Charts of the Week: Back to School

The policy rate consensus Dovish comments from central bankers in recent weeks have amplified expectations for a global policy easing cycle over the past few weeks. Fed Chair Powell’s address at the Jackson Hole symposium, in which he noted that upside risks to inflation have diminished, and the downside risks to employment have increased, have certainly suggested the direction of travel for US policy rates is clear. This chimes too with the latest survey of Blue Chip Financial Forecasts. US policy rates, for example, are expected to decline from current levels by nearly 150bps over the next 12 months. That contrasts with the UK and euro area, where policy rates are expected to decline by 130 and 138 basis points respectively.

Inflation progress Well-behaved inflation data have been another key driver of these interest rate expectations. Headline inflation rates in most major economies have continued to decline over the past few weeks and, at least as far as the US, the euro area and the UK are concerned, were not that far above central banks’ target levels. Incoming inflation data have, on the whole, also been surprising forecasters’ expectations on the downside in recent weeks with some underlying stability in the price of oil a key factor assisting that trend (chart 2).

The global business cycle While forward-looking PMI readings for many economies have remained relatively stable in recent months, several have experienced some significant swings. For instance, France has seen a notable improvement, though it is worth noting that the August figures were significantly bolstered by activity from the Olympic Games. Conversely, Germany has struggled, with its PMI falling further into contraction territory due to ongoing weaknesses in the manufacturing sector. Meanwhile, India continues to stand out relative to its peers with consistently strong PMI readings over recent months (see chart 3).

China’s excess capacity China’s economy stands out too as its latest PMI survey suggest its economy has lost much momentum over the past 3 months, largely because of some further weakening in the manufacturing sector. Digging into some of the underlying details of the manufacturing survey also reveals persistent downward pressure on that sector’s output prices (chart 4). Given the importance of China’s manufacturing sector for world trade, which might herald broader disinflationary pressures in the traded goods sector in the period ahead as well.

Japan’s carry trade While some of the initial volatility in Japan’s currency markets has stabilized since the decision by the BoJ to lifts its policy rate, fundamental drivers are turning increasingly unfavourable for the carry trade. Specifically, Japan’s yield differentials with other major economies are becoming less advantageous, as evidenced in chart 5 below. As chart 1 above additionally underscores, this shift is being further compounded by the BoJ’s ongoing – and expected - tightening measures, which stand in vivid contrast to the easing cycles now underway from other major central banks.

US monetary policy and labour markets With central banks arguably now slowly switching their attention away from inflation, the prospective dataflow on economic growth – and perhaps more significantly, labour market activity - is taking on more importance. On that score (and writing ahead of the publication of August’s US employment report on Friday September 6th) it has certainly been notable that much of the incoming US labour market data have disappointed expectations in recent weeks and that financial markets have responded to this by pricing in more easing from the US Fed (see chart 6).