> The Fed’s meeting (18) will be the important event of the week. We expect a 25bp drop in the Fed’s main rate and nothing on the balance sheet policy. The important point will be Powell’s explanation of this move at his press conference. In July, the main explanations of the 25 bp drop were external factors (trade, global growth). Will these elements remain the principal explanation ? What will be the new growth forecasts consistent with this new monetary policy stance ?
> The US industrial momentum (17) will be an important data as the ISM synthetic index for August dropped below the 50 threshold at 49.1. The consistency between the two indicators suggests that the industrial production index YoY change could go in negative territory. Will the industrial index follow this dynamics in August? The Empire state (16) and the PhilyFed (19) will give information on the economic situation in September
> The ZEW (17) in Germany for September will be key to anticipate the possibility of a German recession and therefore the possibility for a more proactive fiscal policy. Draghi, in his press conference last Thursday, said that a eurozone fiscal policy would be complementary to the ECB monetary policy to boost growth and inflation.
> Chinese number (16) will show how the economic policy efficiency of an arbitrage between an external negative shock and the necessity to feed the domestic demand to stabilize the economic activity. Industrial production was weak in July while retail sales were stronger than a few months ago. > Retail sales in the UK (19) in the midst of a political mayhem. What has been consumers’ behavior ? Have they increased their stocks to prevent the impact of a no deal Brexit ? > US housing market with Housing starts (18) and Existing home sales (19)? The market is quite stable. > In Brazil, the Selic will not be pushed down at the next monetary policy meeting (18) as the Brazilian central bank has had strong intervention on the forex market to limit the depreciation of the real.
> GDP figures for the second quarter in the US (29), Germany (27), Italy (30) and France (29) will give details on the composition of growth in all these countries, providing a better understanding of the current situation. This will be particularly important at this stage of the business cycle, notably because there are fears of recession in Germany and Italy.
> Many surveys on economic activity. IFO in Germany (26), climat des affaires in France (27) and Business confidence in Italy (28). Risk of a weaker index in Germany and in Italy after the political mayhem seen in August.
> Consumer confidence in the UK (30), one month after Boris Johnson has been appointed as prime minister. Consumer confidence in the US (August 27) will bring details on the labor market dynamics at a moment where the situation is changing in the US (Markit index for the manufacturing sector at 49.9 in August) > CPI figures in the Euro Area for August and in the US for July that will bolster central banks in their will to become more and more accommodative.
Trump’s tweets on May 5 fueled tension between China and the US, dramatically triggering
renewed speculation on the conditions of any fresh trade deal. China retaliated
to fresh US border tariffs on its goods by applying taxes to US imports. This
move interrupts a long period of calm that had kicked off after the G20 meeting
on December 1 (see my blog post dated February 21 2019 here)
Trump’s drive to apply fresh tariffs on China reflects his determination to
bring jobs back to the US – especially in the manufacturing sector – and also ease
the country’s dependence on China.
The country had a $419bn trade deficit with China in 2018 due to hefty imports
of goods into the US, while conversely American companies struggled to export
sufficiently to China. The chart above makes for a perfect illustration of this
tricky situation for the US.
The situation recently became a lot more challenging, as the flipside of this
Chinese trade surplus with the US was its financing for the US economy via US Treasuries
purchases in particular. This set-up worked for a long time and it acted as a
way for the two countries to remain tied together, as Chinese goods found a
market in the US while China financed the US economy to make up for Americans’
insufficient savings. The US-Chinese relationship was based on a complementary
approach, but this balance is shifting as China’s contribution to financing of the
US economy has been decreasing over the past several months. In March 2019, the
proportion of US financial assets held by China as part of the United States’ total
external financing returned to lows witnessed in June 2006.
The balance between the two countries is changing and the US can no longer have
the same influence on China that it had in the past. China is standing apart and
wants to achieve greater independence.
White House is also running out of patience with China taking its time to meet
its requests. By taxing Chinese imports, Washington is seeking to dent economic
activity in the country, and there is a danger that this will generate severe
social tension and force the Chinese government’s hand, as it did not want to
take this social risk. Sluggish Chinese economic indicators since the start of
the year could lend credence to Washington’s approach, and prompt it to take an
even harder line on trade, yet this approach is not necessarily the right one.
At the beginning of 2019, the weight of the United States in Chinese exports slowed down considerably. Chinese dependence on the US is reversing, while at the same time, the Chinese are relaunching the “Belt and Road Initiative” whose objective is to further diversify the Chinese market. China is expanding its markets and is effectively limiting the influence of the United States on its economy.
other major disagreement between Washington and Beijing is on technology, andin my view, this is
the main bone of contention between the two countries. China’s
technology has caught up very swiftly over the past twenty years via technology
transfers and by setting aside substantial resources to facilitate this fast progress.
This approach worked well, and China now has some headway over the US,
particularly in 5G and artificial intelligence.
The United States’ loss of technological supremacy is a radical change as China
has the resources to develop these technologies without US support. This kind
of situation could have emerged with Japan a few years ago, but Japan always
remained within the US sphere of influence… the same cannot be said of China.
