Macro Overview

Redington Teach-in

Wednesday 22nd January 2014

Macro Overview

Macro Overview For Professional Investors Only 22 January 2014

Agenda

1. Global Economic and Macro Outlook 2014 – Gavyn Davies

2. Global Economic Outlook – Neil Williams

3. The End of QE – Gavyn Davies

4. The End of QE – Neil Williams

5. Panel Session – Participants:

Gavyn Davies, Neil Williams, David Bennett

Moderator:

Pete Drewienkiewicz

2


Speakers

Gavyn Davies – Chairman, Fulcrum Asset Management

Gavyn is Chairman of Fulcrum Asset Management and Head

of the Fulcrum Investment Committee. Previously, Gavyn was

Chairman of the BBC from 2001 to 2004. He joined

Goldman Sachs in 1986 and was a Partner from 1988 to

2001. He was also the firm’s Chief Economist over that

period and Chairman of the Research Department. He was

repeatedly ranked as the City’s top UK and European

economist in surveys of institutional investors. From 1992 to

1997, he was a member of H.M. Treasury Independent

Forecasting Panel.

He began as a City Economist, first with Phillips and Drew

from 1979 to 1981, then Simon and Coates from 1981 to

1986. Gavyn graduated in economics from St. John’s

College, Cambridge in 1972. This was followed by two years

of research at Balliol College, Oxford. He joined the Policy

Unit at 10 Downing Street as an Economist in 1974 and was

an Economic Policy Adviser to the Prime Minister from 1976

to 1979.

[email protected]

Twitter: @GavynDavies

3

Neil Williams – Chief Economist, Hermes Fund Managers Ltd

Neil joined Hermes Fund Managers in August 2009 and is

responsible for its global economic research. He has over

twenty five years’ experience of providing economic analysis,

and has a forward-looking approach to generate investment

strategy ideas for the company and its clients.

Neil adopts top-down methods - macro and market analysis

to identify interest rate and credit value, and sovereign

default risk. Neil began his career in 1987 at the

Confederation of British Industry (CBI), becoming its youngest

ever Head of Economic Policy. He went on to hold a number

of senior positions in investment banks - including Director of

Bond Research at UBS, Head of Research at Sumitomo

International, Global Head of Emerging Markets Research at

PaineWebber International, and, before coming to Hermes,

Head of Sovereign Research and Strategy at Mizuho

International. Neil earned an MA in Economics in 1986 from

Manchester University, having the previous year completed

his BSc (Hons), also in Economics, from University College

Swansea.

[email protected]

Twitter: @Hermes_fm

mailto:[email protected]



Global Economic and Market

Outlook, 2014

Gavyn Davies, Chairman, Fulcrum Asset Management

Redington Conference, 22 January, 2013

4

Global equities have out-performed all other asset classes for

almost 5 years, with the US market leading. Bonds have been flat for 2 years. Commodities have fallen for 3 years.

5

There is complete unanimity among analysts that equities will

continue to out-perform bonds during 2014, and also a strong

consensus in favour of equities in the euro area and Japan. Opinion

on the emerging markets remains mostly bearish for now.

6

The recession in the developed economies has been deep and long

lasting and may have had permanent effects on potential GDP...

7

80

85

90

95

100

105

110

115

120

2000 2003 2006 2009 2012 2015

Aggregate G4 (US, Euro Area, Japan, UK) GDP, Potential and Trend

Actual GDP Average of Potential Output Estimates Log-linear trend

Source: Fulcrum Asset Management LLP

8

... but for the first time since 2010, domestic demand in developed

markets is leading the recovery

30

35

40

45

50

55

60

2007 2008 2009 2010 2011 2012 2013

Fig 2. Manufacturing Business Surveys

Euro Area United States UK Japan

“Whatever it takes”


G8 activity is rising, especially in the UK…..

