Eurozone

Marine Le Pen

Marine Le Pen  © Getty Images

The European Central Bank has been one of the two main providers of global monetary easing since 2015, and that seems likely to persist throughout 2017. Despite its continuing importance to the setting of global monetary conditions, the bank’s policy deliberations have made only little waves in the markets since deflation risks abated last year.

The eurozone economy seems to be in an increasingly healthy state, at least from a cyclical point of view, and monetary conditions appear to be normalising across the entire region. The latest rounds of asset purchases have proved more successful than previous doses, primarily because they have reduced sovereign and other credit spreads in the troubled economies, thus bringing monetary assistance to countries that needed it most. Read more

In this month’s regular update on global economic activity, the Fulcrum nowcasts have once again identified extremely strong growth rates, especially in the advanced economies. These results continue to suggest that the global economy is expanding at the fastest rate seen since 2010, with the implication that the expansion may be reaching escape velocity, where it is no longer in need of emergency support from the central banks or fiscal authorities.

However, our models have been greatly affected in recent months by the remarkable strength in business and consumer surveys. Hard economic data have also improved, but have done so by less than the surveys. This has led to doubts about the reliability of the nowcasts, especially in the US, where the official real GDP growth rate in 2017 Q1 seems likely to be well below 2 per cent for the second successive quarter.

The sluggishness of US growth based on the official GDP data is clearly influencing the Federal Reserve, which has made no upward revision to its growth forecasts in the past few months, despite the surge in the nowcasts. Furthermore, it may also have influenced the financial markets, which are starting to have doubts about the “reflation trade” in global markets.

Given the extremely large difference between surveys and hard data at present, it is important to consider which of these sources of evidence is likely to be giving the correct signal on the current pace of the global expansion. Based on past evidence, we continue to give considerable weight to the buoyant surveys, even when they conflict with the relative weakness of hard data.

A second question is whether the extremely buoyant growth rates identified by the nowcasts can be maintained into the future. The models expect these elevated growth rates to decline somewhat over the rest of 2017, but growth seems likely to remain well above trend in the AEs, with plenty of scope for upward revisions to consensus GDP forecasts.

My colleagues Juan Antolin-Diaz, Thomas Drechsel and Ivan Petrella have released a technical paper about the use of hard and soft data in nowcasting – see the latest draft attached here. The latest monthly set of Fulcrum nowcasts is attached hereRead more

It has been clear for a while that the most important political risk to global financial markets in 2017 will be the possible election of a President Marine Le Pen in the second round of the French elections on 7 May. Last week, this risk came into sharper focus when a small change in the odds of her winning the Presidency caused a sudden widening in Eurozone bond spreads, with the France-Germany spread reaching about half of the average levels seen during the euro crisis of 2011 (see graph).

Investors have now become accustomed to political shocks driven by swings towards populism, notably in the UK and the US last year. These experiences have led some investors to conclude that a third “populism” surprise is quite likely in France because “no-one can believe the polls any more”. But they have also tended to add that “Brexit and Trump did not disrupt the markets, so Le Pen would not do so either”.

Both of these inferences are wrong. The risk of a President Le Pen is far lower than the ex ante risk of Brexit or President Trump was last year, but the consequence of her winning would be far worse. This time, the “experts” are not exaggerating how bad it could be for markets. Read more

Maurice Obstfeld, the Research Director at the IMF, said last week at the IMF/World Bank Annual Meetings in Washington that global growth “remains weak”, but is “moving sideways”. That is an accurate description of the current situation compared to previous decades, according to the latest results from the Fulcrum nowcasts of global activity.

However, compared to the more recent past, a better assessment would be “solid at the trend growth rate”. Although that trend growth rate is disappointingly low, it is no longer falling (according to the models), and the actual growth rate is no longer below trend, so the global margin of spare resources in no longer increasing. 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 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 hereRead 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.)

 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

This is the latest report in our regular monthly series of “nowcasts” for global activity.

Global economic data published in November have shown a further uptick in worldwide activity growth after the significant dip that was reported after mid-year.

It now appears almost certain that the 2015 Q3 dip in world activity was not the precursor of a slide towards global recession. Instead, it seems to have been another of the minor mid-course corrections that have been a consistent feature of the moderate upswing in global activity that started in 2009.

