Transcript ALCO

USD Outlook
Cheng-Mount Cheng
Asia Pacific Economic and Market Analysis
+886-2-2777-7070
[email protected]
29, September, 2006
Recent Trends in Dollar Index
•Dollar may look consolidated this year
Dollar Index, 2002 Jan=100
110
100
90
80
Source: Reuters
06-Sep
06-Jun
06-Mar
05-Nov
05-Aug
05-May
05-Feb
04-Nov
04-Aug
04-May
04-Jan
03-Oct
03-Jul
03-Apr
03-Jan
02-Oct
02-Apr
60
02-Jul
70
What Strong Dollar?
•Surprise! The real trade-weighted USD declined even in 2006 (average vs. 2005 average).
•There are two primary implications (contrary to conventional wisdom)
•Current account adjustment pressures still affecting USD (just against a different set of
currencies).
•Interest rates are not everything.
CTERI, 2002 Jan=100
105
2002 Average
98.62(0.4%)
2003 Average
92.43(-6.3%)
100
2004 Average
88.16(-4.6%)
95
2005 Average
86.44(-1.9%)
90
2006 Average
86.03(-0.5%)
85
80
02Jan
02Jul
03Jan
03Jul
04Jan
Note: CTERI = Competitive Trade-Weighted Exchange Rate Index.
Source: Citigroup.
04Jul
05Jan
05Jul
06Jan
06Jul
3
USD Weakness Began to Shift
•In the three years after the USD peak in Feb 2002, all of the USD decline was against the majors.
•Last year, at least relative to the majors, some EM currencies finally began to perform well.
Fed Real Trade-Weighted USD Index, Majors vs. Other Important
Trading Partners, Feb 2002 – Dec 2004 (Feb 2002 = 100)
Fed Real Trade-Weighted USD Index, Majors vs. Other Important
Trading Partners, Jan 2005 – Jun 2006 (Jan 2005 = 100)
110.0
110.0
Jan 2005 = 100
Feb 2002 = 100
105.0
100.0
95.0
90.0
85.0
80.0
105.0
100.0
95.0
75.0
90.0
1/1/2005
Ma
r-0
2
Ju
n02
Se
p02
De
c02
Ma
r-0
3
Ju
n03
Se
p03
De
c03
Ma
r-0
4
Ju
n04
Se
p04
De
c04
70.0
Majors
Note: OITP Other Important Trading Partners.
Source: Federal Reserve.
4/1/2005
7/1/2005
Majors
10/1/2005
1/1/2006
4/1/2006
OITP
OITP
4
Yields May Have Helped, But Correlation With USD is Weak
•The USD is only loosely correlated with bond yield differentials: differentials have widened
more than 100bp since 2003, but the USD is still down.
•Some periods of the sharpest spread widening have been associated with the greatest USD
depreciation.
Fed Nominal USD Index (Majors) vs. US-Majors 10-Yr Bond Yield
Differential, Feb 2002 – Jun 2006 (Feb 2002 = 100 and Basis Points)
105
140
120
80
90
60
85
40
20
80
Basis Points
100
95
0
USD Index (Left)
Ja
n06
-40
Ja
n05
Ju
l-0
5
70
Ja
n04
Ju
l-0
4
-20
Ja
n03
Ju
l-0
3
75
Ja
n02
Ju
l-0
2
Feb 2002 = 100
100
US-Non-US Yield (CTERI weighted, Right)
CTERI = Competitive Trade Weighted Exchange Rate Index (calculated by
Citigroup).
Sources: Federal Reserve, Citigroup.
5
US Fiscal Deficit Reduction: Little Impact on CA Deficit
•The US fiscal deficit does not appear to be causing the current account deficit.
•Fiscal tightening might be a good idea, but it wouldn’t necessarily reduce the CA deficit or
strengthen the USD.
US Fiscal Balance and Current Account Balance,
1980 – 2Q 2006 (Pct of GDP)
7
Until about 1989, fiscal and current
account balances more or less moved
in line with each other.
5
Since then, they have more often
moved in opposite directions.
Dec-04
Dec-02
Dec-00
Dec-98
Dec-96
Dec-94
Dec-92
Dec-90
Dec-88
Dec-86
-3
Dec-84
-1
Dec-82
1
Dec-80
Pct of GDP
3
-5
-7
Fiscal balance
Note: Four-quarter moving sum for fiscal balance.
