convinced of economic recovery. The inventory cycle may be supportive of the initial growth phase.0 1.5 1. while standards on loans are easing. The good news is that this does not stop the credit impulse (second derivative of credit) from signaling support for a pick-up in domestic demand in H2 2013. by a cap on ESM involvement. There is no obvious sign of a recovery in bank credit origination yet. the evolution of the economy is rotating from last year’s baseline scenario for the recapitalized banks to the adverse scenario. there is an outside risk that the country could be forced to tap the European credit line again. the politics of which is testy as we have seen in each of the bail-outs to date. The Greek recovery story would be enhanced if the same logic sees Germany support Official Sector Involvement (OSI) in 2014. Banks remain Spain’s Achilles Heel. The centre-right appears to have a significant lead in opinion polls but is unlikely to obtain an outright majority in the upper house. Page 18 Deutsche Bank Securities Inc. Miscalculations by the centre-left PD party in the presidential election ushered in a broad but fragile coalition. with the growing appetite for bail-in. DB Research In the nearer term. The outcome of an election remains highly uncertain. The sizeable wealth position of the Italian household sector can sustain government issuance. but relative to six months ago. If the market . Italy has deteriorated the most.20 June 2013 World Outlook: Fed Policy Tapers Global Markets attainment. This raises the risk of a more staunchly anti-austerity. Our concern is political stability in the periphery is not assured. The degree of protection from OMT might also be questioned. In the absence of structural reforms. the stability of the Italian government depends on a fragmented PD party. Draghi has been reminding markets recently that the OMT backstop rate is high. Germany’s use of the public bank KfW to provide credit support to SMEs in the periphery is a sign of how this direct.2% of GDP this year. There is a risk that OMT has already created moral hazard. It is thus unlikely to generate a sustainable positive growth impulse in and of itself. anti-reform government being elected against a back drop of a deteriorating fiscal position. there continues to be remarkable stability across the crisis states given the extremely high unemployment rates — the European Parliament elections in mid-2014 will test the stability of ruling parties and coalitions — but the political picture in Italy does concern us. the second highest after Greece. Italian gross public debt is already anticipated to be 132. the 5SM is still likely to capture a significant portion of votes. . Quiet markets and an evolving attitude in Brussels permitted an easing in austerity. Weakening growth and a rising deficit have swamped the decline in funding costs. Chances are Italy will return to the polls in mid-2014 against the backdrop of still weak growth. Hence. while the path to structural reforms seems all but blocked by a misleading narrative of the crisis that fails to clearly pinpoint the underlying causes of the decade long-disappointing growth. the limited room for manoeuvre created by this has been consumed by tax cuts on unproductive factors of production. Moreover. Unfortunately. former PM Berlusconi’s legal issues and each party’s judgment on whether they can win the majority premium in the lower house. From one perspective. our worry is that it won’t be self-financing. Bank of Spain efforts to prevent ’ever-greening’ alone could cost the banks a further EUR10bn. However. OMT intervention is conditional on an ESM programme being agreed. The conditions may not be as favourable as they were last year. Figure 7: Policy credibility is seeing an endogenous reduction in banks’ reliance on ECB liquidity but the ECB retains an easing bias 3500 EUR bln Eurosystem balance sheet 3000 2500 2000 1500 Draghi's "whatever it takes" pledge 1000 2007 2008 2009 2010 2011 2012 2013 Source: Haver Analytics. bilateral support for crisis countries is seen to yield a political dividend ahead of the 22 September German federal elections rather than a political cost. which are closely monitoring banking developments in Spain. perhaps higher that the market pricing. but not without a cost of misallocated capital and weakening mediumterm growth prospects. we estimate that potential growth would hover around 1% in France and Spain but tend to zero in Italy.need more reassurance and start questioning the “Wyman exercise”. The key to staying off an upward-sloping public debt trajectory is minimizing financing further aid for banking.and the European partners and the IMF. Italy might not be much different to the average in terms of the ‘natural increase in debt’ (the excess of the debt-stabilising primary balance over the actual primary balance) in 2013. indicates the sensitivity to Fed tapering. The generally higher number of smaller parties in this election may in the end mean the only viable option is a grand coalition of CDU and SPD — a re-launch of the 2005-2009 political setting.5 0 1 . (3) Spanish banks – and the Spanish economy and sovereign – remain exposed to a too timid recapitalization.5 0 0 .4 . The CDU will come out as the strongest party but might have to search for a new coalition partner as the Liberals will have to fight to remain in the parliament (threshold of 5% of votes required).0 . Some peripherals will be more directly exposed to the US demand than others – and those peripherals improving their competitiveness will benefit relatively more (Spain. A majority of Germans consider Merkel the better person to handle the euro crisis. Arguably peripheral yields had proven insensitive to the materialization of risks. The recent sell-off in euro government bonds. (2) Italy is far too large an economy and bond market for the rest of the euro area to remain immune to political risk.2 1 1 .6 4 1 .8 1 .4 . E U R b n T r a d e b a la n c e .5 0 1 .8 5 2012 3 . her social democrat challenger.2 1 2 6 . financing rates for Spain and Italy remain comfortably below 5%. In that sense. Some adjustment was overdue. is trailing behind.7 . % o f G D P P u b lic d e b t .5 0 0 .8 1 1 0 .2 . Portugal.3 . the heavy-handed treatment of Cyprus and some backtracking on banking union. Third. % o f G D P F in a n c i a l f o r e c a st s O f f ic ia l 3M ra te 1 0 Y y ie ld USD p er E UR JP Y p er E UR G BP p er E UR Source: DB Research.7 8 1 .7 0 . well below mid-2012 levels and levels that leave public finances sustainable.1 8 133 0 . While the ideas of the SPD in her election platform – such as higher taxes for better-offs and a wealth tax – might be hard to swallow for conservatives. Europe’s growth prospects improve as the probability of tapering grows.2 6 129 0 . as of June 20 Source: Haver Analytics.2 1 2 . the OMT backstop remains in place.0 4.0 7. The polls so far show a close race with neither party camp – the ruling coalition of CDU/CSU and FDP or the opposition of SPD and Greens – able to achieve the majority of seats in the parliament.9 1 1 5 . % o f G D P C u rr e n t a c c o u n t .5 3.5 5 1 .2 0 132 0 .5 0 0 . % y o y e o p F isc a l b a la n c e . Second.1 5 . stricter banking regulation is a joint request.5 0 0 .5 6.7 9 3 .5 1 . tapering will only proceed in the context of a robust enough US economic recovery. There are reasons for Europe and the ECB to be relatively relaxed about tapering.3 1 . First. But even with the sell-off.6 12M 0 .6 6M 0 . The wide difference in personal popularity scores is behind the different campaign approach where the SPD has just presented a team of experts around Steinbrueck while the CDU/CSU appear to build their entire campaign squarely on Chancellor Merkel’s popularity.8 5 2014F 1 . % o f G D P T r a d e b a la n c e . the period of waiting for the Court’s judgment coincides with the lead up to tapering. in our view. It is possible that OMT uncertainties weaken the euro area’s perceived sovereign backstop temporarily. 10Y sovereign yields among the main crisis sovereigns remain below the level at the time of the last WO in late March.3 2 129 0 . The newly established euro-sceptic party AfD which has received a lot of media coverage recently scores at around 2-3% in the polls and most observers do not expect them to enter the parliament.4 . Chancellor Merkel continues to score high in terms of popularity while Peer Steinbrueck.5 7.0 3.2 8 9 . E U R b n C u rr e n t a c c o u n t .0 . By and large.5 4.1 C u rre n t 0 . it has no direct authority over the ECB in any case.8 4 Impact of Fed tapering on Euro area and ECB OMT continues to exert a strong influence on sovereign yields.5 5. in particular the periphery. should it materialize. We doubt the German Constitutional Court will interfere. However.0 5.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Figure 8: Periphery yields remain low despite recent sell off 8. including the Italian election.0 0 1 .wider spreads in the periphery improve prospects for a returning flow of funds to help normalize financial fragmentation.5 .0 6.3 .0 9 6 .5 9 7 .3 1 5 7 .5 0 2 .0 Jan-2012 Spain 10Y sovereign yields Italy 10Y sovereign yields May-2012 Sep-2012 Jan-2013 May-2013 % than expected external demand and/or continuing domestic deleveraging.7 5 1 . Euro-area risks The main risks to the euro area are: (1) economic growth does not materialize in H2 2013 due to weaker Deutsche Bank Securities Inc.2 .bear in mind that tapering should also raise the dollar and weaken the euro .5 1 .2 3M 0 . Page 19 .8 6 2013F 2 . Ireland). 2013.3 0 . raising the debt stabilization challenge further. DB Research 2011 1 . German election: no shift in euro policy Germany is facing federal elections on Sept 22. in a world in which growth is not getting any worse . Figure 9: Other indicators & financial forecasts: Euroarea M 3 g ro w t h .0 1 .1 1 5 5 . 0 .9 1 .6 4 .0 1 . P ro d u c t iv it y Source: National authorities.8 1 .7 1 .4 3 . .2 .8 2 .9 1 .5 1 .0 2 .0 7 . given our long held forecast of accelerating global GDP growth. though.3 1 .4 1 .4 Q 4F 1 .7 .9 1 .0 . as he set out in a speech at the end of last year entitled.0 1 . With employment expected to see an only temporary dent in H2.0 .1 0 .0 .5 1 .8 2 .4 1 .6 4 .6 1 .8 1 .0 4 .9 3 .2 8 .3 0 .2 3 . % P r i c e s & w a g e s (% y o y ) CP I P ro d u c e r p ric e s C o m p e n sa t io n p e r e m p l.4 1 .4 2 .0 .2 4 .9 1 . so that both components will contribute to next year’s 1.5 2 .9 0 . and the least four of the other eight members would need to agree with him if guidance were to be implemented.7 . More generally speaking.1 0 . With capacity utilization below its long term average the subdued export outlook is weighting on investment spending. public opinion and the Constitutional Court as major veto players will restrain the (euro-) policy of any new government.3%).9 .0 . especially since the global economy is still not offering much support.8 1 .0 .8 1 .5% growth.0 .6 .6 7 .0 1 . Nevertheless. Figure 10: Macro-economic activity & inflation forecasts: UK E c o n o m ic a c t iv it y (% q o q .2 4 .2 1 .3 0 .3 0 . CDU and SPD clash over details such as the transparency of rescue costs but in substance both the current chancellor and her challenger agree on the euro policy course .0 3 . The main reasons for doing so are the below-forecast Q1 GDP reading (0.4 . the Bank has been commissioned by the government to at least think about the issues of using guidance.9 2 .2 .4 2 .4 7 . “Guidance”.1 1 .0 2 .4 4 .1 1 .3 .0 . the SPD favors a pan-European resolution fund whereas the ruling coalition prefers a network of national funds. Private consumption will therefore be the mainstay of growth in 2013.9 Q 3F 1 .6 2 .7 1 .0 1 . and to this end the Committee will be publishing a paper in August which will most probably outline the pros and cons of using such policy.8 1 .0 0 .4 Page 20 Deutsche Bank Securities Inc.5 0 . net-exports did not contribute to growth.4 1 . however.4 8 .4 1 . we have slightly reduced our estimate to 0.6 4 .4 1 . UK: BoE readies for the Carney era What is the ‘Carney trade’? This is the question that we have been hearing most over recent weeks with the previous Bank of Canada Governor due to take up the reins at the Bank of England from the start of July.1% qoq) and the downward revision for Q4 and the 2012 profile. Will he use it again at the Bank of England? We think no.5 .all relevant decisions on euro area issues have seen crossparty parliamentary approval.0 .4 .8 1 .4 2 . wages increasing at a 3% clip and low inflation private consumption should expand by around 1% in 2013 and 2014. although the 0. there will be no fundamental shift in German policy towards euro area policy.7 2013 Q 2F 1 . which additionally depressed the starting level for 2013.1 .9 1 .0 .3 0 . simply.8% qoq rise in Q1 has to be seen in connection with the 0. where the opposition currently holds the majority.5 1 .0 0 .0 . which we expect to decline by another 3% in 2013.1 1 . But even with a new government.9 Q 1F 2 .4 .7 Q 4F 1 .3 0 .0 1 .1 .6 7 .0 0 .7 3 .2 4 . It is worth remembering that Mr Carney represents just one voice on the MPC.5 2 .2 2 .2 0 .8 2 .2 0 .1 0 .8 7 .9 2 .0 0 .2 7 .0 .6 0 .7 1 .1 0 .7 0 .4 2 .1 .4 1 .2 0 .2 . German economy: Moderate recovery Even though our forecast for German GDP growth in 2013 has hugged the lower end of the consensus range for quite a while.9 2 .4 1 .1 .1 .2 1 .4 1 . Still.2 1 . the upper chamber.3% decline in the preceding quarter.0 0 .9 2014 Q 2F 2 .8 2 .75%.9 1 .3 0 .7 2014F % yoy 1 . In spite of a weather-related catch-up effect in Q2 we look for a rather moderate recovery in the course of the year.0 . s a a r ) GDP P riv a t e c o n su m p t io n In v e s t m e n t G o v 't c o n su m p t io n E x p orts Im p o r t s D o m e st ic d e m a n d C o n t r i b u t i o n (p p ): S t o c k s N e t tra d e In d u s t r i a l p r o d u c t i o n U n e m p loy m e n t ra te .2 .6 Q 3F 1 .1 .6 4 .4 1 .0 .0 2012 % y oy 0 .3 . Moreover.8 3 .1% (from 0.8 0 .0 . While there are signs of foreign orders bottoming out.20 June 2013 World Outlook: Fed Policy Tapers Global Markets The legislation on a modified narrow banking system in Germany has just been adopted by parliament as well as the Bundesrat.7 0 .0 .1 .2 0 . ifo export expectations have fallen below their long term average during the last three months.5 1 . In terms of banking union.0 1 .4 .7 0 .3 .6 7 .4 .2 7 . under his stewardship the BoC actively pursued a policy of pre-commitment between the spring of 2009 and mid-2010.1 1 .0 2013F % y oy 1 . Mr Carney’s willingness to consider the use of monetary policy pre-commitments are well known.6 7 .0 .8 1 . Indeed.4 0 .0 2 . prompting us to cut our export growth forecast to 0. it appears that a number of Committee members are dubious about the merits of pre-commitments (as are we).7 1 .0 . In the first quarter exports and imports continued their decline.9 1 .1 1 .0 1 .2 1 . DB Research Q 1F 1 .4 0 .2 1 .6 1 .5 .5 1 . German export and derived from that investment momentum should pick up in the coming quarters.7 2 .0 2 .0 .2 3 .5 .1 0 .1 0 .3 0 . the latest central bank forecasts show that the Executive Board now sees a 50-50 chance of a 25bp easing between the end of this year and mid-2014.50 0. inflation has surprised on the upside over the past two months relative to Norges Bank expectations and the currency has fallen by almost 4% since February. we would not expect the MPC under Mark Carney’s Governorship to delay further easing in the event of another growth slowdown.9 -6. While we retain our view that Norges Bank will not ease policy going forward. On account of this.4 Current 0. which would require an open letter from Mr Carney to the Chancellor). South Africa. Figure 11: Other indicators & financial forecasts: UK M4 growth.5 -6.51 2. we have left unchanged our forecast of 1.7 1. A number of countries in the region would be vulnerable to a further pullback in these flows.41 0. It is not only GDP that looks set to surprise on the upside in the near-term. Still.2 -57.) looks unlikely if the recovery in activity we are seeing proves durable. would be consistent with no further easing of monetary policy (that includes guidance). Moreover. some of the economic news has taken a turn for the better and in our view suggest against further support. further easing (whether it be pre-commitments. in our view.7 -2. we now expect no change in policy rates for the coming year. GBP bn Current account. clearer signs are emerging that it will fall meaningfully from the second half of the year: lower upstream prices and a sharp fall in the British Retail Consortium’s measure of shop price inflation all point to lower CPI inflation looking ahead.50 0.85 12M 0.6 -6. Mainland economic growth in Norway maintained a decent rate in the first quarter of around 2. GBP bn Trade balance. An improving global growth backdrop should also contribute to a recovery in exports.9 -105.3 -20.50 0.3% to its target rate of 2% next year. Deutsche Bank Securities Inc. Related to the buoyant consumer. EMEA: Some vulnerability to tapering Expectations of Fed tapering have precipitated a withdrawal from emerging asset markets over the last few weeks.7 -45. looks less likely to be an impediment to further monetary easing in the event that the recovery stalls. and the central bank's latest forecasts/statement.