A very relevant column on the new stages of the trade war

This column, “The Case Is Only Growing for an Economic Forever War”, by Shawn Donnan, was posted on the Bloomberg website.

“President Donald Trump’s trade war with China has become a bigger, broader economic forever war. It’s hard to look ahead and see any outcome that undermines that emerging reality. A “phase one” deal may be in what U.S. officials say is its messy end stages. But that deal, if it comes, will be partial and more ceasefire than game changer. It also doesn’t mean a larger peace is nigh. Moreover, there are three live truths that are becoming inescapable:” Continue reading here

What to expect this week – 4 November – 10 November 2019


> The ISM global index (5) will be the major data this week. It is consistent with the GDP growth momentum and was particularly weak in September compared to what was seen last summer. A weak number may trigger a change in what the Fed could do in a foreseeable future.

> The Services Markit indices will be released on November 5. But the Euro Area data on manufacturing (4) and on services (6) will be released a little later this month as November 1 is off in most continental Europe countries.
The world markit index for the manufacturng sector will be available on Monday
> The Monetary policy Committee of the Bank of England will meet on November 7. Nothing is expected on its monetary policy stance but extension of the Brexit may imply comments on the impact for the UK economy.
> In the US, we look systematically at details on the labor market. The global employment index of the ISM survey and the JOLTS survey will bring these information. The ISM global index on the labor market was below the 50 threshold in September and maybe a source of concern in case a continuous weakness.

> The Chinese external trade (8) will provide new information on the impact of the trade war on the Chinese economy.

> In Germany, there is a string of data with the industrial orders (6) the industrial production index (7) and the trade balance (8). All of them will highlight the impact of the negative environment on the German short term momentum. Will they increase the risk of a long recession ?
> Japanese households’ expenditures in September at the eve of a VAT rate hike (October). In March 2014 they spend a lot just before the higher VAT rate in April 2014. Have we had the same behavior ?
> General elections in Spain (10) – The probability of a strong majority is low

Central Banks and the IMF – The world economy as at October 14*

Monetary policy has been at the heart of recent market trends once more. The minutes from the US Federal Reserve’s meeting on September 17 and 18 as well as from the ECB meeting on September 12 reveal that central bankers’ views can be fairly diverse. In other news, the Fed announced that it would be buying T-bills to tackle liquidity risk, such as the situation witnessed after September 17 on the US money market. These various factors led to uncertainty and more divergent projections for the financial markets, with interest rates surging as a result.

In the US, the Fed decided to lower the target range for the federal funds rate by 25bps at its September 18 meeting, from a range of 2.00-2.25% to a range of 1.75-2.00%. The dot plot also points to a further likely cut in December.

However, James Bullard, President and CEO of the Federal Reserve Bank of Saint Louis, was in favor of a 50bps cut to help growth take an uptick more quickly and promote a more rapid return of inflation. At the same time, Esther George, President and CEO of the Federal Reserve Bank of Kansas City, wanted to keep interest rates steady as she believes that greater monetary accommodation is not yet necessary given the current state of the economy. Meanwhile, Eric Rosengren, President and CEO of the Federal Reserve Bank of Boston, believes that monetary policy is already sufficiently accommodative judging by the pace of the economy, and that further moves are not necessary. The various central bankers in the US do not share the same view of how the Fed should act, and this could lead to uncertainty for investors.

In the euro area, the ECB’s decisions at its September 12 meeting did not all meet with the same enthusiasm. The decision on banks’ role in financing the real economy via the TLTRO program was approved easily – it is vital to facilitate funding for the economy to ensure strong renewed growth.
The two-tier system for reserve remuneration was also agreed, and banks’ reserves will no longer be entirely subject to the negative deposit facility rate, which was cut to -0.5%. As much as six times banks’ mandatory reserves may now be exempt from the deposit facility rate, and this means a hefty transfer of financing from the Eurosystem to the banking system. The aim here is to safeguard a robust banking system to ensure that monetary policy moves feed through to the real economy. However, there were discussions as to whether these measures were compatible with an easing in the terms of the TLTRO program.
There was even more dissent on the issue of forward guidance. Interest rate and quantitative easing measures will be maintained until inflation converges to a level sufficiently close to, but below, 2% on a structural basis. Should the bank have kept this measure time-specific or should it make moves dependent on achieving the inflation target? Was this the focus for debates?

