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


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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

Fed Chair Janet Yellen Holds News Conference Following Federal Reserve Policy Meetings

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Last week, the Federal Reserve was forced to admit that it had mistakenly released the forecasts made by the board of governors’ economic staff for the June meeting of the Federal Open Market Committee. These forecasts are normally kept secret, until they are released with a five-year time lag.

This embarrassing error could not have come at a worse time for the board, since it is already under considerable pressure from Congress over the alleged misuse of public information in the recent past. Although there is no suggestion that this latest mistake involves any privileged access to secret information, it does mean that the Fed has accidentally made public much more information about its internal forecasts than it usually wishes to.

The rest of us therefore have more information than usual to work on. As this blog noted last weekend, the economic staff’s projections indicate a worryingly pessimistic view of the supply side of the US economy, with only a small output gap at present, and very low productivity growth in the future. If validated by future data, this pessimistic view will involve a much lower medium-term growth rate for the US economy than has generally been assumed by official and private economists, and eventually that might start to worry the equity markets. Read more

Although inflation in the US has been low and stable for many years, it still tends to dominate policy discussions at the Federal Reserve. At Janet Yellen’s latest press conference, “inflation” was mentioned 40 times, while “unemployment” or “employment” were mentioned 28 times. Both sides of the dual mandate are obviously given great attention, but many observers think that the Fed is too conservative in its approach to inflation, while refusing to take any risks to stimulate employment or output growth.

This judgment about the balance of risks is coming to a head now that the FOMC seems fairly likely to announce lift off for US interest rates in September. The GDP growth rate, and the strengthening in the labour market, seem consistent with an early rate rise. But the inflation rate remains well below the Fed’s 2 per cent target for headline PCE inflation, and the FOMC says it needs to be “reasonably confident” that inflation will return to target over the medium term before they can raise rates. Read more

Now that the major downside risks from Greece, China and Iran seem to be under control, investors are redirecting their attention to a much more familiar question: will the Fed impart a nasty shock to US monetary policy before the end of the year? The markets have largely ignored the Fed’s machinations since the taper tantrum in the summer of 2013, but they can do so no longer.

Janet Yellen’s testimony to Congress last week clearly signaled that the FOMC is almost ready to announce lift-off in US rates. The ides of September (or, strictly, three days later, at the FOMC meeting on 16 September) now seems likely to be the fateful date that markets have dreaded for years.

Although economic forecasters are expecting a September lift off, this starting date is still not fully priced into Fed funds futures (see Tim Duy.) What really matters, however, is whether the Fed then embarks on a medium term tightening path that persistently surprises the markets in a hawkish direction.

That is what has happened in each of the three previous tightening cycles, which were periods when fixed income traders consistently lost money by taking long positions at the front end of the yield curve. The current market pricing for forward short rates, which remains far below the Fed’s “dots” for the next three years, suggests that there is a strong possibility that this accident could repeat itself in the coming tightening cycle. Read more

When Jim O’Neill coined the acronym Bric in 2002, he brilliantly identified the main force that would drive global economic growth for the next decade. These four economies – Brazil, Russia, India and China – had little in common, except that they had the scale and growth potential to transform the growth rate of global GDP as never before. For many years, their startling performance was the main manifestation of the phenomenon that became known as “globalisation”.

When the leaders of Brics (which has included South Africa since 2010) met for their annual summit last week, however, they knew that their collective lustre had faded. The bursting of the Chinese equity bubble, following the hard landing in the real estate sector, now looms as a major downside risk for global financial markets and world economic growth. Brazil and Russia have been mired in deep recessions, taking the aggregate Brics growth rate down to only about 2 per cent in April, according to Fulcrum’s “nowcast” activity models. Although these models have identified a pick-up in recent weeks, growth in the Brics remains well below its (falling) long-term trend rate, and Markit reports that manufacturing business surveys in the emerging economies fell in June to the lowest readings since the financial crash in 2009.

Since 2010, the long run underlying growth rate of the Brics has slowed from 8 per cent to 6 per cent. This is not surprising in view of the pronounced tendency for economies to revert to their mean long-run growth rates over time. But the actual growth rate has dropped even more sharply, from 11 per cent to 5 per cent. A cyclical downturn has been built on top of a secular one.

What had once been the brightest spark in the global economy has now become its big headache. What went wrong with the Brics and can they recover? Read more

Shanghai Composite Index Rebounds To 3,700 Points On Tuesday

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The wild events in the Chinese domestic stock market in recent days have shown signs of broadening to other financial markets. Weakness in metal and oil prices, and in commodity currencies such as the Australian and New Zealand dollars, are normally reliable indicators that China is a growing global concern.

But this is more surprising on this occasion, because recent activity data suggest that the hard landing risk in China’s economy has abated. Investors have clearly become concerned that the iron control normally exerted by the Chinese authorities over the financial system is wobbling.

Both Paul Krugman and John Cochrane, from very different analytical positions, have argued that government intervention in stock markets is unlikely to succeed. In any rational world, this would be a far bigger threat to global financial stability than the Greek crisis. Yet investors with long memories will recall that a dramatic intervention in the stock market by the Hong Kong Monetary Authority in August 1998 forcefully reversed the bear market in the Hang Seng index, despite being ridiculed at the time by almost all “informed” international financial opinion.

