Japan's All-Industry Index (METI) Backs Off In July; Global Policy Conundrums Continue

The data facts
Japan's index for all industries, which has separate components for industry, construction, and services (the tertiary sector), showed a slight downtick in July as it fell to 105.0 from June's 105.1. The construction component was dead flat month-to month at a reading of 119.4. The industry reading fell to 101.5 in July from 102.3 in June; it is however above its May value but then below its April value. The services sector ticked up to a slightly stronger reading at 104.9 in July from 104.8 in June. The services sector, however, is still below both of its readings for May and April.

What they mean...
As always, there are several ways to look at these indexes and their performances. The chart shows year-on-year growth rates by sector. On that graphic, we can easily see that construction has been the leading growth sector followed by the industrial sector and followed in turn by services. Both construction and industry appear to have had relatively strong gains in recent months, but both are fading and are off peak as of July. The services sector, while not as strong as the other two, has nonetheless also seen its pace slow.

Growth rankings show moderate results
These general observations are confirmed by more formal growth rankings. In the table, we rank each sector on its year-on-year growth rate compared to its own history. On that basis, the overall all-industry index has a 73rd percentile standing. Ranked over values since 2008, the all-industry 12-month gain has been stronger about 27% of the time. The construction sector has done a bit better than that. Ranked on the same criteria, it has been stronger only 22% of the time. The tertiary index typically grows slower than the other sectors, but even accounting for that as the ranking procedure measures its current growth relative to its past performance, the tertiary index has only at 56th percentile standing, barely above the 50% level that denotes its median growth rate.

Index levels are not impressive
While the all-industry index does not score strongly on growth metrics, it has been growing steadily. When the index level is compared to its historic values, the ranking (of course) is much higher. The overall index level standing has been higher only about 8% of the time; the construction sector has been higher only about 2% of the time; and the services sector has been stronger less than 5% of the time. The industry sector, despite its recent somewhat better growth, lags the other sectors as its level has been better nearly 14% of the time. Despite a recent growth spurt, the industrial sector has been lagging in Japan and currently is undergoing another lull.

BOJ policy
Against this background, the Bank of Japan just met and decided to hold its policy unchanged. There was one dissent as one member thought the BOJ was not likely to reach is policy objective on its current policy path. Still, BOJ policy is unchanged. In addition to the METI indexes, today chain grocery store sales were released and they weakened in August from one year ago, falling by 0.5% year-on-year. Grocery store sales are about as steady as any sector sales are. The weakness there is not good news. Clearly, the BOJ faces challenges and it is not clear where they should turn next or if steady-as-she-goes policy is good enough.

ECB policy
Elsewhere the ECB has released added commentary on its policy and it notes that Europe's improved growth has yet to feed into prices and boost inflation. As a result, the ECB is surprising observers by staying true to its price objective and it is not cutting back on its stimulus in any way with prices still lagging their objective (single mandate) so badly.

Fed policy
In the U.S., the Fed continues to follow its 'Fleetwood Mac' strategy and go its own way and to jam the square peg of policy action into the round hole of 'policy framework' to rationalize it. The Fed did, as expected, announce its great balance sheet shrinking act would commence in October. Janet Yellen noted that it was still likely that there would be a rate hike before yearend (likely in December) based on a majority of Fed members still looking for another hike in their 'dots' presentation. Still, Yellen joined the chorus of voices from Japan to Europe in having no explanation for the weak inflation. She went out of her way to note the various ways that the U.S. jobs market has improved despite the fact that it has generated little-to-no wage/price pressures. Moreover, there is some evidence trend inflation has weakened she admitted. What is left unexplained by the Fed is why with inflation 'too low' around the world a tight U.S. labor market should change that. Indeed, Yellen complained several times that the inflation under-shoots of the past could be explained by a too-strong dollar or by falling oil prices, but that the current episode of price weakness was simply not what the Fed had been expecting. She once again dismissed the special factors in the U.S. price index such as lower prices for cell-phone services as one-off events. But why dismiss that? We live in an age of Schumpeterian technological change. Not all price impacts are the smooth and continuous functions economists embrace in their models. Do you throw out reality when it doesn't fit your model? That's an odd choice.

The global economy offers few clues...
Looking back across the global economy, we find that the OECD has just boosted its outlook by a tick this month. Australia has a view of an improving economy, but Switzerland has cut back its outlook. New Zealand's Q2 growth rate was just revised slightly higher. Despite the OECD lifting its growth-gauge a touch, it also warned that self-sustained growth may not yet be in force as it lamented the lack of progress on structural reforms and noted the still weak inflation background. In an unrelated development - as if to underscore the risk in the global economy- S&P downgraded China's sovereign debt rating following a period of heated credit growth. The rating on China's long-term outlook remained unchanged. On balance, there are still a lot of issues and concerns. If the global growth scene is a jigsaw puzzle, it still has many missing pieces although a good number of new pieces have been slotted into the puzzle. Growth numbers continue to come on line with solid-to-strong performance, but inflation remains elusive. Today a U.S. report on manufacturing in the Philadelphia Fed's region was quite strong while the U.S. leading economic index continued to expand, although somewhat modestly. There is no threat to growth. Asset markets remain strong. Some worry about asset bubbles. Some worry that inflation is ready to pounce out of nowhere and overwhelm central bankers; they argue for relentless increases in rates regardless of the presence or absence of inflation.

First we try their souls... then we put their reputations on trial
It is truly a time that tries men's and women's souls, that is if they are monetary policy-makers. The ECB is being strict to its lone inflation mandate in making policy. The Fed is pushing rates up relentlessly, but slowly, even absent hitting all its policy goals. Japan has pulled out all the money stops, but that may not be enough. What are central bankers going to do? Is it virtue to be true to your policy edict or to press head based on the lessons you have learned in the past? If so, what are those lessons? (1) Are they that central bankers tend to keep rates too low for too long, or (2) as Ben Bernanke once said, is it true that in the wake of great economic downturns policymakers have tended to return rates to 'normal' too soon? Where is the Wisdom? What is the Fallacy? Policymakers are in search of truth. But judging from Janet Yellen's comments yesterday and what is emerging from the policy discussion in Japan, there may be more that central bankers do not know than they are really willing to let on. Are they making policy from the strength of their wisdom or frozen by the fear of the known? And if it is the unknown that is dominant, how does policymaking inspire confidence?