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Perhaps more pertinent to the current conjecture.60 2.0 -100. we have revised down our view on inflation from 3% to 2. we remain less convinced of this argument given the economic backdrop.9 -5. % of GDP Current account. raising the prospect of further inflation increases going forward (though that did not stop Norges Bank revising down its forecasts for how long inflation would take to return to target at its June meeting).6 -6.51 2.51 2.86 6M 0. While inflation could rise over the coming two months (possibly even to 3% or above. but only in the event that growth once again disappoints. a combination of a rising unemployment rate.3% qoq in the first quarter and looks set to beat that in Q2 with the PMI surveys pointing towards continued improvement. The economy expanded at a rate of 0.8 -2. weaker retail sales around the turn of the last quarter and weaker evidence on future growth expectations from the central bank's regional network survey should help prevent policy from being tightened any time soon. and capacity utilisation is broadly around its average over the past 15 years.1 -1.2 -106.3 -6.5% to just over 1% thanks to the stronger Q1 figure and what is shaping up to be decent growth in the current quarter. as of June 20 At the same time.3 -40. % of GDP Financial forecasts Official 3M rate 10Y yield USD per GBP GBP per EUR Source: DB Research. Since then. Inflation.50 1. Turkey and Ukraine.8% for next year. therefore. however.5 -3. Norway: Dovish central bank despite recovery At the beginning of the year there had been some suggestion that Norway's central bank could ease policy.85 3M 0. Assuming he is able to convince the rest of the Committee. look especially exposed on this front given the scale of their current Page 21 2011 2012 2013F 2014F -1. This combination.25 1. And the weakening in the financial markets over recent days suggests that this is not beyond the realms of possibility. more QE etc. That all said.3 -105. . driven by the strongest rise in consumer spending since the end of 2010.3 -3.55 0. the housing market is showing signs of life again and money supply held by households and non-financial firms continues to grow apace. However.0 -7. with higher rates now a more distant prospect.84 In this World Outlook we have revised up our view on UK growth this year from 0. The relationship between growth and inflation is set to improve too. Thus the ‘Carney trade’ in our view is that the new Governor appears willing to expand the array of unconventional policies available to the MPC. % of GDP. the central bank remains concerned about the pace of growth of household borrowing with house prices continuing to rise apace (6% in the year to Q1). % Fiscal balance.5 4.6% this year and from 2. lower interest rates.27 1.47 0.55 0. which represent a sizable portion of GDP in Norway.80 1. That said we remain optimistic about the UK economy. manufacturing output growth has been negative during only one of the last six months. FY Trade balance.50 0. On the output side the PMI survey has risen back above 50 to a 12-month high.5 -6. Confidence (both consumer and business) has turned up.75% annualised. is more welcome given elevated inflation and the need to build credibility in these areas. Western European banks have been gradually reducing their exposures to Central and South Eastern Europe.5 2. both domestic and foreign. This process is close to completion and unlikely accelerate further in response to rising US rates. there is little immediate pressure to hike rates: we still expect further moderate easing in Hungary.0 2005 2006 2007 2008 2009 2010 2011 2012 Source: Haver Analytics. In South Africa. But even here. Russia is less directly exposed than others in the region to the end of Fed asset purchases. Figure 13: Portfolio flows to EMEA 4. though the starting point is a benign one given the weakness of domestic demand in the region and relatively soft commodity prices. Having attracted fewer inflows. especially in debt securities (Figure 13). Recent currency moves seem to reflect this.1%. Elsewhere.5 1.0 0. % of GDP) Debt -8 Deutsche Bank Securities Inc. notably ongoing protests and political uncertainty in Turkey and labour market unrest in South Africa. foreign private creditors owned almost half of government debt in Hungary and Poland. though South Africa will probably need to keep rates on hold given the scale of recent rand depreciation. where credit to the private sector has grown rapidly and has been partially (about one-third) foreign-funded.0 1. and Russia. largely on the grounds that most emerging markets in the region have been levering down rather than levering up in recent years. depreciating more in countries that have received the largest short-term inflows over the last year or so.5 0. the level of private debt is still quite low at 47% of GDP compared with an average of about 90% of GDP in other major emerging markets. The decision to leave monetary and fiscal stances more or less unchanged. While aggregate capital flows to the region are quite modest (well below the peaks reached prior to the global financial crisis and in 2010).20 June 2013 World Outlook: Fed Policy Tapers Global Markets account deficits and reliance on short-term flows to finance them (Figure 12). the economy should start to benefit from the weaker rand although gains in competitiveness could yet be eroded by high wage settlements. Israel. and infrastructure bottlenecks. The end game for the protests in Turkey remains unclear at this stage. accordingly. however. Growth is nevertheless weak: output has been expanding at an annual rate of only 1.5 -1. The sell-off in this region has been exacerbated in some cases by idiosyncratic factors. political uncertainty has increased and this will weigh on investor confidence. The government is contemplating how best to stimulate activity.5 3. Turkey has already tightened domestic liquidity in response to recent market Page 22 TAI CHN HUN RUS KOR PHL ISR CZE COL THA BRZ CHL IDN POL EGY MEX ROM IND UKR TUR ZAF Equity Poland. DB Research But even countries in the region with stronger external positions have been buffeted by the recent reversal in foreign appetite for EM assets. This is undoubtedly disappointing as far as the structural reform agenda goes. European Economics London: (44) 20 7545 2087/88 Frankfurt: (49)69 910 31790 EMEA: (44) 20 7547 1930 Source: Haver Analytics.3% over the last two quarters. The one possible exception in the region is Turkey. But at the very least.0 3. Turkey (four quarter sum. and over 30% in South Africa and Turkey. especially in the power sector. . DB Research This will add to inflationary pressures. for the next several months.0 2. By the end of last year.0 -0. Figure 12: Basic balance in EM 10 8 6 4 2 0 -2 -4 -6 The basic balance is the sum of the current account balance and net foreign direct investment % of GDP volatility and could push rates higher still in the event of sustained pressure on the lira. Few concrete measures have so far been agreed. South A frica. We are less worried about the impact of rising US rates on private credit extension. Poland. strikes. revised down our forecast for growth this year to 4. We have. there has been a marked shift in the composition of flows towards portfolio investments. The moderately softer oil prices that we now envisage will also weigh a little further on fiscal and external balances. which holds the key to generating more investment and higher growth. 4 1 .6 0 .9 . Q2 2013 is likely to be the quarter with the strongest upward momentum in activity.8 0 .1 5 .1 .8 0 .9 4 . but not trigger another recession.3 2 .7 0 .0 1 .0 .0 .3 Q 3F 2 .4 0 .1 0 .1 .7 3 .1 .1 . thanks to JPY depreciation. leading to a larger buffer to finance the fiscal deficit by private savings.9 1 .3 2 .3 4 .8 1 .2 4 .4 0 .0 . and 5% M2 growth. We think the following combination summarizes Japan’s new steady state over the next 3-5 years: 2% nominal GDP growth.0 1 0 .5 .1 3 .0 .9 4 .0 .0 .2 1 . 3) Higher conviction in medium-term economic prospect leading to recovery in capital investment [beyond 18-month horizon].0 1 .1 1 .3 1 . which is more important than reaching 2% inflation. DB Research Deutsche Bank Securities Inc. 2) From earnings recovery to wage growth [12-18 month horizon].4 1 .1 0 . mineral fuel imports Source: MoF.2 0 .6 0 .3 1 .0 Q 1F 4 . We think Abenomics has three stages of transmission channels: 1) JPY depreciation (recovery in exports and corporate earnings) and wealth effects (on consumption) [6month horizon].0 . s a a r ) GDP P riv a te c o n su m p tio n In v e s t m e n t G o v ’t c o n s u m p t i o n E x p orts Im p o r t s C o n t r i b u t i o n (p p ): P riv a te in v e n to ry N e t tra d e In d u s t r i a l p r o d u c t i o n U n e m p lo y m e n t ra te . Figure 3: Macro-economic activity & inflation forecasts E c o n om ic a c tiv ity (% q o q .1 1 .8 4 .0 .8 0 .5 2013F % yoy 2 .8 0 .0 1 .3 0 .1 Source: Ministry of Economy.4 0 .1 .9 1 .3 5 .1 Q 4F 1 .6 4 . % P r i c e s & w a g e s (% y o y ) CPI C ore CP I P ro d u c e r p ric e s C om p e n sa tion p e r e m p l.2 4 .0 .0 .2 .0% real GDP growth.4 1 3 .1 1 . Process more important than outcome Japan has been given a chance to grow faster and for longer without being interrupted by impatient monetary tightening.5 1 .9 2 .0 .2 0 .5 0 .2 2 . because it is in this process where beneficial effects on activity and financial markets flourish.3 .8 9 .6 .6 3 .2 0 .3 4 .0 2 .7 .2 2013 Q 2F 4 .1 0 . When nominal GDP growth exceeds long-term interest rates.4 0 .7 0 .1 4 .8 0 .1 4 .1 Q 1F 3 . The VAT hike in April 2014 should temporarily halt growth in 2014.7 5 .5 1 .2 0 .0 .0 .5 2 .6 9 .5 2 .6 0 .8 0 .0 Source: National authorities.3 Q 4F 1 .4 0 . 1% 10-year JGB yield. P rod u c tiv ity .9 3 .4 1 .8 .0 .4 2 .0 0 .0 2 .4 3 .0 .0 2 .8 8 . wealth effect and global growth. Figure 1: Leading index of the business cycle 115 110 105 100 95 90 85 80 75 70 1995 DB leading index Industrial production 1998 2001 2004 2007 2010 2013 Index Abenomics and transmission channels Our leading index of the business cycle has turned upward after its trough in July 2012.9 2 .5 1 3 .1 8 .0 2 .9 3 .3 .0 .6 2 .2 4 .8 .4 .2 .9 2 .6 0 .2 1 .0 .0 .4 6 .6 1 .8 .0 .0 .6 .5 .6 1 .0 5 .1 5 . JPY depreciation expands the current account surplus.9 5 .9 0 . DB Research Figure 2: Merchandise trade balance 3500 3000 2500 2000 1500 1000 500 0 -500 -1000 -1500 2000 2002 2004 2006 2008 2010 2012 Merchandise trade balance Merchandise trade balance excl.5 1 .0 2 .4 2012 % y oy 1 . Page 23 .3 1 .0 .0 .1 4 .2 8 .0 4 .3 1 .7 2 .8 8 . 1) government debt stability is facilitated and 2) a virtuous circle between economic activity and financial markets is supported.1 1 .2 2 .9 9 .0 .0 1 .7 1 6 .8 4 .6 6 .1 Q 3F 2 .9 4 .4 . sa 2014 Q 2F .20 June 2013 World Outlook: Fed Policy Tapers Global Markets Japan: Recovery has started in Q1 2013 Economic expansion is likely to continue through Q1 2014 with 3.2 0 .9 3 .1 .6 5 .2 4 .1 6 .0 .9 7 .7 . DB Research JPY bln.3 0 .9 4 .2 0 .3 .4 4 .8 4 . Trade and Industry.1 .0 .3 4 .0 1 0 .0 . 1% CPI inflation.5 0 .8 .3 .0 2014F % yoy 0 .8 8 .6 .1 0 .1 9 .8 2 .6 . 5 -7.6 -9. USD b n Cu rren t accou n t.5 220. (81) 3 5156 6768 Page 24 Deutsche Bank Securities Inc. Factors behind recent rise in JGB yield 1) Correction to a structurally too pessimistic assessment of Japan by domestic fixed income investors.7 103. wages. Risks The VAT hike in April 2014 could induce a larger dislocation of demand.30 0. Across-the-board cut in the corporate tax rate seems off the agenda until 2015. as of June 20 Source: Cabinet Office. 2011 2.4 12M 0.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Monetary policy: Heading for uncharted territory The new strategy of the BoJ is to 1) set monetary base as instrument and target JPY60-70trn expansion a year.0 Cu rren t 0. given low capacity utilization and lack of confidence in medium-term prospects. Figure 5 : Capital investment.0 1. DB Research Figure 6 : Acceleration in monetary base expansion 160 140 120 100 80 60 40 20 0 2000 JPY trn. DB Research Mikihiro Matsuoka.0 0. medical services. Economic growth strategy Growth strategy consists of 1) deregulation.5 -2.5 0. sa Total reserves Monetary base 2002 2004 2006 2008 2010 2012 Source: BoJ.1 3M 0. Ministry of Internal Affairs and Communication.00 110 132 2014F 4. triggering a recession. 2) purchasing securitized bank loans. Deregulation in the labor market. and 3) introduction of ‘level’ targeting on nominal GDP or prices.7 1. 3) repeal the ‘banknote rule’ and 4) reach 2% inflation in two years.0 2.7 -9. R&D have been introduced in the FY2013 budget but may not work as designed.80 113 133 Figure 4 :Other indicators & financial forecasts M 2 g rowth .1 63.5 -80.5 JPY depreciation may not continue given creditor country status and lower inflation in Japan. and 3) participation in free trade agreements.08 0. % of G DP Cu rren t accou n t.0 212.4 229. 3) tendency that long-term rates rise under higher stock prices. 4) a rise in US long-term rates.7 58. % of GDP Fin an cial forecasts Official 3M rate 10Y y ield J P Y p er USD J P Y p er E UR Source: DB Research.8 -1.08 0. elderly care services and support for start-up companies is considered a priority.4 -0.4 119. % of G DP Trad e b alan ce. % of G DP P u b lic d eb t.30 1. fresh food (rhs) % balance % yoy 2.4 -21. weaker yen and stable global conditions.1 -1. cash flow. depreciation 22 20 18 16 14 12 10 8 6 4 2 0 1972 1977 1982 1987 1992 Depreciation Cash flow Capital investment 1997 2002 2007 2012 JPY trn Source: MoF.23 0.90 102 129 2013F 3. 2) better medium-term prospect for the Japanese economy.5 -1.2 6M 0.0 -1.86 98 129 2012 2. USD b n Trad e b alan ce.30 0.5 -31. % Fiscal b alan ce.0 -0.3 226.0 -2. We think the next easing actions will be announced in October with a new semiannual outlook report.0 -67. Tax incentives for employment.5 2. Options include 1) continued expansion in monetary base in 2015-16. but some measures may be dropped due to strong opposition.5 1. agriculture. 2) purchase longer-maturity JGBs (gross purchases of JPY80-85trn a year). . DB Research Figure 7 : Price judgment by households 90 80 70 60 50 40 30 20 10 0 -10 2004 2006 2008 2010 2012 Price judgment diffusion index (lhs) CPI inflation excl. Deregulation is a compendium of microeconomic measures whose effects take time to materialize and are difficult to measure.3 -0.10 0.08 0. 2) corporate tax cuts.3 2.0 1.5 -9. Figure 2: Electronics exports from North and Southeast Asia 80 % yoy. But whereas the North Asian economies have reported an increase in growth in electronics exports recently. especially in India where another three rate cuts are likely. our expectation of continued sequential growth in exports in Q1 has been reversed.3 pp to 7.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Asia (ex Japan): A slightly delayed recovery After a slightly disappointing start to the year. leading to weaker currencies. Singapore. Inflation has proved much more benign than expected. Diverging North/South performance? Electronics exports from North Asia and those from Southeast Asia have diverged recently. growth has been a little disappointing only partly due to exports coming in a little lower than expected. Source: CEIC. As we reiterated last quarter. helping to turn growth around. Malaysia. We still expect growth to rise sharply – to 8. this reflects the fact that after the postcrisis recovery that saw US&EU GDP growth averaging about 2. With the exception of the Philippines – whose GDP growth rate in 2013 we have raised by 1. Adjusting Chinese export data for the worst of the over-invoicing problem. DB Research We speculate this might reflect a communications (North) versus computers (Southeast) divide that might see Southeast Asia benefit less from the pickup in global growth than North Asia.3pp to 7. but they appear still to be fluctuating within a narrow band.5% and 0.9% respectively). These two components of Chinese exports in recent months appear to have been most biased by over-invoicing of exports Source: CEIC. Higher bond yields have already caused capital flight from Asia. South Korea and Taiwan. -20 -40 2000 2002 2004 2006 2008 2010 2012 In our view. we expect that recovery in Europe and stronger growth in the US will lift Asian export growth much higher.8% next year. Current export growth of 0. So. (2) exports to HK scaled down since mid-2012 to a constant multiple to reported HK imports from China. Figure 1: Asian exports (with adjusted Chinese exports) 1200 1100 1000 900 800 700 600 500 400 300 200 2000 2002 2004 2006 2008 2010 2012 USD bln Asia exports (w ith adjusted Chinese exports) 60 40 20 0 Note: Chinese exports are adjusted as follows: (1) exports to bonded warehouses and SEZs are removed. The Indian growth forecast has also been lowered slightly after a weaker-than-expected Q1 GDP report. As it became increasingly apparent that there was significant mis-reporting of Chinese export data in recent months.5% qoq (sa) – compared with pre-crisis yoy growth rates of about 20%. the Philippines. our global growth forecasts still imply a midyear pickup in export and GDP growth in Asia that we think will be stronger than consensus expectations. DB Research. 