EXANTE Macro Insights

By Renée Friedman, PhD

The week in summary:

Welcome to Macro Insights #11. This week was Central bank week: the US Federal Reserve, the Bank of England (BoE), the European Central Bank (ECB) along with about a dozen others, all met this week.  

After a week of “will they or won’t they” which saw US markets rise then fall then rise again, the Fed, in an unanimous decision, agreed to double the taper pace of its purchases of Treasuries and mortgage-backed securities to $30 billion a month, concluding the programme by March 2022, which is three months earlier than suggested at its previous meeting. They are projecting three quarter point interest rate increases by the end of 2022, as new economic projections forecast that inflation would run at 2.6% in 2022, falling to 2.3% in 2023 and 2.1% in 2024. and the unemployment rate would fall to 3.5%. The new projections also showed another  three increases (if deemed appropriate) in 2023 and two more in 2024. This would bring the funds rate to 2.1% by the end of 2024. Fed Chairman Jerome Powell said they don’t anticipate raising rates before ending the taper process, but could hike before reaching full employment. Powell said that sharply rising prices had now emerged as a bigger threat to jobs than the pandemic. The Fed is still concerned about the labour participation rate, which remains below pre-pandemic levels. Now the question for many is when the Fed may seek to shrink its balance sheet and will it engage in quantitative tightening, i.e. allowing bonds to “run off” without reinvesting the principal, as it did in 2018? 

Even if uncertainty remains over future Fed action and how it may impact markets, at least one crisis was averted in the US this week with Congress finally raising the national debt limit by $2.5 trillion and extending it into 2023 through the Nov. 8 midterm elections that will determine control of Congress. It passed the Senate in a 50-49 party line vote before moving onto the Democratic-led House, which passed it in a 221-209 vote in the early hours of Wednesday morning for it to then be signed by President Biden. The bill needed to be approved by 15 December as that was the cut off date Treasury Secretary Janet Yellen had given “before the coffers run dry”. 
In the UK the BoE became the first of the major central banks to raise rates with a move that surprised markets after November’s disappointment; it raised rates from 0.10% to 0.25% in an 8-1 vote. The monetary policy committee (MPC) voted 9-0 to keep the central bank's government bond-buying programme at its target size of £875 billion. The BoE has also bought £20 billion of corporate bonds. The bank said, "the labour market is tight and has continued to tighten, and there are some signs of greater persistence in domestic cost and price pressures. Although the Omicron variant is likely to weigh on near-term activity, its impact on medium-term inflationary pressures is unclear at this stage. It said inflation was likely to hit 6% in April - three times its target level. The BoE did acknowledge that the world is in a very different place now than earlier in the pandemic. The BoE is now focused more on "upside risks" around pay trends and said there was little sign of a jump in unemployment after the end of the government's job-supporting furlough scheme on 30 September. Sterling jumped on the news rising against both the USD and the Euro and the FTSE was also up. 

And finally, the ECB said it would continue to cut its bond buying under its €1.85 trillion Pandemic Emergency Purchase Programme next quarter and will wind down the scheme as expected next March. However, to smooth the exit from pandemic stimulus  it will ramp up bond purchases under the Asset Purchase Programme (APP). It will buy €40 billion of bonds under the APP in the second quarter, €30 billion in the third quarter, then from October onwards, purchases will be maintained at €20 billion, for as long as necessary to reinforce the accommodative impact of its policy rates. The ECB continued in its statement that it considers the current high inflation rate to be  temporary . It said , “the governing council judges that the progress on economic recovery and towards its medium-term inflation target permits a step-by-step reduction in the pace of its asset purchases over the coming quarters.”. It also voted to keep its deposit rate unchanged at minus 0.5%. During the ECB press conference, ECB President Lagarde stressed that the ECB will be as “flexible” as needed. Although she admitted that inflation will be significantly higher than in the September projections with updated macroeconomic forecasts showed an average of 3.2% inflation rate  in 2022 before falling to 1.8% in 2023 and 2024, that it will come down as energy prices fall, the German VAT cut falls out of base effects and as supply pressures ease. However she also did admit that “shortages are hampering production of manufactured goods, causing delays in construction and slowing down the recovery in some parts of the service sector and that these bottlenecks will still be with us for some time.”  President LaGarde also agreed that  “the future path of energy prices and the pace at which supply bottlenecks are resolved are risks to the recovery and to the outlook for inflation. If price pressures feed through into higher-than-anticipated wage rises or the economy returns more quickly to full capacity, inflation could turn out to be higher." However, although economic activity has been moderating over the final quarter of 2021 “and this slow growth is likely to extend into the early part of next year,” the ECB still expects output to exceed its pre-pandemic level in the first quarter of 2022. She cited the improving labour market with unemployment projected to reach an Eurozone-wide historical low of 6.6% in 2024. European markets were up as was the Euro after the announcement. 