The most hotly debated issue was the resumption in the quantitative easing program. The ECB will resume its asset purchase program on November 1 at a pace of €20bn per month. This will round out reinvestment of principal payments from maturing securities in the ECB’s portfolio of around €10bn. The new-look QE program is expected to end shortly before the ECB starts raising its key interest rates, while reinvestment will continue past the date that the Governing Council starts raising key ECB interest rates.
There are questions as to the need for this move, although the ECB believes that it is necessary and that previous programs had promoted both growth and inflation. However, some critics of this policy feel that it is not necessary, while other opponents think that QE is not the right policy instrument in this situation. Interest rates surged in the euro area as a result of these various aspects, and with the Bundesbank and the Bank of France opposed to this move, investors felt that there may be some change to come. However, the governor of the Bank of France has since stated that they must now turn the page.

The important point here is that Christine Lagarde’s hands are now tied and she must follow the ECB’s decisions.

In the US, the Fed decided to inject massive liquidity into the money market. The US money market came under pressure on September 17, and the Federal Reserve Bank of New York intervened over the space of several days to inject significant cash into the system to tackle this liquidity risk, as shown by the chart on the size of the Fed’s balance sheet.
The Fed is also set to intervene by buying $60bn in T-bills between mid-October and mid-November and will then adjust this amount depending on market conditions until the second quarter of 2020. It will also continue its overnight repo operation until January 2020 to support the market’s adjustment.

The Fed does not want to call this program quantitative easing, but rather it is a way to provide the liquidity that the money market needs to avoid a shock on financial assets having any knock-on effect. This is a vital point: the central banks – and the Fed in particular – want to make sure they can address any potential financial shock very quickly and avoid any danger of it spreading. This can be seen as a transitional phase as the Fed has only set out plans until next spring, but it can also be viewed as an indication of fears that the situation could get out of hand, so every effort must be made to avoid any negative impact for the markets and the economy.

Indicators issued during week of October 7
We particularly note fairly robust industrial production figures in the euro area, apart from France where industrial output plummeted 0.9% and manufacturing output dropped 0.8% in August. Sound figures from Germany and Spain drove a 0.4% increase in production for the euro area as a whole in August.

The US labor market continues to adjust. Despite a dip in jobless numbers to hit a low of 3.5% in September, survey data show that momentum on job openings is much less robust. The labor market remains solid, but is not as buoyant as before, and this is also reflected in monthly figures on new jobs created, with both private sector and total job creations over the month at their lowest since 2010.

Looking across the globe, Chinese external trade continued to deteriorate, with exports contracting slightly and imports continuing to decline hastily. The Chinese government does not want to embark on aggressive economic stimulus: the economy is not undergoing a shock, but rather domestic demand is sluggish, as reflected by investment as well as imports. We also note the 22% collapse in exports to the US in September yoy, and this downtrend is gathering speed after a 16% drop in August. China is shifting its external trade to make it less dependent on the US, but this change could turn out to be tricky, so a more ambitious domestic policy may be needed to offset this external shock. US-China trade talks are making no progress, despite what the White House says.

Three key points to watch over the week ahead
The first is an ongoing but crucial issue – Brexit. The European summit on October 17 and 18 must address this issue and settle the final position on the matter. BoJo’s proposals for dealing with the Irish border issue are still not convincing, so if a deal is not reached at the summit the Prime Minister will have to ask for an extension, unless the 27 push the UK out of the bloc with no deal, but that seems unlikely.

The second major piece of news this week will be the US Fed’s Beige Book. These figures may clear up Esther George’s and Eric Rosengren’s doubts on the need for the Fed to cut interest rates.

The third event is the World Bank and IMF annual meetings. The IMF will give its outlook on the world economy and issue fresh projections. July’s figures indicated that we had hit the cycle peak in 2017, with a low in 2019 to be followed by a recovery in 2020, mainly on the back of a more robust economy and a rebound for emerging markets. However, doubts may emerge on this trend to an improvement.

But it’s not all doom and gloom. The good news is that Esther Duflo, Abhijit Banerjee and Michael Kremer have been awarded the Nobel prize for economics for their work on tackling poverty using ground-breaking methodology. Esther Duflo and Abhijit Banerjee published the book “Poor economics: a radical rethinking of the way to fight global poverty”, available in paperback.
So why not read this enjoyable and interesting book to find out more.

Have a good week!

