The global manufacturing sector is strongly constrained

Reduction in new export orders is the most important economic phenomenon for the business cycle in recent months. It cannot be ruled out that measures to constrain international trade have had a negative effect on trade and growth.
In the monthly Markit manufacturing survey, the new orders index for developed countries was at 47.4 in September. Order flows have contracted continuously since January. In these circumstances, it is not surprising that the pace of manufacturing output is also degraded in most countries. In August, it contracts in the US over a year.
In emerging markets, the new orders flow index reflects a contraction at 48.7. Since the beginning of the year, the average index is at 49.7.
The ISM survey export order flow index is at its lowest since the 2009 recession (the previous low point was March 2009). This reflects a particular situation that in the past has penalized the US economy.
The shock is severe and international trade is no longer a source of impetus for the economic activity as in the past, but rather a constraint that permanently penalizes growth.
On the graph, we observe the change of regime throughout the year 2018. Tariff measures, non-cooperative strategies and the political consequences of insufficient growth explain this change in trend. Spontaneously, we do not perceive a rapid reversal of the trend.

The other source of concern in the manufacturing sector is employment . After a strong improvement until early 2018, especially in developed countries, it is now contracting. This means that the solvent demand, which improves with the increase in employment, is deteriorating. Internal dynamics fades.

The growth of the manufacturing sector is now strongly constrained. It no longer has a strong impetus from international trade and the solvency of domestic demand is deteriorating due to the low momentum in the labor market. We can expect a negative contribution from the manufacturing sector to growth in the coming months. The only question now is whether services can compensate for this effect. Generally this is not the case. This argues for a further slowdown in activity.

What to expect this week (September 30 – October 6)

Highlights

> The most important data of the week will be the US ISM survey for the manufacturing sector (October 1). It was at 49.1 in August down below the 50 threshold for the first time since 2016 (January). This is an important data as it may affect investors ‘ expectations on the downside if it remains below 50. The ISM profile is consistent with the YoY change of the industrial production index. The current consensus for September is above 50. This suggests that it follows the Markit index profile for the manufacturing sector which has rebounded in September (flash estimate).

> The Markit indices for the manufacturing sector will also be important but we already know (flash estimates) that Japan was weaker in September as was the euro area index with a very weak number in Germany This latter would be consistent with a strong negative number for the GDP growth in Q3 in Germany.
The world index was up in August (but remaining in negative territory at 49.5.
Chinese indices will be out on Monday 30 September.
The services indices for the Markit and ISM surveys will be released on October the 3rd.
On October the 1st, the Tankan survey will be released in Japan.

> The US employment for September will be released on Friday 4. The number was weak in August and we do not expect a strong rebound as households’ perception of the labor market was weaker in September (through the conference board consumer confidence survey). One remarks, the private sector momentum is the lowest since 2010. It’s probably the consequence of the 2018 surge but it can also reflect weaker expectations on companies’ side.
In August, the number of public jobs was particularly high due to the 2020 Census. This may still be the case in September.

> Spanish growth second estimate for Q2 will be released on September 30 (the first was at 0.5% non annualized). The Bank of Spain has revised down its growth profile for 2019, 2020 and 2021. It now expects 2% in 2019, 1.7% in 2020 and 1.6% in 2021.

> The Euro Area inflation rate for September (October 1). It may be close to 1% for both the headline and the core. The convergence to 2% is not there yet.
Inflation rates in Spain, in Germany and in Italy are also expected (September 30)

> Unemployment rate for August in the Euro area (September 30), German retail sales for August (September 30). Industrial production index for Japan for August (September 30). Retail sales in the Euro Area (October 3)

On a more political ground, the 70th anniversary of the People’s Republic of China (October 1st) will be a ceremonial event on the Tienanmen square in Beijing. Xi Jinping will give an address to the nation.

Recession risks in the Euro Area, not yet in the US

Markit surveys for September show a slow momentum in the Euro area and in the US.
The synthetic index for the Euro Area (weighted average of the manufacturing and non manufacturing synthetic indices) is now close to 50 leading to weaker expectations for the Q3 GDP growth. This reinforces me that GDP growth for 2019 will be circa 1.1%. The impact of the new ECB monetary policy will not lead to an impulse on the upside.

In the US, the synthetic Markit index for the whole economy shows a meager rebound in September despite a stronger manufacturing index. The non manufacturing index has been quite weak in September at 50.9 after 50.7 in August. The services sector doesn’t counterbalance the lack of impulse of the manufacturing sector.The global index is now way below the level seen until last spring and is consistent with a slowdown in the US GDP growth as it was seen in 2016. The more accommodative US monetary policy will not change the picture.

