Financial markets have been adjusting to the high likelihood of another aggressive round of unconventional monetary easing by the ECB on 3 December. This will complete a remarkable metamorphosis by a central bank that has traditionally been viewed as the most conservative in the developed economies, with the possible exception of the Swiss National Bank.

Mario Draghi’s official case for extra monetary easing is straightforward. Although the Eurozone economy has performed broadly as expected in recent months, the Governing Council has decided that “downside risks” to growth and inflation have increased, largely due to events in China. As a result, it may take longer to restore inflation to the target of “close to” 2 percent, and there is a greater danger of inflation expectations breaking lower in the meantime.

This may make sense, but there is little hard evidence that these risks are actually becoming reality. Activity growth in the Eurozone has recently increased to over 2 per cent, and core inflation is rising slightly. If the situation is bad today, it was even worse a few months ago. Read more

The new Chief Economist at the IMF, Maurice Obstfeld, posed a challenging question at the end of his first major policy conference in charge last week: “Is China the new Japan?” This question has been asked before, usually in the context of the massive credit bubbles in the two economies. The deflationary lessons from Japan’s imploding bubble in the 1990s are often thought to be relevant to China’s credit bubble in the 2010s, and this story is far from over.

Maurice Obstfeld, however, had something more specific in mind. He cited the work of the late Ronald McKinnon, a distinguished international economist who argued in the 1990s that Japan was being forced into deflation by an overvalued exchange rate. That, in turn, stemmed from the political pressure exerted on Japan to correct its current account surplus by raising the value of the yen. The implied threat, notably (but not solely) from the US Congress, was that direct trade controls would be imposed on Japanese exports if the exchange rate were “artificially” held down. Read more

The latest and, so far, the most severe scare about global deflation started with the oil price collapse in mid 2014, and reached its peak with the sharp drop in global industrial production in mid 2015, swiftly followed by the Chinese devaluation episode in August. Fears of an imminent slide towards a global industrial recession haunted the markets, and both expected inflation and bond yields in the advanced economies approached all-time lows.

But, just when everything seemed so bleak, the flow of economic information changed direction. Global industrial production rallied, and China stabilised its currency. On Friday, the US jobs and wages data were much stronger than expected. Inflation data in the advanced economies have passed their low points for this cycle, and the rise in headline 12-month inflation in the next three months could surprise the markets.

This certainly does not mean that the repeated warnings of the inflationistas will suddenly be proved right. It may not even mean that long-run deflationary pressures in the global economy have been fully overcome: global growth rates are still below trend, and spare capacity is rising in the emerging world. But the peak of the latest, commodity-induced deflation scare is in the past. Read more

In this month’s regular report card on global activity growth rates, we conclude that the downward momentum identified by our “nowcasts” a month ago seems to have been arrested during October. The risk of a global recession has therefore declined recently, but growth in the emerging markets remains well below trend, and global spare capacity is continuing to rise.

Furthermore, the growth rate in activity in the US has dropped since mid year, and is now slightly below trend. Other advanced economies, especially the euro area, continue to record reasonably healthy, above trend growth rates, with some signs of a recent acceleration.

Overall, we therefore conclude that the risk of a global hard landing has diminished in the past month. However, while not in recession, the global economy does appear to be in the midst of a growth malaise, in which the “miracle” of the 2000s in the emerging world is unraveling, and productivity growth in the advanced economies has maintained its long term downtrend.

In this month’s report, we will examine the main sources of the global growth malaise in more detail. (Full results of all the latest global nowcasts are attached here. Last month’s report card, with explanations of the regular graphical layout, is attached here.) Read more

Mario Draghi surprised markets last week with an aggressively easy policy statement, even by his recent standards. No longer shackled, it seems, by the restraining force of the Bundesbank, the European Central Bank Governing Council became the first of the major central banks to react forcibly to the severe downturn now underway in many of the emerging markets. With the US Federal Reserve still expected to raise interest rates in December, the “divergence trade” in the foreign exchange markets (ie long dollar, short euro and yen) seems back in vogue.

