Macro Weekly – Divergence, here it comes

by: Han de Jong

Macro-Weekly-13-November-2015-corrected-table.pdf (93 KB)

It is some 20 years ago since the US Federal Reserve and the key European central bank moved monetary policy in opposite directions. But December promises to be the month when that happens again. Because it is rare and not so easy to read the consequences, such a development will lead to additional uncertainty among financial market participants and may contribute to volatility. Continued pressure on oil and other commodity prices does not help.

Mixed data

Last week’s crop of macroeconomic data was unexciting. Arguably, the most positive ones came from China. Retail sales growth accelerated a fraction in October, from 10.9% yoy to 11.0%. Money growth data for China was encouraging. M1 growth quickened for the sixth time in seven months, amounting to 14.0% (up from 11.4% in September), while M2 growth registered 13.5%, against 13.1% in September. On the negative side, Chinese industrial production growth eased another notch: 5.6% yoy, versus 5.7% in the previous month. In addition, despite accelerated money growth, total new loans disappointed. Of anecdotal value are the record breaking sales on ‘Singles’ Day’, though we will have to wait to what extent these sales will affect November retail sales. They should, really…

151113 Graph1

Eurozone GDP disappointed marginally in Q3, growing 0.3% qoq, slower than in the previous three quarters. The yoy growth rate inched up, nevertheless, to 1.6%, the highest growth rate in over four years. Eurozone industrial production contracted in September, by 0.3% mom, following a 0.4% fall in August. On a yoy basis, growth remained positive, but eased to 1.7% from 2.2% in August.

151113 Graph2

US data did not provide a lot of clarity about where the economy is heading. The labour market seems to be doing well. Initial jobless claims stabilised at 276,000 last week and other labour market indicators were positive. On the other hand, the retail sales report for October was softer than anticipated. Consumer confidence strengthened in November, according to the preliminary reading of the University of Michigan’s index. This was stronger than expected and suggests that consumer demand will continue to grow at a decent clip.

All this is consistent with the narrative that has developed in recent months: lacklustre global growth with particular weakness in the industrial sector.

ECB committed to step up its stimulation

ECB president Mario Draghi confirmed his commitment to take additional measures to boost the eurozone economy and to bring inflation back to the ECB’s target when he addressed the European parliament. Bear in mind that Mr Draghi does not tend to disappoint on such promises. And given continued undershooting of the inflation target and downside risks to the recovery coming from the international environment, one can understand where Draghi is coming from.

Still, Draghi’s explicit commitment to further action is interesting as market participants have recently become more convinced that the US Federal Reserve will actually move in the opposite direction before too long. US monetary tightening may push the dollar up and the euro down. As that is something Mr Draghi is also interested it and possibly hoping to achieve by his additional measures, Draghi might have been expected to back down a little on further stimulus plans. He did not.

The last time the policies of these two key central banks diverged was in the 1990s. At that time, the business cycles of the respective economies had diverged due to the shock to the European economy from German unification. The current situation is different, though one could say that the eurozone business cycle is lagging the US cycle significantly due to the euro crisis. On balance, diverging monetary policy must be considered highly unusual and it is hard to gauge what the consequences will be, adding to uncertainty.

Finding a compromise

With a small number of exceptions, the ECB has recently spoken with one tongue: Mario Draghi’s. Lack of uniformity of view is much more explicit at the US Federal Reserve. But a more consistent message is becoming clear. The doves on the FOMC appear to be giving in to the hawks.

`2Fed officials have said many times that they are data dependent. I think they also depend on something else. They do not want to deliver unpleasant surprises to potentially unstable financial markets. As a consequence, they can only raise interest rates when a majority of financial market participants is expecting it. Until recently, the Fed had tried to convince markets that the first rate hike was imminent, but had failed to do so. That has now changed. The strong October labour market data and the more assertive talk by Fed officials of a rate hike has convinced many market participants that rates will go up at the Fed’s next meeting in December. Unless upcoming data or market volatility changes all that again, the Fed would be unwise not to raise rates in December. However, as the doves are pointing out, it would also be wise to explain to the market that this process of monetary tightening will be one of the slowest if not the slowest on record. Much will depend on how the global economy will evolve in the course of 2016 and beyond, the stability of financial markets and how the exchange rate moves against the background of diverging monetary policy.