Macro 5 Pager – Macroeconomic Momentum – 8 July 2019

> The world economy’s slightly chaotic showings reflect the likely end to a world balance dominated by the US, as well as the hunt for a new world order. This multi-faceted balance would include the US, China and Europe.
> This quest for a new equilibrium can be witnessed first and foremost in the current less coordinated and cooperative context, where each country seeks to get the most out of a situation where the rules are changing. Border tariffs are just one example of this.
> In the short term, this leads to uncertainty that drags down economic activity, as well as investment. Growth is slightly more sluggish across the board, while inflation remains contained and is still a far cry from the central bank’s target, especially in the euro area.

> There is a tendency towards continued accommodative monetary policy. Going too fast when all the risks for the economy have not fully emerged means taking the risk of having an insufficient impact and running out of options when the situation becomes more tricky.
> This would be the case for the US, where interest rate cuts being made too quickly would mean a fresh surge in liquidity, promoting more real estate lending and corporate credit from non-banking institutions, so excesses already seen would become even more severe. This would also heighten risks on these markets and curb the Fed’s ability to act in the event of a future crisis.
> Another key point is that long-term rates are set to remain very low for a very long time, until such times as this new world balance emerges: this will force the financial sector to reinvent itself.

The document is available here Macro 5 Pager – Macroeconomic Momentum – 8 July 2019

What to expect next week ? (July 8 – July 14, 2019)

Highlights

  • External trade for Germany is the statistics I will focus on this week (July 8). Since the beginning of the year, real exports are slowing down as a consequence of the trade war. Expectations are negative and this is a source of concern for the German growth momentum. The German government may have, in coming weeks, an opportunity to boost domestic demand to cushion this disruption.
  • The Chinese external trade will also be a major indicator (July 12) as a measure of the trade war impact.
  • The German industrial production index will also show a slowdown in May (July 8). This would be consistent with expectations on its external trade and with corporate surveys that reflect pessimism.
    The other point to mention here is that the UK industrial production will show a downward trend (July 11). This would be consistent with the Markit index for the manufacturing sector. In May the Markit synthetic index was at 49.4 (from 53.1 in April).
  • The US inflation rate for June (July 11) will slow as seen in European inflation rates for June (flash estimates) while the Chinese will remain strong (2.7% in May) as food price (pork price precisely) will continue to push up the price index.
  • Financial Stability Report by the Bank of England (July 11 at 1130 CET), Minutes of the last FOMC meeting (June 18-19) on July 10 (2000 CET)  and Minutes of the last ECB meeting (June 5-6) on monetary policy (July 11 at 1330 CET)

The document is available here NextWeek-July8-July14-2019

 

The US yield curve is completely inverted.

That’s it, for the last 2 days the rate over the 30 years US has gone below the fed funds rate. All interest rates of the US curve are now below the fed funds rate.
This reflects a terrible concern for the future. Investors no longer want to take bets on the future.
It should be noted that the inversion of the curve no longer reflects a compression effect resulting from the rise in the Fed rate as expected last autumn, but an effect of poor expectations for the future. The two schemes are very different and the second is the most worrying.

Such a signal has always been a precursor of two points:
the first is a decline in Fed rates. For macroeconomic reasons (the data are still robust) and for the credibility and independence of the US central bank, I hope that this rate cut will not take place in July (or even here)
The second point is that this configuration of US interest rates is always a signal of future recession. Simply put, it is not only investors who have poor expectations about the future. The rapid fall in interest rates is simply a signal for the perception of the future. This one is not specific to financiers. The US recession will certainly take place in 2020.
We can imagine that until then, the tenant of the White House will be firing on all cylinders to show that he has done everything possible to avoid this decline in activity during an election year. The pressure on the Fed is going in this direction, as is the pressure on China. But if he fails, there will be no shortage of scapegoats. Jay Powell, the Fed President, will be in the front row but also probably Xi Jinping, the Chinese President who will not have put all the goodwill necessary to reach an agreement with the US. “Heads I win, tails you lose”

Manufacturing ISM down for the 3rd consecutive month

The downward adjustment of the manufacturing sector ISM has continued since the high point of August 2018. The flagship indicator of the US economy must be based on a less volatile and less strong real dynamic. The CFNAI that I take as a reference is calculated as the common trend of 85 indicators of the real economy.
There is still room for adjustment and this will happen in view of the deteriorating international environment and the absence of economic policy measures across the Atlantic that could boost growth very quickly.
This means that the ISM will cross the 50 level in the coming months and will probably fall below it even if only temporarily.