Although the recent flow of data has therefore been somewhat reassuring about the global cycle, serious problems are still prevalent in the world economy. China has not suffered a hard landing; but severe deflation in the manufacturing sector remains unchecked, and the economy is clearly slowing as rebalancing between old and new sectors takes effect.

Most other emerging economies are now embarking on a major deleveraging cycle, and this may drag on EM growth rates for several more years. Growth in the advanced economies as a whole has been stable at about trend rates throughout 2015; but underlying productivity growth remains extremely weak by past standards. Therefore the advanced economies do not appear sufficiently robust to withstand an intensification of the EM shock, should that occur.

Overall, the global economy continues to grow below trend rates, so at some deep level the deflationary pressures in the system are not abating. However, the specific deflationary impetus from the commodity price collapse is now passing its maximum effect so recorded rates of headline and core inflation are likely to rise significantly in the next few months.

The latest data therefore confirm the conclusion reached in last month’s report: the global economy is suffering from a longstanding malaise but not from a cyclical recession. Full details of this month’s nowcasts and global industrial production data are attached hereRead more

Summary

The turbulence in the global financial markets in the past few weeks has been widely attributed to a “China shock” that has increased the risks of a major downturn in global activity. Last month, this blog concluded that our regular “nowcasts” for global activity had not yet corroborated this narrative.

This month, we have identified the first clear evidence that the global economy has slowed down since mid year, with emerging markets and advanced economies both now growing more slowly. A new factor is a clear slowdown in the US economy, though much of this appears to be due to the temporary effects of an inventory shake-out.

The Chinese economy has not shown any further signs of slowdown in September. The dominant contractionary force in the global economy is a commodity shock, which of course is somewhat connected to events in China (as it rebalances its economy away from commodity-consuming sectors), but it is not exactly the same thing.

The commodity shock is redistributing activity away from commodity producers and towards commodity consumers, both within and between countries. Eventually, the commodity shock should be net beneficial to the global economy, but so far global activity growth has dropped to only 2.6 per cent, which is 0.4 per cent below the rate in mid year, and 0.8 percentage points below trend. This means that global spare capacity is currently rising at a worrying rate.

Because the emerging markets are much more exposed to commodity producers than developed markets, they have been hard hit by the commodity shock. They are now growing at 3.5 per cent, or 1.5 percentage points below trend. It is unclear whether this growth rate is still dropping.

In the advanced economies, the growth rate in activity is about 1.7 per cent, which is roughly at trend. The slowdown identified in the US in September has been offset to some extent by signs of firmer activity in the eurozone.

An important and worrying feature of global growth in 2015 has been the large drop in global industrial production relative to services in the second quarter. This was driven mainly by weakness in industrial production in the US energy sector – not in China – and it has since been reversed. Read more

The extreme turbulence of the financial markets in August resulted in a temporary rise in the Vix measure of US equity market volatility to levels that have been exceeded on only a few occasions since 2008. Markets have now settled down somewhat, but it is far from clear whether the episode is over. In order to reach a judgment on this, we need to form a view on what caused the crisis in the first place.

The obvious answer is “China”. The response of the Chinese authorities to the stock market bubble, and the manner in which the devaluation of the renminbi was handled, raised questions about policy credibility that added to ongoing concerns about hard landing risk in the economy. The conclusion that a China demand shock was the main driving force behind the global financial turbulence was given added credence by the simultaneous collapse in commodity prices, and in exports from many emerging economies linked to China.

It would be absurd to deny that China had an important role in the crisis of August 2015. But was it the only factor involved? After all, China’s growth rate does not seem to have slowed very much. Furthermore, standard econometric simulations of the impact of a China demand shock on the major developed economies suggest that the effects should not be very large, and certainly not large enough to explain the scale of the decline in global equity prices, or in the “break-even” inflation rates built into US and European bond markets.

It is conceivable that bad news from China triggered a sudden rise in risk aversion among global investors that exacerbated the shock itself. It also possible that markets were responding to the fact that the Federal Reserve apparently remained determined to raise US interest rates before year end, regardless of the new deflationary forces that were being triggered by events in China.

