The devil’s in the detail

The factors underpinning recent market moves have changed rapidly: Fears of an overheating of the US economy and concerns over China that dominated much of August seem to have given way to an ideal scenario of inflation seemingly under control, reasonable growth, and Beijing taking a firmer hand to stabilise China’s economy, particularly the weak property sector.  

Should we celebrate the return to a Goldilocks’ scenario where levels of growth and inflation provide a perfect environment for risky assets? Movements in equity and bond market suggest it may yet be a little early to pop the champagne corks.

Central banks are pursuing their ‘meeting by meeting’ approach on monetary policy decisions that will be ‘data-dependent’. But what are the economic indicators telling us?

Ongoing slowdown in the eurozone

In August, the eurozone composite purchasing managers’ index (PMI) fell to 46.7, its lowest since November 2020. This was due to slower activity in both the manufacturing and services sectors. While the services PMI had recovered between December and May, it suddenly fell from 50.9 in July to 47.9 in August, marking the first time since December 2022 that services activity contracted, with a particularly sharp decline in Germany and France.

The composite PMIs in June and July had raised fears of a decline in third-quarter GDP growth from the modest 0.1% in the second quarter.

Other business climate indicators (for the eurozone as a whole and for the bloc’s major economies) have highlighted a drop in demand and depressed order books.

US – Rewriting the textbooks?

While the eurozone seems to read like an economic textbook – restrictive monetary policy slows down growth, especially via the channel of credit to the private sector – the resilience of US growth is undermining market expectations and confounding economists.

Recent US indicators have left the impression of strong activity this summer. The Atlanta Fed’s GDPNow forecasting model, including data available as at 6 September, gives a running estimate of Q3 GDP growth of 5.6% annualised, up from 2.0% and 2.1% in the first and second quarter, respectively.

Among the GDPNow indicators that explain the acceleration since mid-August are employment, industrial production, retail sales and, most recently, the ISM services index. This surprised to the upside on 6 September, leading to upward pressure on bond yields.

Exhibit 4 shows that the US economy is harder to read than that of the eurozone despite the US Federal Reserve launching its monetary policy tightening cycle five months earlier than the European Central Bank, hiking rates further (+525bp versus 425bp) and raising its main policy rate higher (5.50% for the US federal funds rate against 3.75% for the ECB deposit rate).

Comparing the level of interest rates on each side of the Atlantic is not necessarily the most illuminating approach, though.

On the one hand, the degree of policy tightening is measured against the macroeconomic fundamentals of each economy. As Fed Chair Powell noted at the Jackson Hole symposium in August: ‘We cannot identify with certainty the neutral rate of interest, and thus there is always uncertainty about the precise level of monetary policy restraint’.

On the other hand, the ECB had to exit from an exceptional policy of negative key rates that profoundly has changed the behaviour of economic agents and financial actors.

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