Governments against the euro zone

Christine Lagarde, in her first official speech as President of the ECB, called for the implementation of a new policy mix to allow the Eurozone to develop all its growth and employment potential. The complementarity between fiscal and monetary policy should, according to the new President of the ECB, allow such a scenario. The Eurozone could then have more growth autonomy and a greater capacity to decide for itself.

Christine Lagarde will have to be convincing because governments do not take the demands of the central bank seriously.
Mario Draghi, before her, had already, and from the beginning of his mandate, called for a rebalancing of economic policies. The request of Christine Lagarde shows that the former President of the ECB has never been listened to or taken into account.
Draghi committed to a strategy of low interest rates to improve the public finances solvency. By pushing interest rates down, he facilitated more aggressive fiscal policies and structural reforms to improve the growth profile of the Eurozone economy.. Governments have never engaged on this point.

The ECB has, since the arrival of Mario Draghi, carried out an accommodative monetary policy. In the summer of 2012 the ECB became the lender of last resort of the Euro Area, thus guaranteeing the safeguarding of the banking and financial system. It then lowered policy rates to around 0% and then launched its QE in March 2015. All these unorthodox policies have been criticized from all sides as being excessive and in no way boosting growth or inflation.

How could it have done when the fiscal policy of the Euro zone is restrictive since 2011? The structural primary surplus (i.e. corrected for cyclical effects) since 2012 reflects a fiscal drag. In no case has there been fiscal stimulus at the euro area level since 2010 (the data are calculated by the IMF and a larger deficit reflects a fiscal stimulus).
At the time, 2008/2009, the collapse of the economy had caused this large public deficit. But as soon as growth resumed, with the revival of the G20 decided in London in April 2009, Europeans have become systematically restrictive again. The ECB then played the same role as the Commission, helping to accentuate the six-quarter recession in the Eurozone.

The Eurozone fiscal policy has never been conducive to supporting activity and enhancing growth.
The primary fiscal surplus has been around 1% of potential GDP since 2013 and has not moved since. The rigor implemented in 2011/2012, which resulted in the very long recession, was never questioned. The budget texts put in place in 2013 to signal the seriousness of the budget options and to reassure the financial markets have not, in fact, helped to strengthen growth in the Eurozone.

One may wonder whether accommodative monetary policy has not been the pretext for not adopting a proactive fiscal policy. Another interpretation, monetary policy became frankly accommodating only because Draghi had the perception that governments and the Commission would never let go on fiscal policy. Since the ECB adopted a strategy to support growth, it was no longer necessary to do so at the Eurozone level.
Draghi has allowed governments not to reform, not to promote growth, to criticize the inefficiency of monetary policy with impunity while being able to complain about populist excesses.

Will Christine Lagarde fall into the same trap as Draghi?

What to expect this week – 18 November – 24 November 2019

Highlights

> —Minutes of the last Fed’s meeting (Nov. 20) and of the last ECB’s meeting (Nov.21)
The Fed’s minutes will reveal the discussions on the drop of the Fed’s benchmark rate but the most useful part will be on the commitment to stop, at least temporarily, the downside trend on the benchmark rate.
In the ECB minutes, the focus will be on the discussions related to the important disagreements between governing council members after September decisions —

> Markit flash estimates for November in the Euro Area, Japan and the US (Nov.22)
In October a rebound in the US for the manufacturing sector was a surprise reflecting mainly the spike in the New export Orders index. The divergence with the eurozone and Japan was astonishing. The November survey will highlight the possibility for the US to remain strong while Japan and the EA are still weak.  —

> The French Climat des Affaires for November (Nov. 21)
The French index has been above its historical average for months. This is consistent with the stronger momentum of the French growth when compared with the Euro Area. This is linked to the specificity of the French economic policy that feed domestic demand in order to cushion a possible external shock. This strategy limits the possibility of a downturn.

> Eurozone Current Account for September (Nov.19)
The Euro Area current account shows a large surplus. It is circa 3% of GDP. This means that there is an excess saving in the Euro Area and that we have means to invest in order to improve the autonomy of our growth process. Because accumulating surplus is just useless.

> Existing homes sales in the US for October (Nov. 21) and Housing Starts (Nov.19)
Existing home sales indicator is a measure of a wealth effect on consumption expenditures. Its recent profile suggests a slowdown in expenditures during the last quarter of this year before a mild rebound at the beginning of 2020. —

> Productivity in the third quarter for the United Kingdom (Nov. 20)
The strong slowdown in the UK productivity suggests an extended period of low growth except if investment rebounds strongly. This will not be the case whatever the Brexit agreement because Brexit will continue to provide large uncertainty. —

> The Phylli Fed index will be release on November the 21st. The Japanese trade balance on November the 20th, the Japanese CPI for October on November the 22nd and the German Consumer Confidence index on November the 21st  

Monetary policy and growth. The world economy at November 4, 2019*

The Federal Reserve, or US central bank, cut back its key rate for the third time this year at its October meeting, after previous moves in July and September. The federal funds rate now stands at 1.5-1.75%, which equates to the range in the dot plot after correction. The Fed also indicated that it does not plan to continue cutting interest rates in the near future.

