2016 03 gic j sicilia vf
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Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities in partnership with the Banque de France
Paris – March 21, 2016
Financial markets, world economy and monetary policy at a crossroad: a few comments
Jorge Sicilia
BBVA/Chief Economist
GIC March 2016
Page 2Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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Developed Emerging
Financial tensions trending upwards and repeated episodes of financial turmoil raise concerns
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & Bloomberg
BBVA Research Financial Stress Index: Emerging markets and Developed Markets (normalized Index) Source: BBVA Research based on Bloomberg data
LehmanBrothers
Taperingtalks
Chinese’sconcerns
European sovereigndebt crisis
Bank’sconcerns
GIC March 2016
Page 3Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
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US EZ
More so when tensions spread to the banking sector in developed markets
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & BloombergBBVA Research Financial Stress Index, Bank credit risk component:
US and EZ (normalized Index) Source: BBVA Research based on Bloomberg data
LehmanBrothers
Taperingtalks
Chinese’sconcerns
European sovereigndebt crisis
Bank’sconcerns
GIC March 2016
Page 4Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Is it the threat of risk scenarios going forward in this new world?
What can we read from recent developments in financial markets?
Very likely! Uncertainty about China and persistent low oil prices raised the risk of second round effects of the current environment that could become self-fulfilling…Together with policy actions and inactions....
Is it a downward revision of the baseline global outlook?
Not likely, the downside revisions have been mild and indicators are not pointing to a recession
Asset performance is radically different under the baseline and the risk scenarios. Changes in probabilities assigned to both scenarios have the potential to generate this market behavior
GIC March 2016
Page 5Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Asset performance in terms of risk/return: 2009-2015 Source: MSCI & Bloomberg
7-10Y Euro
7-10Y US
Equity Euro (MSCI index)
Equity US (MSCI index)
Equity LatAm (USD) (MSCI
index)
Cred. EMs (USD)
Sov EMs (USD)Corp US (7-10Y)
Corp Euro (7-10Y)
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-80 -60 -40 -20 0 20Performance 9/05/08 - 6/03/09
Vola
tility
7-10Y Bonds Euro
7-10Y Bonds US
Equity Euro (MSCI index)
Equity US (MSCI index)
Equity LatAm (USD) (MSCI
index)
Cred. EMs (USD)Sov EMs
(USD)
Corp US(7-10Y)
Corp Euro (7-10Y)
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Vola
tility
Performance
?
Future
Bearish MarketBullish MarketAsset performance in terms ofrisk/return: 2009-2015 Source: MSCI & Bloomberg
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & Bloomberg
Markets are wondering and wandering between two scenarios: Where do we go in terms of risk/return?
GIC March 2016
Page 6Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
How worried should we be about this risk scenario? World GDP growth remains low and fragile
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & Bloomberg
World GDP(*) quarterly growth, short-term forecasts based on BBVA-GAIN (QoQ %) Source: BBVA Research and IMF
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Jun-09 Mar-10 Dec-10 Sep-11 Jun-12 Mar-13 Dec-13 Sep-14 Jun-15 Mar-16
Average 2000-07
Average 2011-15
Annualized rate: 2,6%
Growth forecasts for 2016 are of around 3%, and over 3% in 2017
GIC March 2016
Page 7Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Risks are higher, and mainly to the downside
Emerging Economies
Hard choices in a tougher
background (Oil prices fall and
Flow rebalancing)Source: BBVA Research
Europe“Brexit”, Banking
Union
Geopolitical Risks: (and
refugees crisis)
ChinaHard landing, policy errors
Rising Holding steady Lower
Slowdown in the US?
Market volatility
GIC March 2016
Page 8Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Overwhelming majority that conditions are deteriorating, to what extent?
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & BloombergFrom the “fear” approach… ... To the “hope” approach
Lead among others by the BIS (is this view increasingly shared by the IMF?) that alert about the risks given the underlying economic vulnerabilities:
• High leverage• Low productivity• No room of maneuver
Still shared by G20, central banks and independent observers, but increasingly alert:
• G20: “the global recovery continues but downside risks and vulnerabilities have risen”
• IMF: “global recovery has weakened […] higher risks […] urgency of a broad-based response”
• Fed ” global economic and financial developments continue to pose risks”.
