Gilles Moec’s Post

Hello! Please find here the link to the latest Macrocast, in which I look into the "last mile" of disinflation. Bests Summary: The “macroeconomic fate” of 2024 will depend on whether the disinflation process which started last year can continue swiftly, allowing central banks to remove some of their restriction. Disinflation in 2023 was primarily driven by exogenous factors – the normalisation of supply lines and energy prices - and unfortunately, we are seeing the return of “polycrisis” risks which could derail the general slowdown in the price of tradables in the global economy. The recent developments in the Red Sea suggest that the inflationary impact of the Middle Eastern crisis could take a different form than the “usual’ oil price shock, as supply lines are starting to be disrupted again. The election in Taiwan of a DPP President for the third time in a row forces us to confront again the possibility of another escalation of the Sino-American rivalry, with the potential to trigger another trade war. Yet, we still see reasons to remain reasonably confident. The Red Sea disruption cannot be compared with the general seizure of supply lines when economies reopened after Covid. The fact that the Taiwanese President-elect did not secure a parliamentary majority, in a configuration in which China is not in the best position to take the risk to lose support from foreign demand, could help avoid tension between Beijing and Washington escalating too far. Still, even if the exogenous inflationary forces are kept under control, the latest consumer prices print in the US suggests that the “last mile” of disinflation remains bumpy. On a 3-month annualised basis core inflation has been hitting a “resistance line” above 3% since September. The materialisation of the Bernanke-Blanchard sequence, where labour cost-driven inflation takes the lead while supply-driven shocks fade, cannot be ruled out yet. We are less worried about the Euro area, despite the continued decline in productivity there which pushes unit labour costs up, as we expect the deterioration in economic confidence to take margins down. 

Hello! Please find here my new Macrocast. Summary: Even central bankers may want to believe in Santa Claus sometimes, and after four gruelling years – moving from another episode of extraordinary intervention to the steepest tightening in decades – they could be forgiven for hoping to descend slowly into the festive break torpor without having to say much in their December meetings. Alas, the world is not often kind to them, and their last policy communication of the year is taking place amid aggressive expectations from the markets for significant cuts quite early in 2024, at least for the Federal Reserve, the ECB, and the Bank of England, which they can’t completely ignore. We focus here on the first two institutions. Jay Powell will probably try to steer the market towards more prudence, in line with his last public statements. We think the Fed will use its updated “dot plot” to signal to the market that, indeed, cuts are coming, but not as many as what is currently priced. While a move in early spring rather than in June – our baseline – is gaining in plausibility, we fail to see what the upside for the Fed would be to give a nod to the current market pricing while the economy remains strong enough to keep inflation risks alive. The ECB does not have an equally simple communication tool at its disposal, and the big difference with the Fed is that the real economy in the Euro area is in a much worse state. We think Christine Lagarde will be able to use the new forecasts to signal that, while hikes are no longer on the table – even hawks such as Isabel Schnabel have given up on that option – it will take until 2025 to get inflation back to target, a prospect which does not warrant early cuts. While the bond market in the US and Europe remains of course tuned to even minute change in the communication of the Fed and the ECB, potential moves by the Bank of Japan are getting increasingly relevant. The market is now considering that the BOJ meeting on 19 December could be “live”. We stick to our view that the BOJ will wait until April as it will want to tread carefully amid mixed domestic data while it needs to take on board the ramifications of tightening when the western central banks would be about to cut. Still, the BOJ is indeed preparing minds.

