The desynchronization of economic policies, especially in the US, has caused negative shocks to the global economy, resulting in a downward synchronization of the economic cycle. Trade policies create breaks in value chains and all countries are affected (one product is manufactured in 3 countries A, B and C. If tariffs are put on the link between A and B reducing or modifying the activity on the product in A and B so C is affected). The dynamics of trade has been reduced in recent months in Asia (not just China) affecting exports in the Euro zone (see graph).
Productivity gains are no longer enough to cause an endogenous rebound in growth. Shocks therefore have persistence. Consequently, monetary policies will remain permanently accommodative and interest rates will remain very low for all maturities. The economic model and the social model will have to adjust to this new pace. Hard challenge for European countries
The latest FOMC meeting on
January 29 and 30 saw confirmation of the halt to monetary normalization, with
the end to the Fed funds hike cycle and an easing in the Fed’s balance sheet
management (reduction) policy, although the exact terms of this remain to be seen.
The most surprising part about this decision is that it was dictated by the
threat of shocks from external factors (Brexit, China, etc.) rather than the
desire to tackle any domestic problem, marking the first time that the Fed has
taken this kind of decision to normalize monetary policy without making a
direct reference to its domestic economic situation.
Yet the shift in monetary policy direction could have been based on purely
internal considerations rather than referring to potential external shocks, so
this move raises a number of questions.
With the decline of -0.9% in December, the industrial production of the Euro zone fell by -5.3% over the last quarter (annualized rate). and -2.1% over one year. The slowdown in world trade is an explanation that the European slowdown has itself accentuated.
There is now a more complete picture of industrial activity in 2018. The US is doing well, Japan is still very volatile but Europe is falling back quickly, lacking an internal dynamic capable of offsetting external shocks. We always fall back on this eternal question of coordinated dynamics to get better. Dependence on impulses from the rest of the world is now too important and this is very worrying
Since the referendum on Brexit in June 2016, the dynamics of the British economy have been shrinking. Evidenced by the slowdown in growth in 2018 to 1.4%, the slowest pace since 2012 and a pace, as in 2017, slower than the Euro zone and France.
To fully appreciate the divergence between the United Kingdom on the one hand and France and the euro zone on the other, I calculated a trend starting in 2013 (beginning of the recovery everywhere) and ending in the second quarter of 2016 at the moment of the referendum.
The trend of each country is then extended while retaining the initial parameters. I then calculate the deviation (in%) of GDP to this trend. These are the three curves on the graph.
The UK curve is 2.5% below its pre-referendum trend. The cumulative difference since the choice of the British reflects the cost associated with it even before the Brexit is formally established (March 29, 2019 theoretically).
At the same time, the acceleration of growth in the eurozone and in France throughout 2017 marks these two countries, above their trend. France is 1.7% above the trend and the euro zone 0.8%.
Despite being the UK’s largest trading partner, European expansion has not benefited the UK. This is a very disturbing element.
Nevertheless, the expected slowdown in eurozone growth, beyond the effects of Brexit, should weigh on the economic situation across the Channel and increase, ex post, the cost of the referendum.
The US Federal Reserve decided to bring its monetary policy normalization to an end during its meetings on January 29 and 30, 2019. The interest rate hike cycle had kicked off slowly in December 2015 and stepped up a pace a year later, as nine interest rate hikes pushed the Fed Funds rate up from 0.25% (upper end of range) to 2.5% in December 2018. During last week’s press conference, the Fed Chair indicated that Fed Funds are now in the range of neutral, in response to the first question from journalists: there is no longer an accommodative or a tightening slant. Powell’s confidence in the strength of the US economy suggests that the end to normalization should not just be seen as hitting the pause button for a while.
The rate hike cycle has been long and slow-moving if we compare to the Fed’s previous series of tightening moves from 2004 for example. A comparison with this period also reveals that real interest rates on Fed funds were much higher then than they are now. The figure is currently marginally above the level witnessed at the start of the normalization process in December 2015, unlike the situation after 2004, when the economy was much more restricted, while this is not the case in the current economic situation.
