In a fairly quiet week in global macro, inflation fears remained at the centre of investors’ concerns as data suggested that the UK and China are both struggling to contain price pressures. Rising inflation in the emerging world is fast becoming a headache for the global economy. The eurozone seemed to make some progress on the sovereign debt crisis. And global activity data remained encouraging. Next week, the Fed meets, and US real GDP figures for 2010 Q4 should look pretty good.
In the past week, I have learned that:
1. Inflation concerns continue to spook investors. This week, the global inflation scare was given an extra twist by a rise in CPI headline inflation in the UK to 3.7 per cent (see this blog), and generally strong activity data in China (see this one). This led investors to conclude that the authorities in both countries are “behind the curve”. Bond yields therefore continued their recent climb. Ten year yields have now risen as follows since the beginning of the year: US +14 basis points; eurozone +21 bp; UK +30bp. More interestingly, yield curves have steepened further, as long dated yields have risen particularly fast. The US spread between 2 year and 30 year yields hit a new record again this week at 400bp. However, none of this really qualifies yet as a major inflation scare, at least in the developed world. Core inflation in the US has barely budged. If this were a major scare, global equities would be falling and expectations of Fed/ECB tightening would be changing fast. They are not – yet.
2. Inflation is a more urgent problem in the emerging economies. Food and energy accounts for almost half of the CPI in emerging economies like China and India, and only around 15 per cent in the US. The emerging world is therefore facing a much more urgent need to tighten monetary policy, despite its widespread reluctance to do anything which increases upward pressure on its currencies. Last week, Brazil increased policy rates by 50 bp, and Poland joined the tightening bloc with an initial 25 bp hike. Next week, India, Russia, Hungary and Israel are expected to do the same. However, real policy rates in many emerging economies remain below zero, so policy is still extremely accommodative. There are serious questions about whether policy makers will turn a partial blind eye to rising inflation, in which case property and equity markets in some economies might enter bubble territory. And commodity prices could continue to rise, doing a lot of damage to growth and inflation in the developed world as well. This is fast becoming the most important risk facing the global economy this year.
3. For now, global economic growth remains on track. In a sparse week for news on the activity front, three business surveys for January were largely encouraging.
The German IFO index once again emphasised the current strength of Europe’s export-led manufacturing hub. The Belgian BNB survey - normally a good indicator of European (not just Belgian) economic health – rose again. And although the US Philly Fed headline index fell slightly, all of the details of the survey were very up-beat. This applied particularly to the relationship between new orders and inventories in this important manufacturing region of the US, which is also a good global lead indicator. Next week, we will see the first estimate of US real GDP in 2010 Q4. Forecasts suggest the annualised growth rate will be around 3-3.5 per cent, with (importantly) no support from inventories. Not only is the US growth rate higher than seemed likely a few months ago, its composition is better too.
4. The eurozone is making slow progress towards a March package on sovereign debt. The Ecofin meeting at the start of the week came and went without much real action. But a story in Die Zeit (subsequently denied in Berlin) indicated that some members of the German government are contemplating a bigger restructuring of peripheral debt than had hitherto been on the agenda. The focus now seems to be on an announcement at the heads of government meeting on 24-25 March. Progress is being made, but the key litmus test for this package is whether it alleviates the solvency problems of the peripheral countries, rather than simply postponing a resolution of the crisis by making further liquidity available to the troubled nations. Press reports suggest that we might get a bit of both. Anyway, markets are getting a lot more optimistic about prospects for the eurozone, with the rise in the euro being the most significant shift in the financial markets so far this calendar year.
5. The economist responsible for cheap air tickets has died. What did economists ever do for us? Well, Alfred Kahn, who died recently at 93, did rather a lot. As head of the US Civil Aeronautics Board in 1977, he scrapped many of the regulations which had until then stunted the growth of the over-priced aviation industry. He is responsible for the way the world travels today. A Democrat who sang Gilbert and Sullivan in his spare time, his economic writing on deregulation was an important prelude to Reaganism and Thatcherism. Read this lovely obituary in The Economist.
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