3mma KR+TWN MY+PH+SG China Overview Our optimism last quarter proved premature.3% during 2009-10 since 2011 growth in these economies combined has averaged only about 1%. However. Electronics account for about one-third of exports from China. exports from Southeast Asia have fallen. Higher short-term interest rates – likely only in 2014 in most economies – may be challenging in economies where debt levels have risen significantly since 2007. since mid-2011 Asian export growth has averaged about 2. Page 25 .0% after a remarkably strong first quarter – growth forecasts for most other economies have been lowered although only for Malaysia and Taiwan were the revisions material (cuts of 0. on balance so far this year.9% this year. a general upward trend to aggregate Asian exports remains.5 %yoy for aggregate Asian exports could be as high as 20% by end-2014 if historical relationships hold and US and EU growth rises as much as we expect it will. The Chinese GDP growth forecast was lowered by 0. Deutsche Bank Securities Inc. In China. Hence.6 5. Vulnerability to rising yields Rising G3 bond yields have caused turmoil in Asian bond markets triggering a selloff that has pushed currencies weaker and yields higher.5 6.2 1. % of GDP 1.0 CA balance. which have been growing 15%.6 Asia ex.1 5.3 6.6% -.2 CPI 6. Haver Analytics.3 4. the impact on currencies has surprised us.7 .Private consumption 7.9 . Figure 3: A leading indicator for China GDP 14 13 12 Forecast 11 10 9 % yoy GDP ex-A g Model current account surpluses have sold off along with deficit country currencies.2 8. then it would imply a much more modest rise in GDP growth. DB Research Figure 5: Deutsche Bank forecasts: Emerging Asia 8 7 6 Sep-08 GDP = 2. But given how rapidly debt/GDP ratios have risen and how high the ratios were to begin with.82 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 (% yoy.3 7. DB Research Source: CEIC.4 6.1 1. Even currencies supported by large Page 26 2012 2013F 2014F 6.5 6.3 3.2 7. unless stated) 2011 Real GDP growth 7.8 3. and in the face of lackluster external demand. Michael Spencer. in fact. the more appropriate measure of credit. this may not be an issue until next year.2 6. and traditional loans.Investment 6. . FX depreciation could lead to a reassessment of inflation.04*G2_Ord(-1) R2 = 0. If recent bond market turmoil is not contained. These rate cuts are likely to be more important in sparking a turnaround in Indian GDP than the recovery in exports.3 1. we think it will eventually turn to the impact of higher yields on domestic borrowing.20 June 2013 World Outlook: Fed Policy Tapers Global Markets China and India Both China and India saw GDP growth come in a little below expectations in Q1 and our growth forecasts have been revised downwards slightly as a result. policy may have been kept too tight in the expectation that growth would pick up more strongly.0 3.1 4.Government consumption 7.1 7..0 4.2 .3 6.1 6.3 4.allowing the RBI to cut rates 75bps already this year. Figure 4: ‘Private sector’ debt in Asia 250 % of GDP 2007 200 2012 150 100 50 0 CH HK SG TW TH MY SK IN ID SRL PH Note: Domestic and external debt of corporate and household sectors (including local governments in China) Source: BIS. As policymakers reassess their framework. Our leading indicator for China – which combines US and EU industrial orders and TSF growth in China. which has been growing 22% yoy.8 3.3 + 0.2 5.9 6. CEIC. the turn in the monetary policy cycle could be particularly challenging. DB Research In India.9% while core inflation is at 2.3 4.Exports 12. With most bank loans set with floating rates anchored to short-term rates.3 7. While we had recognized the vulnerability of some Asian bond markets given the very low yields and heavy weighting on foreign investors.0 Industrial production 9. (852) 2203 8305 Deutsche Bank Securities Inc.6 11. we think they may be leaning towards providing some modest fiscal and/or monetary stimulus.2 11. China and India Real GDP growth CPI Source: CEIC.5 .9 3. it seems that policymakers may have misjudged the importance (to growth and inflation) of “total social financing”. While the focus today is on bond yields and capital flows. leading to earlier-than-expected rate hikes.1 6. inflation has fallen faster than expected – headline WPI inflation is now only 4.8 Growth in most Asian economies is so highly export-sensitive that the main risk to the outlook is that growth in the US and EU falls short of our forecasts.3 7. We think another 75bps of rate cuts is still likely in the second half of the year although perhaps not in the very near-term given market volatility.Imports 13.5 6.7 . But if ordinary loans are. suggests GDP growth should rise in the coming quarters even without fresh stimulus.2*TSF(-2) + 0. Figure 1: Gross capital inflows in Latin America 8 7 6 5 4 3 2 1 0 -1 -2 2004 2005 2006 Source: DB Research Rolling four-quarter sum . based on current trends. Therefore.6pp to 2. and remittances. In addition.8% from 3. particularly in countries like Argentina.4pp to 3.5% originally. the region´s specialization in commodity production amid potential dollar strengthening and recent Chinese weakness did not help. Furthermore. Taking aside the two exceptional cases of Argentina and Venezuela. Although weak growth numbers were reported across the board in the region. and Chile continue to be in the most resilient group. we remain optimistic that the Mexican economy could pick up in line with the US in the 2H2013. including even the strong growth performers of Peru. but yet unlikely to derail a decent economic performance this year.6%. Argentina. Colombia. gloomy data have been widespread. The lack of reform appetite however. Peru. Investment spending. the downward revision looking forward is not homogenous.2pp. Page 27 . particularly hard. appears also to decline in the first quarter of the year. Mexico´s recent progress in the reform front appears as the major regional hope ahead. and Colombia. Deutsche Bank Securities Inc. with the help of stronger public spending. Brazil. Indeed. A positive reform outlook is also expected to cheer up business and consumer confidence in the last quarter of the year.1.5% initially to 2. and we have revised this year regional forecast to 2. and Venezuela are leading the forecast adjustment with around 1pp. Sentiment regarding emerging economies seems to have completely turned around in recent weeks as markets started to price the end of Fed asset purchases. Mexico’s main external partner in trade. where growth expectations were adjusted by only 0. where the recent slowdown is mostly reflecting unsustainable policies. % GDP FDI 2007 2008 Total 2009 2010 2011 2012 Growth has surprised on the downside During the first months of the year. economic activity has been reported weaker than initially expected.9% for this year despite the fact that recent trends point to a faster recovery in the US.0.8%. nonetheless. causing some dislocation in regional FX and rate markets. we have revised downwards growth expectations for this year from 3. In addition. A shift in global asset preferences and rising US rates are threatening past strong capital inflows. remains the main long term risk. foreign direct investment. the poor economic performance of the past few months created further doubts about the region´s ability to cope with such new global backdrop. This created expectations of capital reverting direction from last few years. In contrast to 2012. Chile. This has hit Latin America as the region was one of the major recipients of post QE flows. Brazil. this year’s surprises seem to be more related to external forces losing steam while domestic consumption remaining quite resilient.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Latin America: Tested by shifting flows and strong dollar outlook Economic growth has surprised on the downside. In Mexico we cut growth forecast by 0. Figure 2: Private credit growth since 2007 25 20 15 10 5 0 -5 -10 -15 -20 BRA Source: DB Research % of GDP Change in credit to private sector CHL PER COL MEX A RG Capital flows might turn around. which has remained subdued so far this year reflecting the typical pattern of a transition to a new administration. we have also cut 2014 growth forecasts by 0. and Venezuela. 7 5.1 -3. in our view.4 6.6 24. further challenging the recovery ahead.2 3.7 -0.2 -0.6 4. By contrast.7 3.. u nless stated ) A rgentina GDP CPI CA bal.3 4.4 6.0 -1. % of GDP CA balance.2 6. Peru.. Figure 3: Current account 7 % GDP 2011 2012 2013F 2014F 5 3 1 -1 -3 -5 ARG Source: DB Research BRA CHI COL MEX PER VEN Figure 4: Deutsche Bank forecasts: Latin America (% yoy.4 -0. Brazil.8 26. Brazil is probably the exception among the big economies with relatively low inflation. DB Research GDP GDP GDP GDP GDP GDP GDP 2011 7.1 3.2 -3.9 3.2 1050.1 0. Expansionary fiscal and monetary conditions are expected to facilitate economic rebound this year and next.6 858.Exports.7 3.7 0.Investment .2 26. Meanwhile.4 -3.0 -2.8 4. making it the clear regional highlight.6 -3.9 7.. % of GDP Source: National authorities.9 6.3 8.2 6.1 2.4 -2.. % Source: National authorities. in the order of 5%-7% of GDP. % Brazil GDP CPI CA bal.3 0. likely progress on fiscal and energy reforms later this year could push Mexico on an even faster growth path. published on June 14.1 6. Brazil. where portfolio flows have replaced bank financing but where FDI has remained relatively stable.1 -3.0 4. Weaker exchange rates are likely to improve economic conditions in a region where unit labor costs have been increasing in USD terms for almost a decade.8 Gustavo Cañonero. (1) 212 250 7530 2 “Capital flows to EM: Ample but (mostly) not alarming”.4 1..4 -2. DB Research 2011 4.6 -2.. .6 -2.7 5.9 -2.5 3. This is likely to demand tighter monetary conditions.4 5.9 3.7 6. Countries like Mexico and Chile did receive a sizeable amount of portfolio flows since QE started in the US.4 4.3 6.4 6. without a major need for key reforms.0 5.2 5. consumption-driven growth is reaching its limit as regulatory/interventionist uncertainty prevents investment from a pace necessary for sustainable fast growth.1 6.9 2. Actually short term vulnerabilities in the asset universe have been confirmed by recent price action.9 2.6 1. % M exico GDP CPI CA bal. They did represent a significant change in composition.6 3.7 3.9 3.8 24.9 2.0 966.8 -1.6 2.6 -4.4 2. following prudent fiscal and monetary stances. these are not the countries that showed a concerning increase in domestic credit as a share of GDP in the last few years.6 0. unless stated) Real GDP growth .0 7.6 3. % Peru GDP CPI CA bal.6 -2.Private consumption .9 -3.8 4.8 2.2 1. and Colombia. in that regards.8 2. % Chile GDP CPI CA bal.1 5.9 2.3 6.2 2.2 975.4 -2. Indeed.0 24. Unfortunately there is no sign that the authorities are addressing these structural bottle necks in any definite way. Nevertheless.8 Figure 5: Deutsche Bank Forecasts (% yoy.0 3. macro management is likely to remain “business as usual” in Chile.9 4.2 4.4 -3.1 5.6 3.7 0.0 4.8 -1.9 2012 2013F 2014F 2.4 3. % Fiscal balance.7 27. Page 28 Deutsche Bank Securities Inc. USD bn .20 June 2013 World Outlook: Fed Policy Tapers Global Markets As we discussed in a recent note2. but at the cost of increasing strains in the management of the growthinflation trade off. global inflows have not dramatically changed the fundamental strength of a region that has remained relatively unleveraged. 2013.3 6.6 -2.3 3.0 25.3 8.0 965.5 2. we find recent levels of capital inflows to the region not alarmingly high.3 3.4 -1.1 6. However.Imports. did witness a 15% increase in domestic credit as a share of GDP since 2007 and that could create some vulnerabilities ahead. % Ven ezu ela GDP CPI CA bal.5 -3.4 23.3 -1. there seems to be a strong correlation between past inflows and the magnitude of the recent sell-off.4 1155.4 6.0 892. as inflation is accelerating despite sluggish economic growth. % Colombia GDP CPI CA bal..8 8.3 2012 2013F 2014F 1. In particular since inflation has remained low and there is not a serious pass-through risks.1 2.4 -2.1 1071. USD bn Inflation Industrial production Unemployment. Medium term still dependent on reforms As we noted.0 1.8 3.5 1.2 -1.7 2.0 2. 2 2011 2012 2013 % Eurodollar futures 4 years out (lhs) 10y Treasury yield (rhs) 4. The ensuing volatility spilled over across asset classes and saw a broad-based positioning unwind. The first leg saw growth assets rally.0 2010 2.DB Research Five reasons why rising rates in a context of stronger growth are positive for equities and credit spreads: Strengthening growth is by itself positive for growth assets and therefore equities as well as credit quality and credit spreads. 2013 Source: Bloomberg Finance LP. with the cumulative inflow near zero (Asset Reallocation to US Equities. Haver. Haver. Rising rates typically see credit spreads tighten as fixed income investors reallocate away from treasuries.7 1. This asset reallocation mechanism looks to be alive and well in this cycle with every episode of a backup in rates seeing inflows into equities (Four years after the Financial Crisis. Figure 1: Rates first leg up positive for growth assets 12 10 8 6 4 2 0 -2 -4 -6 -8 % Cross asset returns: May 02 to May 21. DB Research Figure 2: Second leg up negative 15 10 5 0 -5 -10 -15 % Cross asset returns: Since May 21.7 2. Factset. an inevitable re-pricing of a very slow pace of Fed rate normalization on better data has been the driver of higher rates. December 8 2009). The normal cyclical asset reallocation mechanism of new savings flows from fixed income to equities is that of gradually rising rates (10Y yields). FRB. The second leg. Longerdated credit spreads similarly tightened during Fed rate hiking cycles.2 % Source: Bloomberg Finance LP. The one exception 1994 is discussed below. the uptrend in equities continued as the Fed began to hike (Equities And The Fed’s Exit. we note that the beginning of past Fed rate normalization cycles were typically nonevents for equity markets.7 3. January 24 2011). while carry sold off.0 3. 2013 Figure 3: Repricing fed normalization pace driving 10Y 4. In that the Fed’s taper represents the beginning of the Fed’s eventual exit. DB Research Deutsche Bank Securities Inc. December 18 2012). as they did in the run up since last November. Factset. It can therefore hardly be argued that US equities were a beneficiary of the Fed's policies through increased inflows.2 3. Beyond the episodic inflows around rates increases there has been almost no inflows into US equities for 5 years. So to argue otherwise would be arguing for a break in this correlation which has been resilient through the launch and pause of various QE programs. There were two legs of the move up in rates. MSCI Japan MSCI Latam MSCI Asia ex Jp MSCI UK MSCI EMEA MSCI Europe Agri Commodities MSCI AC World EM Bonds Latam Fx Trd Wtd $ Ind Metals MSCI USA US HY US 10y EM Asia Fx Europe HY US HG German 10y Europe IG Brent Oil Gold EURUSD JPYUSD -20 Page 29 . FRB.2 1. saw a broad-based selloff across asset classes. Why? In our reading. Limited vulnerability to outflows.5 4.5 3.5 1. This re-pricing got added impetus on the taper comments but began during the first leg.5 2.0 1. Gold JPYUSD US 10y Agri Commodities German 10y EURUSD EM Bonds Latam Fx US HG EM Asia Fx Europe IG US HY MSCI Latam Europe HY Trd Wtd $ MSCI Asia ex Jp Brent Oil MSCI EMEA MSCI USA MSCI AC World MSCI Europe Ind Metals MSCI UK MSCI Japan Source: Bloomberg Finance LP. beginning with the taper comments. especially since the Fed’s taper comments have been at the heart of recent market moves. The driver of growth asset declines was instead the discussion of taper combined with a lack of clarity on the timing and pace of coming normalization that prompted unwinds of positions that had seen the biggest inflows under QE.0 2. The move up in rates. The correlation between bond yields and equities has been positive since the financial crisis as growth concerns predominated both asset classes.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Global Asset Allocation: Growth versus stimulus—The Fed’s taper Two legs of higher rates: one good and one bad for growth assets. 