Thomas White Global Investing
Americas: October 2016

Americas

Economy Trends Update October 2016

 

AT A GLANCE

 

United States: Expectations about a large fiscal stimulus program from the incoming Trump administration have brightened the growth outlook. The new administration is also expected to ease regulatory restrictions, especially on the banking and financial services sector, as well as reduce taxes for businesses. These policies could give a short-term boost to aggregate economic growth for the next several quarters.

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Canada: The Canadian economy rebounded during the third quarter of this year, helped by increased oil production and strong gains in consumer spending. The central bank expects the Canadian economy to end this year with growth of close to 1.5%.

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Brazil: Renewed political uncertainties have delayed some of the reforms and the expected recovery in domestic demand. Brazil’s economy shrunk again during the third quarter, as investments fell more than 8% from a year ago. Slowing inflation allowed the Brazilian central bank to cut its benchmark interest rate from a record high in October.

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Mexico: The Mexican government has cut its growth forecasts for the current year after the economy expanded at a slower than expected pace for the second quarter. The government now expects the economy to expand 2% to 2.6% this year, down from an earlier forecast of between 2.2% to 3.2%.

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Chile: The economy declined during the second quarter, compared to the first three months of this year, as construction activity slowed and private investments remained subdued. The central bank had increased its benchmark rate twice during the second half of last year, and has held the rate unchanged so far this year.

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Peru: : The new government is moving ahead with initiatives that are aimed at boosting aggregate growth to 5% by 2018. The economy is expected to grow 4% this year and 4.8% in 2017, according to the most recent estimates from the government.

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Colombia: The IMF has lowered its growth forecasts for Colombia to 2.2% this year, and 2.7% in 2017. The economy expanded 2% during the second quarter of this year, from a year ago. Though inflation has slowed, Colombia’s central bank left its benchmark rate unchanged in September.

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Argentina: Aggregate output declined at an annualized 3.4% during the second quarter, more than expected, on lower capital investments and construction activity. The central bank’s rate hike earlier this year to tame inflation has restricted domestic demand.

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Trump win, energy and commodity price trends improve regional outlook

The surprising U.S. presidential election result has dramatically changed the economic growth outlook for the region, at least for the next couple of years. If the incoming U.S. administration expands public spending, eases regulatory controls, and lowers tax rates as expected, the growth outlook for the country could brighten. In this scenario, the U.S. Federal Reserve is likely to increase rates more than expected in 2017. In response, investors are likely to be more attracted to U.S. assets for the superior growth rates and potentially higher yields. U.S. domestic equity prices, treasury yields, and the dollar have all strengthened after the election results.

The favorable energy and commodity price trends are likely to help the rest of the Americas region for the next few quarters. Third quarter economic data suggests that several of these economies are now recovering, and their currencies have strengthened this year. Canada is seeing a healthy bounce back, helped by higher oil exports. Monetary policy is also turning more favorable, in select Latin American countries where the central banks were constrained by high inflation. However, persistent political risks could dissuade industrial investments and weaken the outlook for countries such as Brazil.

United States: Fiscal stimulus could brighten growth prospects

The expected fiscal stimulus measures from the incoming Trump administration could lift the U.S. economic growth outlook for the next two years. If the federal government increases infrastructure spending by $1 trillion, as promised by the president-elect during the campaign, it could encourage states and local governments to also expand their spending on public works. The new administration is also expected to ease regulatory restrictions, especially on the banking and financial services sector, as well as reduce taxes for businesses. These policies could give a short-term boost to aggregate economic growth for the next several quarters.

Third quarter U.S. economic growth at 3.2% annualized was higher than expected and has increased expectations that the economy is coming out of a low growth phase. Consumer spending remained the major driver of growth while exports, helped by increased shipments of farm produce, also helped during the quarter. As well, business investments exceeded expectations during the third quarter.

The labor market saw further gains during the third quarter, adding close to 200,000 jobs every month over that period. The economy added close to 150,000 jobs in October, suggesting that employers continue to hire at a healthy pace. The unemployment rate remains below 5%, though the labor participation rate continues to be low. Average hourly wages have increased 2.5% annualized so far this year, helping support consumer sentiment.

