© 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

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

Leicester City fans

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.)

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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 [1].

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 [2]. 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

Just when it all seemed very bleak, the global economy has shown some tentative signs of a rebound in recent weeks. The improved data significantly reduce recession risks in the near term.

Last month, in our regular report on the results of our “nowcasts” for world economic activity, we pointed to a sharp weakening in eurozone growth, leading to new lows for global growth in the recent slowdown. The US and China both seemed to be stuck in a prolonged malaise, and the world growth rate had slumped to more than one percentage point below trend.

Furthermore, momentum was negative. Economic commentators, including the IMF and the major central banks, were warning of increased downside risks to global economic projections. In fact, they are still issuing these warnings.

This month, however, the data have failed to co-operate with the pessimists.

Global activity growth has bounced back to 2.6 per cent, compared to a low point of 2.2 per cent a few weeks back. Much of this recovery has occurred in the advanced economies, with our nowcast for the United States showing a particularly marked rebound after more than 12 months of progressive slowdown.

It would be wrong to place too much importance on a single month’s data, especially when the nowcasts are heavily influenced by business and consumer surveys.

These surveys have remained mixed, but downward momentum has been partly reversed in most advanced economies, especially in the US where the regional Fed surveys for March have been identified by the nowcast models as major upside surprises. In fact, sentiment had become so pessimistic that even slightly better data have represented positive surprises relative to economists’ expectations, according to the Citigroup Surprise Indices.

These better numbers still leave the global economy growing at 0.7 per cent below trend, so spare capacity in the world system is still rising, and long term underlying inflation pressures should therefore still be dropping.

Better, but still not very good, is this month’s verdict. Full details of this month’s nowcasts can be found hereRead more

In the past few years, China’s macro-economic strategy has largely failed to command the confidence of investors in developed markets, despite the fact that the reported performance of the economy has remained fairly impressive.

Part of the problem has been that there does not seem to have been a coherent, joined-up strategy for maintaining growth while rebalancing the economy towards consumption, and reducing overall debt levels. The policy transparency now taken for granted in the developed economies has not come naturally to the Chinese political system, as Ben Bernanke has pointed out.

China has been trying to improve on this record, in consultation with senior western advisers in some cases. In the past two weeks, there has been evidence of “glasnost with Chinese characteristics” in the economic announcements emerging from the annual meetings of the National People’s Congress.

The overall thrust of Chinese macro strategy now seems to be broadly what is needed, but the intended switch away from “zombie” manufacturing companies towards the new economy will happen only at a moderate pace, consistent with the 6.5-7.0 per cent GDP target, and with no overall rise in unemployment.

With the new strategy in place, the Chinese “landing” does not have to be a hard one, but it is still likely to be a long story, with many twists and turns before it is fully resolved. Read more

For many years, investors have been in thrall to the central banks. But recently this has started to change. In particular, the excursion into negative interest rates has caused alarm in the markets.

There is much talk that monetary policy has run out of ammunition. This talk surfaces as frequently in discussions with central bankers themselves as it does with investors. To quote the title of Mervyn King’s riveting new book, is this “The End of Alchemy?”

Last Thursday, the ECB announced a new package that included a rate cut deeper into negative territory. After initial doubts, the equity markets were impressed, because Mr Draghi had learned the lessons of past failures. The package cleverly protected the banks against the effects of negative rates, drew a line under further rate cuts, and instead included a boost to the ECB’s balance sheet that is likely to be much larger than markets initially realised (see graph below).

At the ECB, negative rates are probably now dead, but other forms of “alchemy” are still very much alive.

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Mario Draghi, ECP president  © Getty Images

Even central bankers can learn from their past mistakes. The package of measures unveiled on Thursday by the European Central Bank is an intelligent response to the criticisms levelled against it for the debacle of its previous, underwhelming easing in December, and against the Bank of Japan for its misguided experiment with negative rates last month.

The announcement by Mario Draghi, ECB president, represents just about the best effort that can be adopted nowadays to use unconventional monetary policy to restore inflation to target. It is not overly huge in scale, but is multi-faceted and well directed at the special problems plaguing the eurozone economy. Read more

A few months ago, this blog commented that a rise in inflation in the advanced economies early in 2016 was “almost certain”. Thank goodness for the word “almost”. Since then, oil prices have plumbed new depths, and the markets have remained obsessed with fears about deflation.

The case for higher inflation in 2016 rested on the fact that the impact of energy on headline consumer price inflation would change direction when oil prices stabilised. This “inevitable” arithmetic effect has been delayed by the slump in oil prices in January, but it should manifest itself in the near future.

