Macro Weekly – Goldilocks is back, but clouds are never far

by: Han de Jong

  • Stronger than expected growth so far this year everywhere
  • No signs of imminent slowing
  • Subdued inflation
  • But significant uncertainties easy to identify
170908-Macro-Weekly.pdf (133 KB)

Global economic growth is turning out stronger this year than anticipated at the start of the year. The positive surprise is widespread. Of the large economies it applies to the eurozone, Japan and China. The odd one out is the US where economic growth is developing as we had expected. However, our forecast earlier this year included an assumed stimulus from president Trump’s policy initiatives. That hasn’t happened. So it is fair to say that the US economy without stimulus is doing as well as what we had expected it to do with policy stimulus. Not bad!

Waiting for a slowdown?

Looking forward, we have, for some time, expected some moderation of growth in the main economies. This view has been based on a couple of considerations. First, economic growth in many countries has been above trend for a while; it would be only natural for growth to slow somewhat towards trend. We were expecting this to be underscored by the development of business confidence indices, which have a good track record of signalling the near-term direction of the business cycle. As many of these indicators reached multi-year highs earlier this year, we expected them to come down modestly. In addition, we were assuming that the important Chinese economy would decelerate somewhat, owing to the measures taken by the Chinese policymakers to slow credit growth. So far, however, these signs of moderation of global growth are refusing to appear.

Still going strong

Indeed, looking at recent indicators, little points at an imminent slowing of the various economies. The US ISM for the manufacturing sector surged to its highest level since 2011 in August. The European Commission’s ‘Economic Sentiment Index’ for the eurozone rose to its highest level in over 10 years in August. Recent PMIs in China also rose in August, against expectations. There is more evidence that the global economy, and manufacturing in particular, is holding up better than expected. Base metal prices have been very strong in recent months and logistics data are also strong. Given all this evidence, there is every reason to raise near-term growth forecasts. This then also feeds into 2018.

Subdued inflation

Meanwhile, inflation in the US has been more subdued than expected, a trend that has been relatively persistent for most of this year. This could still be a fluke and it is still possible that the tight labour market will soon lead to stronger wage gains pushing inflation higher. Higher oil prices since the middle of June may also push headline inflation up a little in the short term, while the weaker dollar can also add a little to US inflation. However, as I have long argued, I think there are more structural forces behind low US inflation and I would be surprised to see a significant and persistent rise in inflation.

Eurozone inflation has edged up a little this year, but is still below the ECB’s target. The stronger euro will keep a further lid on inflation and we think that some easing of inflation is likely in the months ahead.

Normalisation of monetary policy

Monetary policy is changing in a range of countries, but not all. The BoJ and the BoE, for example, are likely to keep policy unchanged for a while yet. The Fed stopped QE in 2014 and has raised rates 4 times since December 2015. In its projections the Fed published in June, the median view of the FOMC members was that they would raise rates four times between then and the end of 2018. But given sustained low inflation, this is now in doubt. In fact, players in financial markets never believed it. We expect the Fed to lower the number of expected rate hikes to perhaps only one or two between now and the end of 2018 at their meeting on 20 September. The Fed has also indicated it will reduce the amounts it reinvests from monies flowing in from maturing bonds in order to shorten their balance sheet. We expect them to go ahead with that plan, but they will be flexible if undesirable developments take place.

The ECB will announce its tapering plans at their October meeting. We expect them to emphasize the fact that tapering will be slow, cautious and flexible. At his most recent press conference, ECB president Draghi tried to talk down the euro, but he failed. Market participants understand that the ECB has no policy options to weaken the euro. This would require an easing of monetary policy, but that clearly is not going to happen.

Clouds are never far away

While the short-term outlook for the global economy, consisting of solid growth and low inflation can be labelled ‘goldilocks’, we must bear in mind that there are several significant uncertainties. The normalisation of monetary policy in the US and the eurozone, already mentioned above, is one of them.

China’s economic policy is another as it remains unclear how the efforts to reduce debt ratios will affect economic performance in the short term.

North Korea is also a possible headache. Recent nuclear tests suggest that the capabilities of North Korea in this field are much more advanced than many had thought. The actions of the North Korean leadership remain unpredictable. President Trump has indicated he wants to impose sanctions against countries that trade with North Korea. As 90% of North Korean trade is with China, president Trump appears to be threatening China with trade restrictions. Any escalation could trigger a trade war that would be hugely damaging to the global economy.

The debt ceiling discussion in the US is also something that can upset financial markets. Originally, the debt ceiling was likely to be hit this month. President Trump had said that he will not sign a bill raising the debt ceiling unless he gets money to build the wall between the US and Mexico. A stand-off would have led to a government shutdown. Given the emergency in Texas following hurricane Harvey, a government shutdown would be unacceptable and Congress and the president agreed to raise the debt ceiling by a small amount, pushing the real discussion out to December.

I notice that Europe hasn’t featured yet in this list of uncertainties, apart from the normalisation of monetary policy. However, the messy Brexit discussion and the approaching general elections in Italy could also upset financial markets.