Category Archives: Global Economics

Central banks – A muted second inflexion point

Market focus has shifted from elections to central banks’ next steps

Financial markets, having digested the result of parliamentary and/or presidential elections in the US, Austria, Netherlands, France and UK and expecting German Chancellor Angela Merkel to win a fourth consecutive general election on 24th September, have turned their focus to global central bank policy. Specifically, it has centred on the possibility of tighter interest rate policy in developed economies in the form of rate hikes and/or modifications to central bank balance sheets or quantitative easing programs.

 

End-2016 proved to be an important inflexion point for global central bank policy

Up until the summer of 2016, developed central banks were still very much in monetary easing mode, with the exception of course of the Fed which had hiked its policy rate 25bp in December 2015. But eight years of ultra-low (and in some cases negative) central bank policy rates and expansive bond-buying programs had helped stabilise global growth and inflation, albeit at low levels. At the same time, the costs of ultra-loose monetary policy, including asset price bubbles, distortions in bond markets, pressure on the banking sector and even rising inequality, had started to outweigh the benefits.

This led to me to forecast that major central banks may refrain from loosening monetary policy further and that the ECB and BoE would keep the modalities of their QE programs broadly unchanged near term. At the very least I expected central bank policy rate cuts to become increasingly less frequent than in the past and that the world’s most influential central bankers would start tweaking a discourse which had in recent years largely focused on doing “whatever it takes” (see Global central bank easing nearing important inflexion point, 16 September 2016).

At the same time I argued that bar the Fed and possibly a handful of emerging market central banks still fighting weak currencies and high inflation, no major central bank was likely to hike policy rates or tighten monetary policy in the remainder of 2016 – that was a story for 2017, at the earliest.

 

This scenario has largely materialised, with the exception of the Reserve Bank of New Zealand delivering a final 25bp rate hike in November 2016.

  • Since then no developed central bank has cut its policy rate with a GDP-weighted average of policy rates bottoming out and more recently inching higher (see Figure 1).

 

olivier desbarres cb update fig 1

 

  • The only major central banks to have cut rates are the Central Bank of Russia and Banco Central do Brazil (see Figure 2). In May and June 2017 no major central bank cut its policy rate – the only other time this has happened in the past four years was in December 2016.

 

 

  • Central banks in Turkey and Mexico, in the face of still high inflation, have hiked their policy rates 50bp and 225bp respectively since August 2016.
  • The US Federal Reserve has already hiked rates 50bp this year and there has been growing talk of the Fed shrinking the size of its balance sheet.
  • This week the Bank of Canada hiked its policy rate (25bp) for the first time in nearly seven years.
  • Three out of eight members of the Monetary Policy Council of the Bank of England dissented in favour of a 25bp rate hike at the June policy meeting.
  • The European Central Bank has adopted a marginally more hawkish language in recent months. There is mounting expectation that the ECB will announce as early as September an extension of its quantitative easing program beyond-2017 but also a gradual tapering of the monthly amount of bonds purchased (from €60bn currently), with QE ending fully in late 2018 or early 2019.

 

This has led to growing speculation that we have reached a second inflexion point in developed central bank policy and one which could be sharp enough to dislocate global growth and asset markets, particularly in emerging economies. But financial markets, at present, expect only very marginal policy tightening by developed central banks. Specifically:

  • US Federal Reserve: Markets have all but priced out a September hike and are pricing in only another 12bp of hikes by year-end (i.e. a 50% probability of one more 25bp hike this year)
  • Bank of England: 12bp of hikes priced by year-end (i.e. a 50% probability of one hike this year)
  • Reserve Bank of Australia: No hikes priced in for the remainder of the year and only 15bp of hikes priced in for the next 12 months.
  • Bank of Canada: One more 25bp hike priced for this year.

This skinny market pricing of policy rate hikes is appropriate, in my view. At a global level, there are signs that GDP growth may have plateaued in Q2 2017 at around 3.1-3.2% year-on-year (see Figure 3), as I argued in H2 2017: Something old, something new, something revisited (23 June 2017).

