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MORGAN STANLEY RESEARCH

Global Economics Team


Coordinators of this publication

Joachim Fels
Joachim.Fels@morganstanley.com +44 (0)20 7425 6138

December 18, 2013

Manoj Pradhan
Manoj.Pradhan@morganstanley.com +44 (0)20 7425 3805

Global

The Global Macro Analyst Macro Surprises for 2014


It is ironic, but in a world where so many questions are still largely unanswered, investors, economists and strategists seem to hold very similar views at the moment. But where could this strong consensus be wrong? To help answer that question, we continue a Morgan Stanley tradition introduced nearly three decades ago by our legendary former US strategist Byron Wienwith a few twists. The surprises we list today would surprise the consensus and marketsand us as well since these are not our base case, even though we do have them firmly on our radar. So what could challenge the consensus in 2014? How about: Forward guidance fails and many DM central banks lose credibility The shale revolution goes global A spat at the Fed on the role of forward guidance splits the FOMC Spain learns to love deflation and Germany inflationwhile Italy is Japanified In Asia, the transition towards more sustainable models of growth fails; China hard-landing fears returnwhile North Korea sees a regime change Brazil takes a turn for orthodoxy after its elections, and reforms in Mexico hit speed bumps Moscow becomes the New Brussels while Turkeys central bank returns to conventional monetary policy

Patryk Drozdzik
Patryk.Drozdzik@morganstanley.com +44 (0)20 7425 7483

Sung Woen Kang


Sung.Woen.Kang@morganstanley.com +44 (0)20 7425 8995

Philipp Erfurth
Philipp.Erfurth@morganstanley.com +44 (0)20 7677 0528

Global Economics Forecasts


Real GDP (%) 2013E 2014E 2015E CPI inflation (%) 2013E 2014E 2015E

Global Economy G10 Emerging Markets

2.9 1.1 4.7

3.4 1.8 5.0

3.7 2.0 5.3

3.2 1.4 5.0

3.3 1.6 5.0

3.2 1.5 4.7

Source: Morgan Stanley Research forecasts

The Morgan Stanley Global Economics View ........... p 8

Will these surprises pan out? We dont know, but they would certainly change the landscape in 2014 if they do. As Monty Python has famously said nobody expects the Spanish Inquisition.

Spotlight
Fed Focus: The Fed Dream Team?
Stanley Fischer, the possible next vice-chairman of the Federal Reserve Board, comes with a resume that cannot be topped. A Yellen-Fischer-led Fed would likely work as a world-class institution if all goes according to plan. Perhaps more importantly for Yellen, what signal is the Administration trying to send? p7

Global Macro Watch Global: Global GDP Nowcast: 4Q Update .................. p 10 Euro Area: No Specific Measures Yet ........................ p 10 Spain: Regional Finances No Longer a Problem? ... p 11 Japan: Abenomics, Labour and Wages: Thousand Mile Journey in a Blizzard.................................................... p 11 UK: Autumn Statement: Finally, Some Better Fiscal News ........................................................................... p 12 EM: The Double Deficit Club & the Safe-Haven Club.. p 12 China: Modest Easing in Growth Momentum.............. p 13 Asia Pacific: Asias Boom-Bust-Adjustment Cycles ... p 13 Indonesia: Policy Rate Kept on Hold .......................... p 14 Latin America: Latam Transitions .............................. p 14

For important disclosures, refer to the Disclosures Section, located at the end of this report.

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Macro Surprises for 2014


Joachim Fels & Manoj Pradhan, with contributions from the entire Morgan Stanley Global Economics Team. Over the past couple of weeks, Morgan Stanleys economics team has been busy marketing our 2014 Global Macro Outlook (December 2, 2013) and the accompanying regional outlooks around the globe. One of our key takeaways from the many client meetings, conferences and calls is that most investors, economists and strategists hold very similar views about what 2014 will bring and how to position for it. In fact, we cannot remember a year in the recent decade when the groupthink has been so strong in the international financial community. Most investors are aware of this and so many keep asking where could the consensus be wrong? To help answer this question, we continue a Morgan Stanley tradition introduced nearly three decades ago by our legendary former US strategist Byron Wien. Each year, Byron (now at Blackstone) publishes his Ten Surprises for the upcoming year. He defines a surprise as an event that the average investor believes to have only at most a one in three chance of happening, while Byron believes that it has at least a 50% likelihood of coming true. For our purposes, we are bending Byrons rules. First, reflecting the many thinkers on our team and many regions and countries we cover, we have compiled more than ten surprises from our economists around the globe. Second, these surprises do NOT represent our base case. Rather, the events we describe would come as a surprise to us as well. However, we do believe that they depict plausible scenarios that would represent a meaningful surprise to the prevailing consensus. Shale Gas & Oil Revolution Goes Global While the US and Canada shale gas revolution took off for good, it was held back in other parts of the globe by various factors including political, geological and environmental concerns. But no more. The successful exploration in the US that reduces its external dependence on energy and supports its manufacturing renaissance, high energy prices despite subpar global growth recovery, geo-political developments and bold energy reforms, inspire EM economies to give shale gas and oil a proper go andthey score. Mexicos energy reforms and Poland and Ukraines exploitation of its shale gas reserves (Europes biggest and third biggest reserves, respectively) provide strong results. In China too, liberalisation policies attract involvement of foreign multinationals with necessary know-how. Finally, lifting restrictions on fracking in the UK and the more attractive tax regime of the industry in Australia keep DM involved as well. Meanwhile, global crude price breaks below its range as supply continues to outpace demand. Global energy prices react as they should. They move lower and give the global economy a positive supply shock. Energy importers prosper while new shale gas producers see rapid development of this new sector of their economy. Trade Agreement, Anyone? With steep domestic economic challenges, policy-makers seek to create growth via the international stage, giving a push to agreements such as the TTIP (Trans-Atlantic Trade and Investment Partnership between the US and EU) and TPP (Trans-Pacific Partnership beefed up to 12 countries including the US, Japan and S. Korea). The effect? Trade barriers tumble, investment sees a further liberalisation push and transaction costs are decreased as bureaucracy and red tape are reduced. The improved cooperation leads to more solid pick-up in trade and more sustainable growth in the global economy. Bubble Trouble Housing price and asset price bubbles build up in various economies on the back of prolonged accommodative monetary policy (e.g., NZ, UK, Canada, Sweden and Australia). Central banks are hesitant to pull the tightening trigger too soon, and continue to depend heavily on macro-prudential measures as a substitute to monetary policy. These tools fail to rein in the build-up of bubble prices and central banks tighten policy rates in a panic, only to find that it is too late. The boom gives way to a bust, with a sharp reversal in prices, and financial instability derails confidence and economic growth.

Global
Forward Guidance Fails Many of the major DM central banks (possibly including the BoJ in the future) have moved towards a regime of forward guidance, which has become an important policy tool for a smooth transition from QE towards more conventional policy. One central bank proves unsuccessful in upholding credible forward guidance on interest rates, and this failure is translated around the world to other central banks as well. Forward guidance then increasingly becomes viewed as mere cheap talk and investors lose confidence in central banks credibility to both support growth and deal with inflation when they need to.

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Y=AL K , Capex: Check, but What about Labour? Though the US manufacturing renaissance progresses in 2014, a shortage of skilled labour (thanks to a deep recession and years of outsourcing) throws a spanner in the works. US firms struggle to fill jobs due to a lack of proficient labour supply. Competition for skilled workers leads to upward pressures on wages, which, in turn, hurts competitiveness. Meanwhile in the EU, due to the lack of decisive policy action, long-term youth unemployment stays at record highs, with young jobseekers lacking the experience and skills to drive an economic recovery. Not just in the European periphery but also in countries like the UK, long-term youth unemployment remains at multiples of pre-crisis levels. In both the US and the EU, this skills gap shortage acts as a road block on the way to a sustainable recovery. EM: Showing Policy-Makers the Yellow Card In EM, a dangerous cocktail of economic policies and outcomes cause a serious hangover. Necessary fiscal and monetary tightening measures and other macro adjustments, execution of unpopular structural reforms, a subpar and volatile recovery, currency depreciation and rising divergence between slowing EMs and reaccelerating DMs all play a role. An early World Cup exit for Brazils football team and elections in many, including all core Double Deficit Club EM economies, act as a catalyst for heightened popular awareness about slowing growth prospects and other social problems. The result is social unrest which hurts economic activity in the short term. Policy-makers respond with populist measures which go against the need for structural reforms to help these economies transition from their broken growth models to newer, sustainable ones. A Sharper EM Adjustment, but with a Silver Lining (Finally) As US growth and capex surprise to the upside, EM economies get none of the benefits from better US growth (since they are better equipped to cater to consumer, not investment demand). Higher US Treasury yields and a stronger US dollar create 2013-like effects in the EM world, pushing a sharper adjustment onto asset prices and economic growth. However, this time round, policy-makers finally find religion, and respond with structural reforms that find enough buy-in from global investors aided by the significant adjustment to asset prices. Economic and asset market prospects in EM finally improve for the right reasons.

