EXANTE Macro Insights

EXANTE Macro Insights

By Renée Friedman, PhD

The week in summary:

Welcome to Macro Insights #15. This week saw markets reacting to both a more hawkish ECB and growing concerns over just how aggressively the Fed may seek to tighten policy in March and further into 2022. Fed Bank of Cleveland President Loretta Mester, a voting member of the FOMC, said on Wednesday that all options are on the table for the size of policy makers’ first interest-rate increase in March, but she doesn’t see a “compelling case” for a 50-basis-point hike. Markets are currently pricing in at least 5 rate quarter point rate rises this year and a big question will be how the Fed will start reducing the portfolio of bonds it has acquired through monthly purchases. The Fed’s total balance sheet is currently about $9 trillion. There are suggestions it may just let it passively roll off on a month by month basis as it did in 2017. However, Mester seems to support a more active approach, in which the Fed would outright sell some of the $2.66 trillion in mortgage-backed securities it is holding. She said, “I do think it’s important that the Fed not be allocating its credit to particular sectors.” The Fed’s monthly asset purchases are expected to end completely by March.

Treasury yields in the US, the UK and in Europe rose with Germany seeing a rise of  in its benchmark 10 year well into positive territory (currently at about 0.21%) . Italy, one of the most indebted Eurozone countries, also saw yields rise on its 10 year to over 1.86% earlier in the week. Rising yields will put pressure on the Italian government as it is now facing higher costs when raising funds from public markets. There are increasing expectations that the ECB will tighten monetary policy during 2022 with a possible rate rise later this year as new forecast models expected in March, may show that inflation will not come down as quickly as previously anticipated.  

In the UK this week, Huw Pill, the Bank of England’s (BoE) Chief Economist, said policymakers should raise interest rates gradually rather than taking an “aggressive” activist approach, This was in agreement with last week’s statement from BoE’s governor Andrew Bailey, who  warned that wages would need to fall in real terms this year in order to keep inflation under control. According to the BoE’s latest forecast, wage growth approaching 5 per cent this year would be “stronger than that consistent with the inflation target over the medium term”. If it eased from 2023, inflation could subside without the UK falling into recession. 

European electricity prices jumped after the region’s biggest producer Electricite de France (EDF) said its nuclear production could fall this year to levels not seen since 1990, and cut its nuclear output target for a second time in a month. EDF said nuclear output is expected to fall to 295 and 315 terawatt-hours in 2022, down from an earlier forecast of 300 and 330 terawatt-hours.German power for next year, a European benchmark, jumped as much as 4.7% to 147 euros a megawatt-hour, while the March contract surged as much as 5.5%.

Oil markets were again up this week despite negotiations on a new nuclear deal between the US and Iran, moderated by Europe, finally starting in Vienna. This has raised the spectre of U.S. sanctions being removed from Iranian oil exports. This could add hundreds of thousands of barrels per day onto the market. Nevertheless, oil futures are rising, with global benchmark Brent currently standing at about $91/barrel. U.S. crude inventories fell by about 4.8 million barrels last week, according to government data, compared with an expected increase as demand is increasing. OPEC+ has struggled to meet its targeted output pledges due to the rebound in demand as economies emerged from the pandemic, leading to a significant tightening of the market. The market has also been supported by ongoing threats to supply  in the United Arab Emirates and over the dispute between the US, its NATO allies and Russia due to the presence of thousands Russian troops near Ukraine's border. This will feed into inflation, worsening growth prospects for energy importing countries.  

