Macro Weekly – Draghi must be clear

by: Han de Jong

  • Draghi likely to try and ease fears for early policy reversal
  • PPIs are moving sideways all over the place
  • Don’t worry (too much) about a US government shutdown
180119-Macro-Weekly.pdf (147 KB)

Bond market participants have focussed on the reversal of monetary policy this year. The view on the likely actions of the ECB has been a particular point of interest recently. In fact, markets have changed their view on the likely actions of the ECB, bringing forward the first rate hike in their projections. While it is inevitable that the ECB will end its purchase programme and raise interest rates, it is unlikely they want to see sharp movements in markets. Following the ECB’s policy meeting on Thursday, ECB President Draghi will most likely try to convey to markets that the ECB will change course only gradually and will be alert to respond to any adverse developments should they occur. If he is successful, the euro’s rally should stop (and reverse somewhat?) as should the rise in government bond yields.

Inflation expectations

One of the key things to watch in 2018, globally, is inflation. If inflation rises more than expected, particularly in the US, the Fed may need to tighten more and more quickly than currently anticipated. This is a threat to markets for risky assets. US inflation expectations as indicated by the Fed’s Five-year Forward Breakeven Inflation Rate have risen 20bp since early December after having stuck to a 10bp trading range for 5 consecutive months. It is not entirely clear what is driving this rise. The equivalent for the eurozone shows that inflation expectations there have moved only a handful of basis points. Rising oil prices usually push up inflation expectations, but it would appear that the US tax reform is also playing a role.

We have argued for some time that a deceleration of unit wage costs is probably a main driver behind weak US inflation. That is not going to change any time soon. Looking at inflation at the producer level and looking at the rise of import prices, both across a number of important economies suggests that inflation pressures are not building anywhere. That is, of course, looking in the rear view mirror and things may change. But I do think it is interesting to see such similarity in the development of producer price inflation in so many economies that often have limited links.


Few important macro data

Recent trading days have seen few key macro statistics. Chinese GDP growth was marginally stronger in Q4 on a year-over-year basis than expected at 6.8%. This was mainly due to revisions to earlier data as the quarter-over-quarter growth rate was actually marginally weaker than expected. Chinese retail sales growth decelerated a little in December, but industrial production growth was solid at 6.2% yoy, showing remarkably stable growth around 6% since early 2015. As our China economist Arjen van Dijkhuizen pointed out here, we expect the Chinese economy to continue to grow, but at a gradually lower rate. More important, we expect the policymakers in Beijing to manage to slow down excessive credit growth without hurting the overall economy.

Two key US business confidence measures, the Empire State index and the Philly Fed index both declined a little in January, but neither of them is suggesting a material slowdown. It also is uncertain to what extent January US data is affected by adverse weather on the East coast and some other parts of the economy, including mud slides in California.

US government shutdown will not have material economic effects

At the time of writing it was unclear whether or not a US government shutdown could be avoided as the government’s spending authority was due to lapse on Friday 19 January. This is the usual political folklore unknown in Europe. The US government has spending authority and a debt ceiling for specific amounts. As spending grows and the government is still running a deficit, these constraints bite. Political action is required to extend the spending authority and to raise the debt ceiling to ensure the smooth operation of government. But when the constraints are hit, this is a nice opportunity for political blackmail. Government shutdowns are obviously not popular, they are disruptive. So a political party causing the shutdown risks being blamed and losing out electorally. In most cases, a last minute deal is done after a process of ‘who blinks first’. The economic consequences of shutdowns are usually limited as they do not tend to last long. As such, there is little reason for financial markets to take all that much notice.