Since the crash of 2008, global financial markets have been subject to prolonged periods in which their behaviour has been dominated by an over-arching economic regime, often determined by the stance monetary policy. When these regimes have changed, the behaviour of the main asset classes (equities, bonds, commodities and currencies) has been drastically affected, and individual asset prices within each class have also had to fit into the overall macro pattern. For asset managers of all types, it is therefore important to understand the nature of the regime that applies at any given time. This is not easy to do, even in retrospect. There will always be inconsistencies in asset performance which cause confusion and require interpretation. When it comes to predicting future market behaviour, the uncertainties are obviously even greater. Nevertheless, it is an exercise which is worth undertaking, because it can bring a semblance of order to the apparent chaos of asset markets. In this blog, I will discuss the two main regimes that have been in place since 2012. These are: (a) quantitative easing dominance from 2012 to mid 2015; and (b) deflation dominance from mid 2015 to now. I will suggest that we may now be entering a new regime of partial reflation dominance. I will also discuss some other important cross currents that do not fit easily into these main regimes, in particular monetary policy divergence between the US Federal Reserve and other central banks, and the behaviour of emerging markets, which has not been fully synchronised with the developed markets in recent years.
Ever since the crash of 2008, the global financial markets have been subject to prolonged periods in which their behaviour has been dominated by a single, over-arching economic regime, often determined by the stance monetary policy. When these regimes have changed, the behaviour of the main asset classes (equities, bonds, commodities and currencies) has been drastically affected, and individual asset prices within each class have also had to fit into the overall macro pattern. For asset managers of all types, it is therefore important to understand the nature of the regime that applies at any given time.
This is not easy to do, even in retrospect. There will always be inconsistencies in asset performance which cause confusion and require interpretation. Nevertheless, it is an exercise which is worth undertaking, because it can bring a semblance of order to the apparent chaos of asset markets.
Two main regimes have been in place in the asset markets of developed economies since 2012. (The emerging markets also fit the pattern, with some slight differences.)
These regimes are, first, the period in which quantitative easing was the dominant factor, from 2012 to mid 2015; and, second, the period in which deflation risk has been the dominant factor, from mid 2015 to now.
It is possible that the markets are now exiting the period of deflation dominance, and they may even be entering a new regime of reflation dominance, though this is still far from certain. Secular stagnation is a powerful force that will be hard to shake off. But if that did happen, the pattern of asset price performance would change substantially compared to the recent past. Read more
The yen recorded its sharpest drop in the past three decades last week, as markets sniffed the possibility of helicopter money arriving in Japan. The meetings of “Helicopter Ben” Bernanke with Bank of Japan officials, and then with Prime Minister Shinzo Abe, were the latest trigger for this speculation, but in reality the Japanese authorities have been revving up the helicopters for some while, and they seem to be running out of alternatives.
Whether or not they choose to admit it – which they will probably resist very hard – the Abe government is on the verge of becoming the first government of a major developed economy to monetise its government debt on a permanent basis since 1945.
Why is it opting for this macro-economic policy of the last resort, and will it work? Read more
Germany’s surplus on the current account of its balance of payments surged to a record level last year, reaching $285bn, or 8.5 per cent of gross domestic product. It is now overtaking the Chinese surplus as the largest trade imbalance in the world. Although the term “crisis” is normally confined to trade deficits, not surpluses, this imbalance is clearly causing major headaches, both inside the eurozone and globally.
Not least, the surplus is causing problems for Germany itself. Nevertheless, the Merkel administration follows a longstanding German tradition in viewing it largely as a symptom of economic success, not failure. Both the government and the Bundesbank are resistant to lectures from foreigners on how to fix something that is not, in their view, broken.
There is growing pressure from the IMF and the European Commission to take steps to reduce the surplus but, in the main, this has fallen on deaf ears in Berlin. The consequences of ignoring this quandary could be profound. Read more
This month’s regular report from the Fulcrum nowcast models comes just before Brexit has had time to impact global activity indicators. There is no doubt that Brexit will adversely impact the growth in aggregate global demand as a result of the rise in policy uncertainty, but so far the downgrades to GDP growth forecasts have been relatively minor for the world as a whole.
Furthermore, the latest nowcasts suggest that the world economy was in reasonably good shape just before the Brexit vote occurred. In June, global activity growth was running at 3.5 per cent, which is slightly below trend, but significantly above the growth rates recorded for the majority of 2015 and early 2016. Growth picked up in March 2016, following a significant easing in macro-economic policy in China, and some monetary easing in the US, the Eurozone and Japan. Read more
Brexit is clearly a first order political shock within Britain itself, perhaps ranking just behind the miners’ strikes in the 1970s and 1980s as the most disruptive shock since the Second World War. Over that entire period, it is only the second purely British event that could have a global economic impact, the first being the Suez War in 1956.
