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Global Macro Views

November 2013

Executive Summary

The degree to which the recent slowdown in emerging market economies is cyclical versus structural is an ongoing debate. Our view is that it varies country by country. In the case of China, the slowdown appears to be mostly structural as the government moves to adopt a new growth model oriented toward consumption given diminishing returns to investment. By contrast, in Latin America, the slowdown seems to be mostly cyclical as weaker currencies prompt tighter monetary policies. For these emerging market (EM) countries, the timing of tapering quantitative easing (QE) by the U.S. Federal Reserve (Fed) is of the utmost importance. Our view is that the recent economic data do not warrant any changes in the Fed's asset purchase plan before early next year. We believe that the market is better prepared for this eventuality than it was in the spring. Therefore, we believe the increase in U.S. interest rates will be less disruptive when the Fed finally does taper. Overall, we maintain our forecast for global GDP growth of 3.0% in 2013 and 3.5% in 2014.

United States

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

 

Source: Standish as of November 7, 2013

The U.S. economy expanded at an annual rate of 2.8% in Q3 2013 versus consensus expectations for growth of 2%. However, the upside surprise was primarily due to an inventory build, which is likely to reverse in the coming quarters. Consequently, we downgraded our Q4 growth forecast to 2% as inventories are drawn down and the effects of the 16-day government shutdown filter through the economy. Looking beyond the short-term noise, the recent strength of the U.S. manufacturing and service sector purchasing manager's indices has led us to upgrade our forecast for 2014 to 2.5%. Although the Federal Reserve has indicated that they expect to begin tapering their $ 85 billion quantitative easing (QE) program by the end of 2013, developments in Washington have made this much less likely. Moreover, key gauges of inflation have been trending lower and are well below the Fed's 2.0% target. Therefore, we believe the Fed will wait to adjust its asset purchases until either its January or March meeting.

Euro Area

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

Source: Standish as of November 7, 2013

The initial October purchasing managers surveys for the euro area suggest that the recovery, which began in Q2 2013, has lost some momentum. We expect growth to be sustained, but at a somewhat more subdued pace in the second half. Inflation remains well below the European Central Bank's (ECB) target of just below 2%. Indeed, the October consumer price index (CPI) print came in at 0.7% year-on-year (y/y), significantly lower than the September print of 1.1%. Non-demand related factors such as weak food prices, lower pass-through of the value added tax rise in Italy, and smaller than usual increases in university fees in Spain partly explain the weakness. Nevertheless, the downward trend bears watching. Although it is unlikely the ECB will change its assessment of deflation risks on the basis of just one data point, this does apply downward pressure on its inflation forecasts. Thus, we were not surprised by the ECB's decision to cut its main refinancing rate at its November meeting, and we believe additional measures to enhance liquidity are possible in 2014.

United Kingdom

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

Source: Standish as of November 7, 2013

The preliminary estimate of U.K. GDP for Q3 2013 came in at expectations with an increase of 0.8% quarter-on-quarter (q/q). Economic growth was broad-based, but construction was particularly strong due to several government housing schemes. Other drivers of growth included retail services (up 1.3% q/q) and business/financial services (up 1.0% q/q). By contrast, transport/storage services and government services were relatively weak. The component data suggest that the U.K. economy has failed to rebalance since the recession. Even so, the U.K. recovery has been relatively strong during 2013 with the economy growing at an annualized rate close to 3%. Looking at the components on an annualized basis, service output rose 2.7%, manufacturing rose 3% and construction rose a stunning 9%. In all, the Q3 growth rate is the fastest we have seen in over three years, with long-run average U.K. growth at 0.6% q/q. Thus, we have revised our U.K. growth forecasts for 2013 upwards to 1.4% year-on-year. Despite the headwinds from deleveraging and tighter monetary conditions, we expect strong growth to continue throughout 2014 and 2015.

China

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

Source: Standish as of November 7, 2013

Chinese economic activity rebounded with real GDP increasing 7.8% in Q3 2013. Growth was supported by heavy industries and a bounce back in credit creation following the June liquidity squeeze. We see the momentum carrying forward into Q4, but it may be partly offset by tighter monetary conditions. We expect growth to peak during the second half of 2013 and to slow to 7% in 2014. We anticipate that the government will continue to pursue its reform agenda, balancing the need to contain financial risks in the system against maintaining economic stability. We expect to hear general guidelines on structural reforms in the November plenum of the Communist Party, but we do not believe the implementation of these reforms will be enough to reverse the slowdown in growth we see coming next year. We will be watching the Central Economic Work Conference in December for the official 2014 growth target which will likely be at 7.0%.

