Macro Weekly – Regime shift

by: Han de Jong

  • Normalisation of monetary policy key uncertainty in period ahead
  • Odds of Trump not serving a full term are shortening
  • Stellar growth of the Dutch economy
Macro-Weekly-18-August-2017.pdf (114 KB)

The minutes of the most recent monetary-policy meetings of the US Federal Reserve and of the ECB show that central bankers are struggling with a number of nagging questions. They have both indicated that they want to normalise policy, or in the case of the Fed, that they want to further normalise policy.

The minutes of the ECB meeting show that policymakers are getting uncomfortable with the strength of the euro. That is not surprising. In the past they have shown anxiety at lower levels. The difference with the current situation is that the economy at large is now healthier as it is growing at a decent, above-trend pace. Nevertheless, the currency is an issue, and the ECB has itself to blame, at least partly. Mario Draghi’s comments at the conference in Sintra, Portugal, at the end of June gave the euro a material push. Before that conference, the euro was trading at around USD1.12 and had been at that level for a month and a half or so. Within a month the euro went up to USD 1.17. This was clearly one of the more unfortunate performances of the ECB president.

The ECB’s programme of asset purchases runs until the end of the year and the bank must soon inform financial markets (and the public) what happens after that. One must fear that an (expected) end to the programme will strengthen the euro further. That would imply a tightening of monetary conditions which is not particularly welcome. The ECB undoubtedly wishes to end its buying programme without that leading to a significant tightening of monetary conditions, let alone triggering a ‘tantrum’ in financial markets.

ECB flexible; will respond to a tantrum

I think we must expect two things from the ECB. First, they will try to convince markets that any steps they will take will be very slowly, gradual and cautious. Second, if markets react negatively to (the announcement of) the end of the QE programme, the ECB will respond. They could increase their verbal guidance or they could slow or even halt the tapering process. For now, we expect them soon to announce the start of the ECB tapering their purchases, starting in January 2018, by EUR 10 bn a month and to state that any increase in interest rates will have to wait at least until the QE-programme is fully finished. The risk here is that the ECB opts for a slower tapering process and they could even slow their purchases half way through the tapering if markets behave in an undesirable way.

Fed is confused and divided

US inflation has fallen short of expectations in five months running. This has triggered a debate, also within the Fed, about whether or not the traditional inflation models are still working. There is a possibility that this is just a coincidence and that inflation will reaccelerate again in the months ahead. However, as I have written here before, I think falling inflation is at least partly due to structural factors. The minutes of the Fed policy meeting show that an increasing number of members are starting to doubt the Fed’s own inflation forecast. This division makes policy more unpredictable. In their upcoming meeting, the Fed will surely announce when they will start reducing their balance sheet by lowering the amounts of reinvestments of the monies they receive from maturing bond holdings. But I would also expect the median forecast for likely number of rate hikes before the end of 2018 to be lower than at the previous meeting.

What the Fed and the ECB have in common is that they both want to prevent a market tantrum. Avoiding such a tantrum is more important to them that carrying out any normalisation of monetary policy exactly along the lines they may indicate.


The farce that is US politics is continuing at pace. No sooner had North Korea disappeared from the front pages or Charlottesville took its place. This is not good. The odds of President Trump not serving a full term have shortened for a while, but they must have got another push in recent days. What has caught the attention of the financial markets has been the response of Gary Cohn. Cohn is Trump’s key economic advisor, working on tax reform. He is also the most likely next chairman of the Federal Reserve after Jannet Yellen’s term is up next year. Cohn, who is Jewish, made it clear he did not agree with some of the President’s comments. If he were to leave his post, that would be a very serious setback for the prospects for tax reform and it would create new uncertainty around the future of the Fed. Stay tuned…

Macro data more of the same

Recently published macro data suggest that the global economy is still doing well. In the US, weak car sales and some softness in residential construction is not enough to make me concerned. There are also signs of particular strength. The Empire State index of business confidence in the state of New York rose sharply in August: 25.2, versus 9.8 in July.

Admitted, this is just a regional indicator and other such indicators were not so strong in August, but it is remarkable that the index reach a level normally associated with very strong growth. There must be something happening.

China growing or slowing?

The contribution by China to the current global upturn is hard to overestimate in my view. It is thus very important to follow closely what is happening there. After surprisingly strong data in June, the July data is less impressive. Retail sales growth slowed from 11.0% yoy in June to 10.4% in July, while growth of industrial production slowed from 7.6% to 6.4% yoy.

The positive is that if you take June and July together the growth rate is still higher than in the two previous months while the July number is also still higher than growth rates in 2015 and 2016. We expect a slowdown in the period ahead but nothing dramatic.

Growth explosion in the Netherlands

I might be a little biased, but without a shadow of a doubt, the most remarkable piece of economic data released in the eurozone in recent days was Dutch Q2 GDP. The Dutch economy grew 1.5% qoq, or some 6% annualised, not much lower than China’s growth rate!!!

My colleague Nico Klene commented on it after the data was published. Such a strong growth rate in a mature economy sounds like a fluke. And it probably is in the sense that it cannot be sustained. However, that Dutch growth is healthy was underscored by the underlying data. All sectors are making a contribution while inventories made only a small contribution. We cannot expect this growth rate to be maintained, but the growth rate for the year as a whole is set to exceed 3%. This should help the arithmetic of the budgetary plans of the yet-to-be formed new government.