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At the start of a new month, the purchasing managers indices are amongst the earliest data providing information on what happened the month before. Following the coronavirus outbreak they were even more eagerly awaited than normal. For the manufacturing sector, the picture is very mixed, with a considerable decline for the world index on the back of huge drops in China and Hong Kong. On the other hand, the index for the eurozone saw another increase, driven by Germany, the Netherlands, Spain and Greece with Italy remaining stable and France weakening. In the US, both the Markit PMI and the ISM index declined. Clearly, except for China and Hong Kong, the data do not yet show the impact of the coronavirus epidemic but it is only a matter of time for this to happen
The international propagation of the coronavirus forces a rethink of the consequences for the global economy. Coming after the outbreak in China, the marginal impact on the global economy of the spreading of the epidemic should, a priori, be rather limited. Yet, financial markets have reacted very negatively. This jump in risk aversion reflects concern that the economic consequences may have been underestimated thus far as well as increased focus on tail risk. This ‘financial accelerator’ phenomenon may in turn contribute to the worsening of the growth outlook.
As part of the Federal Reserve’s strategy review, the introduction of a target range for inflation is being discussed. Such a range could provide flexibility in the conduct of monetary policy. It could also take into account past shortfalls in inflation. Introducing a range when inflation is below target runs the risk of being perceived as not being bothered by the inflation shortfall. This would call for an asymmetric range but this increases the risk of market turbulence when a tightening cycle starts.
The data used to chart different measures of uncertainty do not yet take into account the impact of the coronavirus. With this caveat in mind, the signals nevertheless go in different directions...
Putting a number on the consequences of the coronavirus is a huge challenge. On some of the topics we have a satisfactory level of visibility of the order of magnitude: international spillover effects of the demand shock, repercussions of the global increase in uncertainty. The visibility is much lower concerning the effects of the supply disruption. This is even more the case for the impact on China. In the near term, data surprises –the difference between the consensus forecast and the outcome- should be higher than normal. However, provided that the peak of the epidemic is reached quickly, visibility should improve quickly and hence support confidence.
From an economic perspective, the coronavirus epidemic represents a combination of a demand, a supply and an uncertainty shock. The weight of China in world economy, its contribution to global GDP growth and its role in global value chains imply that the international repercussions are more far-reaching than during the SARS crisis in 2003.We have to brace for poor data in February and March, so the real test is whether April sees a pick-up in business surveys. Absence thereof would fuel concerns that the impact is more lasting in nature which would put us in a U-type scenario. An L-type scenario looks unlikely as yet whereas a V-type recovery would supposes a swift decline in new cases.
Recent survey data have picked up, in particular in the manufacturing sector and in terms of export orders. The European Commission noted a marked increase of economic sentiment in the European Union, the eurozone, Germany and France in January, after substantial weakness in Q4. Although economists expect a pick-up in growth in the US as the year progresses, the dispersion is very wide. This means that the median forecast will inspire less confidence than if the level of disagreement amongst forecasters would be lower.
In recent months, the global manufacturing cycle has been bottoming out whereas in services a slight uptick has been noted. In addition, two major sources of uncertainty have seen a positive development: the US and China signed a trade deal and the UK and the European Union can at last start negotiations about their future relationship. Very accommodative central bank policy has contributed to buoyant market sentiment. The combination of these three factors - stabilisation of business sentiment, decline in uncertainty, supportive financial environment - implies conditions are met to see some uptick in growth. Nevertheless, caution prevails in this assessment, if only because later on this year, uncertainty may very well increase again.
The ECB remains cautious in its assessment of the economic situation characterised by risks still tilted to the downside, although less than before thanks to the US-China trade deal. The message is slightly better on underlying inflation where some signs of a moderate increase are noted. Between now and year-end, the strategy review, which has now been launched, will grab a lot of attention, with markets wondering how it could influence monetary policy. The review is also important from the perspective of climate change: will monetary policy operations take it on board as a risk factor or will ambition even be higher?
