UBS Makes A Striking Discovery: Ex-Energy, US GDP Growth Is The Slowest Since 2010
Last week, UBS released its Global Economic Outlook forecast for 2018-2019, which coming in at over 220 pages and with more than 270 charts, is rather “difficult to summarize” as UBS’ chief economist Arend Kapteyn snarkily notes. Still, as Kapteyn helpfully summarizes, the 3 charts below capture some of the main themes from the report, the first of which is a doozy and crushes the Trump “economic recovery” narrative .
Message 1: The 2017 global growth acceleration was largely (70%) a commodity bounce. This applies even to the US which was 20% of the global growth improvement but, as the 1st chart below shows, it was entirely energy investment. Once you strip that out ‘underlying’ growth is only 1% or so (ex inventories) – the slowest since 2010 – and a significant amount of rotation now needs to take place from energy to non-energy investment just to sustain the current growth pace. The surveys suggest that is possible but the surveys have also consistently overstated growth so far. As Kapteyn adds, due to “skepticism about that rotation is why we are about 20bp below consensus for US growth next year.” It also means that contrary to conventional wisdom, the US consumer has not only not turned the corner, but continues to retrench and with the personal savings rate plunging to 10 years lows, there is little hope that personal consumption expenditures will be a significant driver of US growth for the foreseeable future.
More details from UBS:
In Figure 5 we show what we think the contributions to US headline growth have been from the energy sector (structures and equipment investment combined). This is depicted as the grey area. The blue line is headline growth (ex-inventories) and the red line is headline growth minus the energy sector investment contribution, which we call ‘underlying growth ex-energy’. Taken at face value, the chart suggests underlying US growth has been slowing dramatically, from about 2.6% in 2015 to only around 1% in 2017. We do not quite interpret it that way, and view it more as a story of stability and ‘adding-up constraints’. The economy can only produce so much, and when one sector is strong (energy), it absorbs labour disproportionately, while other sectors pull back. Furthermore, when investment is weak the consumer accelerates. US growth post-crisis has hovered around a 2% average and nothing in our recession probability models suggests that there is anything ominous going on. But the point of Figure 5 is to show that as energy investment runs out of steam, other sectors will need to accelerate
significantly to maintain the current pace of growth.
Message 2: The one (developed market) country that no one thinks can generate inflation (Japan) is likely to create more inflation than any other developed market.
“Japan is cyclically 2 years ahead of most other countries and it has a textbook Phillips curve with higher Phillips curve wage and price coefficients than all the other countries we looked at. The labour market is already extraordinarily tight.”
If unemployment goes to 2.5% by end-2018 UBS sees (BoJ) core inflation going up towards 1.5% (70bp above consensus) and Yield Curve Control starting to get tweakend (10y JGB to drift higher.
Message 3 : The Fed is going to $4 trillion in US Treasuries by 2025 even absent a recession, $1.5 trillion more than they hold today. The is because the Fed will hit a trough determined by the ‘floor system’ for monetary policy coupled with some other balance sheet changes, of around $ 3 ¼ trillion by mid-2020 and currency in circulation growth then starts to drive the dynamics of the balance sheet. If they still want to roll off the MBS book they need to buy UST. That is part of the reason that the aggregate size of the G3 central balance sheet by 2025 will still be roughly as large as where it was late last year. And that’s with some fairly aggressive assumptions about BoJ balance sheet roll-off. So good for term premium.