• ECB ” providing substantial monetary stimulus to counteract heightened risks”
• Independent observers: “the world need a reality check from financial panic”, A. Posen, PIIE
GIC March 2016
Page 9Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Over longer horizons, there are little reasons to expect growth rates higher than “old normal” 3.5%...Economic Growth (annual change, %)
GDP, YoY, % 80's expansion 90's soft patch 90's soft
expansionPatch and rebound 00's expansion Crisis and rebound Anemic
expansionWorld 3.8 2.6 3.7 3.7 4.4 3.2 3.3DM 3.9 1.7 3.2 3.5 2.4 0.5 1.7EM 3.8 3.9 4.4 4.0 6.6 5.5 4.4Source: BBVA Research, IMF
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83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15(e)
16(f)
80's Expansion 90's soft patch 90's soft Expansion Patch andRebound
00's Expansion Crisis and Rebound AnemicExpansion
The BIG REBALANCING
WORLD DM EMSource: BBVA Research forecasts
GIC March 2016
Page 10Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Outstanding Debt (*)(% GDP)
…and probably less considering the high debt levels in a very low inflation environment
(*) Source: BIS, IIF
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Households
Non-fin corporates
Government
Financial Corporates
Mature markets Emerging Markets
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HouseholdsNon-fin corporatesGovernmentFinancial Corporates
GIC March 2016
Page 11Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Financial tensions is already having a toll on economic activity
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & Bloomberg
Increasing financial tensions (since last summer to now) are already having an impact on GDP growth (transitory shock) mainly in EM while negligible for DM
If sustained at current levels (permanent shock) financial stress might have major impact across the board, especially in EM
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Transitoryshock
Permanentshock
USEZEM (*)
(*) estimated impact just for a sample of countries, mainly Latamcountries
Estimated impact of financial tensions on GDPTransitory and Permanent shock Source: BBVA Research
GIC March 2016
Page 12Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
(*) BBVA Research Global volatility index constructed using analysis component from principal components of financial variables, including 10years bond yields, exchange rates, stock exchange index for developed and emerging markets.For more detail see https://www.bbvaresearch.com/wp-content/uploads/2015/01/GVI_ING.pdf
Volatile financial markets are unwanted Asset performance in terms of risk/return: Lehman crisisSource: MSCI & Bloomberg
Estimated impact of higher volatility* on world GDP Source: BBVA Research
Volatility in financial markets by itself could also have a major impact on growth: assuming a “risk” scenario where volatility spikes (less intense than LB, 30% but more persistent -about 2 times its duration-), world GDP growth could be affected by around 1 percentage point
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Risk Base
GIC March 2016
Page 13Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Central banks, the art of adjusting their strategy in real time trying to avoid unintended consequencesAsset performance in terms of risk/return: 2009-2015 Source: MSCI & Bloomberg
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & Bloomberg
The deeper the central banks go in this direction, the more debate will arise over the unintended consequences of such policies• Uncertainty about how long can
they go (in magnitude and duration)?• Impairment of the monetary policy
transmission mechanism• Concerns on bank profitability• Global spillovers through exchange
rates • Tail risks (of bank runs)• Counterfactual analysis?
The case of negative rates
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EZ BoJ SW DEN SWI
Official interest rates in some developed central banks (Refi and depo rates)Source: BBVA Research
GIC March 2016
Page 14Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Asset performance in terms of risk/return: 2009-2015 Source: MSCI & Bloomberg
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & Bloomberg
The ECB is increasingly focus on credit easing.
TLTROs improve financial condition for banks: dissipates funding risks and counterbalances the impact of negative interest rates on banks’ profitability.
The impact on the amount of creditto the real economy is uncertain.
The welcome shift of ECB’s strategy, ” from rates instruments to other, non/conventional instruments ”.
Risk perception in the EZ: Peripheral risk premia and Banks ITRAXX- index CDS (bps)Source: BBVA Research
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Senior Bank debtSubordinated bank debtPeripheral risk premiun (avrg ITA SPA POR)
Central banks, the art of adjusting their strategy in real time trying to avoid unintended consequences
GIC March 2016
Page 15Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities ‐ Paris – March 21, 2016
Challenges ahead are huge. Important question marks remains open.
Asset performance in terms of risk/return: Lehman crisisSource: MSCI & Bloomberg
Monetary policy ammunition and coordination: • Central banks, do they have ammunition left?• How could monetary policy be combined with other (most structural) policies?
Can we have a design that avoids fiscal dominance? Helicopter money, if it were legal, how could it be designed?
• Should central banks consider their international responsibility beyond their domestic mandate? [Rajan proposal]
“Financial repression”• How long can it be maintained?• Combined with digital innovation could it foster financial desintermediation?• Is credit quality endogenous to low interest rates?
Central Banking Series: Inflation Expectations, Implications & Policy Response in a New Paradigm for Commodities in partnership with the Banque de FranceParis – March 21, 2016
Jorge Sicilia, Chief Economist BBVA Research
Financial markets, world economy and monetary policy at a crossroad: a few comments