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


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

What to expect this week (September 30 – October 6)

Highlights

> The most important data of the week will be the US ISM survey for the manufacturing sector (October 1). It was at 49.1 in August down below the 50 threshold for the first time since 2016 (January). This is an important data as it may affect investors ‘ expectations on the downside if it remains below 50. The ISM profile is consistent with the YoY change of the industrial production index. The current consensus for September is above 50. This suggests that it follows the Markit index profile for the manufacturing sector which has rebounded in September (flash estimate).

> The Markit indices for the manufacturing sector will also be important but we already know (flash estimates) that Japan was weaker in September as was the euro area index with a very weak number in Germany This latter would be consistent with a strong negative number for the GDP growth in Q3 in Germany.
The world index was up in August (but remaining in negative territory at 49.5.
Chinese indices will be out on Monday 30 September.
The services indices for the Markit and ISM surveys will be released on October the 3rd.
On October the 1st, the Tankan survey will be released in Japan.

> The US employment for September will be released on Friday 4. The number was weak in August and we do not expect a strong rebound as households’ perception of the labor market was weaker in September (through the conference board consumer confidence survey). One remarks, the private sector momentum is the lowest since 2010. It’s probably the consequence of the 2018 surge but it can also reflect weaker expectations on companies’ side.
In August, the number of public jobs was particularly high due to the 2020 Census. This may still be the case in September.

> Spanish growth second estimate for Q2 will be released on September 30 (the first was at 0.5% non annualized). The Bank of Spain has revised down its growth profile for 2019, 2020 and 2021. It now expects 2% in 2019, 1.7% in 2020 and 1.6% in 2021.

> The Euro Area inflation rate for September (October 1). It may be close to 1% for both the headline and the core. The convergence to 2% is not there yet.
Inflation rates in Spain, in Germany and in Italy are also expected (September 30)

> Unemployment rate for August in the Euro area (September 30), German retail sales for August (September 30). Industrial production index for Japan for August (September 30). Retail sales in the Euro Area (October 3)

On a more political ground, the 70th anniversary of the People’s Republic of China (October 1st) will be a ceremonial event on the Tienanmen square in Beijing. Xi Jinping will give an address to the nation.

The ECB will be unable to normalize its monetary policy soon

The ECB will not start the normalization of its monetary policy in 2019. The interest rate level will remain stable, my bet is that the refi rate and the deposit rate will remain at the current level in 2019.
The lack of external impulse, the slower momentum in the manufacturing sector and the convergence of the headline inflation rate to the core inflation rate are three reasons that suggest that the ECB will not take risks in the management of its monetary policy. The monetary policy normalization, even the expectation of it, may weaken economic activity. Therefore it’s not the good policy when the inflation rate is way below the ECB target with no convergence to the target in a foreseeable future.

The framework I have in mind is the following: Due to more heterogeneous behaviors and uncertainty at the political level, global growth will become, in 2019, weaker than in 2017 and in 2018. Inside the Euro Area, there are no coordinated policies that may boost growth, therefore growth trajectories will converge to potential growth. This framework is not a source of monetary policy normalization. But we can add that the dramatic oil price drop in recent weeks (due to excess supply in the US and in Arabia) will push the headline inflation rate to the core inflation rate which has been close to 1% for months. It’s still way below the ECB target and therefore not a source of monetary policy normalization.  Continue reading

Italy – The crisis is coming

The adjustment on the upside is not over on Italian rates. The 10 year bond’s rate is converging to 3%. The spread with the German 10-year rate is now circa 270 bp. This also reflects a safe heaven effect for German bonds.

With a rate at 3% % while the inflation is at 0.5% (in April), the real rate is way too high in Italy compared to real growth prospects. But such a level on the real rate (2.5%) would be just above the average seen since the beginning of the Euro Area (2.2%). It’s too high when the GDP trend is close to 1%. This has deterred investment and it will continue limiting the capacity to grow. We have to expect a slowdown in the economic activity in coming months. It will come from the real rate level but also from the uncertainty in the Italian economy. An austerity program that can be expected from a transition government is not good news for Italy but also for the rest of the Eurozone.
spreaditall29051000.png

British inflation eases

Economists said after the referendum on Brexit that a temporary spike in the inflation rate could be expected due notably to the British currency depreciation.
That’s what has happened with a peak in November 2017 at 3.1%. After this date, the inflation rate is receding at less than 2.5% in March 2018. The core inflation rate has followed the same profile with a current rate at less than 2.3%.
uk inflation rate.png Continue reading

Inflation on the upside in the United Kingdom

The current acceleration of the inflation rate creates a complex situation in the United Kingdom as it weighs on households’ purchasing power.
In April the inflation rate was at 2.7% and the core inflation rate was at 2.5%. The inflation rate has not been so high since the fall of 2013 and november 2012 for the core rate. This is mainly the impact of the depreciation of the currency after last june referendum on Brexit.
A year ago the inflation rate was at 0.3% and the core inflation rate was at 1.2%. This latter magnitude is worrisome as the economy is not growing more rapidly.
uk-2017-aprl-inflation
The main issue is that wages momentum will not follow the inflation profile.  Continue reading