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Why Brazil and Germany Will Outperform IMF Favorites China and India in 2010

Martin Hutchinson — Fri, 10 Jul 2009 15:00:49 +0000

Markets were cheered Wednesday when the International Monetary Fund (IMF) projected global growth of 2.5% for 2010, a slight increase from its earlier forecast of 1.9% growth. That’s good news for investors – but consumers in the United States and investors focused on it may not see much benefit.

The IMF forecast for the United States does not sound like a lot of fun: The organization is projecting growth of only 0.8% for this country next year. That forecast runs contrary to currently optimistic rhetoric about the recession bottoming out, and may account for the stock market’s weakness over the past year or so as the very real prospects of a sustained economic bottom begins to sink in with investors.

My own view is that the IMF is about right for 2010, largely because the U.S. economy may not yet have bottomed. While economic indicators have certainly improved from their dreadful levels of the first quarter, forward-looking signals – such as consumer confidence – are still at very low levels, indeed. And that signals a moderate decline, rather than stabilization of economic output.

What’s more, the U.S. federal government is running deficits far beyond the records ever seen in peacetime. That has already had an effect on the bond markets, which have seen a substantial rise in yields from a low of 2.07% in December to around 3.4% currently – not a usual feature of an economy whose gross domestic product (GDP) is declining substantially. That suggests that the normal healthy bounce from the bottom of recession may be muted by financing difficulties from the huge federal deficits, with the economy continuing to decline for longer than expected and recovering only feebly thereafter.

In that context, the Obama administration’s $787 billion stimulus may have been misguided, based as it was on economic theories that make very little sense. Such a large amount of extra federal spending has to come from somewhere, and if the government is running a budget deficit, that shortfall has to be borrowed. While a country with a modest fiscal deficit can afford a certain amount of stimulus, that’s not the case for a country whose budget was already in deficit by more than $1 trillion – or 7% of GDP – when President Barack Obama came into office.

By enlarging the deficit so much, the administration may well have destabilized the bond market, preventing the rapid turnaround in the economy that could otherwise have been expected. As a side effect, the stimulus may also have made it more difficult to pass President’s Obama’s hoped-for packages on global warming and healthcare, making it counterproductive politically as well as economically.

Beyond the U.S. borders, the outlook is somewhat brighter. Some countries – such as Britain, for instance – are in much the same mess as the United States, with excessive deficits and a money-printing central bank. Indeed in Britain, the central bank has for the last three months been buying enough government bonds to monetize the entire British budget deficit, reducing the upwards push on bond yields, but managing to re-ignite the British housing market, which had become even more overvalued than its also-overvalued U.S. counterpart.

The IMF forecast for Britain is worse than the projection for the United States – a decline of 4.2% in 2009 GDP, and a rise of only 0.2% in 2010. That looks about right, though some of the 2009 decline may be pushed into 2010 by the Bank of England’s actions.

In China, the picture is unclear. The IMF estimates growth of 7.5% in 2009 and 8.5% in 2010, by far the best performance of any major economy, but this both takes Chinese statistics at face value and underestimates the risks facing China’s economy.

Bank lending in China was more than $800 billion in the first quarter and was again running at record levels in June; it is thus likely that China is over-indulging in real estate projects with no tenants, as well as subsidies for hopelessly unprofitable state enterprises. This means there is a substantial downside risk for China’s growth, and 2010 may be much less pretty than 2009.

This is also true for India, where the IMF estimates 5.4% growth in 2009 and 6.5% in 2010, but does not take account of the out-of-control expansion in Indian government spending – up by 36% this year to spawn a deficit in excess of 10% of GDP.

In the past, India’s economic expansions have at times been choked off by credit crunches that surface when government deficits cannot be financed. This time around the same outcome is likely. As with China, I would expect 2010 to be much less likely than 2009.

Finally, there are two countries I believe the IMF is being overly pessimistic about: Brazil and Germany.

For Brazil, the IMF is forecasting a 1.3% GDP decline in 2009, followed by 2.5% growth in 2010. This looks too low. Brazil’s trend growth rate is around 5%, and it has little trouble selling its commodity-and-energy exports when China’s demand is still growing.

Furthermore, Brazil’s budget deficit is modest and its interest rates are just below 10% — still substantially above the country’s inflation rate of 4% to 5%. I would thus expect Brazil to considerably outperform the IMF’s forecast, showing little net decline in 2009 GDP and growth close to its 5% trend in 2010, with domestic demand joining exports as a source of strength.

Finally, the IMF is exceptionally pessimistic on Germany, forecasting a 6.2% decline in 2009 GDP and a further 0.6% decline in 2010. Since German industrial production rose by 3.7% in May and its trade surplus rose to a record 10.3 billion euros (about USD $14.4 billion), this is far too pessimistic.

