Few important economic indicators were released in recent days. Nevertheless, some interesting conclusions can be drawn. Recent data seems to confirm that China's imports are bottoming out. That is important for the global economy. The other important thing is that Fed chair Yellen, having - relatively successfully - tried to talk rate-hike expectations into the financial markets for some weeks has changed direction in response to deteriorating labour market data. Despite all this, the global economy is plodding along achieving modest and rather unspectacular growth.
As chair Yellen has always linked the Fed's actions to the situation on the labour market, it was no surprise she essentially did a U-turn in a recent speech.
Han de Jong Chief Economist
Chinese imports bottoming out
We do not really know in great detail what is going on in the Chinese economy. Data coverage is modest, data quality is questionable, the policymakers are not democratically accountable, nor do they interact very regularly with the press. That was not a problem ten years ago, when the Chinese economy was small. But it is a problem now, as the Chinese economy is the second largest in the world. A lot of growth of the world economy has taken place in or because of China in the last ten years. And let's not forget that China embarked on a stimulus programme following the start of the global financial crisis in 2008 that was several times larger than the Americans or the Europeans did. Arguably, the Chinese stimulus at that time was crucial to the recovery in many other countries.
The most direct link of China and the rest of the world economy is through trade. What the rest of the world feels most directly from China is Chinese imports. Last year, they fell by some 15%. That is in value terms. We reckon they fell by some 5% in real terms. That always looked unsustainable to us in an economy that continues to expand at a decent pace, even if growth is slower than in recent years. Recent months have, indeed, seen an improvement. Chinese import growth is bottoming out. In April, the value of imports was down 0.4% yoy, which was the best showing since October 2014. One needs to be careful with these numbers. They are in nominal dollar terms and they can be volatile. But they seem to be consistent with Taiwanese exports. These have been extremely weak since the latter part of 2014, but they now also are showing some improvement. Having said that, Taiwanese exports were still down 9.6% yoy in May, but that is better than more than 17% down in November. A further improvement in China's imports would be welcome to everybody. Things aren't improving quickly enough for the central bank in Korea and they cut their repo interest rate for the first time in just over a year.
Back in December, the Fed said it thought official rates might be raised four times this year. Rather, that was the median of a diverse field of individual forecasts by FOMC members. Financial market participants did not believe it and were pricing in, roughly, one hike this year and even that one hike was not priced as a certainty. In March, the Fed lowered its forecast to two hikes. I think that was quite a spectacular move. Bear in mind, we are talking here about the Fed forecasting what it is going to do itself. The move in March was actually the Fed saying implicitly that the markets understand the Fed better than the Fed does itself. Wow!
Even after changing its guidance so substantially, there was still a gap between market expectations and the Fed's stated intentions. As economic data was relatively satisfactory and volatility on global financial markets eased in recent months, the Fed decided it needed to close the gap between its own intentions and market expectations. So it started to talk rate-hike expectations into financial markets. This effort was relatively successful, making me think they might pull the trigger on a rate hike relatively soon (even though I think hiking would be a mistake) and we were seriously discussing changing our official view of 'no hikes this year'. Then came last week's employment report with a gain of a mere 38,000 jobs in May. More recently, the Fed published its Labour Markets Conditions Index (LMCI) for May, a composite measure of 19 labour market variables. The index came in at -4.8 points after -3.4 in April. Payrolls are one of the indicators used, so it is no surprise that the correlation between the payroll data and the LMCI is high. But the graphs of the LMCI tell some scary stories. First, the last data point is not out of whack with the recent trend. In fact, it extends the recent trend. So perhaps the payrolls gain of 38,000 is not an aberration, or at least not as big as it appears just looking at jobs data. The long-term graph of the LMCI reveals an unnerving dynamic. The LMCI now stands at -4.8. The reconstructed history of this gauge shows that a drop to this level tends to signal a recession. During the last 40 years, only twice was a reading of -4.8 not followed by a recession. Now, we are not forecasting a recession, but if this sort of indicator continues to be weak, the discussions about a possible recession will heat up.
As chair Yellen has always linked the Fed's actions to the situation on the labour market, it was no surprise she essentially did a U-turn in a recent speech. It would seem, indeed, extremely unlikely that the Fed will now press ahead and tighten monetary policy. They call this 'data dependent'. The Fed being 'data dependent' is seen as a good thing. I think it is a bad thing. Monetary policy works with long and variable lags. In setting policy, a central bank should base its decisions on where the economy will be at some point in the future. I know that is hard, but to respond to monthly data about the past, does not strike me as particularly clever. But then, perhaps basing decisions on historical data is very clever if your track record in forecasting things of the future is as poor as the Fed's.
In any event, the LMCI and Yellen's speech have pushed out any rate hikes, at least to September, more likely longer. This, I think, is good for risky assets. What is less good is that the LMCI also raises fears for an approaching recession.
Europe mixed data
Recent data in Germany was very mixed. Industrial orders fell sharply in April (-2.0% mom) against a jump of +2.6% in March. Industrial production, which should have a high correlation with orders, showed to opposite: a material increase in April, following an even larger drop in March (+0.8 vs. -1.1%). French output data was quite strong. It is hard to draw strong directional conclusions from the European data. Modest, somewhat above-trend growth is the recent past and will also be the future.