9

10

-5

-4

-3

-2

-1

0

1

2

3

2007 2008 2009 2010 2011 2012 2013 2014

US Euro Area UK Japan OECD Total

Fig 12. Fiscal Thrust: change in the underlying government primary balance (% of GDP)

The rise in public sector debt ratios has triggered significant tightening in fiscal policy in

all the major economies and this will continue. But the mix is changing, with less

tightening in the US and the Euro Area, and more tightening in Japan.


11

The Fed has started to taper its asset purchases, but other central

banks might expand their operations, so global liquidity will remain

ample

Projection

Total World

-4%

-2%

0%

2%

4%

6%

8%

10%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Liquidity Injections of Global Central Banks, % of GDP, 12 months change

Other Advanced

BOJ

ECB

Federal Reserve

Emerging Markets


12

The market has completely undone its anticipation of a Fed

tightening: actual rate hikes are very unlikely at least until 2015

0

1

2

3

4

5

6

7

2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Expected Federal Funds Rate Path

Federal Funds Rate Futures as of 31st of October 2013 Futures as of 9th of September 2013


13

The US recovery is dependent on a decline in the private sector financial

balance as investment and consumption return to more normal levels. This

will be helped by much less fiscal tightening from now on.

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1987 1990 1993 1996 1999 2002 2005 2008 2011

Private Sector Financial Balance in the US (% of GDP)

Total Non-Financial Private Sector Households Non-Financial Business


14

Advanced Economies, 1.2%

Emerging Markets, 5.4%

World, 3.1%

-2%

0%

2%

4%

6%

8%

10%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Global Inflation Rates

Global inflation has been low and falling over the past year, with the

exception of a handful of emerging markets


15

Risk 1: The drop in the US labour force participation rate has

proceeded much further than expected and is showing no signs of

recovery.


16

If the participation rate falls further, it might take the unemployment

rate down to levels which could force the Fed to tighten earlier than

expected


Risk 2: China - The PBOC has left its official monetary

settings unchanged since mid 2012

17

The PBOC has “encouraged” market interest rates to rise since last

May, with a short run money market crisis in June/July which has now been brought under control.

18

5 Year Government Bond Yield

SHIBOR Rate: 1-Week

2.25

2.75

3.25

3.75

4.25

4.75

5.25

5.75

6.25

6.75

2012 2013 2014

Chinese Market Interest Rates are Trending Upwards (20-day moving averages)

Tightening starts here


The PBOC has also “encouraged” a decline in the total

expansion of credit in the economy by reducing the access of

the shadow banking sector to funding.

19

There is no sign yet that the monetary squeeze is slowing the

rate of house price or land price inflation, especially in the

major cities. There is still a significant risk of a collision between

the tightening in monetary conditions and the bubble in

housing.

20

21

Apart from the risk of a China hard landing, the emerging markets

crisis is concentrated in a handful of countries (the “fragile 5”) with

weak fundamentals...

-12

-10

-8

-6

-4

-2

0

2

4

6

8

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Current Account Balance as % of GDP

Brazil Indonesia India South Africa Turkey


22

Risk 3: ECB actions have brought about a broad improvement in

financial conditions by reducing euro-breakup fears, but the stance of

monetary policy is still fragmented

0

100

200

300

400

500

600

700

800

2008 2009 2010 2011 2012 2013

Euro Area Sovereign Bond Yields (10-year)

France Germany Italy Spain


23

In the euro area, there has been a slight relaxation of fiscal tightening

but austerity is still acting as a drag on domestic demand

-8

-7

-6

-5

-4

-3

-2

-1

0

2009 2010 2011 2012 2013 2014 2015 2016 2017% GDP

Euro Area Periphery: Headline Deficit Targets and Actual Outcome

Actual Deficit

2011 Target

2012 Target

2013 Target


24

The Euro Area has left recession behind already, but market economists

remain sceptical about a strong recovery. A key issue for the Euro Area is

whether the ECB will act aggressively enough to prevent Japanification.

