Macro Weekly – Who will chase Goldilocks away?

by: Han de Jong

  • 2017 has been a Goldilock’s year…
  • …but will she be chased away in 2018?
  • Hurricanes have obscured the view on US inflation…
  • but recent numbers do not raise concern.
171117-Macro-Weekly-1.pdf (79 KB)

This year has so far been quite remarkable. It has been a real Goldilocks year. Global economic growth has been stronger than expected, it has been above trend and it has been synchronised. What more would you want? Well, actually, what we would really want is for this growth to coincide with low inflation. And that is exactly what we have got so far this year. Above-trend, higher than expected growth, declining core inflation in the US and Europe, cautious central banks, no policy mistakes and no geo-political disasters. This is as good as it gets!

Equity markets have done very well in this Goldilocks environment. But bonds have not, leaving balanced portfolios generally with positive, but unspectacular returns. It is hard to see bonds provide much better returns any time soon. Yet, it is also hard to see equities repeating their performance of the last 12 months during the next 12 months. A significant deterioration of underlying economic fundaments could actually lead to a rude awakening.

The inflation risk

One of the bigger risks to the Goldilocks world is a rise in inflation beyond what should be expected. Such a sharper than expected rise in inflation would force central banks to tighten, pushing interest up and forcing growth down. This would quickly translate into a double hit to equities: earnings will be hit by lower growth while higher interest rates will push valuation down.

Our view has, for some time, been that inflation will remain modest in the medium term due to a variety of factors. Technology is one of them and global excess capacity another. We have also been counting on an improvement of productivity growth in the US. That has worked out reasonably well this year. Stronger productivity growth puts a lid on unit labour costs, which can be a key driver of inflation.

Headline inflation should be expected to move higher in most economies as oil prices and prices for other commodities grind higher. Narrowing output gaps should also lead to upward pressure on inflation. US inflation is particularly low. Economists are involved in debates about the Phillips curve, which reflects the relationship between unemployment and inflation. The idea is that low and falling unemployment puts upward pressure on wages which will push up inflation. But that is not what has happened in the US in recent years. Unemployment has fallen without triggering much stronger wage increases and core inflation has fallen unexpectedly in the course of this year.

The October US inflation numbers do not give any reason to change our view. The hurricanes have distorted many macro series in the US, including inflation. Headline inflation was 0.1% mom in October, after 0.5% September and 0.4% in August. Core inflation was 0.2% mom, pushing the yoy rate up from 1.7% to 1.8%.


Other US data generally confirmed solid growth. Housing starts were robust in October after a somewhat weaker period. Retail sales were firm in October also and industrial production as well. Industrial output advanced 0.9% mom in October after 0.4% in September. Manufacturing production grew even more impressively: 1.3% mom in October. The next couple of months will show to what extent these numbers have been flattered by some bounce following the hurricanes. On the face of them, they look consistent with confidence indices and with the global trend.

Eurozone industrial production was weaker in September, falling 0.6% mom, but this was after growing 1.4% mom in August. On a yoy basis, eurozone industrial output growth is still ahead of the US.

Various US confidence indices showed a somewhat mixed picture. General business confidence indices were off from recent peaks. This is true for the Philly Fed index as well as the Empire State survey. But confidence among small and medium-sized companies as well as home builders’ confidence edged up in the most recent reading.

Europe and China

The data flow in Europe and Asia has been quite light recently. Eurozone GDP growth amounted to 0.6% qoq in Q3 and 2.5% yoy. This is well above trend. German GDP growth was particularly strong, 0.8% qoq while French and Italian growth amounted to a satisfactory 0.5% qoq in both countries. The Netherlands registered a more modest 0.4% qoq growth rate, but this followed an amazing 1.5% yoy. Q3 yoy growth was 3.0% in the Netherlands. As growth is continuing above trend, unemployment in the Netherlands keeps falling: to 4.5% in October. Retails sales growth accelerated in the Netherlands, to 6.6% in October, up from 5.4% in September.

Finally, Chinese data universally showed moderating growth as industrial production growth as well as retail sales growth showed a modest deceleration.

Tax reform in the US

The US House of Representatives passed a tax overhaul bill. This bill includes significant tax changes to the tax code and would undoubtedly provide some stimulus to the economy in the short term as well as the medium term, although the budget deficit would suffer. However, the game isn’t over yet. The Senate are discussing their own tax reform bill. Adoption of the bill in the Senate is a close call. Even if the Senate approves the bill, the two bills will have been merged. Nevertheless, the Republicans have not managed to come this close to significant tax overhaul in a long time.