The decline in the ISM is mainly due to lower order flows and lower delivery pressures.

3 points on the cyclical dynamics in Asia and the Euro zone in June

The first point is the rapid slowdown in manufacturing activity in Asia. It is contracting in the 4 major countries, from China to Japan, South Korea and Taiwan.
The movement is even faster for countries that are more dependent on China for product assembly. This is the case for Taiwan and Korea.

This negative shock is a consequence of Trump’s trade measures and weighs very heavily on Asia in general and China in particular. The postponement of the sanctions planned for US imports from China, which were due to take effect on 2 July, is a good thing. However, if the resumption of the Sino-American dialogue makes it possible to avoid the worst, nothing seems to be resolved on the merits and uncertainties will remain.
(With regard to the Vietnam index, are you surprised by the recent interest of the American administration? Chinese activity has moved there)

Synthetic indices on economic activity and new export orders, world trade will continue to slow in the coming months as Asia has been the region most affected by the US measures.

The dynamics of the Eurozone are slowing down quickly. The advanced estimate published last week for the Euro zone has been revised downwards. In the flash estimate it still showed a contraction to 47.8 but slightly improved compared to May (47.7). The final version is 46.6. Activity is slightly worse than in May. The decline in activity is faster.
In addition to the contraction in activity already observed in Germany, there are now also those in Spain and Italy. The Spanish index plunges to 47.9 and that of Italy to 48.4. The French index, although revised downwards by 52 in the estimate at 51.9, is improving compared to spring developments.
Three of the four major countries in the Euro zone have rapidly contracting manufacturing activity. Will growth forecasts have to be revised downwards?

With regard to the dynamics of foreign trade, it can be seen that the profile is the same as that of synthetic indices. Germany is pulling the whole thing down and Italy and Spain are now making a significant contribution to the contraction in orders.

The German situation will continue to deteriorate. The dynamics of world trade will not reverse rapidly, further penalizing the manufacturing sector. But in addition, the slowdown in the cycle, measured here by the IFO index) will result in a slowdown in the labor market. Employment dynamics will slow down and this inflection will be all the more important as the downward nature of the cycle lengthens.
As a result, domestic demand in the German economy will be weaker and could encourage the government to pursue a more flexible policy to offset the negative effects of the international environment. Let us not doubt then that all the countries in the area would benefit from it. The risk is that we really have to go into the negative part of the cycle for the Germans to react. Moreover, even if the ECB is active, as Draghi suggested last week, this will not be enough to reverse the trend.

What to expect next week ? (July 1 – July 7, 2019)

Highlights

  • The ISM index for the manufacturing sector (July 1) will be the main indicator in the coming week. The slowdown in the US business cycle may be confirmed in June. 
  • The US labor market is the other main indicator (July 7). Its dynamics has recently changed as it adjusts to the new business cycle shape.
  • The Markit indices for the manufacturing sector (July 1) and for the services sector (July 3) will show the risk of a global recession for the manufacturing sector. The hope for the Eurozone is a strong services sector index that will allow an extension of the growth momentum.
    The Tankan survey in Japan will be out on July 1.
  • Employment in Germany for June (July 1) and retail sales for May (July 3) will show the possibility of maintaining a robust domestic demand or if it is necessary to have a stronger economic policy to cushion the impact of world trade negative shock on the German economy.
  • Retail sales in the Euro Area (July 4) for May will be a good proxy on the strength of the internal demand for the Euro zone.

    The document is here NextWeek-July1-July7-2019

Inequality

Issues on inequality are more and more discussed. These questions were not mentioned when I was a student in the 80’s. They à re now part of the economic discussion at the academic level and elsewhere. Angus Deaton and the Institute for Fiscal Studies (IFS) in the UK have launched a first report on inequality. It can be found here. Deaton gave a speech that explains all the diversity of the term inequality and its consequences.

The quote below is the last paragraph of his speech

“I think that people getting rich is a good thing, especially when it brings prosperity to others. But the other kind of getting rich, “taking” rather than “making,” rent-seeking rather than creating, enriching the few at the expense of the many, taking the free out of free markets, is making a mockery of democracy. In that world, inequality and misery are intimate companions.”

The speech from Angus Deaton launching the IFS report on inequality can be found here