United States
A Spat at the Fed Vice chairman Stanley Fischer draws a battle line in the sand, arguing forward guidance is ineffective and should be abandoned. Chairwoman Yellen tries to enforce conformity in favour of forward guidance. Nevertheless, Fischers intellectual gravitas draws enough support to split the FOMC. The Fed drops details of forward guidance and simply states policy accommodation will remain in place until the outlook for the labor market has improved substantially in a context of price stability. Confused financial market participants price in earlier tightening and rates jump. More Aggressive Housing Policy Newly installed Federal Housing Finance Agency (FHFA) director Mel Watt paves the way for the Presidents plan to open up refinancing for millions of families by streamlining the process for mortgages not guaranteed by the government. A new wave of refinancing ensues, freeing up a substantial amount of disposable income. Republican Sweep Since 2010, a divided US Congress has slowed passage of legislation to a near glacial pace. The steady stream of partisan gridlock is only periodically interrupted by artificial funding crises, the product of prior makeshift eleventh hour deals. To reset the course, Republicans pour endless hours and funds into divided senate races until Election Day in November 2014. They net the 6 seats needed to control Congress, the President is forced to the table with fewer bargaining chips, and the elusive budget grand bargain becomes reality. Strong legislation and the removal of policy uncertainty comfort consumers, businesses and financial markets.

Europe
Political Backlash: More Regional than European While investors get increasingly worried about the European Parliament elections and the rise of anti-European or antieuro parties, the real trouble is starting to brew at the regional level within individual European countries. In the context of the Scottish independence vote in September 2014 and the planned Catalan referendum in November 2014, it becomes increasingly clear that Member States will use the full force of the EU treaty, which says that any region leaving a country would also find itself outside of the European Union and would need to reapply for entry, to limit potential devolution of national power up to and including full regional independence.

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Italy Turns Out to Be the Next Japanand Bond Yields Fall Sharply Signs of Japanification take hold in Italy more than anywhere else in the eurozone. Just like in Japan over the past decade and a half, outright deflation happens and affects inflation expectations, and Italys poor demographic prospects contribute to entrench the declining trend in consumer prices. But, like the Japanese economy at that time, the Italian current account is now in surplus, and its bond market much more owned by domestic investors than before. Thus, with structurally low growth and negative inflation, yields on Italian government bonds fall sharply as long as perception of a European policy backstop remains in place Spain Learns to Love Deflation, Germany Learns to Love Inflation. No Fun in Italy Though. The whole of southern Europe sees outright declines in consumer prices. But this happens just as a result of economic weakness and wide spare capacity in Italy, which struggles to shoulder its debts as consumers and firms postpone spending in expectations of further falls in prices. This makes nominal GDP shrink even more. Yet Spain sees a drop in consumer prices as a result of rising productivity and falling wages courtesy of the labour market reforms. In turn, this regained competitiveness supports GDP growth and lowers the debt burden through the export channel but also thanks to domestic spending, given that product market reforms now make the balance-sheet adjustment feeding through into lower consumer prices. Yet, this is shortlived and doesn't trigger expectations of further drops in prices. And, to round-up the good rebalancing within the eurozone, wage growth and rising house prices boost the German consumers purchasing power, which does actually spend! Cyprus Lifts Capital Controls before Iceland With all capital controls in Cyprus being removed and the country resuming its full effective membership of the euro, doomsayers, who were praising Iceland to be lucky for not being restricted by being a member of the European Union or the Single Currency, will have another opportunity to reconsider their views. The same goes for those who were commenting that the difference between Ireland and Iceland was one letter and six months as Irelands exit from the bailout programme will prove highly successful. EMU-Outs Stifled by Tighter Macro-Prudential Policies In our baseline, the UK and Sweden will grow four to five times as fast as the euro area. One factor that is supporting consumer spending in both countries is a strong performance of the housing market. In Sweden, the strength of the housing market and the accompanying increase in mortgage debt have already become a concern both from a monetary and

macro prudential policy point of view. In the UK, the housing market is already becoming a concern on the macroprudential policy side, despite only small increases in mortgage debt. But with macro-prudential policies which are now applied in both countries still largely being untested, they have a bigger-than-expected impact, causing housing markets to come to a grinding halt or even to go into reverse, thus opening the door for more monetary policy stimulus.

Japan
Wage Inflation Triggers Productivity Boost Wages accelerate to 2%Y quickly, in the face of labour shortages. Moreover, wage acceleration starts in small business, where shortages are worst. In addition, pressure from the Abe government on large companies leads to increases of base wages in the spring wage round, and small firms are forced to follow doubling the pressure on the small firms. A shakeout begins among small firms, and this shakeout reallocates labour to better uses. Although the wage pressure starts a political backlash for more small business support, the tight labour market allows a change of labour laws, to allow more flexible management of hiring/firing. Better incentives for business and labour improve skill levels and justify the higher wages. The higher wage inflation gives BoJ more confidence in its inflation forecast, and it postpones new easing measures, leading to changed expectations for both yen/dollar and JGB yields. The yen stabilises towards our end-2014 level of 109/US$, but does not weaken further. JGB yields rise more in line with our bear case, particularly at the long end of the curve. However, the faster move from deflation to inflation improves tax revenue, and contains fiscal pressures. Equity markets may be concerned about higher input costs, but managements that actively raise productivity will be rewarded with higher stock prices.

Australia
Macro-Prudential Housing Restriction: Aussie Does a Kiwi Australia introduces macro-prudential restrictions on housing finance, following New Zealands lead for only the second time in economic history (we concede that they helped pioneer inflation targeting). The RBNZ could fly solo into its 10/80 rule (no more than 10% of loans above 80% LVR from October 2013) given its joint mandate as central bank and prudential regulator, but the RBA will need to work with its counterparts at APRA. RBA Governor Stevens last week flagged that macro-prudential policies have been discussed, although there was no active plan to deploy them right now. If Australia indeed goes macroprudential in 2014, we expect that investor mortgages would be targeted, with loans for new construction likely exempted, as recently announced across the Tasman.

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Asia
Asian Growth Models Transition Fails In China, reforms do not get started in earnest, the government continues to rely on credit-fuelled investment-driven growth which lacks productivity dynamic, thus increasing the financial stability risks. In India and Indonesia, election outcomes bring weaker governments, which fail to address the challenge of lifting productivity while the rise in US dollar and US real rates accelerates. A combination of these developments brings a major downside surprise to GDP growth in the region. China Fast-Tracks Reforms Policy-makers accelerate the pace of rolling out reform measures and the initial impact starts to surface towards late 1H14. In particular, the early initiation of service sector deregulation induced more private sector investment and boosted consumption of service. With the help of a global rebound and domestic demand strengthening, overcapacity has largely been absorbed while local government finance vehicle (LGFV) related liability undergoes more restructuring. Fears of Chinese Hard Landing Make a Comeback Policy-makers inadvertently missed the opportunity to adjust countercyclical policies while they paid too much attention on long-term planning. As a result, domestic demand growth slows down sharply in 1H14. Financial conditions remain tight, which weighs further on manufacturing sector investment. Meanwhile, reform implementation comes to a stall, as downside risks from a widespread deleveraging process loom large. A North Korean Regime Change Following the surprising execution of Jang Sung-taek, the leading political figure and uncle of Kim Jung-un who was believed to be the second person in charge and the de facto country leader during the transition from Kim Jung-il to Kim Jung-un, the stability of the North Korea regime becomes highly questionable. Execution of such a senior official was unseen since the 1950s. Our base case remains that the North Korean regime will be kept intact and that Kim Jung-un may even replace his aides by younger politicians who can bring innovations and reforms to the country. Yet, we cannot rule out the possibility of increasing unrest in the Korean peninsula. This would take a toll on both consumer and business sentiment in South Korea and derail the recovery that we are expecting in 2014. A change in the North Korean regime could possibly see an influx of refugees, posing substantial financial burden on the South Korean government.

