ECB

In this month’s regular temperature check on global economic activity, the Fulcrum nowcasts identify a continuing strong and co-ordinated global expansion, with no significant signs of any meaningful reversion to trend, especially in the advanced economies. We reported a couple of months ago that the very robust rates of growth in the US and China had come off the boil, but these economies have since rebounded again, and the Eurozone has continued to record stellar rates of expansion by its own subdued standards.

Rather belatedly, the consensus growth projections published by mainstream economic forecasters have begun to reflect these strong activity reports, despite the aberrantly weak GDP data in the US in 2017 Q1. These upgrades to global growth projections break the dismal pattern of repeated downgrades that has been experienced ever since 2012.

It is unclear whether these improvements represent merely a short term cyclical recovery based on expansionary demand policy. The absence of any rise in core inflation suggests that, at the very least, supply has so far been able to match any increase in demand, though it is far too early to conclude that this will prove sustainable.

John Williams, President of the San Francisco Fed, strongly expressed the mainstream, pessimistic view about supply side growth in a good speech last month. Nevertheless, it is worth at least considering the possibility that a very modest supply side improvement may finally be underway, while recognising that the case will be unproven for a very long time to come.

The Fulcrum monthly nowcasts are attached hereRead more

Markets are becoming concerned about the central banks’ response – or rather their lack of response – to a series of inflation releases that have surprised economists on the low side recently. A few months ago, with the oil price shock of 2014-16 fading into history, it seemed that the Federal Reserve and the ECB were on a relatively smooth path towards attaining their inflation targets of around 2 per cent over the next three years. Now, that seems much less certain.

In the US, there have been three successive monthly inflation reports that have been much lower than forecast. In the eurozone, the monthly path has been bumpier, but the upshot is that core inflation has been stuck at 1.0 per cent, showing no sign of any progress towards target.

Bond markets have adjusted their inflation “breakevens” downwards. Although this has been in part driven by a widening in negative inflation risk premia, it seems to imply a loss of confidence that the global reflationary forces are gaining momentum.

When inflation surprised on the downside after the oil price collapse in 2014, the major central banks eventually responded by aggressively adding to monetary stimulus (in the case of the ECB), or by postponing the intended tightening (the Fed). This time, the central banks have completely refused to alter their planned monetary stance, and several of them – notably including the ECB – have been making more hawkish noises.

Although the drop in inflation has been very modest compared to 2014-15, some commentators have started to worry about a “Sintra pact” among global central bankers to normalise interest rates.

So what is going on, and does this new policy response spell danger for risk assets? Read more

In this month’s regular update on global activity data, the Fulcrum nowcasts have continued to report that the world economy is expanding at slightly above trend rates. As we noted last month, there have been some signs of a modest slowdown in the US, but the Eurozone, Japan and the UK have remained fairly robust. China had shown a few signs of slowing in the spring, but the most recent growth estimates have rebounded to the 7 per cent average that has been intact for several previous quarters.

There now seems to be less chance that the global economy will achieve a clear upside break in its growth rate this year, but there are no signs of a significant or broadly-based slowdown either.

As we have noted on many occasions, the global financial markets have been in a regime that has come to be known as “global reflation” since March, 2016. However, some of the elements of that regime, including rising inflation expectations in the bond markets and a firm US dollar, have clearly frayed at the edges, following a decline in the market’s confidence that a sizeable fiscal reflation package will be introduced by the Republican administration in Washington, and the publication of weak inflation reports in the US and the Eurozone.

The current market regime is probably better described as one of “global expansion” rather than “global reflation”. In retrospect, that would have been a more accurate description of the entire market regime that started last year, since this period has always been about rising real output growth, rather than rising core inflation.

The latest monthly nowcasts are presented in detail here. Read more

Marine Le Pen

Marine Le Pen  © Getty Images

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

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

As the global economy enters 2017, economic growth is running at stronger rates than at any time since 2010, according to Fulcrum’s nowcast models. The latest monthly estimates (attached here) show that growth has recovered markedly from the low points reached in March 2016, when fears of global recession were mounting.

Not only were these fears too pessimistic, they were entirely misplaced. Growth rates have recently been running above long-term trend rates, especially in the advanced economies, which have seen a synchronised surge in activity in the final months of 2016. Read more

The new UK chancellor Philip Hammond

The new UK chancellor Philip Hammond  © Getty Images

Until recently, the rate of expansion in global central bank balance sheets seemed likely to remain extremely high into the indefinite future. Although the US Federal Reserve had frozen its balance sheet, both the European Central Bank and the Bank of Japan were pursuing open-ended programmes of asset purchases, and the Bank of England actually increased its intended stock of assets by £50bn in August. Global central bank balance sheets were rising by about 2 percentage points of GDP per annum – a similar rate to that seen since 2012.

Some commentators argued that the central banks would never step aside from their programmes of balance-sheet expansion. After QE1, 2 and 3, we would get “QE infinity”. Others argued that unlimited quantitative easing would result in disaster, either through rapidly rising inflation, or bubbles in asset markets.

Neither of these dark outcomes has occurred. Instead, it seems that policy makers are moving away from QE because it is no longer effective and no longer necessary. “QE infinity” is coming to an end, not with a bang but with a whimper. 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

BELGIUM-EU-SUMMIT

Mario Draghi, ECP president  © Getty Images

Even central bankers can learn from their past mistakes. The package of measures unveiled on Thursday by the European Central Bank is an intelligent response to the criticisms levelled against it for the debacle of its previous, underwhelming easing in December, and against the Bank of Japan for its misguided experiment with negative rates last month.

