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Natixis- Financial Markets in 2012

Natixis- Financial Markets in 2012

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The Year in Review
The Year in Review

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10/01/2013

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January 3, 2013 - No. 1Economic Research Department
FINANCIAL MARKETS IN 2012: THE YEAR IN REVIEW
Macroeconomic context: Between private deleveragingand fiscal austerity
As in the two previous years, the sovereign debt crisis in theeuro zone remains the most significant event of 2012. Evenso, other events, such as the US and French presidentialelections and the renewal of the Chinese Politburo, alsomarked the year.The slowdown in global growth that started in 2011 draggedon in 2012, reflected by the slowdown in global trade (from4.5% in 2011 to 2.5% in 2012). The euro-zone crisis was animportant factor in the deterioration in the global economicenvironment, but not the only one. The monetary tighteningsin 2011 in emerging countries, combined with the ongoingdeleveraging among private economic agents in developedcountries and with fiscal austerity in Europe caused a markedslowdown in growth in most countries and regions of theworld in 2012
(Table 1
and
Chart 1)
. Japan and the UnitedStates were the exception, as the former benefited from theafter-effects of the Fukushima disaster (which disappearedfrom Q3-2012) and the latter maintained highly expansionaryeconomic policies in 2012. Growth in the large emergingcountries slowed down sharply: China and Brazil lost morethan 1.5 percentage points of growth compared with 2011and posted GDP growth of 7.7%
1
and 1.0%, respectively, onaverage in 2012. Europe was the sick man of the globaleconomy, with the euro zone - but also the United Kingdom -sliding into recession. All in all, global growth dropped bynearly one percentage point in 2012, from 3.8% (in PPPterms) in 2011 to 2.9% in 2012. After the inflationary shock in2011, inflation tended to decrease in most countries.At the beginning of 2012, we expected a slowdown in globalgrowth but it proved to be more pronounced than expected(2.9% vs. 3.4% forecast). We had in fact overestimatedgrowth in the large emerging countries, especially China(7.7% vs. 8.6% forecast) and Brazil (1.0% vs. 3.3% forecast),
1
 
All growth rates for 2012 are provisional and factor in our forecastsfor Q4-2012; the economic figures mentioned for December 2012that are no
 
t published reflect our expectations.
but also European growth (-0.4% for the euro zone vs. +0.2%expected at the beginning of the year). US growth, on theother hand, was in line with our forecasts at the beginning of2012 (close to 2.2% on average).All the large emerging regions recorded a slowdown in theireconomic growth in 2012
(Chart 2)
, a result of the fall in theirexports
(Chart 3),
monetary tightenings in 2011 and specificstructural features. However, the economic environment wascharacterised by significant heterogeneities according tocountry/region. Some countries showed solid resilience,especially in South-East Asia (Indonesia, Malaysia,Philippines), benefiting from vigorous domestic demand whileother Asian countries showed signs of weakening (thedragons: South Korea, HK, Singapore, etc.). While inflationtended to decline in 2012, it nevertheless remained high in anumber of countries
(Chart 4).
European emerging countrieswere hit by the impacts of the euro-zone crisis and theweakness of the European economy, but they also recordeda marked slowdown in their domestic demand. Growth fellfrom a pace of 3.1% on average in 2011 to 1.1% in 2012.Growth in Latin American countries also slowed in 2012 (from4.2% to 2.8%), but with significant heterogeneities, with somecountries doing quite well (Chile, Mexico, etc.).
Chinese growth slowed down sharply in 2012 (7.7% onaverage vs. 9.3% in 2011),
with a trough in the middle of theyear (7.4% in Q3) followed by a slight rebound in activity inQ4. While exports dropped, domestic demand also weakenednoticeably. At the same time, inflation fell markedly, from arate of 5.4% (on average in 2011) to 2.6% in 2012. Tocounter the slowdown in activity, the Chinese authorities werefaced with an economic policy dilemma: how stimulate GDPgrowth without increasing macroeconomic imbalances(inflation, credit bubble, sharp rise in real estate prices,increasing inequalities, etc.), as it was the case in 2009. Themeasures were more limited in 2012, with public investmentprojects (which nevertheless run counter to the desire topromote private investment) and a limited easing of monetarypolicy. In 2012, Chinese news was also marked by therenewal of the Central Politburo, with Xi Jinping replacing Hu
 
