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In last month’s global growth report card, this blog reported that the growth in economic activity in the major economies was fairly steady at an above trend pace, though the US and China were slowing, while other major economies were accelerating. A similar pattern has emerged from the latest data.

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At the National People’s Congress in Beijing on Thursday, Premier Li set a target of about 7 per cent for GDP growth in 2015, and around 3 per cent for inflation. At present, both targets look hard to attain, especially on inflation. Economic reform remains paramount for the government, but China’s premier made clear that this could only succeed in the context of adequate growth. This will probably necessitate a progressive easing in fiscal, monetary and exchange rate policy – something that is already under way.

The Chinese renminbi’s exchange rate has weakened noticeably against the dollar in the past few weeks, raising concern that Beijing is joining the “currency wars” that are (allegedly) being waged by other major nations.

A big change in China’s exchange rate strategy would certainly be something to worry about. Not only would it mean that the deflationary forces evident in the country’s manufacturing sector would be exported to the rest of the world, it would also disrupt the uneasy truce on trade and exchange rate policy that has emerged between the US and China since mid-2014.

Fortunately, on the evidence available to date, it seems that China has changed its currency strategy in a relatively limited way, and in a manner that is difficult to criticise in view of exchange rate turbulence elsewhere in the world. Read more

February was another very strong month for global equities, with the US market enjoying its best month since October 2011. Global equities are now up by 5.1 per cent this year, exceeding even the heady pace of the 2012-14 advance, though this time the Eurozone (+ 14.7 per cent) has outpaced the US (+ 2.2 per cent).

Once again, the pessimists have been confounded. The US market has now tripled since 2009, and has risen in a virtually straight line for over three years. The analyst community on Wall Street remains almost uniformly bullish about US stock returns in 2015. Although cynics will say “they always are bullish, that is what they are paid for”, many other indicators point to extremely positive market sentiment, with active equity investors generally positioned for further upside. And the VIX measure of equity volatility, a gauge of investor concern, is languishing near its long term lows at about 13.

Has the US market finally reached the point of over-exuberance? As Warren Buffet reminds us this weekend, market timing is always difficult, and it is particularly difficult to pick the top of a rampant bull market. But there are certainly increasing grounds to worry about the sustainability of the market’s advance in the rest of this year. Read more

When Federal Reserve chairwoman Janet Yellen gives evidence to the Senate Banking Committee on Tuesday, she has an opportunity to speak above the heads of the financial markets to Congress and the American people. There is pressure in the Senate to bring the Fed under Congressional “audit”, something that almost everyone in the central bank abhors. So Ms Yellen’s main message is likely to be about how well the Fed has done in recent years, focusing on the generally good out-turns for unemployment and inflation. Read more

When the Federal Reserve starts to raise US interest rates later this year, there will be a major shift in the global monetary regime. Although San Francisco Fed President John Williams has tried to deny that this will represent a tightening in monetary conditions in America, his claim strains credulity beyond breaking point. US monetary conditions may remain easy in absolute terms but, after lift off, the direction of change will unequivocally be towards tightening.

Should investors be worried about what is likely to be only a very gradual change in Fed policy? The taper tantrum in 2013, and the flash crash in bond yields last October, were both unwelcome signals that frothy markets can over-react to very modest changes in economic fundamentals. Read more

Oil prices have rebounded by $16 a barrel since the low point was reached at $45 a month ago, and investors are already wondering whether the worst is over for the energy sector. The bear market that started in 2011 has seen a peak-to-trough decline in overall commodity prices of 46 per cent, which is almost exactly the same decline experienced in the six previous bear markets, though this one has lasted 3.7 years, compared to an average of 2.3 years (according to JPMorgan). Based on the past chronology of commodity bears, the trough is now overdue.

It will of course be impossible to pick the local bottom with any precision. Last year’s collapse in oil prices was not built into the forward markets. Nor was it predicted, even as an outside possibility, by economists and oil analysts. Few macro investors made any significant money from it, until trend-following funds entered significant short positions towards the end of the year.

The inability of economists to forecast such an important event, not just for commodity markets but for bonds and equities as well, is certainly sobering. But almost without pausing for breath, we are faced with another urgent and unavoidable question: does the bounce in oil prices in the past month herald the end of the crash? Read more

This blog presents the first in a regular series of monthly report cards on the state of global economic activity. The real time activity growth rates are derived from the latest Fulcrum “nowcasts”, based on dynamic factor models. These nowcasts, estimated by Juan Antolin Diaz and colleagues, combine a very large number of different statistical releases to identify a single growth “factor” that is assumed to be driving the economies in question.

The Fulcrum models build on the pioneering work of Lucrezia Reichlin, Domenico Giannone and others at the ECB and LBS. (Professor Reichlin’s subscription service is available here.)

As a San Francisco Fed study pointed out last week, GDP forecasts for the year ahead are not only “persistently optimistic”, but they are typically very significantly affected by the actual GDP data for the most recent quarter. Financial markets are therefore sensitive to quite small swings in activity data. It is important for investors to track the data flow, much of which is confused and contradictory, in the most efficient manner possible. We believe that factor models are helpful in doing this.

