Macroeconomics: The Day Ahead for 28 July

The FOMC meeting is centre stage to the day’s proceedings, and is more than likely to sideline the rest of the data and events agenda, though a busy run of corporate earnings will impact at a micro level. Statistically there are Australia’s Q2 CPI (core CPI subdued and below RBA’s target range), UK BRC Shop Prices and Nationwide House Prices, German (missing forecasts as Income and Economy expectations slip from highs) and French Consumer Confidence to digest, while ahead lie Italian Manufacturing & Consumer Confidence, US Goods Trade Balance and Inventories. Govt bond supply sees German auction 15-yr and the US 7-yr. On another busy day for corporate earnings, Asia saw Amorepacific, Hitachi Construction Machinery, Nestle India & Nissan Motor. Banks feature in Europe via way of results from Barclays, Deustche Bank and Santander, with BASF, BAT, Carrefour, Equinor, GSK, OMV, Rio Tinto, Spotify, Suez and Vivendi also on hand. In the US Facebook inevitably gets top billing, with ADP, Bunge, Ford Motor, Norfolk Southern, Pfizer and Qualcomm also among likely headline makers. While a semblance of calm in China’s equity markets has emerged today, the carnage in Asia HY credit spreads due to China can be very clearly seen in the attached chart. Ultimately the question is whether China’s authorities to exercise greater control over many parts of the economy, ostensibly under the guise of trying to curb an array of inflationary pressures, backfires. To be sure the outflows of foreign investor money may actually be something that the authorities want to encourage in the short-term, but government interventions to curb prices in any country have a long history of some short-term gain, but longer term pain. If China really wishes to internationalize usage of the CNY, then this is likely to be another painful lesson about the limits of state control.

U.S.A. – June Goods Trade Balance / Retail Inventories

Neither of these indicators tends to garner much market reaction, but as the final two items of monthly data ahead of tomorrow’s Q2 advance GDP estimate, they may prompt some last minute tweaks to expectations for the latter. The Goods Trade Balance is seen little changed at $-88.0 bln (May $-88.2 Bln), and would imply a marginal improvement in Q2 Net Exports relative to Q1; underlying trends remain difficulty to judge above all due to semiconductor shortages, which have been impeding exports, even if the overall capital and consumer goods balance has improved. The big wildcards remain agriculture and industrial raw materials which continue to be very volatile. The inventory data is likely to be very divergent with the sharp rundown in auto inventories set to drag retail inventories down by 0.3% m/m, while wholesale inventories are expected to rise 1.1%.

U.S.A. – FOMC meeting

– The Fed is expected to hold rates, keep its QE pace unchanged, and stick to its forward guidance, underlining that while the recovery remains robust, there are still downside risks (above all due to the spread of the delta variant). It will continue to argue that inflation pressures are “largely reflecting transitory factors”, and that “substantial further progress” is still needed to meet its employment goals, and by extension to justify starting a discussion on a taper timetable. The question is whether it suggests that this will be on the agenda “at coming meetings”, with markets not expecting this to be signalled until the annual Jackson Hole meeting (even if policy signals are actually rare at this event, above all in recent years). As such tapering will be on the agenda not as a “when” discussion, but “how”. i.e. more ‘talking the talk’ but not ‘walking the walk’. FOMC opinions on how it will taper (i.e. pace of taper for Treasuries vs. MBS) remain divided, though it will be wary of signalling anything that appears to be a ‘protest’ at the sharp rise in house prices, particularly as it stressed in the first place that its MBS purchases were not aimed at shoring up house prices. That said, it has painted itself into many corners in terms of putting constraints on policy flexibility. There will be some perhaps wondering whether the sharp sell-off in Chinese equity markets also prompts additional caution from the Fed. But the FOMC has probably learnt the lesson of overreacting to the 2015 China stock slide, and if anything has reverted to its historical of focussing on the domestic economy, and doing nothing more than acknowledge international developments, unless they are clearly a systemic threat to financial stability.

In that vein, the Fed, ECB and other central banks should perhaps be really focussing their attention on considering whether the models that they continue to rely on in formulating their overall policy strategy and its implementation are anything more than dogma. These ‘equilibrium’ models have long failed to explain and account for the impact of globalization and demographics on economies and financial flows, and above all the accompanying deflationary pressures (actual and expected) Their policy strategies have ridden roughshod over the dramatically divergent impact on household wealth and incomes, above all exacerbating inequality, and yet they stick to the models, and debate ad nauseam the trite semantics of their policy communication, ultimately embedding a belief that they are nothing more than the lapdogs of financial market sentiment.

If the pandemic has any tangible lessons thus far, it is that the obsession with modelling risk has completely lost sight of the concept of ‘Knightian uncertainty’. Knight defined this concept as:  “Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated…. The essential fact is that ‘risk’ means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomena depending on which of the two is really present and operating…. It will appear that a measurable uncertainty, or ‘risk’ proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all.” (Risk, Uncertainty, and Profit. Boston, MA: Hart, Schaffner & Marx; Houghton Mifflin Company (1921)). The world economy was already undergoing profound changes even before the pandemic, above all a sharp push back on globalization and demands for re-shoring, both of which implicitly lean heavily against the deflationary impulse of the post-Cold War era. The additional uncertainties (as opposed to ‘risks’) that will now have to be faced down are the impact of the largest ever increase in global debt outside of war time, escalating health care costs in a rapidly ageing demographic, the cost of meeting climate change goals not only in financial terms but also in terms of labour markets, as well as myriad supply chain disruptions (way beyond re-opening, and above all related to re-shoring), and the much underdiscussed aspect of the pandemic legacy of ‘more government, less market’, let alone the emergent technology cold war (both US/NATO vs China/Russia/SCO and domestic anti-trust policy moves), or the pandemic’s psychological scars on consumers to permanently disrupt services demand. With all these uncertainties, the fact that central banks are now running so scared of withdrawing monetary support, and are therefore opting for reactive and outcome based policy implementation, and eschewing all forms of pre-emptive policy actions has to be also included as a risk factor.