The US-China trade deal has brought relief. It avoids new tariff increases by the US with the risk of further escalation. The deal should be welcomed in China, given its ongoing growth slowdown, but also in the US where companies had increasingly expressed their concern about the trade confrontation The rest of the world will monitor closely the extent of trade diversion which could follow from the agreement. Attention will now shift to the phase 2 negotiations, which could very well mean that trade uncertainty will intensify at some stage.
There is a considerable gap between what are considered to be the geopolitical ramifications of the escalating tensions between the US and Iran since the start of the year and the subdued reaction of markets. The market reaction probably reflects the investors’ view that the probability-weighted impact on growth should be very limited because the risk of a major escalation is considered to be small and/or because of an expectation that the impact of higher oil prices on the economy is limited. What also may play a role in the market reaction thus far is that, leaving the geopolitical uncertainty aside, the economic environment is considered to be conducive to taking risk: stabilisation of survey data, reduction in trade-related uncertainty and accommodative monetary policy.
Cities today concentrate more than half of the world population and more than 80% of global GDP. The underlying dynamics explaining their ever increasing importance are the result of a variety of positive externalities (thicker labor markets, knowledge spillovers, input sharing…) generating self-reinforcing effects. These rapid waves of urbanization have key implications for the production of goods and services, environmental quality and human development. The world is one of density spikes and disparities, driven by the unstoppable ascendance of metropolises. Greener and more inclusive cities should be promoted in order for them to remain livable. In this respect, public policies have an important role to play
2019 has been dominated by uncertainty, in particular about trade tensions and hard Brexit risk, as well as mounting concern about the slowdown of the global economy. his has led to additional policy easing by the ECB whereas the Federal Reserve has reversed course by cutting the federal funds rate on several occasions. This has further reduced the remaining policy leeway of central banks, a subject that will be analysed in the context of the strategic reviews by the Fed and the ECB. It has also led to increased calls for fiscal stimulus. Equity markets have delivered surprisingly strong returns with investors preferring to look at the role of lower interest rates, rather than at the weakening of the profits outlook
We monitor uncertainty by means of different metrics and several have eased as of late. Starting top left and moving clockwise, the economic policy uncertainty index, which is based on media coverage, has declined although it remains at a high level...
Danish monetary policy is closely linked to ECB policy so the recent statement of Denmark’s central bank governor that he expects interest rates to remain around current negative levels in the next five to ten years is not without importance for the eurozone. Forward guidance by ECB implies that policy will only be adjusted when justified by economic conditions. The inability to be clearer in terms of time frame illustrates the complexities of inflation dynamics. Past wage increases will gradually filter through in a pick-up in inflation although low inflation, well-anchored inflation expectations and intense competition in certain sectors may very well moderate this transmission. It thus seems clear that the current policy will remain in place for a considerable time
The latest data on unemployment and job creation have surprised on the upside. They continue to be better than the long-term average. This strong labour market supports household confidence, which remains well above the long-term average, and retail sales, which did slightly better than expected. However, several numbers have come in below expectations and are below historical averages. This points towards a slowing economy, despite the satisfactory GDP data for the third quarter. Noteworthy in this respect are the two ISM indices. In addition, like in numerous other countries, industrial production is under pressure.
Based on business surveys, the cyclical environment, globally, seems to have stabilised. A similar picture emerges for the eurozone and China, whereas in the US it is mixed. Stability’ characterises the monetary policy outlook. After the announcements in September, the ECB can afford to wait before making a judgment of the effectiveness of its policy stance. For the Federal Reserve, it seems that the bar for envisaging a change in the federal funds rate is high, even more so when it’s about considering a rate hike. Stabilisation of economic data and a stable, very accommodative monetary stance provide reasons for being hopeful, but this supposes that uncertainty doesn’t increase again. In this respect, unfortunately, the situation remains very opaque
The ECB’s monetary policy meeting account illustrates the dilemma it is facing: inflation is subdued and risks to growth are tilted to the downside, yet the financial stability implications of the very accommodative policy need to be closely monitored. These implications are covered in sobering detail in the ECB’s Financial Stability Review. A possible side effect of very low to negative interest rates is that borrowing and spending become more procyclical. Quantitative easing (QE), by modifying the risk structure of investment portfolios (less government bonds and more exposure to assets with a higher risk), will probably increase the sensitivity of portfolio returns to the business cycle.