In the short term, the main risk remains in the manufacturing sector. European indices are weak, notably in Germany. This may lead to a recession in this country with a contagion risk to the rest of the euro area. Nevertheless, in the case of a deep recession in Germany, the government would be more active on its fiscal policy, limiting therefore the risk of a recession for the whole zone. This would be the chance for the Eurozone.
Inb September, the US is weak but stabilized. The risk of recession is still low at this moment.

What to expect next week ? (September 23 – September 29, 2019)

Highlights

> Corporate surveys will highlight the business cycle foreseeable future. The IFO will be released on Tuesday 24 as will be the French Climat des Affaires. The French momentum is currently higher than in Germany as this latter is more exposed to the international backdrop. The Italian survey on corporate confidence will be out on September the 27th and may show the impact of a pro-European government on corporate confidence.

> Markit surveys, flash estimates, will be released on Monday the 23rd for the Euro Area, France, Germany and the US. The Japanese release will be done on September the 24th. These surveys are important but I will carefully look at the New Export Order indices in the Euro Area, US and Japan. Its average is clearly consistent with the world trade profile. In August it was as low as 46.6 giving a signal of continuous contraction in trade. September date will be important.

> Consumer confidence in the US (24 for the conference board and 27 for the Michigan), in France (25), Germany(26) and Italy (27). The US conference board will give us relevant signals on the US labor market dynamics. France index will remain above its average, way above the level it has a year ago when the yellow vests demonstrations started.

> Consumption expenditures in the US (27) and Fed’s preferred measure for inflation for August will be released on August the 27th. Consumers’ behavior is the strongest support of the current US growth momentum. Nevertheless it can be very volatile. We expect that it will be strong in August, consistently with retail sales. No strong expectations on inflation. The July core inflation rate is 1.6%.

> Inflation for September in France and Spain.
> New Home sales in August in the US. The real estate market has been stronger recently. A confirmation is expected as interest rates were low in August.

The document is available here
NextWeek-September 23- September 29-2019

Some thoughts on US monetary policy*

The US central bank – the Federal Reserve – has trimmed its key interest rate again, marking a further step forward down a new track. Its monetary policy is now developed independently of the US economic situation, as the Fed’s strategy is dictated by worldwide uncertainty that could hit the domestic economy and push it off its current robust path. Uncertainty on world trade, the impact of the administration’s trade policy and concerns on world growth are all prompting the Fed to adjust it strategy.

In the past, the country usually adopted a more accommodative stance in response to a sharp economic slowdown. In 2007/2008, the Fed changed its policy when liquidity dried up on the money market, but this was the exception rather than the rule, with the Fed only reacting to changes in the US economy with little concern for the rest of the world. This approach was only natural as world trends at the time were dictated by the US.

Fed backtracks after rate hikes in 2018

This shift in focus raises a number of points:
The Fed is backtracking after its upward trend in 2018, when it raised its key rate four times. These were the right moves at the time as the White House had implemented a very aggressive fiscal policy at a time when the economy was close to full employment, so it was vital to keep on a lid on tension that could have surged and dented the economy.
This rearrangement in the economic policy balance was perfectly plausible given economic conditions.
However, fiscal policy was not as effective as expected, and made a smaller contribution to driving the economy than anticipated, so the Fed no longer needed to continue its monetary tightening policy.
The outlook changed when the international context became more risky, particularly as a result of US trade policy.
The combination of these two factors prompted the Fed to maintain the status quo, then start easing, with a very clear timeline: on January 30, 2019 the Fed hit the pause button, then started easing on July 31, and again on September 18. Its policy is now highly accommodative as the real Fed Funds rate is only very slightly positive.

The US policy mix is now very accommodative, while the economic cycle is at a peak

It is interesting to take a closer look at economy policy measurements. The US policy mix is now very accommodative at a time when the country is still at the peak of the economic cycle. The public deficit stands at $1,000bn (almost 5% of GDP) and the real Fed Funds rate is only just slightly positive. Well might we wonder how the Fed will steer economic policy in the event of a shock on growth – can we expect an even bigger public deficit and should we anticipate negative interest rates from the Fed?

We could well think that the Fed rushed to change its accommodative strategy due to this unfortunate combination, as the economy is still robust and does not require monetary stimulus. It is also still very closed to outside influences, with trends and activity heavily dependent on the domestic market. This means that the role of external factors in the way monetary policy is managed is too high. In 2018, the degree to which the US economy was open[1] to outside factors was slightly under 14%, which is barely above the average since 2000 i.e. 13.7% vs. 13.4% average since 2000. The economy is no more dependent on the outside world than it was 10 or 15 years ago. So why change the factors that determine monetary policy by overlooking domestic aspects and only taking on board external dynamics?