We have seen a lawful rebellion against the urban political elite, which has stood for globalisation, low taxation, free markets, free trade and European political integration. The eventual global effects will depend on whether this remains a peculiarly British political upheaval – after all, the European issue has always had a special capacity to disrupt the political order within these shores – or whether it is the start of a European, even a global, political trend.
The drop of 3.5 per cent in the S&P 500 on Friday – an event that happens only three times a year on average – suggests that there are genuine global concerns about the consequences of Britain’s decision. If there is political contagion to other EU members, then the global economic effects could start to get serious, because the shock is coming when the world economy is fairly weak, and when monetary policy options to stimulate activity are apparently limited. But wise policy within the EU can stop that happening. Read more
In January, the markets panicked about a hard landing in China, accompanied by fears of a sudden devaluation of the renminbi that could spread deflationary pressure throughout the rest of the world. In the event none of that happened, and the markets rallied sharply. Why did China-related risks suddenly dissipate, and might they return?
One reason why the risks abated had little to do with China itself, and everything to do with the Federal Reserve. In the midst of the global market melt-down in February, key members of the FOMC, led by Bill Dudley, realised that financial conditions in the US were excessively tight as a result of the rising dollar, and they suddenly adopted a far more dovish tone.
Many people think that an international “meeting of minds” occurred at the Shanghai G20 conference in late February. As a result, the Federal Reserve delayed its rate increases, the Bank of Japan and the ECB desisted from “devaluationist” monetary policies, and China set its face against a sudden devaluation of the renminbi. All this eased global financial conditions and, in a period of dollar weakness, calmed the currency markets. Read more
The 2016 calendar year may well see productivity growth in the US economy slumping to around 0.5 per cent, a catastrophic outcome for an economy in the middle of a cyclical upturn. This is part of a worldwide phenomenon which began some decades ago, and shows no sign of ending.
The productivity slowdown has often been called a “puzzle”, because it has coincided with a period of rapid technological change in the internet sector. I am not sure that this is really a “puzzle”. Many of the obvious benefits of the internet revolution appear to increase human welfare without leading to increases in market transactions and nominal GDP . Furthermore, there are several other plausible reasons for the productivity slowdown, including low business investment and a loss of economic dynamism since the financial crash .
There is however a different puzzle connected to the productivity slowdown. Given that it has greatly reduced the level and expected growth rate in nominal GDP, why has it had so little apparent impact on equities, an asset class that depends on the level and expected future growth of corporate earnings?
Profits are presumably affected by GDP growth, yet continuous downward revisions to the path for GDP have been almost entirely ignored, up to now, by equity investors. With concern about the productivity crisis increasing almost daily, can this insouciance be expected to continue for much longer?
This blog will discuss this issue, mainly from a US viewpoint. The conclusion is that the damaging impact of the productivity slump on the S&P 500 has so far been masked by other factors, but there are signs that this might be changing. Read more
This month’s regular update from the Fulcrum nowcast models shows that global economic activity is growing fractionally below its trend rate, and is little changed from last month’s report. Global recession risks have therefore fallen recently to more normal levels, compared to the elevated risks seen in February. However, neither the advanced economies nor the emerging markets appear to be sustaining a break-out to above trend growth.
The overall picture is therefore one of steady but disappointing growth, with little indication of a major cyclical acceleration at present. In particular, growth in the US remains subdued, and seems to be running at or below the 2 per cent threshold apparently required by the Federal Reserve to justify a June/July increase in interest rates. Although the jury is out on this point, Friday’s weak employment data have given extra weight to the subdued nature of our recent US nowcasts.
We also report for the first time forecasts for global GDP growth over the next 12 months derived from the dynamic factor models that are used to produce the nowcasts. These forecasts are a natural extension of the nowcast models. They should be used in conjunction with other forecasting methods to assess the statistical likelihood of activity “surprises” relative to consensus forecasts in the months ahead.
The latest results suggest that US GDP growth in the period ahead may well come in below the latest consensus forecasts.
The full set of the latest global nowcasts is available here. Read more
© Getty Images
The influence of the global economy on the decisions of the US Federal Reserve has become a topic of frontline importance in recent months.
Since the start of 2016, events in foreign economies have conspired to delay the FOMC’s intended “normalisation” of domestic interest rates, which had apparently been set on a firmly determined path last December.
This delay has taken the heat out of the dollar. But the key question now is whether weak foreign activity will continue to trump domestic strength in the US.
