Daily Macro: UK Cycle: BoE Should See a Tightening Labour Market and more

In this briefing:

1. UK Cycle: BoE Should See a Tightening Labour Market
2. Fed Policy Outlook Gets Even More Complex Due to Multiple Factors
3. 2019 Equity Market Outlook
4. Wanted: A 21st Century Monetary Theory
5. Vietnam: Economic Prestidigitation

1. UK Cycle: BoE Should See a Tightening Labour Market

• Faster employment growth lowered the unemployment rate to 4.0% in Nov-18, contrary to expectations. The labour market still looks to be tightening.
• The BoE will provide its annual update of supply-side conditions in its 7-Feb Inflation Report. I expect it to maintain its 4.25% NAIRU estimate.
• Stronger wage growth suggests an effective tightening of the labour market. Excess demand and inflation provide hawkish pressure, albeit neutered by Brexit.

2. Fed Policy Outlook Gets Even More Complex Due to Multiple Factors

The Fed’s new patient approach to raising the federal funds rate will hinge critically on co-operative incoming economic data, notably subdued inflation signals.

Measures of US inflationary expectations remain well-anchored, thereby providing the Federal Open Market Committee (FOMC) with policy breathing space, while labour market conditions will continue to be closely monitored for overheating risks.

US monetary policy requires both nimbleness and flexibility, analogous to the conduct of the 1990s, although the advanced age of the current cycle raises the risks of a policy mistake.

The Fed has effectively been forced by excessive financial market volatility to return to issuing forward guidance, as investors struggle to envisage the return to a normal environment where short-term interest rate volatility is higher compared to long-term yields.

Fed policy adjustment is being complicated by further declines in the term premium demanded by bond investors that simultaneously boosts financial accommodation, supports the real economy and flattens the yield curve.

3. 2019 Equity Market Outlook

• The equity market in the fourth quarter of 2018 was throwing off recession-like signals with the 19.8% drop in equity prices from the S&P 500’s all-time high through the near-term trough of December 24, 2018.  We see the decline as a correction from an overvalued position in late September rather than as point to an impending recession.
• Key to the outlook for equities and the economy are economy-wide profit margins (share of nonfinancial corporate profits in output).  It appears the balance between price increases and productivity-adjusted labor costs has improved as productivity has accelerated despite a pickup in the growth of labor compensation.  The corporate tax cut has spurred post-tax margins close to record highs.
• We expect nonfinancial corporate profit growth of 7% on average over the next two years, which should support equity prices.   However, the scope for a strong further rebound in equity prices is challenged by our outlook for rising corporate bond yields (our valuation model suggests rising profits and higher yields roughly cancel each other out in our valuation model). 

4. Wanted: A 21st Century Monetary Theory

The globe is facing more than an ordinary business cycle.

Joseph C. Sternberg, editorial-page editor and European political-economy columnist for the Wall Street Journal’s European edition, recently interviewed Claudio Borio, head of the Monetaryand Economic Department of the BIS. Mr. Borio said that politicians have relied far too much on central banks, which are constrained by economic theories that offer little meaningful guidance on how to sustain growth and financial stability. The only tool they have is an interest rate that can affect output in the short run but ends up affecting only inflation in the end.

5. Vietnam: Economic Prestidigitation

On Thursday 27 December 2018 the General Statistics Office (GSO) in Hanoi announced that Vietnam had grown by 7.08% (7.1% to us mere mortals) for full year 2018. Magically, this was exactly the same number as that forecast by the Asian Development Bank in April, long before the travails that affected the rest of the region in the second half of the year. It was also an outlier among economic forecasters (with the IMF in July projecting just 6.6% for last year). Even more magically, the GSO was able to produce this number just before the end of the year when, officially, money supply data were only available up to September and credit data to July. Hey presto, economic statistics are magic!

Truth be told, Vietnam is an object lesson in the worth of most macroeconomic statistics collected by governments at the insistence of the IMF: pinches of salt should be handed out with each release.

Economic data are manipulated around the world by governments. True economic conditions are apparent to anyone who is on the ground (which makes life difficult for fund managers who are not visiting countries they invest in regularly). And in Vietnam, after one day of meetings, we would conclude that, even if the 7.1% number is just pie-in-the-sky, economic growth and general economic conditions are very good.