Fra BNP Paribas:
The Olympics are over, the summer holidays are drawing to a close. Financial-market participants are returning to work and all eyes are on US Federal Reserve Chair Janet Yellen’s speech at the Kansas City Fed’s annual conference in Jackson Hole, Wyoming, on Friday. While it is not clear exactly what note she will strike, recent comments by Fed officials, including New York Fed President William Dudley, suggest that the Federal Open Market Committee (FOMC) is leaning towards raising interest rates in the near future.
The market appears to be sceptical, but it would be a surprise if Ms Yellen said something entirely different. The Fed’s apparent inclination towards a near-term rate increase is fundamentally down to its assessment that the US economy is near or at full employment. We agree. With the FOMC seeing job growth of around 50,000-130,000 as necessary to hold the unemployment rate stable, we think the 250,0000 three-month average pace of job growth that is likely to be the case by the time of the September FOMC meeting will convince the Committee to deliver a rate hike.
To date, we have seen few signs of inflation in the US, with wage gains limited – though the y/y pace of average hourly earnings is about 0.5pp faster than it was in the middle of last year. Given the typical 1-2 year lag between the economy reaching full capacity and its impact on prices, coupled with the lagged impact of monetary policy on inflation, we expect the Fed to respond before inflation reaches its 2% target, not after.
Consistent with this more timely approach from monetary policymakers, Fed speakers have communicated their preference for labour-market data over measures of economic activity, which have been more sluggish. That said, some Fed speakers have also been suggesting that rates will not have to rise as quickly as originally envisaged after the next hike. This is partly down to their view that the neutral rate – the point at which a central bank’s policy rate neither boosts economic growth nor hinders it – has been trending down due to the decline in the US economy’s potential growth rate.
Fed officials are also probably still concerned about the lingering downside risks to the global economy; Fed policy inevitably has a significant impact on the global financial markets, but most other economies are still at a different point in the cycle to the US. If the Fed tightens global financial conditions too much, it may end up importing deflation. The key source of downside risk to global growth remains China, which continues to struggle with considerable excess capacity. What’s more, the downward trend in Chinese growth has deteriorated, primarily as a result of a persistent deceleration in investment growth.
Chinese fixed-asset investment growth slowed to 8.1% y/y in the first seven months of the year, implying that July’s growth was a mere 3.9% y/y. Private-investment growth fell to 2.1% y/y and investment in manufacturing grew just 3.3% y/y in the first seven months. Property-investment growth has slipped and growth in infrastructure investment, though still high, has eased.
The marginal effects of monetary policy are diminishing in China and the aggressive fiscal policy aimed a counterbalancing this is encountering obstacles and failing to have its full effect. The government is likely to continue its stimulus, including more infrastructure construction, measures to lighten the corporate-financing burden and credit-boosting measures to finance real economic activity.
But we believe the risks to the government’s growth target are rising. In the UK, the vote to leave the EU looks set to have a detrimental impact on growth. Consumer and business surveys, in particular, have weakened since June, consistent with a stagnating economy. Q2’s surprisingly strong growth of 0.6% q/q was lifted by strong output in April, which has subsequently given way to weaker production, suggesting growth lost steam at the end of the quarter.
This underpins our view that Q3 GDP growth will be much weaker. UK retail sales have bucked the trend to date, with a 1.5% m/m gain in July. However, retailsector sentiment indicators have plunged, suggesting spending is likely to fall in the coming months. Moreover, there are question marks over the retail-sales data; the first months of the last three quarters have been very strong, followed by weaker readings.
We would treat the robust numbers with caution, as consumers’ income will be squeezed by slower employment growth and rising inflation before year end. A period of stagnation remains our central case. We think the Fed will raise rates in September All eyes on Fed Chair Janet Yellen’s speech Fed relying on the labour market for its cue US at a different point in the cycle to other countries China is struggling with excess capacity Monetary policy having a waning effect in China UK economy is weakening after the Brexit vote Surprise strength in UK retail sales unlikely to last.
Survey indicators of eurozone activity have been mixed in recent releases. The eurozone composite PMI edged up in August after a positive surprise in July; the index is higher than it was prior to the Brexit referendum. Such resilience is likely to reflect market developments, with equities holding up, the EUR seeing only limited appreciation, interest rates lower and spreads narrower.
At current levels, the composite PMI is consistent with growth of 0.4% q/q in Q3, marginally above our forecast of 0.3%. However, some component series of the PMI and a number of country business-confidence indicators have been less upbeat and may be harbingers of a slowdown later in the year. Eurozone PMI service-sector business expectations declined in August, consistent with softer service-sector activity.
French business sentiment eased slightly, while the German Ifo index and Belgian business confidence fell sharply. Overall, we continue to expect some moderation in eurozone growth heading into 2017. Stagnation is already a way of life in Japan; the economy has expanded at an average annualised pace of less than 0.1% over the past five quarters.
Yet, the Japanese economy, like the US, remains at full employment, with the jobless rate currently just 3.1%. This suggests that the weakness of growth is not just a consequence of soft aggregate demand, but also its low potential growth rate. Frustrated by the lack of growth, the government has decided to introduce another supplementary budget, but despite the huge headline numbers, the amount of actual fresh spending is not that big, at 0.9% of GDP or so.
