Based in Paris, BNP Paribas' Economic Research Department is composed of economists and statisticians:
« The Economic Research department’s mission is to cater to the economic research needs of the clients, business lines and functions of BNP Paribas. Our team of economists and statisticians covers a large number of advanced, developing and emerging countries, the real economy, financial markets and banking. As we foster the sharing of our research output with anyone who is interested in the economic situation or who needs insight into specific economic issues, this website presents our analysis, videos and podcasts. »
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Household wealth -the difference between assets (property, financial) and financial liabilities- matters because in the longer run, it should allow to finance expenditures post retirement. During the pandemic, we have seen in the euro area a big jump in the savings rate as well as an above-trend increase in property prices whereas financial assets suffered from negative valuation effects. The European Commission estimates that, on balance, between the onset of the pandemic and the end of 2021, households accumulated around EUR 2.7 trillion of new wealth in excess of the normal trend. This was considered as a factor of resilience for household spending
The US consumer price data for October have reinforced the view that disinflation -the narrowing of the gap between observed inflation and the central bank’s inflation target- has started. That conclusion seems clear as far as headline inflation is concerned -it has peaked in June- but we need confirmation that the decline in core inflation from the September peak is not a one-off. Core goods inflation has been moving down but core services inflation remains stubbornly high on the back of transportation services and shelter. What matters now for the economy and financial markets is the speed of disinflation because this will influence Fed policy, the level of the terminal rate and how long the federal funds rate will stay there
At which level will the Federal Reserve stop hiking the federal funds rate? The question is hugely important for activity and demand in the US economy as well as for financial markets. During his recent press conference, Fed Chair Jerome Powell remained vague about the reaction function of the FOMC but he did mention that they would be looking at real interest rates. This raises the question which inflation measure to use to move from nominal to real rates. A possible solution is to use the term structure of inflation expectations that is calculated by the Federal Reserve Bank of Cleveland. Despite its significant recent increase, the real one-year Treasury yield is still below that reached during previous tightening cycles, with the exception of 2018
The global manufacturing PMI was down again in October, with significant drops in the United States, the euro area, Austria, Germany, Greece, Italy, Spain, Switzerland and the United Kingdom. China saw an improvement but the index stayed below 50. The steep downtrend of new orders continued in the euro area and its member countries, with the exception of France, where the decline in October was more limited after the big drop the previous month. Orders were also down strongly in the US -where the rebound in September clearly did not last- as well as in the UK. China recorded some improvement. India continues to benefit from strong order inflow.
The latest ECB survey of professional forecasters (SPF) shows a downward revision of the growth outlook and an upward adjustment of the inflation forecast. For next year, the real question is not about the direction of inflation but about the speed and extent of its decline. Slower than expected progress could convince the ECB of the need for more rate hikes than currently priced by markets, implying a bigger output cost of bringing down inflation. Disinflation could indeed take longer than expected. Over the past two years, a variety of factors have led to an exceptionally elevated but also broad-based inflation. Not all shocks have occurred simultaneously and it often takes time for them to work their way through the system, from the producer to the wholesaler to the retailer
Our different uncertainty gauges are complementary, in terms of scope and methodology. Starting top left and continuing clockwise, US economic policy uncertainty based on media coverage has been on a rising trend over the past twelve months. This is related to the policy tightening by the Federal Reserve and concern about its consequences in terms of growth. In the US, the latest data show an increase of business uncertainty about sales revenue growth.
A sum-of-the-parts analysis, which is popular in corporate finance, has made its way in the world of central banking, reflecting concern that the multitude of synchronous rate hikes could have a combined tightening effect that is larger than the sum of its parts. To the extent that inflation in a given country is largely a function of global slack, these hikes could cause an unexpectedly large decline in inflation. Rising import prices due to currency depreciation are another factor because they could force countries to tighten monetary policy. Confidence effects may also play a role, especially at the level of export-oriented companies.To address these risks, central banks could insist that synchronous rate hikes should moderate inflation expectations globally
When growth is slowing, risks tend to be tilted to the downside because households and companies adopt a more cautious attitude in their spending and investment decisions. At the present juncture, it is also difficult to see what could create an upside surprise. To the contrary, according to the IMF, there are several downside risks: the cost of energy, the problems in Chinese real estate, persistent disruptions in the labour market. Financial conditions could deteriorate. Already today they create a discomforting environment, with the risk of a non-linear impact on growth. It illustrates the challenge of central banks with growth-at-risk being at the low end of historical ranges and inflation at the other extreme.
