I very much regret that I have to carry on with my recent themes with some new emphasis on the clouds gathering over the US economy, albeit that relatively little news is actually due from there this week. The latest FOMC minutes will no doubt confirm the growing gulf between hawks and doves amongst the regional Fed presidents but Chair Yellen and her fellow governors have probably again tried to say as little as possible. The April CPI is the other significant US announcement and it will likely remain close to zero but the FOMC still do not seem inclined to pay much attention to it.
US economy: not in the script
One of my acerbic correspondents in the US (@smaulgld) pointed out yesterday that ‘lowering GDP estimates is a national sport now’ and indeed he deems the economy already to be in recession. There is certainly plenty of recent data to encourage caution if not downright pessimism. US economic headlines concentrate on monthly numbers and last week reported higher March retail sales but year on year growth’s falling further to a lowly 1.3% is rather ominous. Moreover, the monthly numbers have a history of being revised substantially lower as shown in the chart below.
Even more worrying from last week was a fifth consecutive monthly drop in Industrial Production, which in April was just about chugging at 1.9% year on year. The great hope remains Employment but the weight attached to the headline Non-Farm Payroll numbers is exaggerated. Currently, a debate is carrying on both as to whether US Q1 GDP is always low and also whether there were exceptional factors at work this year. Fresh from forecasting Q1 reasonably accurately, the Atlanta Fed Nowcast is predicting that Q2 is unlikely to be much better. Since these Nowcasts started in 2011 regular technical improvements are resulting in error margins of 0.7% annualised. Accordingly, for my part I am willing to accept that the latest Nowcast of 0.7% shown in the chart below means that US GDP in Q2 is running at somewhere between flat and +1.4%. Others, coyly described as ‘Blue Chip Consensus’, seem to be veering in the same direction. This is not a happy outlook and is still not in the script for many investors.
More slow boating in China
Official China data has long been viewed, along with much else in China, as being managed to reflect Socialist Realism and conformity with Party Policy but somehow the numbers still keep getting worse. Last week it was New Loans, Fixed Asset Investment, Retail Sales, Industrial Production and even Inflation (too low). This chart courtesy of China-expert George Magnus highlights the trend in recent months, with no end in sight.
China Data 2007-15
EMU: Better but don’t forget the deflator
Everyone loves a good headline and there plenty last week proclaiming that EZ GDP growth in Q1 outstripped that in both the US and the UK. There is no doubt that a solid recovery would represent good news for all concerned and maybe things really are looking up a bit but precious little mention was made of the boosting of the nominal numbers by the price deflator. This was negative throughout most of the EZ in Q1, notably so in Spain and Italy. Moreover, deflation persisted despite a fall in the EUR/USD exchange rate of 11.2% in Q1 and following a 12% drop in 2014 and while this previous euro weakness has certainly helped exports the sharp turnaround in Q2 will surely be a drag on each of GDP, Trade and Inflation. At the risk of seeming churlish, it should also be noted that both Industrial Production and Retail Sales are running at levels below 2% while Unemployment remains stubbornly above 11%. We must hope for more progress in Q2 but be prepared for some disappointment.
Meanwhile, Grexit has somehow managed to sneak off the front pages but a leaked internal IMF memorandum suggests its return very soon. The main points are:
- The negotiating process may have got easier, with Prime Minister Tsipras apparently taking more interest, but it remains ‘far from ideal’ with no direct access to ministers.
- Major concerns are deposit withdrawals (increasing dependence on the ‘Eurosystem’), non-performing loans and a deteriorating ‘payment culture’
- There has been progress on reforms to Vat, tax collection and insolvency law
- Loan repayments to the IMF in June, July and August cannot be funded without help from the rest of EMU but there has been no agreement, even on partial disbursement
- IMF staff appear to believe that debt relief is needed but they are not prepared to press other EMU countries to grant this
- The Syriza government seem determined to press on with reversing measures agreed by its predecessor on pension and labour market reforms or on laying off public sector workers.
Significantly, the memorandum seems entirely consistent with Mr Tsipras’s latest pronouncements, in particular his ‘red lines’ on pensions, wages and rehiring of public sector employees. He may or may not still believe that other EMU governments can be shamed into coughing up but they seem more interested in passing off the blame to the IMF, ECB or better still the Greeks themselves. The IMF reckons the cash will run out in June but it probably has already.