Sources: US Treasury, Bureau of Economic Analysis.
CA balance
6
The US Current Account: Debtor or Creditor Problem?
•The other way is from the creditor side (ie, as a share
of non-US savings).
•One way to look at CA imbalances is from the US
side (ie, as a share of US income).
•If you think the main constraint is on the creditor
side, ie, excessive concentration in USD (we do), do
your analysis from this side.
•If you think the US will have balance of payments
problems (we don’t), do your analysis from this side.
US Current Account Deficit, 1976 – 1Q 2006 (Pct of US
GDP)
6
-4
Mar-06
Mar-03
Mar-00
Mar-97
Mar-94
Mar-91
Mar-88
Mar-85
Mar-82
Mar-79
-2
Mar-76
0
Mar-73
2
Mar-70
Pct of GDP
4
Pct of Non-US Savings
8
US Gross International Borrowing (CA Balance
and US Investment Abroad), 1982 – 2007E (Pct
of Non-US Savings)
25
15
5
-51981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
-15
-6
-25
-8
Current Account
US CA Balance
Note: E Citigroup estimates for 2006-2007 US current account, IMF estimates for non-US savings.
Sources: Bureau of Economic Analysis, Citigroup, International Monetary Fund World Economic
Outlook.
US Investment Abroad
7
Different Analytical Approaches
•Debtor side analysis problem: There does not seem to be an “unsustainable” US current
account deficit/US GDP ratio.
•Creditor side analysis advantage: The concept is a mainstay of conventional asset allocation
thinking. If expected returns on an asset (in this case, US obligations) are high, investors will
buy them. If expected returns are low, they will buy fewer of them.
Comparison of Two Main Analytical Approaches to
US Current Account Balance
Key variable
How to define "sustainability"?
Debtor side analysis
US current account/US GDP ratio
Past US experience
Other countries' experience
Advantages of this approach
Everyone is familiar with it
Problems of this approach
Nobody has been able to calculate an "unsustainable"
borrowing/income level
Creditor side analysis
US gross borrowing/non-US saving ratio
Sustainability is a function of two variables:
"Benchmark" US share of non-US saving
Expected US returns relative to non-US returns
Focuses on capital flows
Can have two-way implications for USD
(depending on initial weighting, and relative returns)
Difficult to define the benchmark
Different creditors have different motives
(ie, public vs. private actors)
Source: Citigroup.
8
The Benchmark...
•The benchmark USD share is defined as US financial assets/global financial assets
(adjusted for “home bias”). The benchmark is currently about 20%.
•US borrowing is currently very close to this benchmark.
“Benchmark” US Share of Non-US Saving vs. Actual US
Borrowing/Non-US Saving, 1990 – 2005 (Pct of Non-US Savings)
5.0
0.0
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
Pct of Non-US Saving
10.0
-5.0
-10.0
-15.0
-20.0
-25.0
Benchmark USD Share
US Borrowing/Non-US Saving
Notes: Benchmark USD share = (1- “home bias”) * share of US financial assets/global financial assets. Home bias is estimated at about
50%, and US financial assets are about 38% of the global total. US international borrowing = US current account balance + US overseas
asset purchases.
Sources: Citigroup calculations based on data from IMF, World Bank, U.S. Federal Reserve, World Federation of Exchanges, and BIS.
9
...and Relative Returns (Fixed Income)
•High expected risk-adjusted returns on US assets have enabled the US to attract the lion’s
share of capital that has been “freed up” by the decline in home bias.
•But actual US returns have fallen short of G9 returns in recent years.
•As expectations adjust to this reality, the USD is vulnerable.
WGBI Total Risk-Adjusted Returns, US vs. G9,
Local Currency Terms, Dec 1997 – Mar 2006
6.0
5.0
Return/SD
4.0
3.0
2.0
1.0
US
05
D
ec
-
04
D
ec
-
03
D
ec
-
02
D
ec
-
01
D
ec
-
00
D
ec
-
99
D
ec
-
98
D
D
ec
-
-1.0
ec
-
97
0.0
G9
Note: Risk-adjusted return defined as total index return divided by standard deviation of year-on-year return over two-year period.