Germany has been notably cautious in its stimulus, and the German budget deficit is still only around 3% of GDP. Consequently, that key European nation is likely to find expansion easy to finance, and will outperform significantly the rest of the EU in the months ahead, showing a brisk recovery from its sharp downturn. I would expect Germany’s 2009 GDP decline overall to be a mere 2%-3% and its 2010 growth to be substantial, at least 2.0%-2.5%.

The IMF and I agree that the world economy is once again decoupling, with 2010 growth much stronger outside the financial-services-oriented economies of Britain and the United States. However, we disagree on where growth would be strongest; my picks would be Brazil and Germany, not the IMF’s fashionable China and India.

Source: Why Brazil and Germany Will Outperform IMF Favorites China and India in 2010

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Oil, Ignoring Record OPEC Cut, Hovers Near $40

Contrarian Profits — Thu, 18 Dec 2008 12:03:21 +0000

U.S. crude hovered near $40 a barrel on Thursday, around its lowest price since July 2004, amid doubts in OPEC’s ability to curb output quickly after the group announced record production cuts.

Oil is $107 off its July peak, shedding value as the onset of a global recession cuts into fuel demand. Top forecasters now predict the first decline in world energy use since 1983.

“The verdict was a resounding vote of no-confidence in the (OPEC) cartel’s ability to curtail production given its previous tendencies to backslide on commitments,” said Edward Meir of MF Global in a research note.

U.S. light crude for January delivery tumbled nearly 8 percent on Wednesday as traders dismissed OPEC’s 2.2 million barrel per day (bpd) output cut, decided in Algeria.

The contract touched $39.19 on Thursday, its lowest price since July 2004, and was trading up 24 cents at $40.30 a barrel by 1002 GMT.

London Brent crude for February rose 38 cents to $45.91.

The cut announced by the Organization of the Petroleum Exporting Countries on Wednesday is its third since September.

For those curbs to be effective the fractious group will need to enforce compliance, historically a tricky task in a falling market. OPEC itself estimates November production cut compliance by its members at around 50 percent.

Next year’s outlook is increasingly bleak as economic indicators show a deep global recession taking hold, causing oil demand to fall from the United States to China.

JPMorgan cut its 2009 average crude oil price forecast to $43 a barrel from $69 following OPEC’s cut, and analysts say more losses are in store until a sufficient supply is taken off the market or demand levels swing back up.

Chris Baldwin
LONDON, Dec 18 (Reuters)

Misguided Risk Aversion

Chris Gaffney — Fri, 21 Nov 2008 16:04:20 +0000

Bad data pushes investors into US treasuries… Barclay’s says the euro will rally… SNB surprises with a rate cut… Iceland gets their bailout… And Now… Today’s Pfennig!

Good day…The dollar rallied a bit yesterday on some very poor economic data which illustrated just how bad things are getting here in the US. As Chuck has repeatedly told everyone, in the current trade pattern the dollar rallies whenever we get negative data for the US economy. Investors get spooked by this negative data, and run scared into the ’safety’ of US treasuries.

Ty sent me a quote from respected newsletter owner/author Bill Bonner yesterday: “Misguided risk aversion, anyone? A few months ago, investors stretched for yields. Now, it’s safety they reach for…and grab U.S. Treasury debt with both hands. Investors now seem to have an unqualified trust in the full faith and credit of the world’s largest debtor. Yields on 91-day T-bills have fallen to 0.11% – scarcely a tenth of one percent!”

And when you adjust these yields for US inflation, the real yields on US treasuries are negative (even the 10 yr treasury real yield is -.43%!!). These investors won’t be parked in US Treasuries for long, but while fear continues to drive the markets, the US dollar will remain strong.

The data which sent shivers down investors spines yesterday was a one two punch of weekly jobless claims and leading indicators. The number of Americans filing for unemployment benefits approached a 26-year high of 542,000 last week. The Unemployment rate will likely increase another 100 bps by this time next year, and stay at these elevated levels for an extended period of time.

The second blow came shortly after the jobs data was released, as the index of leading US economic indicators fell in October for the third time in four months. The Conference Board’s gauge dropped .8%, more than forecast, after rising .1% in September. This index points to the direction of the economy over the next three to six months. Consumers and companies are cutting back as job losses mount and housing and manufacturing sink deeper into a slump. These two pieces of data indicate just how quickly the US economy is falling into recession.

Investors fled stocks and moved back into dollars throughout the trading day yesterday, rallying the dollar index back to the highest level since April 2006. We moved above 88 on the dollar index a week ago, but it was unable to maintain the higher level.

The same thing occurred last night, as equity markets in Asia rebounded, bringing the dollar index back below the 88 handle. Apparently there was speculation that a sale of Citigroup Inc. will reduce risk in the financial system, slightly increasing the confidence of investors. This is how perverse these markets have become; the possible sale of one of the largest financial firms in the US actually rallies the markets.

The European Union announced that is crafting a coordinated economic stimulus package to spur its 27 nation economy. European Commission President Jose Barroso told reporters in Brussels today that the commission will announce a fiscal stimulus plan next week. The plan will be based on member states taking measures suited to their own economic situation. I like the approach the EU is taking to the crisis, as they will design the stimulus to try and meet the differing needs by each country. According to the EC president, “Everyone is suffering from the crisis and everyone needs treatment, but not everyone needs the same pill.”