The interesting aspect of the Fed’s decisions is that they are not dictated by US domestic trends. GDP grew 1.9% in the third quarter on an annualized basis, and 90% of this robust figure is driven by private domestic demand. So we are still seeing the paradoxical situation where the Fed’s decisions are not driven by the US domestic outlook, and we will need to keep an eye on this over the months ahead.

The other interesting aspect of Jay Powell’s press conference is that he only briefly touched on the situation and the glitches on the US money market, yetthis is a very worrying factor as the Fed has injected more than $200bn into its balance sheet to manage this crisis since mid-September. The Fed’s message is that it is not that important, but yet it has added $200bn to its balance sheet, given no explanations and pledged to continue hefty purchases until mid-2020 to ensure that the market remains liquid. This “move along, there’s nothing to see here” approach is disquieting, and we will really need to closely monitor this situation.

Christine Lagarde took over from Mario Draghi as ECB President on November 1, and there are two points worth noting on this change. Firstly, Christine Lagarde seems to be “Draghi-compatible”, and just like the former Italian ECB President, she has also made clear her aim of pursuing the development of the euro area by getting governments more involved and looking more to fiscal policy. She has taken a much more political stance than Draghi could right from this start, and this aspect will be both important and very interesting. The euro area lacks a political dimension, and Christine Lagarde could bring this to the table.

Third-quarter growth figures were issued for several euro area countries over the week. The non-annualized growth trend came out at 0.2% for the euro area as a whole, with 0.4% for Spain and 0.1% for Italy. The French growth figure came to 0.3%, in line with the two previous quarters.

This should lead to 1.2% growth for the euro area as a whole for the full year 2019, with a projected 1.3% for France, 0.2% in Italy and 2% in Spain, which has now made up its lag and is posting less vigorous growth.

Looking to the breakdown of figures for France, domestic demand plays a key role. Economic policy is designed to shore up domestic demand and offset any potential external shocks. It does not drive growth but it does rein in the risk of break points.

Looking to the US, growth we mentioned above for the country came to 1.9% in the third quarter and 0.5% on a non-annualized basis, which should lead to overall 2.3% growth for the full year.

The manufacturing ISM index in the US came out at 48.3 for October vs. 47.8 in September, marking the third month in a row below the 50 mark. Economic momentum is weaker, and out of the 18 manufacturing sectors assessed in the survey, only five stated that they are growing. Domestic demand is also weaker and less robust than a few months ago, so we are seeing the US economy change pace slightly.

US job market figures were also released, but stats for October were fairly solid with the economy creating 128,000 new jobs, plus the 42,100 that could have been created without the General Motors strike. Average private sector monthly job creation figures YTD come to 154,000, which is a solid but not excessive figure, and fairly close to stats in 2017. The White House’s very aggressive fiscal policy in 2018 had driven figures up.

Jobless numbers came to 3.6%, which is very low and the employment rate has increased. The job market is dynamic, and the yoy wage rate increase is only 3%. Wage gains are decreasing each month following on from the high of 3.4% in February.

Inflation in the euro area came out at 0.7% in October vs. 0.8% in September, with this slowdown mainly triggered by energy’s negative -0.3% contribution in October. However, this tendency is set to turn around over the last two months of the year as oil prices collapsed at the end of 2018, so inflation is poised to increase slightly in November and December.

Looking to the week ahead, we note the global ISM index, which is the weighted average of composite indices for the manufacturing and non-manufacturing sectors in the US, and which usually fairly closely tracks GDP growth trends. September’s figure was particularly low and slightly above the 50 mark, which fits with sluggish growth of 1.5%, so October’s stats will be particularly important in judging the pace of US growth: if it is excessively weak, the Fed could well change its strategy to keep rates on hold that it set out at its latest meeting.

The Markit survey global manufacturing sector figure will also be announced on Monday, and this indicator has pointed to a contraction in world manufacturing since May. Chinese external trade balance figures for October will also be released on November 8, and the decline in imports points to weaker Chinese demand, while stagnating exports reflect lackluster world trade, particularly as it is dictated by US trade policy.  

September’s German industrial orders will be issued on November 6, and the pace is very much in line with OECD corporate investment figures. The slowdown trend witnessed since the start of the year is worrying for future global economic performances.

Have a good week


The post is available in pdf format

  • *Posted on my French blog on Monday the 4th (here)

What to expect this week (October 28 – November 3)

Highlights

> The Fed’s meeting with a press conference and a press release on Wednesday. Two questions: are disagreements between FOMC members remain as high as in September ? Will the Fed cut its target rate ? The dots graph suggests a third cut this year.

Christine Lagarde will replace Mario Draghi as president of the ECB next Friday. The balance between politics and economics will be different than in the current mandate. The main task for Christine Lagarde will be to maintain the cohesion of the ECB members at a moment where the monetary policy is already very accommodative and the impact of a change will be questioned and lower than in the past.