New econometric work published today by my colleagues at Fulcrum suggest that the perception of an adverse monetary policy shock may have been important in explaining the financial turbulence, in which case the Fed needs to tread extremely carefully as it approaches lift-off for US rates. Read more

Mario Draghi

  © Hannelore Foerster/Getty Images

And then there were none. On Thursday, the European Central Bank became the last of the major central banks to announce a large programme of quantitative easing, involving the purchase of over €1tn of assets, mostly eurozone government bonds, in the next 18 months.

Is this the “credible regime change” which economists like Paul Krugman say is the only way that central banks can affect growth and inflation when interest rates have reached the zero lower bound? It would be too optimistic to say “yes”, but it is certainly a major philosophical shift by the conservative standards of the ECB. Originally designed slavishly on the Bundesbank model, the ECB has declared independence from its German forebears today.

But the long delays in reaching this point have made the eurozone deflation threat more severe than it need have been. Whether this belated recognition of reality is a case of better late than never, or too little too late, remains to be seen.

The markets are likely to assess the package with three litmus tests: is it big enough, are the restrictions placed on the bond purchases too restrictive, and does it matter that the decisions were far from unanimous, with the Bundesbank probably opposed to some key elements? In my view, the good clearly outweighs the bad. Read more

T
he oil price has fallen by more than half in a little over six months, and you might expect investors to be cheering. Perhaps they would have been — had the result not been a precipitous drop in inflation.

A flight to the safety of government bonds has caused yields to fall lower than they have been at any time other than the darkest days of the euro crises of 2012. Although stock markets are still only 3.5 per cent from their all time highs, they have become a lot choppier. Prices are bouncing up and down, suggesting investors have become more nervous about the prospects for economic growth. Read more

The giant Euro symbol stands illuminated outside the headquarters of the European Central Bank (ECB) on November 5, 2012 in Frankfurt, Germany (Photo by Hannelore Foerster/Getty Images)

  © Hannelore Foerster/Getty Images

The markets are waking up to the fact that the euro area faces a critical few weeks in which its economic path for 2015, and maybe for much longer, will be largely determined. Three inextricably linked events will dominate the economic landscape in January: the preliminary opinion of the Advocate General of the European Court of Justice (ECJ) on the legality of central bank bond purchases, due on January 14; the decision of the European Central Bank’s governing council on the size and type of “sovereign” quantitative easing (QE), due on January 22; and the Greek election on January 25.

At the optimistic end of the spectrum, the euro area might emerge with a more complete monetary framework that for the first time enables it to pursue monetary policy effectively at the zero lower bound for interest rates, and with the sanctity of the currency area reinforced. At the pessimistic end, the ECB could become shackled with an ineffective version of QE just when the euro area is officially entering outright deflation, and the single currency itself might become incompatible with political realities in Greece.

The outcome will also have much wider global implications. The markets have remained relatively relaxed about the likely exit of the Federal Reserve from its own zero interest rate policy in 2015, but only because the ECB and Bank of Japan are injecting more monetary stimulus. If large scale ECB action is removed from this equation, sentiment on global risk assets may darken considerably. Read more

The FT’s Martin Wolf has said almost everything that needs to be said about the global economic effects of the 2014 oil shock, but one additional point is worth emphasising. This is the fact that the US Federal Reserve and the European Central Bank view the consequences of the oil shock entirely differently. The markets have, of course, already been acting on this assumption, but the extent of the gulf between the world’s two leading central banks on this issue has been underlined by Mario Draghi’s dovish speech last month, and particularly by the Fed vice-chairman Stanley Fischer in a somewhat hawkish interview with The Wall Street Journal.

In perhaps his most significant statement since becoming vice-chairman in May, Mr Fischer made it clear that the period of low inflation due to falling oil prices will not deter the Fed from starting to raise interest rates next year. Furthermore, he suggested that the Fed might soon drop the assurance that it would not raise rates for a “considerable time”, replacing it with alternative language that is less constraining on its future actions.

It now seems likely that this language change could happen at the next Federal Open Market Committee meeting on December 16 and 17. By contrast, Mr Draghi and his supporters at the ECB clearly view the oil shock as a reason to shift policy in a more expansionary direction – if not at Thursday’s policy meeting, then sometime fairly soon. Read more

The simmering row between the European Central Bank president Mario Draghi and the German Bundesbank president Jens Weidmann is sometimes painted in personal terms, but in fact it epitomises a wider difference between the hawks and the doves on the ECB governing council. It is important to understand the anatomy of this dispute as the central bank prepares for its next critical meeting on December 4.

