Market Overview

Americas: Regional Economic Review – Q2 2014

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U.S., Canada See Healthy Growth, Outlook Weak for Commodity Exporters

Economic trends from the region during the second quarter were in line with earlier periods, as the developed economies in North America are seeing healthier growth while most of the emerging economies in Latin America are facing a slowdown. Recent data from the U.S. and Canada confirm that both economies have recovered from the first quarter slowdown. If these trends are sustained, both these economies could see improved growth during the second half of this year. Gains in domestic consumption are an important driver in both countries and accommodative monetary policies continue to favor further expansion in domestic demand.

In Latin America, only Colombia is enjoying acceleration in economic growth as the country’s energy exports are now fetching higher prices. The decline in international prices of industrial commodities such as iron ore and copper has weakened the growth outlook for countries such as Brazil, Peru and Chile. While the country continues to make steady progress and as a low cost manufacturing location, Mexico needs the ongoing industry reforms to succeed to regain competitiveness and improve its growth prospects. Argentina’s economy could be derailed by a potential debt default, which would severely limit the country’s ability to raise overseas funds.

At a Glance

United States: Better than expected second quarter growth has lowered concerns about another slowdown. Most data suggest faster growth during the second half of this year, helped by higher consumer spending. Labor markets have improved further and the unemployment rate has declined. The Fed has started debating early rate increases if economic growth remains robust.

 

Canada: Improved overseas demand and sustained gains in domestic consumption are helping the Canadian economy. Consumer sentiment has steadily increased in recent months on expectations of further gains in the housing market. The central bank continues to hold interest rates steady.

 

Brazil:  Weak export demand and slowing domestic consumption have restricted the pace of economic growth. Though recent rate hikes have contributed to the fall in consumer demand, the central bank is unable to consider rate cuts as inflation remains high.

 

Mexico:  While growth was below expectations during the first half, better U.S. demand could lift the Mexican economy for the rest of the year. The government is pushing forward with the promised industrial reform measures.

 

Chile: Weak international copper prices continue to restrict the country’s economic growth rate. After growth slipped to 0.8% during the first quarter, the central bank resumed rate cuts.

 

Peru: Subdued global demand for industrial material has led to a larger than expected slowdown in economic growth. The government and the central bank have rolled out stimulus measures to support growth.

 

Colombia: Higher oil prices and increased government spending have made Colombia the fastest growing economy in the region. The central bank has hiked interest rates recently to limit inflation risks.

 

Argentina: The country could face severe financial difficulties if it defaults on debt due later this year, after a U.S. court prevented interest payments to bondholders before settling the claims of investors holding defaulted bonds.

 

 

UNITED STATES: STRONG SECOND QUARTER GROWTH ALLAYS SLOWDOWN FEARS

The stronger than expected 4% growth during the second quarter has allayed fears that the U.S. economy’s recovery from the slowdown at the beginning of this year is weaker than expected. In addition, the revised estimate shows that the economy’s weather-induced decline during the first quarter was not as severe as suggested by initial data. There were apprehensions that the U.S. economy came to a standstill during the first half, and most forecasters had revised their full year growth estimates lower. Instead, if the initial growth estimate for the second quarter holds in subsequent data revisions, the economy would have expanded at a moderate pace during the first half of this year. The Federal Reserve and most economists are now more optimistic about the growth prospects for the second half of 2014, expected to be close to 3%.

The labor market continues to see meaningful improvement and the unemployment rate has seen a moderate decline so far this year. The economy is currently adding over 200,000 jobs a month on average, which suggests that employers are increasingly becoming confident about future demand growth. The average wage rates have also seen some improvement, though marginal at this point. Higher incomes, if the gains are sustained in the coming months, could support increased consumer spending. However, part of the decline in the unemployment rate is due to some of the long-term unemployed dropping out of the labor force. As a result, labor force participation is at the lowest level in recent years.

