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Commenting on the near-term policy outlook at the Fed's Jackson Hole Symposium, Chair Yellen said "I believe the case for an increase in the federal funds rate has strengthened in recent months." This supports our call that the Fed will raise rates once this year, in September. We assign a 45% probability of a tightening next month and 30% for December. Markets have increased the odds to 38% for September and 62% for December.
In line with the title of the speech "The Federal Reserve's Monetary Policy Toolkit", Yellen's comments mostly focused on the Fed's policy toolkit and how it was expanded during the financial crisis to provide additional accommodation.
Not surprisingly, she argued that the unconventional tools including quantitative easing and forward guidance should remain part of the toolkit. While sufficient for now, these tools might not be sufficient to stabilize and stimulate the economy in the next downturn. Therefore, officials need to consider additional monetary options such as purchasing a wider range of assets.
She stopped short of discussing in-depth what other new policy tools or frameworks could be, instead citing that will be subject of future research and debate.
Disappointingly Yellen did not weigh in deeply on the questions surrounding the long-term neutral fed funds rate. She only alluded to a 3% neutral fed funds rate.
Outside of monetary policy, she made a call for fiscal policy to play a role.
She suggests policies to raise productivity growth should be considered. Stronger productivity growth ultimately lifts economic growth, which would give the Fed additional room to cut rates in the future.
Consumer sentiment 89.8 in August; restrained by six-month expectations, current conditions still robust. Inflation expectations remained low, but anchored. Looking ahead, solid fundamentals will keep consumer attitudes upbeat.
The first release of the new monthly GDP-proxy series since the overhaul of the national statistical office showed that the Argentine economy contracted by 2.8% y/y in Q2, whereas we had forecast a drop of 2%. We believe that most of the weakness stems from declining private and public consumption on the back of a squeeze in real wages and the temporary paralysis of public works as auditing procedures are improved. We now expect the economy to contract by 0.8% in 2016, whereas last month we forecast -0.4%.
The government has run into significant political opposition, with the Supreme Court ruling that the government should have carried out public hearings before it raised gas prices earlier this year, and that these must be held if the price rises are to be legalised. This is a major challenge to the government's plan to rein in the fiscal deficit, albeit we expect this setback to be overcome within a few months.
Real GDP growth revised down to 1.1% in Q2, as expected, from the initial 1.2% estimate. Upward revisions to PCE and intellectual property investment offset by downward adjustments to inventories, residential investment, net exports and state and local government spending.We expect real GDP growth to average 2.5% in H2 2016 and continue to call for one Fed rate hike, possibly as early as September.
The second estimate of Q2 GDP (a period almost entirely prior to the EU vote) left growth unrevised at 0.6%. Consumer spending accounted for most of the rise, with business investment also making a surprise contribution. But this still left spending by firms down on a year earlier.
Surveys of consumer and industrial activity from the CBI both pointed to a resilient economy. The reported sales balance of the CBI’s Distributive Trades Survey rose from -14 in July to +9 in August. And while the total orders balance of the same month’s Industrial Trends Survey dipped from -4 to -5, this was above the average of -9 recorded over the previous six months.
Further signs of resilience in the economy prompted sterling to rise by almost 1% against the dollar, reaching $1.32 on 26 August, the highest end-of-week level in a month.
Meanwhile, equity prices were broadly unchanged on the week.
We judge the risk of recession to be unchanged from last week at 30%.
July’s money and credit data confirm that bank lending in the Eurozone continues to recover, despite the uncertainty created by the UK Brexit vote and the ongoing weakness of bank equity prices. The latter has been flagged up by many as a potential trigger for a renewed tightening in credit conditions –by contrast, we are less convinced by this argument.
Meanwhile, the latest batch of consumer data published today suggest that household spending will have remained a key support to the wider economic recovery in the early stages of Q3.
GDP growth in Q2 was left unrevised at a reasonable 0.6%, with a strong performance from consumer spending accounting for the bulk of the increase. Meanwhile, business investment saw the first rise since Q3 2015, confounding predictions of a pre-referendum hiatus.
Admittedly, the Brexit vote threatens to make the latter recovery a short-lived one. But in light of recent positive survey and official data, how severe any slowdown in the economy will actually be is still an open question.
