US economy

The financial markets have begun to wake up to the fact that the Republican reforms to US corporate taxation will probably include important new “border adjustments” to the definitions of company revenues and costs. The basic idea is that US should shift to a “territorial” system, with corporations being taxed only on revenues and costs incurred within the US itself, and not on their worldwide aggregates, which is the principle behind the present system. [1]

A border tax was not explicitly part of the Trump platform before the Presidential Election. It was, however, included in the tax plan published last year by Paul Ryan in the House of Representatives, and Mr Trump has recently tweeted that companies that do not “make in USA” can expect to “pay big border tax”. That might be compatible with the Ryan plan, though it also might not be.

Although most other countries already operate “territorial” systems, the Republican plan includes other features that would make the new tax regime operate like a tariff on imports into the US, combined with a subsidy on many exports from the US, a combination that would have profound international economic consequences.

This is not just an obscure change to the details of America’s corporate tax code. It would be seen by trading partners as a protectionist measure that could disrupt world trade.

The direct effects of a border tax adjustment to the US corporate tax regime would be likely to raise American inflation, cut imports, boost exports and raise tax revenue, possibly by over $1.2 trillion over a decade. However, it would also raise the dollar’s exchange rate, which could offset or cancel out some of these other effects.

The impact on real GDP and employment would depend on how these effects panned out, and how the Federal Reserve reacted to the increase in inflation. It cannot be assumed that the effects would be beneficial. Recent estimates by Michael Gapen and Rob Martin at Barclays Capital suggest that the first year effects would be to raise US inflation by about 0.5-1 per cent, and to reduce real GDP by 1.0-1.5 per cent.

Given these economic effects, it is very doubtful whether this form of border tax, taken in isolation, would be good for the overall equity market, though other planned reforms to the corporate tax regime (including lower marginal tax rates, and full deduction of capital spending in the first year) certainly would be. Read more

Exactly a year ago this week, the mood in the financial markets started to darken markedly. As 2015 had drawn to a close, financial markets had seemed to have weathered the first increase in US interest rates since 2006 in reasonable shape. The Federal Open Market Committee had telegraphed its step to tighten policy in December 2015 with unparalleled clarity. Forewarned, it seemed, was forearmed for the markets.

Meanwhile, China had just issued some new guidance on its foreign exchange strategy, claiming that it would eschew devaluation and seek a period of stability in the RMB’s effective exchange rate index. This had calmed nerves, which had been elevated since the sudden RMB devaluation against the dollar in August 2015.

A few weeks later, however, this phoney period of calm had been completely shattered. By mid February, global equity markets were down 13 per cent year-to-date, and fears of a sudden devaluation of the RMB were rampant. It seemed that the Fed had tightened monetary policy in the face of a global oil shock that was sucking Europe and China into the same deflationary trap that had plagued Japan for decades. Secular stagnation was on everyone’s lips.

We now know that the state of the global economy was not as bad as it seemed in February, 2016. Nor was the Fed as determined as it seemed to tighten US monetary conditions in the face of global deflation. And China was not set upon a course of disruptive devaluation of the RMB. Following the combination of global monetary policy changes of February/March last year, recovery in the markets and the global economy was surprisingly swift.

A year later, the key question for global markets is whether the Fed and the Chinese currency will once again conspire to cause a collapse in investors’ confidence. There are certainly some similarities with the situation in January 2016. The Fed has, once again, tightened policy, and China is battling a depreciating currency. But there are also some major differences that should protect us this time. 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 global markets remained in reflationary mode for much of last week, a regime that has now persisted for many months. Led by the US, bond yields have been rising, mainly because inflation expectations are on the increase. Risk assets have been performing adequately, with the exception of the emerging markets.

This reflationary regime has been driven by much stronger global economic activity since mid-2016, and latterly by a belief that Donald Trump’s election victory will lead to US fiscal easing, along with the possibility of the “politicisation” of the Federal Reserve, implying overly accommodative monetary policy.

There are various ways in which this regime could end. The world economy could suddenly go back to sleep, as it has on many occasions since 2009. The US fiscal easing could become bogged down in the Washington “swamp”. Or the Fed could become unexpectedly hawkish, stamping on the first signs of inflationary growth in the American economy. This last risk is probably under-estimated, and is worth considering in detail. Read more

The response of the financial markets to the US election result has been almost as contradictory as the rabble rousing campaign of the President-elect himself. Unmitigated gloom in the hours after the Trump victory was swiftly followed by a euphoric atmosphere in US markets.