Japan

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

Source: Standish as of November 7, 2013

The outlook for the Japanese economy remains positive. The labor market continues to perform well with total employment trending upwards and the labor force participation rate rising on a year over year basis for the first time since 1996. The unemployment rate has ticked up from 3.8% in July to 4% in September as the number of employed and unemployed rose in tandem. However, in light of Prime Minister Abe's desire to better utilize Japan's human capital, a jump in the unemployment rate in the context of a rising labor force participation rate and consistent growth in total employment should be considered an encouraging sign. We have yet to see definitive signs of rising wages in the official data, but anecdotes suggest that as the labor market tightens (and the government encourages them to do so) Corporate Japan is in the preliminary steps of increasing worker compensation.

Latin America and Brazil

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

Source: Standish as of November 7, 2013

Latin American economic growth continues to disappoint with mixed data readings during Q3 2013. Brazil and Mexico, the two largest economies in the region, will only expand around 1% to 2% in 2013. The timing and magnitude of the tapering of quantitative easing in the United States is now one of the major external risks, as the possibility of this event has a significant impact on global liquidity, risk appetite and currency volatility. Although the outlook suggests a firming up of the economic expansion in 2014, most of the countries in the region will continue to grow at or below the downwardly revised potential output level.

Eastern Europe

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

Source: Standish as of November 7, 2013

The growth momentum in Central and Eastern Europe remains encouraging, although the improvement is from a low base. Growth in Hungary has picked up on exports to Germany and gradually improving domestic demand. The central bank lowered the policy rate yet again, having now reduced the rate 15 times in a row. Headline inflation has come down, partly due to utility price cuts. The government is again aiming to reduce the amount of FX mortgages by pressuring banks to convert these to local currency mortgages at favorable exchange rates. The cost is expected to largely be borne by banks. In Turkey, external imbalances remain, and the pace of stimulus withdrawal from the U.S. Federal Reserve will play an important role in the near term outlook for financial stability and confidence. Slower credit growth has continued given higher rates and tighter liquidity, which at the margin is a positive from an external balance perspective. Inflation remains significantly above the target, and the willingness and ability of the central bank to bring down inflation will be closely watched by the market.

South Africa

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

Source: Standish as of November 7, 2013

Growth indicators remain mediocre in South Africa. The Finance Minister released The Medium-Term Budget Policy Statement in October, predicting a slightly improved balance of 4.2% in 2013/14. At the same time, growth assumptions in 2014 and 2015 were revised down to 3.0 and 3.2% respectively, around a half a percent lower than the previous forecasts. The new forecasts are realistic and in-line with our own. Partly as a result of the lower growth assumptions, public debt to GDP is now expected to peak at a higher level of 44% in 2017. On the external side, the weaker South African rand should be a positive for the trade balance in the medium/long-term, but little evidence of a rebalancing has emerged thus far as weak export prices and labor unrest have hurt exports.

Russia

  ↑ positive surprise more
likely over next six months
↓ negative surprise more
likely over next six months
— no bias

Source: Standish as of November 7, 2013

Recent data releases point to continued economic slowdown in Russia. Retail sales and industrial production are showing further weakness, and flooding has reduced agricultural output, counterbalancing general expectations that the harvest would be strong. Monetary policy remains tight in this context, but the diminished harvest points to headline inflation falling only gradually. Thus, the central bank has been reluctant to cut rates. However, it has signalled that it may do so in November. Exchange rate policy liberalization progresses towards a free float by 2015 and the central bank has widened the inner intervention band for the ruble versus its basket.

The comments provided herein are a general market overview and do not constitute investment advice, are not predictive of any future market performance, are not provided as a sales or advertising communication, and do not represent an offer to sell or a solicitation of an offer to buy any security. Similarly, this information is not intended to provide specific advice, recommendations or projected returns of any particular product of Standish Mellon Asset Management Company LLC (Standish). These views are current as of the date of this communication and are subject to rapid change as economic and market conditions dictate. Though these views may be informed by information from publicly available sources that we believe to be accurate, we can make no representation as to the accuracy of such sources nor the completeness of such information. Please contact Standish for current information about our views of the economy and the markets. Portfolio composition is subject to change, and past performance is no indication of future performance.

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11/2013