Fed Chair Yellen’s long-awaited speech at Jackson Hole is was seen as dovish by markets. Treasury yields fell following the speech. Although Ms Yellen sounded more sure about the case for a rate hike, she gave no definitive signal on the timing. This should be seen against the background that markets had already priced in a higher probability of a rate hike this year over recent days. So the hurdle for a hawkish surprise was rather high. Our base case remains that the Fed will leave interest rates on hold until early 2017, but the Fed Chair’s remarks, taken together with a more hawkish tone from other FOMC officials, as well as signs of a Q3 US growth rebound, suggest the chances of a rate hike by year end have indeed increased.
Overall, we expect an improvement in US economic growth in the second half of the year, though the underlying trend is likely to be moderate
Nick Kounis Head of Macro Research
- Fed Chair Yellen signals that case for a rate hike is stronger…
- …but remains non-commital on the timing of the move
- US growth momentum turning up, eurozone flattening out
- Japan looks set for renewed deflation, which will trigger BoJ easing
Case for a rate hike has strengthened
The Fed Chair asserted that ‘the case for an increase in the federal funds rate has strengthened in recent months’. This reflected that economic growth, while moderate, was still ‘sufficient to generate further improvement in the labor market’. Although the unemployment rate was stable ‘broader measures of labor utilization have improved’. In addition, although she admitted that inflation was still undershooting the Fed’s target, this was partly due to ‘transitory effects’. Overall, ‘the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time’. However, the Fed Chair left the timing of the rate hike open and also stressed that ‘our decisions always depend on the degree to which incoming data continues to confirm the Committee's outlook.’
US and eurozone set to change places
Chair Yellen’s more positive tone may also reflect the improvement in the US data recently. The first half of this year saw the relatively rare occurrence of the eurozone economy outperforming that of the US. In the first two quarters, GDP growth averaged just below 2% annualised in the eurozone, compared to around 1% in the US. However, recent data suggest they are set to change places again.
US investment slump easing
US economic growth has been held back by an unusually aggressive inventory correction that is unlikely to be a drag much longer. However, more fundamentally, business investment has also been contracting, reflecting the correction in the oil sector to lower prices, weak profits and lacklustre exports. Data for capital goods orders improved in June and July suggesting the investment slump will ease. However, given capital goods shipments are still weak, this might be more visible in Q4 than Q3.
Overall, we expect an improvement in US economic growth in the second half of the year, though the underlying trend is likely to be moderate. One reason for this is that consumer demand was buoyant in Q2 and is likely to slow. This will offset some of the positive factors described above.
Eurozone growth momentum flattening out
On the other side of the Atlantic, the economic recovery looks to be stuck in a low gear. The eurozone composite PMI edged up to 53.3 in August from 53.2 in July. This essentially leaves the index in the range it has been in for most of this year. At the same time, the other bellwether survey – Germany’s Ifo – fell in both July and August. One negative aspect in both the PMI and Ifo surveys is a clear downward trend in business expectations.
We expect economic growth in the eurozone to remain around current moderate levels. A somewhat stronger global economy and easy monetary policy are positives. On the other hand, the impact of other positives – such as the fall in oil prices and the euro – is fading. In addition, an adverse impact due to Brexit and political risk in Europe more generally – is also a possibility.
Japan set for renewed deflation
Japan’s authorities look set to ‘snatch defeat from the jaws of victory’. Since the start of 2014, Japanese core inflation (ex food and energy) has been in clear positive territory after being negative for long periods since 1999. This raised hopes that the more aggressive macro policy stance as part of Abenomics (for all its other shortcomings) was finally about to defeat deflation. However, Japan is dangerously close to a new episode of renewed deflation. The nationwide core CPI (ex food and energy) fell to 0.3% yoy in July from 0.5% yoy in June. The same measure for Tokyo, which is already available for August, declined to 0.1% yoy. Given the strength of the yen and the weakness of the economy, the downward trend is set to continue.
All this sets the scene for the BoJ to announce a stimulus package next month. However, it begs the question why it has taken the central bank so long to act. After a good start to its QQE policy, it seems to have gone back to being cautious. Next month’s package risks being too little, too late.