Latin America
Brazil Takes a Turn for Orthodoxy No sooner is the October 2014 presidential election over than the central bank restarts its hiking cycle with an aim at finally denting labour market dynamics and slowing wage growth. We are surprised to find that the fiscal and quasi-fiscal authorities are not far behind as fiscal consolidation takes place to avoid a sovereign rating downgrade that appeared in the cards. 2014 ends on a challenging note for consumers, but hope emerges that on the other side of such painful medicine, Brazil's growth profile might improve with the help of a series of structural reforms. Brazil's Labour Markets Start to Unravel While not our central case, a crisis of confidence triggers a selloff in the currency, which leads to a material pick-up in inflation. The hit to disposable income and consumer spending leads to higher unemployment. In order to control inflationary pressures the central bank tightens monetary policy aggressively, which softens domestic demand even further and raises concerns over Brazil's fiscal and debt dynamics. Mexico Loses a Year and Maybe More While we are firmly in the camp that Mexico's Moment comes to fruition in 2014, the anti-reform proponents could gain ground in the first months of 2014 just as enabling legislation is scheduled for congressional passage. (Surprising as that would be for us, there are some grounds 2014 is the 20th anniversary of both NAFTA and the Zapatista uprising). Legislative delays prove temporary, but they cut into advances for the year. A late start is compounded by a series of regulatory delays as neither Mexicos state-owned oil company nor the new regulatory bodies are ready for a brave new world in the oil and gas industry. Chile Reaffirms Orthodoxy Even before the new administration takes office in March, it surprises those concerned with its campaign initiatives by instead announcing a strong cabinet from the center. Once in office, it unveils an aggressive strategy for the electricity sector, allowing mining and industry to gradually regain some of its lost competitiveness, while at the same time tackling shortcomings on education and health care, succeeding in the dual challenge of strengthening the current business-friendly model and addressing calls for a more inclusive society. More taxes? Yes, but there is no wavering from the traditional prudence in fiscal and monetary management.

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Venezuela Regains Favour with Big Oil Venezuela revamps the regulatory mix in the oil sector and starts attracting major FDI commitments from Big Oil. We expect macro adjustments next year to include a devaluation (with the currency moving to Bs$12.00/dollar from Bs$6.30/dollar), legalisation of a parallel flexible foreign exchange system and some fiscal tightening. But the real surprise (and not our base case) is the governments more aggressive outreach to the international oil companies. After years of oil production and export declines, potential for Venezuelas macro turnaround rests on progress in this oil opening. Argentina Positively Resolves Bond Standoff with Holdouts The move allows Argentina to regain market access and policy turns more orthodox. Given the timeline for the legal process in US courts, it is likely that the standoff with the holdouts is resolved next year. The debate is whether this resolution will be positive for Argentina with Argentina curing the default and regaining access to capital markets or negative for Argentina with Argentina losing the appeal in the US Supreme Court and entering technical default. There also are encouraging signs that an alternative resolution through an inter-creditor solution may be negotiated early next year. A positive resolution would significantly improve the Argentine outlook both in the near term and the medium term by restoring market access more than a decade after the country lost it in the aftermath of the 2001 default.

In order to allay funding concerns, contain currency volatility and to keep inflows intact, the CBT exhausts all possible channels of the current monetary policy. This time the policy traction remains weak and eventually the CBT adopts an orthodox monetary policy which helps TRY to be one of the outperformers among EM. South Africa: Tougher SARB Squeezes CAD Most South Africa watchers expect the countrys current account deficit to remain wide in the coming years. However, concerns about the impact of currency weakness and its associated pass-through effects on forward-looking inflation outcomes in the wake of Fed tapering (and/or an earlier-thanexpected global recovery) may force the SARB to tighten policy much earlier than currently expected. Such a move is likely to cap household and investment spending, which, in turn, enforces a faster closure of the current account gap. While the initial adjustment process is likely to be perceived negatively by markets, we believe that sentiment should change for the better once the implied macro rebalancing has run a fair share of its course. Czech Republic: Of Deflation and Devaluation Another devaluation in the Czech Republic (CZK), as deflationary forces turn out to be stronger than the CNB was expecting. The background is that the CNB believes that the onset of deflation would have serious consequences on the already weak Czech consumer outlook, and it expects the recent FX devaluation to add about 1% to CPI next year (which implies a 20-25% passthrough). This FX pass-through assumption strikes us as a bit high, so another devaluation to push inflation up is a possibility. We would imagine this devaluation to be in the range of 5% versus EUR, possibly larger. Ukraine Unifies and Looks West This year Ukraine authorities created strong expectations of signing the Deep and Comprehensive Free Trade Area (DCFTA) with the EU. However, this was followed by the Uturn in the foreign policy and a deal with Russia, details of which have been announced this week. It includes a purchase of US$15 billion of Ukrainian Eurobonds and a 30% discount of a gas import price, which we think would allow Ukraine to hold the hryvnia and reserves at current levels to the presidential elections in March 2015. Our surprise would be if spurred by the current protests, President Yanukovych and the opposition leaders reach agreement on signing the EU deal in 2014 and implement an IMF programme, which would allow Ukraine to tackle its imbalance without a sharp movement in the UAH or growing dependence on Russia.

CEEMEA
Moscow Becomes the New Brussels In recent years, Putin has promoted a Russian-led Customs Union as a way of strengthening economic and, in time, political ties among the former states of the Soviet Union a theme which we picked up on in last years surprise Back in the USSR. However, this has not worked well so far: no pickup in trade, a high cost in subsidies, and a lack of popular appeal, particularly in Ukraine. Meanwhile, the Russians are concerned that the proposed EU-US Free Trade Agreement may set standards for the global economy. So, our surprise would be a change of tack, with a new Russian focus on negotiating free trade agreements with the US, Europe and globally ideally from Putins perspective with Moscow negotiating on behalf of the Eurasian Customs Union, as Brussels negotiates on behalf of the EU. Turkey: The Return of Central Bank Orthodoxy The commencement of Fed tapering and the associated rise in cost of borrowing reignites funding fears, given Turkey's high borrowing requirement as well as her debt rollover need.

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Spotlight: Fed Focus: The Fed Dream Team?


Vincent Reinhart (1 212) 761 3537 In the summer of 1980, the old guard of the Republican establishment faced the uncomfortable inevitability of the nomination of Ronald Reagan as their partys candidate for president. They doubted Reagan would unseat the incumbent, Jimmy Carter, and wanted policy better anchored in traditional views. The solution was to put forward a co-presidency, with Reagan at the top of the ticket, focused on domestic policy, and former President Gerald Ford running the international portfolio from the office of vice-president. Despite the backers (reportedly to have included Henry Kissinger, Richard Cheney and Alan Greenspan), the proposal lit up the headlines for only two days before flaring out. The idea failed to gain traction because of concerns about: The institution. Could the Constitution be interpreted so flexibly as to allow co-presidents? The signal. Doesnt the desire to break precedent with the number two reveal concern about the number one? The personalities. Would the forced partners have enough emotional intelligence to share the spotlight, especially when decisions have to be ratified by a larger group? The practicalities. Who speaks for the institution, attends international meetings and directs staff? The co-presidency idea failed for the same reason that investors head for the door when boards of directors announce the novel solution of co-CEOs. An institution needs a leader, and a leader speaks with one voice. Other than that, we think it is great news that the Administration may nominate Stanley Fischer to be vicechairman of the Federal Reserve Board. Fischer has been around the inner circle of international economic policymaking for three decades. If he was not at a major meeting in person, one of his students from his long tenure at MIT probably was. The most relevant experience for the job as vice-chairman was his eight years of service as First Managing Director of the International Monetary Fund. He effectively ran the institution for the Clinton Treasury from below an MD who was either headed for retirement (Michel Camdessus) or viewed by it as inadequate (Horst Kohler). When you add his service at the World Bank and as governor of the Bank of Israel, Fischer has a resume that is hard to be topped. As for the content of that career, Fischer is eminently practical. Even though he has written textbooks on macroeconomics, he has not rotely applied lessons from their pages. He has expressed scepticism about forward interest rate guidance and quantitative easing. Indeed, he wondered out loud about interventions at the latest Jackson Hole Economic Symposium, questioning several acts of faith in the policy-making canon, including the benefits of international capital mobility. A Yellen-Fischer-led Fed would likely work as a worldclass institution if all goes according to plan. But in Fischers nomination, Janet Yellen has to wonder about the signal. What is the Administration revealing about her role? How will it be taken by her colleagues on the Federal Open Market Committee and at international meetings? Who will Fed staff be straining to please? And how soon will observers talk about her tenure as four and done? We think that the Administration needs to clarify its intent, if its intent really is to nominate Fischer. Part of that can be done in preparing Fischers way for Senate confirmation to explain the workability of the arrangement and the viability of his candidacy. With the fifty-vote rule in place, the White Houses problem will not be with Senate Republicans. Rather, advisors will have to convince Senators to the Presidents left that a former Citicorp official carrying the baggage of eight years of IMF policy decisions will serve in a supporting position to the chairwoman they so dearly wanted. See US Economics: Fed Focus: The Fed Dream Team?, December 12, 2013.