The key question, though, is whether this automatic rise in headline inflation presages a more important turning point for underlying inflation in the advanced economies – a turning point that has been wrongly predicted for several years now.

The answer is that there are some tentative signs of a slow rise in underlying inflation in the US, where price increases have been higher than expected in recent months. In contrast, inflation rates in the Eurozone and Japan have surprised on the low side. There, fears of “secular stagnation”, leading to deflation, still seem all too real. Read more

Global risk assets have rallied in the last two weeks, encouraged by signs of policy changes in China and the US Federal Reserve, and also by buoyancy in retail sales growth in the US. While this has reduced the markets’ assessment of global recession risk, compared to the dark days in early February, the Fulcrum “nowcast” models have actually moved slightly in the opposite direction. Full details of the monthly nowcasts are available here.

The world economy is still very far from a recession, but the nowcasts show clearer signs of a slowdown in global activity growth. This probably started in early 2015, but the downward momentum has gathered pace since the beginning of 2016. The model’s estimates of global GDP growth (blue line) have declined from 3.4 per cent in late 2015 to 2.9 per cent now, a development which warrants careful monitoring.

It is clear that the advanced economies have slowed significantly since last November.

The estimated US growth rate has remained sluggish at around 1 per cent, so growth in the advanced economies has continued to decline, and is now running at only 1.0 per cent, which is markedly below trend and still dropping. It is true that some alternative estimates for US growth (including the Atlanta Fed nowcast) suggest that the growth rate may have rebounded from 1 per cent in 2015 Q4 to about 2 per cent in the current calendar quarter. But the Fulcrum models have done a good job in identifying the continuous US slowdown in the past 12 months, so their bleak message should not be discounted.

The key change this month is a further decline in the growth rate in the eurozone. This is a distinct change in the pattern identified by the models in late 2015, when the eurozone was the strongest of the major advanced blocs. This situation has changed sharply in the past two months, with the German economy becoming markedly weaker. Read more

As Paul Krugman pointed out a year ago, a sharp difference of views about US monetary policy has developed between two camps of Keynesians who normally agree about almost everything.

What makes this interesting is that, in this division of opinion, the fault line often seems to be determined by the professional location of the economists concerned. Those outside the Federal Reserve (eg Lawrence Summers, Paul Krugman, Brad DeLong) tend to adopt a strongly dovish view, while those inside the central bank (eg Janet Yellen, Stanley Fischer, William Dudley, John Williams) have lately taken a more hawkish line about the need to “normalise” the level of interest rates [1].

My colleague David Blake suggested that this blog should carry a Galilean “Dialogue” between representatives of the two camps. Galileo is unavailable this week, but here goes. Read more

China's Central Bank Governor Zhou Xiaochuan Holds A Press Conference

Zhou Xiaochuan, PBoC governor  © Getty Images

The long and detailed interview given by the People’s Bank of China governor, Zhou Xiaochuan, to Caixin Weekly on Tuesday is in one sense very un-Chinese. It provides a much more fulsome statement of foreign exchange policy, as viewed from the central bank, than anything available in the past. After months in which the governor has been conspicuously absent from the public fray, he has now chosen to go on the attack.

Mr Zhou sees the recent exchange rate crisis as out of line with economic fundamentals in China, and for that reason essentially temporary. He describes a new currency regime that is best characterised as a dirty floating regime, measured against the renminbi basket, not the dollar. “Speculative” attacks on that regime will be opposed and defeated by the central bank. In the longer term, the peg against the basket can be adjusted if fundamentals change, and the links between the two will be explained in more detail in the future.

This statement will further reduce the risk of a competitive devaluation of the renminbi in the near term. But does that mean that the China currency crisis is over? Read more

The dismal performance of asset prices continued last week, despite a rebound on Friday. There are many different forces at work, but recently the focus has turned to the weakening US economy. This weakness seems to be in direct conflict with the continued determination of the Federal Reserve to tighten monetary policy.

Janet Yellen’s important testimony to Congress on Wednesday acknowledged downside risks from foreign shocks, but overall her attitude was deemed by investors to be complacent about US growth. (See Tim Duy’s excellent analysis of her remarks here.)

Why is the Federal Reserve apparently reluctant to respond to the mounting recessionary and deflationary risks faced by the US? It is human nature that they are reluctant to admit that their decision to raise rates in December was a mistake. Furthermore, they believe that markets are often volatile, and the squall could yet blow over.

But I suspect that something deeper is going on. The FOMC may be underestimating the need to offset the major dollar shock that is currently hitting the economy. Read more