 

 

Moreover, inflationary pressures remain muted in developed economies. Headline CPI-inflation in both developed and emerging market economies steadily rose between end-2015 and early 2017 but has since fallen (see Figure 4).

 

 

Perhaps more importantly, core CPI-inflation, which strips out food and fuel prices, has risen in emerging markets but after having flat-lined for years in major developed economies has in recent months dipped lower (see Figure 5). Only in the UK has core CPI-inflation risen and this is mainly attributable to higher imported inflation fuelled by the collapse in Sterling following the 23rd June 2016 EU referendum.

 

 

Moreover, in the US and Australia positive employment growth and very low unemployment rates continue to go hand in hand with only modest growth in real wages, while in the UK real wages are falling – an issue which I first identified in The common theme of low-wage growth, 10 February 2017). The inability of workers to command larger increases in nominal wages is acting as a break on both inflation expectations and consumer demand, and in turn is likely to curb underlying inflation going forward, in my view.

 

Bank of England – Policy rate to remain on hold in August and potentially rest of the year

The weakness of the UK economy and uncertainty associated with the Brexit process are high enough hurdles for the Bank of England (BoE) to refrain from hiking policy rates any time soon (see UK: Land of hope & glory…but mostly confusion, 7 July 2017).

I maintain my view that the BoE’s eight-member MPC is unlikely to hike its policy rates of 0.25% at its August meeting. While I expect MPC member Andrew Haldane to join Michael Saunders and Ian McCafferty in voting in favour of a 25bp hike, new member Silvana Tenreyro is likely to vote in favour of no change which would result in a 3 versus 5 vote in favour of rates remaining on hold. Importantly, I believe that Governor Carney – who has the casting vote in the event of a 4 versus 4 tie – will again vote for no change, even if he has had a tendency to blow hot and cold.

 

US Federal Reserve – Skip September meeting, keep December alive?

The US Federal Reserve has hiked its policy rate 50bp year-to-date but markets, which are pricing only 12bp of hikes for the remainder of the year, are clearly divided as to whether FOMC members will stick to their end-2016 forecast that three hikes would be appropriate in 2017. My core scenario remains that the Fed will not hike rates again in 2017 although this is a modest conviction call. While the labour market is inching towards full-employment, measures of US core inflation have fallen as pointed out by a number of FOMC members, including Chairperson Janet Yellen (see Figure 6).

 

 

The Reserve Bank of Australia has given every indication that it will remain pat on interest rate policy for the foreseeable future and while the Bank of Japan is prone to tweaking inflation targets and yield targets I do not foresee major policy changes at this juncture.

 

Olivier Desbarres

Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.

Politics suspected of interfering with economics and markets

In the US, political intrigue, seemingly lifted straight out of a John Le Carré novel, has reached a crescendo and there are now multiple investigations running concurrently.

If we assume these investigations will run over weeks/months, the question is whether and to what extent this political backdrop is likely to impact financial markets, US government policy-making, the US and global economy and Federal Reserve monetary policy.

US equities have corrected lower, volatility has spiked and markets are seemingly ignoring positive data surprises

It has all been rather orderly so far but it is difficult to see how at this juncture, with major policy initiatives likely kicked down the road, US equities can launch another meaningful rally. If anything big data misses are likely to further pressure stocks. 

The Dollar’s performance has been mixed in the past month, posting its biggest loss against the euro in line with the fundamentally bullish euro view I expressed in December and April.

Capital inflows into the eurozone allied to a 2% of GDP current account surplus, a pick-up in economic activity and receding political risks following the French presidential elections are likely to extend the euro’s current rally near-term.

However, the ECB’s stance on its quantitative easing program will be key in shaping the euro’s medium-term path.

US economic indicators paint a blurry picture while solid global GDP growth is seemingly struggling to make further gains.

The Fed and US rates market have the unenviable task of making sense of these macro trends and a quickly changing political landscape.

The apolitical Fed will of course stay above the political fray, even if markets do not with pricing for the probability of a 25bp hike at the 14th June policy meeting continuing to oscillate between 60% and 75%.

