Global Data Watch: A sharp downshift in industry ends now

Global Data Watch: A sharp downshift in industry ends now

Amid rising uncertainty around where the global expansion is heading, the path the industrial sector is following is plain to see. During the first quarter, strong output gains were accompanied by a softening in final demand that was due largely to the consumption drag from rising energy and food prices. A divergence between output and demand growth signaled that a slowing in the pace of inventory growth was inevitable and looked likely to play out over a number of months. However, the disruptions caused by the Tohoku earthquake point to a faster and more intense adjustment. The 15.5% decline in Japanese output in March underscored the power of an event that we felt would have major global repercussions (see “Global repercussions from the Japanese earthquake,” Global Issues, Mar 25, 2011). With a full slate of April activity data now in hand, its powerful global impact is on display. Global output ex.-Japan fell 0.5% in April. Japan’s footprint is evident in the generalized output declines in its closest trade partners—EM Asian output fell 2.0%—in the 8% declines in auto production in the US and UK, and in the collapse in imports from Japan across a wide range of countries.

The intensity of decline over March and April—global industrial activity fell an estimated 1.3%—confirms an accelerated inventory correction and sets the stage for output to rebound into midyear. May will mark the start of the anticipated V-shaped recovery in Japan. Over the next two months we expect Japanese output to rise by more than 10%. Global auto production also is due for a bounce. This message is signaled by Mexico’s May output gains and upcoming production plans in the US. Next week, May industrial production gains in the US (0.5%m/m sa) and China (0.6%) should provide tangible evidence that this sharp downshift in industry is over.

A midyear rebound in manufacturing output should calm fears regarding the sharp slide in growth momentum and signal that the life of the global expansion is not at risk. However, the inventory adjustment is not complete, and the pace of non-Japan output gains is expected to remain subdued through the summer months (see “Global manufacturing slowdown unfolds in stages,” GDW, Jun 3, 2011). Our attention now turns to the path of final demand, which holds the key for the pace of overall growth during 2H11. But, the path ahead is not as clear as the one for production. We remain confident that consumption growth will soon pick up as a fading commodity price shock combines with a rebound in Japanese demand. Outside Japan, this rebound does not look to have yet materialized. Next week’s May US retail sales report is expected to produce a soft core gain (0.1%m/m). In China, falling car sales are weighing on demand in the face of solid overall retail sales volume growth (1.3%m/m sa).

The behavior of US and Chinese firms will be important to track. Both economies have downshifted during 1H11, raising questions about whether this will feed into softer hiring and investment. In China, a rebound in imports last month was a positive signal although details suggest an inventory correction is still in train. Next week’s reading on fixed investment should show sustained solid growth outside of real estate. US releases should continue to highlight softness in the June homebuilding and regional manufacturing surveys. A more positive tone is expected from survey details on inventory adjustments and capex intentions.

Greek debt restructuring likely in 2012

In advance of the Eurogroup meeting on June 20, the situation regarding the next leg of financial support for Greece remains highly confusing. After officials appeared to have agreed on the concept of a Vienna initiative-type rollover last week, the German finance minister caused an uproar this week with a letter to his fellow finance ministers and the ECB insisting that private sector participation had to go far beyond a Vienna initiative, with the German government apparently pushing for a seven-year maturity extension.

Meanwhile, President Trichet reaffirmed the ECB’s opposition to any kind of event that causes the credit rating agencies to move Greek debt to selective default or default. The central bank would only go along with the most voluntary of voluntary rollovers, which would unlikely deliver much participation. Given its ability to refuse to accept restructured debt as collateral in its liquidity-providing operations, the central bank is in a strong negotiating position.

Somebody has to concede ground over the coming days or the region will experience a full-blown financial crisis. Our inclination is to think that the German government will back down and that the region will reach an agreement on a financing package that will include some modest, voluntary private sector involvement. This compromise should be revealed either following the Eurogroup meeting on June 20 or following the heads of state summit on June 23-24.

But the question about a more formal debt restructuring is unlikely to go away. As part of a new package the Greek government will have to commit to additional fiscal tightening and an aggressive program of asset sales. Given the political situation in Greece, it is highly likely that it will fail to meet the new program objectives over the next six to 12 months. The Greek prime minister is struggling to build a broad consensus of support for both fiscal measures and asset sales, within the government itself as well as with the opposition and the public. If Greece does indeed fail to meet the new program objectives, then the restructuring debate will return to where it is currently.