Last week, the markets shifted slightly away from pessimism about global growth, with bond yields, commodity prices and US equities all rising for the first time in quite a while. This is in line with the recent information flow, which seems to be be moderately encouraging.

A pick-up in activity in both the Eurozone and Japan is countering, and perhaps more than offsetting, a slowdown in the US. Global retail sales volume is rising strongly as oil price effects feed into consumer confidence, and manufacturing sectors seem to have eliminated the excess inventories that accumulated late last year. In the advanced economies, growth is now running at a significantly above the trend rates derived from the models. But in China, the progressive and gradual slowdown continues.

We show the recent history of results from these models, updated daily, in the graphs below. In future, this blog will update these results soon after the global PMI surveys and the US jobs data are published in the first week of each month. Read more

As global bond yields plumb new depths, an unprecedented experiment in monetary policy is underway in two small countries in Europe. By pushing policy interest rates more deeply into negative territory than ever seen before, the Swiss and Danish central banks are testing where the effective lower bound on interest rates really lies. The results are being closely watched by bond investors, and by the major central banks, which had previously assumed that the effective lower bound was close to zero.

The Danish central bank cut interest rates to -0.5 per cent last week, the third cut in the last two weeks. The Swiss National Bank cut its deposit rate to -0.75 per cent when it recently removed the ceiling on the Swiss franc.

Money market rates in Switzerland have fallen to a low of -0.96 per cent. Bond yields have followed suit, right across the curve (see graph). Those who believed that long bond yields could not go negative have had a rude awakening.

Denmark and Switzerland are clearly both special cases, because they have been subject to enormous upward pressure on their exchange rates. However, if they prove that central banks can force short term interest rates deep into negative territory, this would challenge the almost universal belief among economists that interest rates are subject to a zero lower bound (ZLB). Read more

The Federal Open Market Committee of the Federal Reserve (FOMC) will meet on Wednesday amid signs that the broad consensus among economists in favour of an interest rate increase around mid year is beginning to crumble. So far, there is no public indication that Ms Yellen and her key supporters are changing their minds, but many leading economists outside the Fed, from across the spectrum of economic thought, are now vehemently opposed to the Fed’s plan. It would not be surprising if the Yellen camp were reviewing their intended date for lift off, though we are not likely to see much evidence of this at the January FOMC meeting.

Since the last FOMC meeting in December, when Ms Yellen gave a very clear signal in favour of a June lift off, the market has moved sharply in a more dovish direction. Bond yields have continued to plummet, with break-even inflation expectations falling markedly. Furthermore, the front end of the bond market is now ignoring the FOMC’s projections for rates almost completely (see the “dots” chart on the right), in effect challenging Chair Yellen to tell them next week that they are wrong.

This is getting much more tricky for Ms Yellen. The smooth, fully anticipated, glide path towards a June lift off is now being seriously challenged, both in the markets, and among influential outside economists, who are directly accusing the Fed of complacency (here and here). But there is still some time left before the final decision has to be made. The Fed Chair will probably want to retain her option to move in June in next week’s FOMC statement but, on the other hand, is unlikely want to deliver a major hawkish shock to market opinion at this stage. This week’s meeting will be a holding operation. 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

The completely unexpected decision of the Swiss National Bank (SNB) to remove the 1.20 floor on the Swiss franc against the euro on Thursday was one of the biggest currency shocks since the collapse of the Bretton Woods system in 1971. The decision has been heavily criticised, both for its tactical handling of the foreign exchange market, and for the collapse of the centrepiece of its monetary strategy, without (apparently) any overriding cause. The credibility of a central bank that has traditionally been hugely respected by the markets has clearly been dented.

The decision has already caused severe stress and bankruptcies in the currency market, and it is far too early to judge whether this has now settled down. More importantly, the deflationary shock to the Swiss economy will be severe. And there are concerns that the failure of the SNB’s policy of unlimited market intervention may have much more profound implications for the credibility of the wider market interventions by global central banks, on which asset prices currently depend.

It is important to keep this in perspective. The SNB decision may have been driven to a large degree by the fear of losses on the central bank’s balance sheet, which are peculiar to the ownership structure of the central bank in Switzerland. Furthermore, other major central banks are not operating currency pegs, where large balance sheet losses tend to occur. Even so, this event will clearly make investors question whether the central banks can indefinitely exert as much control over the financial markets as the period of quantitative easing has suggested. 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 Brent oil price has fallen by a further 9.3 per cent in the first few days of 2015, making the total decline since mid 2014 a remarkable 56 per cent. With Saudi Arabia showing very little sign of restricting supply, economists have been scrambling to reduce their global inflation forecasts in line with the new reality in the oil market.

For investors and central bankers, two questions are dominating discussion – how much deflation will be seen in 2015, and how severe a threat does it pose to the health of the global economy? The answers are complex, because deflation is occurring simultaneously in two different varieties.