According to Barclay’s Capital, the euro will strengthen 16 percent against the dollar in the next 12 months as Chinese demand drives up prices for oil, reducing the US currencies attractiveness. Two-thirds of the euro’s 22 percent slide since the July peak of $1.6038 can be accounted for by plunging oil prices, Barclays said. China is the second largest oil consumer after the US, and “Contrary to current received wisdom, oil prices are much more important for the euro-dollar cross than either the stock market or interest rate differential right now,” wrote London-based David Woo, global head of currency strategy at Barclay’s. Declining oil prices have helped the greenback by narrowing the US current account deficit, reducing the US’s need for overseas funding, Woo said. He forecasts the euro will trade in a range around $1.24 in the next three months, but then rally to $1.45 over the next year as accelerating growth in China helps oil prices retrace their recent fall.

I agree with Barclay’s analysis of global commodity prices. China and the rest of Asia will continue to be the world’s growth engine, and demand for commodities will increase. The stimulus packages which are being pushed will put additional upward pressure on raw material prices. The commodity rally will not only help the Euro, but will help push up prices of the Norwegian krone, Australian dollar, and Brazilian real.

Switzerland’s central bank surprised the market yesterday, dropping its benchmark interest rate by 100 basis points. The Swiss National Bank reduced its target for the three month Libor to 1 percent and promised a ‘generous and flexible’ supply of Swiss Francs. It’s the third unscheduled move by the SNB since the beginning of October. I would expect the SNB to keep rates on hold at their meeting next month given the extent of yesterday’s move. The Swiss Franc fell as the dollar strengthened yesterday, but rallied overnight and is now trading close to where it was prior to the SNB move.

In other interest rate news, the Bank of Japan kept its benchmark rate at .3 percent today and said it will consider pumping more money into the financial system to prop up an economy that fell into recession last quarter. Japanese banks are in a much better financial position that banks in the Eurozone or the US, and the Japanese consumers are flush with cash. Japan went through a long deflationary period, and consumers there are less leveraged than here in the US. The stronger position of Japanese banks, and the more solid consumer base will enable the Japanese economy to weather the global slowdown much better than most other economies. The yen will retain its attractiveness as the world faces a long, long recession.

Technical analysts predict the yen may rally to 92.50 in the short term, and could move above the 13 year high of 90.93 which it hit on October 24. According to the analysts, the so-called support level is near the bottom line of a trend channel that tracks the dollar’s decline from a two week high of 100.55 yen on Nov. 4. The US currency is poised to extend a 3.5% loss this month as it failed to rise above the 20 day moving average and the down trend is still very clear.

The Australian dollar approached a five year low against the dollar in late US trading and the New Zealand dollar traded near a six year low as investors moved out of the carry trades after the negative US data yesterday. But the Australian dollar bounced back overnight as the Reserve Bank of Australia announced it had bought a record 3.15 billion Australian dollars in October. The RBA continued to purchase its own currency this morning, “providing liquidity as on previous occasions,” said a spokesman for the Sydney-based central bank. The Australian dollar has posted a record monthly drop in October and the RBA has been purchasing the AUD$ in an attempt to slow the drop. Commodity prices continue to fall, dragging down the exchange rates of commodity exporting countries. Falling interest rates have also put pressure on the higher yielding currencies of NZD and AUD.

Iceland finally got the long promised bailout from the IMF and four Nordic countries yesterday. The IMF and four Nordic countries gave Iceland a $4.6 billion bailout. The Icelandic government will also borrow about $6.3 billion from the UK, Germany, and the Netherlands to cover foreign deposit guarantees at failed lenders. While the rescue was desperately needed, it will heap almost $11 billion of debt on the shoulders of the islands population of just 320,000. “This is an extraordinary scale of problem related to the size of the economy,” IMF Mission Chief to Iceland Poul Tomsen told reporters. “Iceland is in an unprecedented situation.” GDP in Iceland is predicted to shrink about 10 percent next year, the IMF says. The island had the fifth-highest per capita income in the world in 2007, but the collapse of their financial system has caused the Icelandic krona to lose two thirds of its value this year. The rescue may start to add some liquidity back into the banking system, but the massive amount of debt will likely keep the Icelandic economy from rebounding for a number of years.

Currencies today 11/21/08: A$ .6212, kiwi .5272, C$ .7817, euro 1.258, sterling 1.4982, Swiss .8194, ISK (No Quote), rand 10.46, krone 7.0831, SEK 7.2031, forint 211.78, zloty 3.046, koruna 20.405, yen 94.87, baht 35.22, sing 1.5304, HKD 7.7513, INR 50.02, China 6.8311, pesos 13.8031, BRL 2.457, dollar index 87.56, Oil $50.38, Silver $9.17, and Gold… $756.88

Source: Misguided Risk Aversion