Gains in the housing market are showing signs of leveling off, after more than two years of steady improvement. Though existing home sales continue to rise, new home sales and housing permits have seen weaker trends recently. Average homes prices have recovered appreciably in recent years, thereby discouraging potential buyers from entering the market. In addition, low inventory levels in some of the large cities continue to push up prices. Nevertheless, mortgage rates remain very affordable and select banks have started easing lending standards further.

The better than expected economic data for the second quarter has rekindled debate about the timing of the Federal Reserve’s next interest rate move. The Fed continues to wind down its bond purchases and is on course to completely end the program by October this year. The Fed’s official statements suggest that the target fed rate is likely to remain very low through most of 2015, or until the central bank is confident that economic growth has become more sustainable and inflation moves close to 2%. However, minutes of Fed meetings show that there is a growing internal debate about bringing forward the rate hikes. While the majority of the Fed governors now favor maintaining the low rates, strong growth during the second half of the year could make them reconsider.

CANADA: GROWTH OUTLOOK POSITIVE AS OVERSEAS DEMAND IMPROVES

Canada’s economic outlook remains positive as the improving U.S. demand has lifted exports, while buoyant consumer sentiment is helping domestic consumption growth. Though the 1.2% growth during the first quarter, when weather conditions were adverse, was lower than expected, subsequent data shows that the economy has gathered pace. Though some of the subdued trends continued into April, the month of May saw healthy gains in economic activity. The Bank of Canada estimates that the economy likely expanded 2.5% annualized during the April-June quarter, helped by robust gains in manufacturing, The central bank expects GDP to grow by 2.2% this year and 2.4% in 2015.

Consumer confidence in Canada continues to firm up, helped by optimism about higher housing prices and further improvement in economic conditions. An index of consumer sentiment has seen consistent gains in recent months and is now at its highest level since 2010. Activity in the housing sector has rebounded after the weather induced slowdown at the beginning of this year, as mortgage rates remain highly affordable when compared to historical trends. Canadian housing prices recovered relatively swiftly after the global financial crisis, forcing the government and the central bank to introduce policy measures aimed at preventing another price bubble.

The Bank of Canada has maintained its benchmark rate unchanged at 1% for nearly four years now, and is expected to hold steady until the second half of 2015. Though inflation exceeded the central bank’s 2% target during the second quarter, the central bank believes the gains are temporary. As the unemployment rate remains relatively high at 7%, despite the labor market gains in recent year, the bank believes there is excess capacity in the economy that would limit inflation risks going forward. The central bank now expects the economy to expand 2.2% this year and 2.4% in 2015.

BRAZIL: WEAK EXPORTS AND SOFTER DOMESTIC CONSUMPTION RESTRICTS GROWTH

The Brazilian economy almost came to a standstill during the first three months of this year, and subsequent data suggest that economic activity is yet to see any appreciable improvement. Weaker global demand for industrial commodities has hurt exports while domestic consumption remains restricted. The central bank had repeatedly hiked interest rates over a one year period through April to fight inflation, but higher borrowing costs have also reduced consumer demand. Prices of iron ore, one of the major exports from Brazil, have seen a moderate recovery in recent months but remain well below last year’s levels. Both exports and imports declined in June, while foreign direct investments have also been trending lower. The Brazilian currency is among the better performers against the U.S. dollar so far this year, hurting exports even more.

The Brazilian economy is expected to grow at a modest pace of 0.9% this year, according to a survey by the central bank, one of the lowest among major emerging countries. Industrial output in the country has declined for four successive months through June. Lower export demand from neighboring Argentina, which is facing a possible debt default, has also contributed to weaker factory output. The automobile industry, one of the largest manufacturing sectors in the country, has seen a 17% decline in output during the first half of this year. To revive domestic demand, the central bank has lowered the reserve requirements for the banking industry. This measure is expected to make more than $20 billion in additional credit available for domestic borrowers. However, persistent inflation rules out the possibility of a rate cut by the central bank this year. The IMF has cautioned Brazil against market interventions to strengthen the domestic currency when growth remains weak.

