Head of Macro Analysis
Summary: Trade war and China's growth slightly less important for now, focus on the central banks.
Trade war mess and weak domestic demand
The macroeconomic outlook in Asia and notably in China has not changed much over the past weeks. Stabilisation of the economy continues but it is not broad-based. Q2 GDP print was released at 6.2%, the lowest level in 27 years, but what is probably more interesting is that many sectors have shown strong signs of revival in June: industrial production was up 6.3% YoY, manufacturing production beat expectations at 6.2% YoY and fixed asset investment grew by a solid 5.8% in the first six months of 2019 compared to a year earlier. Like it has been the case since the beginning of the year, domestic demand is still weak, as pointed out by the latest import figures (June total imports dropped by 7.3% from year-ago levels) and by the pursued contraction of passenger car sales (the three-month moving average was out at minus 8.08% YoY in June). Further fiscal stimulus measures are certainly needed to support domestic demand in the coming months.
Rest of the world: A very mixed picture
In the United States, the latest June data were broadly better than expected which tends to indicate growth is strengthening: unemployment is near a 50-years low and way below NAIRU, inflation expectations are slowly rising, retail sales were strong for two months in a row, ISM manufacturing was out at 51.7, with production and employment growing. The weakest spot is industrial production which has moved lower again in June, at 1.3% YoY, as a consequence of the gloomy global trade outlook. One risk that investors will need to monitor in the coming months is linked to rising inflation that could negatively impact US households’ purchasing power in a context of low wage increase. To assess it, we like to look at unconventional indicators in order to detect very early signals of inflationary pressures. We are a fan of Disney Parks attendance growth, which has been a reliable tracker of economic activity in the past. Based on preliminary data, it could be one of the slowest summers at US Disney Parks in over a decade. It is bright clear that price hikes are finally having an effect on guest attendance. This is also one explanation behind the fact that one-fourth of Americans canceled vacation plans this summer. We fear that it might be an early indicator that inflation starts to be at pain level and will require more attention from the Fed in coming months if it lasts.
All eyes on central banks in the coming weeks
Looking ahead, we all know that the main market focus will be on central bank meetings at the end of the month. It will be the confirmation we are in a completely new monetary and economic paradigm where unconventional tools used after 2008 are becoming conventional tools in a world of very low neutral rates.
What is quite unique this time is that both the Fed and the ECB are ready to pull the trigger to act pre-emptively. Though there are more fundamental reasons for the ECB to act (risk of recession in Germany and subdued inflation), it is more questionable for the Fed. The macro case for rate cuts in the United States is debatable, especially if we consider that the Fed is first and foremost “data dependent”. The economy is in a rather good shape, but it seems that the Fed’s goal to loosen monetary policy is motivated by other considerations:
- In his speech early this week, Powell implicitly confirmed that the Fed has certainly overtightened this cycle and is now looking to reverse the December hike which looks increasingly like as a monetary policy error.
- The Fed has always taken into consideration the global context, but it seems this time it is playing a dominant role. In his short testimony to Congress, Powell used the words uncertainties and risk many times, putting very special attention on global factors, which constitutes a change compared to previous cycles.
Finally, as it was the case many times over the past decade, it is likely that the Fed and the ECB will try to avoid monetary policy divergence that could have a negative impact on exchange rates while we are on the breach of a currency war triggered by the Trump administration. The latest ECB minutes mentioned a “broad agreement” among the Governing Council to be ready to ease monetary policy again, referring to “strengthening forward guidance, resuming net asset purchases and decreasing policy rates”. We see a policy move more likely on September 12th than on the next policy meeting on July 25th. It could be officially motivated by subdued inflation, but the primary concern will be the deteriorated economic outlook in Germany. At first, we expect a slight adjustment in interest rates, by moving the deposit rate further into negative territory. However, as it is unlikely to have a significant impact, the ECB will need to apply more drastic measures, especially exiting limits of its QE program by rising the ownership ceiling for bond issues to 50% from the current 33%%. This is the era of QE infinity.