Due to the recent significant increase in interest rates, Eurozone countries now have a borrowing cost on newly issued debt that, for an equivalent maturity, is higher than that of the existing debt. From a debt sustainability perspective, this necessitates a smaller primary deficit or a larger surplus, depending on whether the average interest cost is, respectively, lower or higher than the long-term nominal GDP growth rate. However, this effect will only be fully operational when the entire debt has been refinanced at the higher interest rate. Given the long average maturity of existing debt, the annual adjustment effort is small for the time being but it will grow over time. However, debt sustainability is about more than keeping the debt ratio stable under certain circumstances
The global manufacturing PMI has continued its decline in September. There was a small improvement in Canada and the US but the euro area recorded a further decline, with data dropping in France, Germany and the Netherlands. The index was also down in China whereas India, Indonesia and Vietnam are holding up well. The situation deteriorated significantly in terms of new orders. It is particularly bad in the euro area and the UK although the negative environment is now very broad-based across countries. Orders were down in Japan and China as well, whereas Indonesia saw an improvement. Despite the low readings for the overall index and in particular the new orders component, the employment survey continues to show some resilience.
Financial markets in the UK have recently been confronted with a ‘dash for cash’, whereby investors sell off even safe assets such as long-term government bonds to obtain cash. The catalyst was the announcement of an expansionary fiscal policy, which might force the Bank of England to hike interest rates more aggressively given the potential inflationary consequences. Leverage and the ensuing margin calls acted as an accelerator of the jump in Gilt yields. The events show the necessity for a coordination of economic policy
Inflation has been the dominant economic theme for months, but, under the influence of aggressive monetary tightening, one can expect this won’t last. At the same time, recession concerns are mounting. Central bankers acknowledge that their action may cause a technical recession, a huge majority of US CEO’s expect a recession and consensus forecasts show an increased recession risk in the US and even more so in the euro area. The recession narrative should lead to a wait-and-see attitude, of putting spending and hiring decisions on hold and creates a mutually reinforcing negative interaction between hard data and sentiment. A key condition for this to end is growing belief that central banks will have done their job and can afford to stop tightening
The tight US labour market plays a crucial role in the effort of the central bank of bringing inflation back to target. Slower growth in labour income should lead to slower demand growth, whereas smaller wage increases will ease pressure on corporate profit margins and reduce the need for companies to charge higher prices. The labour market is characterized by a dynamic interaction between job openings, unfilled vacancies, voluntary departures (quits) and layoffs. In the US, unfilled vacancies and the quits rate have started to decline and one should expect that this dynamic will gather pace, causing a slowdown in wage growth. The question remains to what extent this will bring down inflation, which is why the Federal Reserve’s policy is completely data-dependent.
In recent months, the huge and rising gap between observed and target inflation has confronted central banks with an urgency to act. It could be called the panic phase of the tightening cycle. What followed was a swift succession of significant rate increases. Tightening was frontloaded, rather than gradual, to avoid an unanchoring of inflation expectations. This perseverance phase will be followed by a long wait-and-see attitude once the terminal rate -the cyclical peak of the policy rate- will have been reached. During this patience phase of the monetary cycle, the central bank will monitor how inflation evolves. With the risk of further rate hikes having declined, the government bond market should stabilize, which can have positive spillovers to other asset classes
There is a large consensus that 2023 should be a year of disinflation. Monetary tightening will play an important role in that respect. However, it is difficult if not impossible to estimate when and at which level of official interest rates, inflation will have sufficiently converged to target. This explains why the Federal Reserve and the ECB have decided to frontload their rate hikes. It should reduce the risk of inflation surprising to the upside. A lot will depend on how inflation expectations evolve. Recent research shows that firms use price information to which they are directly exposed to form an opinion of future, aggregate inflation
The downward trend of the manufacturing PMI has continued in August. In most advanced economies, the index is below 50, which corresponds to a contraction of activity in the manufacturing sector. A significant deterioration could be noted in the UK last month. The Chinese index has also dropped below 50. The drop in terms of new orders has been particularly large since the month of May. It is also widespread. In the euro area and most of its member countries as well as in the UK, the index has moved below the 46 mark. The readings are also very low in Mexico, the Czech Republic, Poland and Turkey. The situation has also deteriorated in China.