The first is “good” deflation, stemming from the huge beneficial supply shock from oil. But the second is “bad” deflation, stemming from a persistent shortage of aggregate demand in the developed economies, especially the eurozone.

At present, good deflation is definitely dominating the global picture, and this is being priced into asset markets. But the threat from bad deflation in the eurozone is still rumbling away in the background. 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

After several years in which inadequate demand has seriously constrained activity in the global economy, causing repeated downgrades to growth forecasts, 2015 should see an improvement. Lower oil prices and a more demand friendly fiscal/monetary policy mix should result in faster growth in aggregate demand. And the depressing weakness in aggregate supply, which shows no sign of any improvement, is not yet a binding constraint on global growth. This will be a year in which excess capacity in the global economy will start to be absorbed. Read more

In macroeconomics, this has indisputably been the year of Thomas Piketty. Rarely, if ever, has a single book so profoundly influenced the public discourse on a central topic, the inequality of wealth and income in the developed economies over many centuries. In an age of tweets and sound bites, the fact that a Herculean intellectual work can have such influence is surely uplifting [1].

The financial markets, however, have largely ignored the book, seeing it as outside the realm of their direct interests. This is a mistake since, whatever one might think of Prof Piketty’s policy recommendations, he has written a major treatise on the economic process that generates wealth in our societies, and that is exactly what most investors are trying to understand.

On Friday last week I was on a platform with Prof Piketty at the London Business School, and the slides from my presentation are downloadable here. The LBS does not plan to upload the video of the presentations on the web until early next year, so this blog contains my main points.

Parts of this are inevitably a bit technical. Skip to the final section for the bottom line. Much of this is still very controversial; debate is welcome.

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The financial markets saw only bad news in the oil shock last week. Despite extremely strong US consumer data, there is a reluctance to recognise the shock for what it is – a long-lasting structural change, with mostly beneficial consequences for aggregate demand in the developed economies.

As John Authers explains, weak Chinese data are causing concern, but there is little evidence that China has been the main cause of falling oil prices. Global oil demand has been fairly stable as supply has surged, and it is surely revealing that the latest oil price drop followed the Saudi decision to maintain oil output after the November OPEC meeting.

Like investors, economists have been thrown into confusion. Almost no-one in the profession (including myself) predicted the oil price collapse in advance. After the shock, it took months for oil price forecasts to be brought into line with the new reality. Futures prices in the oil market have performed no better: predicting oil prices can be a mug’s game.

More surprisingly, there has also been a disinclination to accept the potential benefits in the oil shock. Some economists have said it largely reflects an adverse demand shock in the global economy, so it is axiomatically bad news. Others have said that, even if it is a supply shock in the oil market, which would normally be beneficial, this time will be different, because it will be deflationary, and will therefore raise real interest rates.

There are some honourable exceptions, like Martin Wolf and David Wessel who have viewed it mainly as a supply shock with net beneficial consequences. But the pessimists have thrown up a lot of noise, reminding me of Professor Deirdre McCloskey’s maxim:

Pessimism sells. For reasons I have never understood, people like to hear that the world is going to hell, and become huffy and scornful when some idiotic optimist intrudes on their pleasure.

If the pessimists have a case, it is in oil producers in the emerging world, especially Russia. But, among oil importers in the developed world, it is hard to see too much of a dark side. Read more

One of the most successful rules for investors in the past few years has been never to underestimate the innate dovishness of the Federal Reserve. Whenever there has been a scare that the Fed might move in a hawkish direction, this has quickly proven to be a mistake. Forward curves for short term interest rates have consistently moved “lower for longer”, and incoming economic data have always ensured that the Federal Open Market Committee (FOMC) has remained comfortable with this tendency.

In recent months, however, the markets may have become over confident about the Fed’s dovishness in the face of a large and persistent decline in the US unemployment rate. The forward interest rates now priced into the bond market are much lower than the FOMC’s “dots” chart, which shows the interest rate expectations of individual FOMC members. Even after the market’s upward adjustment in rates following Friday’s strong labour market data, that remains the case.

The “dots” will be updated at the next FOMC meeting on 16/17 December, and it is unlikely they will be revised downwards towards the market’s view. “Normalisation” is the new buzzword. Fed Vice Chairman Stanley Fischer made it clear in an interview with Jon Hilsenrath of the Wall Street Journal last week that he believes that interest rates are far below normal, even if inflation stays low. A further upward adjustment in market rates may become necessary soon, unless inflation greatly surprises the Fed on the downside. 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

UK Chancellor George Osborne’s Autumn Statement next Wednesday will re-affirm his intention to embark on the second half of the fiscal consolidation that he started in 2010. The pause in fiscal tightening from 2012-14 will end immediately after polling day.

The Chancellor will promise large cuts in public spending relative to GDP, resulting in a budgetary tightening of over 5 per cent of GDP between 2014/15 and 2018/19. As a result of shortfalls in income tax receipts this year, spending restraint may need to last even longer into the next Parliament than previously expected. Read more