The country has a huge domestic market, while development outside the country
is vast, so this can now generate self-sustaining technological momentum.
has been particularly tense on this issue over recent months, with sanctions against
ZTE in April 2018, and in particular against Huawei in December 2018 attesting
to this strain. European governments have also come under pressure to steer
clear of Chinese technology (read here). More recently, Donald Trump blacklisted Huawei
(read here – behind paywall), while other Chinese companies no
longer have access to the US market such as China Mobile (read here – article in French).
stakes are very straightforward – the country that decides the standards for
these new technologies will gain a massive competitive advantage and be able to
more easily develop innovations using these technologies. This is the stumbling
block for negotiations as China has invested substantial resources to notch up this
technological advantage and does not want to be dictated to by the US. Similarly,
it seems unthinkable that the US would spontaneously accept China’s progress
and be dictated to by the country in order to use its technologies.
technological battle of wills will not be resolved by itself. Neither country
is set to give in, so an agreement looks unlikely, unless the Chinese economy
takes a severe downturn, but this is not part of our scenario.
However, it does not stop there. Development of 5G for example is at the heart
of a number of innovations and countries outside China and the US are
developing businesses that use this technology. This means that developing
these innovations on a mass scale will probably require use of Chinese
technology, and this is set to trigger more tension with the US. Emmanuel
Macron has already made his position clear on this issue (see statement at the
Vivatech event here).
The dynamics of the world economy are changing, but the new world order is not
going to emerge straight away. This is the first time in history we have seen
this kind of situation, and the first time that the world economy could shift
towards a new region as a result of technological innovation. When the center
of gravity of the world economy shifted from the UK to the US, there was still
a degree of continuity, but the same cannot be said of today’s situation. And Europe
will also have to find its place in this new order.
This transformation will overturn the dynamics of the world economy and change
the entire balance between the various regions of the world.
What a fascinating time to observe world events.
I follow this graphic step by step. The change in trend on the Jolts’ survey reflects that found in the Conference Board survey. The job market may be changing in the United States. You must have that in mind.
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 US Federal Reserve decided to bring its monetary policy normalization to an end during its meetings on January 29 and 30, 2019. The interest rate hike cycle had kicked off slowly in December 2015 and stepped up a pace a year later, as nine interest rate hikes pushed the Fed Funds rate up from 0.25% (upper end of range) to 2.5% in December 2018. During last week’s press conference, the Fed Chair indicated that Fed Funds are now in the range of neutral, in response to the first question from journalists: there is no longer an accommodative or a tightening slant. Powell’s confidence in the strength of the US economy suggests that the end to normalization should not just be seen as hitting the pause button for a while.
The rate hike cycle has been long and slow-moving if we compare to the Fed’s previous series of tightening moves from 2004 for example. A comparison with this period also reveals that real interest rates on Fed funds were much higher then than they are now. The figure is currently marginally above the level witnessed at the start of the normalization process in December 2015, unlike the situation after 2004, when the economy was much more restricted, while this is not the case in the current economic situation.
A comparison of current real interest rates with previous phases of monetary tightening shows that today’s situation is completely different to these episodes. Real interest rates in November 2018 stood at around 0.4% (inflation figures for December are not yet available on the PCE index), which is much lower than figures in 2006, 1999 or 1990. Does this mean that the US economy is too weak to be able to deal with a real rate above 1%? This would be extremely worrying and would undermine Jerome Powell’s comments that the US economy is in a good place.
It is difficult to understand why
US normalization is coming to an end when we look at the economy, as unemployment
is near its low, so the central bank should be tightening the reins. The Fed’s
projections for 2019 and 2020 are for figures above the country’s potential
growth rate and this also fits with the economists’ consensus, at least for 2019.
Against this backdrop, monetary policy needs to be tighter to ensure that
growth does not create imbalances that then have to be addressed, and this was the
message from Powell in 2018, when he suggested that fiscal policy (too
aggressive for an economy running on full employment) would need to be offset
by tighter monetary policy to rebalance the policy mix. During the press conference
on Wednesday January 30, he did not raise this question: the issue was side-stepped,
but yet the analysis still remains the same. There are only two possible
economic explanations for the halt to normalization: either there are
expectations of a severe downgrade to projections when they are updated in
March, but this would not be consistent with Powell’s comments; or the Fed is
doing whatever it takes to extend the economic cycle at any cost, with the end
to the rate hike cycle aimed at cutting back mortgage rates and taking the
pressure off the real estate market. However, with the overall economy
remaining robust, the risk of this type of move is that it could lead to imbalances
that would be difficult to eliminate. This is the opposite approach to the Fed’s
strategy right throughout 2018, so it would be a strange tactic.
ISM index dropped: a healthy adjustment. In the USA, the fall of the ISM may reflect a return to a more normal situation? For many months, this indicator for the manufacturing sector was well above the CFNAI index which is a measure of 85 indicators of the economic activity (prepared by the Chicago Fed). This situation, which has been a regular occurrence since 2004, always ends with a sharp and brutal adjustment of the ISM to the CFNAI. The adjustment always takes place in this direction. Finally, the overly optimistic expectations contained in the ISM index adjust to the “real economy” which does not present excessive optimism. This adjustment is rather healthy.