Jintao, implying a generational change in the Chineseleadership.
The Brazilian slowdown was spectacular in 2012
, withgrowth up only 1% on average after 2.7% in 2011. Hit by theslowdown in global trade, and especially China’s weakness,Brazil was also affected by an overvaluation of its exchangerate. The reason was that due to the monetary policiesconducted by the US Federal Reserve in the past few years,the
real 
had appreciated drastically, hampering thecompetitiveness of the Brazilian economy. In addition, giventhe persistent inflationary pressures, the room for manoeuvrein terms of economic policy has remained limited. Even so,the Brazilian central bank cut the Selic rate by more than 5percentage points between August 2011 and end-2012 andstimulus measures aimed at boosting growth were taken,which stopped the fall in domestic demand.After the rebound in growth recorded in late 2011 and early2012 linked to the after-effects of Fukushima
, the Japaneseeconomy slowed down sharply in the second half of 2012(Chart 5)
. All in all, growth will come in at 1.6% on average in2012 after a recession of 0.7% in 2011. Growth was alsoaffected in the second half by the political tensions with Chinaand the parliamentary elections. The Japanese economyonce again remained in deflation in 2012.
In the United States, the elections were the mostsignificant event of 2012
. They did not change the politicalconfiguration that had prevailed in the previous two years,with on the one hand the re-election of Barack Obama to thePresidency and on the other hand the persistence of adivided Congress (the House of Representatives remains inthe hands of the Republicans while the Democrats have themajority in the Senate). This means that the implementationof the Obama programme is far from assured and that anydecision will be the result of a bipartisan agreement. From theautumn onwards, the economic news was also dominated
bythe discussions on the fiscal cliff
. A fiscal shock of 4percentage points of GDP should have hit the US economy inearly 2013 barring a vote by Congress in favour of anextension of certain tax cuts or a limit to the automaticspending cuts. An agreement finally occurred the last day ofthe year. The political divisions once again caused a climateof uncertainty at the end of 2012, a replay of the drama in thesummer of 2011 when an agreement was found at the verylast moment (increase in the debt ceiling). On the growthfront, the US economy weathered the global slowdownrelatively well, with a growth rate of 2.2% on average in 2012after 1.8% in 2011. This resilience is to a large extentexplained by the economic policies conducted, as fiscalpolicy did not become restrictive and monetary policycontinued to ease. Nevertheless, the fiscal deficit declined to6.7% of GDP in 2012 from 8.6% in 2011 thanks to a reboundin revenues
(Chart 6).
Household consumption slowed in2012 (+1.8% on average vs. 2.5% in 2011) and companiesalso invested less in equipment (+6.5% after +11% in 2011).On the other hand, investment in structures and residentialinvestment accelerated, giving way to a real estate marketrecovery.
2012 was marked by an improvement in the realestate sector after five years of adjustment
: housing startstook off again, inventories fell markedly and prices returned toan upward trend
(Chart 7). 
The job market improved, witharound 1.8 million jobs created and a fall in theunemployment rate from 8.3% in January to 7.7% inDecember
(Chart 8).
Inflation fell noticeably over the year(2.1% on average after 3.2% in 2011), thanks to the gradualdisappearance of the effects of the sharp increase incommodity prices in 2011.