Hello! Please find here the link to my latest Macrocast. Summary: A bumper print for Q3 GDP, driven by private consumption, further demonstrates the resilience of the US economy to the monetary tightening. At the beginning of this year, we were expecting US consumers to run out of excess saving to spend at a time when the labour market would start to correct in earnest. It however appears that the combination of still robust job creation, strong nominal wage gains and disinflation is allowing more than decent purchasing power growth, while the savings rate fell again. Spending was particularly strong for durable goods, normally quite sensitive to interest rates. It seems US consumers are still happy to ignore the monetary stance. The resilience of the US economy is likely to rank high in the questions Jay Powell will be asked this week. The likely continuation of the policy pause was telegraphed clearly by his speech at the New York Economic Club we discussed last week. The market-driven tightening in financial conditions will help the FOMC stay in monitoring mode despite the strong real economy data, and we count on the ECI for Q3, to be released ahead of the Fed meeting, to confirm wages have started to decelerate.   In contrast, we think GDP stagnated last summer in the Euro area. This would further justify ex post the ECB’s cautiousness last week. While the press conference was uneventful, we would highlight the readiness of the Governing Council to explicitly acknowledge the impact the accumulated tightening is already having on inflation dynamics. The Bank Lending Survey confirms monetary transmission is operating “forcefully” in the Euro area – to quote directly from the ECB. While the financial position of the corporate sector provides a buffer, we are starting to detect some unease in some quarters of the Eurosystem. The idea that maybe the central bank has gone too far is gaining traction. We do not think rate cuts can be really within reach before the end of next spring at the earliest, but with base effects helping disinflation in the coming months, we expect the ECB to come under significant market pressure to accommodate well before that if, as we expect, the real economy displays more mediocrity.

Hello! Please find the link to this week's Macrocast. Summary: The disappointing inflation print for September in the US may not be too alarming. It could be mere mean reversion after a “too good” August print. Yet, we cannot exclude that a line of resistance is emerging, under a “pincer movement” from higher oil prices combined with a still tense labour market generating persistent wage pressure. The tragedy in Israel has raised the risk that oil prices rise further. The market reaction has been measured so far, as the lack of unity of the Arab world – a difference with the 1970s – limits the ramifications through OPEC. It is a very volatile situation though as the market ponders the effect of the likely ground operation by Israeli forces in Gaza. The capacity of the US to control the escalation is going to be crucial, but that is what Joe Biden is clearly attempting. When it comes to endogenous inflationary forces in the US, the intensification of strikes calls for attention. A key issue though is to determine whether there is still a significant real wage gap in the US which could unleash a catch-up ahead. Average wages deflated by headline inflation have been marginally exceeding their pre-Covid level since the end of last year. Non-supervisory and production workers have seen more substantial gains, and after three years of gyrations their real wage is today roughly where it should be when prolonging the trend observed between the end of the GFC and Covid. This should bring a measure of reassurance on the capacity to tame inflation. The interest in the strike in the auto sector goes beyond the inflation issue. Indeed, we think it illustrates very well the challenges of reindustrialisation in a context of energy transition. Still, at least the US has stopped the decline in manufacturing jobs – even before IRA. This helps with the social difficulties of sectorial reallocation. People working in manufacturing may not always be able to keep their current job, but they have a higher chance to find a similar job than during the big industrial contraction of the 1990s/2000s. 

Hi. Please find the new Macrocast in this link. Summary: The “Table Mountain” approach to monetary policy may not bring the expected sense of “peace and quiet.” The bond market has been very active across the Atlantic and, as usual, the weaker signatures get under pressure. Even if we should not overstate the magnitude of the turmoil last week, Italian long-term yields approaching a 200-bps spread vis-à-vis Bunds deserves some attention.   As often, pressure on the Italian bond market was triggered by the combination of some national policy moves (an upward revision in the deficit trajectory) and deteriorating cyclical indicators. A third ingredient is the noise coming from the ECB on a swifter action on its balance sheet. We thought Christine Lagarde had put this to rest when she stated at the last post-meeting press conference that terminating the reinvestment of PEPP had not even been discussed at the Governing Council. Yet, more avenues are being opened, e.g., the possibility to significantly raise the Minimum Reserve Requirement of banks to force a transfer from excess reserves to non-interest-bearing mandatory ones. While this may read as an obscure technical move, the distributional consequences could be significant, triggering an asymmetric additional tightening in monetary conditions detrimental to peripheral countries. The financial stability and macro consequences of such action, combined with good news last week on the European inflation front, should convince the ECB to move cautiously, but we do not think national governments have taken the full measure of the changes at work at the central bank. It may be slow, but the ECB’s balance sheet is only heading in one direction, and fiscal policy needs to adjust to this new reality.    Meanwhile, in the US a last-minute stopgap has given us a 6-week respite in the shutdown drama, but additional funding to Ukraine was a collateral victim. It is tempting to connect this to the electoral victory of Robert Fico in Slovakia to find that more cracks are appearing in the consensus in the West to stand with Kyiv. 