The modest softening in industrial production growth in July hid a sharper fall in demand momentum, largely caused by slowing fixed asset investment (FAI).
We expect economic growth to remain under pressure in the rest of 2016 from softer real estate construction and continued weak corporate investment. While consumption should remain resilient, it cannot completely offset the impact of weaker investment. The subdued outlook for organic growth means that, if the government wants to meet its overly ambitious GDP growth target of at least 6.5%, it will have to continue to rely on stimulus.
So far, ensuring rapid credit growth has been a key element of the government's policy stance. However, because of the lack of appetite among corporates – especially private firms – to invest, the current credit expansion is having a limited and declining impact on growth. Also, while China may not be on the cusp of a financial crisis, the current pace of credit growth is clearly unsustainable.
We do not envisage a rapid policy shift. But as the limits to credit-based stimulus are becoming more obvious, the government may try to rely (even) more on fiscal policy stimulus.
The annual inflation rate fell to -0.5% in July – a three-year low. And while the BoJ's own core inflation measure held steady at 0.8%, this is down from the 1.3% peak recorded in December and likely to move lower.
An appreciation in the yen and falling inflation expectations support our view that the BoJ will most certainly miss its 2% inflation target for FY2017. We expect the authorities to revise their projection at September's monetary policy meeting as well as announce a further ¥10tn in asset purchases.
The downside risks facing the economy have increased since the failed coup in July. We have kept our growth forecast unchanged this month, with growth expected to moderate to 3.3% in 2016 from 4% last year. But we are concerned that the composition of growth may worsen following the coup.
Turkish assets have recovered most of the losses experienced during the immediate post-coup turmoil, supported by a favourable external environment which has allowed the central bank to continue easing policy despite higher inflation. The fact that neither Moody's nor Fitch have downgraded Turkey's credit rating this month gives the government some breathing room to cement its economic policy response to the coup. But the risk of a downgrade by either agency in the next three months is still high.
Solid 4.4% gain in July durable goods orders. Broad-based increases across industry grouping. Weak foreign demand, a strong dollar, and depressed oil & gas activity will continue to drag business investment. The Brexit decision adds uncertainty to the outlook but the impact on the real US economy will be marginal.
Germany’s Ifo business climate index unexpectedly weakened to 106.2 in August from 108.3 in July, against expectations of a slight rise. But sentiment in the services sector in fact strengthened, and a weighted average Ifo points to a pick-up in momentum.
Meanwhile, the final estimate of Spanish Q2 GDP yielded more good news for Spain, showing an upward revision from 0.7% to 0.8%, the strongest among ‘core’ EU economies, boosted by a surge in exports. Portugal is also in the headlines today, with the EC giving the green light to a recapitalisation of CGD, the ailing state-owned bank. The fact that CGD is state-owned, however, makes this irrelevant to the problems in the Italian banking sector.
Fed officials are rethinking their long-term neutral fed funds rate projection and the future monetary policy framework. The Fed discussions per se do not alter our interest rate forecasts, since we view Fed estimates falling more into line with ours. The potential changes to the policy framework will have limited near-term consequences.
We look for one rate hike this year, most likely coming at the September FOMC meeting. However, the doves on the FOMC could delay tightening until December.
However, the recent downturn in business investment raises the possibility that productivity growth might not rebound as much as we forecast, which would lower the long-term neutral rate. We will examine this in an upcoming Research Briefing.
Fed Chair Yellen's speech on Friday at the Fed's Jackson Hole symposium is a key event. The title is "The Federal Reserve's Monetary Policy Toolkit". We expect her comments to focus mostly on how the policy framework or tools may have to eventually evolve in a low interest rate environment. However, she may also provide some insight into the near-term path for interest rates.
Beyond Yellen, the symposium should be rich in research examining two different focuses of policy makers. First, researchers will be examining whether the current monetary policy framework is "resilient" enough to provide adequate accommodation in the next economic downturn, given that the long-term neutral rate is low.
Second, Fed officials will be discussing what the level of the long-term neutral fed funds rate is, and given that, what the optimal path is for rates in this tightening cycle.
The Fed is more prominently considering global conditions in its policy assessment.