Further questions on factors driving monetary policy

Questions to Jay Powell during press conferences should seek to address this question. Does this change reflect pressure from investors to get their hands on ever higher financial valuations? Is it the result of pressure from the White House as it wants the Fed to push interest rates ever lower? Is it because Powell has not set a clear doctrine on what monetary policy should be in this topsy-turvy world? These three factors can all be taken on board, but this rushed move makes for an economic policy error.

We can find another explanation for the Fed’s strategy

World growth is weaker than everyone would like. The world looks more fragmented than before and no longer has the coordination and cooperation momentum we saw just a few years back during the period of globalization. In other words, the dynamics of our world are increasingly diverging and this leads to uncertainty and dents growth.

Meanwhile, there no longer seems to be a way to conduct coordinated fiscal policy worldwide, and stimulus initiatives undertaken in 2009 seem to belong to a very distant past. The US, China and Europe have very differing views on this issue, so we should not expect a worldwide economic stimulus program, despite the fact that it would probably provide strong and sustainable support for the economy.

Central banks are all applying very accommodative policy to avoid putting any limitations on the world economy

In light of this situation, central banks worldwide are all applying highly accommodative policies to make sure they do not put any limitations on the economy. The aim is not to spur economic growth at any cost: growth projections from the ECB and the Fed most definitely do not point to this. Rather the goal is to limit the risks on world growth, and the ECB, the Fed, the Bank of Brazil and several other emerging country central banks have taken up this strategy, which can help explain why the aspects dictating US monetary policy focus on external factors.

Waiting for impetus from fiscal or technological factors

The only problem here is that this joint effort is admittedly necessary, but collective impetus looks a bit like a last-chance strategy while waiting for fiscal or technological stimulus to change the situation on a long-term basis. So central banks’ interest rates are set to stay low for a very long time to come: in this respect, the ECB indicated that its leading rate would stay where it is for such times as inflation does not move towards 2% on a structural basis. This could take a very long time – much longer than anyone expects. The Fed still has some leeway as compared to the euro area, but this could narrow very quickly.
The central banks are giving governments time to come up with some answers, but they will not necessarily hold on for as long as many would like.


* This document was posted on LeGrandContinent website. Le Grand Continent is a French think-tank on the geopolitical backdrop See the original post here in French
[1] The degree to which an economy is open to outside factors is the ratio between half of the total of imports and exports to GDP

The Federal Reserve reduces its rate as expected

The Federal Reserve reduced its interest rate by 25 basis points. It is now moving in the 1.75 – 2.00% corridor. The median rate for 2019 remains at the current level, therefore no further rate cut is expected in December. The monetary policy stance would be stable for 2020 at the end of 2019 level The reference rate would go up (25 bp per year) in the 2.00-2.25% corridor in 2021 and 2.25-2.50% in 2022. The long-term trend in the fed funds rate would then be 2.5% as in June.

The Fed and it’s chairman,Jerome Powell in his press conference, recognize that the economy is going pretty well. The central bank has marginally revised upward its growth forecast for 2019 to 2.2% against 2.1%.

The logic of the US central bank is as follows: the economy is doing well but its international environment is degraded. The decline in productive investment has thus to be perceived as evidence of the negative consequences of this uncertainty on the cycle. It is to strengthen the internal dynamics against external hazards that the Fed is loosening its monetary policy. This approach is new since generally the central bank becomes more accommodative when the economic situation is frankly weaker than currently observed.
This framework also means that in the event of a higher overall uncertainty, the Fed may not respect the rate profile derived from expectations. That’s what Powell said. Trade uncertainty and weaker global growth may create the need for lower rates to support domestic demand.

The main concern with such an approach is that the indicators of US economic policy are already very accommodative while the economy is at the peak of the cycle. The public deficit is $ 1,000 billion over one year in August and the real fed funds rate is now almost 0%. What mode of regulation will it be necessary to put in place during the economic downturn that will not fail to happen? I anticipate a sharp slowdown in the second half of 2020. Will the public deficit rise to 6 or 7% of GDP and the Fed rate land in negative territory?

Finally, we note that the measure taken does not reflect an unanimous vote . James Bullard wanted to go further while Esther George and Eric Rosengren were in favor of the status quo. As with the ECB, the measures taken no longer succeed in silencing differences. Behaviors change because the diagnosis is not so uniform.

The ZEW remains weak in September

The ZEW measured as the average of its two components remains in very negative territory in September. Its reversal mentioned here and there is very relative. The expectation component is less degraded but remain at a low level. The current conditions component has trending downward for at least a year and September is not immune to this negative dynamic.
The pace of the ZEW still suggests that the GDP figure will still be in the red in the third quarter. The upturn in activity and the reversal of the trend in the fourth quarter are not yet clearly perceptible.