To judge from last week’s surprisingly hawkish FOMC minutes, which I had not expected, the Fed seems to be reverting to type (see Tim Duy). Many committee members have downplayed foreign risks and have returned to their earlier focus on the strength of the domestic US labour market, which in their view is already at full employment. Read more
The Bank of England’s dire analysis of the impact of a Brexit vote inflamed UK political opinion last week. I want to steer well clear of that dispute. However, the economic and market impacts of this issue are becoming too important to ignore, and they were not fully covered in the Bank’s analysis.
For example, Mark Carney, BoE governor, did not attempt to give precise estimates of the impact of Brexit on sterling and gross domestic product, while he did not even provide a directional guide to the likely effect on UK interest rates.
Nor did the governor make any attempt to estimate the likelihood of a Brexit vote, simply saying that the Monetary Policy Committee had made the standard assumption that government policy (in this case, to remain in the EU) would apply during the forecast horizon. Finally, he did not say anything specific about far Brexit risk is already priced into asset markets.
Investors, of course, have to make explicit or implicit attempts to answer all of these questions, hopefully free from political bias. This blog will comment on the key issues involved. Read more
Janet Yellen in December announcing the Fed's first rate rise since 2008 © Getty Images
This blog has barely commented on the Federal Reserve’s thinking in the past few weeks, which is unusual. It probably indicates that the Fed has temporarily disappeared from the centre of the markets’ focus, as the probability of a June rate hike has receded. Even the earlier hawks among the analyst community have been sharply reducing the number of rate hikes to be expected this year.
The Federal Open Market Committee has not entirely given up on June, as these statements from Dennis Lockhart, the Atlanta Fed president, and John Williams of the San Francisco Fed indicate. But since the latest employment report, which was widely taken to have dovish implications, there has been no attempt among the inner circle surrounding Janet Yellen to prepare the market for a shock.
The most recent evidence for this is the important interview with Bill Dudley, head of the New York Fed, by Binyamin Appelbaum at the New York Times. Tim Duy, a professor at the University of Oregon and close Fed watcher, rightly says this is a “must read”, but it has created remarkably little interest in the markets. Since this is the first detailed piece of analysis from the heart of the FOMC for some time, it is worth taking careful note of the main points that Mr Dudley raises. Read more
One of the surprises of the Great Recession period since 2008 has been that global protection against free trade has increased only slightly, in sharp contrast to the enormous spread of trade controls during the Great Depression from 1931-34.
This period of opposition to autarky might, however, be coming under threat. Two of the three candidates left in the American presidential race are clearly protectionists. Although Hillary Clinton, the likely winner, has always leaned towards free trade agreements, she has recently hedged her previous support for the Trans Pacific Partnership because of the developing political climate.
Betting markets think there is a 30 per cent chance of a President Trump. He has called for a 45 per cent tariff, no less, on imports from China. His presumptive nomination, according to Edward Luce, overturns decades of Republican support for free trade.
And he would have a lot of sway in this area, because the usual checks and balances in the US political system do not really apply in the case of protectionist trade policy. In that field, the president has been accorded unusual powers to act, ever since President Roosevelt’s Reciprocal Trade Agreements Act in 1934. Read more
Jubilant Leicester City fans © Getty Images
Apologies for being distracted from macroeconomics, but these are extraordinary times.
Leicester City’s wonderful triumph in English football’s Premier League has led to suggestions that the monopoly of success in the hands of a few very rich clubs has finally come to an end. Many football romantics hope that this 5,000/1 victory will not just be a statistical “black swan”, never to be seen again. As a Southampton fan, I am certainly one of them. But what does economics tell us about this?
It is tempting to view Leicester’s win as a refutation of those 5,000/1 odds. The bookies cannot have been that “wrong” can they? But remember what these odds mean. They mean that if we could replicate the position of Leicester a year ago, and run the experiment 5,000 times, then the team would be expected to win the Premier League only once. (I am ignoring bookies’ margins for simplicity.)
Since we cannot actually run that experiment, we cannot prove whether bookies under-estimated the ex ante probability of Leicester winning. Maybe this was just the exception that proves the rule, which tells us nothing about whether the event will be replicated in future. Read more
Since mid-February, the financial markets have become much less concerned about a hard landing in global economic activity, or at least about a potential clash between slowing economic activity and inappropriately tight macroeconomic policy from China and the US Federal Reserve. Financial conditions indicators have eased in the big economies, and this has been accompanied by a partial recovery in business surveys in many parts of the world.