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

2007 2008 2009 2010 2011 2012 2013 2014

Euro Area GDP Forecasts

% Growth Q/Q Ann. % Growth Y/Y


25

Risk 4: Bubbles in equities – New econometric techniques enable us to

estimate the probability of a bubble in the S&P 500 Index in real time. At

present, the risk remains very low.


26

US Equities are expensive relative to their long-term historical

averages, but fairly valued relative to the past 2 decades...

0

5

10

15

20

25

30

35

40

45

50

1921 1931 1941 1951 1961 1971 1981 1991 2001 2011

Fig 20: US Equities - Very Long Term "Shiller" P/E Ratio

Long Term P/E Ratio (Shiller) 20 Year Moving Average Long Term Average


Although bond yields may rise somewhat as activity forecasts for

2014 are increased, we do not expect this to be permanent,

given the central bank attitude to short rates. And anyway,

equities remain very cheap relative to bonds.

27

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28

Disclaimer

Global Economic Outlook

Redington Teach-in 22 January 2014

Neil Williams

Chief Economist

Page 30 Hermes Fund Managers Ltd I Global Economic Outlook I

Outline

Where are we now?

Policy environment

Economic outlook for 2014…


Is Japan leading the way? Ten-year JGBs vs lagged…

Source (all three charts): Thomson Reuters Datastream

…10-yr US Treasury… …& 10-yr Bund …& 10-yr Gilt


…and, there’s a lot of ground to make up Real GDP levels, rebased to Q1 2007…

Source: Thomson Reuters Datastream, based on national data Source: OECD

Q1 2007 = 100. Grey denotes US recession Deviation of a country’s actual from potential GDP, as % of potential

Major economies slow to recoup output lost during the crisis


…So, core inflation should stay tame…

Source (all charts): Thomson Reuters Datastream, & OECD

US Japan Euro-zone


US – it’s different this time

Source: Hermes Fund Managers Ltd, based on BLS, & NBER

Core CPI in US recoveries Unemployment in US recoveries Core CPI (%yoy) into & out of recessions. Years shown are recessions

Source: Hermes Fund Managers Ltd, based on BLS, & NBER

Unemp rate (%) into & out of recessions. Years shown are recessions

3.5

4.5

5.5

6.5

7.5

8.5

9.5

10.5

-8 -6 -4 -2 0 +2 +4 +6 +8 +10 +12 +14 +16

19801990-'91

2001

Into & out of the 2007-'09 recession1981-'82 recession

No of quarters from recession's trough

0

2

4

6

8

10

12

14

-8 -6 -4 -2 0 +2 +4 +6 +8 +10 +12 +14 +16

1980 recession1981-'82

1990-'91

2001

2007-'09

No of quarters from recession's trough


US – fitted Phillips Curve…

Source: Thomson Reuters Datastream, based on BEA, & BLS data


US – tapering is loosening!…

Source: Hermes Fund Managers estimates & assumptions, based on OECD data, & Bloomberg

*2014 taper assumptions: $bn

FOMC j 75

f 65

FOMC m 65

FOMC a 55

m 45

FOMC j 45

FOMC j 35

a 25

FOMC s 25

FOMC o 15

n 5

FOMC d 5

total extra 460

Fiscal Real rate CPI* 3m money**

% GDP % % %

(cyc adj) Yr-end

92 -5.1 0.4 3.0 3.44

93 -4.4 0.4 3.0 3.38

94 -3.3 3.9 2.6 6.50

95 -2.5 2.8 2.8 5.63

96 -2.4 2.7 2.9 5.56

97 -1.4 3.5 2.3 5.81

98 -0.6 3.6 1.5 5.07

99 -0.7 3.8 2.2 6.00

00 -0.2 3.0 3.4 6.39

01 -2.0 -0.9 2.8 1.88

02 -4.9 -0.2 1.6 1.38

03 -6.1 -1.2 2.3 1.15

04 -6.0 -0.1 2.7 2.56

05 -5.1 1.1 3.4 4.54

06 -4.3 2.2 3.2 5.36

07 -4.8 1.8 2.9 4.70

08 -7.4 -2.4 3.8 1.43

09 -11.2 -1.6 -0.3 -1.94 (-219bp for $1.753trn QE1 which started 18 March 2009)

