Haver Analytics
Haver Analytics

Viewpoints: January 2022

  • Japan's consumer confidence diffusion index eroded in January, edging down to 36.6 from December's 38.9. The index is net lower over three months and over six months, but it is up by 6.5 diffusion points over its value of 12-months ago.

  • So... there it is, the paradox of the central banker…How much is enough? How much is too much? How much is too little? What happened to Goldilocks?

    Back in the early 1980s, monetary experimentation was rampant. I worked at the New York Federal Reserve Bank back in those early days (1977-1983). My look back at the research and experimental looks at money (M1, M1a, M1b, M2 MZM…L, etc.) leaves me with the feeling that while there was a lot of research there was more investigation than there was learning. Subsequently, the Fed left the quantity of money to the wind and focused more on the price of money by targeting interest rates. But that does not mean money does not matter. It just means that money is not targeted. In fact, the Federal Reserve in the U.S. even STOPPED PUBLISHING M2 money supply numbers weekly. Shame!

    The Fed in the U.S. further loosened constraints on itself by claiming to target some (unspecified) average rate of inflation and the ECB followed suit, dropping the less-than 2% objective for a 'higher' (also unspecified) 2% 'average.' So now central banks have a known objective for inflation (2%) which they are evaluating by looking at an unknow benchmark - some average of actual inflation. This, of course, leaves markets more mystified than before because we really don't know what the central bank is looking at to make policy. Since inflation has jumped so much, there is an enormous difference in what you see for inflation depending on which average you look at. And central banks think they are doing a 'excellent job' at communication!

    Can we be anything but NOT SURPRISED that all this has led to rampant inflation?

  • France's INSEE industry climate reading spurted to 112.4 in January to start the New Year from 109.7 in December despite an assault across Europe by the Omicron virus and some sharp words for the unvaccinated from French President, Emmanuel Macron. The French service sector, however, stepped back to 104.8 in January from 107.4 in December, marking a two-month drop of more than 13 index points, a very sharp pull back. We know that the service sector is more vulnerable to viral outbreaks, so my working hypothesis is that the virus smacked the service sector hard, but the manufacturing sector is signaling that growth is still in the groove. We will, of course, monitor French data closely to see if this is confirmed in forthcoming data releases.

  • The ZEW experts' macro conditions readings for January show deteriorations for Germany, the EMU, and the United States. The German reading logs in at -10.2 in January while the EMU logs a reading of -6.2. In sharp contrast, the U.S. logs a reading of +41.1 (diffusion readings for individual reporters are not shown here). Germany has a 44.6-percentile queue standing, the U.S. has a 57.4-percentile queue standing and the EMU has a 64.3-percentile queue standing. Among the three assessments, only Germany, with a standing below its 50th percentile, is performing at a pace below its median.

    Economic expectation readings are available for Germany and the U.S. Germany has the higher diffusion reading at +51 (not shown) while the U.S. has a +22-diffusion reading. This translates to a 72-percentile queue standing for Germany and a 60.5 percentile queue standing for the U.S. Both are above their respective medians for the period (the median occurs at a ranking of 50). And the diffusion reading for both Germany and the U.S. rose sharply on the month.

    The early take on the ZEW outlook is that expectations have held their ground in January even has macro conditions assessments have slipped a bit. This may be an acknowledgement that the virus set back some activity in January but is not expected to continue to have that effect going forward.

    Inflation expectations are negative in January and are lower on the month in the EMU, Germany, and the U.S. This is an interesting finding since inflation has been flaring and it is and has been troubling and excessive relative to the ECB target as well as the U.S. inflation target. However, what inflation is and what it is expected to be are different things. Inflation expectations peaked around March 2021 at diffusion values in their 80s for the EMU, Germany, and the U.S. In January these expectations are coalescing around a diffusion value of -40… as actual inflation has flared expectations have pulled back. While central bankers have played dumb about inflation (see no inflation, hear no inflation, speak of no inflation – and expect it to go away on its own), the ZEW experts were right on (prescient) and foresaw this blast in the making. The ECB for now seems unconcerned and is of the belief that no policy change is required, and that inflation will simply deflate. Or maybe even Godot will show? In the U.S., the central bank is making preparations to hike rates by winding down and eliminating asset purchases and signaling that it expects to raise rates multiple times in the year ahead.

    Not only were ZEW expectations on inflation elevated earlier, but ZEW respondents now see central banks as closer to acting to contain it (I guess that would be despite some official pronouncements to the contrary). We can compare responses to the levels of those same responses of last year when ZEW inflation expectations were elevated. At that time, short-term interest rate expectations hovered near 10 for the U.S and the EMU. The expectations for the EMU are up to a diffusion value of 25 while the U.S. is up to 81. A net rise of over 70 points for the U.S. and a net rise of about 13 points for the EMU. So it appears that the ECB's declaration on rates is holding back ZEW expectations. Still, the ranking for rate hike expectations in the U.S. and in the EMU are high at the 74% mark in the EMU and the 84-percentile level in the U.S.