Investors are apparently assuming that the new administration will usher in a mix of fiscal reflation, prudent monetary policy, deregulation and tax cuts that will prove very good for the American economy. Trade controls are seen as damaging the emerging economies, but not the US. A steeper yield curve is seen as reflecting a “better” mix between fiscal and monetary policy.

With one very graceful acceptance speech, Donald Trump has suddenly morphed into Ronald Reagan in the markets’ consciousness. Read more

Hillary Clinton and Donald Trump

Hillary Clinton and Donald Trump  © Getty Images

Presidential elections have often marked major changes in American attitudes towards fiscal policy.

The arrival of President Kennedy in 1960 represented the beginning of Keynesian fiscal activism. President Nixon’s election in 1968 marked the high point of inflationary budgetary policy designed to finance the Vietnam War.

President Clinton in 1992 ushered in a period in which the reduction of public debt was paramount. The elections of President Reagan in 1980, and George W. Bush in 2000, marked eras in which tax cuts took precedence over budget balance, and counter-inflation policy was ceded to the Federal Reserve.

As the 2016 election approaches, investors are wondering whether another major change in the approach to fiscal policy is in the works. Is a lurch towards fiscal stimulus the “next big thing” in Washington? Possibly, but I am not convinced. Read more

Maurice Obstfeld, the Research Director at the IMF, said last week at the IMF/World Bank Annual Meetings in Washington that global growth “remains weak”, but is “moving sideways”. That is an accurate description of the current situation compared to previous decades, according to the latest results from the Fulcrum nowcasts of global activity.

However, compared to the more recent past, a better assessment would be “solid at the trend growth rate”. Although that trend growth rate is disappointingly low, it is no longer falling (according to the models), and the actual growth rate is no longer below trend, so the global margin of spare resources in no longer increasing. 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

Janet Yellen in December announcing the Fed's first rate rise since 2008

Janet Yellen in December announcing the Fed's first rate rise since 2008  © Getty Images

This blog has barely commented on the Federal Reserve’s thinking in the past few weeks, which is unusual. It probably indicates that the Fed has temporarily disappeared from the centre of the markets’ focus, as the probability of a June rate hike has receded. Even the earlier hawks among the analyst community have been sharply reducing the number of rate hikes to be expected this year.

The Federal Open Market Committee has not entirely given up on June, as these statements from Dennis Lockhart, the Atlanta Fed president, and John Williams of the San Francisco Fed indicate. But since the latest employment report, which was widely taken to have dovish implications, there has been no attempt among the inner circle surrounding Janet Yellen to prepare the market for a shock.

The most recent evidence for this is the important interview with Bill Dudley, head of the New York Fed, by Binyamin Appelbaum at the New York Times. Tim Duy, a professor at the University of Oregon and close Fed watcher, rightly says this is a “must read”, but it has created remarkably little interest in the markets. Since this is the first detailed piece of analysis from the heart of the FOMC for some time, it is worth taking careful note of the main points that Mr Dudley raises. Read more

Most investors have been able to muster only two cheers for the year that has just ended.

In 2015, the performance of the main asset classes just about managed to maintain the broad pattern that has been seen since the equity bull market started in March 2009 but there are now definite signs of market fatigue. And although some major trends were obvious in retrospect — weak oil prices, falling euro, rising dollar, tumbling emerging currencies – they recorded sharp reversals that many macro investors failed to navigate in real time.

Global equities returned about 2 per cent in local currency terms [1], less than in recent years. In dollar terms, returns were slightly negative and market peaks in May 2015 have not yet been re-attained. A top may be forming, but as yet there is little sign that a major bear market trend has started.

Government bonds returned about 1 per cent, defying widespread predictions of a trend reversal, and yields were almost exactly flat during the year. Commodity prices plummeted by 33 per cent, continuing the crash that started in mid 2014, and they eventually took credit markets down with them. US high yield securities, for example, returned -9 per cent in 2015. Emerging markets (with the perplexing exception of Chinese equities, the best performing of the major markets) were also hit by the commodity melt-down and generally continued to under-perform developed market assets, in equities, credit and currencies.

Overall, then, the magic mix of moderate gross domestic product growth combined with extremely easy monetary conditions has continued to work in the developed markets. However, overall global asset market returns (bonds plus equities in local currencies, equally weighted) were only about 1.5 per cent, suggesting that some of the magic is wearing thin.