10 -10.5 -3.5 1.6 -1.94

11 -9.2 -6.2 3.2 -3.04 (-110bp for $880bn QE2 which started 3 November 2010)

12 -8.1 -5.5 2.1 -3.36 (-32bp for $255bn QE3 which started Sept 2012 (3x $85bn))

13e -5.4 -6.1 1.5 -4.64 (-128bp for $1.02trn QE3 (12x $85bn))

14p -4.9 -6.9 1.7 -5.21 (-57bp for $460bn QE3 (ass -10bn taper signalled at each 2014 FOMC meeting*)

15p -4.0 -6.7 2.2 -4.46 (No QE; assumes +75bp ON rates)

In totem: $4.4trn QE = -546bp

US


UK - remember QE1?…

This is how QE is supposed to work…


Cash went down the asset route...

Source: Hermes Fund Managers Ltd, adapted from BoE


UK – BoE’s ‘likely wish list’ when it started QE

Source: Hermes Fund Managers Ltd, based on BoE

Our view

Expand the money supply Was slow. Took till mid 2012 for M4 growth

to reverse downtrend started in Feb '09

Keep gilt yields down Successful - though 10yr yield did quickly

go back up to pre-QE levels

Improve the functioning Will have helped sentiment, though

of corporate credit markets BoE corporate buy-backs were small

Higher corporate bond & Will have helped, though how much

equity prices of rallies was down to QE?

Increased capital market Will have helped - 2009 supply was

issuance way up on 2008

Higher real economic output Recession ended in Q3 2009, then GDP

flat-lined till last summer

Higher inflation Uptrend in targeted CPI started in Sept '09,

but had as much to do with VAT etc

Objective


UK – CPI ex indirect taxes…

Source (both charts): Thomson Reuters Datastream, based on ONS data

…but, ex-VAT, services remain sticky VAT undoubtedly lifted the CPI… Ex indirect taxes CPI by sector; all % yoy CPI, core CPI, & CPI ex indirect taxes; all % yoy


…But real wages & profit-margins slow to recover

Source: Thomson Reuters Datastream, based on ONS data


UK’s policy mix adjusted for QE

Source (both charts): Hermes Fund Managers Ltd, based on OBR, & OECD data, & Bloomberg

This is how UK policy is shifting… Total stimulus* vs output gap Using QE adj 3m rates, CPI & cyclically adjusted fiscal balance as % GDP *{(QE adj real rate – its long-run av) + (cyc adj fiscal bal as % GDP – its long-run av)}

-4

-3

-2

-1

0

1

2

3

4

5

-10.5 -5.5 -0.5 4.5 9.5

Looser

Output gap (% GDP)

Total stimulus* (%pt)

'15p

'14p

'09

'06

'92

'08

Adjusted for QE'11

-10

-8

-6

-4

-2

0

2

4

-6.0 -4.0 -2.0 0.0 2.0 4.0 6.0

Fiscal deficit (as % GDP)

Real interest rates (%)

Looser

'13e

'15p

'06

'09

'92'08

Adjusted for QE


No G7 country has loosened its policy more than the UK…

Shows shifts in real rates (using CPI, 3m Libor) & likely 2013 cyclically-adjusted budget balances

Source: Hermes Fund Managers Ltd, based on OECD projections, IMF, & Bloomberg

…during the crisis (since Dec ’06) …and since 2000

-10

-8

-6

-4

-2

0

2

-5.00 -4.00 -3.00 -2.00 -1.00 0.00 1.00

Looser

Tighter

Shift in real rates (% pt)

