The publication March’s Markit indices confirms the downward pressure on activity in the manufacturing sector. The leading indices published for the Euro zone, Germany and France, on March 22, have been revised downward. This is never a very good signal as to the strength of the activity. This revision was marginal in the Euro zone (from 47.6 to 47.5) and in France (49.8 to 49.7) but more marked in Germany from 44.7 to 44.1. This latter has not been so low since July 2012. For the Euro zone, the index has not been as low since June 2013 but at the time the movement was bullish while here it reflects a deterioration of the activity. For the other two major countries, Spain and Italy, there is a slight rebound in Spain from 49.9 in February to 50.9 in March, but the Italian situation continues to deteriorate, from 47.7 to 47.4.
A good explanation is the pace of international trade. Germany is frankly penalized by the contraction of trade due to an openness rate higher than 44% of GDP. Any shock on world trade has an immediate impact on it. More generally, because of the intensive trade between countries of the zone, any external shock is amplified by a contagion effect and penalizes the activity of all. This had been a very positive uptrend in 2017 but is declining today. Germany saw its export orders revised downwards compared to the March estimate (38.9 vs. 39.5 initially). For France, the figure is unchanged.
The proactive economic policy of the Eurozone can only be seen on monetary side with a very accommodative policy but it cannot go further in that direction to limit the impact and the spillover effect of the shock. Except for a sudden and unexpected reversal of world trade, the trend in the Euro zone is here to stay. It should be possible to support domestic demand for this through budgetary means. This is not the current mood at the European level even if France plays constrained by the social unrest
The labor market indicator in the Conference Board household survey changed trend in March. It is always easy to find a job but the indicator is now on the downside. Given the strong link with JOLTS labor market indicator, one may wonder about a possible reversal of the US labor market. This is a signal that seems relevant to me (see here for longer data and more in-depth analysis).
The Macro 2 pager explains how the interest rates profile will remain low for an extended time. The central banks’ stimulus after the 2008 crisis has been caught up by an economy whose characteristics have changed and which can now accommodate only low rates thus conditioning the behavior of central banks.
The modest rebound in the IFO index in March is sometimes interpreted as the counterpoint to the drop of the Markit index released last Friday. There is indeed an opposition in March between the pace of the two indicators. One goes up again while the other is down.
However, what shocked in the Markit survey is the sharp downturn in the manufacturing sector, while the services sector was doing quite well. The manufacturing index was 44.7 against 47.6 in February. It contracts for the third month in a row. In contrast, the composite services indicator (calculated as the non-manufacturing ISM) is stable in March at 53.7 as in February. The culprit is the manufacturing index. Yet when comparing the manufacturing index of Markit and that of the IFO we have exactly the same profile.
The peak of the two indices is almost the same and the break observed since the beginning of 2018 is similar. The shock on the German economy reflects the rapid slowdown in the world trade momentum. The impact on the German economy is through the manufacturing sector whether measured by IFO or Markit. The pace of service between the two measures is not the same and this is what differentiates synthetic indicators from the two surveys. But services are more reflective of the domestic market than the sensitivity of the German economy to world trade via the manufacturing sector. The external shock is strong and brutal in Germany and it has first to be stabilized before the beginning of a recovery. It will take time and this justifies the pessimistic forecasts for Germany.
INSEE, the French statistical institute published its new forecasts for the first half of this year. (Its forecasts are just for a semester to avoid being in conflict with the government expectations). Activity would increase by 0.4% in the first and second quarters (non annualized rate). INSEE slightly revised up its second-quarter figure. The carryover growth for 2019 would thus be 1.1% at the end of the first half. To reach the new government forecast at 1.4% (indicated by Bruno Le Maire while the budget for 2019 had a forecast at 1.7%), quarterly growth has to be at 0.4% for each quarter. The current trend for the first semester would therefore be extended to the whole year. This figure, 1.4%, is also the one recently published by the Banque de France.
The articulation of the INSEE forecast is based on two elements.
The first is the rebound in domestic demand in the first months of 2019. On this point, all experts agree. The measures that have been taken on purchasing power should be support for household consumption. The pace of growth of this one would thus pass from an average figure per quarter of 0.125% in 2018 to 0.5% in the first quarter and 0.4% in the second. (Measures to boost the purchasing power have been taken after yellow vests’ protests. The amount of these measure is around Eur 11bn)
The second element of the framework drawn by INSEE is the momentum associated with the international environment. The Institute considers that the slowdown seen at the end of 2018 is just temporary and that the situation will rapidly improve to regain a more robust outlook. The demand’s profile to France from the rest of the world is unchanged from the INSEE’s December economic outlook. And this is a fairly solid figure, rising 0.7% in the first quarter and 0.9% in the second, while the average figure for 2018 was 0.5% per quarter.
If the strong slowdown of the last quarter, which conditioned the strong downward revision of the OECD forecasts (from 1.8% to 1% for the Euro zone) and the ECB (from 1.7% to 1%), is reversed then the outlook may be robust in coming months. Such a conjecture implies a rather robust pace for exports as world trade regains a stronger track. It also implies a rebound in business investment, as expected demand would recover. In that case, a strong recovery can be expected as companies’ financial situation will improve dramatically in 2019 (Lower taxes which was a policy proposed by Hollande in 2013 will be replace in the future by lower charges on wages. But in 2019 both measures are available as the new measure will be put in place and the former has a one year lag. This is a opportunity for firms. They will take advantage of that if expected demand improves dramatically).
If the global shock is persistent then the pace of exports will be less sustained and the investment will be gloomier. The improvement of financial conditions are only permissive conditions but not decisive when the expected demand is mediocre. The pace of employment will also be conditioned by the persistence or not of the shock.
If one assumes a more persistent shock from the rest of the world then the figures are less robust beyond the jump of the first quarter and without being catastrophic growth would tend to 1.1- 1.2% on average for 2019. And this does not suggest necessarily a re-acceleration of growth in 2020 as suggested by the Banque de France.
The key element will therefore be the overall momentum beyond the short-term effects of government measures. The Fed, the OECD and the ECB are wondering about the pace that this global dynamic can have. The Fed no longer wants to make commitments (on the pace of interest rates and on the reduction of its balance sheet) in order to be able to respond to a possible global shock without having hands tied. But France resists this mood.
In the first months of 2019, the economic situation will largely depend on domestic demand and therefore the measures taken by the government on purchasing power. An immediate consequence is that the government will not be able to engage in a policy of reducing public spending which is a precondition for a credible reduction in taxation. An expenditure reduction policy would annihilate support measures. The public deficit will therefore remain high, probably at best around 3.5% in 2019.
Look at this map. Who then can expect a trade deal between China and the USl The real question is about techno leadership? Huawei has a step ahead of the US.
The Chinese company already has deep discussions with many countries throughout the world. From Asia to Europe, Africa and Latin America the Chinese web is already impressive. On the other side, the US has forbidden purchases of infrastructures coming from Huawei. Australia, New Zélande, Japan and Taiwan follow the same rule. But it is a minority.
Recently, the US has generate pressure on Germany to forbid the German to buy Huawei products in the renewal of their mobile network. Germany has not changed its mind and has allowed Huawei to compete.
The balance of strength at the global level may change rapidly at the expense of the US.
How to expect an agreement that would validate the dominance of one over the other? From China to the US?