Light Economic Calendar Week Allows New Thinking on Macro

The drip-feed of high frequency economic data from the major economies slows in the week ahead. The data that is reported is
unlikely to have much impact on the expectations of policy going forward.
The state of
play is fairly straightforward. 
 The Federal Reserve is finding it difficult to take
the next step in the normalization of monetary policy.  According to
Bloomberg calculations, the Fed funds futures strip does not show greater than
a 42% chance of a rate hike at any meeting through the end of next year.  

The BOJ and the
ECB have signaled a review of their respective monetary stances next month.
   Neither the BOJ’s increased
equity purchases and new dollar lending facility (which could be more important
due to changes in the US money markets that impact dollar funding), nor the
“fresh water” in Abe’s fiscal plans have impressed investors.  There
is some speculation that BOJ Governor Kuroda may abandon the 2% inflation

We have argued
that the target is on the wrong inflation measure (CPI excluding fresh food),
and the timeframe was too ambitious. 
  It should be a medium-term target
or goal.  Making it short-term, and the repeated moving it further out, undermines the very credibility and transparency that an inflation target
theoretically enhances.
The ECB staff
will offer updated forecasts next month.
  There are two areas that many
investors expect action.
following the staff forecasts, it will be clear that officials cannot be confident
that its inflation target will be approached.
  Eurozone fiscal policy became
a little easier this year as ostensibly to cope with the refugee challenge.
 It is anticipated to be somewhat less accommodative next year. The
80 bln euro a month of asset purchases may be extended from March until
September 2017.  This would be the
second extension.
Second, the
extension of the asset purchases may aggravate the shortage of some securities
in the eurozone. 
 Some speculate that the capital key (a function of
size of the economy) as the determining mechanism of how the 80 bln euro in
asset purchases is distributed among the
member may be abandoned.  We demur.
 There are a number of other
adjustments that can be made, and we see
the capital key as an important principle
that is unlikely to be easily eschewed.
When the Fed
was engaged in asset purchases, before the ECB or BOJ initiated their program, a popular chart showed the size of the
respective balance sheets.
  It seemed to show that the expansion
of the Fed’s balance sheet was weighing the dollar.  We were skeptical.
 Over the past year, the ECB and BOJ’s balance sheets have expanded by
nearly 50%, while the Fed’s balance sheet has contracted by 5%.  During
the period, the yen has appreciated by over 22%, while the euro has risen 1.6%
against the dollar.   On a real broad trade-weighted basis, which is the
most relevant economic measure, is about 3%  higher over the past year.
The Fed’s
hesitancy in lifting rates is not due to the dollar any more.
 At first,
policymakers were thrown off balance by the shockingly poor May employment
report.  We argued at the time that a statistical quirk was not uncommon;
taking place once a year or so. Of course, confidence in this assessment was
only possible because the June and July employment data.  The two-month
average stands at 274k, which is the highest this year, and above all but two
months last year.
More recently,
the weakness of Q2 GDP shook confidence. 
 However, investors may be more
rattled than policymakers.  Our understanding is that the Fed’s leadership
tries to focus on the signal and look past the noise.  In terms of GDP, the signal comes from final domestic
demand, which excludes inventories and net exports, leaving the components of GDP that monetary policy can directly
The main reason
that the initial estimate of Q2 GDP fell well short of market and official expectations was due
to the continued liquidation of inventories. 
 The strong
consumption (4.2%), which was nearly three-times larger than the Q1 increase
(1.5%) was met by inventories rather than new output.   It was the third
consecutive quarterly liquidation, and it appears to have largely run its
At the same
time, US consumption appears to have
begun Q3 on a firm note.
  US auto sales rose from an
annualized pace of 16.61 mln in June to 17.77 mln in July.  Domestic
brands accounted for the lion’s share of the increase.  It is the
strongest sales since last November.   The industry figures do not always
translate into retail sales, but if they do, there may be upside risks to the
median forecast of 0.4% for July, which the US data highlight of the week
The components
of retail sales, which are used for GDP
calculations, had their strongest quarterly advance in Q2 since Q1 12. 
 After rising 0.5% in May and June, the pace may have
slowed to 0.3%.  That would match the 12-month average. Still, as we
approach the middle of the quarter, the Atlanta Fed’s GDPNow tracker puts Q3
growth at 3.8%, helped by an 8.8% increase in private sector investment.
An alternative
methodology at the NY Fed puts Q3 growth at 2.6%.
  Of course, the Atlanta Fed estimate,
if true, is preferable, but even under the NY Fed’s less optimistic results, after three-quarters of
disappointment, the economy bounces back above trend. Even if we have
struggled to anticipate the quarterly pattern of growth, the important point is
that the US economy is re-accelerating as the headwinds from oil (on
investment, manufacturing, etc.) and the inventory cycle dissipate, and not
entering a recession as so many naysayers warned.  
Incidentally, a
GDP tracker has been launched by the Bank
of Italy
 for the eurozone. The coincident indicator
(hence it is dubbed COIN) was updated at
the end of July. 
It estimates Q3 GDP at 0.31%, up from
0.29% in June.  The initial estimate of 0.3% in Q2 will likely be
confirmed this week.
The US election
has moved within the three-month time frame that is important for numerous
market participants.
   The dramatic departure from
American tradition and the status quo that Trump’s candidacy represents brings
a new level of attention to the contest.    Like many, we are surprised
that Trump secured the Republican nomination in the first place.  While
his unorthodoxy may have yielded some advantages in the primaries facing many rivals, his vulnerabilities have been highlighted over the past few weeks.
In the
electoral cycle, the situation tends be fluid until around Labor Day, or early
September in the US. 
   However, there has been a
deterioration of Trump’s support that the national polls only partly reflect.
  The key is the Electoral College, and a handful of swing states.
When political
analysts look at the Electoral College map, Pennsylvania is emerging as a
critical state for Trump and, demographically, it is his sweet spot.
  The state is 20% whiter than the
country as a whole, exposed to manufacturing, with a large working class base.
   Romney lost the state by five percentage points.  It is a
truism, that for Trump to win he must do better than Romney. Trump is trailing
by more than 10 percentage points in a
recent poll of likely voters.