Fiscal shift (% of GDP)

UK

US

Canada

Japan

NB: Exc all liquidity injections

€-zoneGermany

Sweden

Australia

NZ

-12

-11

-10

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

-8.00 -6.50 -5.00 -3.50 -2.00 -0.50 1.00

Tighter

Looser

US

Japan

€-zone

UK

Canada

Shift in real rates (% pt)

Fiscal shift (% of GDP)

NB: Exc all liquidity injections

Germany

SwedenAustralia

NZ


…Which helps explain the pound’s weakness

Source: Thomson Reuters Datastream

Shows trade-weighted exchange rates, re-based to Feb 2000 (= 100)


Still mixed competitiveness since the euro…

Change since 2000 in relative unit labour costs (RULC), vs c/acc shift as % GDP. Grey denotes shift since 2010 austerity

Source: Hermes Fund Managers Ltd, based on national sources & OECD. (*NB: Greece’s from 2001 when it joined the euro)

-9

-7

-5

-3

-1

1

3

5

7

9

11

-22 -12 -2 8 18 28

C/acc shift

RULC change

Falling competitiveness

Improving competitiveness

France

€-zone avUKItaly

Germany

Spain

Neths

Greece*

Portugal

Ireland

Austria

Finland

Belgium

Denmark

Sweden


…But Spain & Italy – between ‘a rock & a hard place’

Source: Thomson Reuters Datastream, based on Eurostat data

Male youth unemployment Consumption lost Unemployment rates (%) - males under 25 years old

Source: Thomson Reuters Datastream, based on national data

Real household consumption levels, re-based to Q1 2008 (= 100)


Euro-zone – our ‘Misery Indices’ (MIs)…

Source: Hermes Fund Managers Ltd based on Eurostat data, & Hermes/Nomura International projections (p)

Method & sample data behind our Misery Indices. The higher the MI, the greater the expected economic hardship

U rate CPI 2008 '09 '10 '11 '12 5-yr av 2013 2014

Greece 26.8 -0.1 7.7 9.5 12.6 17.7 24.3 14.4 15 12

Cyprus 16.5 -2.0 3.6 5.3 6.2 7.8 12.1 7.0 14 11

Spain 27.0 1.8 11.4 18.0 20.1 21.7 25.1 19.3 8 6

Portugal 18.0 0.4 8.5 10.6 12.0 13.0 15.8 12.0 8 7

Ireland 15.4 0.4 6.3 11.9 13.7 14.5 14.9 12.3 5 3

Italy 11.9 1.6 6.8 7.8 8.4 8.4 10.7 8.4 4 4

Netherlands 6.4 3.0 3.1 3.7 4.5 4.4 5.3 4.2 3 2

France 10.9 1.2 7.8 9.5 9.8 9.7 10.2 9.4 3 2

Belgium 8.2 1.2 7.0 7.9 8.3 7.2 7.6 7.6 2 1

Luxembourg 5.4 2.1 4.9 5.2 4.6 4.8 5.0 4.9 1 1

Germany 7.0 1.6 7.5 7.8 7.1 6.0 6.8 7.0 1 1

Austria 4.7 2.1 3.8 4.8 4.4 4.1 4.3 4.3 1 1

Finland 8.0 2.2 6.4 8.2 8.4 7.8 7.7 7.7 0 0

Unweighted av 12.8 1.2 5 4

Weighted av3

11.6 1.5 3 3

1Standardised unemployment (%), & HICPs (%yoy)

2 Absolute CPI deviation from 2.2% (+) added to u rate deviation from 5-yr av (+/-)

3Using adjusted GDP weights. Excludes Cyprus

4Orange shaded areas show 'above-average misery'

2013p1

Unemployment rates Misery

% point 2, 4


Euro-zone – converging on the weakest

Source: Hermes Fund Managers Ltd, based on Eurostat data, & Nomura International projections (p)

-6.00

-1.00

4.00

9.00

14.00

90 92 94 96 98 00 02 04 06 08 10 12 14p

'Least miserable' euro-zone country

'Most miserable' euro-zone country

Weighted average


Euro-zone’s policy mix...