The dispute is fundamental and longstanding. Mr Draghi has adopted the New Keynesian approach that dominates US academia and central banking. There is really no difference between the philosophy that underpins his latest speech and that of Ben Bernanke, vintage 2011-13. In contrast, recent remarks by representative hawks such as Mr Weidmann and ECB executive board member Yves Mersch stem directly from the Austrian school of European economics. It is no wonder that these differences are so difficult to bridge. Read more

The examination is over. For more than a year the European Central Bank has been shining a light on the books of the eurozone’s banks; this weekend it reported its conclusions.

The balance sheets of 25 institutions were found wanting; the ECB concluded that they need an extra €25bn between them to be able to withstand a nasty economic surprise. Two crucial questions remain. Has enough at last been done to fix the European banking system? And will this on its own be enough to ward off the threat of deflation that is hanging over the eurozone? Read more

Tuesday’s extremely weak German industrial production figures published for August have come an awkward time for the German government. An informal “employment conference” including some EU leaders has been called by Italian Prime Minister Renzi, and it is scheduled to take place, amid little advance publicity, in Milan on Wednesday. This will presumably set the stage for the next European Council meeting on October23. In between will be the International Monetary Fund/World Bank annual meetings in Washington, when the German approach to economic policy in the euro area will be heavily scrutinised.

The official German line heading into these meetings is that the recovery is proceeding well, both in Germany and in the euro area as a whole, implying that the recent marked weakening in both gross domestic product and inflation data are just a temporary aberration. There is no sign that the Merkel administration is ready to change its longstanding formula for economic success in the eurozone: member states should stick to the fiscal targets in the Stability and Growth Pact, and should accelerate structural reforms, so that the expansionary monetary stance provided by the European Central Bank can bear fruit. Read more

Mario Draghi (DANIEL ROLAND/AFP/Getty Images)

  © Daniel Roland/AFP/Getty

Mario Draghi’s remarkable speech at Jackson Hole has raised expectations that ECB purchases of sovereign debt will be soon announced by the governing council, if not this Thursday, then perhaps by the end of the year. In all the excitement about QE, the importance of Mr Draghi’s remarks about fiscal policy have gained less attention in the markets.

Mr Draghi’s speech broke new ground for an ECB president, and this could herald a significant change in the stance of fiscal policy in the entire euro area. Unusually, fiscal policy could be as interesting for markets as monetary policy in the months ahead.

Traditionally, ECB presidents have always argued in favour of fiscal austerity, and have of course refused to countenance any form of monetisation of budget deficits. The stance on monetisation changed a few months ago, and now even the Bundesbank accepts that QE is within the terms of the treaties.

But the Germanic approach to the fiscal stance (ie the level of budget deficits, as opposed to how they are financed), is only now being seriously questioned by the ECB for the first time. Not surprisingly, this is reported to have triggered consternation in Germany, and approval in France.

Mr Draghi’s new views on fiscal policy stem from a change in his underlying analysis of the economic problem facing the euro area. This has led the ECB president to throw his weight behind a fiscal plan which is slowly emerging from the European Commission, in conjunction with France and Italy. Now that the ECB has gone public on this, the pressure on Germany to give ground has increased markedly. The debate on this subject within Germany itself is clearly becoming crucial. Read more

Although the European Central Bank took no concrete action on Thursday in the face of a decline in consumer price inflation to only 0.5 per cent in March, president Mario Draghi’s statement contained new language which has moved the goalposts for future action by the bank. By stating that the governing council is now unanimously willing to adopt quantitative easing in order to cope with prolonged low inflation, the statement substantially alleviates the risk of secular “lowflation” that has been worrying investors for some time.

To recognise the importance of this change of stance, consider what the ECB has said about QE in the past. A few years ago it tended to dismiss the option on the grounds that it was too close to direct financing of government budget deficits, and was therefore against the terms of the euro treaties. More recently, while becoming gradually less dismissive of QE on constitutional grounds, it has been unwilling to concede that unconventional monetary easing was necessary, saying that conventional measures were still available, and would be used first. Read more