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ECONOMIC RESEARCH DEPARTMENT Summary They did it again! ■Another dovish rate increase from the Fed ■And a fully assumed United Kingdom What if Brexit never happens? symmetric inflation target For the moment, anything is possible, even what is currently considered impossible. The Fed did it again: raising rates while US YIELD CURVE Maybe Brexit will never happen. using a dovish tone. As fully expected, ► Page 2 the Fed raised its key rate by a quarter of -- 16 March ; -- 2 February ; -- 15 December, 2016 a point. From the beginning, it was 3,50 Emerging countries obvious the Fed would use any opportunity to advance the normalisation Argentina-Venezuela: a tale of two 3,00 of monetary policy, in order to move stories away from the discomfort zone that is Argentina and Venezuela were both hit by 2,50 the downturn in commodity prices. zero. As the labour market strength remains unquestioned and inflation is 2,00 Argentina succeeded in clearing its slowly but surely moving back to target, external debt arrears while Venezuela is 1,50 close to default. A look back at two the March meeting could not be missed. Still, this second rate increase comes opposing trajectories. 1,00 ► Page 3 only three months after the previous one, and FOMC members were willing to 0,50 make it clear that they were not rushing, 3-m 6-m 1-y 2-y 3-y 5-y 7-y 10-y 30-y Market overview that this was not the sign of a steeper ► Page 4 hiking cycle in the making. Jane Yellen Source: Federal Reserve once more said that with the currently Summary of forecasts very low level of neutral rates, there was THE WEEK ON THE MARKETS ► Page 5 no need for a lot of rate increases to turn the monetary stance towards neutrality. Week 10-3 17 > 16-3-17 CAC 40 4 993 } 5 013 +0.4 % A retrouver dans She also said that this rate increase had nothing to do with a reassessment of the S&P 500 2 373 } 2 381 +0.4 % economy, and unchanged projections Volatility (VIX) 11.7 } 11.2 -0.4 % from her and her colleagues confirm this. Euribor 3M (%) -0.33 } -0.33 +0.0 bp But more strikingly, the minor changes Libor $ 3M (%) 1.12 } 1.15 +2.7 bp within the statement came with a crucial OAT 10y (%) 1.12 } 1.09 -2.7 bp one. There is now an adjective attached to the inflation target. It is said to be Bund 10y (%) 0.49 } 0.45 -4.5 bp “symmetric”. In a way, there is no news US Tr. 10y (%) 2.58 } 2.53 -5.0 bp here, as the symmetry has been claimed Euro vs dollar 1.07 } 1.07 +0.8 % and assumed for long. Still, mentioning it Gold (ounce, $) 1 200 } 1 229 +2.4 % within the statement makes it way more Oil (Brent, $) 51.9 } 51.6 -0.5 % credible. In short, the Fed raised rates, Source: Thomson Reuters signalled it would continue to do so as expected, and confirmed that the limit was substantially lower than usual. A new formula for lower for longer. economic-research.bnpparibas.com EcoWeek 17 March 2017 – 17-11 United Kingdom What if Brexit never happens? ■ The UK parliament has given the government the green Northern Ireland, the majority of the population voted to remain in the light to trigger Brexit, which it will do before the end of March EU. They are finding London’s hard Brexit hard to digest. Nicola 2017. Sturgeon, Scotland’s First Minister, has just confirmed her intention to hold a new referendum on Scotland’s independence, in late 2018 ■ Prime Minister May’s hard line towards Brexit is or early 2019. potentially the most damaging position for both the UK and the EU. But one man’s pain is not another man’s gain: EU member countries ■ Yet things could change over the next two years, which is would have nothing to gain if the UK decides to go it alone. The EU not much time for conducting negotiations, but a very long would not only have to forego a net annual financial contribution of 2 time from a political perspective. several billion euros , but the UK makes a profitable trading partner. Its advantageous tax system and status as an international financial ■ For the moment, anything is possible, even what is marketplace attract capital and allows it to cover its deficits easily… currently considered impossible. Maybe Brexit will never This has led to numerous trade surpluses in the EU. The UK is one happen. of France’s rare sources of a foreign trade surplus. It’s almost done. Within the next few days, the UK will officially trigger No exit for Brexit? article 50 of the Lisbon Treaty signifying its a priori irrevocable exit from the European Union (EU), after 44 years as a member. This will Like the Nash equilibrium in game theory, individual strategies start a 24-month negotiating period in which London and Brussels towards Brexit have a collective cost that surpasses that of must agree not only