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

The Morgan Stanley Global Economics View


Our Core Global Views
Five key transitions: 2014 will mark year five of a post-crisis global economic expansion and the transition to a sounder, safer and more sustainable second half of this expansion. For this to be achieved though, policy-makers around the globe will have to master five transitions in the US, euro area, Japan, China and EM. In our base case, these transitions will eventually be accomplished and we expect global GDP growth to accelerate to 3.4%Y in 2014, from just below 3%Y in 2013. Continued accommodation by central banks: The transitioning to a better second half of this expansion will require ongoing support from central banks. With global inflation likely to remain low for longer, we forecast continued accommodation by DM central banks. However, we expect 13 EM central banks to hike rates in 2014. Eurozone not out of the woods yet: The Japanification of the euro area is a serious risk, but can still be avoided if policy-makers heed lessons from Japans past. We think that resolution of the euro area sovereign and banking crisis requires both a fiscal union and a banking union coupled with the ECB being willing and able to be the lender of last resort to governments. While the ECB has taken a decisive step towards fulfilling this role, progress on fiscal and banking union remains painfully slow and full of setbacks. Fiscal dominance and financial repression: Dont expect DM central banks to tighten soon they are locked into a regime of fiscal dominance, where increases in the real interest rate worsen government debt sustainability. Part of the solution to high government debt levels can be imposing artificially low, or even negative, real returns on captive investor groups financial repression. EM growth model broken needs structural reform: EM economies face external and internal challenges that render the old, export-led model of growth defunct. Weak DM consumers, onshoring of DM manufacturing and risks to external funding all work against EMs externally.

Key Macro Risk Events


December 18, 2014 US FOMC meeting- Tapering start 15% probability January 15, 2014 Deadline for expiration of US continuing resolution January 30, 2014 US FOMC meeting- Tapering start 25% probability February 7, 2014 Next soft US debt ceiling deadline, extraordinary measures to avoid default until summer March 1, 2014 ECB expected to assume supervisory tasks within Single Supervisory Mechanism March 20, 2014 US FOMC meeting- Tapering start 35% probability March, 2014 Turkey Local elections April, 2014 Indonesia Parliamentary elections May, 2014 India General elections May, 2014 European Parliament elections

EM Regional Themes EM growth has stabilised but important transitions are needed to progress recovery
towards a more sustainable one and/or improve macro-stability. Asia ex-Japan: China needs to focus on pro-market reforms, economic rebalancing and deleveraging which might come at the expense of short-term performance but will improve medium-term outlook. India needs higher real rates and more friendly investment environment to alleviate the macro-stability risks. Koreas growth needs to be more consumption driven. Indonesia needs higher rates and lower REER. Latin America: While there is unlikely to be near-term unravelling in Brazil, we also dont expect a major policy shift necessary to fix the structural challenges before elections either. Mexico and Colombia will need to implement proposed reforms, while Chiles political transition could be accompanied by greater focus on inequality issues. Peru is shifting to a new lower normal on the back of lower mining investment. CEEMEA: Russias mild cyclical rebound will need stronger investment while Turkey needs to tighten monetary policy to ease external balance sheet concerns. Polands growth is on the mend and rebalancing towards greater contributions from domestic demand. S. Africa CAD will involve a painful adjustment for the domestic economy.

Chart of the Week


5 Key Transitions to Sustainable Growth
Five Tricky, Tough and Testing Transitions
SSS = Sounder, Safer, more Sustainable

US QE --> Forward Guidance

SSS Growth

For our global forecasts, see 2014 Global Macro Outlook: Five Key Transitions, December 2, 2013. For our cross-asset views, see Global Debates Playbook: The Alpha Games: Catching Fire, December 6, 2013.

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Key Forecast Profile


Global Economics Team

Quarterly
2013 Real GDP (%Q, SAAR) 1Q 2Q 3QE 4QE 1QE 2QE 2014 3QE 4QE 1QE 2QE 2015 3QE 4QE

Annual
2013E 2014E 2015E

Global** G10 US Euro Area Japan UK EM (%Y) China (%Y) India (%Y) Brazil (%Y) Russia (%Y)

2.5 1.1 1.1 -0.9 4.3 1.5 4.9 7.7 4.8 1.9 1.6

3.5 2.2 2.5 1.1 3.8 2.7 4.5 7.5 4.4 3.3 1.2

4.0 2.3 3.6 0.3 1.9 3.2 5.1 7.8 4.8 2.0 1.2

3.4 1.6 1.9* 0.5 2.3 2.8 4.5 7.4 4.8 2.0 1.9

3.3 2.3 3.3 0.2 3.3 2.4 4.8 7.5 5.0 2.1 2.4

2.8 1.3 2.8 0.4 -3.0 2.0 4.8 7.3 5.0 1.3 3.2

3.6 1.9 2.5 1.1 0.7 2.4 4.8 7.0 5.2 2.0 2.6

3.7 2.1 2.8 1.2 1.5 2.0 5.1 7.1 5.3 2.3 2.0

3.3 2.0 2.6 1.2 1.1 2.4 4.8 7.2 5.5 1.9 2.9

3.8 2.1 2.7 1.2 1.7 2.4 5.0 7.6 6.1 1.4 3.9

3.7 2.1 2.6 1.2 2.8 1.6 5.1 7.4 6.3 1.2 4.9

3.5 1.8 2.7 1.2 -1.1 2.4 5.3 7.4 6.3 1.5 5.9

2.9 1.1 1.6 -0.5 1.8 1.4 4.7 7.6 4.7 2.3 1.6

3.4 1.8 2.6 0.5 1.3 2.5 5.0 7.2 5.1 1.9 2.7

3.7 2.0 2.7 1.1 1.1 2.2 5.3 7.4 6.0 1.5 2.6

Consumer price inflation (%Y)

Global G10 US Euro Area Japan UK EM China India Brazil Russia

3.3 1.8 1.7 1.9 -0.3 2.8 4.9 2.4 10.7 6.4 7.1

3.2 1.7 1.4 1.4 0.0 2.7 4.6 2.4 9.5 6.6 7.2

3.2 1.8 1.6 1.3 0.7 2.7 4.7 2.8 9.7 6.1 6.4

3.2 1.5 1.2 0.9 1.0 2.3 4.9 3.0 10.0 5.9 6.3

3.1 1.3 1.1 0.9 1.2 2.4 4.8 2.2 9.2 5.9 5.7

3.3 1.4 1.7 1.1 3.1 2.5 5.1 3.4 8.8 5.8 5.4

3.3 1.2 1.5 0.9 2.8 2.6 5.3 3.8 7.8 6.1 4.9

3.1 1.2 1.6 1.3 2.8 2.5 4.9 3.3 6.9 6.4 4.8

3.3 1.8 1.5 1.2 2.5 2.4 4.8 3.4 6.4 6.2 4.8

3.4 1.6 1.6 1.3 0.5 2.3 5.1 3.5 6.4 6.2 4.8

3.6 1.7 1.6 1.3 0.5 2.3 5.3 3.8 6.2 6.0 4.9

3.3 1.7 1.6 1.2 1.8 2.3 4.9 3.6 6.5 5.9 4.7

3.2 1.4 1.5 1.4 0.3 2.6 5.0 2.7 10.0 6.2 6.7

3.3 1.6 1.5 1.1 2.4 2.5 5.0 3.2 8.2 6.0 5.2

3.2 1.5 1.6 1.3 1.3 2.3 4.7 3.6 6.4 6.1 4.6

Monetary policy rate (% p.a.)

