Macro Weekly – Bring it on: 19 December

by: Han de Jong

  • Uncertainty over future Fed policy persists
  • US inflation still tame
  • Eurozone economic sentiment marginally lower in November
  • China’s PMIs soften further in November
181130-Macro-Weekly.pdf (252 KB)

Equity markets responded strongly, positively, to Fed Chair Powell’s speech last Tuesday. His words were seen as suggesting that the Fed tightening cycle is coming to an end before too long, or that, at least, a pause is coming. We have, indeed, changed our forecast for Fed policy. We still think they will raise rates at the 19 December FOMC, but we now expect only one more hike in 2019.

The view that Powell’s speech represents an important change in tone is disputed by some other commentators. Fed watchers poor over the texts and compare every letter and comma with previous communication. Having looked at other people’s comments, I am still convinced an important change is happening. Early October Powell said rates were ‘a long way’ away from neutral. That surely indicated the need for a number of hikes. Last Tuesday, Powell said that rates are ‘just below’ the range generally considered neutral. Hawkish commentators point out that FOMC members see that range as 2.5%-3.5% and that the Fed will move rates to the middle of that range. That would imply at least three more hikes. But even if that is correct, that is still short of the five more the FOMC had pencilled in at their September meeting between now and the end of 2020.

Long and variable lags

I would also like to add that Powell keeps stressing that the effects of policy measures work their way through the economy with lags, something that we all know and is well understood. As he is keen not to kill the recovery prematurely, surely the Fed does not need to move rates to the middle of the range considered neutral if there is no direct pressure from the inflation front.

Recent inflation data is not particularly worrying. The core PCE yoy rate, the Fed’s favourite measure, eased back to 1.8% in October, from 1.9% in September. The rate stood at 1.6% a year ago. That is not much of an acceleration in such a strong economy. This provides room for the Fed to pause and see what happens. More hawkish commentators argue that wage increases are accelerating and that this will feed into higher inflation before too long. I must say, I just don’t see that. But I recognise a significant acceleration of inflation as a very important risk to the way we look at the economy and financial markets.

Powell also keeps stressing that the Fed is data dependent. I always find that a bit of an obvious and therefore silly remark. My interpretation here is that the Fed will change from its more or less pre-set strategy of 2018 of one hike per quarter. This suggests at least a pause in rate hikes before too long is likely.

Bring it on

The FOMC’s next meeting is on 19 December. We should get a lot more clarity then.

When I look at the cyclical position of the US economy, I would characterise it as strong with some weaker areas and modest inflation. Recent releases showed all of these three. Q3 GDP growth was confirmed at 3.5%. Personal income and personal spending were up 0.5% mom and 0.6% mom, respectively in October. So that is all pretty solid.

Yet, there are weaker areas. New home sales amounted to 544,000 in October, almost 9% down from September and the lowest number since March 2016. New home sales reached a cyclical peak last December when they amounted to 712,000. So the October reading is almost a quarter lower. Bear in mind that this is a volatile series and these comparisons from month to month are not necessarily very meaningful. But still…

Eurozone economic sentiment: weaker again, but not by much

Recent days have seen relatively few important data. Eurozone monetary statistics showed an acceleration of M3 growth: 3.9% yoy in October, versus 3.6% in September. Credit growth remained relatively modest. Credit to households was up 3.2% yoy, unchanged from September. Credit to non-financial corporates eased from 4.3% to 3.9%. None of this is earth shattering. But neither does it point to a lot of strength.

The European Commission’s index of economic sentiment fell marginally in November: 109.5 versus 109.7 in October. That was a little better than expected, but still a drop. The German Ifo index was a touch weaker than expected in November: 102.0, versus 102.9 in October. I find that a disappointment. As is widely known, German car manufacturers have had all sorts of problems recently and car production in Germany was down some 25% yoy in August/September. This is largely related to new emission testing procedures. One would have hoped that the companies would have overcome these problems by now and that we would see a bounce in production, and therefore in the Ifo index, as a result. Car output was better in October and I am anxious to see the November data. But the Ifo does not suggest there has been a strong recovery, although we need to bear in mind that the correlation between the Ifo index and car production is weak.

Eurozone inflation eased in November. Headline inflation fell back from 2.2% to 2.0% and core inflation from 1.1% to 1.0%. We have long thought, and are still convinced, that the ECB’s expectation of a gradual rise of inflation will take longer than they are forecasting.

Chinese PMIs fall in November

Chinese business optimism is softening. The PMI for the manufacturing sector eased to 50.0 in November, down from 50.2, the third consecutive monthly decline. The PMI for the non-manufacturing sector fell from 53.9 to 53.4. It is clear that these series, while they can be volatile, have weakened recently. The Chinese authorities have already taken various measures to prop up growth. We need to wait and see when the effects of these policy initiatives come through in the data.