This column was posted in French on Monday the 14th (See here)

An enduring crisis (part 1)

The world was thrown into disarray by the financial crisis in 2008 as it was forcibly pushed out of its previous very definite state, with its own momentum and its own very effective endogenous systems of control. This previous world order drove the economic success of western countries, but the world must now find a new stable framework with a new dynamic and different systems of control. The structure for this new order still remains very unclear and while there are a number of potential options, the transition from this previous – and very familiar – state to the new ill-defined set-up makes for a time of crisis.

The certainties of the past are now being called into question, and the new world order is only just emerging, so the certainties of tomorrow are not yet fully formed. This situation makes for a crisis as the past world has gone, while the world of the future is struggling with seemingly – and sometimes actually – contradictory signs.

The world as we know it in 2019 is nothing like the pre-crisis world of 2007. Our reference points have all completely changed and this is highly disconcerting. So it comes as no surprise that more radical political movements have developed and are all very similar in that they hark back to the past to try to find their bearings. Our ability to imagine these changes creating an ultimately coherent environment where we can see ourselves living comfortably is shaped by anxiety and uncertainty, which drive our behavior.

Today’s crisis is multidimensional. It is obviously a source of disruption, but contrary to common belief, it is not necessarily characterized by financial watershed. The financial aspect is merely just another source of uncertainty and while it is probably the most impressive at the time, it is actually not the most difficult aspect to address. Rather it is our changing world that lies at the heart of everyone’s gloom – and this scaremongering is excessive and contrived.

We are witnessing a very diverse and extensive range of changes that have taken place in a fairly short space of time, and it is this vast array of change that can seem frightening.

Phenomenally fast technological change is creating a new and unprecedented situation, e.g. visual recognition, which impinges on personal freedom, and feelings of being just another anonymous user, useful only as a target for personalized in-app advertising. An incredible revolution is taking place at unparalleled speed, yet this transformation does not feel like it provides a major or sustainable improvement in our wellbeing. What recent innovation has contributed more to our comfort than the refrigerator? None.

The world is also changing massively for the middle classes. Polarization of the labor market means that work for highly educated and for unqualified workers is increasing – albeit in very different ways – while intermediate jobs for those with few or poor qualifications are decreasing, with innovation primarily driving this trend. This middle class played the lead role in economic growth during the three post-war decades of boom in France, but now they just feel like bit players. This feeling is further aggravated when these employees live far from large cities with less access to healthcare, education and other public services. Here again the context has changed and the future looks much more bleak for this group. However, this situation is not just specific to France, as the Deaton review in the UK also reveals startling inequalities. This does not mean that the situation is the same across the board, but rather we must entirely overhaul some of our projections as past trends will not continue into the future.

The world balance is also changing dramatically. The same manufacturing methods are now being used in both developed and emerging countries, so the size of the world labor market has increased considerably, and this is another factor fueling difficulties for the middle classes.

Yet there are other aspects to this change in scale for the world economy. Tension between the US and China was inevitable as the real issue at stake here is political leadership, pursued via technological domination. China very quickly and relentlessly made up its previous lag as a result of vast efforts in the country, and also perhaps because of inadequate public investment in the US. This now casts doubt over US leadership in innovation: given China’s size and its increasing contribution to world growth, the balance of power in this battle of wills is fairly even. China is also developing a new way of managing its dealings with the rest of the world via its Belt and Road Initiative for example, which harbors a highly political dimension. The country’s expansion does not depend on Washington, unlike the situation in the west since the end of the Second World War.

This situation means a reallocation of resources for the US – and all to the detriment of Europe. So Europe must now stand united: the UK’s current ill-judged move is set to have drastic consequences. The world will not go back to its pre-globalization state, unless walls are built between countries around the globe. China is powerful, making it a key partner in future choices on global systems of control, whether in terms of people, goods, services or capital. Three-party communication between Europe, the US and China is vital, and a Europe that fails to stand united cannot have any influence in this trio, which would be highly damaging.

Another aspect of China’s rise is the fracture in the world’s historical dynamics. The industrial revolution took place in Europe and then extended naturally to America, so the shift towards China marks a huge swing in the world balance. French historian Fernand Braudel’s economic history went from the Mediterranean to Flanders via the Champagne fairs before making it to London and then New York – maybe China will be the last stop on this trip.

This all makes for a radical shift in the world’s reference points, with the feeling of losing our bearings and our grip on the future. America was easily seen as a natural successor to Europe, with a full range of virtues, but the same cannot be said of China.