    Turning to longer term rates, there are extremely high percentile standings for long-term rate expectations in both the U.S. and Germany. However, the average shift in expectations is smaller for long-term rates (+10) than for short-term rates (+20). This suggests – and the above responses are consistent with this - that ZEW experts expect rates hiked at the short end to be more powerful than the rate rises in the long end or at least to be sufficient to stop inflation. And this is reflected in the way inflation expectations have been pulled back as we saw. The monthly change in long rate expectations was higher in the U.S. this month than it was for Germany.

    But in this environment the stock market is no longer as favored. Stock market percentile standings are all below 50 indicating a worse than median expectations and the month-to-month decline is an average drop for the U.S., German, and EMU markets of 17 points.

  • Global| Jan 13 2022

    What's the Consensus Call?

    The evolution of consensus forecasts can often yield useful insights about the plight of the world economy. And the latest Blue Chip survey of economic forecasters, published earlier this week, is no exception. The latest January survey, for example, suggest that global growth prospects remain hostage to the COVID pandemic. But inflation concerns are also mounting in some countries and taking a toll on their growth outlook at the same time. Those inflation concerns are now mapping more into the interest rate outlook as well in some of those countries following recent hawkish communications from, for example, the US Fed and the Bank of England. The absence of any material inflationary pressures in Japan and China has been noteworthy, however, as has the relatively dovish response to recent events in Europe from the ECB. And the implications of all this for expected interest rate differentials between the US and most other major economies has had some predictable implications for consensus forecasts for the US dollar as well.

    In what follows we briefly discuss some of these considerations with reference to a few exhibits.

    Growth forecasts pared back in the US and Europe, lifted in China and Japan

    We'll start with the outlook for economic growth. Consensus forecasts for GDP growth in most major economies for 2022 have been pared back in recent months (see figure 1 below). COVID considerations, inflation concerns and the policy response to both of these have been arguably to blame.

    Figure 1: The evolution of consensus forecasts for GDP growth for 2022

  • Try to recall a period when the Fed has misjudged inflation and labor market dynamics as poorly as they have in the past year. The Fed initially called the inflation jump "transitory," only to back away from that assessment when it continued to move higher and broaden. Consumer price inflation will end the year near 7%, the highest in several decades. At the same time, despite growing evidence of labor shortages, the Fed continued to argue it still did not meet its full employment mandate. If an unemployment rate of 3.9% at year-end, down nearly 300 basis points in a year, and a 5.8% increase in average wages for non-supervisory workers, the highest jump in several decades, is not evidence of an economy well-beyond full employment, then what is it?

    Never before has the Fed continued to ease policy in the face of sharp increases in prices and wages. As flawed as the current monetary policy stance is nowadays, the more significant issue is how policymakers undo the past year's mistakes. Because of adhering to rigid rules of communicating a policy change well before and only at regularly scheduled meetings, policymakers cannot lift official rates for a few more months. Being late on rate adjustments suggests that modest policy steps to contain inflation and emerging imbalances would not be enough. Uncertainty over monetary policy spells trouble for the economy and deepens the downside for risk-assets.

    A few weeks ago, Randall Forsyth, Associate Editor, Up & Down Wall Street columnist at Barron's, interviewed Mr. Felix Zulauf, a longtime member of the Barron's Roundtable. Mr. Zulauf expects a sharp drop in the S&P 500, falling to 3000, as "the markets are about to be slammed by a reversal of the extraordinary fiscal and monetary stimulus applied to fight the pandemic. While policies remain loose, what counts is the change in, rather than the absolute level of, stimulus.

    Mr. Zulauf did not offer a forecast for fed funds, Yet, history shows that it requires a fed funds rate above consumer price inflation to reverse or stop inflation cycles. That does not mean the Fed needs to raise rates equal to peak inflation. Policymakers are more concerned about persistent inflation, running well ahead of its 2% target. Suppose we assume roughly half the rise in consumer price inflation in 2021 is pandemic-driven, probably an overly generous assumption. In that case, that still results in an underlying inflation rate in the 3.5% to 4% range and a policy rate of equal scale. Yet, policy rates might never reach that scale as it would trigger declines in asset prices similar to or greater than Mr. Zulauf's forecasts.

    Mr. Zulauf did not offer any timeline for the sharp drop in equity prices. But he felt the sharp decline would "shake authorities," forcing them to stop and reverse course at some point. An equally bullish view follows Mr. Zulauf's bearish outlook. He believes the Fed will turn on the monetary spigots again, triggering a rally in the S&P 500 to 6000. A u-turn of that magnitude is not a 2022 event.

    In my view, with the market valuation of equities trading 2X times GDP, above the tech-bubble levels, risk assets are most vulnerable to a rapid change in Fed policy. An increase in official rates spells trouble for equities, and a decision to shrink the balance sheet at some point would be doubly bad as the latter would lift long-term rates and reduce the present value of future cash flow. Blunders by the Fed in 2021 come with a cost---higher rates, increased volatility, and sharply lower equity prices in 2022.

    Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.