3 0. DB Research % Fed target rate (lhs) Rates carry index (rhs) Index 325 275 The ghost of 1994: major financial market event with no impact on the trajectory of economic recovery.9 0.5 2004 2006 2008 2010 2012 8 7 6 Source: Bloomberg Finance LP. the beginning of this Fed normalization follows a record period of postrecession easing and pause. In any event.00 3. encouraging fixed income carry.00 8. Despite the severe sell off in rates and broader market volatility. Figure 7: Bond volume rose during the 1994 hiking cycle fell during the 2004 cycle 9 % Fed target rate (lhs) Move Index (rhs) A verage Index 290 -0.1 -0. DB Research Fed normalization is negative for carry.5 0. The first Fed hike in 1994 saw rates carry sell off while equities were resilient. both in terms of the market and Fed context at the time. There are parallels but also important differences between the disorderly fixed income sell off in 1994 and the current one.00 1990 1993 1996 1999 2002 2005 2008 2011 2014 Source: Bloomberg Finance LP.7 0. The taper comments added to bond volume which had been rising from very low levels. In contrast to 1994 which saw aggressive hikes with little communication.00 6. . There is a clear negative association between Fed rate cycles and the performance of rates carry. the Fed has communicated it is considering a taper while continuing QE.00 1. The 1994 rate hiking cycle did raise bond volume. and rate normalization is still 2 years out.00 7. As the Fed hiked quickly again. carry declined further in an extended sell off (down 14% peak to trough) while equities fell by much less (6%) and recovered in four months.00 2. Like 1994.00 5. But normalization cycles do not have to be associated with higher and certainly not high volume. But the 2004 hiking cycle when the Fed raised rates in a steady manner saw bond volume fall steadily. the impact on a broad set of economic indicators including housing proved very limited. Fed easing cycles saw positive returns and performance while hiking cycles saw flat at best but usually negative performance.00 4.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Figure 4: Rates and equities positively correlated 0. DB Research Trading days around Fed hikes (Fed hike = Day 0) Note: 6 of the last 8 Fed rate hikes did not impact the upward trajectory of the S&P Source: Bloomberg Finance LP. Figure 6: Carry inversely related to Fed cycles 9. the market and economic impacts of 1994 are worth noting.1 -0. Page 30 -126 -114 -102 -90 -78 -66 -54 -42 -30 -18 -6 6 18 30 42 54 66 78 90 102 114 126 225 175 125 75 Deutsche Bank Securities Inc. DB Research 240 Figure 5: Beginning of Fed hiking cycles typically had no impact on equities A vg in 6 episodes when S&P trajectory was unaffected 110 106 Fed hike 102 98 94 90 Index 5 4 3 2 1 0 1990 190 140 90 40 1993 1996 1999 2002 2005 2008 2011 Source: Bloomberg Finance LP.00 0.3 Recession 3m correlation b/w 10y yields and S&P Higher volume is a negative but is not a necessary implication of normalization. Outlook We see higher rates as a central element of the normalization process since the financial crisis. Page 31 . Total equity inflows were flat with EM equities again getting large inflows.2tr of inflows above trend into bond funds since 2009. Figure 10: Bond outflows as Fed starts to hike % of assets 21 16 11 6 Fed rate hike 12 month sum of bond flows (lhs) Fed rate (rhs) % 95 10 9 8 7 6 5 Source: Bloomberg Finance LP. investors positioned for a weaker USD but are now very long. But this will happen only slowly.25 4.75 Dec-1993 76 75 74 A pr-1994 A ug-1994 Dec-1994 % Macro indicators around 1994 fed rate hike Index Fed target rate (lhs) Leading economic indicators (rhs) Fed hike in February 1994 80 79 78 1 -4 -9 -14 1988 4 3 2 1 0 1992 1996 2000 2004 2008 2012 Source: ICI. Macro data and Fed pushback the near term stabilizers. And we continue to expect rates to rise with the 10Y at 2. since the taper comments there has been USD27b of bond outflows with HY.25 5. Extraordinary monetary policy easing fueled USD1. but as having a much longer-lived impact on asset reallocation away from QE beneficiaries.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Figure 8: In 1994 rates carry fell 14% while equities fell by 6% and recovered quickly 7. Spring seasonality again saw data surprises turn down globally.75 77 4. Since QE2.FRB. while US equity flows were flat.0 6. We see this as part of the transition process and as having a transitory impact on risk appetite. The first 3 weeks of May saw inflows to bonds.5 3.5 5. with cumulative inflows of 160% of AUM but also a large 40-60% for other bond segments. Continued pricing in of Fed normalization should see further bond outflows. DB Research Source: Bloomberg Finance LP. DB Research Figure 9: 1994 saw little to no impact on the recovery 6. May 21 2013).5 6.25 2. EM equity outflows were also large. Equity positioning can go much longer if macro data turns up and flows resume. EM bonds benefitted spectacularly. In contrast. Outflows from bonds were 14% of AUM in 1994.5 Dec-1993 85 A pr-1994 A ug-1994 Dec-1994 90 100 Rates and equity perf around 1994 fed hike Index Fed target rate (lhs) % S&P 500. Similarly. DB Research The post taper flows and positioning unwind Large bond outflows on Fed normalization historically. In the very near term.5-2.0 4.0 2.75 5. QE positions cut as investors move closer to neutral. Indeed the Fed has already begun to pushback on expecting too quick a pace of rate normalization and we expect it will do so again at this week's meeting and this should provide some stability. However. Index = Dec 1993 (rhs) Rates Carry index (rhs) Fed hike in February 1994 110 105 calendar rate guidance and twist. Haver. market expectations for Fed rate normalization remain far below historical tightening cycles. commodity positions rose during each QE but net longs have been cut with the exception of oil.65 by year end as expectations roll up the forward curve (After Spring Seasonality. credit and equities continue as rates rose. equity positioning has stayed close to neutral during QE3 with exposures cut in recent weeks. The thesis that they would turn up with a positive data surprise phase to come is tracking.5 4. Even after the repricing. rates positioning has been consistently long.0 3.75 3. At the onset of each QE. Higher rates at this stage of the cycle are positive for equities and credit spreads. with a rise in longer duration positions (10Y and 15+) after Aug 2011 when the Fed began to provide Deutsche Bank Securities Inc. We view the recent market tumult as reflecting the unwind of large rates carry and other QEdriven flows and positioning. The rise in rates should see the cash that has moved out of bonds go to equities with a lag as it has historically. But Fed communication and clarity on its reaction function can provide an anchor for market expectations and therefore bond yields.25 3. 8% in 2000 and 5% in 2004. The Conference Board. Rates positioning is now neutral but can go short.0 5. government and EM worst hit. expectations of Fed policy remain the key. especially precious metals. Binky Chadha. (1) 212 250 6605 John Tierney. (1) 212 250 7448 Parag Thatte. especially US equities have the smallest if any QE flows and positioning overhang and a steady source of demand from corporate buybacks. April 18 2013). Commodities. Bonds in general and EM in particular have the biggest QE overhang.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Long growth while avoiding asset classes. (1) 212 250 4776 Keith Parker. had been a big beneficiary of QE but have been in a down channel for over 2 years and have seen some significant outflow and position adjustments already (Trading The Commodity Underperformance Cycle. excess longer term inflows around QEs means they will likely continue to be subject to recurring pullbacks. regions. Within equities. The latter are likely to stabilize near term with rates on Fed communication and shorter term positioning has in many cases unwound. . the bond-like high dividend yield sectors and stocks were the beneficiaries and are richly valued. EM equities which were disproportionate beneficiaries of equity inflows during QEs have the biggest overhang. (1) 212 250 6795 Page 32 Deutsche Bank Securities Inc. sectors and stocks with the biggest QE flows and positioning overhangs. But with rates moving higher. Equities. 2%.5% 2. Figure 2: S&P 500 fair value at 2013 – 2015 ends 2013 Nominal CoE LT inflation Real CoE: or ERP: 2013 end 2014 end 2015 end Source: DB Research 2014 8. business spending and exports remain sluggish – which all weighs on S&P 500 EPS growth – steady US job growth and improvement in housing and discretionary spending despite tax hikes and government spending cuts has reduced recession risks. i. The 1950s and mid 1980s PE expansion toward the historic average PE was on fading inflation and acceptance of secularly lower long-term interest rates. Notable periods of post-war mid-cycle PE expansion are: 1950s. DPS growth >10% 2) US 10yr Treasury yield <3% 3) US deficit falls to equal nominal GDP growth 1) Fed stops asset purchases 2) Interest rates rise only gradually: US 10yr Treasury yield <4%.0% 1753 1859 1972 2015 8. M&A . . If interest rates rise only gradually.0% 2.5% in 2013 to 5. Lower long-term real interest rates should boost stock PEs. 3) Lower repatriation tax rate will promote continued double-digit DPS growth S&P EPS & target USD109 1625 USD115 1850 Only time will prove if interest rates stay low PE expansion usually occurs as recessions end and during early cycle growth on an improving economic outlook. Brent at ~USD100/bbl 1) Long lasting expansionary cycle 2) S&P releveraging. Figure 1: Path to PE expansion from 2013 to 2015 Year & PE 2013 S&P PE 15+ 2014 S&P PE 16+ Criteria: 1) EPS growth >5%. 2014E 16x and 2.20 June 2013 World Outlook: Fed Policy Tapers Global Markets US Equity Strategy: Attractive long-term S&P 500 outlook as economy returns to normal S&P 500 long-term yearend targets: 2013 – 1625. The US is proving its propensity to continue healing and overcome fiscal drags.0% 2. 2015 – 2000 S&P 500 EPS: 2013E USD109. 2014E USD115. For the S&P to make a sustained move higher we want to be confident that: 1) EPS deceleration bottoms soon and healthy 4Q Page 33 Deutsche Bank Securities Inc.2% Sector strategy: Over-weight Financials and Tech. 2015E USD45 Implied PE and dividend yield targets: 2013E 15x and 2. etc.0% 4.5% 4.5% 1800 1900 2006 9. but investor confidence in sustainably lower rates will take time.5x and 2. mid 1980s and mid 1990s. China is still slowing and US manufacturing. rotation.5% 1623 1730 1843 PEs to rise as interest rates are liberated and the private economy drives moderate growth We expect the S&P to deliver attractive returns from decent EPS growth boosted by PE expansion over the next few years amidst a long lasting expansionary cycle.2%.e.9 15 10 5 0 18 16 14 Lower interest rates 12 drove mid 1980s 10 PE expansion 8 6 4 2 0 -2 1960 1966 1972 1978 1984 1990 1996 2002 2008 2014 Note: Shading denotes recession Source: DB Research LTM PE (lhs) Ratio Implied ERP (rhs) % 12 10 8 6 4 2 0 % 10yr Yield Real 10yr Yield 2015 S&P PE 17+ USD120 2000 Source: DB Research Cautious near-term as we watch cross asset volatility for other secular shifts beyond rates We expect the S&P to trade within a 1550-1650 range this summer as investors watch the interaction of interest rates. 10yr treasury yields stay under 3% in 2013 and plateau under 4% in 2014. then the S&P PE should climb from 15x today to 16x or higher by 2015. even as Fed asset buying stops. similar to today. rates 30 25 20 A verage PE = 15. the dollar and oil prices.5% 5. implied equity risk premium. 2015E USD120 S&P 500 DPS: 2013E USD36. Interest rates staying lower than history on a secular basis as EPS growth stays respectable over the next few years driven by return disciplined reinvestment and also double-digit dividend growth will drive PEs higher. The US deficit is falling and federal government debt to GDP should stop rising. 2014E USD40.5% 3. Staples and Telecom Strategic preference: Global growth industries Figure 2. 2015E 16. Figure 3: S&P PE. Whereas the late 1990s PE expansion to above historic averages was on very strong extended cycle EPS growth. Although Europe is still in recession. S&P fair value as real cost of equity (CoE) falls from 6.5% 6. 2014 – 1850.5% 6. Under-weight Energy.5% in 2015 as ~2% is accepted as a sustainable long-term risk free real interest rate. This increased investor confidence in S&P EPS sustainability has shifted the debate from normalized earnings to normalized long-term interest rates. 10yr TIPS 1-2% 3) Oil: WTI at ~ USD90/bbl. But this is unlikely given federal spending cuts. a stronger dollar and low inflation which is likely to keep the Fed Funds rate on hold until 2015. and Oil Services.(1) 212 250 8169 Priya Hariani.00 0. Banks balance sheets have healed and earnings have largely normalized but dividends remained depressed.0 2.5x and perhaps even Consumer Staples PE at 18x if it hikes its shareholder distributions. Pre-crisis payout ratio was 44% at Banks.0 8. and its dividend yield at 1.0 6.5x 2013E EPS and offers the best dividend growth potential.70 Higher EBIT margins Lower effective tax rate 1995-97 net margin Constituent changes Lower interest expense 2012 net margin Risks to view: Surge in rates or collapse in oil A surge in long-term interest rates would prevent the PE expansion we forecast. A sudden jump in interest rates could spark surge fears and dislocate credit. Its payout ratio at only 25% suggests more dividend hikes to come.5 2. At 9.5 3. EPS sensitivity to interest rate changes at S&P non-financials is limited. We expect double-digit dividend growth at Banks over the next few years as the payout ratio rises from 20% in 2012 to 35% by 2015. We expect Tech’s PE to rise on the first signs Page 34 .20 June 2013 World Outlook: Fed Policy Tapers Global Markets growth is likely.0 Source: DB Research 1. David Bianco. Source: DB Research Summer with Banks and Tech Banks and Tech are our overweight sectors for summer as we watch macro conditions. But we prefer Tech and Financials as a stronger dollar and or global growth concerns could pressure Energy. A 50bps increase in the average borrowing rate would reduce S&P EPS by 0.85 0. 2) interest rates rise only gradually. This should drive PE expansion from about ~11. but not margins as both non-dollar sales and costs rise.80 7. Prices straying high enough to justify production capacity additions for consumption oriented commodities like energy and agriculture is central to our long-term strategy.5 10.0 7.0 3.0 9. Tech’s indicated dividends are up 36%. Tech is trading at ~13. three times as much as the S&P.0 % 0. Banks are our preferred US play given cheap valuations and strong dividend growth. Chemicals. S&P net margins are long-term sustainable S&P net margins collapsed during the recession but recovered quickly and continue to grind higher despite a challenging macro environment. By sector. Tech.6%. FX and commodity markets. but a significant Brent or WTI price decline would threaten capex and be adverse to S&P EPS. We expect stable oil prices. (1) 212 250 2766 Ju Wang.5x now. (1) 212 250 7911 Deutsche Bank Securities Inc. This improvement in net margins came from a lower effective tax rate. S&P net margins are 270bps higher than in the mid 1990s. provide energy or labor efficiencies and lift urban living standards underlie our constructive view on Industrial Capital Goods. Oil prices are a significant driver of S&P EPS and global investment spending.7% now. This and the expectation that Asia demand for capital goods that employ its transportation infrastructure. higher foreign operating margins and changes in the composition of the S&P 500. Figure 4: S&P net margin increase contribution of better enterprise spending and close the gap with Industrials PE at 15.5 Dividend yield (%) 4. over two-thirds of the net margin expansion has come from Tech where all these factors are most pronounced. This EPS headwind could be managed by increasing debt usage from today’s low levels. lower interest expense due to less net debt and lower interest rates. But if markets show orderly transitions to more normal interest rates this summer it strengthens the foundation of longer-term bullish S&P 500 views. slow loan growth. A weaker dollar helps to boost foreign profits. These factors are mostly structural and support higher mid-cycle or normalized net margins. and 3) the dollar appreciates gradually and oil prices are stable.0 4.8% is no longer paltry. Financials and Energy are the only sectors still trading <15x 2013 EPS.80 9. Figure 5: PE and indicated dividend yield by sector 20 Telecom 18 Consumer discretionary Staples Healthcare Industrials Materials Utilities 2013E PE (ratio) 16 14 Technology S&P 500 12 Financials Energy 10 1.25 0. 