Global G10 US Euro Area Japan UK EM China India Brazil Russia

3.1 0.6 0.15 0.75 0.10 0.50 5.9 6.00 7.50 7.25 5.50

3.0 0.5 0.15 0.50 0.10 0.50 5.7 6.00 7.25 8.00 5.50

2.9 0.5 0.15 0.50 0.10 0.50 5.7 6.00 7.50 9.00 5.50

2.9 0.5 0.15 0.25 0.10 0.50 5.4 6.00 7.75 10.00 5.50

2.8 0.4 0.15 0.10 0.10 0.50 5.4 6.00 8.00 10.50 5.50

2.9 0.4 0.15 0.10 0.10 0.50 5.5 6.00 8.00 10.50 5.25

2.9 0.3 0.15 0.10 0.10 0.50 5.6 6.00 7.75 10.50 5.25

2.9 0.3 0.15 0.10 0.10 0.50 5.7 6.00 7.50 10.50 5.00

2.9 0.3 0.15 0.10 0.10 0.50 5.7 6.00 7.50 12.00 5.00

2.9 0.3 0.15 0.10 0.10 0.75 5.7 6.25 7.50 13.00 4.75

2.9 0.3 0.15 0.10 0.10 0.75 5.7 6.25 7.50 13.00 4.75

3.0 0.3 0.15 0.10 0.10 1.00 5.9 6.25 7.50 12.00 4.75

2.9 0.5 0.15 0.25 0.10 0.50 5.4 6.00 7.75 10.00 5.50

2.9 0.3 0.15 0.10 0.10 0.50 5.7 6.00 7.50 10.50 5.00

3.0 0.3 0.15 0.10 0.10 1.00 5.9 6.25 7.50 12.00 4.75

Note: Global and regional aggregates are GDP-weighted averages, using PPPs. Japan policy rate is a range from 0.00-0.10%, with 0.05% as the midpoint; CPI numbers are period averages. *US GDP forecast for the current quarter is a tracking estimate. **G10+BRICs+Korea Source: Morgan Stanley Research forecasts

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Global Macro Watch


Global GDP Nowcast: 4Q Update
Philipp Erfurth (4420) 7677 0528 Manoj Pradhan (4420) 7425 3805 Update: 4Q13 Global GDP
2013 Real GDP (% SAAR) 4Q 3.6

Euro Area: No Specific Measures Yet


Elga Bartsch (44 20) 7425 5434 As expected, the ECB left interest rates unchanged and also did not announce any other measures after the December 5 meeting. The press conference made clear that no specific measures within the array of possible future policy actions were discussed not even an additional rate cut. Instead, the Council feels that its November cut has been confirmed by subsequent market action. While additional action was the topic of many questions, Mario Draghi was not willing to talk about specifics. The new ECB staff projections brought the inflation forecasts in line with ours a small downward revision for both 2013 and 2014. Contrary to us, the ECB sees core inflation moving higher over the forecast horizon though. Somewhat surprisingly, the ECB slightly raised its 2014 growth projection to 1.1%Y, making the bank even more optimistic on growth than we are, at 0.5%Y. At the same time, the ECB seems to share our cautious view on 4Q, saying that incoming data point to positive GDP growth, but the bank is no longer talking about an acceleration in growth in the near term. If the ECB was to offer another LTRO, it will want to make sure that it is used to fund the real economy, and that it does not subsidise carry trades and a recapitalisation of the banking sector. Hence, there is a risk that any future LTROs could be limited to SME loans. Again, ECB President Draghi was not to be drawn into a discussion on the specifics. But he stressed that the situation two years ago was very different in terms of uncertainty and in terms of funding stresses for banks. On balance, we continue to expect the ECB to lower the refi rate again 1Q14 and also see a high outside chance of a depo rate cut. Disappointment on euro area growth looks like a potential trigger. We also believe that the hurdle to fullblown QE is very high a view that seems to be confirmed by Draghis detailed explanation on why the euro area is different from Japan.

As introduced in the 2014 Global Macro Outlook, we use an early indicator model or nowcast to get an early take on quarterly global activity before the quarter ends. The indicators used in the model are: OECD Composite Leading Indicators Global Purchasing Managers Surveys (PMIs) CPB World Trade Index Morgan Stanley Nowcast Model

GDP = constant + 0.26 CLI (lagged) + 0.20 PMI + 0.32 Trade


All coefficients statistically significant at the 5% level; HAC errors used for estimation, S.E of regression =1.0 Given data availability, CPB trade is updated real-time using Korean exports

Accuracy of Nowcasts

Deviations of Nowcasted GDP Growth from Actual

Source: Morgan Stanley Research

For full details, see ECB Watch: No Specific Measures Yet, December 5, 2013.

10

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Global Macro Watch


Spain: Regional Finances No Longer a Problem?
Daniele Antonucci (44 20) 7425 8943 Why look at the local finances With less visibility on the lower levels of public spending, the Spanish regions are a key and less explored driver of the overall budget outlook, given that they depend on central government willingness and ability to extend aid. and whats the main takeaway: Courtesy of institutional reforms, the checks on regional deficits are now more effective, so overall fiscal risks are more balanced. Yet, some regions are better positioned than others to reduce their dependence. Central government deficit tracking well: State budget execution has improved, and the fiscal goals are within reach. Even factoring in some slippages at the regional level, but less than before, this years overall budget balance should not overshoot the target by much. The economy and the banking system: Yet, the budget deficit is still quite wide and debt would rise even if the government balance met the target in full. So, the fiscal ratios should benefit from growth in their denominator (GDP), and from a stronger financial sector. For full details, see Spain: Regional Finances - No Longer a Problem? December 9, 2013.

Japan: Abenomics, Labour and Wages: Thousand Mile Journey in a Blizzard


Robert Alan Feldman (81 3) 5424 5385 Abenomics in the labour market has focused on employment laws and female participation. These are only the tip of the labour iceberg: A broader analysis suggests ten striking facts. If recent participation trends continue, aging will cut the labour force to about 62.3 million by 2020, from 65.7 million in 2012. Productivity growth of 2.5% per year, compared to 1.0% for 1990-2008, would be needed to reach 2% real growth. Even if Abenomics achieves its goal of a 5pp rise of participation for the 20-64 age group, the overall labour force will fall to 64.4 million in 2020. Achieving 2% real growth would require labour productivity to grow by 2.1% per year. If Abenomics succeeds, high demand for labour will face modestly reduced supply. If it fails, even modest demand for labour will face sharply reduced supply. In either case, real wages will rise. We quantify these scenarios. The major difference between the two scenarios is corporate profits: If Abenomics succeeds, accelerated productivity will allow higher real wages while real profits rise as well. If Abenomics fails, low productivity growth will allow higher real wages only at the cost of declining real profits. For full details, see J-Insight: Abenomics, Labor and Wages: Thousand Mile Journey in a Blizzard, December 3, 2013.

Spain: Shrinking Budget Deficit, Rising Debt


6% 3% 0% -3% -6% -9% -12% 2003 2005 2007 2009 2011 2013 2015 Overall budget balance (lhs)
Source: Eurostat, Morgan Stanley Research forecasts

Public finances (% of GDP) MS forecast

120% 100% 80% 60% 40% 20% 0% Gov't debt (rhs)

Japan: Ten Striking Facts on Labour and Abenomics


1: Japans female participation rates are only about 3.5pp lower than the advanced county average (once corrected for population age structure). 2: Japans female participation rates have risen sharply across age groups. 3: Male participation in Japan is much higher than in most advanced countries, despite aging. 4: There is ALREADY a labour shortage among nonmanufacturing firms, despite the slow recovery. 5: Abenomics actually has numerical targets for employment ratios, etc. 6: Abenomics labour policy is missing in some crucial elements. 7: Even if Abenomics labour goals are reached, the labour force falls! 8: Even if labour goals are reached, productivity growth must double to hit GDP growth targets. 9: Wages will rise, whether Abenomics works or not. 10: Failure of Abenomics will push real wages up more than a success at the cost of growth and profits.

11

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Global Macro Watch


UK: Autumn Statement: Finally, Some Better Fiscal News
Melanie Baker (44 20) 7425 8607 Jonathan Ashworth (44 20) 7425 1820 More pleasant reading: As broadly expected, the OBRs forecasts for GDP were revised up significantly. Largely flowing from this, the OBR also revised down its deficit forecastsand by more than we had been expecting. The bigger picture is unchanged though (the deficit figures look poor by European standards and austerity is set to remain something of a drag on the economy for several years yet). But the prospect of lower deficits while achieving stronger growth is clearly very welcome. Promised measures to help household finances appeared, and make a modest difference to our inflation forecasts. Substantial OBR forecast changes: The OBRs deficit forecast at the end of this parliament (2014-15), for example, is now 13 billion lower at 4.9% of GDP, compared to 5.9% in the March 2013 forecasts. Note though that this compares to 2.1% at the time of the current governments first budget in 2010. The OBR no longer forecasts government debt to exceed 100% of GDP on the internationally comparable general government gross debt measure (although it is 201617 before this debt metric starts falling). Fiscally neutral-ish: We expected 1-2 billion of net giveaways. Net, we got a little less than that. We did get help for household finances. Fiscally though, this was offset by various revenue-raising measures and government spending cuts. For full details, see UK Economics and Interest Rate Strategy: Autumn Statement: Finally, Some Better Fiscal News, December 6, 2013.

