Macro Weekly – Easy does it

by: Han de Jong

Big Picture - 22 September 2014 - Easy does it.pdf ()

Last week was a big one. The Federal Reserve managed to guide rate expectations up a little without any tantrum in the markets. European banks took up less TLTRO money than expected and the Scots voted to stay in the UK. Less noticed, perhaps, Chinese policymakers informally announced some stimulus measures in response to weakening data and the Celtic Tiger seems to be waking up.

Comfortable Yellen

From a global markets perspective, last week’s FOMC meeting was, arguably, the most important agenda item. Financial markets are pricing in a path of monetary tightening by the Fed that is, in our view, underestimating when and by how much the Fed will, when the time comes, raise official interest rates. So Fed chair Yellen’s challenge is to guide market expectations higher, but to do it in a way that does not lead to a significant rise in volatility and nervousness in markets. When Ben Bernanke mentioned tapering last year, bond yields rose very sharply, upsetting markets for risky assets. Yellen did a great job last week. She was balanced and calm and she expressed what must be the average opinion on the FOMC. Two members dissented. The Fed adjusted its own expectations for interest rates (upwards). Short-term interest rate expectations implied by futures market edged up, while the Treasury market stayed very calm and yields rose very modestly at shorter maturities, but very little, if at all, in the longer part of the yield curve. Having said that, the battle has not been won yet. There still is a gap between Fed forecasts for rates and market expectations, with the latter trailing behind. We think markets are underestimating the degree and the timing of Fed rate hikes, but are hopeful that the inevitable adjustment will not lead to market upheaval. We continue to look for a first rate hike in June next year. That is still a long way away.

Economic data confirming our long-held views

We have argued for some time that the US economic recovery would broaden and strengthen in the course of the year. Recent data is supportive of that view. We have also argued that the eurozone had hit a soft patch but would not slide back into contraction. The jury is still out on that one, but Dutch and Irish data last week were welcome. Another view we have is that a scenario with US inflation rising and the eurozone falling into deflation at the same time is extremely unlikely. Last week’s data is supportive of the view that neither accelerating inflation, nor deflation is of particular concern in the near term. Finally we have had the view that should Chinese economic growth threaten to weaken below the authorities’ comfort level, they will take targeted stimulus measures. That view, too, seems to be correct.

Last week’s US economic data was very supportive of our conviction that the recovery will gain momentum and become broader. Business confidence measures show that confidence is strong. True, the Philly Fed index eased a little in September, but look at the trends in the Philly Fed and the Empire State index! And look at the absolute level of these indices compared to their recent history. Industrial production disappointed in August. Output was down 0.1% mom and manufacturing production was even down 0.4% mom. But this followed a rise of 0.7% in July and the yoy rate for total industrial production still stood at 4.1% yoy (down from 4.8% in July). Housing starts were also weak in August, falling 14.4% mom. Here too, this followed a strong July: +22.9%. Judging by the jobless claims data last week, the US labour market continues to strengthen: claims were down to 280,000, the second lowest since 2000.

140919 - US indices.

140919 - Homebuilders

Last week did not produce a lot of eurozone economic data. The ZEW index of confidence in the economy on the part of financial market analysts weakened further in September. The gauge for Germany has fallen in eight consecutive months and has now also fallen below long-term averages. At least de drop in September was very modest. I expect this downward trend to trough before too long. Data in two other eurozone economies was more upbeat. Dutch unemployment fell to 8.0% in August, the sixth consecutive monthly decline. This improvement is genuine as the decline in the unemployment rate is not (only) caused by people leaving the labour force but also by actual jobs being created. Dutch consumer spending rose 0.5% yoy in July. That does not sound very exciting, but it was the strongest reading since 2011. Irish GDP data trumped everything last week. The Irish economy expanded at a decent 1.5% rate qoq in Q2, following growth of 2.8% qoq in Q1. This lifted the yoy rate to no less than 7.7%. These are Celtic-tiger-like growth levels. Irish GDP data can be extremely volatile and can be revised significantly, but other indicators support the view that the recovery is strong. Clearly, this is also very favourable for debt-ratio numbers.

Chinese data for August was weak. Industrial production growth, in particular, decelerated sharply: 6.9% yoy, down from 9.0% in July. The August reading was the weakest since late 2008. It must be said however, that the drop in the growth rate was so pronounced that either something really bad happened in the economy or this is a statistical aberration. Having said that, even if it is an aberration, the trend in growth is clearly down. Consumption growth has also been on a slowing trajectory. The upside is that commodity prices are weakening. The softer data seems to have triggered a response from policymakers. They appear to have taken some, albeit modest, actions to support credit growth. While the growth rate may undershoot the authorities’ target this year, we do not believe they will allow growth to fall below their comfort level by too much or for too long. So if recent measures turn out insufficient, we think more measures are likely.

140919 - China


Commentators have been warning for accelerating inflation in the US and deflation in the eurozone. It would be extremely unusual for both developments to occur at the same time. Last week’s data provides some comfort on both sides. US headline and core inflation eased in August. Both measures stood at +1.7% yoy, easily within the Fed’s comfort zone. The eurozone’s inflation rate for August was revised up to 0.4% (from 0.3%). This is still well below the ECB’s target and it still justifies more policy accommodation by the ECB. Labour costs are an important driver of inflation. The rise in eurozone labour costs accelerated from 0.6% yoy in Q1 to 1.2% in Q2. Deflation will not occur if this trend can be maintained. Hopefully, the stronger rise in labour costs is a reflection of the modest improvement in labour market conditions in many countries.


Eurozone banks only borrowed EUR82.6 bn in the first TLTRO. This was less than expected. Many market economists had expected something around EUR 150 bn. Our expectation had been below that of most others, but even our guestimate of EUR 100 bn was undershot somewhat. This does not worry me. We always thought the first tender would not attract that much demand and we continue to expect a bigger uptake in December as banks are then much closer to having to pay back the LTRO money they borrowed three years ago.

No to Scottish independence

In the end, the ‘No camp’ in the Scottish referendum won with a comfortable majority. Lots has been said and written about this. Let me just add some comments about an aspect that does not get a lot of attention: the impact this may have on UK membership of the EU. The UK’s prime minister, David Cameron, has promised the electorate a referendum on the UK’s EU membership during a possible next term for his government. Enthusiasm for EU membership is bigger in Scotland than in England. So last week’s no vote makes a UK departure from the EU a little less likely. In fact, my guess would be that the Scots will vote overwhelmingly in favour of EU membership. They have now reconfirmed their ties with the rest of the UK and they probably will want that relationship to be part of something bigger. And perhaps, but I am speculating here, the decision to stay together may also have a positive influence on the English, Welsh and Northern Irish electorate’s desire to stay together in Europe when (or if) the other referendum comes.