Source (both charts): Hermes Fund Managers Ltd, based on OECD data, & Bloomberg

This is how €-zone policy is shifting… Using 3m rates, CPI & cyclically adjusted fiscal balance as % GDP

Total stimulus* vs output gap *{(Real rate – its long-run av) + (cyc adj fiscal bal as % GDP – its long-run av)}

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

-2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0

Real interest rates (%)

Fiscal deficit (as % GDP)

Looser

'92

'15p

'13e

'09

'00

'06

'14p

-4.5

-3.5

-2.5

-1.5

-0.5

0.5

1.5

2.5

3.5

-4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0

*Total stimulus (%pt)

Output gap

(% GDP)

Looser

'13e

'14p'09

'07

'92

'15p

'00


Euro-zone – disparate real rates

Source: Hermes Fund Managers Ltd, based on Eurostat, & ECB

Using ECB refinancing rate, & spot CPIs, %

Latest HICP (% yoy) Real policy rate* U rate*

Greece -1.9 2.2 27.3

Cyprus -0.5 0.8 17.0

Ireland -0.1 0.4 12.6

Portugal 0.0 0.3 15.7

Spain 0.0 0.3 26.7

Malta 0.5 -0.3 6.4

France 0.7 -0.5 10.9

Belgium 0.7 -0.5 9.0

Slovakia 0.7 -0.5 13.9

Italy 0.8 -0.6 12.5

Luxembourg 1.0 -0.8 5.9

Slovenia 1.1 -0.9 10.1

Germany 1.2 -1.0 5.2

Netherlands 1.3 -1.1 7.0

Austria 1.5 -1.3 4.8

Finland 1.7 -1.5 8.1

Estonia 2.2 -2.0 8.8

Median 0.7 -0.5 10.1

*Orange flash denotes higher-than-median out-turns


Japan will need even more aggressive monetary easing

Source: Thomson Reuters Datastream, based on BoJ

JGBs outstanding, banks’ & BoJ BoJ has to mop up more JGBs JGBs outstanding in ¥ m on LH Scale, & % shares on RH Scale

Source: Hermes Fund Managers Ltd, based on MoF, & BoJ

0

10

20

30

40

50

60

0

10

20

30

40

50

FY98 '00 '02 '04 '06 '08 '10 '12* '14p*

Net new JGB issuance (¥trn) Rinban as % net new issuance (rhs)

*FYs11-14 include Reconstruction Bonds


China - hardening reluctance to revalue the currency?

Source: National Bureau of Statistics, & Ministry of Human Resources & Social Security Source: Thomson Reuters Datastream, based on IMF data

China - slowing productivity? China’s surplus with the EU vulnerable China/EU bilateral surplus, 12m rolling total, $m, versus RMB per €

-10

-5

0

5

10

15

20

25

30

0

2

4

6

8

10

12

14

16

18

20

Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008 Q1 2010 Q1 2012

Ind prodn (%yoy) Manu empl (%yoy, RHS) Est product'y growth (RHS)


But, the legacy is debt build-up…

Source: OECD, Thomson Reuters Datastream, & Moody’s Investor Services

Gross & net, as a % GDP. *’98 data; **’00 data

Moody's Gross Net Gross Net

local ccy

US Aaa (-ve) 65 47 106 84

Japan Aa3 102 34 232 149

Euro-zone n/a 81 54 107 69

UK Aa1 51 29 110 77

Greece Caa3 100 77 192 130

Italy Baa2 (-ve) 130 104 68 118

Iceland Baa3 (-ve) 77* 43* 127 53

Ireland Baa3 63* 42* 131 92

Latvia Baa2 (+ve) 53** n/a 75 n/a

OECD av 73 43 112 73

1997 2014p


Summary of our economic forecast, published in our ‘Looking into 2014’ Economic outlook quarterly