This trade has worked well at times in the past 12 months, mainly because of the unexpectedly large programme of quantitative easing by the ECB. Up to now, the Federal Reserve has contributed very little to the policy divergence, essentially doing nothing since tapering ended a year ago this week. This would change markedly if the Fed now implements its “expectation” to tighten monetary policy in December. Read more

Janet Yellen

Janet Yellen, Fed chair  © Getty Images

This week has seen speculation about a mutiny from two members of the Federal Reserve’s board of governors against the leadership of Janet Yellen and Stanley Fischer, both of whom continue to say that they “expect” US rates to rise before the end of the year. Although “mutiny” is a strong term to describe differences of opinion in the contemplative corridors of the Fed, there is little doubt that the institution is now seriously split on the direction of monetary policy.

Furthermore, these splits could extend well beyond the date of the first rate hike to the entire path for rates in the next few years. Ms Yellen faces an unenviable task in finding a compromise path that both sides of the Federal Open Market Committee can support. Read more

After several years of moderate but sustained worldwide GDP growth, the spectre of a global recession in 2016 can no longer be completely discounted. Brazil and Russia are already suffering from eviscerating economic down-turns and the growth rates of many other emerging economies, including China, have subsided to well below trend. Although the advanced economies are still growing roughly at trend, the world economy in aggregate is now slowing and the IMF is among many to warn about a sharp increase in downside risks.

The good news is that global recessions are very rare. On the IMF’s preferred definition (ie negative growth in global GDP per capita – the blue line in the graph), there have only been four such events in the entire post war period, in 1975, 1982, 1991 and 2009. The bad news, though, is that when they do occur, they are catastrophic for financial markets and unemployment.

As Lawrence Summers has pointed out, economists are not good at predicting recessions a year in advance. Famously, Paul Samuelson said the stock market had predicted “nine of the last five recessions”. Economists, on the other hand, have predicted none of them. Recessions happen suddenly, sometimes out of a clear blue sky, and forecasters hardly ever build a severe recession into a “main case” forecast more than a quarter or two in advance. Read more

In the aftermath of the supposedly “weak” US employment data published last week, investors seem to have shifted their assessment of the likelihood of the US Federal Reserve tightening interest rates by December — and also of the extent of tightening in the next two years.

Since the data were published, several investment banks’ economics teams have ruled out a December rise. Furthermore, equities have been strong; and the bond market’s implied probability of a 25 basis points rise in the federal funds rate by December has fallen from 76 per cent in mid-September to only about 40 per cent.

Nor is this seen as a minor postponement in the first rate rise. The expected federal funds rate at the end of 2016 implies only two Fed rate hikes in total over that entire period. Clearly, investors increasingly believe that the US economy is now slowing enough to throw the Fed off course.

This big change in market opinion is, frankly, surprising. The rise of 142,000 in non-farm payrolls in September was not all that weak, given the normal random fluctuations in the monthly data. And as John Williams, president of the San Francisco Fed, has pointed out, a slowdown to a monthly rate of increase of under 200,000 was long overdue anyway. Rightly or wrongly, there is little indication so far that important Federal Open Market Committee members share the market’s increased post-jobs-data dovishness.

The crucial question is how much growth in the US has slowed since the middle of the year, and whether this will continue. This is the kind of question that economic “nowcasts” are best suited to answer, so let us examine the recent evidence. Read more


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

In her latest speech last Thursday, Janet Yellen left no further room for doubt that the vast majority of the Federal Open Market Committee supports a rate hike this year, and that she personally shares this view. They are confident that a firm recovery has now taken hold in the US. But the markets are nervous about this, believing that the emerging market shock is gathering momentum and that it could bring the developed economies down with it. What would happen if the Fed is making a historic mistake?

That was the question posed, implicitly, by the Bank of England’s Chief Economist Andrew Haldane in one of his challenging speeches on 18 September. As he points out, it is quite likely that the next recession in the developed world will arrive with interest rates still stuck close to the zero lower bound. What then? Read more

When Janet Yellen announced last week that the Federal Open Market Committee had considered, but decided against, a rate rise in September, many commentators concluded that the Fed had taken a decisive shift towards dovishness. Yet the markets, so far, have not really shared this interpretation. Since Thursday’s press conference by the chair of the US Federal Reserve, the interest rate path expected by the bond markets has dropped very slightly; but the dollar has risen and equities have remained weak.

