Brief Macro: India: Outlook on Capex Recovery Continues to Brighten and more

In this briefing:

1. India: Outlook on Capex Recovery Continues to Brighten
2. BoJ Steps in as ECB Exits
3. Fed Remains Unfazed by Recession Doomsayers, but Political Challenges Lurk on the Horizon
4. Japan: Upcycle Intact
5. Free Money Has Flown

1. India: Outlook on Capex Recovery Continues to Brighten

As per the CSO, gross fixed capital formation (GFCF) has grown above nominal GDP for 4 consecutive quarters now (latest data for September quarter). This, after GFCF grew slower than nominal GDP in 20 of the preceding 21 quarters. Capex cycle is thus picking up. And there are good reasons to expect this continue in the foreseeable future. Capacity utilisation is increasing in a broad-based manner. Liquidity conditions have improved, and cost of capital is likely to fall. Corporate profit cycle is no longer a headwind, although it is not yet a strong tailwind. The nascent signs of a recovery in the capex cycle are thus likely to get stronger in the months ahead.

2. BoJ Steps in as ECB Exits

By Shweta Singh, Managing Director Global Macro

• Global central banks turning dovish
• But BoJ maybe the only DM central bank ‘properly’ injecting liquidity this year
• European debt – including Italian BTPs – could benefit the most  

3. Fed Remains Unfazed by Recession Doomsayers, but Political Challenges Lurk on the Horizon

Following the release of the December US retail sales report, recession doomsayers have become much more vocal and their calls will invariably become louder as economic deceleration unfolds.

There are currently no major signs of excesses in important sectors of the US economy to unhinge the flat Phillips Curve, while structural shifts over time have made forecasting inflexion points in the business cycle much more difficult.

Meanwhile, although the Federal Open Market Committee (FOMC) is concerned about externally-sourced headwinds, members seem content with the current behaviour of the domestic economy, at least for the time being.

The Trump Administration will be keen to ease fiscal policy again to prevent a 2020 recession if growth slows significantly this year, while the Democrats would face a tricky task obstructing if there was a sizeable infrastructure spending component included as part of the measures.

Meanwhile, some Democratic politicians have been exploring deploying Modern Monetary Theory to facilitate the greater provision of free government services, but financial markets would baulk at this prospect, particularly bond market vigilantes.

The behaviour of the bond market vigilantes have highlighted the problems facing the Fed in trying to raise the policy rate significantly above zero, but they have at least provided the FOMC with an interest rate buffer to counter economic slowdown, something conspicuously absent in the Eurozone and Japan.

4. Japan: Upcycle Intact

Following 3Q’s contraction, economic activity rebounded in the final quarter of 2018 led  by investment spending. Global trade tensions and the planned increase in the consumption tax in 2019 are headwinds but we expect the Japanese economy to sail through. The investment upcycle remains intact underpinned by rising profits and consumption spending well supported by easy monetary and fiscal policy. We reiterate our overweight call on Japanese equities.

5. Free Money Has Flown

The world will soon discover that debt matters.

The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.