Brief Macro: An Unconvincing Transmission Mechanism of the Yield Curve to the Economy and more

In this briefing:

1. An Unconvincing Transmission Mechanism of the Yield Curve to the Economy
2. FLASH: UK Inflation Grinds near Its Trough in Jan-19
3. Preserving Animal Spirits Becomes the Endgame for Fed Policy
4. The Pros and Cons of Whether We Will See A Deal
5. No Upside For Korean Companies – Underweight

1. An Unconvincing Transmission Mechanism of the Yield Curve to the Economy

Researchers at the St. Louis Fed recently published a paper concluding that “an inverted yield curve might do more than predict a recession: It might actually cause one.”  This analysis of the effect of the flattening of the Treasury yield curve on bank profitability and lending, while common, looks incorrect to us.

2. FLASH: UK Inflation Grinds near Its Trough in Jan-19

• UK inflation disappointed consensus expectations in Jan-19 but was broadly in line with my forecasts at 2.5% on the RPI and 1.85% on the CPI.
• The energy price cap was probably poorly accounted for, and it looks set to induce further volatility in the April and October prints.

3. Preserving Animal Spirits Becomes the Endgame for Fed Policy

Fed Chair Powell’s forthcoming Congressional Testimony on monetary policy later this month assumes greater importance compared to recent years due to the recent dovish tilt in policy posture following communication errors in 2018.

Financial market volatility may have adversely affected animal spirits in the real economy, an outcome which the Federal Open Market Committee (FOMC) seeks to avoid, but members will still be open to accusations that they capitulated to pressure from financial markets.

Accepted proxies for corporate animal spirits in the real economy indicate moderation over the past 12 months even before Q4’s market turbulence, but current levels are still far from disastrous and hitherto do not suggest a total cessation in risk- taking activity.

Supply-side responses in the labour market over the 12-months, notably a rise in the participation rate for prime aged workers, have reduced the downward pressure on the unemployment rate, thereby enabling the Fed to embrace its patient policy approach.

The FOMC will retain their dovish tilt towards policy conduct until March, but, thereafter, the tone of incoming economic data, notably inflation, will ultimately determine the direction of the next change in the federal funds rate and its timing.

4. The Pros and Cons of Whether We Will See A Deal

There is rising discussion about the probability of whether we will see a deal between the US and China to prevent a full blow trade war by March 1.  We wanted to give you our assessment and its many layers.

5. No Upside For Korean Companies – Underweight

Korean overseas shipments are falling and so are export prices. Manufacturing inventory to shipment ratios are soaring and the sector itself has been flirting with recession for months now. Corporate profits remain healthy but not for long. With minimum wages slated to rise 54% between 2017 and 2022 and corporate tax rates having already moved higher, there are few upsides for Korean companies. We expect the investment cycle to remain subdued and for companies to accelerate the move abroad to lower cost manufacturing hubs. The government’s ‘income-led growth’ strategy will boost domestic consumption temporarily at best. The growth outlook is dim. Underweight Korean equities.