Macro Weekly – A dismal year for markets

by: Han de Jong

  • Global slowdown continuing as China signals more stimulus
  • Markets (and Trump?) disappointed by the Fed
  • Political uncertainty increases
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This is my last Macro Weekly for 2018. It has been a disappointing year. Global growth has slowed more than I had expected. And financial markets have reacted much more negatively than I had expected. Political uncertainty has been a dominant force this year and that is unlikely to change much for the better in 2019. A year ago, all economists and market commentators were optimistic. The year turned out worse than expected. Now, everybody appears to be pessimistic. Perhaps the consensus is wrong again…

Another drop in Ifo, weak Korean trade data, but China signals more policy stimulus

Recent data confirms the further slowing of the global economy. I had hoped that European, in particular German car producers would sort out their problems with the new emission testing procedures that started in September and that that would lift economic activity at large and business confidence. But the December reading on the Ifo index of German business confidence fell again: 101.0 versus 102.0. This is still a level suggesting a reasonable pace of economic growth, but for that to continue, the Ifo index should bottom out soon.

Recent days have been quiet in terms of important economic data in Asia. Regular readers know that I keep a close eye on trade flows in Asia. South Korea reported imports and exports during the first 20 days of the month of December. Imports were up 2.2% yoy, sharply lower than November’s 12.8%. Export growth amounted to 1.0% yoy against 5.7% in November. The December data is weak, but the series are volatile. In addition, front loading US and Chinese tariffs by importers and exporters in China may have also distorted trade of other Asian economies. Korean exports to China were very weak in December so far, but had been strong in previous months.

Against this background, it is important to keep an eye on Chinese policymakers. They have recently indicated that monetary policy will be eased further and other measures to support growth are likely as well. We must bear in mind that transparency over Chinese policies is relatively poor. But it seems that the slowing of the Chinese economy in recent months has the policymakers concerned enough to take some action.

US economy solid, but some signs of weakness

The US has been the strongest growing economy of the key countries. But even there, growth is past its peak. That peak was in Q2 when growth was 4.2% qoq annualised. The trend growth rate for the US is probably just below 2%, so growth has exceeded its long-term potential for a while and a return to potential should be expected. Nothing wrong with that. Interest rate sensitive sectors have shown some weakness in the last couple of months, in particular housing. The most recent data on housing starts, building permits and existing home sales were all positive, though. On the negative side, the NAHB index, which measures confidence of home builders, fell from 60 in November to 56 in December, the second, material drop in a row. The first regional business confidence indices in the US, the Empire State index and the Philly Fed index both declined in December. The Empire State fell from 23.3 to 10.9 and the Philly Fed index fell to 9.4 from 12.9, while it had fallen more strongly in November. The commentary accompanying both releases pointed out that these headlines are weaker than the detailed data would justify.

Powell disappoints Trump and the markets; Trump and the markets have a point

Arguably the most important event of recent days was the Fed’s policy meeting. The Fed raised rates, as expected. They also lowered their growth forecast for 2019 and the inflation forecast. And they lowered the number of rate hikes they think they will need to implement in 2019 from three to two. The equity market, already not in great spirits, did not like it at all and sold off heavily.

I think the market is saying to the Fed that monetary policy is too tight or threatening to get too tight if the Fed, indeed, implements two hikes next year. To be honest, I think the market has a point. Powell himself has indicated that growth will slow next year as the fiscal stimulus wears off, that the US will feel the effects of the slowdown elsewhere and that it is yet unclear how past monetary tightening will affect the economy. Add to that the fact that inflation continues to be moderate, that interest-rate sensitive sectors are softening and that the drop in equity markets will lead to negative wealth effects and make funding for corporates more difficult. Against all that I find it hard to understand why the Fed thinks it needs to raise rates twice next year. Our base case is that they will deliver one hike.

Perhaps the difference of view between the market and the Fed does not lie in how to read the current state of the economy, but in where everybody thinks the ‘neutral’ interest rate is. And perhaps the market has just misinterpreted Fed chair Powell. He has stressed time and time again recently that policy becomes more data dependent now that the actual official rates are not far away anymore from neutral. So perhaps we must not take the ‘dot plot’ (which shows where the FOMC members think rates will be at various points in the future) too seriously.

The Fed’s decision and the market’s reaction will do very little for the feelings of affection president Trump may have for Fed chair Powell. The president has threatened to sack Powell. That may not be as easy as it sounds. And I think it would be a particularly bad idea as it signals to the market that the Fed is less independent than everyone assumes. It is true, as former chairman Alan Greenspan has said recently that pressure from the White House is nothing new for the Fed. However, in Greenspan’s days, that pressure was not public. I think that makes a big difference.

Jim Mattis’ resignation from the White House does not bode well for 2019

2018 has been filled with political uncertainty, largely related to the unconventional behaviour of the US president. The trade war, immigration issues, the border wall, the withdrawal of US troops from conflict areas, the Mueller probe into the alleged collusion of the Trump camp with Russians before the elections are just a few examples. Europe also has had its fair share: Brexit, the Italian budget, the protests in France, the strength of populists and eurosceptics in opinion polls and elections etc.

The most recent development is the resignation of Jim Mattis, the US Defense Secretary. Mattis clearly does not agree with president Trump on foreign and defence policies. Mattis was seen as a calming, or restraining influence on the president. With him gone in a few months’ time one must fear that policy will only become more aggressive and erratic. I think the same happened after Gary Cohn (Trump’s main economic advisor as Director of the National Economic Council) left in April this year. Cohn was uncomfortable with the protectionist agenda of the President. It is most likely not a coincidence that the trade conflict with China has escalated after Cohn left.

 

I would like to use this opportunity to wish all readers happy holidays and a healthy and prosperous 2019. Thank you for your support.