The Fed cuts its rate

The #Federal Reserve drops it’s rate by 25bp to 2.00-2.25%. Reasons are too low inflation rate and global uncertainty. It’s a kind of preemptive move which is quite weird. Usually the US central bank drops it’s rate when the environment is already bleak.

One reason for that comes from the fact that we don’t know the future, neither the Fed nor us. There is therefore a risk of credibility for the Fed if there is a rebound in the economic activity of a size that has no relation with the rate cut. The other risk is associated with political pressures from the White House. It’s also a source of concern.

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

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.

ECB: How to burn ammunition for nothing

In Sintra, at the ECB seminar, Mario Draghi stressed the risk on growth and the difficulties of converging to the inflation target (close but below 2%).

If additional risks materialize then the ECB could reduce its rates and restart an asset purchase procedure. The idea is to take back and accentuate what has been the success of the ECB since 2013. (Low rate = less incentive to defer its wealth over time given the low return associated with has been strong support for a stronger momentum for the domestic demand)

At the same time, Draghi called for an active economic policy. On this point, the failure to implement a euro area budget reflects non-homogeneous behavior in the euro zone. As a consequence there will be no common fiscal policy in the euro area. One can not therefore imagine a two-component euro-zone policy.

A major rule of the theory of economic policy is that it requires as many instruments as objectives. There are two objectives (growth and inflation) and one instrument, monetary policy.

This will not work especially with a series of negative external shocks. In 2016/2017, monetary policy benefited from a favorable international context even if fiscal policy was not active. Today, the environment is no longer as buoyant and the absence of fiscal policy will make it difficult to cushion external shocks. The ECB will act alone and becoming more accommodating it will burn ammunition for a poor result.

Lower ZEW index implies turmoil in Germany

The drop of the #ZEW survey increases the downside risk for the #German economy. It is linked with the rapid slowdown of the world trade. As no agreement is expected rapidly (even with the Trump/XI meeting at the G20), the risk of recession is increasing for Germany.

The current conditions index is far from its recent highs but the June important fact is the strong change in expectations.The 1st component reflects the drop in German exports(-5% in April vs March and -3% in real term since Dec 2018).The momentum will not improve (expectations)
Mario Draghi said in Sintra that the ECB will ease if necessary. It may be sooner than usually expected