Housing market data has remained robust in recent months as higher incomes and low borrowing costs have kept home ownership affordable. Sales of new and existing homes increased more than expected in October and builders remain confident of future demand. Even if mortgage rates move higher, expected income gains could partially offset the increased interest expenses. Sustained gains in average home prices are also likely to support housing demand, though some of the potential buyers are likely to be priced out of the market.

The U.S. Federal Reserve is widely expected to increase its benchmark rate in December, only the second rate hike after the 2008 financial crisis. The central bank has been cautious in its interest rate outlook as economic growth fell short of forecasts during the first half of this year. If the economy accelerates as expected next year, the Fed is likely to consider more rate increases. Consumer inflation has firmed up in recent months and the core inflation measure, excluding food and fuel prices, has moved past 2%. However, the Fed believes inflation will remain at this level for the next two years.

 

 

Canada: Energy exports and consumers revive the economy

The Canadian economy rebounded during the third quarter of this year, helped by increased oil production and strong gains in consumer spending. The economy expanded 3.5% annualized compared to the same period of last year as energy exports surged more than 25%. Consumers increased their spending by 2.6% while business investments, after declining for more than two years, expanded more than expected. The central bank anticipates the Canadian economy will end this year with growth of close to 1.5%.

Rising household debt, fueled by low borrowing costs and the strong housing market, remains a major risk for the Canadian economy. The ratio of average household debt to income has moved past 150% and aggregate consumer debt now exceeds the country’s annual GDP. Though rising incomes and low interest rates have increased the debt repayment ability of households, they remain vulnerable to unexpected rate increases or a housing market correction. To lessen the risks, the Canadian government has tightened lending norms for mortgages, especially in large cities where average home price gains have been more pronounced.

Despite the improved economic conditions, the Bank of Canada continues to hold its benchmark rate at 0.5%. The central bank believes the economy remains vulnerable to external shocks, especially another decline in energy and commodity prices as happened in 2015. Inflation was 1.5% annualized in October, below the central bank’s 2% target, suggesting that healthy domestic demand is yet to lift consumer prices.

 

 

Brazil: Persistent political uncertainties slow economic recovery

Favorable economic policies by the new government and the sharp rebound in commodity prices were expected to help Brazil recover from the ongoing two year old recession. However, renewed political uncertainties have delayed some of the reforms and the expected recovery in domestic demand. New corruption allegations against leaders of previous administrations have dampened the optimism of businesses and potential investors. Despite healthy trends in sentiment surveys, domestic consumers have not increased their spending and credit demand remains subdued. 

Brazil’s economy shrunk again during the third quarter, as investments fell more than 8% from a year ago. After this decline, the country’s aggregate economic output has retreated to the same level as it was in 2010. The Brazilian government and the central bank now expect the economy to recover next year. However, less optimistic forecasters expect the Brazilian economy to stagnate in the coming year before a modest revival in 2018.

Slowing inflation allowed the Brazilian central bank to cut its benchmark interest rate from a record high in October. Inflation declined to below 8% in October and is widely expected to fall further in 2017. If the currency remains stable, import prices could ease and allow annual inflation to move closer to the central bank’s 4.5% target by the end of next year. Lower inflation risks, if realized, should allow the central bank to bring down the benchmark rate even further in the coming year.

 

 

Mexico: Outlook weakens on potential trade friction and currency decline

Mexico’s economic growth outlook could weaken if a new U.S. administration imposes higher taxes, or withdraws from current trade agreements. Though currency weakness could partly offset the loss of competitiveness from increased trade barriers, export volume growth could become more subdued. The Mexican government expects the economy to expand nearly 3% in 2017, based on recently approved budget estimates. However, most economists have pared down their forecasts closer to 2%. 

The Mexican government has cut its growth forecasts for the current year after the economy expanded at a slower than expected pace for the second quarter. GDP growth declined to 2.5% annualized during the most recent quarter, from the same period of last year. Aggregate output declined during the second quarter when compared to the first three months of this year. This was the first quarterly fall in economic output in the last three years, and was mostly due to a contraction in industrial activity. The government now expects the economy to expand 2% to 2.6% this year, down from earlier forecast of between 2.2% to 3.2%.

Heightened currency volatility has forced Mexico’s central bank to hike its benchmark rates again. The benchmark rate has moved higher by 200 basis points so far this year, to the highest level in nearly five years. The resultant increase in borrowing costs for consumers and businesses has played a substantial part in the recent softening of domestic spending.

