Green light for the Fed, bullish data out of China and the Eurobonds solution
Let me pick through the news stories today with a few thoughts of mine on what’s happening in the markets and the economy. And I want to start with inflation.
The Fed’s preferred inflation gauge, the price index for personal-consumption expenditures, rose a seasonally adjusted 0.1% in February from the previous month and climbed another 0.2% in March, the Commerce Department said. Figures for the two months were released simultaneously on Monday because the partial government shutdown at the beginning of the year had delayed data compilation.
While the pace of inflation marked a pickup from January, when the PCE price index slowed to its weakest pace since 2016, price increases were well below the Fed’s goal at just 1.49% since March 2018.
The shortfall relative to the Fed’s inflation target came even as energy prices began to recover from a steep decline in late 2018 and early 2019, and as services prices picked up from a slowdown early in the year.
My take: Federal Reserve Chairman Jay Powell has been talking about the lack of inflation as a reason to remain on pause. Even before the Fed’s dovish turn, there was disquiet about the lack of inflation, despite low unemployment and decent wage growth. But now, I believe the lack of inflation will be the Fed’s main reasoning behind remaining on hold.
There is a Fed research meeting in Chicago coming up in June. And the Fed may want to signal ahead of that meeting its desire to move to a more symmetric inflation target, where 2% is the target and the Fed is truly indifferent to outcomes clustered around that target. WHat that would mean is that the Fed would be on hold indefinitely due to a persistent undershooting of target.
Moreover, to the degree inflation actually did overshoot the target, the Fed would want to see ‘catch-up’ inflation on the overshoot, so as to move the longer-term historical average inflation rate toward 2%. In effect, that means 1.5% inflation would be cancelled out by 2.5% inflation and 1% inflation would need the economy to run hut toward 3% to get the Fed to move.
Let’s see how much the Fed moves in this direction. If it does, it could give the credit markets (and the larger economy) room to run as investors reach for yield in the knowledge that the Fed will not attempt to cut the cycle short.
China’s industrial profits show biggest gains in eight months as hopes rise for end to US-China trade war – SCMP
Profits at China’s industrial firms made their biggest gains in eight months in March in the latest sign that the economy is stabilising in response to Beijing’s stimulus and as hopes rise for a deal in the trade war with the United States.
Industrial profits rose by 13.9 per cent year on year in March to 589.52 billion yuan (US$87.5 billion) in the biggest increase since July, and rebounding after four months of contraction, the National Bureau of Statistics said on Saturday.
The bureau said the rebound was driven by growth in production and sales, with rises in prices translating into higher profits. Industrial enterprises were also more efficient, it said.
My take: This is bullish. It tells you the Chinese stimulus is having the desired effect of (temporarily) boosting Chinese economic growth. And that’s not only good for China, it’s also good for emerging Asia and exporters dependent on China like Germany.
This news does not mean the Chinese are moving back to an infrastructure-led over-investment that ballooned private debt balances and is still being worked off of balance sheets. But, it does mean we can take Armageddon scenarios off the table, with the likely outcome being a relatively stable but decelerating rate of growth for the Chinese economy.
Premier Li has also said that he is committed to using stimulus only to generate stability. The priority is to wring out debt excesses and shift China to less of an export or infrastructure-led model that accumulates so much debt. With domestic consumption growth still weak, some level of stimulus is likely to be in place for a while.
If you consider the most probable sources of future tension, the eurozone is no stronger today than it was before it acquired a half-baked banking union and the European Stability Mechanism.
The eurozone only survived during the crisis years between 2010 and 2015 thanks to two decisions, both initiated by Mario Draghi, president of the European Central Bank. The first, in the summer of 2012, was the vague but forceful promise to do “whatever it takes” to prevent the break-up of the European single currency. This was followed up in March 2015 with purchases of eurozone sovereign bonds. But it is worth recalling that quantitative easing was not an overt crisis response. It was only possible because of the eurozone’s descent into disinflation in 2014. Without it, Mr Draghi would otherwise never have found a majority in his governing council for the scale and length of the sovereign bond purchases that ultimately succeeded in stabilising the eurozone bond markets. It was a fortuitous coincidence.
Without an ECB able or willing to do the heavy lifting in the next crisis, real reforms will be needed. Those agreed recently are of the wrong kind. The eurozone does not really need another small structural budget facility. Even if a eurozone budget were to grow to 1 or 2 per cent of gross domestic product eventually — which is beyond what is imaginable by several governments — it would not be enough even to make a dent in a severe financial or economic crisis.
My take: The Eurozone is not fit for purpose. It’s a disaster waiting to happen. None of the northern eurozone countries want mutualised sovereign debt, which is what every sovereign currency area has. They are deathly afraid of their electorates’ reactions to a sovereign ‘bail out’ of ‘profligates’. And they seem to think that for sovereign nations, the discipline of being a currency user and being prey to the bond vigilantes is the right way to run things.
There will be another sovereign debt crisis in Europe. That much is certain. And when it happens, the popular unrest will be worse than the first time. I don’t have a whole lot of positive things to say about the eurozone. The euro has a lot of things going for it as a currency. But I think the eurozone — as designed — is a gargantuan mistake.
I’m going to stop there for today. And a mostly Happy Monday