Macro Weekly – Three little birds

by: Han de Jong

  • Risk of contagion from Turkey limited
  • Canary in the coal mine: ZEW?
  • US economy remains robust
  • Lower Chinese growth with the emphasis on gradual
180817-Macro-Weekly.pdf (262 KB)

There is a lot of stuff today that people can worry about. Can Turkish policymakers get their problems under control? Will the problems in Turkey lead to significant contagion to other economies and financial markets worldwide? How will the trade conflict evolve? What will the 2019 Italian budget look like and will the sovereign be downgraded by the rating agencies? What the heck is happening in the Brexit negotiations? Will Chinese growth drop sharply? Will Chinese debt problems lead to some sort of implosion of the financial system? Will the slowing of the European economy turn into an actual downturn? Will the US yield curve invert, signalling a recession? Will the US Fed lose its independence? Will freedom of the press survive? Will antibiotics become ineffective? Can we reverse trends in obesity? Will the best players of my favourite football club leave my club before the transfer window closes?

According to an old Dutch saying, when an emergency appears to be at its peak, the solution is just around the corner (als de nood het hoogst is, is de redding nabij). In his “Three Little Birds” Bob Marley suggests we shouldn’t ‘worry about a thing, cause every little thing gonna be all right’. That is perhaps a little extreme. Nevertheless, in my experience, by far most problems have a funny sort of way to get sorted out, even though people just love identifying risks and thinking about the disasters that are looming.

Contagion risks

A number of my colleagues have written extensively about the Turkish crisis. I do not need to repeat their analyses. Let me focus on the question of contagion. How likely is it that international investors will dump their holdings of other Emerging Markets assets, triggering sharp falls of these markets, threatening financial stability in these countries, which in turn, will affect these economies at large and eventually also markets and economies of advance countries? There clearly is always a risk. But I think cautious optimism is the right position here. Contagion is more likely to occur if the causes of the problems hitting one country are also characteristic for other countries, if the fundamentals of economies are poor and if their currencies are overvalued.

It seems to me that the key problems for Turkey are not shared with many other countries. The key problem for Turkey is that the country has a large external financing requirement due to a combination of a large deficit on the current account of the balance of payments and a large amount of short-term debt (mostly owed by corporates). On top of that, president Erdogan has centralised a lot of power in himself. The independence of the central bank has been curtailed and the new finance minister is his son in law. This has done little for the confidence financial-market participants have in the policymakers. Furthermore, president Erdogan’s unconventional views on economic policies aren’t particularly helpful either. The deteriorating relationship with the US adds to the mix. Other EMs don’t tend to share all of these issues, although many countries have fallen out of favour with the American president and EMs generally feel negative consequences of rising US interest rates.

Another reason to be cautiously optimistic is that many other EMs that are potential contagion candidates have much improved economic fundamentals these days. In most of these countries, external deficits have been reduced sharply or even turned into surplus in recent years and the public finances are in reasonable health. Inflation tends to be at reasonable levels and central banks tend to follow policies that support confidence.

What should also help limiting contagion, in my view, is that currencies have weakened in recent years and it cannot be argued that there is widespread overvaluation, which would make currencies great candidates for wholesale selling.

On balance, therefore, I think the contagion effects will remain limited. Unfortunately, one cannot guarantee this. As Mervyn King, the former Bank of England governor, once said, ‘it rarely makes sense to start a bank run, but it always makes sense to join one. Market behaviour can become irrational.

A good sign for Europe

I have often written about weakening confidence indicators in the eurozone in recent months. Not today. The ZEW index, a gauge that is based on surveys among analysts, rose for the first time this year. The ‘expectations component’ of the German ZEW index, generally seen as the most important of these series, rose from -24.7 in July to -11.1 in August. That is still not a great level, but at least it is a move in the right direction. And: it was the first monthly rise this year. Our view is that growth in the eurozone will not decelerate further. So an improvement in variables like the ZEW are very welcome as they provide support for that view.

Eurozone GDP data was also supportive. Eurozone GDP grew by 0.4% qoq in Q2, after 0.3% in Q1. This is lower than in the latter part of 2017, but it is roughly in line with trend, not below. German GDP grew by 0.5% qoq. While few details were published, the commentary provided by the statistics office suggested that domestic demand remained strong while the growth contribution from international trade was weaker. This picture was not confirmed by Dutch GDP. Overall growth amounted to 0.7% qoq and the contribution from trade was positive while private consumption stood still. It is very possible that the underlying components of Dutch GDP are too volatile to infer messages for the eurozone as a whole.

A point that has to be made is that the deterioration of confidence indicators in the eurozone in the course of this year is not fully reflected in the actual slowdown of growth. That is a positive for me.

US still robust

Meanwhile, US economic data was firm in recent days. Business confidence among SMEs, measured by the NFIB index moved higher to a new record for this cycle. The Empire State business confidence index moved up from 22.6 in July to 25.6 in August. That means it is essentially holding on to the high levels seen in recent months. The Philly Fed index was the odd one out, falling to 11.9 in August, from 25.7. I am not sure what that means. Most likely it is largely noise.

The harder data on retail sales and industrial production were strong. Retail sales advanced 0.5% mom in July. Excluding cars, the advance was 0.6%. The yoy numbers are impressive. Total retail sales were up 6.4% yoy, and excluding cars, yoy growth amounted to 7.3%. Bear in mind this is nominal. Prices are part of this. Higher oil prices can have a big impact. Americans spent 21.6% more than a year earlier in ‘gasoline stations’.

Industrial production grew 0.1% mom in July, after a 1.0% rise in June. Manufacturing output alone was up 0.3% mom, after 0.8%. The annual growth rate has now moved above 4% and has overtaken the eurozone.

Problems for mortgage holders eased again in Q2. The number of mortgages registered as ‘delinquent’ fell to 4.36%, down from 4.63% in Q1. Following the financial crisis, delinquencies exploded and reached a peak of over 10% in 2010 (The long-term average is 5.33%). A steady decline followed due to the economic recovery but a rise occurred last year. Fortunately, that rise has now been almost entirely reversed. Foreclosures are following a similar development, expect they did not bounce up in 2017. The share of mortgage loans where the house is being foreclosed is 1.05%, lower than the historic average of 1.51% and, obviously much lower than the peak of 4.64% during the toughest times.

China’s gradual slowdown continues

My colleague Arjen van Dijkhuizen has recently published a more extensive commentary on China (Pressures are building) which I do not need to repeat. The most recent data show that growth of retail sales eased further in July, but is still strong at 8.8% yoy, down from 9.0% in June. Industrial production growth stabilised at 6.0%. The message is that growth in China is slowing, but only gradually and the policymakers have this process under control. If it goes too fast, that might lead to social and political instability, so the policymakers take measures to prop up activity whenever they think it is necessary.


Overall then, while there is turmoil in Turkey’s financial markets and many people worry about a long list of things, the underlying global economy is not doing too badly at all.

This is my message to you-ou-ou!