Source: National data, Hermes Fund Managers Ltd, OECD, & Consensus Economics

…Until economies fire again

EURO % yoy unless stated '08 '09 '10 '11 '12 '13e '14p

Real GDP 0.3 -4.4 1.9 1.6 -0.6 -0.5 0.3

Private consumption 0.4 -0.9 1.0 0.3 -1.4 -0.9 0.0

Fixed investment -1.6 -12.7 -0.6 1.7 -3.8 -3.3 0.5

Industrial production -1.8 -15.1 7.3 3.2 -2.3 -1.2 0.7

Consumer prices (HICP) 3.3 0.3 1.6 2.7 2.5 1.3 1.0

Unemployment rate (%) 7.7 9.6 10.1 10.2 11.4 12.2 12.5

Current account (% GDP) -1.6 -0.2 0.0 0.1 1.4 2.1 2.3

Gen budget balance (% GDP) -2.1 -6.4 -6.2 -4.2 -3.7 -3.0 -2.6

ECB refi' rate (yr-end, %) 2.50 1.00 1.00 1.00 0.75 0.25 0.25

UK % yoy unless stated '08 '09 '10 '11 '12 '13e '14p

Real GDP -0.8 -5.2 1.7 1.2 0.3 1.5 2.1

Household consumption -1.6 -3.6 1.0 -0.5 1.2 1.8 2.3

Fixed investment -4.6 -16.7 2.8 -2.4 0.9 -2.3 3.0

Manufacturing production -2.5 -10.2 4.2 1.8 -1.7 -0.8 1.5

Retail prices index 4.0 -0.5 4.6 5.2 3.2 3.1 2.9

Consumer prices 3.6 2.2 3.3 4.5 2.8 2.6 2.0

Unemp, ILO rate (%) 5.6 7.5 7.9 8.0 8.0 7.7 7.4

Current account (% GDP) -0.9 -1.4 -2.7 -1.5 -3.8 -3.4 -3.0


BoE Bank rate (yr-end, %) 2.00 0.50 0.50 0.50 0.50 0.50 0.50

JAPAN % yoy unless stated '08 '09 '10 '11 '12 '13e '14p

Real GDP -1.1 -5.5 4.7 -0.6 2.0 1.9 1.2

Private consumption -0.9 -0.7 2.8 0.5 2.4 1.6 0.6

Business investment -2.9 -14.2 0.7 3.3 1.8 -1.1 2.5

Industrial production -3.4 -21.6 15.6 -2.6 0.2 -2.0 3.0

Consumer prices 1.4 -1.3 -0.7 -0.3 0.0 0.1 2.1


Current account (% GDP) 3.3 2.9 3.7 2.0 1.1 1.0 1.5


BoJ target rate (yr-end, %) 0.10 0.10 0.10 0.10 0.10 0.10 0.10

US % yoy unless stated '08 '09 '10 '11 '12 '13e '14p

Real GDP -0.3 -2.8 2.5 1.8 2.8 1.6 2.7

Personal consumption -0.6 -1.6 2.0 2.5 2.2 2.0 2.5

Business investment -0.8 -15.6 2.5 7.6 7.3 2.6 4.8

Industrial production -3.5 -11.3 5.7 3.4 3.6 2.5 3.3

Consumer prices (nsa) 3.8 -0.3 1.6 3.2 2.1 1.5 1.7


Current account (% GDP) -4.7 -2.7 -3.0 -3.1 -3.0 -3.1 -3.3

Fed budget balance (% GDP) -6.6 -11.9 -11.4 -10.2 -8.7 -5.8 -5.3

Funds target (yr-end, %) 0.25 0.25 0.25 0.25 0.25 0.25 0.25


Summary

Despite a firmer US, it’s too soon to allow aggressively higher bond

yields. Inflation benign - driven more by cost than demand factors.