Dr. Urjit Patel takes over as RBI Governor amid rising inflationary pressures. While the latter have been primarily driven by an unexpectedly large increase in food prices, other factors like unfavourable base effects and higher public sector salaries could delay the return of inflation to the RBI's projected glide path of 5% by early 2017. But we take comfort in the knowledge that Dr. Patel is likely to share Rajan's views on stable and low inflation being key for sustainable growth. To that extent, we do not perceive any risks to our monetary policy "pause" view from his appointment.
Also, our bottom-up analysis of growth suggests that the economy may have passed its low point. This is, however, not reflected in our top-down forecasts. From a national accounts perspective, we expect growth to moderate going into 2017 because of the outsized role played by "discrepancies" in driving up growth in the last few quarters. But aside from that, the underlying dynamics point towards a possible improvement in the growth picture, largely driven by consumption
However, the risks to the growth outlook remain to the downside, given the ongoing fragility of the global economy.
Final GDP data confirmed German economic growth at 0.4% in Q2. Europe’s export powerhouse is alive and well, with growth primarily driven by a strong rise in exports.
Eurozone consumer confidence fell for a third consecutive month in August, and remains more affected by the Brexit vote than other survey indicators in the Eurozone which have shown surprising resilience. However, sentiment is still high by historical standards. Meanwhile, the ECB’s Cœuré once again warned that lack of reforms and fiscal action by national governments could force the ECB to apply further stimulus.
As we expected, the final GDP growth print for Q2 was slightly revised up to -0.2% q/q from the flash estimate of -0.3%. Retail and services expanded by 0.1% while primary and secondary activities fell by 0.3% and 1.5% respectively.
Economic activity expanded by 0.6% m/m in June, led by a sharp (6.3% m/m) recovery of the primary sector, while secondary and tertiary activities expanded by 0.1% m/m.
our August global macro chartbook, we summarise our asset views and key global themes. We also highlight the contributions of our recent research.
Germany continued its strong start to the year in Q2 and appears to have shrugged off the UK's Brexit decision, leaving it on track to outperform the Eurozone this year. Although monthly activity data painted a downbeat picture of growth prospects in Q2, the flash release showed that GDP rose 0.4% on the quarter, not much weaker than Q1's healthy 0.7% rise. The quarterly increase appears to have largely reflected a strong export performance.
For now, at least, there appears to be little evidence that the underlying pace of growth will weaken in H2. But we see Brexit and the impact of higher inflation on real incomes having some negative influence on the pace of growth. In H2, we expect GDP growth to average about 0.3% compared with 0.5-0.6% in H1. This would result in growth of 1.8% for 2016 as a whole, the best outturn since 2011. This is 0.4% points higher than our forecast last month, mainly reflecting the Q2 upside surprise.
August’s rise in the Eurozone composite PMI adds to the evidence that any near-term adverse effects of the UK Brexit decision on Eurozone activity in the region are likely to be small. Against this backdrop, speculation that the ECB will announce a further extension to QE, perhaps even in September, seems wide of the mark.
The Peruvian economy expanded by 3.7% y/y in Q2, marginally above our 3.6% forecast. The breakdown revealed a fairly weak picture, with quarterly growth largely dependent on private consumption and a fall in imports.However, with regard to H2 2016 and beyond, the new administration’s commitment to ease regulation and increase fiscal spending may prompt a much-needed rebound in private investment and government consumption. We continue to expect that the economy will expand by 3.7% in 2016 as a whole.
Despite the announcement by Banca Monte dei Paschi (MPS) of a “structural and definitive solution to the bad loan legacy” just before the release of the EBA stress tests results, the market is still pricing in a significant risk of default by MPS.
The success of the rescue package is not guaranteed as it is conditional on the sale of MPS’s non-performing loans (NPLs), which will be securitised. A consortium of banks led by JP Morgan has to find €5bn of fresh capital by the end of September to cover the negative impact on capital from the NPLs’ disposal.
If the plan fails, Italian retail customers will be the first to incur a loss. During the financial crisis, banks sold households (very risky) MPS’s juniorsubordinated bonds as a safe placement, paying a very low 2.4% coupon. (This compares with the 7% paid to institutional investors for less risky bonds.) Tax incentives were even provided to bolster the purchases of these bonds.
The political impact of failure will also be strong, with the ‘No’ campaign more likely to win the constitutional referendum in the autumn. Italy could then see a period of political gridlock.