While about three-quarters of this will be spent on infrastructure investment and disaster relief/prevention, implementation is likely to be stymied by a shortage of construction workers. The economy should continue to eke out some meagre growth in the coming quarters, but a significant upturn looks pretty unlikely. Emerging Asia’s fortunes remain inextricably tied to those of China.
China’s latest drive to increase infrastructure spending, combined with demand for components for the new iPhone, appear to be fuelling the beginnings of an industrial upswing in the manufacturing-focused economies of Taiwan and South Korea. With both drivers likely to peter out, however, the sustainability of any upturn is questionable. Therefore, the pressure on the Korean and Taiwanese central banks to ease monetary policy further is only likely to ebb temporarily. The uptrend in Indian growth, in contrast, is more advanced and likely to be more sustainable.
The fiscal windfall from lower oil prices has allowed the Indian government to ramp up fixedinvestment spending, paving the way for an industrial upswing, with the assistance of supportive monetary policy. ASEAN appears more mixed, with the near-term boost of stronger Chinese manufacturing being offset by the longer-term damage accruing from lower commodity prices. Growth strains are epitomised by Indonesia, where nominal GDP growth has slowed to its lowest in nearly 20 years.
The distraction of the recent tax amnesty is likely to keep Bank Indonesia on the sidelines until growth concerns return to the fore, prompting a rate cut in Q4. Central European countries have been growing strongly since early 2013, so there is little slack left in these economies, as evident in the very tight labour markets across the region. Even so, inflation remains muted, primarily thanks to the impact of cheap commodities.
Still, we think that wage pressure will eventually translate into faster price growth, especially as governments across the region have either recently increased public-sector salaries, or are planning to them. Russia, in contrast, has been mired in recession since the beginning of 2015. Recent data, however, show a flat seasonally adjusted, year-on-year GDP growth rate for July.
We expect the Russian economy to pick up over the remainder of the year and into 2017, as suggested by an improvement in the leading indicators and higher oil prices of late. In Latam, the outlook is a bit brighter: below-potential growth in 2016 should pave the way for a recovery in 2017. This will be particularly evident in Brazil and Argentina, where we forecast a return to growth next year. Brazil is on the cusp of an upturn after its biggest recession on record and is already showing convincing signs of an improvement in the second half, with confidence indicators rebounding smartly.
Our above-consensus forecast for 2017 sees the Brazilian economy growing 2%. We forecast the Argentinian economy to rebound and grow by an above-consensus 4% next year after a contraction this year. A healthier policy mix should lift investment, while lower inflation and interest rates should benefit consumption. Other initiatives, including pension reform and utility subsidies, should boost disposable income. Inflationary pressures set to build in Central Europe Latam may finally be bottoming out Eurozone Brexit fallout has been limited so far A moderation in eurozone growth is still likely Japan facing supply-side constraints Upswings in Taiwan and Korea not sustainable India looks better, but ASEAN is more mixed
Fed Chair Yellen: The long and the short of it
Fed Chair Janet Yellen is likely to set the scene for the September FOMC meeting when she speaks at 10am EST on Friday at the Kansas City Fed’s Jackson Hole conference.
Ms Yellen’s speech, “The Federal Reserve’s Monetary Policy Toolkit”, will focus on longterm policy ideas, but we expect her to strike a note that underscores Fed data dependence.
Most on the FOMC believe the US economy is at or near full employment. With payrolls growing at an impressive clip, we expect the Fed to deliver a rate hike in September. When US Federal Reserve Chair Janet Yellen takes the stage at the Kansas City Fed’s annual economic symposium – this year entitled “Designing Resilient Monetary Policy Frameworks for the Future” – in Jackson Hole, Wyoming, on Friday, it will be one of only a handful of times she has spoken outside of an official Federal Open Market Committee (FOMC) press conference or Congressional testimony this year.
Expectations are high that the Chair of the FOMC will deliver clear guidance as to what to expect at the next, 21 September policy-setting meeting. In our view, Ms Yellen is extremely unlikely to front-run the August payrolls report, which will be released a week later, or the Committee meeting before it happens.
However, with the majority of Fed speakers (including the most influential members) since the July FOMC meeting highlighting the increased probability of a near-term rate hike (Table 1), we expect the Chair to carry the torch and set a tone that suggests a greater likelihood of a September hike than the market is pricing in (32%). Ms Yellen is likely to address the short-run outlook before the long-run prospects, we believe. Typically, in her speeches, the Chair tends to put the meaty bits up front. Consequently, we expect a positive assessment of the state of the economy before Ms Yellen gets into tools that the Fed has at its disposal to combat any economic downturn.
Chair Yellen is likely to acknowledge that most FOMC members see the economy at or near full employment. With this in mind, and with the FOMC seeing job growth of around 50,000-130,000 as necessary to keep the unemployment rate stable, we think the current three-month average rate of payrolls growth (190,000 as of July) is likely to be highlighted. We think Ms Yellen’s message will be focused on the Fed’s data dependency, more specifically, the fact that when the data are good and the risks have been minimised, the odds of a rate hike go up.
Moreover, she is likely to stress the FOMC’s preference for labour-market data, as a gauge of the economic temperature, than activity data, particularly when interpretation of the latter is clouded by wild swings in inventories. Despite the US being at or near full employment, however, we have seen few signs of inflationary pressure to date, with wage gains limited (though the y/y pace of average hourly earnings growth is about 0.5pp faster than it was in the middle of last year).
