Transcript
Speaker: This is HSBC Global Viewpoint, your window into the thinking, trends and issues shaping global banking and markets.
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Speaker: Hello and welcome to the Macro Viewpoint from HSBC Global Research, our weekly podcast featuring the views of leading HSBC analysts on the outlook for the global economy and markets.
Speaker: I'm Chris Brown-Hulmes and I'm joined by Mary Watkins.
Speaker: Hi Chris, coming up on this week's programme, the ECB has just concluded its latest strategy review and amongst other measures it set a new inflation target.
Speaker: We get the details from Chris Hare, senior European economist.
Speaker: Staying in Europe, we assess the demographic shifts underway across the continent.
Speaker: James Pomeroy, Fabio Balboni and Edward Stanford talk us through the economic and investment implications.
Speaker: The dollar has been on the front foot in recent weeks.
Speaker: We look at whether this can continue with Paul Mackle, Global Head of FX Research.
Speaker: And following a rather positive second quarter, can the performance of emerging market assets be sustained going into the second half of the year?
Speaker: We speak to Ali Chakiroglu, EM Strategist.
Speaker: This podcast was recorded on Thursday, the 8th of July, 2021.
Speaker: Our full disclosures and disclaimers can be found in the link attached to this podcast.
Speaker: We begin this week in Europe where the ECB surprised by publishing the outcome of its strategy review earlier than expected.
Speaker: Let's get the details from Chris Hare, European economist.
Speaker: So, Chris, I think the main focus here is obviously going to be inflation because the ECB has now set a symmetric 2% inflation target.
Speaker: Can you just tell us how that differs from what's currently the case and what it means?
Speaker: Yeah, so the ECB announced in its review that it would essentially switch to a so-called straightforward symmetric 2% inflation target rather than a current formulation whereby the ECB would target below but close to 2% inflation.
Speaker: Now, the thinking behind that is that the existing or the soon-to-be defunct inflation target is seen as somewhat vague and potentially it has a sort of 2% cap to it, whereas now,
Speaker: you might think that people should expect perhaps a little bit more tolerance on the part of the ECB for inflation overshoes or as little intolerance of overshoes as inflation undershoes relative to 2%.
Speaker: So it's sort of housekeeping de facto.
Speaker: It only lifts the inflation target very slightly, but it is a little bit of a change in approach.
Speaker: And they're also adding into the calculation something to do with housing, though, aren't they?
Speaker: Yes.
Speaker: Well, this is a long-term policy objective.
Speaker: Essentially,
Speaker: The ECB has said that it wants to include a measure of housing costs known as owner-occupier housing costs in the inflation measure.
Speaker: There is a bit of a problem with that, though, in that the data currently aren't produced at a high frequency and on a very timely basis.
Speaker: And that will take quite a lot of time for the statisticians at Eurostat to actually put together.
Speaker: So it's something that may not come into play for a few years.
Speaker: But that also could have some implications in terms of policymaking.
Speaker: By our calculations, we reckon that over the last few years, if you included housing costs in inflation, it may have lifted average inflation by perhaps around 0.2 percentage points.
Speaker: So if you've got slightly higher average inflation, well, that might have some policy implications.
Speaker: It might make you all else equal, a little bit less dovish than you otherwise would.
Speaker: The Fed, of course, did its own review a couple of years ago.
Speaker: And the big thing that came out of that was average inflation targeting.
Speaker: That's not the way the ECB has gone, though.
Speaker: Why?
Speaker: The ECB has gone for a much less radical approach than the Federal Reserve.
Speaker: And in the press conference, President Christine Lagarde categorically said that it is not following the Fed with average inflation targeting.
Speaker: Now, one of the problems here in the Eurozone is the credibility of trying to adopt an average inflation target would be very difficult.
Speaker: And the reason is because while in the US, inflation has tended to trend somewhat higher so that achieving a period of above 2% inflation in the US is rather achievable.
Speaker: But in the Eurozone, over the past several years, if you look at core rates of inflation, they haven't trended much higher than 1%.
Speaker: So if you suddenly say to markets and people in the economy more generally, you're trying to overshoot the 2% target,
Speaker: I think that would come across as not very credible at all, not very achievable, and I don't think somewhere where the ECB would want to go.
Speaker: So, Chris, there's also a climate dimension to this.
Speaker: Tell us what that's about.
Speaker: Yes, it's quite a major climate dimension here, potentially for credit markets in particular, potentially the most important thing to come from the strategic review.
Speaker: And this includes things like the ECB trying to tilt towards greener corporate bond purchases as part of its QE programme.
Speaker: But actually to set this up, this might take some time in terms of setting up the relevant company disclosures.
Speaker: The ECB plans to set out its plans in more detail sometime next year.
Speaker: So yes, there is a green agenda here, but it may take some time to properly set up.
Speaker: And finally, Chris, are there any policy implications from all this?
Speaker: So in terms of the very near to medium term policy outlook, very few implications.
Speaker: I think this strategic review should be seen as more of a longer term framework rather than what we expect over the coming months.
Speaker: So no change to our current view, whereby rates are unlikely to move anywhere anytime soon.