EM: The Double Deficit Club and the SafeHaven Club


Manoj Pradhan (44 20) 7425 3805 Patryk Drozdzik (44 20) 7425 7483 The two big EM stories in 2014 will likely be: i) Further adjustment of asset prices in order to catalyse economic change; and ii) A focus on which economies change their membership, switching from the double deficit club to the safe-haven club, or the other way. The double deficit club Brazil worries: The double deficit club hosts Brazil, India, Indonesia, South Africa, Turkey and Ukraine, and Mexico and Thailand to a lesser extent, for reasons that go beyond just deficits see Emerging Markets: What if the Tide Goes Out? June 14, 2013). Whos closest to leaving? Indonesia and India have both made progress but are not out of the club yet. Whos applying for membership? Russia (whose deficits are rapidly deteriorating despite high oil prices) and Thailand (whose easier monetary policy could stimulate demand and keep its current account deficit under pressure). Whos staying put? Turkeys double deficits are unlikely to disappear in the foreseeable future, South Africas current account deficit shows how much more work needs to be done, but it is Brazil that concerns us the most. The curiously tight labour market (since growth has already unwound) has yet to unwind but policy-makers appear to be resisting, thereby pushing the starting point for rebalancing further away. The safe-haven club hosts mature EMs (Korea, Taiwan, Chile) and those with sound macro-stability (China, Poland, the Philippines, Colombia, Peru), and is now accepting applications from those who are rebalancing or reforming (Mexico has just turned in a strong one with its recent energy reform). India and Indonesia could apply in the future, but much needs to be done. Chinas position: Some ambivalence: China remains a safe haven when EM is under stress from rising real rates. However, the deleveraging process, complicated by financial reforms that add to volatility (see The Global Macro Analyst: Chinas Inherent Reform Tensions, November 20, 2013), will likely put pressure on financial stability and growth in China and EM as well. For full details, see Emerging Issues: EM 2014: The Double Deficit Club and the Safe Haven Club, December 11, 2013.

UK: Deficit Projections Look Better


PSNB (the deficit), % of GDP 8 7 6 5 4 3 2 1 0 2012-13
Source: OBR

Royal Mail pension assets transfer flattered 2012-13 figures

2013-14

2014-15

2015-16

2016-17

2017-18

Mar 2013 OBR projections

Dec 2013 OBR projections

12

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Global Macro Watch


China: Modest Easing in Growth Momentum
Helen Qiao (852) 2848 6511 Yuande Zhu (852) 2239 7820 Yin Zhang (852) 2239 7818 Novembers macro data show that overall activity growth momentum started to abate after stabilising in September-October: Against a less favourable base last year, the modest deceleration in growth may be attributed to the recent tightening in financial conditions. Even so, SOEs had outperformed other firms in both IP and investment growth, probably owing to their better access to funding through the official commercial loan channel when limited funding sources are available. Meanwhile, financial conditions tightened further: The moderation in M2 and outstanding TSF growth suggest that financial conditions have tightened further, which is confirmed by higher money market rates and treasury yields. We expect credit control, exchange rate appreciation, higher interbank interest rates and the CBRCs ongoing effort to curb interbank activities to make overall financial conditions tighter towards year-end. On the other hand, as the government remains assured that the annual GDP growth target is certain to be reached, the threshold for potential policy easing is still high (see China Economics: Financial Conditions Tightened Further, December 11, 2013). Growth outlook and policy implications: Despite the modest slowdown in November, we think that China should still achieve the official growth target of 7.5%Y. So far, we dont think that the combination of a modest slowdown and tame inflation will induce any immediate countercyclical policy fine-turning. However, further deterioration in growth momentum could test the policy-makers resolve to prevent downside risks. At the Central Economic Working Conference, which concluded on December 13, policy-makers maintained the official policy stance, thus making 2014 all about reform and urbanization. Specific plans on reform implementation include categorising measures into those that can be fast-tracked, those that need specific changes, and those that can be explored through pilot programs. On the urbanisation side, the key priority is for an orderly assimilation of rural migrants who already live in cities (see China Economics: 2014 Is All About Reform and Urbanization, December 16, 2013).

Asia Pacific: Asias Boom-Bust-Adjustment Cycles


Derrick Kam (852) 2239 7826 Chetan Ahya (852) 2239 7812 Jenny Zheng (852) 3963 4015 Focusing on the central role of productivity: The strong economic performance of the Asia ex-Japan region over the past two decades has had its inevitable ups and downs. What is the key factor that drives these cycles and how do they affect the regions economic welfare and asset price outlook? We provide an economic framework that focuses on the central role of productivity in driving the business cycles. We apply this framework to the developments in the region over the past two decades. The Asian business cycle can be distinctly characterised into three phases: Boom phase of strong economic growth, which first transits into a Bust phase as the productivity dynamic gets exhausted before moving into an Adjustment phase, where the economy unwinds the macro excesses and refocuses on improving productivity. As productivity improves, the foundations for the next Boom phase will then be put into place. The developments over the past five years suggest that the region is now in the early stages of an Adjustment phase: During this phase, the relatively elevated macrostability risks and consequently lesser room for countercyclical policies mean greater exposure to any potential domestic or external economic shock. More than before, productivity growth will have to do the heavy lifting to push the region out of the Adjustment phase: In turn, this depends crucially on how quickly policymakers can and will move to lift productivity from here. For full details, see Asia Insight: Asias Boom-BustAdjustment Cycles, December 5, 2013.

13

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Global Macro Watch


Indonesia: Policy Rate Kept on Hold
Deyi Tan (65) 6834 6703 Zhixiang Su (65) 6834 6739 Bank Indonesia kept the policy rate at 7.50% on December 12, in line with consensus; we expected a 25bp hike: This follows the surprise 25bp rate hike in November. Cumulatively since June, BI has hiked the benchmark policy rate by 175bp, the FASBI deposit facility rate by 175bp and the FASBI lending facility rate by 75bp. In the statement, BI stated its belief that the current policy stance is consistent with ongoing efforts to bring inflation back towards the target corridor of 4.5+/-1% in 2014 as well as to reduce the current account deficit to a more sustainable and sound level. Our thoughts: The policy adjustment so far warrants less bearishness at the margin. However, we think that Indonesia remains in a state of disequilibrium. Further policy rate tightening is part of the macro rebalancing process required to bring Indonesia to a more sustainable near-term equilibrium. Indeed, for an economy which is running a CAD in an environment of rising real rates in the US, Indonesias real interest rates would need to rise at an even faster pace in order to attract liquidity and manage its external imbalances. Morgan Stanleys US macro team expects rising real rates in the US and QE tapering in March. In view of this and our expectations of Indonesias inflation, we think that policymakers should ideally take the real policy rate to 2% i.e., an 8.5% nominal short-term interest rate amid what we think would be a normalised inflation level of 6.5% after the base effects from the retail fuel price hike wear out. However, in terms of what policy-makers would do, we are only expecting BI to take the policy rate to 8% in 2014, given BIs more sanguine expectations on inflation (4.5% +/-1pp). Apart from policy rate tightening, we reiterate our view that currency depreciation is required even at current levels first to take the real exchange rate from overvalued to fairly valued territory, and thereafter to maintain a stable real exchange rate. As a result of such a continued macro rebalancing process, the macro slowdown is likely to continue into 2014. To this point, we believe there still exists a negative expectation gap on the growth front. Consensus expects GDP growth for 2014 to be similar to 2013 at 5.6%Y. We expect 5.1%Y for 2014 and view growth risks as still somewhat skewed to the downside. For full details, see Indonesia Economics: Policy Rate Kept On Hold, December 12, 2013.

Latin America: Latam Transitions


Gray Newman (1 212) 761 6510 After three consecutive years arguing that Latin America would likely see slower (but still above-trend) growth for the coming year, we are now seeing signs of a modest acceleration: And after years of worrying about the risks to the region from abroad, the global backdrop appears more benign in 2014 than we have seen in recent years. We expect Latin America to grow by 2.9%Y in 2014, up from an estimated 2.7%Y this year. This modest improvement comes as our global team sees 2014 as a transition year from what has been five years of post-crisis global expansion that has been bumpy, below-par and brittle to a new phase of sounder, safer and more sustainable growth (see 2014 Global Macro Outlook: Five Key Transitions, December 2, 2013). Of course, risks remain to our base case of an improving global outlook: Indeed, our global chief economist Joachim Fels highlights five transitions whose success is central to our improved global outlook, ranging from the USs move from quantitative easing to credible forward guidance on rates, to Japans path from deflation to (moderate) inflation to Chinas progress on reform-driven growth. While I am intrigued by the notion that we may be in the midst of one of the longest (post-war) global recovery cycles, and while our global outlook sounds somewhat reminiscent of the not too hot, not too cold narrative of the past, I continue to worry that the transitions (which our global team expects to be by and large successful) may bring with them bouts of turbulence. Those potential bouts of turbulence could easily obscure the modest recovery under way and, in turn, obscure Latin Americas own transitions. Indeed, it is the challenge of Latin Americas transitions that has prevented us from producing a stronger set of numbers for 2014: While the region as a whole is seeing a modest uptick, we do not expect the regions largest economy to join in the upturn. Arthur Carvalho sees Brazilian activity slipping slightly in 2014 and posting 1.9%Y growth after advancing by an estimated 2.3%Y this year. Brazils slippage is tied to its inability to transition from its current model a challenge that Arthur thinks is unlikely to be resolved next year either. To one extent or the other, each of the major economies in the region faces an important transition in 2014. For full details of key transitions by country, see Latin America: Latam Transitions: Week Ahead in Latin America, December 6, 2013, and Chile, Peru & Colombia: 2014 Outlook: Week Ahead in Latin America, December 13, 2013.