This intervention severely damaged many macro investors and effectively marked the end of the Asian financial crisis, though the Russian crisis was still to come. Read more

The latest results from Fulcrum’s “nowcast” models of the global economy, based on data published up to last week, indicate that the dip in global economic activity that was apparent in the early part of this year has now been fully reversed. In fact, in early July the models are reporting that underlying global activity growth has risen to 3.5 per cent, which is the highest since last November, when the Chinese and US economies both embarked on a slowdown. That now appears to have been temporary, and the world economy has resumed growing at near its trend rate.

There has been a simultaneous improvement in activity growth in many regions of the world in the past two months – including in the US, the UK, Japan and China – which increases our confidence that the pick-up in activity is genuine.

However, it is noteworthy that while US activity has now re-accelerated, the euro area has slowed moderately from the firm growth (by its own standards) reported earlier in the year. Therefore a gap of almost 1 percentage point has opened up between US (2.6 per cent) and euro area (1.7 per cent) growth, after a period in which the two regions were running neck-and-neck.

Within the euro area, there has been a marked recent slowdown in Spain, which had previously been the strongest of the major European economies. It is possible that the Greek crisis has had some effects on economic confidence in Spain, as shown in recent weakness in business survey data.

In the emerging economies, recent data have been mixed, with the improvement in China offset by pronounced weakness in Brazil, Russia and some smaller Asian economies. It is too early to conclude that the slowing in activity in the emerging economies is definitively over, but the signs are improving somewhat. Read more

The deleveraging of the Chinese economy has always seemed likely to be a long and troublesome saga, lasting many years or even decades if it is to prove successful. The latest episode involves a sudden collapse in domestic “A” shares, which have dropped by 19 per cent in less than a fortnight, and have triggered what has been widely described as an “emergency” easing in monetary policy this weekend. Read more

Before last week’s FOMC meeting, there was much debate about whether the Fed would officially draw attention to the awful US productivity data that have been published lately. Both William Dudley and Janet Yellen have highlighted the problem in recent speeches, and there was speculation that some members of the FOMC might revise down their estimates for potential GDP growth at the June meeting.

In fact, however, they did not do so, preferring to sweep the problem under the carpet for at least another meeting. Instead, they focused attention on the “gradual” nature of the likely upward path for interest rates after lift-off, which now seems marginally more likely to start in December than in September 2015.

The FOMC’s range for long run GDP growth fell sharply from 2011 to 2013, but has not been changed now for about a year. Potential GDP growth depends on underlying productivity growth, and on the projected growth in the labour force, which is about 0.4 per cent per annum at present. So the Fed’s central projection of 2.15 per cent for potential GDP growth implies a productivity projection of about 1.75 per cent.

The problem, however, is that this range is not consistent with the actual productivity numbers that have been published at any stage during the present economic recovery. Since 2009, productivity has risen at an average of 1.5 per cent per annum while over the past two years it has risen at only 0.5 per cent. Normally, as a recovery matures, productivity growth should be speeding up, but that is not happening this time. At some point soon, the FOMC will need to acknowledge this. Read more


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As the Greek drama dominated news bulletins throughout the first half of 2015, there was generally little impact on global financial markets, outside Greece itself. It is true that eurozone equities underperformed the world equity market after mid April, but the euro actually strengthened over this period, and the yield spreads between peripheral eurozone bond markets and German bunds widened only slightly, at least until this week.

This general aura of market calmness had consequences for the talks themselves, since it emboldened the Germans and other EU negotiators to take an even harder line with the Syriza-led Greek government. With no hint of a concession to take back to Athens, Mr Tsipras had nothing to sell to the left of his party.

Paradoxically, the fact that the markets remained quiet for months has therefore increased the chances of a major accident taking place as political nerves fray.

The prolonged period of market insouciance should not lull any of Europe’s leaders, headed towards Brussels for an emergency summit on Monday, into a false sense of security. There is no guarantee that the markets would remain relaxed in the case of a Greek default or exit from the euro. The real test starts now. Read more


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Economists have always recognised that the long-run growth of productivity is, in the end, almost the only thing that matters for the living standards of the population as a whole. Recently, there have been significant downgrades to consensus estimates of productivity growth which, if maintained for long, would have enormous effects on the attainable level of gross domestic product per capita.

But the future impact of technology on long-run growth is one of the great unknowns — perhaps even the greatest — in economics.

An excellent example of this uncertainty occurred at the FT Business of Luxury Summit last week, in contributions from Johann Rupert and Martin Wolf. The former painted a picture of unprecedented technical advance, quoting examples from The Second Machine Age by Erik Brynjolfsson and Andrew McAfee. This book has captured the imagination by describing a future in which machine learning increases at exponential speed, rapidly replacing human skills in large parts of the economy. In a world of robot technology, driverless cars and delivery-by-drones, measured productivity growth would surely advance very quickly.

Martin Wolf, however, disagreed. He argued that the great technological advances of the 19th and 20th centuries would not be replicated in the future, so productivity growth would remain subdued, as it has been since about 2003. Sympathising with the somewhat gloomy paper published by Robert Gordon in 2012, Martin felt that the low-hanging technological fruits had already been picked, and that the period of rapid advance that ended in the early 1970s was an aberration.

Who is right? Read more