Speaker: And through our forecast horizon, we're expecting net purchases under the QE programme to continue.
Speaker: Chris, thank you very much indeed for that summary.
Speaker: Thank you.
Speaker: From a short-term view on Europe to a much longer-term one now, as we consider the demographic challenges facing the continent,
Speaker: Demographics is, of course, one of our key themes here at Global Research, and we're joined by James Pomeroy and Edward Stanford, who coordinate our research on the topic, and Fabio Balboni, Senior European Economist.
Speaker: James, if we can start with you, what is the broad outlet for European demographics?
Speaker: It's widely known that Europe's demographic situation is particularly challenging.
Speaker: We've got a situation over the next decade where the working age population is likely to shrink
Speaker: in almost every single country across the continent, and the number of pensioners is likely to rise particularly quickly.
Speaker: And there's a good chance as well that a lot of the projections beyond the next 10 years could be even worse because fertility rates could fall, particularly in the aftermath of the pandemic, and we could see populations fall by quite a considerable amount by the end of the century.
Speaker: Fabio, let's dig deeper into the economics of this.
Speaker: What are the fiscal implications?
Speaker: Indeed, this also means a higher cost for the government.
Speaker: In Europe, pension systems are largely public and largely unfunded.
Speaker: So ageing means that there will be more pensioners in the future and fewer workers to finance those unfunded pension systems.
Speaker: So using the estimate by the recent aging report by the European Commission, we estimate that aging could add about 1% of GDP in terms of pension costs for the EU and Eurozone by 2030.
Speaker: And when we add other aging related costs, such as, for example, health care,
Speaker: These could add to 2% of GDP and even more for high debt countries such as Italy, for example, where the additional bill for the government could be 3% of GDP.
Speaker: What does that mean for debt?
Speaker: So that, of course, could be a problem.
Speaker: And we plugged some of those numbers into our debt sustainability model.
Speaker: And what we found is that it could drift debt on an unsustainable path.
Speaker: For example, for Italy, we estimated the debt to GDP, which is already 160%, could move towards 200%
Speaker: by 2050.
Speaker: And the OBR made similar estimates in their fiscal sustainability report for the UK.
Speaker: So clearly this is a big issue and it could force some very difficult consolidation choices by governments in the future to prevent that spiraling out of control.
Speaker: Edward, what are the implications for markets?
Speaker: Well, first of all, I think it's fair to say that there's a geological quality to demographic trends.
Speaker: We all know the tectonic plates are shifting, but the impact on a conventional investment horizon of two to five years is probably quite limited.
Speaker: If you look at what might happen in Europe, we may see population growth affecting economic growth.
Speaker: We may see government debt rising as unfunded pension promises have to be fulfilled.
Speaker: And in that case, we may see the equity risk premium rising to tempt investors from overseas to invest in European markets.
Speaker: On the other side, as increasingly individuals will be reliant on defined contribution pension schemes, we may see the rise in demand for income producing assets, perhaps compressing yields, and also demand for equities themselves, given that pension outcomes will be reliant on long term investment returns and returns from bonds yielding very little at the moment are not particularly attractive.
Speaker: In terms of the impact on sectors, that too is difficult to be precise about.
Speaker: First of all, and most importantly, because companies have got plenty of notice to change.
Speaker: This thing isn't going to happen overnight and they can adapt.
Speaker: Secondly, because European markets are very international, over half revenues in the FTSE Europe Index come from outside Europe and exposure to very different demographic trends.
Speaker: But we've talked already about rising health care spend, likely to benefit the health care and pharmaceutical sector, automation likely to benefit the industrial sector, and also changing requirements for pension income is likely to benefit banks and insurance companies.
Speaker: On the other side, we may see a decline in housing formation, which may see a decline in demand for houses, perhaps declining demand for housing wealth.
Speaker: But that's some way off.
Speaker: So, James, back to you.
Speaker: What are the solutions to these challenges?
Speaker: Well, that's all very depressing, isn't it?
Speaker: A world where demographic challenge in Europe is likely to mean slower growth, greater fiscal challenges and headaches for investors.
Speaker: But it's not all bad news because there is the possibility of some solutions.
Speaker: Now, that could be on the demographics front itself.
Speaker: It could see the governments invest in programmes to try and raise fertility rates across the continent that may help some of the demographic projections further down the line.
Speaker: We could see governments start to think about raising retirement ages, no matter how politically unpopular that may prove to be.
Speaker: Or we could see efforts put in place to try and get labour force participation rates up, either amongst females or amongst older populations more broadly.
Speaker: And on top of that, we could see things that offset the demographic drag.
Speaker: This could be productivity increases that come through investment, either in digital technology, green energy or in infrastructure.
Speaker: And all of these things could help to offset this demographic drag that Europe is facing.
Speaker: So whilst there's enormous challenges out there, it may not necessarily mean we see weaker growth going forwards.
Speaker: James, Fabio and Edward, thanks very much.
Speaker: Let's turn to the currency markets now.
Speaker: The dollar's been trading well lately, but can this continue?
Speaker: Paul Mackle is our Global Head of FX Research, and he joins us from Hong Kong.