The announcement by Mario Draghi, ECB president, represents just about the best effort that can be adopted nowadays to use unconventional monetary policy to restore inflation to target. It is not overly huge in scale, but is multi-faceted and well directed at the special problems plaguing the eurozone economy. Read more

A few months ago, this blog commented that a rise in inflation in the advanced economies early in 2016 was “almost certain”. Thank goodness for the word “almost”. Since then, oil prices have plumbed new depths, and the markets have remained obsessed with fears about deflation.

The case for higher inflation in 2016 rested on the fact that the impact of energy on headline consumer price inflation would change direction when oil prices stabilised. This “inevitable” arithmetic effect has been delayed by the slump in oil prices in January, but it should manifest itself in the near future.

The key question, though, is whether this automatic rise in headline inflation presages a more important turning point for underlying inflation in the advanced economies – a turning point that has been wrongly predicted for several years now.

The answer is that there are some tentative signs of a slow rise in underlying inflation in the US, where price increases have been higher than expected in recent months. In contrast, inflation rates in the Eurozone and Japan have surprised on the low side. There, fears of “secular stagnation”, leading to deflation, still seem all too real. Read more

Global risk assets have rallied in the last two weeks, encouraged by signs of policy changes in China and the US Federal Reserve, and also by buoyancy in retail sales growth in the US. While this has reduced the markets’ assessment of global recession risk, compared to the dark days in early February, the Fulcrum “nowcast” models have actually moved slightly in the opposite direction. Full details of the monthly nowcasts are available here.

The world economy is still very far from a recession, but the nowcasts show clearer signs of a slowdown in global activity growth. This probably started in early 2015, but the downward momentum has gathered pace since the beginning of 2016. The model’s estimates of global GDP growth (blue line) have declined from 3.4 per cent in late 2015 to 2.9 per cent now, a development which warrants careful monitoring.

It is clear that the advanced economies have slowed significantly since last November.

The estimated US growth rate has remained sluggish at around 1 per cent, so growth in the advanced economies has continued to decline, and is now running at only 1.0 per cent, which is markedly below trend and still dropping. It is true that some alternative estimates for US growth (including the Atlanta Fed nowcast) suggest that the growth rate may have rebounded from 1 per cent in 2015 Q4 to about 2 per cent in the current calendar quarter. But the Fulcrum models have done a good job in identifying the continuous US slowdown in the past 12 months, so their bleak message should not be discounted.

The key change this month is a further decline in the growth rate in the eurozone. This is a distinct change in the pattern identified by the models in late 2015, when the eurozone was the strongest of the major advanced blocs. This situation has changed sharply in the past two months, with the German economy becoming markedly weaker. 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

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

LATVIA- EU-SUMMIT

  © Getty Images

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

Downturn In Oil Prices Rattles Texas Oil Economy

  © Getty Images

Ever since the collapse in oil prices started last summer, the behaviour of the global economy and financial markets has been heavily affected by the consequences of lower energy prices. Now, however, there is gathering evidence that the primary effects of the oil shock have been absorbed into the system, and there are signs that other forces are beginning to take control. What are these forces, and how will they affect the global economy in the months ahead?

When the oil shock reached its maximum early in 2015, economists were largely agreed on its likely impact. Since it seemed to stem mainly from the supply side of the oil market, not the demand side (a fact corroborated by IMF research last week), it was thought likely to boost real global GDP growth this year by about 0.5-0.75 per cent, leading to a break-out in global growth to the upside. It also had a dark side, increasing the deflation threat in the eurozone and Japan, but this was likely to be offset by further aggressive monetary easing by their respective central banks. Read more

The Federal Reserve Begins Last Meeting Of 2008

  © Getty Images

When the Brazilian finance minister Guido Mantega complained that the Federal Reserve was waging a currency war against his country in September 2010, his comments led to a wave of sympathy and concern. The Fed’s aggressive monetary easing was causing a capital flight from the US into the apparently unstoppable emerging markets.

Uncompetitive exchange rates and domestic credit booms in the EMs were the result of US quantitative easing. American monetary policy makers showed little sympathy, arguing that the US had its own domestic inflation and unemployment mandates to worry about. If the dollar fell in the process, so be it.

That episode proved short lived. The Brazilian real is now a chronically weak currency. Yet the term “currency wars” has stuck. It is now alleged that almost all the major central banks are engaged in weakening their currencies, if not against each other then certainly relative to commodities, goods and services. Read more

Mario Draghi

  © Hannelore Foerster/Getty Images

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

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

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

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

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

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

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

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

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

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

Mario Draghi

  © CARLO HERMANN/AFP/Getty Images

Last week’s press conference by ECB President Mario Draghi left the markets disappointed and somewhat perplexed about the shift towards quantitative easing that had just been sanctioned by the governing council (GC). Because this was focused on private sector assets, in the form of asset backed securities and covered bonds, there were doubts about whether the new policy could be implemented in sufficient size to deal with the deflationary threat in the euro area.

Mr Draghi was noticeably hesitant about giving any firm indication about the likely scale of the programme. Although private sector quantitative easing (QE) is likely to suit the needs of the euro area rather well, as I argued here, the absence of any firm guidance on scale certainly undermined the beneficial announcement effects of the policy change.

The ECB president addressed this issue on Thursday in an appearance at Brookings in Washington. This time, freed from the need to speak for the entire GC, he clearly changed his tune on the scale of the programme. But this highlighted the extent of the gap between his view and that of Bundesbank President Jens Weidmann, who presented his position in a revealing interview with the Wall Street Journal on Monday. It is far from obvious how this disagreement will be bridged. Read more