G9 = simple average of risk adjusted returns for G10 excluding the US. Data showing relative returns in USD, and in an average
of EUR, JPY, and GBP terms, available upon request.
Source: Citigroup.
10
Relative Returns: Equity
•Much the same holds for equities.
Equity Market Total Risk-Adjusted Excess Returns, US
vs. G9, Local Currency Terms, Dec 1997 – Apr 2006
6.0
Dec-05
Jun-05
Dec-04
Jun-04
Dec-03
Jun-03
Dec-02
Jun-02
Dec-01
Jun-01
Dec-00
Jun-00
Dec-99
Jun-99
-2.0
Dec-98
0.0
Jun-98
2.0
Dec-97
Return/SD
4.0
-4.0
-6.0
US
G9
Note: Risk-adjusted excess return defined as total index return (including dividends) minus short-term interest rate divided by
standard deviation of year-on-year return over two-year period. G9 = simple average of risk adjusted returns for G10 excluding the
US. Data showing relative returns in USD, and in an average of EUR, JPY, and GBP terms, available upon request.
Source: Morgan Stanley Capital International.
11
US Returns Too Low To Justify Current Account Deficit
US-G9 Total Risk-Adjusted Excess Equity and WGBI Returns vs. US
Current Account Balance, Dec 1997 – Dec 2005 (Pct/SD and Pct of GDP)
6
4
Dec-05
Aug-05
Apr-05
Dec-04
Aug-04
Apr-04
Dec-03
Aug-03
Apr-03
Dec-02
Aug-02
Apr-02
Dec-01
Aug-01
Apr-01
Dec-00
Aug-00
Apr-00
Dec-99
Aug-99
Apr-99
Dec-98
Aug-98
-2
Apr-98
0
Dec-97
Return/SD
2
-4
-6
-8
US-G9 returns
US Current account balance
Note: Figure shows a simple average of US and G9 excess equity and WGBI risk-adjusted returns Risk-adjusted excess
equity return defined as total equity index return (including dividends) minus short-term interest rate divided by standard
deviation of year-on-year return over two-year period. G9 = simple average of risk adjusted returns for G10 excluding the
US.
Sources: Citigroup, Morgan Stanley Capital International, Bureau of Economic Analysis.
12
The Benchmark: The Size of US Financial Markets...
Breakdown of Global Financial Assets, 2005 (Pct of Global Financial Assets)
EM Asia
6%
Others
8%
CAD/AUD/NZD
4%
US
37%
Other developed europe
3%
UK
5%
Japan
15%
Euro area
22%
Sources: World Federation of Exchanges, Bank for International Settlements.
13
US Markets Offer the Most Choices for Risk-Reward
•It is often said that the US attracts capital because US asset returns are higher.
•Maybe so, but just as importantly, US financial markets are very diverse. They offer the most choices to
meet a range of investor risk-reward expectations.
•If inflows into equities or bonds decline, it is likely that inflows into the other category will rise.
•This means that if investors turn bullish on the economy, they can buy high-risk assets. If investors turn
bearish on the economy, they can buy low-risk assets.
•No other major area can match this range of financial market choices.
Probability that Decline in Capital Inflow Will Be Offset By Increase in Other
Capital Inflow, 1996-2004 (Pct)
US
Equity inflows decline...
...and bond inflows rise
...and bond inflow rise fully offsets equity decline
Bond inflows decline...
...and equity inflows rise
...and equity inflow fully offsets bond decline
0.56
0.80
0.60
0.22
0.50
0.25
Japan
Euro area
0.56
0.33
0.60
1.00
0.40
0.33
0.56
0.11
0.75
0.25
0.50
0.25
Note: Period since 1996 selected, because this is the period after the big decline in “Home bias” cited above. Euro-area data only from 1998.
Source: International Monetary Fund.
14
Global Saving – Investment Balance
28.0
27.0
World (Ex US) Saving and Investment Rates, 1982 – 2006E (Pct
of World Ex US GDP)
26.0
25.0
24.0
23.0
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
22.0
World Saving Rate
World Investment Rate
Notes: Chart represents an aggregation of saving and investment rates, based on IMF and World Bank data, for about 180
countries. Data availability varies by country. Citigroup forecasts for major countries’ GDP growth used.