To be followed…

This column was posted on the French Forbes’ website. You can retrieve it here

What to expect next week ? (September 16 – September 22, 2019)


> The Fed’s meeting (18) will be the important event of the week. We expect a 25bp drop in the Fed’s main rate and nothing on the balance sheet policy.
The important point will be Powell’s explanation of this move at his press conference. In July, the main explanations of the 25 bp drop were external factors (trade, global growth). Will these elements remain the principal explanation ? What will be the new growth forecasts consistent with this new monetary policy stance ?

> The US industrial momentum (17) will be an important data as the ISM synthetic index for August dropped below the 50 threshold at 49.1. The consistency between the two indicators suggests that the industrial production index YoY change could go in negative territory.  Will the industrial index follow this dynamics in August?
The Empire state (16) and the PhilyFed (19) will give information on the economic situation in September

> The ZEW (17) in Germany for September  will be key to anticipate the possibility of a German recession and therefore the possibility for a more proactive fiscal policy. Draghi, in his press conference last Thursday, said that a eurozone fiscal policy would be complementary to the ECB monetary policy to boost growth and inflation.

> Chinese number (16) will show how the economic policy efficiency of an arbitrage between an external negative shock and the necessity to feed the domestic demand to stabilize the economic activity. Industrial production was weak in July while retail sales were stronger than a few months ago.
> Retail sales in the UK (19) in the midst of a political mayhem. What has been consumers’ behavior ? Have they increased their stocks to prevent the impact of a no deal Brexit ?
> US housing market with Housing starts (18) and Existing home sales (19)? The market is quite stable.
> In Brazil, the Selic will not be pushed down at the next monetary policy meeting (18) as the Brazilian central bank has had strong intervention on the forex market to limit the depreciation of the real.

The detailed document is here

Some thoughts on Hong Kong

Massive demonstrations in Hong Kong have set inhabitants of the Chinese-controlled territory (handover on July 1, 1997) against the Chinese government, with 1.7 million people involved in demonstrations on August 18, equating to 25% of the population.

The key issue at stake here is the shift in the political landscape in Hong Kong after the region’s government announced plans to amend its extradition law, as Hong Kong inhabitants fear Chinese control over the HK legal system, giving rise to concerns that they could lose their independence from Beijing. This means the risk that Hong Kong could lose some of its special status (one country, two systems since the agreement implemented in 1997), jeopardizing the personal safety of all HK inhabitants.

Hong Kong Chief Executive Carrie Lam stated on July 8 that the extradition bill was dead, but this did not appease demonstrators, who are calling for her resignation: not only was she was the instigator of the proposed amendment, but she is also not democratically elected – rather she is appointed by a 1,200-member election committee, mostly appointed by Beijing. The Chief Executive should be appointed via elections based on universal suffrage, but since the umbrella revolution in 2014, Beijing’s approach to HK has changed and the Chinese government no longer seems to want to comply with the initial democracy agreements. 
This public backlash against political changes in HK is also due to the fact that the Chinese government meddles in legislative elections, stepping in to rule against one candidate or another. 
China has taken a firm stand to quash this social unrest, and troops are barracked at the border with Hong Kong, involved in maneuvers although not intervening. 

It is interesting to look back in time to understand what is happening and gain some insight into the Chinese government’s heavy-handed reaction. 
During the UK handover of Hong Kong to China in 1997, it was agreed that there would be one country, two systems i.e. Hong Kong would remain subject to market forces and China would maintain a socialist system. China would be in charge of HK’s defense and foreign affairs, but the region would have its own constitution with a strong degree of autonomy from China, maintaining freedom of the press, freedom of assembly and the right to demonstrate, etc.
The agreement that came into force on July 1, 1997 was signed for a duration of 50 years – i.e. until 2047 – after which the one country, two systems set-up could become one country, one system.

But this is the very issue that is attracting concern in Hong Kong: the initial idea was that the two systems would converge, based on the assumption that China would develop economically and its political system would evolve towards the HK system, not vice versa. This was the idea put forward by Samuel Pisar i.e. greater economic affluence would lead to the gradual implementation of a more liberal and democratic political system.
However, judging by moves from Beijing, residents of Hong Kong look on as their system shifts and moves towards the Chinese political system. They are concerned that they will gradually be incorporated into this system and become just another Chinese province among others, which would mean access to information being more restricted and freedom of speech becoming much more limited than it is now: Hong Kong has a lot to lose.