On the Brexit side, a vote is expected today on the possibility of general elections on December the 12th  Boris Johnson will probably not have the qualified majority for it.
The EU, in a draft, has proposed an extension of the Brexit until the end of next January.

> GDP figures will be released this week in the US and in France (30) and in the Euro Area, Italy and Spain (31). Expectations are on lower figures than in the second quarter. This would be consistent with the business surveys seen during this third quarter.

> ISM index for the manufacturing sector (November 1) will be key to anticipate the business cycle profile in the US. The index was below the 50 threshold in August and September.

> The Chinese official PMI index (31) and the Markit index for the manufacturing sector (1st )

> The Markit indices for the manufacturing sector will be released on November the 1sr except on Continental Europe.

The US employment report next Friday. The momentum is lower than in the first part of the year even with a very low unemployment rate

Inflation flash estimates will be released in Europe this week. (Euro Area 31). As the oil price is on average lower than in September (53.7 € in October vs 56.7€ in September )  and has to be compared with a high level in October 2018 (70.3€). The energy contribution will be strongly negative and the inflation rate will be probably below the 0.8% seen in September.

The document is available here
NextWeek-October28-November3-2019

nwoct28

ECB accentuates financial repression for an extended period

The ECB has lowered its deposit rate by 10bp to -0.5% and will keep all of its rates at the current level or lower until inflation converges to 2%. In the ECB’s forecasts, inflation will be 1.5% in 2021. Therefore, the short-term rates will remain at the current level until at least 2022.
The ECB has also decided to resume it Quantitative Easing program (QE) by 20 billions euro from November the 1st.. This has already resulted in a spectacular decline of the 10y Italian rate.
This QE measure will accentuate financial repression. The aim is to push the entire rate structure for all countries in negative territory, Italy included. It can last beyond what we imagine. The purpose of financial repression is to reduce the incentive to save and to increase the incentive to spend to curb activity on the upside.
The wish of the ECB is that fiscal policy will change and be more active so that the measures taken are more effective and faster. However, he has been repeating this since the beginning of his term.
The ECB will reduce its deposit rate to -0.5% with the adoption of a system that will adjust this rate according to the type of reserve (tiering). Excess reserves will be paid at 0% and the rest at -0.5%.
The TLTRO is extended to 3 years and the rate on each transaction will be the main refinancing rate over the remaining time of this TLTRO tranche.
Given the length of the TLTRO and the expectations mentioned above on inflation, the applicable rate could be on average the deposit rate over the duration of the transaction for banks whose loans exceed the loan reference defined by the ECB. This means that for banks with excess liquidity, they may have an interest in lending and placing their loans in excess reserves. This will strengthen the banking sector.

The financial repression put in place by the ECB implies that interest rates for all maturities and for all countries are low and negative for a very very long time.
Economic players have changed their behavior when interest rates dropped to 0 or negative. But this change is now over. Behavior’s change will be marginal. The upward macroeconomic impact will therefore be very limited.
Moreover, the ECB’s signal could also be interpreted as reflecting a particularly degraded situation, thus raising concern for households and companies. Th risk is that signal may, at the end, have a negative effect on the economy. Will the stronger banking sector be enough to counteract this effect? It’s an unknown today.
Growth forecasts are revised downwards to 1.1% in 2019, 1.2% in 2020 and 1.4% in 2021. An external shock could tip the Eurozone into recession. For now, the ECB considers this probability to be very low.
This nonetheless reinforces the need for an effective and proactive fiscal policy to get out of the current liquidity trap whether or not there is a recession.
Given the lack of willingness of governments to have a coordinated fiscal policy, the position of Draghi is associated with a strong bet on the future at the risk of becoming wishful thinking.
Good luck Christine Lagarde

What to expect next week ? (September 9 – September 15, 2019)

Highlights

> The ECB meeting will be the most important event of the week. Bazooka measures are expected with lower deposit rate (associated with a tiering depending on the size of the bank) and the resumption of the Quantitative Easing Program.
> The lower deposit rate with tiering will help the banking system. The EONIA may even be higher than what is currently seen.
The QE program will push down all interest rates and reinforce financial repression
We do not expect strong impact on the Eurozone growth momentum or on its inflation.

> External trade in Germany will highlight the impact of the world trade lower momentum. Lower exports have pushed the German GDP change in negative territory during the second quarter. An extended slowdown of the world trade (as expected when we look at the worldwide lower exports orders in the Markit survey) would push Germany in recession.

> Retail sales in the US for August (13) are the last good numbers expected. In September, tariffs on Chinese consumer goods imported in the US will have a negative impact on consumers’ behavior.
> JOLTS (10) will show the probable change in the US labor market trend
> The UK economy  had a negative change figure in the second quarter. This will have an impact of the labor market (10) for July.

The detailed document can be read here
NextWeek-September9-September15-2019