14

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Inflation Target Monitor & Next Rate Move


Global Economics Team. Contact: Manoj.Pradhan@morganstanley.com
Latest month 12M MS fcast Next rate decision Current rate Market expects (bp) MS expects (bp)

Inflation target

Risks to our call

US Euro Area Japan UK Canada Switzerland Sweden Australia New Zealand Russia Poland Czech Rep. Hungary Romania Turkey Israel S. Africa Nigeria Ghana Kenya China India Hong Kong S. Korea Taiwan Indonesia Malaysia Thailand Brazil Mexico Argentina Chile Peru Colombia

2.0% PCE Price Index < 2% HICP (u) 2% CPI (u) 2% 1-3% <2% CPI (u) 2.0% CPI 2-3% over the cycle 1-3% CPI 5-6% CPI 2.5% (+/- 1%) CPI 2.0% (+/-1%) CPI 3.0% CPI 2.5 (+/-1%) CPI 5% 1-3% 3 - 6% 9% +/-2% 5% +/-2.5% 2.5%-3.5% 4.5% +/- 1.0% 0.5-3.0% core CPI 4.5% +/-2.0% IPCA 3% +/-1% CPI 15.5-24.2% M2 growth 3% +/-1% CPI 2% +/-1% CPI 3% +/-1% CPI

0.7% 0.9% 0.7% 2.1% 1.2% -0.5% 0.1% 0.9% 1.4% 6.5% 0.6% 1.1% 0.9% 1.8% 7.3% 1.9% 5.3% 7.9% 13.2% 7.4% 3.0% 11.2% 4.3% 0.8% 0.8% 8.4% 2.8% 1.9% 5.8% 3.6% 10.5% 2.4% 3.0% 1.8%

1.5% 1.3% 0.6% 2.4% 1.8% 0.2% 1.4% 1.5% 5.0% 2.1% 1.8% 2.1% 2.9% 6.9% 1.6% 5.5% 9.5% 10.5% 8.1% 1.8% 7.5% 4.5% 2.5% 1.8% 6.5% 2.5% 2.8% 6.4% 4.3% 10.4% 3.0% 2.4% 3.2%

18 Dec 09 Jan 20 Dec 09 Jan 22 Jan 19 Mar 13 Feb 4 Feb 30 Jan 14 Feb 08 Jan 06 Feb 26 Jan 08 Jan N/A 23 Dec 29 Jan Jan-14 05 Feb 09 Jan N/A 28 Jan 29 Jan 09 Jan 26 Dec Jan 2014 29 Jan 22 Jan 15 Jan 31 Jan N/A 16 Jan 09 Jan 20 Dec

0.15 0.25 0.10 0.50 1.00 0.00 1.00 2.50 2.50 5.50 2.50 0.05 3.00 4.00 4.50 1.00 5.00 12.00 16.00 8.50 6.00 7.75 0.50 2.50 1.88 7.50 3.00 2.50 10.00 3.50 N/A 4.50 4.00 3.25

-2 2 0 -1 -1 0 0 -4 10 0 -1 -2 7 2 7 13 26 4 -7 -5

0 0 0 0 0 0 0 0 0 0 0 0 -20 -25 0 0 0 0 0 0 0 0 0 0 0 0 0 0 25 0 0 0 -50

ECB could announce additional liquidity measures Balanced risks Cut unlikely, given a balanced outlook in October statement Housing market pressures, weaker currency, US Fed policy 25bp cut FX blow-out/growth recovery ushers in earlier hike EMFX pressure prompts tightening by the CBN Upside surprise in inflation increases risk of a rate hike Rate cut due to weak exports and low inflation. No rate change due to Feds likely delayed QE exit Upside risks Evenly balanced Evenly balanced EM funding crisis Limited as central bank signaled easing over -

(u) = unofficial Notes: Inflation numbers in red indicate values above target; MS expectations in red (green) indicate our rate forecasts are above (below) market expectations. Japan policy rate is an interval of 0.00-0.10%; Source: National central banks, Morgan Stanley Research forecasts

15

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Global Monetary Policy Rate Forecasts


Current US Euro Area Japan UK Canada Switzerland Sweden Australia New Zealand Russia Poland Czech Rep. Hungary Romania Turkey Israel S. Africa Nigeria Ghana Kenya China India Hong Kong S. Korea Taiwan Indonesia Malaysia Thailand Brazil Mexico Chile Peru Colombia 0.15 0.25 0.10 0.50 1.00 0.00 0.75 2.50 2.50 5.50 2.50 0.05 3.00 4.00 4.50 1.00 5.00 12.00 16.00 8.50 6.00 7.75 0.50 2.50 1.875 7.50 3.00 2.25 10.00 3.50 4.50 4.00 3.25 4Q13 0.15 0.25 0.10 0.50 1.00 0.00 0.75 2.50 2.50 5.50 2.50 0.05 3.00 4.00 4.50 1.00 5.00 12.00 16.00 8.50 6.00 7.75 0.50 2.50 1.875 7.50 3.00 2.25 10.00 3.50 4.50 4.00 2.75 1Q14 0.15 0.10 0.10 0.50 1.00 0.00 0.75 2.50 2.50 5.50 2.50 0.05 2.60 3.75 4.50 1.00 5.00 12.00 16.00 8.50 6.00 8.00 0.50 2.50 1.875 8.00 3.00 2.25 10.50 3.50 4.25 4.00 2.75 2Q14 0.15 0.10 0.10 0.50 1.00 0.00 0.75 2.50 2.75 5.25 2.50 0.05 2.60 3.75 4.50 1.00 5.00 12.00 16.00 9.50 6.00 8.00 0.50 2.50 1.875 8.00 3.00 2.25 10.50 3.50 4.25 4.00 2.75 3Q14 0.15 0.10 0.10 0.50 1.00 0.00 0.75 2.50 3.00 5.25 2.75 0.05 2.60 3.75 5.00 1.25 5.00 12.00 16.00 10.00 6.00 7.75 0.50 2.50 2.00 8.00 3.00 2.25 10.50 3.50 4.25 4.00 2.75 4Q14 0.15 0.10 0.10 0.50 1.00 0.00 0.75 2.50 3.25 5.00 3.25 0.05 3.25 4.00 5.50 1.50 5.00 12.00 16.00 10.00 6.00 7.50 0.50 2.75 2.125 8.00 3.00 2.75 10.50 3.50 4.25 4.00 3.50 1Q15 0.15 0.10 0.10 0.50 1.00 0.00 1.00 2.50 3.50 5.00 3.75 0.05 3.75 4.25 6.50 1.75 5.00 11.50 16.00 10.00 6.00 7.50 0.50 3.00 2.25 8.00 3.00 3.00 12.00 3.50 4.25 4.25 4.00 2Q15 0.15 0.10 0.10 0.75 1.00 0.00 1.25 2.75 3.75 4.75 4.00 0.05 4.00 4.50 6.50 2.25 5.00 10.50 16.00 10.00 6.25 7.50 0.50 3.00 2.375 8.00 3.00 3.00 13.00 3.50 4.25 4.25 4.25 3Q15 0.15 0.10 0.10 0.75 1.00 0.00 1.50 3.00 4.00 4.75 4.00 0.25 4.25 4.75 6.50 2.25 6.00 10.50 16.00 10.00 6.25 7.50 0.50 3.25 2.375 8.00 3.00 3.00 13.00 3.50 4.25 4.25 4.50 4Q15 0.15 0.10 0.10 1.00 1.00 0.00 1.75 3.00 4.25 4.75 4.00 0.50 4.50 5.00 6.50 2.25 7.00 10.50 16.00 10.00 6.25 7.50 0.50 3.25 2.375 8.00 3.00 3.00 12.00 4.00 4.25 4.25 4.50

Source: National Central Banks, Morgan Stanley Research forecasts; Note: Japan policy rate takes a mid-range value.