Automatic fiscal stabilisers help cushion the impact of economic shocks on GDP via changes in government revenues (because of progressive taxes) and expenditures (unemployment insurance). The limited remaining monetary policy leeway in the eurozone is fueling interest in the effectiveness of the automatic stabilisers. European Commission research confirms that, to some degree, automatic stabilisers iron out the impact of negative shocks on GDP. Whether that is enough is another matter. It warrants a debate on the role of discretionary fiscal policy in case of a recession.
In recent weeks, equity markets performed well. Focussing on the US, it is hard to argue that this reflects an improvement in the earnings outlook or a perspective of more rate cuts than hitherto expected. This would imply that a decline in the required risk premium was the key driver. US treasury yields also increased significantly, which probably reflects to a large degree an increase in the term premium. The decline in the equity risk premium and the increase in the bond term premium were driven by a common factor, namely a reduction in economic tail risk on the back of progress in the trade negotiations between the US and China and a stabilisation of certain survey data
Recent business surveys such as the purchasing managers’ indices, point towards a broad-based stabilisation in October. This is a welcome development after a prolonged downward trend. However, in a historical perspective, the recent readings are low or, looking at the manufacturing sector, very low. This points to an ongoing subdued growth environment. Going forward, a sideways movement of these surveys should increase the likelihood of a growth acceleration: when the frequency of bad news drops, confidence should eventually rebound, fuelling spending, all the more so given the very accommodative financial and monetary conditions.
Do fluctuations in uncertainty have a symmetric or asymmetric effect on the economy? The question is important considering that since last year, uncertainty has been acting as a headwind to global growth. Moreover, recent news about the US-China trade negotiations and Brexit have raised hope that uncertainty may have peaked and that growth in activity could accelerate. Empirical research shows that an increase in uncertainty has a bigger effect on the economy than a decline, in particular in a subdued growth environment. This would suggest that, should the decline in uncertainty be confirmed, the pick-up in growth would be very gradual.
The US-China trade conflict and Brexit have been acting as a headwind for growth for a considerable time now. Recent developments have raised expectations that these sources of uncertainty may have peaked. Should it turn out to be the case, this could spur spending by unleashing pent-up demand by companies or households. However, in an environment of slowing global growth and, quoting the IMF, a precarious outlook for next year, we probably will see a more limited reaction, with other sources of concern taking over from the previous ones: uncertainty make have peaked in certain areas, but is likely to migrate to other.
According to the IMF’s chief economist, the growth outlook is precarious. Although the Fund expects somewhat of a pick-up of growth next year, this is driven by a small group of emerging and developing economies which are currently under stress or underperforming. The modest growth acceleration reflects country-specific factors, rather than the expectation of a broad-based improvement. In the US, the growth slowdown is expected to continue well beyond 2020 and Chinese growth is projected to decline to 5.8% next year. Against this background, the projected slight pick-up in the eurozone, driven by Germany and Italy, and which supposes that external demand regains some momentum, looks challenging.
We monitor uncertainty by means of different metrics. Starting top left and moving clockwise, the economic policy uncertainty index, which is based on media coverage, is at a historical high, on the back of US-China trade tensions and fears about a disorderly Brexit. The recent trade deal between the US and China, although of a very limited scope, and the agreement between the UK government and the European Union on Brexit, have fuelled hope that uncertainty will abate in the near term. This obviously remains to be seen...