A comparison of current real interest rates with previous phases of monetary tightening shows that today’s situation is completely different to these episodes. Real interest rates in November 2018 stood at around 0.4% (inflation figures for December are not yet available on the PCE index), which is much lower than figures in 2006, 1999 or 1990. Does this mean that the US economy is too weak to be able to deal with a real rate above 1%? This would be extremely worrying and would undermine Jerome Powell’s comments that the US economy is in a good place.
It is difficult to understand why
US normalization is coming to an end when we look at the economy, as unemployment
is near its low, so the central bank should be tightening the reins. The Fed’s
projections for 2019 and 2020 are for figures above the country’s potential
growth rate and this also fits with the economists’ consensus, at least for 2019.
Against this backdrop, monetary policy needs to be tighter to ensure that
growth does not create imbalances that then have to be addressed, and this was the
message from Powell in 2018, when he suggested that fiscal policy (too
aggressive for an economy running on full employment) would need to be offset
by tighter monetary policy to rebalance the policy mix. During the press conference
on Wednesday January 30, he did not raise this question: the issue was side-stepped,
but yet the analysis still remains the same. There are only two possible
economic explanations for the halt to normalization: either there are
expectations of a severe downgrade to projections when they are updated in
March, but this would not be consistent with Powell’s comments; or the Fed is
doing whatever it takes to extend the economic cycle at any cost, with the end
to the rate hike cycle aimed at cutting back mortgage rates and taking the
pressure off the real estate market. However, with the overall economy
remaining robust, the risk of this type of move is that it could lead to imbalances
that would be difficult to eliminate. This is the opposite approach to the Fed’s
strategy right throughout 2018, so it would be a strange tactic.
The inflation for the Euro Area was at 1.4% in January after 1.6% in December. The main reason for this drop is the negative impact of the oil price. The energy contribution to the inflation rate was 1% in October and just 0.25% in January. This will continue and the contribution will become negative during the first quarter of this year. This reflects that the oil price is currently lower than in 2018 and this will continue allover the year. As the core inflation rate is circa 1%, the headline inflation rate will close but below 1% in 2019.
Except in the US, the mood perceived through all the Markit surveys is negative. In the Euro Area the index is just above 50 at 50.5 but the German index, its main engine, is now in the contracting zone. Japan is converging rapidly to 50. This US will not have the possibility to pull up the global activity. Its momentum is not strong enough. Moreover, this US index has also to be interpreted with the Fed new monetary policy framework. The US central bank has stopped its monetary policy normalization at its January meeting and I can’t imagine that it’s mainly linked with external downgrades. It would be the first time ever that the Fed makes a change in its monetary policy orientation on external elements. I can’t believe that the Fed change is not dependent mainly on the US outlook.
The French GDP growth was 1.1% (at annual rate) during the fourth quarter of last year. The same number than during the third quarter. Social unrest has had no impact on the headline figure. Nevertheless, details show that the private sector domestic demand stalled (0.2%) during the last quarter after a strong 2.4% growth in the third quarter. Households’ consumption was 0 and investment contribution was at 0.2% versus 0.9% in Q3. On companies’ side, investment contribution decreased on the same scale (0.2% after 0.9%). Residential investment was down with a negative contribution (-0.1%). The good surprise was on exports’ side with a strong increase at 9.8% vs 0.7% in the third quarter. Therefore and despite a rapid imports’growth, the external demand contribution was positive at 0.9% after 1.1% in Q3. Inventories have had a marginal negative contribution.
For 2018, the average growth was at 1.5% after 2.3% in 2017 but the end of 2017 was the peak of the cycle and the economy is now converging to its potential. In 2019, with 1.2% per quarter which is close to the 2018 average, growth will be at 1.1%. We have a forecast at this level. It way below the government forecast at 1.7%. We can’t expect a strong reversal in the GDP momentum that could justify such a forecast. In 2019 consumption will be pushed up by all the measures on purchasing power that has been announced by the President Macron in December. But as long as social unrest remains companies will not boost their investment. The improvement seen on exports will not last. World trade is slowing down rapidly and France will follow this trend. In other words, the French economy has a limited growth momentum (just 0.9% from Q4 2017 to Q4 2018). With social unrest and uncertainty on external trade, the French economy will continue this trend close to 1% in 2019.