Macro Weekly – Divergence in the global economy?

by: Han de Jong

  • Europa, China and Japan looking encouraging
  • US diverging briefly – most likely noise
  • Central bankers communication leading to confusion
  • Low inflation persisting
Macro-Weekly-30-June-2017.pdf (150 KB)

Recent moves on equity markets appear to suggest that economic problems are brewing. If they are, it is very much below the surface. Half way through the year the global economy is looking encouraging to me. Although… an unusual divergence appears to be opening up between the US on the one hand and the rest of the world on the other. That cannot last.

European economic data continues to be firm, Japan is strengthening and the expected slowdown in China seems very modest. The US economy is the only key economy showing regular disappointments recently. Unfortunately, the US is the key economy of the key economies. However, as the US is the odd one out and I cannot see what should cause a serious weakening of US economic activity, my conclusion is that recent weakness there is mostly noise, likely to be reversed in the months ahead.

Inflation, meanwhile, continues to be very low. There is every reason to debate the inflation outlook for the next couple of years. My personal view is that structural changes in the economy, in particular technology, related changes in the dynamics of markets and changing dynamics on labour markets will keep a lid on inflation for an extended period of time. This will make it difficult for central banks to achieve their inflation goals. Their challenge will be how to react. I must admit that this is not a majority view and even in my own team, there is not a lot of support for this view.

Recent communication from Mark Carney and Mario Draghi appears to suggest they are also confused.

Eurozone continues to show strength

Business confidence indicators in the eurozone continue to impress. The European Commission’s gauge of Economic Confidence rose again in June more than reversing May’s little drop. I have chosen to show this indicator on a graph (overleaf) with a very long history in order to put its current strength in perspective. Since 1985 there have only been four periods when the index was higher. The first period, at the end of the 1980s, coincided with German unification. The two strong periods around the turn of the century were related to the tech-bubble. The last time this indicator was above current levels was shortly before the credit crisis erupted. So perhaps it is justified to say that the strength of the index then was related to the building to the credit bubble. What is happening now to this index is unusual and during the previous times current levels were reached or exceeded there were clear factors responsible (German unification, the tech-bubble and the credit-bubble). This begs the question if the current upswing is also driven by something that is completely unsustainable. It may be, but I do not see it. I think what we are seeing is genuine strength after a period of significant difficulties for eurozone countries.

Other data in the eurozone is also positive. Take French consumer confidence. Sure, the Macron victories in the presidential and parliamentary elections may have provided a temporary boost to consumer confidence, but this measure has strengthened consistently for some time and has also reached a level that is high in comparison to its history, the highest in some 15 years.

Business confidence in Germany, measured by the Ifo-index improved further in June and Dutch producer confidence also rose in June, though it did not fully reverse the May drop.

Japan and China also firm

Elsewhere, Japan’s economy is strengthening. Industrial production was up 6.8% yoy in May, after 5.7% in April. The Japanese labour market continues to tighten. The job-to-applicant ratio continues to edge higher and it hasn’t been as high as it currently is since the 1970s.

Not all Asian data recently released has been strong. Korean industrial production growth slowed to 0.1% yoy in May and business surveys are also showing some weakening. But the most crucial economy in Asia beside Japan, China, is holding up better than expected. Chinese authorities are trying to address problems related to potential financial instability. In trying to curb lending and encouraging some deleveraging, they are risking a slowdown of the economy. If they step on the brakes too strongly, they risk causing a material slowing of their economy which would feed into weakness elsewhere. At least for now, that is not happening. The national indices of business confidence improved in June. The index for the manufacturing sector suggests that the sector is doing well. At 51.7 in June, the index has almost entirely reversed weakness in the previous two months and it is actually at a higher level than the average for the last five years. The non-manufacturing indicator rose for the second month in a row in June and was also above its average of the last five years. So it would seem that the slowdown in China is very modest at worst, which is positive for the rest of the global economy.