Recent economic data paint a picture of increasing concerns about the economic outlook. In the US, high inflation and rising interest rates play a key role. In the euro area, the same factors play a role -although interest rates are still below those in the US- but skyrocketing energy prices and gas supply disruption are additional forces that should drag down growth. Easing price pressures in business surveys are a hopeful development but selling price expectations remain nevertheless exceptionally high given the weakening of order books. This could point to input price pressures that force businesses to charge higher prices to protect their margins. It is to be feared that slowing demand will make this increasingly difficult, forcing companies to cut back on investments and new hirings
US economic policy uncertainty based on media coverage has increased slightly recently, reflecting the hawkish tone of the Federal Reserve and hence concern about the extent and the impact of additional monetary tightening. In the US, business uncertainty about sales revenue growth has declined slightly as of late after a rising trend lasting several months.
The last twelve months, inflation has continued to surprise to the upside, due to a combination of a series of supply shocks (covid-19, disruption and shortages, the war in Ukraine, weather conditions) and the strength of demand, which had been underestimated. Today, the broad-based nature of inflation and its persistence are the real issues, which reduce the visibility in terms of future inflation developments. Therefore, central banks have decided to change their approach. The theory of inflation and monetary policy has been put aside, the only thing that matters are the data. The main worry of the ECB and the Fed is that inflation expectations become unanchored and influence pricing decision of companies as well as wage negotiations
At the Jackson Hole symposium, Fed chair Powell and Banque de France governor Villeroy de Galhau have insisted that their responsibility to deliver price stability is unconditional. It gives a new meaning to ‘whatever it takes’. Faced with uncertainty about the persistence of elevated inflation, the Federal Reserve and the ECB will increase their policy rates to bring inflation under control, whatever the short-run cost to the economy, because not doing enough now would entail an even bigger economic cost subsequently. Equity markets declined and bond yields moved higher. Tighter financial conditions will help the monetary tightening in achieving the desired slowdown in growth
The ECB Governing Council has surprised markets by a 50 bp rate hike and by dropping its forward guidance and moving to a data-dependent tightening cycle. This may reflect unease about how quickly the euro area economy might react to the policy moves and about the consequences of uncertainty about gas supply during the winter months. Another key decision was the introduction of the Transmission Protection Instrument (TPI), a tool to address unwarranted spread widening that would weigh on the effectiveness of monetary policy transmission. The data dependency of further rate hikes and the vagueness about the triggers for using the TPI may lead to an increase of the volatility in interest rates and sovereign spreads whereby investors try to understand the ECB’s reaction function.
Next Thursday’s meeting of the ECB Governing Council is eagerly awaited. The rate hike decision has been pre-announced so the more important question is whether the new tool to address unwarranted sovereign spread widening will be unveiled. The rationale for such an instrument is well understood but its design and use raise several questions. One is easy to answer. To avoid a conflict with the monetary policy stance, bond purchases by the central bank would need to sterilized. The others are more challenging. Where is the threshold to call a spread widening ‘unwarranted’? Should the ECB be clear or ambiguous on this threshold and on its reaction when it would be reached? The final question concerns moral hazard and, hence, conditionality
The prospect of several rate hikes by the Federal Reserve, as well as the risk of disruption of gas supply in Europe and its negative impact on growth, are the main factors that have recently caused a depreciation of the euro versus the dollar, leading to a parity between the two currencies. The economic consequences are significant for the euro area and predominantly negative, the only positive one being a gain in competitiveness. In the short term, a change in direction is unlikely but in the medium term the euro should strengthen against the dollar.
Recent data send conflicting signals about the outlook for the US economy. A survey of chief financial officers shows they have become gloomier and the nowcast of the Federal Reserve Bank of Atlanta is forecasting a contraction of real GDP in the second quarter. This would mean two successive quarters of negative GDP growth, which corresponds to the popular definition of a recession. However, the labour market continues to be strong and the majority of indicators used by the NBER Business Cycle Dating Committee are still in an uptrend. This suggests there is no imminent risk of recession yet.
The downward trend of the global manufacturing PMI continued in June. The index dropped in the US and declined in the euro area to respectively 52.7 and 52.1, which brings us close to the crucial 50 mark. The various euro area countries for which data are available all recorded lower numbers. Data were also weaker in the UK and Japan. Australia, Mexico and, in particular, China saw an improvement.