Sources: IMF, World Bank, National Sources, Citigroup forecasts.
15
The Biggest Saving Sources: Asia vs. Middle East
•Middle East saving and investment are much more volatile, and tied to oil
prices.
Pct of Regional GDP
40
45
35
30
25
20
Gross National Saving and Investment
Rates, Middle East, 1980 – 2007E (Pct
of Regional GDP)
40
35
30
25
20
15
10
10
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
15
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
Pct of Regional GDP
45
Gross National Saving and Investment
Rates, Asia Ex Japan, 1980 – 2007E (Pct
of Regional GDP)
Gross national saving
Gross national saving
Investment
Investment
Source: IMF.
16
Marginal Increases from Middle East Slowing
•The total amount of net saving from the Middle East has risen sharply, but it might be
peaking relative to emerging Asia.
400
Net Saving (Current Account Balance), Asia Ex-Japan vs.
Middle East, 1980 – 2007E (USD Billions)
350
USD Billions
300
250
200
150
100
50
0
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
-50
-100
Asia ex Japan
Middle East
Source: IMF.
17
The Importance of China
•China has a much higher saving rate than the rest of emerging Asia (plus China is
bigger, and growing faster).
54
39
49
Pct of GDP
44
China’s Saving and Investment Rates, 1982 –
2005 (Pct of GDP)
44
Emerging Asia Ex China’s Saving and
Investment Rates, 1982 – 2005 (Pct of GDP)
39
34
29
29
24
24
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
34
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
Pct of GDP
49
54
Saving
Saving
Investment
Investment
Sources: IMF, World Bank, National Sources, Citigroup forecasts.
18
Current Account Deficit: Don’t Expect It To Decline
• Little relative price change (Asia sacrifices margin
for market share).
• Little relative growth change
• Little relative productivity change in critical
sectors (retail)
• It is not unusual for current account decline to lag
USD decline
19
Weak USD, But Little Relative Price Shift
120
110
105
100
2000 = 100
115
USD (Left)
Sep-04
Sep-02
Sep-00
Sep-98
Sep-96
Sep-94
Sep-92
Sep-90
Sep-88
Sep-86
95
Sep-84
80
85
90
95
100
105
110
115
120
125
130
Sep-82
2000 = 100
Real Trade-Weighted Dollar (Inverted) and Ratio of Import Prices (ex Oil) to
Core PPI, Sep 1982 – Jun 2006 (2000 = 100)
90
Import prices ex-oil/Core PPI (Right)
Sources: Federal Reserve Board, Bureau of Labor Statistics.
20
Asia Still Not Raising Prices to US
•Despite broad USD weakness since early 2002, USD import prices have risen only from Canada
(commodities) and the euro area.
•Prices of imports from Asia (even Japan) are still falling. These exporters are either willing to
sacrifice margin to maintain market share in the US, or they are gaining rapidly in productivity.
US Import Prices by Locality of Origin, Dec 1992 – Jun 2006 (Yr-Yr Pct Chg)
12.0
05
ec
-
04
D
ec
-
03
D
ec
-
02
D
ec
-
01
D
ec
-
00
D
ec
-
99
D
ec
-
98
D
ec
-
97
D
ec
-
96
D
ec
-
95
D
ec
-
94
D
ec
D
ec
-
93
0.0
D
Yr-Yr Pct Chg
6.0
-6.0
-12.0
Canada
Euro area
China
Japan
NICs
Source: Bureau of Labor Statistics.
21
Weak Relative Non-US Growth
US, Real Exports and Imports, 1996 – 2Q 2006 (Yr-Yr Pct Chg)
20
US export growth has finally exceeded US
import growth, but it has a long way to go to
stabilize deficits.
15
5
n06
Ju
n05
Ju
n04
Ju
n03
Ju
n02
Ju
n01
Ju
n00
Ju
n99
Ju
n98
Ju
n97
-5
Ju
n96
0
Ju
Yr-Yr Pct Chg
10
-10
-15
-20
Exports
Imports
Source: Bureau of Economic Analysis.
22
USD Decline Should Reduce CA Deficit, But It Takes Time
•The US CA deficit has not declined yet during the current dollar downtrend.
