Macro Weekly – US marches on as Europe fails to excite

by: Han de Jong

  • The US economy is still producing solid growth and modest inflation
  • Confidence in the eurozone continues to weaken
  • Italy’s budget disappoints, but does it justify a huge sell off?
  • The Fed sticks to its plan
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Eurozone economy fails to excite

The economy of the eurozone is unable convincingly to shake off the growth slowdown that set in the first half of the year. It is clear that growth has eased and that international trade has been the culprit. We think the origin of weaker global trade growth must be looked for in Asia, even though the Asian economies themselves are not doing too badly overall. Recent trade data in Asia have shown strength and the CPB’s world trade monitor is confirming that trade growth is regaining some strength. But this has so far failed to translate into much of an improvement of (business) confidence. The German Ifo institute reported a modest drop the September reading of its business confidence index: 103.7 versus 103.9 previously. But this followed a sharp monthly improvement in August. The much broader index of Economic Sentiment, put together by the EU Commission continues to slide. It has not seen the improvement of Ifo in August and disappointed again in September: 110.9, versus 111.6. Still at a high level, though.

Monetary developments aren’t much different. The growth rate of eurozone M3 fell from 4.0% in July to 3.5% in August, the slowest growth since 2014. Admitted, these developments are always hard to interpret. But it would not appear to suggest an early and material reacceleration of growth is on the cards. The most recent inflation data suggest a continuation of recent trends. Admitted, headline inflation rose to 2.1% yoy and has gained strength in recent year. But core inflation stays stuck close by the average for the last couple of years. Eurozone core inflation actually eased marginally to 0.9% in September according to the advance-reading, as opposed to 1.0% in August and 1.1% a year earlier. We remain convinced that the ECB’s forecasts for rising core inflation in the period to the end of 2019 will be undershot.

While the US economy is marching on

The cyclical position in the US is very different. Personal income and spending continue to move higher at a nice pace. The labour market is strong and so are property markets. No wonder that consumer confidence is high and even strengthening further. But business confidence is strong as well. And companies are putting their money where their mouths are. Business investment has been growing nicely in recent years. Capital goods orders, non-defense, ex-aircraft chalked up another plus last month. These orders, which can be seen as a proxy for investment spending were up 8.0% yoy in August, down a little from 10.2% in July, but above the 7.4% average so far this year. Despite solid growth of the economy inflation remains modest. The key measure on the Fed’s radar screen is the so called PCE-core rate. It was unchanged mom in August, and the yoy rate stuck to 2.0%.

Fed sticks to plan

The Fed raised rates again late September. We think they are happy with how the economy is performing: decent growth and no apparent threat of a material rise of inflation. Given that everything is going well and that political pressure on the Fed is a distinct risk, the Fed will most likely stick to its excellent plan of hiking once every quarter for the next couple of quarters.

Italian budget a bomb shell

The Italian government released the highlights of its 2019 budget. The numbers were eagerly awaited because the two (very different) coalition members had great plans for spending increases and tax cuts. The Finance Minister Tria was trying to keep the budget deficit under control. With a government debt of slightly more than 130% GDP, there is some urgency to reduce that ratio by limiting the deficit. Plans of the coalition members had been calculated beforehand to lead to an increase in the deficit to 5% of GDP or more. What came out in the end was much more modest, but at 2.4% GDP, the deficit was above market expectations and seen as a defeat for the Finance minister. The Italian bond market sold off sharply, the spread over Germany jumping by more than 30 bp. A deficit of 2.4% (if it can be held at that) and nominal GDP growth of roughly the same magnitude leads to a marginal reduction of the debt ratio, given that the ratio is above 100%. However, a meaningful decline of the ratio has disappeared from the radar screen. This is a disappointment and also raises the risk of a downgrade of the Italian sovereign rating, which is currently only two notches above junk at the key rating agencies.