Given the risk that investors may not rush to buy the senior tranche of the securitised NPLs – even with some state guarantee – the Italian government may either put pressure on local insurers and banks so that they increase their contribution to Atlante II (a fund arranged by the Italian government and financed by Italian banks, insurers and pension funds) or claim an exemption clause to the Bank Recovery and Resolution Directive (BRRD), in order to be able to inject public money in MPS.
The likelihood of the first safety net will depend on the potential losses of local financial institutions from their existing exposure to the Italian banking sector (mainly their additional Tier 2 capital), as AT2 bonds could be converted into equity and wiped out in the case of a bail-in. But local banks and insurers could also be reluctant to increase their exposure to Italian banks, given the perception of the sector as a “house of cards”.
The second safety net is the exemption clause (Article 32(4)(d)(iii)) in the EU BRRD, which would allow the government to provide “extraordinary public financial support” to MPS. This clause could be activated to “remedy a serious disturbance in the economy of a Member State and preserve financial stability”.
But it is not clear whether this way of avoiding a full bail-in will still mean some burden sharing by private investors. Whether the MPS junior creditors (Italian households) could avoid incurring losses will largely depend on Renzi’s ability to convince its European peers to interpret the EU Directive in a flexible way a few weeks before the constitutional referendum.
We attach a 15% probability to a scenario in which JP Morgan is not able to find the €5bn by the end of September, the Italian insurers and banks refuse to provide additional capital and the exceptional circumstances can’t be triggered and the government is unable to provide support to MPS. We would then expect strong contagion effects not only to Italian banks but also to the European banking sector.
Italian PM Renzi said that the next elections will not be before 2018, suggesting that he may be reconsidering his intention to quit if he loses the senate referendum. We still expect him to resign if the referendum does not pass, but this adds another scenario to the complicated political situation; if he resigns, the President can still ask him to form a new government.
Later today, Merkel, Hollande and Renzi meet to discuss post-Brexit EU reforms ahead of the September informal EU summit. As there are still some differences among the three, we do not expect any important decisions, just a signal of more flexible application of the current rules.
We explore two trends that worry policymakers and investors. The gap between rapid credit expansion and slowing GDP and, in particular, investment has two distinct causes with different implications. Meanwhile, the apparent divergence between strongly slowing private investment and soaring public investment is caused by data problems.
The appointment of Dr. Urjit Patel - the architect of the RBI’s inflation targeting framework - as the new Governor, should assure observers of policy continuity in India and assuage concerns regarding the central bank’s independence.
We expect Patel to share Rajan’s views on the importance of low and stable inflation for sustainable medium-term growth. Hence, we do not perceive any risk to our policy “pause” view from his appointment.
Growth accelerated to 5.2% in Q2, the fastest pace recorded since 2013. Growth was supported by a pick-up in government consumption and some improvement in private spending. Following the better than expected outturn in Q2, we have revised up our 2016 GDP growth forecast to 5.1% from 5% previously.
Bank Indonesia has moved to its new policy framework focusing on the 7-day reverse repo rate (currently set at 5.25%). Given the latest data and our view that domestic activity will improve in H2, we expect the central bank to maintain its policy stance unless there is evidence of a serious threat to the domestic recovery.
Growth in real activity continues to be robust, with the manufacturing and services PMIs both reporting a healthy expansion in July. Amid concerns about inflation expectations anchoring below target, the RBA cut interest rates in August to 1.5%. We expect one further 25bp cut in the easing cycle in November to support spending, put downward pressure on the currency, and boost inflation.
Retail sales volumes grew by 1.4% y/y in July, against consensus expectations of only a 0.1% increase. The rise was broad-based, with July’s relatively good weather boosting clothing and food sales.
The Claimant Count measure of unemployment saw a surprise 8,600 fall in the same month, the first drop since February. And the official LFS numbers for April to June pointed to resilience in the labour market in the run-up to the referendum.
Annual CPI inflation ticked up from 0.5% in June to 0.6% in July, largely as a consequence of higher fuel prices. Producer input prices rose for the first time since mid-2013, pointing to an acceleration in consumer price inflation in coming months.
Better-than-expected economic data supported a modest rally in sterling. The pound made gains against both the dollar and the euro. And borrowing costs for the Government and corporates declined further.