Brazil is holding presidential elections later this year and there are growing expectations that government policies will become more growth friendly after the elections. The incumbent president Dilma Rousseff is expected to be reelected, though her popularity has declined appreciably in recent opinion polls.

MEXICO: HEALTHIER U.S. DEMAND COULD LIFT GROWTH DURING THE SECOND HALF

While the Mexican economy expanded at a slower than expected pace of 1.8% annualized during the first quarter of this year, subsequent trends suggest a moderate improvement in growth during the April – June period. Though domestic demand remains relatively softer, exports have gained traction as U.S. demand has recovered from the lull at the beginning of this year. The improvement in exports is mostly led by automobiles, as Mexico is likely to become the largest auto manufacturer in Latin America this year. More than three fourths of Mexico’s exports are destined for the U.S. and the momentum in exports is expected to be sustained during the second half of this year.

The Mexican central bank unexpectedly cuts its benchmark rate in June after the first quarter GDP growth data disappointed. Though inflation has moved closer to the upper end of the central bank’s target range, the bank remains confident that economic growth will pick up during the second half without worsening inflation. The bank is also not anticipating further rate cuts as it is confident that growth will accelerate to 4% by the last quarter. However, the modest expansion during the first quarter is likely to limit the aggregate growth for the current year to between 2.3% and 3.3%.

Mexico’s policy reforms aimed at making the domestic industry more efficient and competitive are seeing further progress. The proposal to open up the country’s energy sector for foreign investments has won the approval at the Senate committee level, and is now likely to come up for voting before the full Senate. The government estimates investment inflows of over $30 billion into the sector after policies become more favorable. The government’s proposal to end monopolistic domination in the telecom sector has also won Senate approval and is now likely to be discussed by the Chamber of Deputies, or the lower house. If approved, this legislation is expected to increase competition and could also lead to the break-up of the largest service provider.

CHILE: ECONOMIC GROWTH SLIPS ON LACKLUSTER GLOBAL COPPER DEMAND

The decline in copper prices continues to hobble the Chilean economy, and aggregate economic growth is down to the lowest levels seen in recent years. International copper prices declined at the beginning of this year on concerns that demand in China and other emerging countries could drop appreciably. Though copper prices have recovered somewhat during the second quarter, they remain below the levels seen during the end of last year. Copper is Chile’s largest export and global copper demand remains one of the main drivers of economic growth in the country.

Chile’s economic growth slowed to 0.8% annualized in June, from a year ago, after expanding at a lower than expected pace of 2.3% annualized during the previous month. Industrial output remains weak while domestic consumption growth has also moderated. The economy expanded only by 2.6% during the first quarter, compared to 4.1% for the whole of 2013. The Chilean government now expects GDP growth to be 3.2% this year, while the central bank has lowered its estimate to 2.5%. The Chilean peso has also dropped to its lowest level in more than four years, which could partly offset the lower export prices.

To help revive the economy, the Chilean central bank has resumed interest rate cuts after holding the benchmark rate unchanged for most of the second quarter. Though inflation remains above the 4% upper end of the central bank’s target range, recent trends suggest that inflation is declining and could slip further during the second half of this year. The bank had lowered its benchmark rate during the last quarter of 2013 and at the beginning of this year, before pausing on inflation concerns.

PERU: SUBDUED GLOBAL METAL DEMAND RESTRICTS THE PACE OF GDP GROWTH

Weak prices of copper, gold and other metals are hurting the Peruvian economy, which has been one of the best performers in the region in recent years. GDP growth for the first quarter declined to 4.8% annualized, compared to 6.9% during the previous three months. The mining and manufacturing sectors expanded slower than expected while consumer spending and construction activity were relatively more robust. Aggregate exports declined more than 10% during the first half of this year, suggesting that some of the economic weakness likely persisted in the second quarter as well. GDP growth for the month of April declined to 2% annualized, well below the recent trends. The country’s central bank has lowered its GDP growth forecast for the current year to 4.4%, from 5.5% earlier.