The odd one out

The US is the odd one out. Recent months have produced a number of indicators falling short of expectations. In recent days, durable goods orders were unimpressive. The long-term graph below on capital goods orders, non-defence, ex aircraft shows that there has been an improvement since the middle of 2016, but it is not very strong. In addition, the graph shows that the rise has lost momentum. Given how corporate profits have developed, the rise in orders for capital goods, a proxy for corporate investment, is disappointing. It is not clear what is causing this. It could simply be that companies are reluctant to invest. But it could also be that the data is actually underestimating what is really happening. The series I am showing in the graph is in nominal dollars. Capital goods generally have a tendency to drop in price. This would hold back the overall numbers. In addition, the energy sector may be over-represented. Energy is a capital intensive industry and the current level of energy prices may simply hold back investment, but this may not be representative for what is happening throughout the rest of the economy.

The Chicago Fed’s national activity index (which comprises no less than 85 economic series) reached its highest level since early 2014 in April. However, it dropped sharply in May, reflecting the mixed nature of recent economic data in the US.

On the other hand, some recently published US data was actually strong The Conference Board reported an unexpected rise in June. It wasn’t a strong rise, but it followed two months of decline.

Personal income rose 0.4% mom in May, after +0.3% in April. Disposable personal income rose 0.5% and because prices actually fell on the month, real disposable income rose a very solid 0.6% mom in May. In the first five months of the year real personal disposable income has risen by an annualised rate of some 3.8%. That is serious stuff and not exactly a situation to expect a material downturn in the economy. Having said that, spending was weaker. Personal spending rose only 0.1% and during the first five months of the year, real personal consumption expenditures grew at an annualised rate of around 1%. As income has risen faster than spending, the savings rate has risen: 5.5% in May, versus 4.5%. This will allow spending to rise faster than income some time in the future.

The Chicago PMI, measuring business confidence in the Chicago area, which is economically important, rose to 65.7 in June, from 59.4 in May. During the last 20 years, this index has been higher only a handful of times. This is impressive and completely inconsistent with the notion that a material downturn is occurring or likely to occur in the short term in the US. My conclusion thus remains that recent weakness in a variety of US indicators is mainly noise.

Confusing or confused central bankers?

Central bankers have recently confused markets. After the last policy meeting of the US Fed, chair Yellen argued that low inflation was transitory. Market participants seem to think that the Fed is missing the message from recent weak inflation numbers and bond yields sagged immediately after her press conference.

The Bank of England’s Mark Carney had sounded very relaxed about the relatively high inflation in the UK after their last policy meeting, although the three of the four external members on the MPC had wanted to raise rates at that meeting. Subsequently, Carney suggested that an early rate hike might be on the cards.

The ECB’s Mario Draghi had sounded more dovish than we had expected at his press conference following the June meeting of the Governing Council. In a recent speech in Portugal, he seemed to follow a more hawkish line of argument. ECB officials, apparently, tried to convince markets afterwards that Draghi had not intended to be hawkish. In our view, what he said in Portugal made perfect sense: the economy is doing well, deflation risks have abated and any ‘normalisation’ of monetary policy will be very gradual.

The real inflation debate

The real debate has to be about inflation. Eurozone inflation has been somewhat erratic recently. Headline inflation eased in June to 1.3%, but core inflation accelerated to 1.1%, up from 0.9% in May. The latter does not reflect an actual increase in inflationary pressures. It would appear that German package holidays were the culprit, but this is likely to be reversed next month. The key question really is why inflation is still so low why wage increases are so low. The answer is that the slack in the eurozone economy is still significant. And after years of stagnating wages and risks of unemployment, employees may assume there is no point in demanding higher wages. Perhaps more important is that labour-market reform has made this market more flexible. A tightening of market conditions will therefore result in a stronger response on the supply side than previously. The impact on wages is less as a necessary consequence.

The personal income and spending report in the US also contained important information about inflation. The Fed’s preferred inflation gauge is ‘core PCE’. Measured on this basis, inflation decelerated further in May: 1.4% yoy, down from 1.5% in April and 1.8% in January. The disinflationary forces were obvious in the report. Deflation of goods prices intensified. If this trend continues, the Fed will take note.


I will be travelling for work and subsequently on holidays for the next three weeks. Regular services resumes on Friday 28 July 2017.