While a formal debt restructuring is unlikely over the next few weeks, it now seems likely that one will occur before the end of 2013, which had been our central view until now. Thus we are now inclined to expect some kind of formal maturity extension to take place in the first half of 2012. Officials will still want to avoid a more aggressive principal haircut. Of course, a maturity extension does not solve Greece’s debt sustainability problem: it is another way of buying time and trying to incentivize Greece to make further adjustments to prevent a more aggressive debt restructuring later on.

Demand shock fading in Japan

While much of the focus has been on the collapse in Japanese IP and exports in the immediate aftermath of the March 11 disasters, the economy also experienced a shock to demand. Although this pales in comparison to the 15%-plus decline in IP, consumer spending contracted nearly 5%m/m in March. The good news is that like production, consumer spending is rebounding quickly, with this week’s reports delivering a 2.4%m/m advance in April. The impressive advance in the Economy Watchers small business survey, which was led by consumer-oriented businesses, points to continued recovery into midyear. Next week’s reports will shed light on the progress of corporate activity. We think the machinery orders report will show that Japanese capital spending was little affected by the March 11 disaster. The June Reuters Tankan is expected to confirm the robust production plans from the April IP report.

EM rate hikes to slow after June

Central banks in Brazil, Korea, and Poland hiked rates this week, in a reminder that EM policy normalization continues even in the face of a widespread growth slowdown (EM growth is forecast at a decidedly subpar 4.5q/q saar rate this quarter). Policymakers in India, the Philippines, and Chile are expected to follow suit with actions next week. Although there are still moves in the pipeline, it appears all but certain that the pace will soon slow as growth fears mount and a retreat in headline inflation looms after midyear.

The Bank of Korea has maintained a relatively cautious approach to normalization, and there was speculation it would pause this week. In the event, the BoK did raise rates, with Governor Kim indicating that he expects the recent softening in the economy to be temporary. Although the Bank expects a decline in headline inflation in 2H11, it sounded a warning about a further rise in the core rate. If our forecast that GDP growth will bounce back next quarter is correct, then the next rate hike should occur in early 4Q.

The next test of the determination of EM Asian policymakers to proceed with normalization is next week’s Reserve Bank of India meeting. Activity indicators have moderated in India as elsewhere in Asia. Balanced against this is the prospect of high inflation readings in both next week’s May report and in subsequent months. While we recognize the possibility of a pause in the rate cycle, our call remains for a 25bp hike. In the Philippines, the central bank is expected to raise rates 25bp and then go on hold. Action also could come in China, if not next week, then sometime this month, in response to next week’s expected 5.4%oya May CPI inflation reading.

We pushed back expected rate hikes in several CEEMEA countries this week. In Turkey, weaker activity data, the increased chance of some fiscal tightening after the elections, and especially the CBRT’s determination to stick to its unorthodox monetary policy mix prompted us to push out expected rate hikes to 4Q11. In Russia, we now look for a more extended pause through September or October. In South Africa, we continue to expect the central bank to begin a rate cycle with a 50bp hike in September, yet with very recent SARB communications turning more dovish, the risk is that the move is postponed until November.

Political noise intensifies in Latin America

Last weekend’s election of the leftist presidential candidate Ollanta Humala in Peru’s runoff vote and the subsequent collapse in Peruvian markets on Monday came as reminders that politics can still be a powerful market driver in the region. While the 12.5% drop in the Lima equity market on Monday was partially reversed in the following days amid talk of market-friendly cabinet appointments, concerns over Humala’s true policy intentions linger. Indeed, the economic impact of such uncertainty is already showing up in leading indicators. Apparently for that same reason Peru’s central bank decided to pause its rate tightening cycle this week. We think the BCRP will remain on hold indefinitely.

Political issues have also come to the fore in other countries in the region. Argentina is gearing up for its own presidential elections in October, and uncertainty lingers over the precise lineup of candidates and political alliances that need to register in the coming weeks. Recently, Argentine markets have been volatile in response to press speculation (which we would disregard) that President Kirchner may not run for re-election. In turn, Tuesday’s resignation of Antonio Palocci as President Dilma Rousseff’s Chief of Staff in Brazil will likely weaken political coordination within the administration (for example, Palocci was crucial in the approval of a lower-than-anticipated minimum wage) and reduce the likelihood of advancing any positive economic agenda through Congress or of restraining government spending.

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