5 -3. The real improvement in PMIs came from the peripheries. IP grew by 0. For the Euro area as a whole. On a quarterly growth basis. Italy mildly disappointed. Figure 1: Euro area IP versus GDP growth 4 2 0 0. Our confidence in a Euro area growth recovery has grown recently given gains in the May PMIs and strong April IP. even if we see IP contract in May. DB Research Euro area growth surprise expected We continue to expect Euro area growth to surprise to the upside in the coming months.7 and if it continues to rise at this rate over the coming months this would be consistent with positive GDP growth by Q3 (an average PMI over 50). the Stoxx 600 has de-rated to 12. After a fall over the last 4 weeks. giving a little over 10% upside to our 315 target price for 2013.5 -2.0x fwd PE.6% yoy. We expect positive qoq growth in Q3 but we believe there are upside risks to Q2 growth given this recent data.5 Source: Haver Analytics.0 -1. which would give rise to a positive credit impulse. In Q1 demand growth on a yoy basis improved for the second quarter in a row to -2. manufacturing rose by 3.4 pts to 48. inventory sentiment (from the EC sentiment survey) has stabilised at levels Page 35 . Despite this improvement the PMIs are still consistent with growth of -0. Spain and Italy. We are beginning to see evidence of this turn in the growth rate of demand growth in the Euro area.8 points. Given April’s number. and in this environment we prefer to hold domestic cyclicals. Although our view is for positive qoq growth by Q3.4pts (the second largest rise on record).3% qoq in Q2 in our view. As the pace of deleveraging in the Euro area has stabilised the credit impulse (the change in credit growth) has returned to neutral. Insurance. After disappointing us (but not consensus) by falling sharply from February through to April. We also believe that we are at an important stage in the inventory cycle. Chemicals and Telecom. In France and Germany. Media. the Stoxx 600 currently sits at 286. that the upside risk to growth comes from the strong April IP numbers we have seen over the past week. In Spain.0 2004 2006 2008 2010 2012 % qoq Euro area % qoq 1. We believe Deutsche Bank Securities Inc. implying upside potential from a rerating. IP grew by 2. The current period of destocking has been severe and nearly the entire decline in GDP between Q2 2011 and now can be explained by the fall in inventories.3% qoq was the best since 2011. We continue to target a target multiple of 12.2% and 1. Construction.4% mom April. the PMIs in the Euro area showed signs of significant improvement in May. In this environment real private sector demand growth should rebound and start to surprise to the upside. Our sector strategy is to overweight Banks. We continue to believe that a return to growth in this timeframe will be a positive surprise to the market.0 0. and underweight Food & Beverage and Healthcare. Recently however.0% in 2013 on the back of a rebound in global GDP growth.8% mom respectively.20 June 2013 World Outlook: Fed Policy Tapers Global Markets European Equities Strategy: The domestic cyclical strategy We continue to have a positive stance on European equities.8 points to 47. IP in Spain contracted but by less than expected. We have been expecting a positive growth surprise in the Euro area since we turned tactically positive on European equities at the end of last year. followed by flat growth in June.0 -2 -4 IP (lhs) -6 -8 -10 2002 GDP (rhs) -0.5 -1. We expect the pace of deleveraging to start to slow from here. The composite for the Euro area rose 0.1 and the details of the survey were even stronger with output gaining 4. In Italy services were mildly disappointing but the manufacturing PMI rose a very decent 1.5 1. We expect further gains to come from earnings growth of 6. Since earnings expectations have remained flat over the period of decline in equity prices. Q1 demand growth of -0. we believe recent data coming from the Euro area suggests that the risks are weighted to the upside with respect to Q2 growth. This would imply positive qoq GDP growth for the Euro area in Q2.5x fwd PE. The underlying basis for this expectation is because of an improvement in the credit impulse.0 -2.2pts and orders up 6. IP growth for Q2 overall would still be positive. Outperformance is seen as the CDS narrows. Since the middle of April. As can be seen. Our sector recommendations as given above reflect this preference. In addition. which in turn would make dividend yields more believable. caterers. (iv) Southern Europe: Credit growth in both Italy and Spain fell to very low levels. (44) 20 7541 6568 95 90 85 80 Euro recovery basket (DBCGEA RP) / cyclicals indexed to Nov11 75 Nov-2011 Mar-2012 Jul-2012 Nov-2012 Mar-2013 Source: Bloomberg Finance LP. As the Euro area recovers. there is little evidence to suggest that it has been the domestic stocks that have driven this cyclical outperformance. This increased in Q2 to the highest level since 2011. (44) 20 7545 2762 Lars Slomka. the recent trend has shown no outperformance of the domestically exposed group of stocks. (iii) The capex cycle: A turn in the capex cycle is still very much ahead of us. Michael Biggs. cyclical stocks have outperformed defensives by around 8%. However. both of the headwinds should lessen. This expectation underpins or recommendation on the Media and Construction sectors. Page 36 Deutsche Bank Securities Inc. Because of the scope for upside surprise from these countries. we believe the current improvements in inventories are voluntary. (ii) Consumer discretionary: In the US. Furthermore. The inventory component of the PMIs is also consistent with a stabilisation in inventories. travel & tourism and autos. there is reason to expect improvement based on the material rise in the business credit impulse over the past 2 quarters to a level that is consistent with a return to flat investment growth in the Euro area. we would hold exposure to the peripheral equity markets. Favour a domestic-focussed strategy Given the potential for a recovery in Euro area growth. giving a negative credit impulse and a severe contraction in domestic demand. Figure 2 shows the performance of a basket of domestic cyclical stocks that should benefit the most from recovery in Euro area growth relative to a basket of broader cyclicals. there is a long way to go in terms of performance for Euro area domestic stocks. Putting the performance of Euro area domestic stocks relative to global stocks shows a period of consistent underperformance lasting for over 4 years. We see significant upside potential from a stabilisation and improvement from these very low levels as this would imply a positive credit impulse and a sharp rebound in domestic demand growth against very depressed expectations. DB Research Furthermore. (49) 69 910-31813 Thomas Pearce. Although the CDS have narrowed a long way already. (v) High yield: High yield has failed to be a defensive style in the Euro area because of the sharply negative divided revisions they have suffered. DVFA. a better outlook for growth should firm revenue expectations for the high yield companies. spending has surprised to the upside thanks to a positive credit impulse over the last 4 years. (44) 20 7545 5506 Gareth Evans. This points to a slowing in the pace of de-stocking in Q2 relative to Q1. as measured by the ECB’s bank lending survey. In anticipation of a positive credit impulse in the Euro area we prefer consumer spending exposed subsectors such as broadcaster. It has also been negatively impacted from its exposure to companies with high levels of debt. .20 June 2013 World Outlook: Fed Policy Tapers Global Markets in line with historical norms. Importantly though for our call. Figure 2: Domestic cyclicals / cyclicals 105 Index 100 We further structure our domestic equity strategy along the lines of 5 key themes. we favour an equity strategy geared towards domestic cyclical exposure. The cost of funding of these companies should improve alongside the fall in sovereign CDS. (49) 699 103 1942 Jan Rabe. The inventory cycle has been well correlated with the demand for credit for working capital purposes. (i) Financials: Performance of financials has been extremely well correlated with changes in the sovereign CDS of the Euro area peripherals. Alongside this has been a consistent outperformance of the consumer discretionary sector. we believe that they can continue to do so in the event of better than expected economic data. Figure 2 also illustrates this point as the price relative between domestic cyclicals and a broader basket of cyclicals remains at lows. which is a positive contribution to growth. 40% vs. financial markets may be entering the “Year Zero” of the post financial crisis. More importantly. Finally. In contrast. A simple comparison of the level of rates vs.5% to reflect the 6. the money market slope beyond 2 years) remains too benign.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Rates Outlook: Rates to sell-off beyond the peak of monetary stimulus and fiscal tightening Under our base case scenario of tapering sometime around September. We do not expect the ECB to cut the depo rate into negative territory. Given that the latter has been all but priced out. but the risk of one more refi rate cut is real.25-2. we expect peripheral bond market to be relatively resilient. Fed tapering: the primary market driver The pricing of QE has had its biggest impact on real rates and on the 5Y-10Y sector of the curve.0 4. European peripheral debt could be one of the major casualties of a reduction of the liquidity injected by the Fed. However.5 1.5 3.75% if the QE impact is completely unwound (see figure 1).0 3.25%-2. UST 10Y 5.0 2. even if it does not necessarily lead to lower 10Y nominal interest rates. the market is now close to fully pricing a tapering starting in early Q4 and completed in early Q1.5 5.0 2000 2002 UST 10y (lhs) US surprise index (rhs) % 5. Thus the pricing of tapering per-se is unlikely to be the key driver of the rates market.25-2. it is likely that the Fed will manage expectations as to how quickly QE could be ended and the policy rate normalized. At first sight.0 2. More importantly.0 1.5 3. and we thus expect 10Y UST to settle in a 2.5% necessary conditions for a first rate hike. 1. a US economic data surprise index suggests that 10Y rates should be close to 2. we estimate a “Crisis Taylor Rule” that incorporates the FOMC’s latest guidance by widening the unemployment and inflation parameters by 0. Given that the latter has been all but priced out. This should lead to steeper curves.75% range. Conversely. Such normalization process should be accompanied by an increase of volatility and risk premium from abnormally depressed levels. By our account.75% range. Peripheral bond market to be relatively resilient to a reduction of liquidity by the Fed. the likely increase in volatility and risk premium in the front-end of the curve should initially be detrimental to carry trades and spread products.5 4. The BoJ should be successful in reducing volatility in the JGB market. In Europe. semi-core names such as France. Rather. a tapering of QE by the Fed should lead to a sell-off driven by the 5Y5Y real rate.5%/2. However. core EU rates should outperform US rates.0 1. This should lead to a steeper JGB Deutsche Bank Securities Inc.5 1. we do not expect the ECB to cut the deposit rate into negative territory. which have benefited from more significant non-domestic inflows may be more at risk. Given the fragmentation of financial markets in Europe. curve. Figure 1: Surprise index vs. thanks to a significantly reduced reliance on foreign investors. Page 37 . This should cap the sell-off in rates.10% currently. but the risk of one more refi rate cut is real. To illustrate this fact.0 3.0 4.5 4.5 2. we expect the BoJ to succeed in reducing volatility in JGBs. the ECB’s LTRO is far more relevant to the periphery than the Fed’s QE. Under such Crisis Taylor Rule and the current FOMC’s median forecast. core European rates should outperform US rates in the months ahead. Under our base case scenario of tapering sometime around September. we expect 10Y UST to settle in a 2. thanks to a much reduced reliance on foreign investors. the likely increase in volatility and risk premium in the front-end of the curve should initially be detrimental to carry trades and spread products. the June 16 Fed Funds should be at 1. as the quid-pro quo for announcing an early tapering will be to ensure that it won’t be disruptive.75% range later this year. The Fed tapering could mark the beginning of a long and most likely uneven process of normalization of interest rates.0 2004 2006 2008 2010 2012 Index Source: DB Research Post crisis year zero As the Fed is likely to taper its QE program and the peak in fiscal tightening in the US and Europe is overcome.5 2. as the market pricing of the interest rate normalization (i. we expect 10Y UST to settle in a 2. it is the 2Y-5Y sector that should lead any further sell-off in US rates.5 5.e. This is particularly true for Italy and Spain where the share of foreign holdings in Italian and Spanish government debt is back to preeuro levels while semi-core markets such as France are more at risk on a beta-adjusted basis given significant participation from foreign investors (see table below). there are risks around the scenario described above. Notwithstanding its dovish bias.8% (see table below). even though Europe is still facing non-trivial structural and political issues. . the Fed will most likely delay the policy normalization pushing 10Y UST back towards 1. i.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Moreover. Moreover. Fed’s Taylor Rule Crisis Taylor Rule FOMC SPF 25% SPF 75% median percentile percentile forecasts Time of first hike FF in June 2016 Hikes in first year Source: DB Research Figure 3: Historical tightening cycles Hiking cycle Nov-86 Jan-94 Jan-87 Jun-04 Feb-15 Cycle length (mths) 26 13 11 24 90 Total hikes 388bp 300bp 175bp 425bp 350bp Hikes in Avg Avg first year hikes/year hikes/month 100bp 300bp 175bp 225bp 50bp 179bp 277bp 191bp 213bp 47bp 15bp 23bp 16bp 18bp 4bp Fed Taylor Rule FOMC median forecasts Sep-14 2. which saw the Fed relent on its intention to withdraw its stimulus. On the other hand. the Fed may find it difficult to support such pricing. we would expect the Fed to be able to lean against it.50%. at least until the end of this year. Beyond the repricing of higher rates. and the same FOMC’s median forecasts. Volatility has been pushed down to historically low levels on back of the combined effect of the asset purchase program and the forward guidance. 200 180 160 140 120 100 80 60 40 1999 2001 2003 2005 2007 2009 2011 2013 Source: DB Research Rather the downside risks to the scenario may now stem from weakness in China that could turn the current disinflationary trend into a more worrying deflationary one. The increased uncertainty around the size of the Fed’s balance sheet and the scope for a material repricing of the path of monetary policy beyond 2 years should lead to some normalization of volatility. The most obvious risk would be a repeat of the last three years. 200bp per year on average in previous cycles). or more simply a faster repricing of the rate hike cycles beyond 2015 could lead to a more aggressive bond market sell-off than the one envisaged in our base case scenario. June 16 Fed funds should be closer to 2. Figure 2: Market is pricing in benign rate hike cycle vs. financial markets should be more directly impacted by the inevitable increase in volatility. These risks should be lower now as the peak in fiscal tightening is passed in Europe and about to be overcome in the US.e. a succession of negative events in Europe and the US fiscal crisis in the context of a tepid recovery led the Fed to increase its stimulus.40% 100bps Mar-16 0. At the time. 170bp above current pricing. Page 38 Deutsche Bank Securities Inc. The Fed will remain data dependent and as a result.60% 150bps Figure 4: 5Y volume has room to increase 240 220 Index USD 3M5Y implied normal volume Similarly the pace of rate hikes priced by the market remains low relative to historical precedent (about 44bp per year on average vs. at some point the Fed will have to return to its pre-crisis Taylor rule (which we refer to as the “Fed Taylor Rule”). This should have adverse implications. However. we expect the European bond market to be more resilient to event risk thanks to a significant de-risking of foreign investors that was facilitated by the Troika loans and the ECB’s LTROs.60% 45bps Dec-14 2. a faster than expected recovery. for carry trades whether in the front-end of the core curves of in spread products.15% 50bps Source: DB Research Jun-15 1. Under this less dovish Taylor rule.80% 150bps Market FF futures and OIS swaps Mar-15 1. There is certainly scope for such repricing to occur given the very benign hiking cycle currently priced by the market. In this scenario. it is the rise in volatility that should be more of a concern. Page 39 . Finally. as QE would have been expected to keep volatility low. This should be supportive of the front-end of the JGB curve and of steepening positions. (44) 20 7547 4458 Dominic Konstam. As it has been all but priced out by the market. breakevens would rise to 2% and real rates would decline. we remain structurally more constructive on European rates relative to US rates. The rise in nominal yields should not be a source of concern in itself. if the BoJ was successful. we expect the BoJ to succeed in reducing volatility via amongst others increased liquidity injection. Given our relatively constructive view on European growth in the second half of the year. in the context of improving macro data the decline in real yields would be unlikely to match the rise in breakevens and as a result. nominal yields would increase. (33)144956408 Abhishek Singhania. However. the risk of another refi cut remains real. (1) 212 250 0332 Deutsche Bank Securities Inc.00 France (%) 20.40 67. Francis Yared. Rather. Indeed.