Trump’s positions have alienated many Hispanics.  This
threatens his performance in other swing states, such as Florida and
Nevada.  Michigan is also an important Electoral College state that Trump
needs to win but is slipping further
behind Clinton.  The gap is now near 10
percentage points.  In New Hampshire that was the home to Trump’s
significant victory in the primaries, he is trailing Clinton by 15 percentage

Nationally, Trump continues to do a few percentage points better than Romney
did among non-college educated, especially white men. 
 However, he is trailing Romney by more than twice as much among college-educated whites.  Ethnic voters account
for a larger share of the electorate than they did in 2012, and Clinton is
polling better than Obama.  Trump lags Clinton by almost 70 percentage
points among these voters.  Earlier, the polls that included third party candidates tightened the contest, meaning they
took votes from Clinton.  This seems
to be less the case in more recent polls.

The takeaway is
that with the election in three months, it is becoming more difficult to see how Trump will be able to secure the 270 Electoral
College votes he needs to become the next president. 
 Although humbled by difficulty in anticipating
political (let alone economic) developments, it might make sense for investors not to completely discount the possibility of a Trump
victory, but spend more energy on contemplating the policy implications if the Democratic Party can secure the legislative branch, as well.  The Senate is possible, if not likely, while the House of
Representatives is regarded as more difficult for the Democratic Party, but not

The legislative agenda of a Democrat in the White House and a Democrat-dominated Congress would be different than what Obama has experienced, for example.  There would be budgets and appointment confirmations.  The Federal Reserve’s Board of Governors would be fully staffed.  Some form of Glass-Steagall could get resurrected, though it is ironic to note that it was in the Bill Clinton’s Administration that Glass-Steagall, which had already been largely gutted was put out of its misery.  It would have implications for trade policy.  The Federal minimum wage would likely rise.  
The Reserve
Bank of New Zealand meets in the week ahead.  
Indicative prices in the derivatives
market suggests investors are as confident that a cut rates will be delivered as they were that the Bank of
England was going to cut last week.  As we saw last with the Australian
rate cut, lower rates in high rate countries need not undermine a currency.
 The Australian dollar was one of two major currencies that appreciated
against the US dollar last week (The yen was the other appreciating currency).
The health of
European banks continues to be important issue for investors.
  The IMF identified three European
banks it said posed the greatest threat to the global financial stability.
  The branches of two European banks failed the Federal Reserve’s stress
test.  The problems at Italian banks,
especially Monte Paschi, were seen as more pressing.  It was the only bank
that failed the recent European stress test.  In the past week, the banking index of the Stoxx 600 was flat last week,
and the MSCI European bank index rose 0.5% last week.   An index of
Italian banks fell 6.2%, which includes a 5.5% rally in the last two sessions.
A few
hypotheses have been suggested as
possible explanations for the reason the stress tests did not seem to make a
difference to investors. 
  One is that what ails European
banks is not capital cushion needed in an economic crisis.  That is to say
that the regulators have done their job.  They have delivered a more
resilient banking system.  
hypothesis is that the stress tests are largely
 What concerns investors may not be
if banks have sufficient capital to whether
a prolonged economic downturn, but if they can survive the grind of the status
quo.  There is no end in sight of negative interest rates, loan growth is
slow, the nonperforming loan problem has barely been
addressed, and, arguably, there are too many banks and branches in
Europe.  But apparently, a deep and protracted economic downturn won’t wipe out their capital.   
The stress
tests may be irrelevant on another level.
  Officials stress tested around 50
banks.  These are large institutions.  These are the ones that have
been under pressure to raise regulatory capital, adopt better risk controls,
and address governance issues.   Surprises do not often arise from where one looks, but from where one doesn’t.
Italy’s bad
loan problem is not limited to the five banks that were stress tested. 
 German Landesbanks are
not seen as systemically significant.   Many institutions that
failed, including Bear Stearns, may not have been systemically important.
 A year ago, it was relatively small Greek banks which were not systemically
important, that appeared to threaten to bring down the entire EMU. 
In the US, the FDIC has helped wind down
hundreds of banks, without much fanfare.
  Accounts up to are insured (up to $250,000), unlike in Europe where the depositor is insured.
 Early in the Great Financial
Crisis, the US did two things, before the forced recapitalization of healthy
and weak banks.  It raised the deposit insurance
cap to $250,000 and allowed small business accounts to be treated like deposits.   In effect, the US moved to strengthen the system before reducing risks.  

Ultimately, Europe’s
problems are symptoms of the failure to complete the banking union.
  It is
caught in a Catch-22.   Germany
and the creditor nations do not want to move to greater union without first
reducing risk in the system.  It is proving difficult if not impossible to
reduce risk without greater union. 

While not discounting the insight of the second hypothesis, there is a third possibility. The simplest
and most benign hypothesis is that observers
are rushing to judgment.

The bank shares did continue to fall in the first couple days of last week but finished with a 2-3 day advance.  Let’s see what happens this week.   The danger of attributing short-term price
action to macro forces is that the price action often reverses before the purported
cause are removed.  

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