The government in Beijing does not want to take the risk of allowing social unrest to gain a foothold, and has not shied away from repressing any demonstrations that take place across the country. To avoid this type of situation, the Chinese authorities take a very active approach to applying economic policy, and are strict in ensuring that social instability does not take root. This is one of the factors underpinning the widespread development of electronic surveillance in China, as facial recognition and the social credit system are ways of curbing these risks in a type of digital dictatorship engineered to avoid social strife.
This need for the authorities to curb unrest is exacerbated by the fact that growth is slowing and the Chinese economy is struggling to create all the necessary jobs.

In other words, the authorities in Beijing do not want the Hong Kong demonstrations to spread to the rest of China, which is fettered by more sluggish growth. This is a dangerous situation, as citizens in both Shenzhen and Guangzhou are closely watching how the Hong Kong-Beijing relationship pans out: a number of Shenzhen residents work in Hong Kong, so there is no longer a strict separation between the territory and the rest of China.

This battle of wills raises a number of questions.
Chinese military intervention in Hong Kong is one of the list of potential options, but this kind of political move could well draw parallels with the Tienanmen Square events in the spring of 1989.
This would be damaging for China as its international expansion has been exponential since 1989 and moves aimed at extending the country’s influence – such as the Belt and Road Initiative – would be threatened by military intervention. This would also be a major risk as that the country is involved in a stand-off with the US and is able to offer technological capabilities that could help skew the world balance in China’s favor: in this respect, the Huawei affair is symbolic as the company has the wherewithal to replace mobile telephone networks and swiftly migrate all European countries to Chinese 5G technology.
So this kind of move would trigger hefty risks at a time when China wants to challenge the US both economically and politically.
Meanwhile, a deterioration in Hong Kong’s status resulting from Chinese intervention and putting it on a par with other Chinese regions would increase mistrust of Beijing from all other world capitals. 

However, this mistrust may only last a short while, and China can hope that its economic and technological firepower would ensure that it emerges as leader over the years ahead, with intervention having a limited effect over time. After all, the events of Tienanmen Square did not stop China growing and extending its influence in the world over the past 30 years.

Ultimately, the issue at stake here is China’s role in the world, as the country stands against the US in a worldwide economic and political battle of wills. Technological, economic and political leadership is being played for, and Washington has not managed to put an end to its contest with Beijing after Chinese retaliation forced Donald Trump to back down last week when he delayed border tariffs on electronic consumer goods to December 15.
China is also currently finding its domestic balance, and keeping Hong Kong’s current status would mean maintaining access to the rest of the world and allowing the rest of the world to have access to China. This communication is vital, although HK admittedly only accounts for 3% of China’s GDP as compared with 20% in 1997. 
China could well be on the way to becoming the economic heavyweight it was before the industrial revolution in Europe. The choices it makes in addressing the demonstrations in Hong Kong will be a harbinger of just how it plans to act in this leadership role in today’s globalized world. 

What to expect next week ? (August 19 – August 25, 2019)


> Discussions on trade war between China and the US have been the main trigger for financial markets last week. It will continue as China is ready for retaliation. That’s the way we must interpret the recent change in the White House measures. It has postponed new tariffs to December the 15th. It was said to ease Xmas gifts but it was more probably the consequences of the discussions between the two countries. After December the 15th, 96.8% of Chinese exports to the US will have tariffs. That’s a terrible change compared to the 5.3% seen in 2013.
The situation between the two countries and the Chinese announcement of retaliation are a source of concern and of lower interest rates. The risk is to jump into a global recession.
With the deep slide seen on interest rate this week (August 12) after the discussion on trade, the main question is to anticipate until which level they will be able to go in negative territory in the Eurozone.

> The impact of this trade war is already seen in exports figures for Japan. In real terms, the exports are already down more than 2% in YoY comparison. The figure for July (August 19) will probably confirm this trend implying new risks for the Japanese growth.

> The Markit indices for August will be released as flash estimates for Japan, Euro Area, Germany, France and the US on August the 22nd. We will look carefully at the manufacturing sector where the world index (will not be released next Thursday) is already in the contraction zone and where all indices for larges developed countries are close or below the 50 threshold.

> In the UK, the CBI survey on new orders may confirm the risk of a deep recession (August 20). The recent drop of this index is already impressive as accumulated inventories for the Brexit limit the possibility of a supplementary demand.

> The last point to look at will be the US housing market. The Existing Home Sales figure will be released on August the 21st. This is an important data as it supports a wealth effect for US households. Recent figures do not show an improvement even with lower mortgage rates. New Homes Sales will be released on August the 23rd.
> August 19 Final CPI release for July in the Euro Area. August 21, the German consumer confidence for August and CPI for Japan on August the 23rd.

The document is here