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Figure 5: Foreign ownership of government bonds Italy (%) 27.50 1999 2010 Latest Source: DB Research But don’t forget Europe and Japan While the Fed is considering reducing its policy easing. the ECB has been debating whether to cut the depo rate into negative territory. Looking ahead.00 30. However. we do not expect the ECB to resort to such extreme measure.10 62.50 51. (44) 20 7545 4017 Jerome Saragoussi. in Japan the BoJ’s QE announcement has been met by significant volatility in bond markets and higher yields. (1) 212 250 9753 Stuart Sparks. . We think that the former might continue to lead to spread volatility but ultimately tighter credit spreads over a 3-6 month period. absolute change in spread (left) and 3m percentage change in treasury yield vs. In order to ascertain this. Higher Yields With 10Yr US Treasury yields rising over 70bps in the past seven weeks there has been a wobble in credit markets. However the latter would be a very difficult environment for credit given how much liquidity has flown into the asset class in recent months. absolute change in spread (right) Change in BBB Spread (bp) 200 100 0 -100 -200 -300 -400 -300 -200 -100 0 100 200 Change in Treasury Yield (bp) 300 Change in BBB Spread (bp) 300 R² = 10% 300 200 100 0 -100 -200 -300 -400 -40% -20% 0% 20% Change in Treasury Yield (%) R² = 12% 40% Source: Moody’s. a short period of sharply higher yields has historically had a greater impact on credit spreads than a similar move spread out over 12-months. We used the 3-month period to see whether for example. absolute change in spread (left) and 12m percentage change in treasury yield vs. We also make a distinction between absolute moves in Government yields and the same moves on a % basis relative to the starting yields. DB Research Figure 2: 12m absolute change in treasury yield vs. Figure 1: 3m absolute change in treasury yield vs. Much depends on whether the rise in yields reflects a genuine improvement in the underlying economic environment or whether it indicates a reduction in demand for Government securities without an associate recovery. In this piece we want to highlight what a rising yield environment has typically meant for credit and what it might mean if yields continue to rise. DB Research Page 40 Change in BBB Spread (bp) Deutsche Bank Securities Inc. Figure 1 and Figure 2 show what the relationship is between Government yields and spreads over 3 and 12-month periods.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Credit Strategy: Credit in the face of QE tapering Credit vs. The impact of yield changes on spread Using the BBB rating band as a base case for our analysis. We should be able to see if large moves in yields over these time periods have a notable impact on spreads. GFD. Let's now look at what history tells us of the relationship between yields and spreads. the scatters on the left are absolute yield changes whereas those on the right are a percentage change relative to the starting yield. GFD. absolute change in spread (right) 500 400 300 200 100 0 -100 -200 -300 -400 -500 -500 -400 -300 -200 -100 0 100 200 Change in Treasury Yield (bp) R² = 3% R² = 4% 500 400 300 200 100 0 -100 -200 -300 -400 -500 -60% -40% -20% 0% 20% 40% 60% 80% Change in Treasury Yield (%) Change in BBB Spread (bp) 300 400 Source: Moody’s. Clearly a 100bps move in yields when the starting point is say 1% might have a different impact on the results than when one sees a 100bps move when yields were 10%. 50 6. real GDP since 1988 (right) 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% -6% 0 Source:. real GDP since 1948 (left) and Single-B spread vs.600 200 400 BBB Spreads (bp) 600 What about 1994? 1994 provides a relevant case study of sharply higher yields.00 7.25 5.20 June 2013 World Outlook: Fed Policy Tapers Global Markets The impact of GDP on spread Figure 3 shows that there is a reasonably good correlation between GDP and credit spreads through time and is arguably stronger than for yields. The 1994 analysis is perhaps enhanced with Figure 5 which shows 10 year US Treasury yields alongside US GDP growth between 1993 and the end of 1995.00 Jan 93 Jul 93 Jan 94 Jul 94 Jan 95 Jul 95 Jan 96 550 530 510 490 470 450 430 410 390 370 350 As can be seen Government yields rose over 200bps between Q4 1993 and Q4 1994 with around 100bps occurring in the first 5 months of 1994. Figure 4: BBB spreads vs. US treasury yield (left) and Single-B spreads vs. US treasury yield (right) 8.25 6. DB Research UST Yield (LHS) BBB Spreads (RHS) 150 145 140 135 130 125 120 115 110 105 100 8. Weakness in the economic recovery would be far more worrying. yield rises have not been a big problem for credit spreads. As we saw above credit spreads struggled more in the lower yield/weaker economic environment of 1995 than the higher yield/stronger economic environment of 1994. DB Research R² = 27% 6% R² = 41% Real GDP Growth Real GDP Growth 4% 2% 0% -2% -4% -6% 0 400 800 1. so what reaction did credit spreads have over this period? Figure 4 shows what happened to BBB spreads and single-B spreads relative to Government yields over the period.50 7. By late 1994. . However there is no real evidence that spreads were negatively impacted. and the economy then weakened back and yields fell through 1995.00 6. this had started to peak.75 Jan 93 Jul 93 Jan 94 Jul 94 Jan 95 Jul 95 Jan 96 Source:.75 6. Indeed the initial yield sell off in late 1993 led to a tightening of spreads and spreads didn’t start widening until late 1994/early 1995 when yields started to fall. Again this makes sense as traditionally the economic cycle is a large determinant for defaults which in turn should impact spreads.200 Single-B Spreads (bp) 1.00 5. Page 41 . argues that the main reason yields rose so sharply was because of a rapidly improving economic environment. probably due to the Fed’s aggressive rate rising policy that year. This Deutsche Bank Securities Inc.50 UST Yield (LHS) B Spreads (RHS) 5. Figure 3: BBB spread vs.75 7.25 7. So it’s fair to say that from the historical US database. .20 June 2013 World Outlook: Fed Policy Tapers Global Markets Figure 5: US 10 Year treasury yields vs. Other factors that could also put negative pressure on credit spreads that have perhaps not been apparent through history are the continued increase in regulation for banks that has seen dealers less able to hold on to inventory and therefore provide any sort of buffer when clients look to reduce risk.5% 7. We have already seen credit spreads widen since Bernanke’s JEC testimony and the Page 42 Deutsche Bank Securities Inc.0% 4. The danger being that by the very nature of the Fed raising the tapering warning flag they create a global risk selloff that endangers the recovery. DB Research Is this cycle different? We've now laid out the evidence from the past but it’s fair to say that this cycle is behaving very differently than any seen through history.5% 4. then it’s difficult to justify a scenario where we see a material widening of credit spreads. We would probably expect any move wider in credit spreads to be capped over time as long as the economy responds as per the Fed's expectations. There is also far more money that has flowed into ETFs.5% 3. Jim Reid.0% 3. (44) 20 754 71970 1.0% 7. putting further pressure on the credit market. Most of these issues revolve around the flow of investments into credit that may be unwound if there is a pull back in liquidity.5% 10yr Treasury Yield (LHS) US Real GDP YoY Growth (RHS) 5.5% 2. (44) 20 754 72943 Nick Burns. However.0% 5.. longer-term if the tapering of QE is justified due to stable and sustainable economic growth.5% 6.5% 5. which would likely keep default rates low. This has continued in the hours post the June FOMC. so if credit starts to weaken we may see this investment quickly reallocated.0% Dec 92 Jun 93 Dec 93 Jun 94 Dec 94 Jun 95 Dec 95 Source: Bloomberg Finance LP.0% 2. The aggressive level of bond buying provided by QE has arguably artificially increased demand for fixed income so even a slow removal of these purchases could have ramifications for flows into credit funds.5% 8. US real GDP growth (1993-95) 8.0% 6.0% publication of the minutes of the May FOMC meeting. MBS itself has arguably priced in a taper. Since REITs hold more than USD340 billion in MBS. MBS should hold spread. Risk management in many REITs is opaque. Investment grade spreads have tightened by roughly 50 bp since discussion of QE3 seeped into the markets. Liquidity should reprice. MBS performance under DB’s expected Fed exit path accompanied by a market event The worst case for MBS under an otherwise smooth Fed exit would come from either a sharp widening in credit markets. too. The tighter spreads would reflect the large share of MBS – roughly 30% . The taper will mark the likely beginning of the end.0% passthroughs. potentially because of concern that inflation might one day force the Fed’s hand. Concern about Fed commitment to holding its MBS could widen spreads by 25 bp. Higher rates would lengthen the duration of REIT MBS beyond the duration of most of their hedges. Holders of MBS derivatives would come under pressure. Page 43 . Broad parts of the credit markets have relied on a steady rise in Fed liquidity. The likely taper would deliver on that. If the market has confidence. (1) 212 250 3125 Deutsche Bank Securities Inc. A sharp widening in credit spreads would come if market demand for liquidity picked up sharply ahead of uncertainty about the Fed’s ultimate path. MBS tightened by more than 25 bp.20 June 2013 World Outlook: Fed Policy Tapers Global Markets US MBS and Securitization Outlook: Fed exit and MBS MBS performance under DB’s expected Fed exit path MBS will likely widen by 5 bp to 10 bp in concert with other spread assets when the Fed finally confirms a taper. Investment grade credit would suffer the most since compensation for liquidity represents the largest component of its spread. But MBS performance on confirmation of a taper will depend. every year that sector duration went beyond aggregate risk limits could spur selling of the equivalent of USD49 billion in 30-year 3. They could unwind a large part of that and push MBS 10 bp wider in sympathy. REITs would come under pressure. MBS should widen by 2 bp. The market has widened this year in large part out of concern that the Fed might one day sell or use MBS reverse repo in a disruptive exit.that the Fed had effectively taken out of private markets. so it is hard to pinpoint the risk. These could collectively widen MBS by 25 bp to 50 bp. Steven Abrahams. Spreads should widen by 2 bp to 3 bp for every USD50 billion in sales. MBS performance also will depend on market confidence in the Fed’s ability to hold and not sell MBS. For every 10 bp that investment grade credit widens. Given the impact of earlier QE on MBS. A sharp rise in rates could force MBS selling as MBS REITs tried to bring their duration of equity back into a tolerable range. stress at MBS REITs. On these grounds alone. lack of market confidence in the Fed’s commitment to holding MBS or some combination of these. The market would doubt the Fed’s ability to hold MBS indefinitely. But a credible commitment to hold MBS for at least five to 10 years without selling could more than offset the news of the Fed’s terminal demand. on performance in competing spread assets – corporate debt above all – and there spreads stand to widen. In the few weeks after the initial QE3 announcement. the tightening corresponded to roughly USD600 billion in implied Fed MBS purchases. MBS performance with a macro event A sharp jump in inflation expectations along with likely rising rates and a flattening yield curve would create the most risk for MBS. The combined impact could leave MBS a net 5 bp to 15 bp tighter. That spread would reflect complete lack of confidence in the Fed ability to hold. These could collectively widen MBS by 35 bp to 75 bp. The REITs could sell MBS or shed duration in other ways to bring their duration gap back in line. Credible assurances from the Fed could reverse that. then MBS could tighten by 15 bp to 25 bp. together with the non-petroleum sector’s response to past USD weakness.20. as signaled by our long-term PPP. 2 year lag (rhs) 120 % of GDP USD 160 140 100 80 -14 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: Ecowin. This is more than a tapering real/nominal rate story. 24m rolling change Current account deteriorates % yoy 10 8 6 4 -1 0 1 2 3 4 1960 Current account improves US: Current account (lhs. Beyond the QE tapering talk. The dual improvement in ‘the twin’ budget and trade deficits usually presages a stronger USD by close to 2 years.DB Research 40 This is the first recovery since the early 1970s where the current account is not deteriorating at this stage in the business cycle. dominated most recently by USD gains against commodity and emerging market currencies. JPY and GBP are 1. The EUR’s external accounts continue to improve and are one reason why the EUR will lag the bigger USD trend. Importantly. Figure 1: US C/A plus the Federal budget deficit as a share of GDP versus the USD TWI against major currencies 2 0 -2 -4 -6 -8 -10 -12 60 US twin deficits (lhs) USD trade weighted index. or net equity flows that were the foundation of USD gains in the late 1990s. behavioral exchange rate (BEER) and fundamental exchange rate equilibria (FEER) measures. 110 and 1. The twin deficits (public sector plus external deficits) that has historically led the USD by two years is starting to improve more sharply than during any cycle in the last 50 years. The near term positive USD outlook should be seen in the context of a multi-year uptrend in the USD tradeweighted index that started in July 2011 and is already up over 10% versus major currencies and 7% versus a Page 44 Deutsche Bank Securities Inc. Bloomberg Finance LP. inverted axis) US: Real GDP (rhs) 1970 1980 1990 2000 2010 2 0 -2 -4 -6 -8 -10 Broad-based USD gains are expected as the Fed shifts to a less accommodative QE phase through the latter part of this year.20 June 2013 World Outlook: Fed Policy Tapers Global Markets FX Strategy: Rotation within a USD trend The dollar uptrend is going through a period of rotation. The US C/A is not deteriorating in contrast to all upswings since the early 1970s. differentials in output gaps and deleveraging cycles. . There are a few areas of caution. notably the lack of improvement in US FDI flows. Year-end forecasts for the USD vs.DB Research This only adds to DB’s conviction that the USD is still cheap. suggest USD rate advantage will build on a multi-year basis helping the USD reassert itself against all G10 currencies. Bloomberg Finance LP. We expect capital flows to prove responsive to Fed policy signals given the policy divergence with other G4 central banks. EUR. -2 Source: Ecowin.41 respectively. This partly reflects the US’s energy supply side revolution. Figure 2: 2Y rolling change in US current account as a percent of GDP versus real GDP % yoy -4 -3 % of GDP. the positive USD story is much more than a US interest rate cycle. Either the Abe government is successful reflating which will necessarily include a weaker yen to boost financial conditions. will be particularly exposed given commodity cycle weakness relative to equities.DB Research We are also closely monitoring the extent to which spreads mirror the pattern of 1994. Lower commodities historically are associated with a US positive terms of trade shock.3 -25 -30 1. 