Tapering is loosening! Guidance to help growth assets, but could backfire

Consumer balance-sheet re-building needs more time. US is expanding

after five years of ultra-loose policy. Even in 2014, QE-adjusted US policy rate

will be -5¼%; the UK’s about -2¼%. Yet, exit strategies premature

Most governments deferring repair of their own balance sheets - storing

up problems for later. In euro-zone, default-risk is not dead

Euro-zone is taking the biggest risk with growth. UK has housing, but euro-

zone will return to recession. When rates rise, shallow tightening cycles

But, with deficits high, most governments unready to repair fiscally, &

central banks encouraging inflation, bonds no longer a low-risk asset


Disclaimer

The views and opinions contained herein are those of Neil Williams, director, chief economist & strategist, and may not necessarily represent views expressed or reflected in other Hermes communications,

strategies or products. The information herein is believed to be reliable but Hermes Funds Managers does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or

opinion. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations.

This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is published solely for informational purposes and is not to be

construed as a solicitation or an offer to buy or sell any securities or related financial instruments.

This communication is directed only at recipients who are eligible counterparties or professional clients, as defined in the Glossary to the Financial Conduct Authority’s Handbook of Rules and Guidance. This

communication is issued and approved only for the purposes of section 21 of the Financial Services and Markets Act 2000 by Hermes Investment Management Limited. (“HIML”). Hermes Investment

Management Limited has its registered office at Lloyds Chambers, 1 Portsoken Street, London E1 8HZ. Hermes is a multi-boutique asset manager, independent of any broader financial services organisation.

Each Hermes operating company is either a subsidiary of, or is otherwise affiliated to, Hermes Fund Managers Limited. [CM100322 UK 11/10]

Figures, unless otherwise indicated, are sourced from Hermes.


The End of QE:

Is it nigh, and what might it mean

for markets?

Recent economic data suggest the UK is finally recovering from the

financial crisis, whilst the Bank of England is preparing investors for

the end of monetary stimulus through the introduction of forward

guidance.

Should the IMF be proved correct in upgrading the UK’s growth

outlook, what might the end of monetary stimulus look like and what

are the potential effects on markets and the end investor?

57

58

Some Thoughts on the Exit From Quantitative Easing

1. The experiment worked at the beginning, but the benefits have been less obvious in recent times, and the costs have been mounting.

2. There is a broad consensus on the Fed that the programme should be brought to an end this year, but no consensus on when to start raising rates.

3. A concern is that the “signalling” effects of ending QE will lead to an unintended tightening in monetary conditions.

4. The BoJ is replacing a great deal of the global monetary stimulus which previously came from the Fed, and the ECB may have to start QE as well.

5. The Fed intends to raise rates before reducing the size of its balance sheet. 6. The technical mechanisms needed to exit QE are available to the Fed (and the

BoE), but the impact on bond yields is unknown. 7. Governments might act to prevent the central banks from exiting in order to

hold bond yields down (financial repression). 8. There is some risk that QE may have long term inflationary consequences if it is

not reversed in a timely manner. 9. Will we ever see central bank balance sheets returning to “normal”?



QE – as in the 1930s – is no ‘flash in the pan’

0

1

2

3

4

5

6

7

8

1934 1938 1942 1946 1950 1954 1958 1962 1966 1970

30-year Treasury yield T-Bill, 3m rate

Source: Thomson Reuters Datastream, & Federal Reserve Board

This is how QE is supposed to work…


Cash went down the asset route...

Source: Hermes Fund Managers Ltd, adapted from BoE

Gavyn Davies, Neil Williams, David Bennett

Moderator : Pete Drewienkiewicz

Panel Discussion


Austin Friars House, 2-6 Austin Friars, London EC2N 2HD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk

62

Disclaimer

For professional investors only. Not suitable for private customers.

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Contacts

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Economy & Finance

Macro Overview