My core scenario is that the Fed will hike rates only once more in 2017 although I acknowledge that this is not a high conviction call. The market seems still on the fence, pricing in a further 32bp of hikes in the remainder of the year.
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US, UK and global GDP growth update – Put the champagne on ice

US GDP data weakest of a disappointing lot

Data released today show that Q1 2017 real GDP growth:

  • In the US slowed to 0.7 quarter-on-quarter (qoq) annualised, from 2.1% qoq in Q4 2016 – the weakest growth rate in three years (see Figure 1);
  • In the UK halved to 0.3% qoq – the weakest growth rate in a year;
  • In France slowed to 0.3% qoq from 0.5% qoq in Q4 2016; and
  • In Spain rose to 0.8% qoq from 0.7% qoq in Q4 2016.

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The common theme of low-wage growth

Weak wage growth runs through the many themes which markets are focussing on

The media and financial markets have tried to make sense of a number of key themes in the past twelve months, including:

  • The only modest rise in GDP global growth, major central banks’ reluctance to tighten monetary policy and the Fed’s glacial pace of rate hikes despite the improvement in the US labour market ;
  • Donald Trump’s surprise election victory in the November US presidential elections;
  • The Brexit referendum vote in the UK; and
  • The rise of nationalism and populism in Europe.

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Tradespotting: Choose protectionism. Choose higher inflation. Choose weaker trade and growth

The future of global trade, which has slowed despite a pick-up in global GDP growth, is hogging the headlines, with the spotlight on both the US and UK.

US President Trump and his team have so far focused on (1) substituting US imports for domestic production, with Trump adopting a carrot-and-stick approach (2) trade in goods, particularly manufactured goods and (3) trade with China and regional trading partners and in particular Mexico.

There is in theory nothing irrational in President Trump wanting to boost domestic production and exports, narrow the $500bn trade deficit and spur US employment.

However, his current approach may in practise fall well short of delivering the improvement in US trade and jobs which he seeks. In a more extreme scenario, his tactics could at least in the near-term lead to higher US inflation and weaker trade, creating headwinds for both the US and global economy.

The high-labour cost US economy should be looking to better compete with the likes of Germany, not China. But the quality and desirability of exports matters.

The Dollar’s strength, over which the Trump administration has little or no control, will likely continue to weigh on the overall competitiveness of US exports while at the same time fuelling cheap US imports.

A stronger Renminbi is not the solution as exporting nations other than the US may be better positioned to capitalise on such a relative-price change, while the USD-cost of imports from China may rise.

If the US imposed higher tariffs on imports from China and other countries (such as Mexico), it would take time for US-based companies to boost production given insufficient quality and capacity in US manufacturing.

Moreover, China and other exporting nations such as Mexico and Canada may respond to higher US import tariffs by increasing their tariffs on imports from the US. This would put US exporters at a clear disadvantage vis-à-vis other exporting nations. Read more

Hawkish pendulum may have swung too far

I have long argued that the risk of a collapse in global economic growth and inflation was over-stated and more recently that major central banks had likely reached an important inflexion point.

A global recession and global deflation have seemingly been averted and central bank policy rate cuts and extensions of quantitative easing programs have become rarer occurrences.

Donald Trump’s election has turbo-charged expectations that reflationary US-centric policies will drive global, and in particular US growth and inflation in 2017, that the Fed’s hiking cycle will step up a gear and that US yields and equities and the dollar will climb further, heaping pressure on emerging economies and asset prices.

But analysts and markets may now be getting ahead of themselves.

My core reasoning is that US inflation may not rise as fast expected, due to lags in the implementation of Trump’s planned fiscal policy loosening and immigration curbs, residual slack in the US labour market and disinflationary impact of higher US yields and a stronger dollar.

As a result, the FOMC, which will see important personnel changes in early 2017, may argue that the market has already done some its work and not be as hawkish as expected.

In this scenario, US short-end rates could lose ground while long-end rates continue to push higher, resulting in a steepening of a still not very steep US rates curve.

One corollary is that factors which have wakened the euro may lose traction as 2017 progresses.

 

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What will Asian central banks do?