Fed and Eurosystem Balance Sheet Monitor

Source: Haver Analytics

Source: Haver Analytics

16

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Global GDP and Inflation Forecasts


Real GDP (%) 2012 2013E 2014E 2015E 2012 CPI inflation (%) 2013E 2014E 2015E

Global Economy G10 US Euro Area Germany France Italy Spain Japan UK Canada Sweden Australia Emerging Markets CEEMEA Russia Poland Czech Rep Hungary Ukraine Kazakhstan Turkey Israel South Africa Nigeria Ghana Kenya Asia ex-Japan China India Hong Kong Korea Taiwan Singapore Indonesia Malaysia Thailand Latin America Brazil Mexico Chile Peru Colombia Argentina Venezuela

3.2 1.5 2.8 -0.6 0.7 0.0 -2.6 -1.6 1.9 0.1 1.7 0.9 3.7 4.9 2.7 3.4 2.0 -0.9 -1.6 0.2 5.0 2.2 3.2 2.5 6.5 7.9 4.5 6.1 7.7 5.1 1.5 2.0 1.3 1.3 6.2 5.6 6.5 2.9 1.0 3.8 5.6 6.3 4.0 1.9 5.5

2.9 1.1 1.6 -0.5 0.4 0.2 -1.9 -1.3 1.8 1.4 1.7 0.6 2.6 4.7 2.2 1.6 1.4 -1.6 0.9 -1.2 5.8 3.6 3.8 1.8 6.8 7.0 5.0 6.0 7.6 4.7 3.0 2.9 2.0 3.6 5.7 4.5 3.1 2.7 2.3 1.3 4.2 4.9 3.9 4.9 1.9

3.4 1.8 2.6 0.5 1.4 0.4 0.2 0.6 1.3 2.5 2.4 2.5 2.8 5.0 3.4 2.7 3.0 1.5 2.2 1.3 6.8 3.9 3.0 2.8 7.8 7.5 5.2 6.0 7.2 5.1 2.7 3.5 3.4 3.9 5.1 4.7 4.0 2.9 1.9 3.3 3.9 5.4 4.4 3.0 2.5

3.7 2.0 2.7 1.1 1.8 1.1 0.8 1.2 1.1 2.2 2.5 3.0 2.9 5.3 3.7 2.6 3.2 2.5 1.9 2.8 6.3 4.7 3.1 3.5 7.5 7.5 5.8 6.4 7.4 6.0 3.0 3.7 3.7 4.0 5.5 4.8 4.5 3.0 1.5 4.0 4.4 5.3 5.1 2.0 2.9

3.4 1.9 2.1 2.5 2.0 2.0 3.0 1.8 -0.1 2.8 1.5 0.9 1.8 4.8 5.6 5.1 3.7 3.3 5.7 0.6 5.1 8.9 1.7 5.7 12.2 9.2 9.7 4.2 2.6 9.7 4.1 2.2 1.9 4.6 4.3 1.7 3.0 6.2 5.4 4.1 3.0 3.7 3.2 10.0 21.1

3.2 1.4 1.5 1.4 1.5 0.9 1.2 1.8 0.3 2.6 1.2 0.0 2.0 5.0 5.3 6.7 1.0 1.4 1.8 0.6 6.0 7.6 1.6 5.8 8.5 11.4 5.8 4.3 2.7 10.0 4.5 1.3 1.0 2.4 7.0 2.1 2.2 7.4 6.2 3.7 1.8 2.7 2.1 10.6 40.7

3.3 1.6 1.5 1.1 1.5 1.3 0.5 0.0 2.4 2.3 1.8 0.9 2.1 5.0 5.0 5.2 2.0 1.4 1.5 2.0 6.1 6.3 2.1 5.6 9.0 10.2 8.0 4.3 3.2 8.2 3.6 2.5 1.8 2.5 7.5 2.9 2.6 7.6 6.0 3.8 3.0 2.7 3.1 10.4 44.1

3.2 1.5 1.6 1.3 1.7 1.3 0.9 1.3 1.3 2.3 1.7 1.8 2.5 4.7 5.0 4.6 2.6 2.1 3.2 5.3 6.4 6.6 1.6 5.5 9.0 9.2 8.1 4.1 3.6 6.4 2.8 2.8 2.0 2.6 6.5 3.2 2.5 6.7 6.1 3.6 3.1 2.4 3.2 12.0 29.2

Source: IMF, Morgan Stanley Research forecasts

17

MORGAN STANLEY RESEARCH December 18, 2013 The Global Macro Analyst

Global Economics Team


Global Economics Joachim Fels Manoj Pradhan Patryk Drozdzik Sung Woen Kang Philipp Erfurth Americas Vincent Reinhart Ted Wieseman Ellen Zentner Dane Vrabac John Abraham Gray Newman Luis Arcentales Arthur Carvalho Daniel Volberg Europe & Africa Elga Bartsch Daniele Antonucci Olivier Bizimana Melanie Baker Jonathan Ashworth Marcus Gedai Tevfik Aksoy Pasquale Diana Michael Kafe Andrea Masia Jacob Nell Alina Slyusarchuk Asia Robert Feldman Takeshi Yamaguchi Chetan Ahya Helen Qiao Sharon Lam Yuande Zhu Yin Zhang Jason Liu Deyi Tan Zhixiang Su Derrick Kam Daniel Blake Upasana Chachra Japan Japan Asia ex-Japan, India China Korea, Taiwan China, Hong Kong China Korea, Taiwan ASEAN ASEAN Asia ex-Japan, Hong Kong Australia India Robert.Tokyo.Feldman@morganstanleymufg.com Takeshi.Yamaguchi@morganstanleymufg.com Chetan.Ahya@morganstanley.com Helen.Qiao@morganstanley.com Sharon.Lam@morganstanley.com Yuande.Zhu@morganstanley.com Yin.Zhang@morganstanley.com Jason.JL.Liu@morganstanley.com Deyi.Tan@morganstanley.com Zhixiang.Su@morganstanley.com Derrick.Kam@morganstanley.com Daniel.Blake@morganstanley.com Upasana.Chachra@morganstanley.com +81 3 5424 5385 +81 3 5424 5387 +852 2239 7812 +852 2848 6511 +852 2848 8927 +852 2239 7820 +852 2239 7818 +852 2848 6882 +65 6834 6703 +65 6834 6739 +852 2239 7826 +61 2 9770 1579 +91 22 6118 2246 Euro Area, ECB, Germany Italy, Spain, Greece, Portugal France, Belgium UK UK Euro Area, ECB, Germany Turkey, Israel Poland, Hungary, Czech, Romania South Africa, Ghana, Nigeria South Africa, Nigeria Russia, Kazakhstan, Ukraine, Belarus Russia, Kazakhstan, Ukraine, Georgia Elga.Bartsch@morganstanley.com Daniele.Antonucci@morganstanley.com Olivier.Bizimana@morganstanley.com Melanie.Baker@morganstanley.com Jonathan.Ashworth@morganstanley.com Marcus.Gedai@morganstanley.com Tevfik.Aksoy@morganstanley.com Pasquale.Diana@morganstanley.com Michael.Kafe@morganstanley.com Andrea.Masia@rmbmorganstanley.com Jacob.Nell@morganstanley.com Alina.Slyusarchuk@morganstanley.com +44 (0)20 7425 5434 +44 (0)20 7425 8943 +44 (0)20 7425 6290 +44 (0)20 7425 8607 +44 (0)20 7425 1820 +44 (0)20 7425 9668 +44 (0)20 7677 6917 +44 (0)20 7677 4183 +27 11 587 0806 +27 11 282 1593 +7 495 287 2134 +44 (0)20 7677 6869 US US US US US Latam, Brazil Chile, Mexico Brazil Peru, Colombia, Argentina, Venezuela Vincent.Reinhart@morganstanley.com Ted.Wieseman@morganstanley.com Ellen.Zentner@morganstanley.com Dane.Vrabac@morganstanley.com John.A.Abraham@morganstanley.com Gray.Newman@morganstanley.com Luis.Arcentales@morganstanley.com Arthur.Carvalho@morganstanley.com Daniel.Volberg@morganstanley.com +1 212 761 3537 +1 212 761 3407 +1 212 296 4822 +1 212 761 1929 +1 212 761 5629 +1 212 761 6510 +1 212 761 4913 +55 11 3048 6272 +1 212 761 0124 Global Global Global Global Global Joachim.Fels@morganstanley.com Manoj.Pradhan@morganstanley.com Patryk.Drozdzik@morganstanley.com Sung.Woen.Kang@morganstanley.com Philipp.Erfurth@morganstanley.com +44 (0)20 7425 6138 +44 (0)20 7425 3805 +44 (0)20 7425 7483 +44 (0)20 7425 8995 +44 (0)20 7677 0528

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