on the terms of the divorce, but also on their compromise, which becomes the only possible solution. The future relations. incentives for reaching a compromise could be economic: nature abhors a vacuum, and the UK would see trade weaken as the Yet there is no obligation to reach an agreement, and anything is deadline for Brexit approaches. Any investment decisions that do not possible, including the possibility of failure. If the March 2019 harm the outcome are bound to be postponed until tomorrow. And deadline passes without an agreement, the EU would apply its the people’s desire to shake things up will probably weaken with the common foreign trade regime to the UK by default, including trade first sounds of breaking glass. tariffs, VAT advances, border controls, and visas for UK nationals. Of course, the UK would reciprocate. The risk of escalation would be The two-year period that lies ahead will be very short for conducting high, as would the cost of breaking off relations. negotiations, but excruciatingly long from a political perspective. The cards could be reshuffled again and again. But what will be the new A hard Brexit is doomed to fail deal? One solution is a soft Brexit, in which the UK leaves the EU but remains a member of the European Economic Area, like Norway, For the UK, which conducts half of its trade with the EU, maintaining Iceland and Lichtenstein. The UK would maintain free access to the 1 a hard line on Brexit could be courting disaster. A recent CEPII single market, but in exchange it would continue to make a financial study shows that for the UK automotive industry alone, a reciprocal contribution, albeit a smaller one. And it would still have to respect common tariff of 10% would trigger a 3% drop in sales, i.e. 48,000 the four fundamental freedoms: the free movement of goods, production units, thousands of job losses and a 6% increase in services, capital and people, which would be a major concession for automobile prices. But this is only the minimum impact, since the the advocates of a hard Brexit. scenario did not take into account any plant closures. Although not as bad as breaking off relations, a limited separation And it is just one example: all sectors integrated into global trade would not be a good solution either. The UK would gain some stand to lose out from Brexit. In air transport, agrifoods, aeronautics, freedom from EU rules (Norway, for example, is allowed to protect chemicals & pharmaceuticals, and mechanical engineering, intra- more its agriculture), but in exchange it would lose influence over EU group trade is the norm. Moreover, access to the single market does rule making. Moreover, belonging to the European Economic Area not depend solely on tariffs: it is also defined by thousands of would not guarantee that its financial sector could continue to benefit technical, environmental, sanitary and social regulations. Eliminating from banking passports to do business in the EU. The City is arguing them would be so disruptive that it becomes simply inconceivable, in for a system of equivalences, but implementing it risks taking much the strict since of the term. longer than two years. Enough time for the UK to reconsider its And that is not all. Brexit – especially a hard Brexit – also threatens choice and for its citizens to return to the voting booth? the very integrity of the United Kingdom. In Scotland, but also in 1 Centre d’études prospectives et d’informations internationales (CEPII). See Mayer, T. 2016. “Brexit, Trumpit: the end of regional trade agreements? Consequences for the automotive industry.” Lettre du CEPII, n°371, November 2016. 2 11.5 billion euros in 2015. economic-research.bnpparibas.com Jean-Luc Proutat 17 March 2017 - 17-11 2 Emerging countries Argentina-Venezuela: a tale of two stories ■ Argentina and Venezuela were both hit by the downturn Official foreign exchange reserves (USD bn) in commodity prices. ▬ Argentina ▬ Venezuela ■ Argentina succeeded in clearing its external debt arrears 60 while Venezuela is close to default. 50 ■ A look back at two opposing trajectories. 40 To cope with the downturn in the commodity price cycle and the 30 recession that followed, Venezuela and Argentina are following two diametrically opposed macroeconomic management strategies. 20 In Venezuela, Nicolas Maduro’s government, in power since 2013, 10 has pursued an external strategy in which the structural shortage of dollars is managed through a system of multiple exchange rates, one 0 that is as complex as it is ineffective, while giving preference to 2012 2013 2014 2015 2016 2017 bilateral sources of financing (China, Russia) in a vain attempt to Chart Source: Macrobond curtail the haemorrhaging of central bank reserves.