Happy Jackson Hole Day

By Maartje Wijffelaars, Senior Economist at Rabobank

Stock and bond markets have had quite a busy week in the run up to central bankers’ speeches later today at the Fed’s annual symposium. They’ve both moved up and down, weighing incoming economic data and monetary policy makers’ statements. Currently, the S&P500 is almost back at last week’s close, after it gained 1.5% by the midst of this week. Meanwhile, 10-year treasury yields are almost back at last week’s close of 4.25%, after having reached a 16-year high earlier in the week and dipping upon weak incoming PMI data.

This afternoon, markets and analyst will be searching for any hints regarding the future monetary policy path when Fed chair Jerome Powell takes the stage at 10:05 ET/ 16:05 CET – to be streamed at the Kansas City Fed’s YouTube channel. Later in the day/ evening, at 15:00 ET/ 21:00 CET, ECB president Christine Lagarde will take the floor. Yet don’t hold your breath, as both might well be unwilling to give much guidance into their respective September meetings.

This far into the hiking cycle and with the sticky core inflation still high, it becomes ever more difficult to balance the risk of doing too much or doing too little. Given the rather mixed signals provided by recent data coming in, it seems likely both the Fed and ECB will prefer to gather as much data as possible to make a decision on the best way forward.

Indeed, while recent data quite convincingly suggest economic growth is slowing in Europe, core inflation gave no sign of retreat in July as it stayed put at June’s 5.5% y/y. Next week we will get the first figures for August and it could help the ECB a lot they down as expected by analysts (core is expected to drop to 5.2% y/y and headline to 5.1% y/y).

With respect to the economic data, German GDP figures this morning confirmed the eurozone’s largest economy stagnated in the second quarter of the year. And this morning’s IFO survey for August confirmed the ongoing weakness that was already laid bare by last Wednesday’s PMI data. The IFO Business Climate came in below consensus at 85.7, down from July’s 87.3. In fact, all sectors saw their diffusion index declining, which is further proof that weakness is spreading more broadly into the economy. Remember, that the composite PMI dived deeper into negative territory as well, as activity in the services sector is weakening. At 44.7, Germany’s composite PMI convincingly showed that the tide is worsening rather than improving.

Germany is not alone, however, as the composite PMI for the Eurozone came in at a 33-month low in August, falling starkly into contractionary territory. It dropped from 48.6 in July to 47 in August, also convincingly below the consensus of 48.5. Most worrying is the fact that weakness is more visibly spreading to services. If anything, the risk of a near-term recession has clearly increased. All in all, these figures have let us to revise down our growth projections for the euro area from stagnation in the second half of this years to a minor contraction in the current and final quarter of the year. Minor because, for one, we don’t expect major labour shedding as companies will try to hold on to their workforce in the currently very tight labour market. That being said, risks are clearly tilted to the downside. We will explore our projections in more detail in forthcoming publications.

At the other side of the Atlantic, yesterday’s durable goods orders joined the recent PMI figures in suggesting that the US economy is slowing down. The former came in at -5.2% m/m in July compared to -4% m/m consensus and after 4.6% in June. Remember, the composite PMI fell from 52 in July to 50.4 in August. Yet whilst slowing down, the PMI figure for the US still points to growing rather than contracting activity, driven by the services sector.

This is underscored by the Nowcast forecast by the Atlanta Fed. Its updated figure on 24 August, shows the US economy grew by a still staggering 5.9% annualised rate in the third quarter. Clearly, only so much data has come in for the third quarter so far, yet at least it suggests the US is not as close to entering a recession as the EU – although the US still has a recession approaching further down the road, according to our US watcher Philip Marey. Meanwhile, albeit on a downward trend, core CPI still stood at 4.4% in July, down from its peak of 5.6% in March.

Importantly, while board members of both the ECB and Fed publicly disagree – or at least express doubts – about whether another rate hike is warranted in September, none of them hints at a pivot coming soon. On the contrary, all reiterate yields will need to stay higher for longer. And the latter thinking seems to have been gaining ground in the markets, especially in the US where a pivot was already priced in earlier than in Europe. That said, the weak data in the euro area so far has left a bigger mark on 10-year bond yields than in the US. And, we would also argue that the ‘China factor’ may have had a bigger impact than on the other side of the Atlantic.

US outperformance with respect to the Eurozone and a growing belief that yields will stay higher for longer have supported the dollar recently. The EURUSD cross has dropped from 1.12 last week to 1.08 yesterday, and the euro’s decline is continuing this morning. Our FX strategist Jane Foley believes the dollar is up for some more gains in the coming months, reaching 1.06 on a three-to six-month horizon, before it loses some strength as the gap in economic performance tightens and Fed rate cuts move into view.

As mentioned, bond yields in the euro area have come down from last week’s peak. While non-negligible, they will give governments little respite, however, in terms of rising interest costs. Indeed, while debt ratios, are set to fall in the short term, helped by high nominal GDP growth, in a recent publication we show that projected interest costs are to rise substantially over the coming few years, especially in high-debt countries.

While interest payments will require a larger portion of all countries’ revenues, Italy and Spain are expected to face the greatest debt affordability challenges. In the former, interest-to-revenue ratios are expected to exceed the threshold above which countries tend to enter speculative grade rating territory. On the bright side, there is still time to avoid such a situation and we don’t forecast a new eurozone debt crisis – not the least because of all the EU safety nets set up over the past few years -, but we do point out several vulnerability risks and argue there is no time for complacency in a number of countries. For more insights please read the report or reach out.

Day ahead

The most interesting event of the day will certainly be the Fed’s symposium titled “Structural Shifts in the Global Economy”. Apart from Jerome Powell’s view towards the economic outlook and any possible hints with regards to monetary policy going forward, it will also be interesting if and what he has to say about de-risking, decoupling, and de-dollarization. Will he reiterate parts of Lagarde’s speech earlier this year on the structural impact on consumer price indices of decoupling? Will he share his views on the BRICS extension announced yesterday?  

Yesterday the BRICS asked six out of twenty-two applicants to join the bloc: Saudi Arabia, Iran, Egypt, Argentina, Ethiopia and the UAE. Looking at all the vowels it does not seem to make for a nice new acronym. Yet given its increased heft and the inclusion of several heavy weights in commodities (and hence with extensive financial powers), it certainly warrants attention. Will the group be able to agree on a future economic and political course? Will it lead to faster de-dollarization – towards perhaps yuanization? – and a stronger front against Western hegemony in global institutions? As we have already covered in several Dailies this week, in spite of all the heft, it remains to be seen if and how the enlarged group will be able to move forward, given the many different voices, aspirations, dependencies and economic sizes and structures of the countries within the group. Yet it certainly is not a development to neglect by analysts and policy makers.

This afternoon the University of Michigan will also publish its consumer survey outcome  for August and the Kansas City Fed will present its services survey activity index for August.

Happy Jackson Hole day