Please find the new Macrocast in the link below. Summary: As the curtain is falling on the tightening phase of monetary policy, we can take a break from focusing on central banks and explore some of the other trends shaping the macro debate at the moment. We attempt this week to “connect the dots” between China’s efforts are reviving domestic consumption and the BRICS summit last August which, beyond the extension to new members, sent another signal of the “clubification” of the world economy.   Our point is that China’s difficulty to deal with its chronic excess savings will increasingly be a limit to the extension of the BRICS’ project to the whole of the Global South, irrespective of the already wide political fault lines across members. If China continues to post a large, structural current account surplus, at a time when the West is increasingly tempted to reduce its reliance on Chinese supply, then the natural counterpart of China’s excess saving will be a growing bilateral trade surplus vis-à-vis the rest of the Global South. There are exceptions, some emerging countries such as Brazil are posting bilateral surpluses vis-à-vis China but many of them find themselves in the uncomfortable position of being reliant on imports from China while remaining dependent on the West for their exports (e.g., Vietnam). China is increasingly recycling its surpluses as FDIs in the Global South – which can elicit some resistance. The US is a hegemon with a chronic current account deficit. This is probably not a coincidence.

Hello! All great things pass and so does the summer recess.... Here is the link to the new Macrocast. Summary: 1/ In our latest Macrocast on 31 July we had left our readers with a – probably typically – pessimistic note, describing the short-term outlook for the Euro area as a “hardish landing” and expressing doubts on a soft landing being all what it is going to take to tame inflation in the US. We don’t feel chirpier after a few weeks’ rest and unfortunately it now seems the markets are also looking somewhat downbeat. As of Friday 26 August, the S&P500 was down nearly 4% on the month while the Dax lost a bit more than 5%. Summer markets can be fickle, and there has already been some rebound from the lows hit around 20 August, but investors’ caution could be justified as the world economy is having to deal with two unrelated headwinds. The confirmation of the resilience of the US economy is putting to rest the market’s hopes of a swift reversal of the Fed’s policy stance, which has pushed long-term yields further up, while the scenario of a “deflation trap” in China is getting more substantiated by the recent dataflow, with only timid policy response from Beijing so far. In a nutshell, economies are growing either “too fast” or “too slow”. 2/ There is not one single “paradigm” explaining cyclical conditions across the main economic regions now. For China, Rogoff’s “debt supercycle” model is persuasive – but then the PBOC should react by engaging in more decisive rate cuts, to ease the pain of the balance sheet adjustment while structural reforms deal with the persistent imbalances in Real Estate. For the US, Charles Goodhart’s focus on a reversal of the balance of power on the labour market provides an interesting model.  3/ Europe finds itself faced with the double whammy of slower Chinese demand and some contagion from higher interest rates from the US which compound the ECB’s tightening. A new concerning development is that business confidence is deteriorating markedly outside Germany, affecting countries which so far had been performing rather well, such as France.

