Monthly Macro Outlook: The Age of Hope
Head of Macro Analysis
Summary: October is one of the peculiarly dangerous months for investors. So far, this has not been the case. Yet, the macroeconomic outlook remains very gloomy, especially in Asia. This slightly more positive investor sentiment is mostly related to hopes of trade agreement between China and the United States and the belief that the combination of monetary and fiscal push will be able to avoid a recession.
October is one of the peculiarly dangerous months for investors. So far, this has not been the case. Risk aversion is vanishing: the DXY is down 1.75% since the start of the month while it was up more than 2% over the same period last year. Trade optimism is fueling the stock market, and we even start to see the early innings of a rotation away from defensive stocks to more cyclical stocks. The Emerging Market MSCI has broken out of a 20-month downtrend last week, and we see a flow of capital entering into EMs again. Yet, the macroeconomic outlook remains very gloomy, especially in Asia. This slightly more positive investor sentiment is mostly related to hopes of trade agreement between China and the United States and the belief that the combination of monetary and fiscal push will be able to avoid a recession. We share this view, but we also acknowledge the coming months will be decisive to revive economic growth. Many emerging markets, notably in Asia, have started to accommodate both on the fiscal and on the monetary side but developed markets will need to follow up quickly by resorting to fiscal policy as well.
China: A good example of fine-tuning policy
The latest Chinese GDP print, at 6% in the third quarter, was not really a surprise for those monitoring closely high-frequency data. We estimate there is no sense of urgency to massively stimulate further the economy. Except for freight volume growth, the most important data we monitor for the Chinese economy are back to life: the PMI manufacturing is standing at 51.4, real estate FAI growth remains well-oriented and the CNY exchange rate has been stable over the past weeks. These indicators tend to validate the fine-tuning strategy implemented by the authorities.
On the top of that, it is also getting obvious that the room for maneuver of monetary policy is limited in the short term due to the surge of CPI (related to higher pork prices), deflated PPI and weakness of the monetary policy transmission mechanism to the private sector. We expect that Chinese stimulus will be limited in coming months and will mostly target some specific sectors, especially the real estate sector (which represents 80% of Chinese people’s wealth).
Rest of the World: A couple of green shoots and a lot of negative headlines
In the rest of Asia, the broken supply chain continues to negatively impact trade, growth and inflation. Besides China, there are three other Asian countries with deflated PPI in September: Taiwan (-4.5%), Japan (-1.1%) and South Korea (-0.7%).
South Korea’s GDP is the perfect reflection of the weak Asian momentum. It was out at 0.4% QoQ in Q3 from 1% in Q2, which is in line with the slowdown thesis for global growth. Without much surprise, the BOK cut rates by 25bps to 1.25%, and we expect much more rate cuts from EMs in coming months, notably in Russia and in Indonesia. The main motivation to accommodate further monetary policy is mostly related to global capital flows and geopolitics.
In Europe, we had confirmation that the weakness in the manufacturing sector is spilling over to services. The euro area PMI manufacturing is evolving at the weakest point since 2012 and the service sector, except for some countries like France, is becoming less resilient. On the top of that, Germany’s private sector employment is falling, albeit slightly, for the first time in six years. The latest data confirm that Q4 euro area growth will be close to flat. However, the situation is not bad enough for Germany to decide to implement a more significant stimulus package. Only a more accentuated deterioration in employment could become a game-changer and push the CDU and its allies to consider a massive fiscal stimulus.
In the United States, the outlook is rather positive considering we are at the end of the business cycle. The broadest indicator to track the evolution of the economy is still well-oriented. The CFNAI (Chicago Fed National Activity Index), which is based on a weighted average of 85 existing monthly indicators, is at 0.1 (the three-month moving average is standing at -0.06) while the long-term value is at 0 and the risk of recession at -0.7. We still think the risk of recession is rather limited in the next 6-9 months.
It will be all about politics again
In the coming weeks, politics will be at the center of attention. We identify five main market movers.
October 28th: China’s Communist Party is set to hold a key meeting. Traditionally, the Fourth Plenum is devoted to political reforms and party building but, considering the ongoing economic situation, it will also certainly focus on economic stimulus and the ongoing negotiations with the United States. It should also be the occasion to assess the impact of policies decided in last year’s Third Plenum. We don’t expect any immediate macroeconomic or political change following the meeting.
October 30th: A new rate cut of 25bps by the US Federal Reserve is a done deal. The market is now pricing over 90% odds of a rate cut.
November 1st: Former IMF chief Christine Lagarde replaces Mario Draghi. In his latest press conference yesterday, Mario Draghi has done a fine job setting up policy for at least the next two or three ECB meetings. However, we still believe that Lagarde’s appointment may be challenging considering she does not have a strong monetary policy background. Lagarde and her vice-president, De Guindos, mostly bring management experience to the position but, if the economic outlook does not improve fast, we will need policymakers that are able to think out of the box and bring fresh ideas and strategies, which might not be the case of Lagarde. The risk is high that we will see her leadership questioned by hawkish members of the Governing Council and that it will shift the balance of power to the governors of national central banks and the ECB chief economist.
November 10th: Legislative elections will take place in Spain. The polls indicate there is no clear coalition emerging. The PSOE is still leading the polls, but support in its favor is declining to levels close to April election, whereas PP is gaining more support. Podemos is stable. As of now, the only viable coalition would be a grand-coalition PSOE-PP which would be a first in Spain’s history.
November 16th-17th: The United States and China could agree on a mini trade deal at the APEC Summit in Chile (“phase 2” of the negotiations). In our view, what will certainly matter the most is whether a currency pact will also be part of the mini deal as it could push the DXY lower and increase risk appetite. It does not mean that trade tensions will disappear overnight, and that global trade will escape from recession. Nonetheless, it could have a positive effect on confidence and growth momentum, and it could give a decisive boost to EMs that are among the most dependent on manufacturing to growth, especially in Asia.