There is little sign that investors’ assessment of the Fed’s underlying policy stance has been altered by what is increasingly seen as nothing more than a “postponement” of the almost inevitable rate hike later this year. Whatever it intended to do, the Fed has not cleared the air. Read more

After increasing relentlessly for two decades, China’s foreign exchange reserves started to decline about a year ago, and during the crisis month of August 2015 they plummeted alarmingly. Seen by many investors as a signal of waning confidence in the credibility of Chinese economic policy, a collapse in the reserves is now taken as one of the prime reasons to dump risk assets on a global basis. As the balance sheet of the PBOC shrinks, investors fear that “quantitative tightening” will be triggered in developed bond markets, and worry that a credit crunch will occur in China itself.

These concerns are not entirely without foundation but a confidence run on the renminbi is still unlikely. Much will depend on whether the Chinese authorities can shed their cloak of secrecy sufficiently to lay out a clear strategy for the reserves, the exchange rate, monetary policy and the necessary clean up in the domestic banking system. If the right strategy emerges, confidence can be restored, because China is very far from being an insolvent nation. Read more


Janet Yellen, Fed chair  © Getty Images

As the Federal Reserve’s open markets committee meets for its crucial two-day session in Washington, Janet Yellen faces her first real policy test since assuming the chair in February 2014. Amazingly, she is already almost halfway through her first term. But, so far she has had the relatively easy task of piloting the exit from quantitative easing. The exit plan had already been mapped out by Ben Bernanke, and it was not particularly contentious inside the committee.

The decision on whether to raise interest rates this week is, however, proving more divisive. Among her key lieutenants, vice-chair Stanley Fischer seems somewhat hawkish, while William Dudley has stated the case for the doves. John Williams, her successor at the helm of the San Francisco Fed, and a key ally, also seems inclined to a more dovish view than he championed earlier in the summer.

Mr Williams recently told the Wall Street Journal that he would “honestly, honestly, honestly” want to hear the opinions of his colleagues at this week’s meeting before making up his mind. Does he protest too much, I wonder? Perhaps the decision has already been taken, but the Yellen camp wants to allow the hawks a full and fair hearing before announcing that rates would remain unchanged. Read more

Global investors have been in thrall to the central banks ever since quantitative easing (QE) started in 2009 and, of course, all eyes are on the Federal Reserve this week. The Fed has now frozen its QE programme, and may raise rates sometime this year, though perhaps not as early as next Thursday. Nevertheless, global investors have been comforted by the extremely large increases in balance sheets proposed by the Bank of Japan (BoJ) and the ECB, and the overall scale of worldwide QE has seemed likely to remain sizeable for the foreseeable future.

However, in recent months, an ominous new factor has arisen. Capital outflows from the emerging market economies (EMs) have surged, and have resulted in large declines in foreign exchange reserves as EM central banks have intervened to support their exchange rates.

Since these reserves are typically held in government bonds in the developed market economies (DMs), this process has resulted in bond sales by EM central banks. In August, this new factor has more than offset the entire QE undertaken by the ECB and the BoJ, leaving global QE substantially in negative territory.

Some commentators have become concerned that this new form of “quantitative tightening” will result in a significant reversal of total central bank support for global asset prices, especially if the EM crisis gets worse. This blog examines the quantities involved, and discusses the analytical debate about whether any of this matters at all for asset prices. 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


Recent turbulence in global financial markets has been widely attributed to fears that a hard landing in China could lead to a sharp slowdown in activity growth in the rest of the world, including in the US and other developed economies. With global markets likely to be very sensitive to small changes in activity data in the months ahead, activity “nowcasts” should be a particularly useful tool for investors.

In this month’s global growth report card, we find little evidence that the feared global hard landing is actually happening, so far at least. According to the Fulcrum “nowcast” models, the global activity growth rate has remained virtually unchanged at around 3.1 per cent this month. This is around 0.4 per cent below the model’s estimate of the long run trend, and is similar to the growth rate recorded since spring 2015.

The advanced economies have continued to grow steadily, with the latest estimate of 1.9 per cent being slightly above trend (1.7 per cent), and also a little above the growth rates recorded in the spring.

On the other hand, the emerging market economies (EMs) continue to struggle, and are currently growing at 4.4 per cent, which is almost a full percentage point below trend. Commodity driven economies have, of course, been particularly badly hit. Both Brazil and Russia are still mired in deep recessions, with little sign of improvement, and Chinese activity has dipped again in August, after apparently rebounding in the aftermath of the piecemeal policy easing that was announced in April. There is no sign of much generalised improvement in activity in other emerging economies in Asia, where trade flows continue to slow sharply.

