Long-term yields undermined by uncertainty surrounding the tax cuts in the US, housing moderation in China

Macro Highlights - 29-11-2017

In short
  • Long-term yields undermined by uncertainty surrounding the tax cuts in the US, housing moderation in China
  • Swiss focus: The weaker franc should prop up the economy

Key takeaways of the week from Lisa Turk, Economist, United States, François Léonet, Economist, Emerging Markets and Sophie Casanova, Economist, Central Banks.
  • While businesses have high expectations for the tax cuts and the possibility of deducting their investments from their taxable base…
  • …the uncertainty surrounding the outcome of the Senate’s vote is reflected in continued doubts on the markets and is impacting the 10-year Treasury yield
  • In China, the housing slowdown is continuing. We expect this real estate moderation to continue over the coming months due to tighter mortgage conditions and restrictive measures being maintained

Following the break in discussions for Thanksgiving week, the Senators are expected to resume their debate concerning the tax cuts this week. While the proposed law setting out the new tax measures was approved by the House of Representatives on 16 November, the outcome of the Senate’s vote is more uncertain. On the one hand, the Republicans have a weaker majority in the Senate than in the House of Representatives, and on the other hand, not all Republican senators are in favour of a law that will deepen the deficit. This has maintained the uncertainty for the past few days and seems to be weighing on investors’ expectations for GDP growth.

We expect the Senate to amend its proposal over the coming weeks with a view to reaching an internal agreement by the end of the year. For the moment, we do not expect the differences between the proposed act approved by the House of Representatives and the Senate’s proposal to significantly change our estimates of macroeconomic impacts. Both versions are proposing to reduce the government’s revenues by a total of around USD 1,400 billion over 10 years.

The major difference for 2018 concerns a one-year deferral - to 2019 – for the reduction in the corporation tax rate from 35% to 15% in the Senate’s version, compared with a rollout from 2018 in the House of Representatives’ version. However, the other flagship measure, allowing businesses to deduct their investments immediately, has been kept in both versions for 2018. US GDP growth in 2018 is expected to be boosted primarily by this measure. For five years, businesses will have the possibility to deduct their equipment and machinery investments from their taxable base from the first year when they are acquired, instead of applying a conventional depreciation approach. US businesses are particularly optimistic about the adoption of the tax cuts, as shown by the many surveys concerning their future investments (see right-hand chart). If the tax cuts are adopted, GDP could be accelerated through the business channel. In the end, we expect that the proposed law’s adoption in the Senate could further strengthen expectations for growth, leading to a slight increase in the 10-year Treasury yield, climbing to 2.90% for the second quarter of 2018 according to our forecasts.

In China, the slowdown in prices for new-build residential properties is continuing. The prices recorded in the country’s 70 biggest cities show year-on-year growth of 5.4% for October, compared with 6.3% in September (see chart). This slowdown can be seen for all the cities considered, regardless of their relative size, and looks set to continue over the coming months. On the one hand, financing conditions on the mortgage market seem less flexible compared with 2016. The average rate applied for retail borrowers is 5%, compared with an average of 4.5% last year. Mortgage borrowing growth is also in a slowdown phase. On the other hand, the measures adopted by certain Chinese cities to discourage real estate speculation are expected to remain in force. While various measures have been adopted, the most common include restrictions on residential property purchases or sales, as well as the setting of higher levels for down payments to acquire property.

Sophie Casanova, Economist, Central Banks, Lisa Turk, Economist, United States, François Léonet, Economist, Emerging Markets


Swiss focus: The weaker franc should prop up the economy

  • Following a disappointing first half of 2017, with a year-on-year performance of 0.4%, GDP growth is expected to accelerate to 1.8% in 2018 and 1.7% in 2019
  • The export sector is expected to be supported by sustained growth of Switzerland’s main trading partners and the franc’s depreciation
  • Due to the fragile nature of the economic recovery and the weak inflation, we expect the SNB to maintain its accommodative monetary policy

Swiss GDP growth was particularly disappointing in the first half of 2017, with a year-on-year figure of just 0.4%. This slowdown has been amplified by various exceptional factors, such as the methodological revisions introduced during the summer (see left-hand chart) or even the normalisation of the pharmaceutical industry’s export performance following a particularly strong year in 2016. In addition, economic activity indicators point to very robust growth for the coming months. For several months, the manufacturing PMI has been at a level that has historically been associated with a growth rate of 3% to 4% (see right-hand chart). We have therefore revised our GDP growth forecasts down from 1.4% to 0.8% for 2017. However, the Swiss economy’s growth is expected to accelerate at the end of 2017 to reach 1.8% in 2018, driven by the strength of its foreign trade.

Switzerland’s export sector looks set to benefit from the increase in foreign demand for Swiss products, against a backdrop of strong growth for its two main trading partners, the eurozone and the US. Alongside this, the Swiss franc has depreciated by more than 8% against the euro since April, making Swiss exports more price competitive. While the acceleration in exports should remain contained, this is because our analysis shows that Swiss export volumes are not particularly sensitive to exchange-rate fluctuations and that the franc’s depreciation is partly being used by export firms to increase their margins. This trend has been confirmed by the latest Switzerland Global Enterprise survey, which shows that most businesses are not yet feeling any concrete impact of the depreciation on their export volumes, while 53% of them said that the new exchange rates have improved their margins.

The higher margins for businesses are expected to boost the employment of full-time staff, which had fallen to be replaced with part-time positions due to the stronger franc (see left-hand chart). Private consumption is therefore expected to accelerate slightly in 2018 despite the continued rise in inflation, which is weighing on household purchasing power. Business investment is also expected to benefit from the franc’s depreciation and industry confidence in an environment where financing conditions are still very favourable and the capacity utilization rate is growing strongly. On the construction side, residential investment growth is expected to remain moderate. While the shortage of financial investments will continue to be a source of support, several factors will have a negative impact on residential construction, including a vacancy rate that is up to an 18-year high (1.47% in June 2017) and the reduction in the reference rate for leases to 1.5% in June 2017, which will impact rental returns.

As rental costs make up 20% of the consumer price index (CPI), their moderation will weigh on inflation. However, inflation is expected to accelerate in 2018, climbing to 0.7% for the year, compared with 0.5% in 2017. It should be supported by the franc’s depreciation, since imported goods represent 24% of the CPI, as well as the acceleration in activity and the recent increase in oil prices. Since the Swiss economy is expected to remain below its potential until the end of 2019, inflationary pressures look set to remain under control and inflation should reach only 1.0% in 2019.

Faced with weak inflation and a still fragile recovery, the SNB is expected to maintain its accommodative monetary policy. However, we expect the SNB to be satisfied with the franc’s current value, which it now considers to be “highly valued” rather than “significantly overvalued” (see right-hand chart, p.6). It is therefore not expected to make any significant interventions on the currency markets while the franc remains close to its current level. In addition, the SNB looks set to keep its key rates unchanged as long as the ECB does not raise its rates.