The first point to mention is the long lasting divergence on economic outlook between the USA and the Euro Area.
In the USA the ISM global index is a weighted average (by employment) of synthetic indices from the manufacturing and non-manufacturing sector. The index is in November at a very high level (59.2) which feed expectations of robust growth prospects. This is not really the case in the Euro Area. The index, which is designed with the same methodology, is now marginally below the threshold of 50. The probability of a contraction of the economic activity is non null.
The impact on monetary policy expectations is immediate
In the USA the main question is related to the change on the upside of interest rates. The structure of expectations may also have changed compared to what was expected.
Conversely in the Euro Area, the lack of economic momentum and the absence of initiative on economic policy can be a worry.
We cannot in the Euro Area adopt a wait and see strategy because it has two types of behavior that are not satisfactory: on one side you just see that the growth path is low following the current situation, it’s a fatalist perception of the current situation; on the other side such a strategy can reflect the expectation of an endogenous recovery but without any precisions on its timing and of its depth.
That’s why there is a need for a more active monetary policy in the Euro Area, just to try to change the current growth trajectory. Without it a low and long lasting growth path would lead to social and political instability as everyone will try to improve its own situation through selfishness.
Mario Draghi, the ECB president, wants to find a way to change the picture. But even with weak growth prospects, with very low inflation rate (0.3% in November) and downward revisions of GDP and inflation forecasts for 2015 and 2016 he cannot find strong support even in the ECB council.
In the council it seems that the 6 members are on each side of the table. Mario Draghi, Vitor Constâncio and Peter Praet support the initiative of a strong and reactive monetary policy; on the other side it seems that Sabine Lautenschlager, Benoit Coeuré and Yves Mersch are hardly convinced of the positive impact of this kind of monetary policy. (see here)
This is a major issue and we still expect that rapidly the ECB will be able to put in place a Quantitative Easing strategy that would translate in the purchase of sovereign debt. This will avoid a breakage in the Euro Area.
It is necessary to go quickly: this week-end Hans Werner Sinn the head of the IFO institute explained in an interview with the FAZ that in the treaty that created the ECB the ECB target was price stability. This can be compatible with a 0% target and not with the 2% that has been taken by the ECB and was not in the treaty.
This is nonsense but it can be very harmful. It gives the feeling that we stop thinking when we speak of monetary policy.
The third point to mention is the strong momentum on the US labor market. 321 000 new jobs have been added in November. That’s huge but consistent with what can be seen since last April. There is a change in regime since April as jobs creation are systematically higher that the average of the last three years.
This is clearly positive for the American economy. Nonetheless the job recovery is not that strong, it is still weaker than in the past. The chart below shows that employment in November 2014 is just 1.2% higher than in January 2008 at the employment peak of the last business cycle. This is clearly weaker that in every cycle seen since the 60’s.
On another issue, the recovery is still very heterogeneous at the sectoral level. Only three sectors have net jobs creation in November 2014 when compared to January 2008. And for construction and the manufacturing sector there is still a net loss of circa 1 500 000 jobs in each sector when November 2014 is compared to January 2008.
With this sectoral heterogeneity and the weak trend in wage growth (only 2.1% on a year) we cannot expect that the Fed will change its mind rapidly. The Fed will wait for more inflationary pressures to change its strategy.
For the coming week
We will be very attentive to the November retails sales in the US. It will be interesting as there is a collection of opposite short term trend: the “not so good” Black Friday but the strong auto market and the downward trending gas price.
We will also have a lot of Chinese figures for November. It will start on Monday with figures on the trade balance, will continue on Wednesday with the inflation rate and will finish on Friday with data on investment, industrial production and retail sales. It will give a good view on the current economic situation in China and will feed expectations on what type of monetary policy the Chinese Central Bank will decide: We expect lower interest rates in coming weeks as real interest rates are still very high for companies (production price index is down by -2.2% and add up on nominal interest rate)
Employment figures for the third quarter are expected in France (Wednesday) and in the Euro Area (Friday). We also expect figures on flows on the US labor market (JOLTS). These data are observed with scrutiny by the Fed as they can show a change in confidence on the labor market (if people quit by themselves it is because they expect with a high probability that they will find rapidly a new job. This can reflect a more balanced labor market. That’s the kind of data that will be provided on Tuesday.
On Thursday, the second operation of TLTRO will be put in place by the ECB. It’s an important leg for monetary policy. The question is to guess if the amount of the operation will be higher than the first operation held in September (Eur 82.6bn)
The last point is the law that will launched by the French government on the modernization of the economy. No macroeconomic breakage but some improvement on micro-economic competition
Have a good week