Please find here the link to this week's Macrocast, Summary: We have had “dovish hikes” from both the Fed and the ECB last week. We still see it as marginally likelier than not that the ECB Governing Council will add a last 25 bps hike in September while we are more confident that we are already at the beginning of a long plateau at the Fed, but the gist is the same: both central banks will probably stop at some point in Q3 2023 having brought their policy rates at roughly twice the equilibrium level. The juxtaposition of this high level of policy restriction with another strong US GDP growth print and tangible disinflation over there is fuelling hopes that a “soft landing” is all it will take to converge to the Fed’s 2% target, and Peter Hooper has just offered a very cogent narrative on how a recession could be avoided in the US. We are unconvinced though. While the Fed has started tightening nearly 18 months ago – the usual transmission lag – it has reached restrictive territory in September 2022 only, and we think the bulk of the impact has not yet passed through. Peak impact could coincide with the exhaustion of the excess savings Hooper mentioned as one of the factors which could help avoid a US recession. Some of the “protective factors” listed by Hooper can also be found in the Euro area – credible central bank, sound financial position of the private sector, specific nature of the Covid-triggered inflation wave – except for the labour market institutions which remain probably more conducive to second-round inflation effects than in the US and may force the ECB to inflict much more macro damage to “break the back” of inflation. In any case, it is already clear that the Euro area is underperforming the US, and we are concerned with how the monetary tightening is increasingly affecting so-far resilient member states such as Italy and Spain. So, as much as we would like to leave our readers with a rosy view before our August recess, in a nutshell we see an already “hardish” landing materialising in the Euro area, while the soft landing in the US, albeit more plausible, still looks far from certain in our view.

Hello! Please find attached a link to the new Macrocast, tackling both this week's central banks meetings and the unclear results of the Spanish elections. Summary: 1/ The Fed is highly likely to hike by 25 basis point this week, but focus will be on the next steps. In the absence of new forecasts, it should be relatively easy for J. Powell to keep his hands free for September. After all, the June statement was already quite non-committal. We think July will mark the end of the Fed’s tightening cycle, but that remains conditional on the further accumulation of signs the US economy is slowing down. We also think the ECB will hike by 25 bps this week, but to move more convincingly into data dependent mode – now that even hawks don’t want to take a September hike as a given - the central bank must alter its prepared statement to remove the notion that policy rate “will be brought” to sufficiently restrictive level. This would be taken as a major dovish shift by the market, and we think Lagarde will have to offset this by sending some hawkish messages in the Q&A. Looking ahead, there is still a key element missing for the Governing Council to stop hiking beyond July: an observable deceleration in core inflation, unlike in the US. 2/ The BOE will have until August to decide on its next move. We must be cautious, but the better-than-expected inflation print for June could keep the next hike at 25 bps “only” and reduces the risk the BOE steers a lonely and painful tightening course beyond the summer. 3/ With near complete results on Sunday night, it seems the right-wing block failed to reach a majority in parliament. Pedro Sanchez could in principle cut a deal with regional parties to stay in power, but this would put him in a fragile position and another election in a few months is a real possibility. We review the country’s underlying position and find it overall robust enough to deal with some months of uncertainty without too much market tension. 

Hello. Please find here the link to this week's Macrocast, Summary: There was not much to dislike in the US inflation print for June, with all the main components of core going in the right direction. This keeps our hope alive that the Fed’s July hike will be the last one. Real wages need to be monitored though: US employees have been gaining purchasing power again since May. This could re-start consumption, and make the “last mile” of disinflation, down to 2%, more difficult. This is the type of issues which are likely to keep the debate on the post-July trajectory live at the FOMC. It's unlikely that inflation can completely normalize without a tangible contraction in aggregate demand, and a crucial issue is how deep such contraction needsto go, and whether central banks should tolerate a higher inflation regime, given the potential cost of going all the way to 2%, and lift their target. O. Blanchard had reopened this debate last October, and we hear more voices supporting such a shift. As much as there may be a theoretical case for lifting the inflation target, we think the ramifications for long-term interest rates can be so adverse that it could become counter-productive, e.g. by making the cost of the green transition – one of the forces possibly pushing inflation up – even higher. We are also concerned by the long-term competitiveness impact. While the West is debating whether 3% inflation would be acceptable, China is dealing with a real deflation trap risk. A stimulus is needed to deal with the current aggregate demand deficit, and the central bank has been operating with much caution so far. Focus is turning to the fiscal policy, and expectations are building around announcements which could be made at a Politburo meeting later this month. There are only difficult choices though. The plight of the Local Governments Financing Vehicles is drawing attention to the fact that the policy space is probably less wide than often thought. In any case, fundamentally, China should probably distance itself from its usual approach to stimulus – pouring more capex in the economy – and focus on consumption.