Macroeconomics

Fiscal policy activism is firmly back on the agenda. After several years of deliberate fiscal austerity, designed to bring down budget deficits and stabilise public debt ratios, the fiscal stance in the developed economies became broadly neutral in 2015. There are now signs that it is turning slightly expansionary, with several major governments apparently heeding the calls from Keynesian economists to boost infrastructure expenditure.

This seems an obvious path at a time when governments can finance public investment programmes at less than zero real rates of interest. Even those who believe that government programmes tend to be inefficient and wasteful would have a hard time arguing that the real returns on public transport, housing, health and education are actually negative [1].

With monetary policy apparently reaching its limits in some countries, and deflationary threats still not defeated in Japan and the Eurozone, we are beginning to see the emergence of packages of fiscal stimulus with supply side characteristics, notably in Japan and China.

Investors are asking whether this pivot towards fiscal activism is a reason to become more bullish about equities and more bearish about bonds, on the grounds that the new policy mix will be better for global GDP growth. This is directionally right, but it is important not to exaggerate the extent of the pivot. Read more

As investors anxiously await the key monetary policy decisions from the Federal Reserve and the Bank of Japan next week, there have been signs that the powerful rally in bond markets, unleashed last year by the threat of global deflation, may be starting to reverse. There has been talk of a major bond tantrum, similar to the one that followed Ben Bernanke’s tapering of bond purchases in 2013.

This time, however, the Fed seems unlikely to be at the centre of the tantrum. Even if the FOMC surprises the market by raising US interest rates by 25 basis points next week, this will probably be tempered by another reduction in its expected path for rates in the medium term.

Instead, the Bank of Japan has become the centre of global market attention. The results of its comprehensive review of monetary policy, to be announced next week, are shrouded in uncertainty. So far this year, both the content and the communication of the monetary announcements by BoJ governor Haruhiko Kuroda have been less than impressive, and the market’s response has been repeatedly in the opposite direction to that intended by the central bank.

As a result, the inflation credibility of the BoJ has sunk to a new low, and the policy board badly needs to restore confidence in the 2 per cent inflation target. But the board is reported to be split, and the direction of policy is unclear. With the JGB market now having a major impact on yields in the US, that could be the recipe for an accident in the global bond market. Read more

The equilibrium real rate of interest, or R* in the jargon of macro economists, has moved into the centre of the debate about monetary policy in the US. Macro investors have become very familiar with the concept over the past couple of years, because it is clear that it is driving the Federal Reserve’s attitude towards the normalisation of US monetary policy.

Recently, the frequent mention of the concept in the minutes of the FOMC has forced it into the minds of a much wider field of investors, who do not need reminding that the Fed is still the key player driving global asset prices in the medium term. Anything that matters to the Fed matters to all investors.

But many people are still confused by R*. This blog is intended to clarify the somewhat obscure, but critically important, concept of R*. It is written in a Q&A format. Read more

In last month’s report on the Fulcrum nowcasts for global economic activity, we documented a marked pick-up in growth rates in many big economies, ending a prolonged period in the doldrums. At that time, global growth was running slightly above its trend rate, and the widespread nature of this improvement led us to ask whether the world economy might be approaching escape velocity for the first time since 2010.

Although our answer to this question was “probably not”, the mere fact that we posed the question at all was seen as ridiculously optimistic by some commentators. The general view among economists seemed to rule out even a short term, cyclical upswing in activity in present deflationary conditions.

The financial markets, however, have been more hopeful that a phase of moderate cyclical growth may be taking hold, after the powerful contractionary forces of the previous 18 months have started to abate. Global equities have risen by about 6 per cent since the upswing in world activity became apparent in June, and bond returns have been slightly negative.

In August, we have received no confirmation that a cyclical upswing is gaining momentum. But nor has there been a significant decline in activity: the jury is still out

Full details of the latest nowcasts are shown hereRead more

Professor Christopher Sims

Professor Christopher Sims  © Getty Images

The most far reaching speech at the Federal Reserve’s Jackson Hole meeting last week was not the opening address by chairman Janet Yellen, interesting though it was, but the contribution on the fiscal theory of the price level (FTPL) by Professor Christopher Sims of Princeton University.

The FTPL is normally wrapped in impenetrable mathematical models, and it has therefore remained obscure, both to policy makers and to investors. But the subject is now moving centre stage, as Prof Sims’ lucid explanation makes very apparent. It has important implications for the conduct of macro-economic policy, especially in Japan and the eurozone member states.

In these countries, Prof Sims is challenging the claim that further quantitative easing can achieve the 2 per cent inflation target, without explicit co-operation with the government budget. In the US, he is disputing Ms Yellen’s assertion last week that the Fed has further unconventional monetary weapons in reserve if the economy is hit by negative shocks in the future. Read more

Several commentators (see here, here and here) have noted recently that the Federal Reserve has made a major shift in its attitude towards the future path for US interest rates. When the FOMC increased rates last December, they seemed quite confident that the 0.25 per cent hike was the first in a long line of similar increases each quarter, driven by the need to “normalise” interest rates gradually over time.

At that stage, they also seemed fairly sure that they knew what “normal” meant. Now, they seem to have lost that certainty, and have simultaneously shifted their central assessment of the “normal” level for short rates sharply downwards. This has not surprised the markets, which moved in that direction well ahead of the FOMC. But it has strengthened the conviction among investors that the doves are now firmly in control at the Fed.

Last week, Ben Bernanke released an important blog, analysing the main reasons for the FOMC’s change of view, and largely giving his seal of approval. Although the former Fed President has of course been inclined towards dovishness ever since 2008, it is significant that he views the shift as being underpinned by deep fundamental forces inside the US economy, not by minor fluctuations in incoming economic data.

Mr Bernanke is certainly right that domestic fundamentals have changed, but I think his blog has underplayed another significant reason for the Fed’s shift, which is a dawning realisation that events in foreign economies are far more important in determining the equilibrium level of US rates than has previously been accepted. In fact, this has probably been the main factor in the Fed’s U-turn this year. Until this changes, the Fed will err on the dovish side whenever a key decision is taken. Read more

The latest Fulcrum nowcasts for global economic activity have identified a broad pick-up in growth in many major regions, both in the advanced economies and the emerging markets. The latest estimate shows global activity expanding at an annualised rate of 4.1 per cent, a marked improvement compared to the low point of 2.2 per cent recorded in March, 2016.

The synchronised nature of this improvement in growth is notable. Not only have the risks of a global recession in the forthcoming months fallen sharply, there are now some early indications that the world economy could be moving into a period of above trend expansion for the first time since early 2015. Read more

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 [1]. 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 [2].

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 hereRead 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

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

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