Macro Weekly – Draghi’s lap of honour

by: Han de Jong

ECB President will undoubtedly express satisfaction with how things are going in the eurozone and claim success for his programme of quantitative easing. And fair play to him! While I still think that the programme was not really necessary as the economy was already improving, I suppose a bit of additional fuel to the fire cannot harm. In any case, the eurozone economy is on the right track.

Meanwhile, Fed chair Yellen has, so far, failed to push market expectations for official interest rates by the end of this year and next up, despite her efforts to explain that the first rate hike is close. Given how assertive she, and some of her colleagues, have been, one must assume that the Fed will, indeed, raise rates before too long.

Most eurozone data was positive

The eurozone economy has been improving since the second half of last year and that trend is continuing. Several economic indicators released during the last couple of days confirm this. The European Commission’s comprehensive index for overall confidence, its so called Economic Sentiment measure was stable in May, but clearly above its long-term average. The index was actually fractionally higher in March, but, apart from the March reading, one has to go back to early 2011 to find stronger sentiment. A similar message is borne out by the index of producer confidence in the Netherlands. Consumer confidence in Germany is even more impressive, at least according to the Gfk gauge. This measure, labelled for June, rose to the highest level I can find in my Bloomberg system where history goes back to 2005. Admitted, other measures of German consumer confidence are less jubilant.


Eurozone monetary statistics for April were also better than expected. M3 growth accelerated to 5.3%, from 4.9% in March. This was the strongest since 2008. The narrow aggregate M1 is actually a better indicator for economic activity. Its growth accelerated to 10.5%. That is high and M1 has been a reliable leading indicator for overall growth of the eurozone economy. So that is promising. Bank lending data contained in the monetary statistics was less strong, but it is clear that the credit cycle has made a decisive turn for the better.

Deflation fears also seem to ease further as Italian and Spanish inflation came in ahead of expectations. Spain’s HICP inflation amounted to -0.3% yoy in May, but that is up from -1.5% in January. Italy’s headline inflation ticked up to 0.2% yoy after the number had been negative in three of the previous five months.

Draghi will do a lap of honour

ECB president Mario Draghi will most likely claim credit for all this when he meets the press in a few days’ time following the ECB’s upcoming policy meeting. While I would want to begrudge him success, I think the economy was already on the mend long before the ECB started its large-scale asset purchasing programme. And I also think, and have argued in the past, that deflation risks are smaller than many believe. Frankly, that is not really all that relevant. The main point is that the economy is improving. Given where unemployment is and where inflation is relative to the ECB’s target, there is no doubt we need the economy to continue to grow and the ECB will certainly not consider ending its asset purchasing programme any time soon.

Greek saga approaching the end game

As an outsider, I have no idea what’s going on between Greek authorities and their partners discussing the financial situation of Greece. Nobody seems to know how much cash the Greeks have, but the end of it must be coming within sight. One must therefore assume that the end game is getting close. Mental games still seem to be the order of the day. The Greeks recently claimed that a deal was near. Their partners were quick to point out a deal was not exactly just around the corner. All this is understandable. Having created the impression that a deal is within reach, the Greek government will be able to blame the other side if things do not work out in the end. Perhaps they also tried to convince deposit holds to keep their money in Greece. On the other side of the negotiating table the game is to get as tough a deal as possible and declaring that a deal is near would weaken their hand. I still think that a deal will be reached, but it will go down to the wire and nobody seems to know when that is. I must admit that one cannot feel particularly confident of a good outcome.

Yellen trying to push market expectations: to little avail

Federal Reserve chair Jannet Yellen argued, once more, that a rate hike is coming closer and closer. It seems like a done deal that the first US rate hike in nine (!!) years will occur within a few months’ time. There still is a wide gap between the median forecast of where the Fed funds rate will be by the end of this year and next. Yellen presumably fears that if the Fed carries out what it now considers the most likely path of monetary policy, financial markets will be taken by surprise. If markets then have to adjust their expectations, the result could be a sharp increase in market volatility. By repeating her message time and time again, Yellen is probably hoping to shift expectations in the right direction so that such volatility can be avoided. Such volatility would include a sharp rise in bond yields. 1994 shows that such a development is not a walk in the park. More recently, the announcement by Ben Bernanke in May 2013 that the Fed might taper its asset purchasing programme led to a violent move of bond yields.

This pushed up mortgage interest rates, which had a very negative effect on the housing market. This can be seen clearly in the graph showing pending home sales the yield on the 10yr Treasury bond. Another rude disturbance of the housing market recovery would be most unwelcome.

The Fed chair has been remarkably unsuccessful on this front. Fed funds futures, for example, have hardly budged recently, showing that markets continue to price in official rates to be lower by the end of this year and next than the FOMC members are projecting.

Erratic data

Perhaps this is not surprising. Economic data in the US continues to be erratic. GDP growth for the first quarter was revised down from +0.2% to -0.7%, which was actually marginally better than feared. True, at this stage, the first quarter is ancient history and we all knew that the number would we revised down. What is more annoying is that the data has failed to show a comprehensive and compelling improvement recently. Durable goods orders for April were ahead of expectations, particularly if one considers the revisions to earlier published data. Capital goods orders for non-defence items, excluding aircraft, rose 1.0% mom in April while the march number was revised from -0.5% to +1.5%. Perhaps the weak spell of corporate investment spending is over. The recovery of the housing market seems to be continuing and house prices continue to tick up gradually.

On the side of disappointments, the Chicago PMI fell hard in May. The index fell dramatically in February and stayed low in March only to bounce relatively sharply in April, suggesting that the adverse weather over the winter had been left behind. But the May reading was a big disappointment and pushed the index materially below its long-term average.

We remain confident that the US economy will gain momentum in months to come. And despite the mixed data, we think the Fed will raise rates, most likely in September, as zero interest rates simply look odd against an economy in its sixth year of recovery after the last recession.