However, it is important to note that there are some isolated bright spots, including India and Korea, that have prevented a nose-dive in overall EM activity this month. Furthermore, while China has slowed, it has only done so to the extent that has happened several times in the past couple of years. The latest picture is therefore one of below trend, but not collapsing, growth rates in the emerging world. Whether the developed economies will catch the EM disease with a time lag remains to be seen but, since they should gain from the commodity shock, this is far from inevitable. Read more


> on March 5, 2015 in Beijing, China.

President Xi Jinping (L) with Chinese Premier Li Keqiang  © Getty Images

It would be easy to dismiss the recent extreme turbulence in global financial markets as a dramatic, but ultimately unimportant, manifestation of illiquid markets in the dog days of summer. But it would be complacent to do so. There is something much more important going on, involving doubts about the competence and credibility of Chinese economic policy and the appropriateness of the US Federal Reserve’s monetary strategy. These doubts will need to be resolved before markets will fully stabilise once more.

The August turbulence was triggered initially by a renewed collapse in commodity prices. For the most part, this was due to excessive supply in key energy and metals markets, and the sell-off only became extreme when there were panic sales of inventories, and a final unwinding of “commodity carry” trades. This inverse bubble was a commodity market event, not a reflection of weak global economic activity. In fact, taken in isolation, it would probably have been beneficial for world growth, albeit with very uncertain time lags.

However, that reckoned without the China factor. Activity growth in China had rebounded slightly following the piecemeal policy easing in April, but the data available so far for August suggest that the growth rate has subsided again to about 6 per cent, roughly 1 per cent below target. Although this is very far from a hard landing, it undermined confidence. Read more


  © Getty Images

For many months, as dark clouds have gathered over the Chinese economy, it has seemed obvious that the authorities might be tempted to press an escape button that has been used by all the other major economies since 2008. That button is labelled “devaluation”. Yet, until Tuesday, this temptation was stoutly resisted. Premier Li Keqiang has never seemed particularly attracted to a traditional Asian devaluation strategy. Indeed, export-led growth is the reverse of the economic rebalancing that he has always championed.

China has now clearly blinked, and the renminbi has fallen by 4 per cent in two days. However, as so often in China, it is impossible to tell from official statements whether a major regime shift has actually taken place.

The PBOC is trying to describe the devaluation as nothing more than a tactical shift to allow market forces to work more actively, thus allowing the currency to enter the SDR fairly soon. But the PBOC has also warned that the short term market moves might be quite large. They may be seeking to dress up a deliberate devaluation in the clothes of a “market friendly” reform.

If China really has pressed its own escape button, the consequences for everyone else will be far reaching. Read more

Gavyn Davies’ blog will appear only sporadically in August

According to the latest results from Fulcrum’s “nowcast models”, the global economy has continued to perform adequately in July, despite considerable doubts in the financial markets about a possible hard landing in the Chinese economy, and rising concerns about weakness in the emerging world, especially in commodity-driven, and smaller Asian, economies.

The latest growth rate in global activity is estimated to be 3.2 per cent (PPP weighted), which is roughly the same as last month’s estimate.

The advanced economies are estimated to be expanding at an annualised rate of 1.7 per cent, which is very close to trend. Meanwhile, the major emerging economies are growing at a rate of 4.6 per cent, which is about one percentage point below trend, but better than recorded a few months ago.

The gap of 2.9 percentage points between the growth rate in the emerging and advanced economies is far smaller than the 3.8 percentage point gap in the estimated long term growth rates in the two blocs, reflecting the continuing cyclical downswing in most emerging economies.

The continuing weak state of the emerging bloc remains a major headache for the world economy and global financial markets, though the risk of a global hard landing does seem to have diminished since the first quarter.

The main conundrum this month concerns the growth rate in China. On our models, which are based on a mix of official economic data and other series (like electricity and cement production, car sales, freight traffic and trade flows through harbors), China is growing at close to its 7 per cent trend. But other factors, like the weakness of commodities and of industrial production in the rest of emerging Asia, seems consistent with much weaker growth in China.

Many observers are very sceptical about the accuracy of Chinese data, especially during downturns, but an alternative explanation is that Chinese growth has recently been more concentrated in service sectors, which have lower commodity useage than manufacturing and real estate sectors. In the absence of any obviously superior sources of data, official or unofficial, our activity models are driven by the latter view. Read more