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
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.
Financial markets strongly value the possibility of a trade agreement between the United States and China. Such a situation would make it possible to reduce the constraints on global trade and to order them according to the framework defined by the agreement. Nothing would then stand in the way of the return of larger trade flows likely to bring global growth once again.
This idea is attractive because it would leave the area of concern that marks the global economy since last fall and for which we do not spontaneously see a way out.
Yet this possibility of an agreement seems to me to be totally illusory. Tensions between the US and China mainly reflect a problem of technological leadership. Which of these two countries will set the standard for developments like 5G or artificial intelligence or other technologies. Both countries are in fierce competition. I can’t imagine an agreement in which one of the two countries would agree to be subject to the developments of the other. Tensions between the two countries will remain strong even if minor agreements could be signed.
This will generate tension and volatility in the overall dynamics.
The end of the reduction of the Fed’s balance sheet is what we have to keep in mind after the publication of the minutes of the last FOMC meeting. It will take place during the second half of this year.
The US Central Bank does not want to be too constrained in the management of its monetary policy. The pace that was taken and the level targeted until then could add to the difficulty of the good calibrage of the monetary policy.
The Fed clearly does not want to be constrained in its choices because the global environment which is now more uncertain.
The way Yellen initiated the downsizing movement of the balance sheet was possibly compatible with a stable and predictable international environment. The arrival of Trump has created noise and spillover effects because of its policies. Now the Fed must take into account these noises and the risk of contagion which are attached to them.
The Fed does not yield to Trump by not raising rates, but it does not raise them in order to be able to intervene quickly to contain the negative effects of the policy pursued at the White House. She wants to be agile to limit risks. It’s well thought out.
With the decline of -0.9% in December, the industrial production of the Euro zone fell by -5.3% over the last quarter (annualized rate). and -2.1% over one year. The slowdown in world trade is an explanation that the European slowdown has itself accentuated.
There is now a more complete picture of industrial activity in 2018. The US is doing well, Japan is still very volatile but Europe is falling back quickly, lacking an internal dynamic capable of offsetting external shocks. We always fall back on this eternal question of coordinated dynamics to get better. Dependence on impulses from the rest of the world is now too important and this is very worrying
World trade, seen from developed countries, is now at risk. The average export orders (Markit) of the USA, Japan and Euro zone fall to 48.6. The braking action is terrible. If China slows further, the global economy will be stifled.