To revive economic growth, the Peruvian government and the central bank have announced fiscal and monetary support measures in recent months. The government is stepping up funding for healthcare and education projects and has also announced a one-time bonus payment for government employees. To boost competitiveness, the government is also proposing to restructure the bureaucracy and attract investments for infrastructure and other basic sectors. On its part, the central bank has lowered its benchmark interest rate as well as the reserve requirements for banks.

Despite the moderation in economic growth, rating agency Moody’s has raised Peru’s credit rating by two levels as public debt and the government’s dependence on resource exports to generate revenues have declined. Inflation remains moderately above the central bank’s target range, but is expected to fall during the second half. Industrial investments are expected to recover later this year, but the mining industry is likely to see reduced investments until prices gain.

COLOMBIA: GROWTH ACCELERATES ON HIGHER OIL PRICES AND PUBLIC SPENDING

Colombia has become the fastest growing economy in Latin America, helped by buoyant energy prices and higher government spending. Economic growth accelerated to 6.4% annualized during the first quarter, well above estimates and faster than the 4.9% for the last quarter of 2013. Unlike other countries in the region that export mostly metals and ores, nearly half of Colombia’s exports are oil and gas. This has helped the country avoid the slowdown most other economies in the region are facing. In addition, the government also substantially stepped up spending ahead of the presidential elections held in June. President Juan Santos has been reelected, thus providing political stability and policy continuity. The government is expected to continue the talks with rebels to end the civil war that has lasted nearly 50 years.

Faster economic growth has forced the Colombian central bank to repeatedly hike its benchmark rate in recent months. Though inflation remains below 3%, the mid-point of the central bank’s target range, growth forecasts have been revised higher. The central bank now expects the economy to grow 5% this year, more than its earlier estimate of 4.3%. The unemployment rate also seen an appreciable decline recently, as the farm sector has also seen improvements.

Meanwhile, the healthier economy has boosted the Colombian peso, which is one of the best performing emerging market currencies so far this year. The currency’s gains also reflect expectations of increased investment inflows, after rating agency Moody’s lifted Colombia’s crediting rating to be on par with Brazil. To prevent further currency appreciation, the central bank has doubled its U.S. dollar purchases to $2 billion for the July-September quarter.

ARGENTINA: POSSIBLY ON THE VERGE OF ANOTHER DEBT DEFAULT

Argentina could default on its debt payment if ongoing negotiations with a group of shareholders holding bonds that the country had defaulted in 2002 fail. A U.S. court had ruled recently in favor of these investors, preventing the Argentinean government from paying interest on other bonds before settling these claims from the holders of defaulted bonds. The Argentinean government has refused to entertain these claims, arguing that the investors who are holding out should follow the lead of the majority bond holders who accepted a restructuring of the debt several years earlier. If the country is unable to pay interest on its outstanding debt, it will lead to a default and trigger redemption claims. This could result in a major crisis for the government that is already fighting slower economic growth.

The Argentinean economy contracted during the first quarter of this year, following a weaker than expected 3% expansion last year. A substantial 6.4% drop in exports was the major reason for the decline, while private consumption and construction activity were also weaker. Nevertheless, higher exports of farm produce after a record harvest could support the economy during the second half of this year. Following repeated allegations about the reliability of economic data, Argentina had changed the base year for GDP calculations, which lowered the pace of growth in 2013. Based on the revised data, the country’s economy expanded less than earlier estimates during the period from 2005 to 2012.

The Argentinean government has announced additional tax incentives to attract investments to the country’s energy sector. The proposal allows energy producers to export part of their domestic production without paying taxes. Last year, the government had forced out the foreign investment partner from the country’s largest energy company.

 

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FORWARD LOOKING STATEMENTS

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