Oil was down this week in response to both dollar strengthening and the International Energy Agency (IEA) saying the Omicron coronavirus variant is set to dent global demand recovery.

Things to look out for this coming week:

In the run up to Christmas, the next week will be a relatively slow news week: 

• In Europe on Friday there is German Producer price and Ifo Business sentiment data as well as Eurozone CPI data. On Tuesday is the GfK consumer confidence survey for Germany, Europe’s largest economy. There is also Italian Producer Price and Industrial sales data and Eurozone consumer confidence data. On Thursday there is Spanish GDP data. 
• In the US on Wednesday is the Chicago Fed National Activity Index, Personal consumption expenditure data, consumer confidence data and Q3 GDP data. On Thursday there is initial and continuing jobless claims, Personal income data, Core personal consumption index data, Durable goods orders, non-Defense capital goods orders, the Michigan Consumer Sentiment Index, and New home sales data. 
• In the UK on Friday there is Retail sales data and the Bank of England will release its Quarterly Bulletin. On Wednesday is Q3 GDP and Total Business Investment for Q3 data. On Thursday is GfK Consumer Confidence survey results 

Also look out for the People’s Bank of China (PBOC) decision on Monday and the Bank of Japan monetary policy minutes on Tuesday. 

Covid, markets, and the state 

Over the course of the pandemic, much has been written about “the return of the state” as the global challenges posed by the pandemic have amplified the interconnectivity between regions, something again brought to the fore by November’s COP 26 meeting which highlighted the global challenges of climate change and who was best suited to allocate resources efficiently and effectively to deal with these emergent challenges. 

For many this has manifested as a campaign to “change the paradigm” of capitalism to make it more inclusive and fairer, identifying that in a world where the consumer is king, especially due to the influence of social media on reputational and litigation risk, that a multitude of stakeholders need to be considered and shareholder capitalism should be ended. However some in this debate believe that the markets (and corporations) have distorted incentives and can’t make capitalism fairer or more inclusive  and that only the state can promote this. What they often ignore is that markets are themselves dependent on rules. As noted by Luigi Zingales, Professor of Finance at the University of Chicago, in a recent article, the question is not whether there should be rules, but rather who should set them, and in whose interest. State intervention can promote markets and innovation, e.g. the UK government’s willingness to work with the private sector contributed to the speedy creation of the AstraZeneca vaccine. And markets do react to societal changes; witness the growth in the availability of ESG investment products. 

It is critical to recognise that there are many things that the state can do well, but also many things it cannot.  Therefore, as central banks’ and government policies and areas of focus  are expected to slowly shift over the next year as we (hopefully) move on from the Coronavirus pandemic, the argument for the balance between who should make the rules that support an innovative society and growing economy should also shift. The focus  needs to be more on the nature of the state’s interventions as it is these which have the power to move markets, for good or for bad. A November 2021 article in The Economist highlighted the importance of maximising the role of markets and individual choice. It said, for example, that climate change should be fought with a price for carbon, research-and-development subsidies and highly scrutinised public investments, not by rationing flights, promoting green national champions or enlisting central banks to distort financial markets. As we think about our post-Covid world,  we need to not think about more state or less market to create a “more inclusive” capitalism, but instead each’s ability to carry out the functions it performs best. During the pandemic many states successfully  provided direct capital injections through investments, loans and grants. injections of capital into the banking system to spur investment, and were able to develop public–private partnership structures. What happens next will depend on how much each trusts the other and how agile public and private institutions are to respond to an intrinsically different world than the one that existed before the Covid pandemic.

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