We judge the risk of recession to be unchanged from last week at 30%.
Spanish PM Mariano Rajoy announced yesterday that the confidence vote will take place on August 30. Rajoy has accepted Ciudadanos’ conditions and will start negotiations in order to ensure their support in the vote.
Nevertheless, the Socialist Party still holds the key to a possible PP government and has so far refused to budge, so there remains a substantial risk that Spain will go to the polls again. Given the Spanish electoral calendar, potential third elections would take place on Christmas Day.
Although July yielded a surplus in the public finances of £1bn, this was smaller than the surplus of £1.2bn recorded in the same month a year earlier. And July’s outturn did little to narrow the projected shortfall with the OBR’s full-year borrowing forecast.
However, dampening any Brexit-related slowdown and the opportunity presented by record low borrowing costs mean that deficit goals are set to play second fiddle to supporting the economy in the forthcoming Autumn Statement.
At an aggregate level, July trade data paint a subdued picture in both nominal and real terms, and contained fewer positive signs than June’s data. This supports our cautious outlook about both the pace and extent of improvement in global trade – which is expected to be patchy and mild, leading to only a modest recovery in the open economies that depend heavily on global and regional trade flows.
A referendum vote in favour of the new constitution means that military dominance of Thailand's government is set to persist. However, the debate was highly controlled, perhaps implying less voter support than appears at first sight. The detailed consequences have yet to be outlined, but suggest a continuing military presence guiding political developments.
This is another negative for the economy, adding to growing insecurity after the recent bombings. This could threaten tourism, the mainstay of the lacklustre economy. Elections in H2 2017 will prolong the uncertainty.
The Chilean economy expanded by 1.5% y/y in Q2, a notch above our 1.4% forecast and the markets’ 1.2%.Today’s numbers do not change our view that the economy will expand by 1.7% in 2016 as a whole. For H2, we expect mining activity to dampen overall growth while services will maintain a relatively solid pace. However, the risks remain to the downside.
A light day on the release front saw French unemployment falling into single digits for the first time since 2012. Consumer sentiment held steady in the Netherlands in August, offering further proof that – so far – the confidence shock from the Brexit vote has been limited in the Eurozone. Inflation in the Eurozone was confirmed at 0.2% in July, the highest in eight months.
Moving south, Spain remains stuck in political limbo as PM Rajoy is ignoring Ciudadanos’ demands in exchange for its potential support in an investiture vote. There is an increasing risk that Spain could be headed for a third election.
The Brexit debate has highlighted free movement of people as a source of destabilisation. Divergent mobility trends describe Eastern European citizens migrating to wealthier countries. But at the scale of the Eurozone, labour mobility has become an increasing source of stabilisation, highlighting the economic importance of free movement of people.
EU citizen mobility, the share of the population which moves across borders to live and work, is limited. In 2014, it only reached 0.4% compared with 2.3% in the US.
The 2004 enlargement set a movement from east to west in motion. While adding to the labour supply of western EU countries, Eastern European migrants have been a source of brain drain at home. As a result, the convergence process, a promise tied to EU accession, may have actually slowed.
Meanwhile, deeper EU integration with the common currency has reduced barriers to migration and with this spurred higher labour mobility.
With the euro crisis, Europeans from the south have moved north for work. This has increased the role of mobility as an economic stabiliser in the event of asymmetric shocks. Yet it is too limited to reduce the gap in unemployment rates in the Eurozone.
The refugee crisis has put a strain on the free movement of labour with some countries closing their borders. The EU-Turkey deal to limit refugee arrivals is looking shakier than ever, but EU member states are still likely to uphold it to avoid the political challenge of increased coordination in matters of asylum policies.
Meanwhile, the advent of Brexit will change EU labour mobility with net migration to the UK reduced by 1 million by 2040. Those migrants will move to other prosperous EU countries, especially Ireland and Germany, and where ties are strongest.
A very strong retail sales performance in July saw monthly growth in volumes of 1.4% run well ahead of expectations and confound fears that the outcome of the EU vote would stymie consumers’ appetite to spend.
Granted, it is early days and Brexit uncertainty may still make its presence felt in the consumer sector. But falling interest rates, relatively cheap oil and a banking sector in a position to supply plentiful credit offer some compensation.
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