Euro Macro: German manufacturing still in negative territory – Germany’s factory orders and industrial production data improved in March, but the details of the two reports, as well as sentiment indicators signal that the tide in the sector has not yet turned and weakness continues. Factory orders increased by 0.6% mom in March, which is very modest considering that it followed upon two consecutive monthly drops of 6% in total. As a result, during Q1 as a whole, orders dropped by more than 4% qoq. The weakness in orders was concentrated in capital goods orders, particularly from outside the eurozone ( -10.3% qoq in Q1), but orders for intermediate goods also fell noticeably (-3.1% qoq in Q1). Orders for motor vehicles and trailers declined by more than 5% in Q1 after they had risen by 7.5% in 2018Q4, underlining that this part of Germany’s manufacturing sector still remains in the doldrums if we correct for the temporary distortions that were created by the introduction of new emission standards in September 2018. Turning to industrial production, which rose by 0.5% mom in March after 0.4% in February, the details also point at ongoing weakness in manufacturing. Indeed, the rise in total industrial production in Q1 was entirely due to construction (up by 1.0% mom in March and by 3.9% qoq in Q1 as a whole), whereas manufacturing contracted for the third consecutive quarter in a row in Q1, albeit modestly (-0.1% qoq). Finally, the Ifo business climate in manufacturing dropped again markedly in April and the manufacturing PMI remained well below the 50 boom-bust mark, indicating ongoing weakness in the sector. All in all, we think Germany’s manufacturing sector will remain sluggish in the coming months. Indeed, output is likely to decline significantly going forward as it catches up with the weakness in orders and in business surveys. Later in the year, it should pick up on the back of a modest improvement in global trade. (Aline Schuiling)
Fed View: Policy framework debate seeing more concrete contributions – As we approach the upcoming research conference in Chicago on 4-5 June, some Fed officials are already setting out their views on how best to improve the central bank’s strategies and tools. The most important recent contributions have come from NY Fed President John Williams, who has co-authored an academic paper that makes the case for an average inflation target, while today, board member Lael Brainard gave a speech signalling scepticism over whether the Fed should make such a shift, instead arguing for the Fed to beef up its toolkit by considering, for instance, a yield curve target. The Williams paper relies on a model-based analysis of various policy frameworks (including the existing 2% inflation target), and finds that an average inflation target would help the Fed ‘eliminate the downward bias in inflation expectations’. However, some Fed officials have expressed scepticism, with Cleveland Fed President Mester, for instance, asking ‘do the assumptions of the model really play out in real life?’, while St Louis Fed President Bullard warned that making radical changes to the framework could ‘unleash chaos’ in financial markets.
Brainard, meanwhile, referred to scepticism that central banks would be able to support above-target inflation sustainably, without ‘becoming concerned that inflation might accelerate and inflation expectations might rise too high’. With that said, Fed officials overall are expressing an open mind going into the June conference, and could yet be persuaded that the benefits of changing the framework would outweigh any costs. At the same time, less controversial proposals to bolster the Fed’s toolkit are much more likely to find support. Brainard’s yield curve target proposal would involve the Fed targeting slightly longer term interest rates – one or two-year bond yields – using the balance sheet. However, instead of quantitative bond purchase targets, the goal would be purely to control rates (the Bank of Japan already has a similar policy, but targeting 10y yields). Such a policy could give greater credibility to a central bank’s forward rate guidance, although we note that it might also tie the central bank’s hands should it wish to expand the balance sheet quantitatively.
We are likely to see further proposals from Fed officials over the coming weeks and months, and following the conference in June, the FOMC will conduct a full assessment, sharing its conclusions in the first half of 2020. Should the Fed adopt an average inflation target – currently the most likely of the proposed framework changes – we believe it would raise the risk of easier policy next year, although our base case remains that the Fed keeps rates on hold. (Bill Diviney)