 

 

Chile: Government’s fiscal restraint limits growth outlook

Though most economic indicators remain soft, the Peruvian government has announced a smaller than expected increase in public spending for the year 2017. This is widely believed to be aimed at protecting the country’s reputation for prudent fiscal management. To prevent a growth slowdown after the commodity price decline, the government had increased public spending in 2015 as well as this year. The increased outlays have also widened budget shortfalls and could possibly force the government to borrow more.

The political alliance behind the current Chilean government was less successful than expected in the recent municipal elections, partly due to the subdued economic growth. This has lifted expectations that the government will consider new initiatives to boost the economy, though public spending would remain restricted. The government has also appointed a new central bank director who is expected to adopt more pro-growth monetary policy measures.

The economy declined during the second quarter, compared to the first three months of this year, as construction activity slowed and private investments remained subdued. Though the unemployment rate remains relatively low, domestic demand has not picked up pace. The central bank had increased its benchmark rate twice during the second half of last year, and has held the rate unchanged so far this year. This has probably dampened consumer sentiment, though consumer inflation slowed to 3.1% in September.

 

 

Peru: Policy changes and public spending to boost growth

Peru’s new government is moving ahead with initiatives that are aimed at boosting aggregate growth to 5% by 2018. Among the proposals are reductions in sales tax, lower corporate taxes for small firms, and an amnesty scheme for undeclared earnings. The government is also planning to establish an infrastructure fund to finance new construction and upgrades, as well as a scheme to reduce the financial leverage of local governments. Some of the proposals are likely to boost tax revenue, which the government is planning to spend on infrastructure. The economy is expected to grow 4% this year and 4.8% in 2017, according to the most recent estimates from the government.

The Peruvian government is also seeking increased investment inflows to the country, to revive capital investments in the mining sector. The government is focusing on countries such as China that are already major trade partners of Peru. Investment proposals include new copper mines and railway lines. Peru is also trying to increase the export of farm produce, which currently accounts for about $5 billion in annual export revenues.

Consumer inflation moved above the central bank’s upper target of 3% in September, and is anticipated to shift higher by next year. The central bank now expects inflation to touch 4% by the end of this year, and average 4.5% next year. These estimates, and the improving economic growth outlook, are likely to discourage the central bank from rate cuts in the near term.

 

 

Colombia: Political risks surge after peace deal rejection

In a referendum held in September, Colombian citizens narrowly rejected a much heralded peace deal that could have ended the country’s long civil war. In an unexpected setback for the government, the peace deal that was under negotiation for the last several years failed to win approval from a majority of voters. The agreement would have brought the armed rebels into the political system and given them representation in the country’s parliament. The peace deal had won praise internationally, and President Santos won this year’s Nobel Peace Prize for his leadership that resulted in the agreement.

The increased political risks could weaken business and consumer sentiment, and reduce aggregate growth in Colombia in the coming quarters. The currency declined after the referendum result was announced and foreign inflows are likely to reverse in the short term. The IMF has lowered its growth forecasts for Colombia to 2.2% this year, and 2.7% in 2017. The economy expanded 2% during the second quarter of this year, from a year ago.

Though inflation has slowed, Colombia’s central bank left its benchmark rate unchanged in September. From a high of close to 9% in July, inflation has declined to 7.3% in September. However, inflation is still above the central bank’s upper target of 4% and is not expected to slip below that level even in 2017.

 

 

Argentina: Government steps up efforts to end recession

While Argentina’s new government has received favorable attention and inflows from global investors, the country’s economic environment remains weak. Aggregate output declined at an annualized 3.4% during the second quarter, more than expected, on lower capital investments and construction activity. The central bank’s rate hike earlier this year to tame inflation has restricted domestic demand. The peso devaluation has also limited household purchasing ability, while it’s too early for the government’s reform measures to produce results. The central bank could find it difficult to lower rates as the IMF has lifted its inflation forecast to nearly 40% at the end of this year, from a more optimistic 25% estimated earlier.

The government is now trying to boost the economy through increased public spending and fiscal measures aimed to boost production. The government is now planning wider fiscal deficits in the coming years so that public spending on construction and other activities can be increased. Other measures such as an export rebate for farmers are expected to boost output. The government is also increasing cash transfers to the poor, as the economy has lost jobs this year and poverty has worsened by some measures.

 

 

 

 


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