2) The high beta G10 commodity currencies the AUD. NZD. and the latter because a weak currency is an integral part of the reflation strategy ahead of the planned 2014 tightening of fiscal policy. Given the relative growth performance.3 -20 1.20 June 2013 World Outlook: Fed Policy Tapers Global Markets broader range of currencies. including ZAR. In contrast. For the coming year. Short-term Deutsche Bank Securities Inc. Figure 4: EUR/USD versus 2 year Govt yield spreads 1. the yen will weaken longer-term as growth concerns undermine fiscal sustainability. This is because it led the early stages of the USD correction. overvaluation by most long-term measures. Figure 3: USD TWI versus S&P/CRB ratio 120 USD 9 8 110 7 100 6 5 90 4 80 3 2 70 USD nominal trade weighted index (lhs) S&P/CRB Ratio (rhs) 1993 1997 2001 2005 2009 2013 1 0 interest rates are another factor that has helped the EUR of late. where tightening triggered a bond market rout.4 -5 1. there are three groupings of currencies that are most vulnerable to Fed tightening: 1) The more flexible and popular emerging market carry trades where foreigners have considerable domestic bond exposure. and the large and increasing euro area current account surplus is offering considerable protection. or.3 Sep-2012 -40 Jun-2013 Source: Ecowin. As spreads readjust we expect EUR/USD will push down through this year’s lows. Bloomberg Finance LP.the former because of a lack of external rebalancing. and CAD. UK Japan Sweden Norway Italy France Germany -2 -1 0 1 2 3 4 pp 5 Source: Ecowin. rate Fed and the Figure 5: Change in policy rates and 10yr yields in 1994 Change in 10 yr yield A ustralia US Canada Change in nominal policy rate 60 1989 Source: Ecowin.3 -10 -15 1. Most other EMG currencies will follow suit as they work to avoid any loss of competitiveness against their peers. Bloomberg Finance LP. and.DB Research 3) Those G10 currencies with relatively poor fundamentals including the GBP and the JPY . Government 10yr bond spreads moved against USD versus most G10 currencies. MXN. Bloomberg Finance LP. BRL.DB Research Page 45 . Additional gains of 20% in the US broad trade-weighted index over the next 3 years would not be extraordinary when placed in the context of other large USD upswings since the fall of Bretton-Woods. as EUR 2 year rates have more than matched the rise in 2yr US T-Note yields.3 EUR/USD (lhs) EUR-USD 2y yield spread (rhs) Dec-2012 Mar-2013 -35 1. we expect this spread to more closely reflect the actions by the ECB and Fed and move against the EUR in coming months. without a specific EUR crisis. KRW and TRY.4 USD bps 5 0 1. the EUR will lag rather than lead any USD weakness. suggests that in present circumstances. Bloomberg Finance LP.20 June 2013 World Outlook: Fed Policy Tapers Global Markets The sharp deviation in output gaps. A reversal in the China carry trade that would open the door to a much larger USD adjustment versus Asian currencies could be one such catalyst. The longer these trends continue. Bilal Hafeez. The performance of the China carry trade is now reaching levels seen before unwinds of major carry trades of the past including the AUD/JPY preLehmans. scaled) A UD/JPY 2008 unwind 80 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Ecowin. or encourage other flows including corporate bonds and equities. regulatory clampdown. evident in the dramatic rise in euro area unemployment relative to the US since 2009. . that were the source of USD strength in the late 1990s. Some combination of higher US yields. providing another leg to the stronger USD trend. will not be sustained over the medium-term.DB Research Against this there are also potential surprises that could accelerate the USD turn higher. Figure 6: CNY carry trade reaching JPY-carry trade extreme levels Total returns (spot+carry) 220 200 180 160 140 120 100 CNY/USD (onshore) USD/JPY 1995-1999 A UD/JPY 2002-2009 Index USD/JPY 1998 unwind CNY/USD (onshhore. is that so far stronger relative US growth has done nothing to improve the large US FDI deficit. higher FX volatility and less CNY appreciation could trigger an unwind. (44) 20 7547 1489 Alan Ruskin (212) 250-864 Page 46 Deutsche Bank Securities Inc. a similar shift in short-term rates against the USD. the more it will slow the USD’s upturn. and USD/JPY in 1998. Another point of caution. we expect prospects will be closely tied to the outlook for US growth and by default the speed with which the Fed exits QE. We find that commodity returns tend to under-perform relative to other asset classes such as US equities in rising dollar environments. we view new crop fundamentals as bearish. We look for Chinese restocking and tight WTI fundamentals to support crude into H2 2013. Finally at the end of last year Fed rhetoric triggered a turn in US real interest rates. In gold. which have helped to reverse the significant discount of WTI relative to Brent. Deutsche Bank Securities Inc. such that many of the forces that had powered gold higher over the past decade are fading and in some instances moving into reverse. ytd % Emerging markets: DBIQ EMLE Commodities: SPGSCI Bonds: DBIQ Global IG Sovereign FX: DB Currency returns index Equity: MSCI Global 9.3 EM -3. it started to move lower which contributed to a broad based sell-off across a range of safe haven assets such as the Japanese yen. lead and zinc. In our view. This has been triggered by concerns towards disappointing Chinese growth.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Commodities: Hazards from new supply. We believe we are witnessing new headwinds in the gold market.2 Source: Bloomberg Finance LP (Data as of June 11. While dollar strength has typically been most negative for precious metals. which we expect will gather steam over the coming year. 2013). However. the pace at which US real interest rates normalize and the vigour of the upturn in the US dollar. Of the four broad commodity sectors we expect industrial metals will be more resilient to a rising dollar and since it will find support from an improvement in global growth. We would therefore prefer to position for a China rebound via the industrial metals complex and specifically aluminum. if we are right and world growth starts to accelerate during the second half of the year then we would expect this would be an environment where silver would outperform relative to gold. Figure 1: 2013 asset class returns compared 14 12 10 8 6 4 2 0 -2 -4 -6 -4. 2013).2 1. we expect it will also place downward pressure on crude oil prices. value and momentum.DB Research SPGSCI Commodities are competing with emerging markets to be the worst performing asset class on a total returns basis so far this year.2 Total returns. Despite our forecast of an eventual acceleration in Chinese economic activity. This was followed by the US equity risk premium. market balances for iron ore and thermal coal are moving into surplus.6 Commodities Bonds FX Equity -0. While the corn market may be supported over the next few weeks by concerns towards the US growing season. Fed exit and a turn in the US dollar The majority of commodity prices have traded lower during the first half of this year. Page 47 . In crude oil. the Swiss franc but also gold. Figure 2: 2013 SPGSCI sector returns compared 5 % Spot return Roll return Total return 0 -5 -10 -15 -20 Precious Industrial Livestock A griculture Energy Metals Metals Source: Bloomberg Finance LP (Data as of June 11. Figure 2. The poor performance of long only commodity index strategies has been a feature of the commodity complex for the past few years and this has inevitably led to the increasing focus on systematic strategies such as carry. having peaked in October 2012. we doubt this will provide much long term support to the bulk commodity sector. We expect gold will struggle to rally convincingly in environment where US real interest rates are moving higher and the US dollar stages a more vigorous upturn. Indeed headwinds for gold began in July 2011 when the US dollar trade-weighted index began to move higher. increasing guidance by the Fed towards QE exit and rising market surpluses and expectations of rising supply in a number of key markets such as crude oil.DB Research Of the five broad commodity sectors. not just in corn but also in soybeans in response to increased US plantings and South American supply. precious metals have been the worst performer on a total returns basis so far this year. the rapid growth in US shale oil production has been matched by significant infrastructure expansions. copper and soybeans. Another hazard for the commodity complex has been the gradual appreciation of the US dollar. 5 89. we expect a further compression of the spread will be a function of how quickly pipelines and railroads can clear Padd2 inventories.36 94. Indeed one of the biggest forecasting errors that has occurred in commodity markets over the past few years has been attempting to predict US crude oil production growth.0 44. (1) 202 626 7021 Page 48 Deutsche Bank Securities Inc.9 80.7 21.4 70.0 42. retail demand across emerging markets has remained strong. Two years ago.7 17.00 92.4 81. This year has seen significant progress in this regard.3 78.6 104.6 59.7 43. For example.6 85.4 65.2 66.4 48.9 47.7 116.0 69.00 100.0 109. while institutional investors in the western world have been liquidating gold holdings. with substantial accumulated oil savings.00 105.5 87.1 122.4 70.. Haver Analytics. there will likely be spill-over effects on other regional crude oil markets Indeed with US imports of foreign crudes declining.00 Michael Lewis. we expect physical fundamentals in the oil market will tighten in the second half of the year.1 96.7 2009 69.2 103.9 102.64 103.6 112. on balance we expect financial forces will overpower physical drivers over the medium term implying the underperformance of gold relative to industrial metals.3 116. (44) 20 7545 2166 Soozhana Choi.9 23.1 41.9 26.7 80.8 111.4 93. .1 33.8 53.3 90. we expect it will mean Brent will have to be priced more competitively in order to find a home in Asian markets.7 GCC Bahrain Kuwait Oman Qatar S. Figure 4: DB oil price deck WTI (USD/bbl) 2012 2013 Q1 Q2 Q3 Q4 2014 2015 2016 Note: Figures are period average Source: DB Research Brent (USD/bbl) 111.4 72.2 60. Figure 3. there has been a significant divergence of reactions to the gold price correction during the second quarter not just by region but also investor type.00 96. In an environment where world GDP growth stands at 3% or above.6 84.2 118. While we would not rule out a short term bounce in gold given the extreme liquidation that has occurred recently.00 107.A rabia UAE Nigeria Kazakhstan Russia Brent price Source: JODI. However. we expect the rise in US shale oil production will tend to keep WTI trading at a discount to other crude oil benchmarks. crude oil prices have dropped by at least 25% within a three month horizon. our medium term outlook is increasingly turning towards US shale oil supply growth and the build out of US infrastructure. Saudi Arabia would still be able to weather even a sustained drop in oil prices.7 2008 43.7 25.8 82.9 105.1 65. industry forecasts suggested US crude oil production would rise 50kb/d in 2012 when in fact it rose by 1 million barrels with upward surprises in US oil production growth continuing into this year.5% as this would imply a contraction in global oil demand.4 64.1 72.7 80.4 122. Indeed the possibility of a further drawdown in Padd2 inventories may also help to sustain the tightening in the WTI market.0 2013F 78.00 97.3 61.8 139.4 38. OPEC will naturally be watching US shale oil developments closely since further downward pressure on the oil price would start to hurt budget balances in key oil producing countries. Indeed work conducted by DB’s Emerging Research team reveals that budget breakeven oil prices have risen to a new all time high across many countries in 2013.1 47.8 129.68 112.9 2010 68.6 72. However.9 82. We estimate that in response to lower oil production and a modest rebound in spending growth.1 85.8 113.6 2011 79. DB Research We believe the most likely trigger for a sharp correction in the oil price would be if world GDP growth fell towards 2. at least for the time being. which has encouraged a significant flattening in the forward curve and the prospects of the entire curve moving into backwardation in coming months.0 117.3 47.5 76.15 94. In previous environments where world growth has fallen to this level.4 2007 42.1 80.3 112.1 135.8 53. Energy and the role of shale Following Chinese destocking over the past five months. largely contained within the borders of the US. In addition we expect EM central banks will remain a source of gold demand going forward as they continue their diversification programme into gold.00 105.9 45.7 97.5 61.0 98.00 107. Even though the expansion of US crude oil production will remain.8 52.1 57. Currently DB expects world GDP growth to rise 3.00 94.7 18.9 32.6 59.0 2012E 73.00 85.7 79. In a scenario where the US continues to prohibit the export of crude oil.20 June 2013 World Outlook: Fed Policy Tapers Global Markets However.00 95.3 62.0 60.8 57.0% in 2014.1% this year and 4. the budget breakeven in Saudi Arabia has reached USD90/bbl (Brent equivalent).5 83. Figure 3: Budget breakevens for key oil producing countries (USD) 2006 32.0 28. the Assad regime has been secular in its rule. now taking the form of crippling sanctions over the nuclear arms dispute. Libya. and more outside forces. which has occurred sporadically in Turkey and Lebanon. Jordan in the south and Iraq in the east. Most noteworthy. small units and individuals from Hezbollah quietly began to participate alongside Syrian army forces in some of the battles in the interior. Fourth. “US to keep Patriot missiles and F-16s in Jordan”. Hezbollah attacks Early in the conflict Hezbollah was not a participant. the drivers of the Libya intervention. the Syrian civil war is unlikely to end quickly.h BBC News. US anti-missile units and an F-16 squadron to Jordan. The rebel side was supplied with weapons initially by Qatar. Syria’s neighbors have increased their military forces on their borders with Syria to deter combat from spilling over the frontiers. A tangled web of conflicting forces A wide range of interests and conflicting forces keep refueling the Syrian civil war as an accelerating struggle. 2013. First. if the rebels seem to be flagging. 6 Deutsche Bank Securities Inc. they have made three air raids into Syria this year to destroy anti-aircraft missile shipments on the way to Hezbollah. 2013. there is the humanitarian crisis that has pushed hundreds of thousands of refuges into Turkey. which was joined by competition from Saudi Arabia. “Syrian and Hezbollah Forces Take Strategic City”. Therefore.6 It is also the entry between Syria and northern Lebanon. http://abcnews. Jordan and Lebanon with the resulting destabilization and push-back on Syria. The Israelis seem to have no preference over which side wins.com/blogs/headlines/2013/06/syrian-andhezbollah-forces-take-strategic-city/.reuters. June 15. there is the direct USIran conflict of 35 years. These supplies move across most of Syria’s borders: from Turkey in the north. along with nearby Homs. Hezbollah suddenly revealed itself as an “international brigade” spearheading the attack for the demoralized Syrian army. Third. The Western countries have supplied the rebel forces with non-lethal aid and organization.4 The Syrian civil war is in effect also becoming a proxy war between Iran and its clients on the one hand and a loose and shifting alliance of Sunni Arab and Western countries on the other. 4 ABC News. who could be threatened by a sectarian Sunni victory.” October 14 2012. It has evolved into an Iranian commitment of military personnel and resources in a war in a nonneighboring country at a time when it is economically squeezed by sanctions.3 Numerous other Sunni majority countries are in support of the rebels. have largely been supporters of Assad.com/article/2013/05/05/us-syria-crisis-blastsidUSBRE94400020130505. a natural strategy. seeing both as risky. May 5. The US now has several experiences— Afghanistan.5 The EU is concerned about the humanitarian catastrophe but had been reluctant to provide weapons to the rebels until France and the UK.co. Rather. 5 Reuters. Sixth. Iraq—in which overthrowing secularist governments in Muslim states by arming jihadis or by using its own forces has led to post-conflict disaster. it holds the potential to swirl more and more external forces into the fight. the Assad regime. so the other minorities in Syria. there is a standard local nation state alliance struggle against a rising and dominant Iran. there is the continual Israel/Arab/Iran conflict. perhaps. The rebel defeat was decisive and the battle was important because Qusair.go. Attempting to overthrow Iran’s client. there is a traditional Great Power engagement with Russia in a rearming and aggrandizing moment in the face of a seemingly hesitant US and a visibly weak Europe. Gradually. http://www. bringing with them ever more sophisticated weapons. controlled the road communications between Damascus and the Alawite stronghold along Syria’s Mediterranean coast. swung a recent vote to be allowed to provide weapons themselves. and more virulently.bbc. Finally. says targeting Hezbollah arms”. there is a rising Turkey caught between a rising Iran and a newly outward reaching Russia. This has created an essentially inevitable basis for prolonging the war and.com/2012/10/15/world/middleeast/jihadists-receivingmost-arms-sent-to-syrian-rebels. and Israeli anti-missile units toward its Syrian front. in the recent battle for Qusair. Outside forces directly involved in combat appeared early on in the form of radical jihadi combatants on the rebel side and Iranian al Quds advisers and combatants on the side of the Assad government. http://www. Page 49 . an incentive for resupplying them with weapons.html?pagewanted=all&_r=0. “Israel strikes Syria. June 5. Syrian weapons were supplied by Iran and Russia with transportation through Syria’s Mediterranean ports and by air via Iraq and daily Russian supply flights. Despite all these interests. In spite of this dimension. for many outside players there appears to be considerable ambivalence about the desired outcome. However. http://www. Fifth. on this battlefront Iran has been challenged in a military conflict without risking the feared closure of the Straits of Hormuz or a war in the territory of a major oil producer.uk/news/world-middle-east-22924078. “Rebel Arms Flow is Said to Benefit Jihadists in Syria. which the rebel forces could have used to communicate with friendly 3 See NY Times. with the Syrian Sunni majority controlled by the minority Alawite (Shia) Assad regime. there is the sectarian Sunni-Shia struggle. So it has been reluctant to supply weapons to overthrow Assad. these included deployment by NATO of anti-missile units to Turkey. 2013. training.