There was a lot of economic news in the euro zone in2012
with a number of European summits paving the way forsome progress on the institutional level but still not on thecrucial path towards federalism (budget at euro-zone level,pooling of public debts, etc.). Progress was made on the issue of banking union, but without any real pooling of risk
2
.
The euro zone
- the weak link of the global economy in 2012-
continued to be affected by the sovereign debt crisisthrough various channels
. While the financial environmentgradually improved thanks to the interventions by theEuropean Central Bank
3
, the ongoing fiscal austerityhampered growth significantly in the peripheral countries andalso, as a consequence, in the other countries in the zone viatrade flows. The zone-euro fiscal deficit was reduced from4.1% of GDP in 2011 to 3.5% in 2012. Some countries foundit difficult to keep their fiscal deficit commitments, given thenegative effects on growth
(Table 2)
. Furthermore,deleveraging among private agents continued in certaineconomies, also weighing on growth. The heterogeneitywithin the zone was pronounced, with some countries stillposting positive growth rates, e.g. Germany (1% on average),and some countries recording falling GDP
(Chart 9).
Spainand Italy, which slid into recession in the second half of 2011,remained there in 2012, with GDP contracting by 1.6% and2.1%, respectively. France avoided a recession, but recordednegligible growth, i.e. 0.1%. Consumption as well asinvestment declined in the euro zone. Household incomesadjusted downwards due to the deterioration in employmentand wages while inflation remained relatively high during alarge part of the year (2.5% at an annual average),nevertheless before declining towards the end of the year
(Chart 10)
. Faced with the deterioration in demand, thegloomy outlook and difficult lending conditions, companiesreduced their investments in 2012
(Chart 11).
Theunemployment rate stayed on its upward trend, rising from10.8% at the beginning of the year to 11.9% in December,with marked divergences between countries: the Germanunemployment rate fell slightly (from 5.6% to 5.4%) while theFrench unemployment rate rose by 1 percentage point, from10% to 11% at the end of 2012. The unemployment rateincreased sharply in some peripheral countries (+3percentage points to 26.5% in Spain)
(Chart 12)
. Frenchnews was marked by the presidential elections and by the leftreturning to power. In terms of public finances, slashing thefiscal deficit remained the new government’s priority so as toanchor its credibility, which will inevitably have an impact onFrench growth in 2013.
The United Kingdom,
while not part of the euro zone
, alsoshowed signs of weakness in 2012 with a recession of0.2%, 
mainly owing to the reduction in the fiscal deficit.Activity fluctuated strongly during the year, with the temporarypositive effects of the hosting of the London Olympic Gamesduring the summer.
In 2013, we do not expect any noteworthy recovery in theglobal economy
, with a growth rate that on average willremain close to the pace recorded in 2012 (slightly lower than3% in PPP terms). Our forecasts are in the lower range of theforecasts for many countries, especially the United Statesand the euro zone. Our caution is based on the idea that theongoing adjustments in economic agents’ balance sheets willcontinue to hamper growth in developed countries and thatthe economic policy leeway in the large emerging countries islimited. The key features of our scenario for 2013 are asfollows: 1/ The deleveraging among private economic agents
2
 