Looking ahead, it seems likely that 2016 will, at best, see similarly low asset returns. That, anyway, is overwhelmingly the consensus central view among mainstream forecasters. But as the bull market matures, it seems inevitable that one year soon we will experience a major setback to asset prices. Will 2016 be that year? Read more

This is the latest report in our regular monthly series of “nowcasts” for global activity.

Global economic data published in November have shown a further uptick in worldwide activity growth after the significant dip that was reported after mid-year.

It now appears almost certain that the 2015 Q3 dip in world activity was not the precursor of a slide towards global recession. Instead, it seems to have been another of the minor mid-course corrections that have been a consistent feature of the moderate upswing in global activity that started in 2009.

Although the recent flow of data has therefore been somewhat reassuring about the global cycle, serious problems are still prevalent in the world economy. China has not suffered a hard landing; but severe deflation in the manufacturing sector remains unchecked, and the economy is clearly slowing as rebalancing between old and new sectors takes effect.

Most other emerging economies are now embarking on a major deleveraging cycle, and this may drag on EM growth rates for several more years. Growth in the advanced economies as a whole has been stable at about trend rates throughout 2015; but underlying productivity growth remains extremely weak by past standards. Therefore the advanced economies do not appear sufficiently robust to withstand an intensification of the EM shock, should that occur.

Overall, the global economy continues to grow below trend rates, so at some deep level the deflationary pressures in the system are not abating. However, the specific deflationary impetus from the commodity price collapse is now passing its maximum effect so recorded rates of headline and core inflation are likely to rise significantly in the next few months.

The latest data therefore confirm the conclusion reached in last month’s report: the global economy is suffering from a longstanding malaise but not from a cyclical recession. Full details of this month’s nowcasts and global industrial production data are attached hereRead 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

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

Summary

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

US-ECONOMY-BANK-RATE

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

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

 

> 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

Global Growth Report Card, June 2015

According to Fulcrum’s “nowcast” factor models, global economic activity has improved significantly in the past month, with data from China and Japan recording stronger growth than has been seen for some time.

The eurozone remains fairly robust (if only by its own rather unimpressive standards), but the US has failed so far to bounce back from a sluggish first quarter, even after the strong jobs report last Friday. There have been further downward revisions to forecasts for US GDP growth in the 2015 calendar year, including notably by the International Monetary Fund. This will be yet another year in which US growth has failed to match the optimistic expectations built into consensus economic forecasts at the start of the year.

Despite some lingering doubts about the US, the improvement in global growth this month has significantly reduced the tail risk that the world might be heading towards a more serious slowdown. The reduced risk of a more severe global slowdown, along with signs of a bottoming in headline inflation in most economies, has probably been a factor behind the sell-off in bond markets in recent weeks, as the perception of global deflation risks has faded.

The regular proxy for global activity that we derive from our “nowcast” factor models (covering the main advanced economies plus China, see graph on the right) shows that activity growth is now running at 3.5 per cent, which means that the slight dip in the growth rate that we identified around March/April has now been eliminated. Although the “recovery” in growth is only around 0.7 per cent from the low point, it is nevertheless significant because it suggests that the risk that a hard landing in China could drag the world economy into a more severe downturn has diminished, at least for now. Read more

Ever since the crash in 2008, the central banks in the advanced economies have had but one obsession — how to set monetary policy to ensure the maximum growth rate in aggregate demand. Interest rates at the zero lower bound, followed by a massive increase in their balance sheets, was the answer they conjured up.

Now, those central banks contemplating an exit from these policies, primarily the US Federal Reserve and the Bank of England, are turning their attention to the supply side of their economies. When, they are asking, will output reach the ceiling imposed by the supply potential of the economy?

The Bank of England has been in the lead here, with the Monetary Policy Committee recently conducting a special study of the supply side in the UK. Its conclusion was that gross domestic product is now only 0.5 per cent below potential, which implies that tighter monetary policy will soon be needed if GDP growth remains above potential for much longer.

In the US, the Fed has been much less specific than that, but the unemployment rate has now fallen very close to its estimate of the natural rate (5.0-5.2 per cent). Sven Jari Stehn of Goldman Sachs has used the Fed staffers’ supply side models to calculate that their implied estimate of the US output gap may be only 0.6 per cent, not far from the UK figure.

If the UK and US central banks were to act on these calculations, the implication would be that they no longer hold out much hope that they can ever regain the loss in potential output that has occurred in the past decade, relative to previous trends. That would be a massive admission, with an enormous implied sacrifice in future output levels if they are wrong. It would also be very worrying for financial assets, since it would draw the market’s attention to a downgrade in the Fed’s estimation of the long-run path for GDP. Read more