Things to look out for this coming week 

  • In Europe on Friday is the German Harmonised Index of Consumer Prices. On Tuesday there is Spanish CPI data, Eurozone Employment change data, and Eurozone GDP. There is also Eurozone ZEW economic sentiment data. On Wednesday is Eurozone Industrial Production data. On Thursday is the ECB Economic Bulletin.
  • In the US on Friday there is the Fed Monetary Policy report which is submitted to Congress and reviews the conduct of monetary policy and economic developments and prospects for the future. There is also the Michigan Consumer Sentiment Index.  On Tuesday there is PPI data and the New York Manufacturing Index.  On Wednesday is Retail sales data and the release of the FOMC minutes. On Thursday there are continuing jobless claims, initial jobless claims, Housing starts, Building permits, and the Philadelphia Fed Manufacturing Survey. 
  • In the UK on Friday there is a slew of data: GDP data, Industrial production data, Index of Services data, Manufacturing production data, Total Business Investment data and trade balance data. On Tuesday is data on Average earnings, with and without bonus, as well as Claimant count change, claimant count rate, and the ILO unemployment rate.  On Wednesday is CPI, PPI and the RPI data.

Also keep an eye out for Japanese GDP data on Monday. In China on Tuesday look out for data on Foreign Direct Investment, while on Wednesday there is CPI and PPI data. The People Bank of China (PBoC) has been cutting rates to support the economy amidst the slowdown due to  shakiness in the property sector following Evergrande’s dramatic failure to meet international bond payments last year.  

Building an economic bridge too far?

As has been well documented, the Coronavirus pandemic threw open the discussion on decades of growing income inequality, asset ownership inequality and inequality of opportunity (something we touched upon in issue #11 Covid, markets, and the state). The growing economic geographical disparities between regions in some countries have exacerbated the problem. As noted by former US Secretary of Labour, Robert Reich,  technology and globalisation offer far-reaching benefits, but they also increase the risk of some people being left behind. Accordingly, he says, we should build bridges to help people move to the sectors that will define the new economy. What we should not do is build walls to protect the industries that will be rendered unproductive by the forces of creative destruction.” 

For many, this growing inequality has come to mean that the state has to get involved in “levelling up” and reducing the disparities between regions. This is not just a politically motivated exercise, although social tensions may heighten as a result of the increase in equality laid bare by the pandemic. It is that longer term prosperity has been dependent on increasing productivity, usually gained by innovation and the upskilling of labour. It is also dependent on the competitiveness and creativity of regions including  changing their characteristics, e.g. education levels and infrastructure. 

This “levelling up” is something the UK government has pledged to do following the release of a White paper earlier this month Levelling up the United Kingdom which also calls for  increased public investment in research and development outside of London and the southeast. This additional government funding will seek to leverage at least twice as much private sector investment over the long term to stimulate innovation and productivity growth. 

However, as admirable such policy objectives may be, it may not be sufficient to “level” up. Experience (Cohesion policies of the EU) from decades of European “cohesion policy” shows that  positive effects were not evenly distributed across the regions of all Member States. This is something acknowledged by the OECD as well. As it has noted (OECD regions) regions are facing a new economic and sanitary environment in a post Covid world, prompting a rethink of participation in globalisation, as well as their attractiveness for investors, talent and visitors. An answer to the crisis means regions need to fully  understand the structural challenges emerging or reinforced by the pandemic and how their international profiles may have changed, while maintaining a focus on providing benefits to local residents and businesses, while preserving environmental resources.

The cost of building new economic bridges will be high. All this intervention will come at least some cost to the taxpayer as market forces alone will not be capable (or maybe even willing) to deliver the high risk projects needed to boost technological innovation across disparate regions.  This also may not be as palatable when governments, particularly in the West, have to deal with budget deficits incurred during the pandemic while ensuring their economies remain able to generate economic recovery despite rising inflation, primarily due to supply factors. 

What history, particularly in the UK and in southern Europe has shown, is that interventions generally fail to generate the lasting impact on demand for locally supplied goods and services, which is necessary if they are to deliver economic growth. However, the failures  of past policies to alter the economic geography of some countries was not just dependent on the amount promised and eventually, to some degree, invested by governments, but the political will to implement such policies. Let’s hope, for the sake of stronger, more even and more sustainable growth, that governments really will take a wider view that includes measurable KPIs that allows them to adjust these “levelling up” plans moving forward. 

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