UK: Land of Hope……
….and maybe even a modest amount of economic glory as last week yet another set of strong Employment numbers and signs of renewed growth in Manufacturing and Construction after a dull Q1. Productivity is now seen as the UK’s Achilles Heel, although it is also a problem in most other advanced economies. Chancellor Osborne is likely to have something to say on the subject in his second Budget on July 8th with a major splurge on Supply Side stuff: apprenticeships, capital allowances, seed capital for new technologies and high value sectors, funding for small business, house building and Infrastructure. His Northern Powerhouse and other offers to local authorities are still not being taken sufficiently seriously but are of huge economic and social s as well as political ignificance. On the tax and welfare fronts Mr Osborne is likely to deliver his IHT pledge to ‘ordinary’ house owners while using higher CGT on the wealthiest to pay for it but both the main pain and jam are likely to be postponed.
Meanwhile, Mr Cameron seems to have plans of his own, including for the EU referendum. Having seen off UKIP with his pledge to hold it he has now while impressed his Tory Eurosceptics by being in a position to do so. Foreign Secretary Hammond, an erstwhile Eurosceptic is clearly on board with his newly emollient approach to EU Treaty changes while other ministers have at last admitted that many of the friction points can be dealt with internally. Also helpful is Andy Burnham’s offer of support, albeit with conditions, for the negotiations: a smart move by him, helpful to Mr Cameron and in the national interest.
Election post mortems are continuing and The Spectator has run two contrasting stories of quiet confidence at Tory HQ and manic delusion at Labour’s. Even with a generous pinch of salt it is hard to argue with the description of the professional expertise of the Tories’ Lynton Crosby and the smouldering divisions within Labour, which have now come to the surface. Peter Mandelson’s spoke for many in the party with the devastating comment that what Ed Miliband most lacked was an economic policy. It is hard not to sympathise personally with Mr Miliband while also remembering that those who live by the sword often die by it.
Central Banks: running out of ideas
Nobody could ever say that central banking was easy but those who try run an economy with an interventionist monetary policy end up reaping the whirlwind, as it were.
FOMC: They clearly want to raise rates not so much to tighten per se but to get some flexibility after six and a half years of near-zero rates and various QE programmes. They have, however boxed themselves by making any change ‘data dependent’ and, of course, the numbers are starting to go the wrong way. Various committee members keep sending out conflicting signals and have managed to confuse many economists, if not themselves. The Wall Street Journal has been tracking changings views on the date of the first rate hike so far in 2015 ,as shown in the chart below. Although I do not participate in the WSJ’s surveys, I would have gone with the June consensus (red) until the March FOMC but now am blue, most likely in December 2015.
PBoC: It has so far eschewed both ZIRP and ‘conventional’ QE but successive cuts to both lending and deposit rates and to the Reserve Requirement Ratio for banks do not seem to be having much effect. Bailouts of local authorities, state-owned enterprises and even private sector companies look to be the next step, which will look and feel very much like QE but only using vast accumulated reserves rather just printing money. In fact, the first bailouts have already been arranged via the state-owned banks. The PBoC is, of course, under the control of the Communist Party leadership, who seem to be willing to pursue high risk policies such as encouraging booms in real estate and shares. Sound familiar?
ECB: Never a shrinking violet, Mario Draghi is already boasting about the success of his QE programme, the mere rumour of which did indeed start the depreciation of the euro. However, in the last few weeks the euro has come roaring back, bond yields have soared and many European share prices have been hit as a consequence. Supermario is, in fact, assailed on two fronts:
- The Bundesbank (and many others) saying that QE was unnecessary and competitive currency devaluations only work in the short-term and can rebound.
- The various EMU governments creating a new existential challenge to the euro by refusing to hand over any more money to Greece despite pressure from him, the EU Commission and the IMF. Rubbing salt into the wound, the ECB itself is facing a multi-billion hit on Greek sovereign paper it holds.
MPC: It is hard to tell when Governor Carney decided doing nothing was the best monetary policy for the UK but he is surely right to leave well alone. In retrospect, he must be grateful that previous MPCs did not cut rates to zero and continue indefinitely on the QE treadmill. The election of a majority Conservative government committed to fiscal correctitude must suit him while he keeps monetary policy loose but he is also right to argue for an early resolution to continuing membership of the EU. This means that the worst criticism he faces is over poor economic forecasting. Below is the GDP chart from the latest Quarterly Inflation Report, which shows that the MPC believe growth will be in 2-3% range for the next three years but…..er….it could be as low zero or as high as 5%! The other non-shock forecast was that Inflation will eventually return to the target of 2%. Well, put like that it could just happen!