Speaker: So, Paul, what's behind the dollar's recent performance?
Speaker: Well, obviously, the change in thinking from the Federal Reserve has caused more volatility in the FX market and to the benefit of the US dollar, because now we're thinking about whether they're actually going to follow through and begin to raise rates at some point in the future.
Speaker: And the positioning was very much skewed the other way.
Speaker: That is, many market participants were short the dollar, and that's unwinding.
Speaker: And as it is happening, that is leading to the dollar rallying.
Speaker: Do you agree with the idea that the dollar is bottoming now?
Speaker: The short answer is no.
Speaker: We still think that there is a semblance of some global growth tailwinds that should be weighing on the dollar over the next few months.
Speaker: Now, we've also been very clear in our thinking that this should be a finite decline in the dollar on a cyclical basis.
Speaker: In other words, yes, what will happen is that this global growth momentum will begin to peter out.
Speaker: And then if we overlay what could happen with the Federal Reserve beginning to taper its balance sheet towards the end of this year, this should sow the seeds of the dollar beginning to recover versus a number of major currencies.
Speaker: So what are the risks to your broad dollar outlook?
Speaker: Well, there are two that stand out.
Speaker: One is that actually whether global growth is already peaking and in turn, is this going to be feeding into the dollar to begin to swing back and make a stronger recovery, which is typically the case when the global economy begins to slowly cool or moderate.
Speaker: The other risk is probably associated with the Delta variant, which is beginning to pop up in a number of different countries, and it's adding to some of the concerns in financial markets, and could things become very risk-off?
Speaker: If that's the case, that could also amplify some of the recent dollar strength.
Speaker: Again, these are risks.
Speaker: Our baseline assumption is still one that the dollar recovery will not really become more prominent until towards the end of this year.
Speaker: Finally, what other currencies have you got your eye on at the moment?
Speaker: So the renminbi very much stands out.
Speaker: What we've been arguing is that it should be gradually weakening in the second half of this year.
Speaker: Lately, we've seen the communication or indication that China could actually lower its reserve requirement ratio.
Speaker: This is not a broad monetary policy easing, but it plays into this idea about how, over time, there is divergent monetary policy outlooks between, say, the PBOC and the Federal Reserve.
Speaker: This supports our view that actually dollar CMY should gradually be going higher.
Speaker: Paul, thanks very much for your time.
Speaker: Thank you very much.
Speaker: After a volatile start to the year, emerging market financial assets have had a stronger run in recent months.
Speaker: So where do they go from here?
Speaker: Let's speak to Ali Chakaroglu, EM strategist.
Speaker: Hi, Ali.
Speaker: You've just published the latest GEMS Investor.
Speaker: Can I start by asking you what's happened in emerging markets in the first half of the year?
Speaker: Well, Mary, it wasn't a straight line for emerging markets.
Speaker: EM assets had a volatile start to the year as the focus in the global reflation narrative shifted towards inflation from growth.
Speaker: However, we saw some decent comeback over the last couple of months as there was a stabilization in core bond yields.
Speaker: And this was largely due to a better expectations management from core central banks, which helped with the stabilization of core bond yields.
Speaker: So how do you see EM in the second half, given the recent hawkish tilt by the Fed?
Speaker: It's true that some EM economies are still grappling with the higher COVID-19 cases and inflation is creeping higher as well.
Speaker: And on top of that, the pace of growth in global liquidity is coming down and Fed has turned a lot more hawkish compared to the earlier markets.
Speaker: in the year and we have looked at various economic and financial indicators and our conclusion is that the traffic light is not red yet so we proceed albeit with caution first and foremost em economic activity should benefit from the pickup in vaccinations and ongoing reopening of the global economy
Speaker: Also, we should see some strong data in the fixed investments.
Speaker: New orders, less inventories are at their highest level in 10 years, which suggests some pick up, strong rebound, and our economists forecast a solid improvement in capital expenditures.
Speaker: Secondly, the risk premium that has vanished last year following the ultra-expansionary monetary and fiscal policies is now coming back fast, and central banks are hiking and turning a lot more hawkish.
Speaker: And thirdly, external positions are robust and actually getting stronger, particularly for commodity producers, given the positive terms of trade show.
Speaker: So is it going to be a tantrumless taper?
Speaker: Frankly, it's still too early to tell whether it will be a tantrumless taper or not.
Speaker: But it's fairly clear that EM is now preempting the Fed and external positions are much better compared to 2013.
Speaker: Ali, thanks very much.
Speaker: Thank you, Mary.
Speaker: That brings us to the end of another edition of the podcast.
Speaker: Thank you to our guests, Chris Hare, Paul Michael, James Bomeroy, Fabio Balberni, Edward Stanford, and Ali Chakiroglu.
Speaker: From Chris and me, thanks very much for listening to the Macro Viewpoint.
Speaker: We'll be back again next week.
Speaker: Thank you for listening today.
Speaker: This has been HSBC Global Viewpoint, Banking and Markets.
Speaker: For more information about anything you heard in this podcast or to learn about HSBC's global services and offerings, please visit gbm.hsbc.com.
