Macro Weekly – How far can this go?

by: Han de Jong

  • Confidence indices for the manufacturing sector continue to rise
  • This is corroborated by trade data in Asia
  • Fed sticking to its guns, but the inflation conundrum remains
170922-Macro-Weekly.pdf (118 KB)

An optimist like me is always looking for positive economic signals that confirm an optimistic view, in this case on the short-term outlook for the global economy. This year has been good to me. The synchronised global recovery has gained strength and forecasts for economic growth have been raised in the course of the year. All of this was signalled by the stellar rise in business confidence indices that started around the middle of last year. As these indices moved higher and higher, even an optimist like me started to wonder about when they would turn and how fast they might fall. And, truth be told, some of these indices have reached highs in past months that are not often exceeded. Therefore, I thought they might turn and move lower, though not very fast.

The amazing PMIs

Looking at recent data, it looks to me as though that isn’t happening. For what it is worth, the preliminary Markit PMI data for the eurozone and for a few individual key eurozone economies suggest that growth momentum in the manufacturing sector of the economy isn’t easing at all, quite the opposite. Of course, we can have a debate about a gap between confidence indices and the so called hard data such as industrial output and GDP. Many economists think that the hard data is more relevant. I am not so sure, in fact, I disagree. The confidence indices started to improve around the middle of last year in many countries. The hard data was slow to follow, but that eventually happened. I think the message is that the soft data can signal what is likely to happen next, particularly if these confidence indices are so consistent in many countries.

The Markit PMI for the manufacturing sector in Germany was reported on a preliminary basis as 60.6 in September, up from 59.3. The last time this index reached such a level was in 2011, just before the euro crisis pushed the eurozone economy in recession. The growth rate of the German economy was then over 3%! I am not saying that is where we are heading, but it is at least remarkable. The same gauge for France also rose in September, though not as much as in Germany.

The US Markit PMI-manufacturing for September was also a touch higher than in August, 53.0 versus 52.8, but the rise here is less compelling. Nevertheless, even the US data contributes to the view that momentum is not weakening but strengthening.

Supportive trade data in Asia

The question then is whether this is just a fluke, soon to be reversed or if evidence can be found elsewhere supporting the message from these indices that momentum in the manufacturing sector is still gaining strength. Taiwan, a good gauge for the health of global trade, released data on export orders for August recently. They were up 7.5% yoy. That was down from 10.5% in July and 13.0% in June. Nevertheless, Taiwanese export growth numbers have benefitted in the first half of the year from a base effect. As export orders were very weak in the first half of 2016, the yoy-comparison was made easy. The first time export orders were up yoy in 2016 was in August. So the friendly base effect is now over. Taking that into account, I think the August 2017 data is not bad at all.

South Korea is another economy heavily dependent on the international trade cycle, which is obviously strongly related to the manufacturing sector. It published export and import data for the first 20 days of September recently. They were unambiguously strong. Exports were up 31.1% yoy, after 11.6% in August, while imports grew by 23.9% against 11.2% in August. These numbers were flattered by the number of trading days, but even adjusting for that factor, one cannot escape the conclusion that this data is strong.

Japan’s trade data for August is also showing strength. Japanese exports were up 18.1% yoy (up from 13.4% and the highest growth rate since 2013), while imports gained 15.2%, slightly lower than July’s 17.3%.

It isn’t exactly scientific evidence, but the combination of the PMIs, and the trade data in some Asian countries suggests that global momentum in manufacturing is at least being maintained. That is a big positive for the global economy.

Fed sticking to their guns

My colleague Nick Kounis commented on the US Fed’s decisions and communications following their most recent policy meeting. The FOMC did not change the ‘dot plot’, meaning that the median of their projections is still suggesting one more hike this year and three next year. We changed our view recently and now believe that there will not be a rate hike before Christmas and only two next year. Nick highlighted that the ‘dot plot’ does not distinguish between voting and non-voting members and that the voting members may be a little more dovish that the total. Nevertheless, it is fair to say that the chance that the Fed will hike once more before the end of the year is significant.

The key uncertainty in this equation is what will happen to inflation and, even more important, how the Fed will weigh that. I have long had the belief that the US economy is characterised by strong disinflationary forces. That is not to say that, in my view, inflation will certainly ease further in the months ahead. Higher oil prices, the lower dollar and the tight labour market may push inflation up in the months ahead. But longer term, I think the Fed will find it difficult to achieve its inflation target. And there is at least a possibility that the data of the months ahead will bear that out already. The question is how the Fed should weigh that. In my opinion, the Fed should not desperately stick to its inflation target. If they do that, they are likely to keep monetary policy too easy. But the Fed should take the longer-term outlook for low inflation into account and realise that in such an environment interest rates need not to rise as much as in a situation in which inflation returns no historically more normal levels.