•This in itself is not unusual. In the 1980s’ USD decline phase, the deficit was larger three
years after the USD peak.
•What is unusual is the magnitude of the increase in the current account deficit this time.
Dollar Decline CA change
-6
-0
3
M
ar
-9
8
M
ar
-9
3
-4
CA balance
Sources: Bureau of Economic Analysis, Federal Reserve Board.
M
ar
-8
8
M
ar
-8
3
-1.4
???
-2
M
ar
-16.2
???
0
-7
8
-0.4
0.6
2
M
ar
-32.5
-30.5
4
-7
3
0.5
-0.1
Pct of GDP
-9.4
-18.5
6
M
ar
Decline starting:
1973
First three years
After five years
1985
First three years
After five years
2002
First three years
After five years
80
85
90
95
100
105
110
115
120
125
130
Mar 1973 = 100
US Current Account Balance and Broad
Dollar Index, 1Q 1978 – 4Q 2005 (Pct of
GDP and Mar 1973 = 100, Inverted Axis)
Change in CA Deficit During Dollar
Decline Periods, 1973 – 2Q 2005
(Cumulative Dollar Decline, Pct Points)
USD Real TWI
23
This Is Still a Benign Decline
•We are four years into the current dollar decline phase (starting in Feb 2002).
•Malign corrections are ones where bond yields rise and equity prices fall (lower right quadrant).
•Benign corrections are ones where bond yields fall and equity prices rise (upper left quadrant).
•The current correction is benign so far – more like the 1980s than the 1970s.
Change in 10-Yr Bond Yields and S&P 500 During Periods of USD Declines
Beginning in 1973, 1985, and 2002 (Basis Points and Pct)
Jan 1973: Malign
90
Mar 1985: Benign
Equity prices
90
70
70
50
50
Jan 1988,
-29.4%
30
Start, Jan 1973
Bond yields
-500
-300
10
Bond yields
Feb 2002: Benign
Equity prices
90
70
50
May 2006, USD
-16.6%
30
10 Start: March 1985
-10
-100
100
300
Bond yields
30
10
-30
-10
-100
-30
-50
-50
-50
-70
-70
-70
-90
-90
-90
-10
-100
-30
100
300
Nov 1975, -11.0%
500
-500
-300
Equity prices
500
-500
-300
Note: Charts show the change in bond yields (basis points) and equity prices (percent) from the starting point of the dollar
correction, measured from the peak of the dollar’s real trade weighted index (calculated by the FRB).
Source: Federal Reserve Board.
Start, Feb 2002
100
300
500
24
Shifts of Geographical Distribution of Economic Influence
Emerging Markets — Share of World
Exports (Percent), 1990-06E
United States and Emerging Economies — Current
Accounts (Percent of Global Savings), 1980–2006F
50
50%
40
10
10%
Emerging Markets (Left)
Emerging Asia (Left)
China (Right)
9%
9
-9
-9%
6
-6
3
-3
0
0
-3
3
8
30
6
20
4
10
2
0
0
1990
1994
1998
2002
2006
E 2006 estimate based on data from 3Q 05-2Q 06. Source: IMF and Citigroup.
1980
1985
1990
Emerging Economies (Left)
1995
2000
2005
United States (Right, inverted)
Emerging Asia Will Play a Key Role
Global — Foreign Exchange Reserves
(US$ in Billions) 1990-06E
$5000
5000
B
4000
China
Emerging Asia
Emerging World
World
3000
Global — Composition of the World Output
(Percent of Global GDP), 1500–2030F
$5000
5000
B
60
60%
60
60%
4000
50
50
40
40
30
30
20
20
10
10
3000
2000
2000
1000
1000
0
0
1990
1994
1998
2002
Note: Country groupings follow the IMF classification.
Source: IMF.
2006
0
0
1500 1700 1820 1870 1913 1950 1973 1990 2003 2030F
Advanced Economies
China
India
Note: Advanced Economies include Western Europe,
Japan, United States, Canada, Australia and New
Zealand. Sources: Maddison (2000) and (2006).
26
Disclosure Appendix
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I, Cheng-Mount Cheng, economist and author of the report, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the
subject issuer(s) or securities. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report.
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