Brief Macro: Trade War Uncertainty Bites into Investment Spending and Production and more

In this briefing:

1. Trade War Uncertainty Bites into Investment Spending and Production
2. An Unconvincing Transmission Mechanism of the Yield Curve to the Economy
3. FLASH: UK Inflation Grinds near Its Trough in Jan-19
4. Preserving Animal Spirits Becomes the Endgame for Fed Policy

1. Trade War Uncertainty Bites into Investment Spending and Production

Import elasticities. Ease of transferring business between countries. Reliability of alternative supply chains. Time taken to relocate production. The list of unknowns on how easily companies could relocate production from China goes on and on but the bottom line is that uncertainty has been raised and that is bad news for global growth.

In Reality Check: China and the US Trade War, we wrote “Even if the Trade War ends tomorrow, the damage  has already been done”. 

2. 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.

3. 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.

4. 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.