See section on interest rates for a review of the main events of thesovereign debt crisis
 
3
 
See section on monetary policies.
 
N°01I2
 
is set to continue in many developed countries, but its scalecould become less pronounced, especially in the UnitedStates. 2/ Fiscal policies will overall continue to tighten duethe fiscal deficit reduction under way in a large number ofcountries. 3/ Monetary policies, on the other hand, will remainhighly expansionary with interest rates close to zero in thelarge developed countries and with a likely status quo inemerging countries. However, an inflationary spiral could leadto an earlier tightening than expected in some emergingcountries, especially in Brazil. 4/ Uncertainty will continue toprevail and still put a brake on economic agents’ investmentdecisions.
Monetary policies: When unconventional becomes thenorm
To counter the recessionary effect of the fiscal deficitreduction and the private-sector deleveraging, central banksoverall eased their monetary policies in 2012 via rate cuts inemerging countries
(Chart 1) 
and unconventional measuresin the major developed countries, where interest rates werealready very low
(Chart 2)
.In emerging countries, after the tightening that took place in2011, central banks generally eased their monetary policies,but some countries were constrained by the persistent risk ofinflation. The Russian central bank in particular was forced tohike its key intervention rate by 50 bp to 8.5% in September,owing to persistently high inflation. India lowered its ratesonly marginally (by 50 bp to 8%). China lowered the reserverequirement ratio and twice (in July and August) cut the 1-year lending rate (from 6.56% to 6%). To counter theappreciation of the
real 
and the weakening of its economy,Brazil cut the Selic rate drastically in 2012, i.e. by 375 bp to7.25% (after already cutting it by 150 bp in H2-2011).In developed countries, the large central banks all pursuedtheir unconventional policy, but with significant differences interms of the amounts involved and the tools used.The US Federal Reserve was very innovative in 2012,especially in the areas of transparency and communication.Already in January, it announced the introduction of aninflation target (2%). It also continued to communicate a dateuntil when rates would be kept at a low level. This date wasput back from mid-2013 to end-2014 during the first FOMC in2012 and then to mid-2015 during the FOMC in September.Towards the end of 2012, it took an additional step byreplacing this date by a condition related to the level of theunemployment rate. In other words, rates will be not hiked aslong as the unemployment rate remains above 6.5%,provided that expected inflation does not exceed 2.5% andthat inflation expectations remain anchored. On theunconventional monetary policy front, several measures weretaken. 1/ The Fed continued its Operation Twist (launched inOctober 2011), which involves a change in the structure of itsbalance sheet to increase its duration by selling short-termsecurities to buy long-term securities in order to drive downlong-term interest rates. From an initial amount of USD 400bn, Operation Twist was extended into the second half of2012, for a further USD 267 bn. 2/ It eventually decided tolaunch a third wave of quantitative policy (QE3) in Septemberwith purchases of Agency MBS for an amount of USD 40 bnper month without any maturity limits. The purchases will stoponce there is a significant improvement in the labour market.3/ Lastly, in December 2012 it announced a new purchaseprogramme of Treasury securities for an amount of USD 45bn per month, which will start in early 2013. All in all, the sizeof the Fed’s balance sheet should increase noticeably in2013, by around USD 1,000 bn to a total amount of USD3,900 bn by end-2013
(Chart 3).
 In the euro zone, the arrival of Mario Draghi in November2011 at the helm of the European Central Bank (ECB)marked a turning point in the conduct of monetary policy. Onthe interest rate policy front, the ECB lowered the Refi rate by25 bp to 0.75% in July, bringing it below 1% for the first timesince the creation of the ECB. Short-term interest rates(eonia, 1-month and 3-month Euribor) declined during theyear and reached very low levels (reflecting the excessliquidity and the fall in banking risk,
Chart 4
). The ECB wasalso very active on the unconventional policy front in order toprevent a liquidity crisis (with the interbank market seizing up)and to reduce sovereign risk. 1/ While the ECB already in2011 had carried out operations with unlimited allotments ofliquidity in maturities up to 18 months, it now allottedunlimited amounts of liquidity to the banks with a maturity of 3years. After the first operation in December 2011 (totallingEUR 489 bn),
a second VLTRO
(Very Long TermRefinancing Operation) in late
February
allotted EUR 530 bn
 (Charts 5
and
6).
These operations caused a marked easingof banking and interest rate risks. 2/ In July, Mario Draghiused
communication
as a tool to calm the markets,declaring that the euro was irreversible and that the ECBwould do
 
whatever it takes to save the single currency. 3/ After the statements in July, the ECB officially announced theclosing of the SMP (Securities Markets Programme)
4
and
thelaunch of OMT
(Outright Monetary Transactions). Theseoperations, which consist in purchases of sovereign paperwith short maturities (up to 3 years) in the secondary market,are subject to the participating countries requesting Europeanhelp. Moreover, they would be sterilised, i.e. the ECB wouldmop up the liquidity each week. Conditionality, which marks abreak with the SMP, turned out to be required to prevent thepurchases from being considered as monetisation of publicdebt
stricto sensu 
, something the ECB is not allowed to do.As no country made a request in 2012, the OMT programmehas not yet been launched operationally.The Bank of England (BoE) and the Bank of Japan (BoJ) alsoextended their government bond purchase programmes in2012. Faced with a recession, the BoE purchased Gilts forGBP 100 bn in 2012 (GBP 50 bn in February and GBP 50 bnin July), bringing the total amount held to GBP 375 bn. Inaddition, it launched a programme in August to boost thefinancing of the economy: "Funding for Lending", whichallows the banks to obtain cheap funding over a period of upto four years (in exchange for collateral) in order to enablethem to support the economy. To combat the persistentdeflation and in an attempt to weaken the yen, the BoJ alsoextended its government bond (JGBs) purchase programmeon five occasions from JPY 55,000 bn to JPY 101,000 bn (byJPY 10,000 bn in February, by JPY 5,000 bn in April, by JPY10,000 bn in September, by JPY 11,000 bn in October andby JPY 10,000 bn in December).Lastly, the Swiss National Bank continued its policy,introduced in August 2011, consisting in keeping theEUR/CHF exchange rate above 1.20 (see section onexchange rates).
4
 
SMP, the first sovereign bond purchase programme withoutconditionality introduced in 2010 to try to drive down interest rates onGreek debt.
N°01I3

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