In the last edition of our monthly report card on Fulcrum’s global nowcasts, we commented that economic activity had turned a corner in the US and China, but this was offset by continued weakness in several key economies, including Japan and the UK. A similar pattern is apparent in this month’s nowcasts. Global recession risks, which seemed elevated in January and February, have now receded, but the world economy is far from robust.
We therefore leave the overall verdict unchanged from last month: global activity growth is somewhat better, especially in the emerging economies, but it is still a long way from being satisfactory. (Full details of the latest nowcasts are shown here.)
Foreign exchange traders are buzzing with talk of a new “Plaza Accord”, following the marked change in the behaviour of the major currencies after the Shanghai G20 meetings in late February.
Since then, the dollar has weakened, just as it did after the Plaza meetings on 22 September 1985. The Chinese renminbi has been falling against its basket, in direct contrast with the “stable basket” exchange rate policy that was publicly emphasised by PBOC Governor Zhou just before Shanghai. The euro and, especially, the yen have strengthened, in defiance of monetary policy easing by the ECB and the Bank of Japan.
Following Shanghai, the markets have become loathe to push the dollar higher, believing that the G20 may now have come to a co-ordinated agreement, as they did at the Plaza, to reverse the direction of the US currency. Does this comparison make any economic sense?
The Shanghai communique did place increased emphasis on an agreement among the major economies to avoid “competitive devaluations”. The main suspects here were Japan, the Eurozone and (sometimes) China, all of whom have good reasons to push their currencies down. The fact that the communique eschewed this course of action is therefore a reason to believe that the dollar might be subjected to less upward pressure. But that does not make it a new Plaza. Read more
As regular readers will know, this blog carries monthly updates of Fulcrum’s activity “nowcasts” for all of the major global economies on a monthly basis. We believe that this is one of the few publicly available sources of regular updates of global nowcasts, which are rapidly becoming an important frame of reference for investors seeking to interpret the latest fluctuations in economic activity in the major economies.
In the US, for example, the Atlanta Fed’s GDPNow model is very widely followed, and the New York Fed has just started to publish weekly updates from a nowcast model on a weekly basis. The NY Fed nowcasting report may become the market’s preferred “benchmark” to assess the recent behaviour of US activity.
However, these two Fed models do not use the same methodology, and the term “nowcasting” can mean very different things to different economists. This has already caused confusion about the recent state of the US economy, which has slowed down substantially in Q1 according to the Atlanta Fed, and has strengthened only slightly in Q2, according to the NY Fed model. The Fulcrum model however suggests firmer growth during March and April.
In today’s blog (and in the attached paper, co-written with Juan Antolin-Diaz), we attempt to explain the key differences between the various approaches. Apologies in advance – this is a somewhat technical explanation, but these details are becoming important for investors and policy makers to understand. Read more
In 1975, one of my first jobs as a young economist, working for Bernard Donoughue in Harold Wilson’s Policy Unit in 10 Downing Street, was to assist with the renegotiation of the terms of Britain’s membership of the European Economic Community, now the EU.
I was not remotely competent to do this at the time, but Bernard and his senior economist Andrew Graham (subsequently Master of Balliol) certainly were. Along with the prime minister’s canny press secretary Joe Haines, they ran a brilliant referendum campaign that kept the UK in the EEC, and kept Labour in office – an apparently impossible combination.
I was lucky enough to have an insider’s view of how the campaign was won. It will be more difficult for the pro-Europeans this time.
I recall having some economic input into a government leaflet distributed to all households, arguing the case for membership. This created a brief furore, similar to last week’s row over the 2016 version, which was derided as “crazy, a complete waste of money” by Boris Johnson .
But it turned out alright on the night for the government, with a 67 per cent majority in favour of membership in the referendum in June 1975.
In the years before the campaign started, a resounding two-thirds majority in favour of the EEC had looked inconceivable . But, in that distant era, the overwhelming advice of Britain’s political establishment (including Margaret Thatcher, who had just been elected as the new Tory leader) proved decisive. Read more
Financial asset prices have been on a roller coaster in 2016. In mid-February, gloom was pervasive and global equities were down about 10 per cent year to date. Then came a sudden rally, wiping out all of the losses in the US equity market, but not in the eurozone market, and especially not in the Japanese market, which fell further.
What happened to generate this abrupt change of direction in February, and what does this tell us about the future? Read more
How much would an average American, whose annual disposable income is $42,300, need to be paid in order to be persuaded to give up their mobile phone and access to the internet, for a full year? Would it be more, or less, than $8,400 for the year? Ponder that question – its importance will become apparent later.
The question is relevant to a much more familiar issue. Why has productivity growth slowed down so much in all major economies (both advanced and emerging) in the past decade? Read more