Macroeconomics And Psychology

There is a broad consensus around the macroeconomic picture. The headwinds slowing the US economy in H1 16 have eased, and above trend growth in H2 16 appears to be carrying into 2017. Q4 16 GDP is expected to be revised to 2.1% up from 1.8%. Many economists appear to accept that a good part, though not all, of the decline in the estimated trend growth in the US, is a function of demographic considerations.  

Price pressures are gradually increasing, though the Fed’s preferred and targeted measure of inflation, the core PCE deflator is likely to have remained at 1.7% in January, the base effect warns of topside risk in the coming months. Meanwhile, the labor market continues to improve. The four-week moving average of weekly jobless claims fell to a new cyclical low the same week the BLS conducted the survey for non-farm payrolls, which will be released on March 10.  

The Federal Reserve raised rates once in 2015 and once in 2016. This year will be different. The shift in opinion is not so much in the increase of the likelihood of a March increase or June increase, but in a move in May. As we have noted, the advantage May is that it would be part of the normalization process when every meeting must be live. Up until now,  there was a general recognition that Fed action would take place at the quarterly meeting that had the economic forecast updates and was followed by a press conference.  

That was good and arguably necessary. However, this may no longer be the case. As the pace of removing accommodation increases, the Fed needs greater flexibility. Just as the minutes of the January FOMC meeting showed that the Fed would tweak the dot plot communication tool by including fan lines of confidence, as we have argued before, the Fed ought to consider a press conference after every meeting, like many others, including the BOE, ECB, and BOJ, and that would kill two birds with one stone, so to speak. Communication would be enhanced, and the Fed would double the number of actionable meetings. Alternatively, the Fed could scramble and put together an ad hoc press conference, but there are risks of leaks and fails to take advantage of the opportunity to evolve the Fed’s communication and transparency.  

Eurozone growth is solid and stable, and above trend, which is estimated near 1.25%. This is likely to be confirmed with the final January PMIs due in the second half of the week ahead.  Individual countries will update Q4 16 GDP estimates, and most likely will not have much market impact, but will be revealing nonetheless. The Spanish economy motored ahead by 3.0% year-over-year in Q4 16. France and Italy both appear to have grown 1.1%. Among other European countries reporting GDP, Sweden’s 1.9% puts it a little ahead of Germany’s 1.7%, while Switzerland’s 1.2% places it nearer France and Italy.  

The risks of deflation have evaporated in Europe thanks to the rise in oil prices. Indeed, the preliminary estimate for February CPI, which is to be reported on March 2, is expected to tick up to 1.9%-2.0%. The higher oil prices have knock-on effects on transports, heating, and energy prices.  It was also unseasonably cold in southern Europe, which may have underpinned unprocessed food prices as well. In any event, core prices are expected to be flat at 0.9% for the third month and have seen a steady pace of 0.8%-0.9% since last May. It bottomed at 0.6% in January 2015.