According to the Federal Government’s Expert Group from the SECO, Swiss GDP growth will be 2.2% in 2014 and 2.7% in 2015. They see a strong expansion of investments and both imports and exports.
The SECO judges that the trade balance will continue the rising trend that has been valid for years, that exports expand more than imports. Moreover they think that personal consumption will increase only modestly by 1.8% in 2014 and 2% in 2015. As for investments and employment they are utterly optimistic. They see investments in equipment rise by 4% and 5%, while unemployment should come down to 2.8% in 2015.
The fact that the trade surplus continues to rise implies that margins of Swiss companies and exporters increase more than the ones of foreign companies.1 Costs of locally produced and imported products for Swiss companies have recently fallen by 0.8% y/y. For the first time in months the change in this producer price index (PPI) is lower than the one in the euro zone (-0.3%). For us the reasons for the lower cost rises for Swiss companies is the high availabilty of capital, innovation, lower wage increases and the late effects of “strong franc” on the import side. Lower costs increase margins, and it implies that foreign investors will continue to buy Swiss stocks, possibly more than Swiss citizens buy stocks abroad. A trend visible in the Swiss balance of payments and the asset market model.
The CHF upwards movement implied by the asset market model can be only overriden by the expectations of an ECB or a Fed rate hike. In this case money market funds would move in EUR or USD and help to foster these currencies.
However, bigger rate hikes typically happen when personal consumption is rising very strongly, e.g. 3% or 4%, like before the financial crisis. Rising consumption and demand lead to lower unemployment and later to pay rises and higher inflation. In both Europe and the United States we are still far away from this moment. The U.S. participation rate is falling, meaning there are still many people that are “inoffically” unemployed. The euro zone unemployment rate has just started falling from its highs. Moreover, in advanced economies, rational expectations of wage hikes got destroyed due to the financial crisis and the competition from emerging markets. If wages are steady, inflation will not edge up over the longer-term and so will not interest rates. Another reason is that rate hikes lead to higher government bond yields; hence it would destroy public finances in the U.S. and in Europe.
Our view on Swiss GDP components is different
For us, the SECO forecast (and the ones of other Swiss institutes) were just a copy/paste of 2013 enhanced by more optimistism reflected in higher investments.Their inductive approach to GDP estimates based on previous years has some lacunas, which the following deductive arguments may reveal.
We reckon that personal consumption in Switzerland will edge up more quickly than the 1.8%, foreseen by the SECO, values of 2.5% in 2014 and 3% in 2015 are possible. Despite the general Swiss preference for higher savings, increasing home prices, the big surge in Swiss wealth, low unemployment and the improving climate in Europe will help Swiss consumers to spend more.
Driven by continuing weak demand in Southern Europe and the Emerging Markets (EM), however, Swiss exports should not rise as much as the SECO expected. For us the crisis in EMs has just started and will continue for another two or three years. The reason is that wage expectations are still too high in the fragile five (Brazil, India, Indonesia, Turkey and South Africa), and also in Russia, where nominal wage growth was 5% per year since 2008. Weaker EM currencies and the resulting cheaper labor in international comparison are not able yet to compensate for the capital outflow. Brazilian retail sales, for example, were up 7% y/y but industrial production was nearly flat y/y; a similar disparity between high spending and weak production will continue to put pressure on currencies of the fragile five and Russia. A weaker currency will result in inflation. Inflation and the ncessary tightening in the public sector will depress EM consumer demand.
Until 2012 global growth was mostly driven by EM, but now lower EM growth and still weak demand in advanced economies will lead to very modest global economic growth. This implies that Swiss foreign direct investments will rise only slowly; investing in Switzerland is currently less risky and potentially more profitable (see why the Swiss capital account will not neutralise the persistent current account inflows).
The Swiss dependency on Europe, Russia and other emerging markets will continue to hamper Swiss export growth, while sales to the U.S. will not rise that much because many Americans are still stuck in a balance sheet recession. Driven by higher Swiss consumption and investments, we see the Swiss trade surplus weakening in 2014, a trend already visible in the “Swiss boom quarter” of Q4/2013. Higher private consumption, however, will increase the margins of Swiss companies.
But both cases, either that
- the Swiss trade surplus continues to rise (as the SECO thinks)
- or that Swiss private consumption edges up but the surplus will weaken (as we think)
imply that foreign inflows into Swiss equities and the Swiss franc will not stop. Further CHF strength lies ahead.
- This is valid when local private demand increases similarly. [↩]