Global risk appetite nudges higher as “West Wing” versus “Yes Minister” plays out

Cinemagoers have in recent years been treated to the daft yet watchable Alien vs Predator and Superman vs Batman movie franchises but nothing compares to the Frankenstein-esque beasts of US and UK politics which have been thrust on voters both sides of the pond – a tragi-comic blend of “the West Wing” versus “Yes Minister” with more twists and sub-plots than a John le Carré novel. Read more

All to play for

Sceptical FX and rates markets looking at Fed (and world) through dovish-tinted spectacles 

The US Federal Reserve (Fed) has cried wolf many times in the past nine months, preparing the market for a rate hike only to then back down and further cut its estimate of the appropriate policy rate. As a result, the sceptical US rates and FX markets’ natural tendency is to look at US and global data and events through decidedly dovish-tinted spectacles, giving weight to “negatives” while seemingly discounting all but the most compelling evidence pointing to a December hike. The past eight days are a case in point. Read more

Global Central Bank Easing Nearing Important Inflexion Point

Recent comments from the Fed, ECB and BoJ have rattled financial markets after a summer of relatively low volatility.

The correction in financial markets has so far been relatively modest, particularly for equities and the dollar. But the questions remain where global monetary policy goes from here, the implications for asset valuations and ultimately whether elevated global risk appetite will correct more forcefully.

My core view is that eight years of ultra-low (and in some cases negative) central bank policy rates and expansive bond-buying programs have helped stabilise global growth and inflation, albeit at low levels.

At the same time, the costs of ultra-loose monetary policy, including asset price bubbles, distortions in bond markets, pressure on the banking sector and even rising inequality, may be starting to outweigh the benefits.

Therefore, major central banks, with the exception of the BoJ, may refrain from loosening monetary policy further near-term.

I would certainly expect central bank policy rate cuts to become increasingly less frequent than in the past and the ECB and BoE to keep the modalities of their current QE programs broadly unchanged for now.

At the very least, the world’s most influential central bankers may going forward tweak a discourse which has in recent years largely focused on doing “whatever it takes”.

To be clear, the risk near-term remains biased towards more central bank monetary policy easing. Bar the Fed and possibly a handful of EM central banks still fighting weak currencies and high inflation, no major central bank is likely to hike policy rates or tighten monetary policy this year, in my view. That’s a story for 2017, at the earliest.

But if we have indeed reached an inflection point in global central bank monetary policy, if anything financial markets will become more sensitive to any downturns in still tepid global growth and inflation and to the negative side-effects of loose monetary policy.

In this context higher volatility is likely to prevail and global risk appetite may struggle to forcefully regain traction for now. Read more

Fed – Sense of déjà vu

Recent US data have likely put a Fed rate hike at its 21st September policy meeting beyond reach, with a post-US presidential election rate hike now the more feasible scenario.

US labour market data for August – sandwiched between very weak ISM prints – suggest that there is still slack in the US labour market. Aggregate weekly payrolls in the private sector rose only 3.5% year-on-year, which in turn is likely taming inflation.

Job creation growth was stable at around 1.9% yoy, which in itself is compatible with a Fed hike in September. But working hours fell in August, earnings growth slowed further and the pool of potentially available workers has now increased for three consecutive months.

These numbers will have done little to convince Chairperson Yellen that the time for reflection is over and the market is now only pricing rate hikes of 5bp and 13bp, respectively, for the Fed’s September and December meetings.

There is a sense of déjà-vu and the path of least resistance is probably for the Fed to keep rates unchanged this month while keeping alive the possibility of a hike on 14th December.

Moreover, the Fed will have the added benefit in December of knowing the still uncertain outcome of the US presidential elections scheduled for 8th November.

The Fed remains apolitical and has in the past hiked rates in the run-up to US presidential elections, but a Clinton victory and a positive US and global market reaction are probably necessary if insufficient conditions for the Fed to hike with conviction.

Should the Fed hike in December, this almost unprecedented glacial pace of rate hikes would be in line with my January forecast of only one or two hikes in 2016.

Financial markets’ reaction to recent US data has been a familiar one – lower rates, weaker dollar and stronger EM currencies and global equities. But it has revealed little about how markets are likely to respond if and when the next Fed rate hike comes into clearer focus.

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