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Geopolitics: More internationalization of the Syrian Civil War The Syrian civil war continues as an ever-widening attractor for intervention by external powers. Meanwhile. Second. Thus. Nevertheless.nytimes. Russian support for Syria Between Russia and Iran there is a clear mutuality of interest in preserving the Assad regime. Russia has been a natural protector of Syria at the Security Council and an openly large supplier of weapons. . Should Assad triumph. The resurgent Syrian forces will conceivably push northward toward Aleppo to try to break the rebel hold on the north of Syria. this could create a major geopolitical problem on Europe’s southeastern flank. so for security reasons. it is an additional anti-aircraft deterrent against air attacks from Israel. the fleet deters attempts to interfere with shipping into Syria’s ports.7 What purpose does a large fleet serve in a civil war fought on land? Originally. http://www. Russia recently announced that it would permanently deploy a fleet of 16 ships to the Mediterranean Sea for the first time since 1992. signaling that it expects to maintain a permanent toe-hold in Syria. This increases the risk to any decision by the West to enforce a no-fly zone. However. Moreover. Also. Most problematic of these has been the recent announcement that it will supply S-300 long-range antiaircraft missiles to Syria. It also creates a strong European security interest in seeing off the Assad regime. In addition. It also perches a powerful naval squadron exactly where Israel’s paradigm-changing gas fields are located. and thus feel obliged to eliminate such missiles on delivery. such a push could well turn into a see-saw struggle as more Sunnioriented forces are poured in by the rebels’ foreign supporters. it was thought that the deployment was to cover the contingency of evacuating Russian personnel in case of a collapse of the Assad regime.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Sunni groups there. these missiles likely have a range sufficient to cover much of Israel and therefore could engage Israeli aircraft over their own bases. Russia has posted a large naval squadron off of Syria. although it seems unlikely that Russia would engage in a direct clash. the Israelis fear that the S-300 could be delivered to Hezbollah. Depending on the version. 2013.csmonitor. But mainly the fleet deploys a significant anti-aircraft and inland bombardment capability along Syria’s coast. In a second major intervention. Page 50 Deutsche Bank Securities Inc. More credibly. At a time when the US navy is downsizing and redeploying to the Pacific and with what appears to be less US interest in covering the sea lanes to the Middle East. sends regime new missiles”. Syria is the last Russian client state in the Middle East left over from the Soviet era. with their historical sympathies with Russia.com/World/terrorism-security/2013/0517/Russiaboosts-its-naval-presence-in-Syria-sends-regime-new-missiles-video. (1) 212 250 5466 7 See Christian Science Monitor. the euro zone core arguably cannot be too tough on them. This is clearly a weapon aimed against intervention by outsiders such as any attempt by Western powers to establish a no-fly zone or any further Israeli air attacks. Peter Garber. “Russia boosts its naval presence in Syria. Greece and Cyprus. It is also Russia’s only military base in the Mediterranean at just the moment when it is reasserting itself militarily with more forward deployments of naval and air units and a rearmament program. may come into play. May 17. the Israelis would likely regard this as a further intensification of the Iranian threat. Therefore. 6 6.2 1.7 0.6 1.6 1.5 -1.3 -3.8 -4.8 5.2 1.8 0.5 1.3 2.8 -3.0 -3.8 1.6 2.5 -6.1 1.1 1.3 1.3 0.1 1.9 -0.5 3.9 5.3 6.2 1.4 5.3 6.7 3.2 3.5 10.8 -0.4 1.6 4.2 0.8 -0.5 3.3 2.2 -3.9 1.7 3.9 13.1 3.2 2.9 6.7 -4.6 4.2 2.2 0.8 1.1 -0.4 0.8 -9.9 -0.6 -3.6 -0.4 -3.7 -2.7 5.0 -2.8 Fiscal Balance (% of GDP) 2012 2013F 2014F -6.8 3.9 3.6 -3.0 5.3 -4.9 5.2 4.2 7.3 5.1 2.8 7.8 0.2 -7.2 2.5 (% qoq annualised) Q2 2013F Q3 2013F 2.3 6.5 2.1 0.6 1.5 2.2 -3.8 -1.8 24.0 -1.6 0.8 8.0 3.2 -1.7 1.0 0.5 2.3 8.4 7.9 -3.1 1. National Statistical Authorities Deutsche Bank Securities Inc.8 -2.0 -3.6 0.0 2.7 1.0 6.5 0. Page 51 .9 5.1 -2.3 2.0 6.1 -1.3 -3.1 -2.1 2.8 4.3 2.7 5.8 0.0 -5.5 Q1 2012 USA Japan Euroland Germany France Italy United Kingdom Canada G7 2.4 4.2 0.4 -3.6 -5.0 4.0 1.9 0.1 -4.4 27.0 -2.0 2.2 0.6 -1.0 -2.4 10.3 -0.1 -3.5 2.1 1.6 -1.3 2.7 -1.6 -4.6 9.9 -9.5 0.4 -3.8 -1.3 -2.2 -3.8 1.1 0.5 5.3 4.5 5.0 -2.9 -2.3 1.7 23.3 1.2 2.6 1.0 -3.5 4.0 -4.0 -1.3 -3.8 2.0 -1.3 -2.1 1.9 3.6 5.0 6.1 0.5 3.0 -5.3 1.9 -3.8 1.5 1.9 1.9 2.0 7.8 2.4 4.0 -10.4 -2.9 3.5 2.0 2.2 1.8 -3.6 2.3 4.6 -3.8 3.5 1.9 0.0 -8.2 0.2 -3.5 -1.7 6.6 -0.2 -1.2 4.7 1.4 -7.0 -1.0 0.6 -0.8 -4.1 4.4 1.3 -3.8 -0.1 2.1 6. CPI (% yoy) 2012 2013F 2014F 2.0 -0.9 3.3 -3.4 1.7 2.2 3.0 6.8 0.8 5.9 -0.4 2.5 1.4 1.4 -3.8 2.0 0.7 1.5 2.1 -0.7 3.8 4.1 -0.6 0.5 0.3 Q4 2012 0.7 0.6 3.9 19.7 14.0 5.5 6.0 5.5 0.6 2.0 1.9 4.9 0.9 Inflation.0 -0.5 0.7 1.2 Current Account (% of GDP) 2012 2013F 2014F -2.5 1.1 7.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Key Economic Forecasts Growth of real GDP (% yoy) 2012 2013F 2014F US Japan Euroland Germany France Italy Spain Netherlands Belgium Austria Finland Greece Portugal Ireland Other Industrial Countries United Kingdom Denmark Norway Sweden Switzerland Canada Australia New Zealand EEMEA Czech Republic Egypt Hungary Israel Kazakhstan Poland Romania Russia Saudi Arabia South Africa Turkey Ukraine United Arab Emirates Asia (ex-Japan) China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Sri Lanka Taiwan Thailand Vietnam Latin America Argentina Brazil Chile Colombia Mexico Peru Venezuela EM Countries World QUARTERLY GDP 2.7 0.8 1.9 -2.8 14.5 1.6 9.2 2.0 -5.9 0.4 -3.7 1.4 3.1 2.5 -2.9 -4.3 -3.8 1.1 0.1 1.0 -0.6 -0.2 -4.2 1.0 7.7 -0.3 -3.7 -8.0 7.0 -1.8 5.0 4.4 -5.0 3.2 -2.0 -3.7 -2.7 1.3 -3.9 0.4 3.0 2.5 -2.5 2.1 -2.9 -5.2 -0.7 0.0 0.8 -3.2 13.4 Q1 2014F 3.1 5.6 2.1 -7.8 6.7 0.0 7.1 -0.3 2.4 -1.6 -6.4 -3.4 -2.5 4.7 3.5 -1.7 -3.5 2.1 -0.9 6.1 1.0 2.2 2.0 5.9 1.9 1.3 -4.3 -4.5 24.1 3.2 5.7 7.4 1.7 -4.6 -6.6 2.6 3.2 -3.9 4.2 1.4 -4.1 5.0 1.8 -2.8 2.4 5.3 -2.8 5.0 4.1 -1.6 1.0 1.2 17.4 -1.0 -4.5 2.4 2.6 -5.5 1.1 -3.3 -3.4 0.1 3.0 -1.0 -3.5 -0.7 0.9 2.4 -1.5 -3.0 1.1 1.6 8.5 -3.0 3.8 1.0 15.4 26.6 4.6 0.8 6.7 -0.4 1.4 -2.5 -1.7 3.3 2.8 4.5 4.6 6.4 -6.0 3.6 1.0 -2.5 0.4 2.0 2.3 2.4 -7.7 2.1 2.0 -2.7 3.2 -2.1 4.6 10.1 7.8 -3.3 -2.9 2.3 -4.4 6.1 6.2 5.2 -6.8 -1.5 1.1 0.2 2.8 3.2 1.5 5.4 3.1 -3.2 -7.1 1.8 0.3 8.9 -10.0 3.7 8.9 6.8 2.1 1.0 7.5 2.2 -1.0 -6.5 -2.0 4.7 -4.6 5.9 1.0 12.7 -7.3 -3.5 2.8 1.8 1.0 2.7 -0.8 2.9 -3.8 -3.5 7.0 12.4 -3.0 -2.5 -4.1 4.8 1.0 -2.3 -2.7 Q4 2014F 3.8 0.5 7.9 6.1 0.8 -3.4 -1.7 18.6 2.3 7.2 6.4 1.8 1.6 0.9 5.0 -4.3 -6.4 -10.4 6.5 0.2 1.3 -3.8 Q4 2013F 3.0 -1.3 0.8 -3.2 2.5 3.5 8.9 3.0 -2.5 3.1 -0.9 -1.0 -0.5 -3.9 Q3 2014F 3.6 3.8 7.5 3.6 5.8 2.5 5.7 1.4 -1.5 4.5 7.0 -2.5 -1.7 3.3 -1.2 0.6 -1.5 -1.4 6.9 -6.5 1.2 1.0 -2.0 2.9 -3.0 0.3 -2.7 -7.2 1.3 3.4 1.6 -1.0 1.1 1.8 1.2 -1.3 -1.7 3.5 4.5 1.4 2.5 0.5 6.4 1.4 -0.0 -0.6 -1.8 0.9 -0.7 5.3 8.2 1.3 Q1 2013F 2.5 -2.2 2.6 -2.7 4.5 0.3 1.7 -0.5 2.7 2.3 1.0 0.3 -0.6 2.6 3.8 4.6 Q2 2014F 3.2 -3.4 1.0 3.8 1.3 Q3 2012 3.0 -2.7 2.4 -2.2 3.6 -2.7 1.0 4.1 8.5 0.9 0.9 5.4 2.5 5.8 2.6 0.5 1.8 1.5 -1.3 0.0 1.3 -6.5 1.3 -0.0 3.9 1.9 -2.6 -1.1 3.0 -1.1 -3.4 -1.3 2.4 3.8 1.5 3.1 23.0 3.2 -3.3 2.4 1.6 1.5 1.7 7.7 15.5 5.4 -2.4 1.2 1.2 -7.6 4.1 2.5 0.7 2.5 2.8 -0.5 -2.3 -0.5 0.3 5.7 5.9 0.7 2.3 25.2 -4.5 -1.9 -3.3 1.8 3.3 2.5 1.7 6.8 -1.5 -4.2 1.1 2.7 -5.0 -2.8 6.1 13.1 2.8 1.1 -2.3 8.0 3.3 2.0 0.2 0.0 1.0 13.2 3.8 0.4 1.1 1.0 0.5 3.8 0.6 -6.7 5.0 3.6 -1.8 1.0 1.7 5.6 7.8 3.9 -2.5 3.3 -3.8 1.1 1.0 -0.7 3.0 2.1 -3.1 6.8 5.6 -3.3 1.6 3.0 5.2 2.4 0.7 1.7 -2.2 -1.7 -2.9 -1.1 5.0 1.6 0.5 3.2 5.4 2.7 -3.3 -6.9 -1.0 1.0 -2.0 2.0 -4.9 2.1 6.3 2.0 3.3 -6.3 1.1 -3.5 2.2 -3.9 0.9 1.3 -0.9 -10.2 -2.6 -1.2 3.3 2.1 6.2 2.4 5.3 4.5 -2.3 7.6 1.5 -0.8 6.6 7.0 13.2 1.5 -4.8 0.3 -1.0 2.1 5.5 1.9 18.0 12.7 Q2 2012 1.4 Source: DB Research.3 5.2 1.0 -5.8 -1.7 -2.7 -5.0 13.6 3.5 7.1 0.5 -2.8 2.0 1.2 2.8 2.9 3.5 8.8 0.9 4.3 2.8 -6.6 7.0 -1.3 -0.8 2.1 -10.9 -0.1 -5.8 6.4 1.9 0.8 -2.3 1.9 2.9 8.6 0.1 2.4 5.8 1.3 2. 60 9.50 3.00 5.55 6M 2.00 3.00 2.00 7.75 12M 3.50 7.50 2.00 5.75 2.63 4.40 3.50 12M 0.76 Sweden 1.00 5.25 0.00 1.50 Ukraine 7.20 2.10 0.05 0.50 7.10 0.00 Turkey 4.75 2.23 0.08 0.25 3.50 7.20 1.45 9.50 0.00 12M 0.75 4.88 2.00 1.75 1.65 0.00 3.50 Poland 2.00 EMERGING MARKETS OFFICIAL RATES Current 3M Emerging Europe 0.00 16.50 2.00 2.10 0.00 1. as of June 20 Page 52 Deutsche Bank Securities Inc.00 Current 0.95 2.00 2.75 3.00 3.00 3.50 0.51 0.25 4.75 3.40 2.02 Canada Australia New Zealand 1.00 0.77 2.50 Romania 5.05 Czech Republic Hungary 4.90 2.00 Asia (ex-Japan) China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Sri Lanka Taiwan Thailand Vietnam Latin America Argentina Brazil Chile Colombia Mexico 6M 0.50 9.35 1.25 2.25 6.00 12.00 1.27 0.25 4.00 0.10 0.50 0.15 3.30 0.50 0.08 0.25 1.00 8.50 Official rate 3M 0.50 0.50 0.50 3.50 2.50 3. Bloomberg Finance LP.00 0.50 9.50 7.50 0.00 2.50 1.00 1.25 6.25 5.10 0.25 5.00 0.50 1.25 4.00 3.00 1.50 0.75 2.10 0.85 1.25 4.00 0.80 2.20 1.64 10Y rate 3M 2.05 3.88 2.99 3.50 US Japan Euroland Other Industrial Countries United Kingdom 0.00 1.85 1.00 3.00 2.50 5.50 4.00 1.50 0.50 2.50 South Africa 5.00 2.90 1.80 2.82 0.51 0.27 0.50 1.38 9.30 0.10 1.10 1.39 0.75 6.41 2.25 2.50 6.65 3.60 0.00 5.50 Current 2.75 4.45 2.00 1.50 6.10 0.21 3M 0.00 5.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Interest Rates (End of Period) 3M rate Current 0.88 2.09 2.00 17.50 7.50 2.50 2.30 Sources: DB Research.08 0.25 2.75 Russia 8.60 2.26 Norway 1.50 6.25 4.50 6M 0.95 2.05 0.50 5.05 2.25 8.00 13.27 1.50 6.75 2.30 1.50 3.50 3.45 0.00 5.50 9.25 4.00 3.50 7.50 2.50 4.00 0.70 0.05 0.00 0. .51 Denmark 0.10 0.75 4.88 2.00 3.80 2.00 3.05 3.30 0.00 8.50 4.50 1.50 6M 0.00 2.00 0.00 2.50 12M 0.00 1.13 Switzerland 0.50 6.00 0.10 1.10 0.50 2.90 0.00 7.50 4.30 1.00 3.05 1.50 7.10 0.70 9.50 0.50 3.86 1.50 0.50 0. 0 2.03 0.9 94. Page 53 .2 17.06 2.25 127.316 14.5 110.7 18.44 1.10 35.7 0.20 1.930 12. US Dollar) Current US Japan Euroland 98 1.134 16.53 7.50 0.7 1.00 0.04 6.49 Switzerland 0.00 4.55 5.09 32.27 3.98 0.17 10.53 43.32 6.6 110.59 25.71 0.58 1.7 3.38 40.800 1.24 1.68 35.5 2.05 1. as of June 20 Deutsche Bank Securities Inc.58 0.407 15.62 2.76 59.1 2.76 1.84 7.25 1.80 55.18 3M 6M 12M Current 1.896 13.146 3.60 30.68 1.0 105.9 0.60 2.10 7.0 19.100 6.50 152.12 505 1.25 9.6 2.00 1.08 9.005 18.950 11.30 38.301 14.1 237 3.80 1.18 2.0 29.18 133 129 129 132 133 Current 98 FX Rate (vs.4 31.26 110 1.586 7.10 6.20 132 12M 1.68 50.32 9.53 3.2 16.22 1.36 66.514 4.005 5.88 1.40 35.90 10.2 2.130 3.0 14.9 280 4.27 5.04 Sources: DB Research.0 5.6 15.8 3.7 13.040 6.33 10.93 Canada Australia New Zealand Emerging Europe Czech Republic Hungary Poland Israel Romania Russia Turkey Ukraine South Africa Asia (ex-Japan) China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Sri Lanka Taiwan Thailand Vietnam Latin America Argentina Brazil Chile Colombia Mexico 1.2 0.94 660 2.24 1.2 5.01 0.600 1.12 7.05 21.910 12.23 1.85 7.1 1.07 4.02 27.7 90.80 25.982 1.25 1.92 0.80 29.8 88.60 5.56 590 2.00 10.10 10.17 500 1.80 54.0 2.25 1.92 8.005 16.77 55.01 0.4 289 4.0 0.30 13.140 3.78 4.300 8.26 129 6M 1.22 9.80 1.07 42.8 3.30 2.9 0.62 3.15 9.95 0.344 3.41 6.02 0.6 161 17.6 16.424 3.0 0.92 24.06 6.2 102.54 37.78 1.2 76.4 0.45 4.99 1.33 3.32 129 FX Rate (vs.27 3.34 2.6 1.47 31.8 2.10 37.1 0.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Exchange Rates (End of Period) FX Rate (vs. Euro) 3M 1.120 3.91 53.20 113 1.43 32.60 1.09 30.9 2.345 3. Datastream.18 9.25 126. Bloomberg Finance LP.230 1.0 29.04 1.68 169.0 12.79 69.32 4.9 18.8 1.3 6.800 7.8 14.30 1.65 Norway 5.4 30.0 1.86 7.2 30.88 1.7 299.4 87.505 17.440 7.6 90.99 13.5 33.71 9.78 1.46 7.1 0.13 7.13 4.70 1.0 100.200 6.91 10.79 13.85 8.3 0.10 21.29 1.0 160 17.98 2.90 7.43 26.60 21.00 12.5 226 3.92 5.20 63.25 37.06 2.500 1.72 11. Yen) 3M 102 6M 110 12M 113 Other Industrial Countries United Kingdom 1.15 8.39 3.00 30.38 5.88 7.79 8.55 Denmark 5.8 3.0 5.50 21.2 229 3.0 76.85 8.00 7.7 107.8 2.58 602 2.53 152 17.3 158 17.1 0.46 7.67 636 2.52 7.2 0.26 129.54 10.3 16.65 41.50 3.25 8.6 0.27 12.52 36.25 78.5 15.8 107.22 500 1.46 7.4 81.85 7.9 3.20 4.000 1.05 41.37 1.00 10.58 31.27 128.10 42.8 0.20 1.98 0.1 4.26 1.00 25.01 0.0 235 3.48 148.00 4.45 1.0 81.77 0.41 39.29 20.00 10.0 30.80 38.4 0.9 3.10 25.70 21.97 1.05 25.46 7.4 3.40 8.3 3.005 18.16 35.0 107.1 104.8 1.01 0.15 502 1.21 1.2 282 4.35 8.00 21.47 6.78 9.45 3.90 Sweden 6.01 31.60 32.60 49.0 0.6 88.22 6.20 43.59 162.32 102 1.5 33.70 0.189 1.23 57.8 102.00 0.500 1.85 8.81 2.83 6. 9 0.9 Population growth.00 10.1 0.44 1.8 0.2 0.00 8.3 1.19 69.2 1.5 6. n.75 5.0 6.8 1.8 3.00 10500 2.1 0.2 1.5 2.2 1.5 1.a.25 8. Emerging Markets Russia South A frica China India Indonesia Brazil FX rate vs.00 115 1.20 1.0 0. n. n.0 -0.3 2016F 1.9 0.25 1.25 n.3 -0.0 7.00 3. % (eop) 2011 Industrial countries USA Japan Euroland United Kingdom Canada A ustralia 0.00 1.3 0.20 9.2 1.6 1.a.0 CPI inflation.1 2.00 0.27 41.25 n.22 38.a. n.9 1.08 0.3 -0.10 0.79 1.0 3.85 34. n. 1.08 0.20 8. % yoy 2016F 2017F 2011 2012 2013F 2014F 2015F 2016F 2017F 2012 2013F 2014F 2015F Emerging Markets Russia South A frica China India Indonesia Brazil GDP per head.50 7.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Long-term Forecasts GDP growth. 2015F 4.3 2017F 1.1 0.a.a.58 2012 2013F 2014F 2015F 2014F 1.a.5 0. n.50 0.20 1. n.00 1.29 72.7 1.29 36.00 5.98 1.0 2.00 3.4 1.90 2.a.5 2.3 1.00 110 1.05 0.4 1.41 1.4 2.5 7.75 4. n.00 7.06 3.80 3.02 1.5 2.4 1.04 30.a.37 8.25 1.8 1.0 3.2 1.50 n.5 2.5 1.25 4.86 9.33 1.5 0.3 3.00 0.5 0.9 2.a.25 2.8 3.6 5.50 7.3 2.05 1.0 5.16 0.1 -0.0 2.85 52.9 0.8 1.84 1.9 2.a.6 2.2 0.3 7.0 1.4 9.00 0.50 7.00 5.8 5.0 4.9 7.53 2016F 1.a.5 1.50 3. n.2 2.2 0.4 8.7 -0.83 1.50 6.00 0.3 1.4 1.3 2.80 9.0 -0.00 7.a.30 53.5 0.4 2.0 6.a.0 3.6 6.3 -1.80 1. n.5 2.50 5.04 1.3 3.50 2.2 0.5 1. n.5 5.6 1.00 8.24 11743 2.7 4.75 8.9 1.4 3.5 3.98 31.0 3.75 n.00 0.7 -0.0 -0.a. n.1 1.1 1. n.21 1.3 3.25 5.7 2.1 3.4 6.85 1.7 4.a.1 0.00 3.1 1.94 53.4 0.0 5.13 0.93 60.5 6. .5 2.0 1.50 n.1 3.9 0.99 1.00 2.2 7.70 FX rate vs.28 n.4 6.13 10500 2.50 7.75 4.50 1.1 2.2 0.31 1.a.3 1.15 132 1.20 9. n.7 1.5 4.0 1.00 9800 2.10 1.20 4.50 7.9 0.83 1.1 1.2 1.00 77 1.50 6.8 3. n.0 5.8 3.7 2.4 -0. % yoy 2011 Industrial countries USA Japan Euroland United Kingdom Canada A ustralia 1.3 2.03 32.0 4.0 2.05 1.a.7 6.7 2.3 4.83 1.0 5.4 4.21 1.a.0 -0. n.75 2.0 2.88 1.9 1.0 2.20 9.2 0.4 0.2 0.75 2.7 1.50 4.00 0.1 1.0 2.00 87 1.49 6.50 4.4 1.1 7.5 6.10 1. n.1 1.53 58.5 5.a.6 0.10 3.2 2.a.6 2.6 2.05 116 1.00 4.50 9.00 115 1.0 -0.6 2.8 2.50 3.70 6.13 0.09 11.a.a.5 1.2 1.3 2.00 3.16 10.75 1. n.5 4.10 6.a.2 1.75 7. n.50 1.0 7.4 5. % yoy 2011 Industrial countries USA Japan Euroland United Kingdom Canada A ustralia 1.08 0.0 1.45 6.3 4.8 -0.4 4.38 1.2 0.75 0.a.8 1.3 3.08 1.8 0.9 3.8 1.37 1. USD (eop) 2011 Industrial countries USA Japan Euroland United Kingdom Canada A ustralia 1.3 3.8 1.55 1.9 2.00 7.0 2.3 2.44 1.a.18 34.9 0.50 7.5 0.1 6.5 0.3 2015F 1.2 1.4 2. n.3 0.25 0.00 1.20 132 1.8 8.4 0.9 0.3 8.a.3 4.7 5.4 3.00 9.30 1.3 1.85 10.24 34. n.5 1.1 1.50 0.7 1.3 4. 2016F 5.4 1.6 6.8 2.6 2.92 7.5 2.7 3.a.50 8.30 8.4 0.3 0.00 3.31 12722 2. n.7 0.85 4.30 100 1. EUR (eop) 2016F 2017F 2011 2012 2013F 1.75 0.75 0.5 5.16 0.85 33.8 1.5 -0.25 0.28 54.28 37. 10Y bond yields (eop) 2017F 2011 2012 2013F 2.8 1.88 0.2 1.14 55.2 6. DB Research Page 54 Deutsche Bank Securities Inc.5 5.7 -0.3 2.00 110 1.0 2. 2017F 5.00 5.8 5.8 5.9 8.10 0.2 2.3 6.50 0.3 3.68 n.95 11500 2. n.1 0.32 114 1.1 0.69 1.32 1.58 8.0 4.3 8.94 3.4 1.00 5.05 0.5 1.8 1.3 0.00 3.5 6.44 1.8 4.a.00 5.50 2.10 127 1.8 1.6 3.a.7 2.9 -0.39 1. n.0 5.03 53.9 0.44 Emerging Markets Russia South A frica China India Indonesia Brazil Source: National Authorities.a.2 2.30 1.8 2.3 0.5 0.00 0.a.49 2017F 1. % yoy 2016F 2017F 2011 2012 2013F 1.50 6.7 1.8 1.5 1.5 6.78 52.4 1.00 3.8 3.15 1.a.8 6.16 1.15 10.6 5.0 2.1 2.5 5.30 9.8 -0.2 1.00 5.5 7.27 40.00 0.90 6.2 3.01 6.75 4.3 5.50 7.6 1.00 9800 2.81 1.00 9.0 6.5 1.00 0.9 1.a.8 0.3 1.63 1.8 1. n.0 4. n.a.3 2012 2013F 2014F 2015F 2014F 1.1 -0. n.1 2.3 -0. n.00 5.a.0 1.14 6.50 2.50 1.78 9638 2.a.2 1.0 7.90 32.4 2.26 9033 1.2 1.4 3.5 6. n.8 0.8 1.3 Emerging Markets Russia South A frica China India Indonesia Brazil Key official interest rate.1 5.15 1. n.4 1.76 0.75 5.50 10000 2.5 2.5 1.00 9.30 4.25 6.75 7.9 0.4 6.5 8.00 4.8 6.3 7.2 1.00 10000 2.10 0.00 6. n.00 110 1.50 3.50 9.0 -0.0 5.4 1. n.0 4.3 4.0 1.0 2.50 4.2 2.85 33.a.59 2015F 1.90 3.6 1.a. n.4 2.3 4.1 1.30 11000 2.50 5.21 8.00 1.1 3.10 55.a.44 1.00 12600 2.7 1.00 11.5 0.75 0.2 5.5 0.8 8.75 0.75 3.00 0.5 9.50 3.a.78 52.0 3.5 7.75 1.5 6.9 5.a.32 1.73 1.00 110 1.0 7.1 -0. n.6 7.1 0.00 3.a.90 4.00 1.25 4.3 5.2 0.5 2.75 7.1 5.5 1.3 2.32 66.25 5.2 1.50 7.3 3.00 1. n.3 2.8 2.00 10000 2.8 1.0 2. 2012 2013F 2014F 2015F 2016F 2014F 3.4 8.2 3.2 2. 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[email protected]@db. db. Peter Hooper/Thomas Mayer/Michael Spencer Page 56 Deutsche Bank Securities Inc. the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. .eqsr Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.com/ger/disclosure/DisclosureDirectory.20 June 2013 World Outlook: Fed Policy Tapers Global Markets Appendix 1 Important Disclosures Additional information available upon request For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research. In addition. changes in tax policies. and/or fluctuations in market value. These trade ideas can be found at the SOLAR link at http://gm. 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