#MacroMemo: Jan 30 – Feb 3, 2017

How is Trump doing in his first days in office? How about the central banks? I explore that and more in this week’s #MacroMemo. I hope you find it insightful.

Peak central bank:

• We suspect “peak central bank” has now been achieved, though it is fair to concede that the unwinding of monetary stimulus over the coming years will be sporadic, gradual and ultimately incomplete.
• There are a number of reasons we think monetary stimulus – on the aggregate – is staring to pass its peak.
• First, our global central bank tracking tool shows there were more central banks tightening than easing over the past month – a rare occurrence for the post-crisis era, and possibly a sign of things to come.
• Second, economic slack has shrunk considerably over the past several years for the great majority of developed countries. Inflation is also rising. These factors argue for less monetary stimulus.
• Third, bond yields have increased considerably since last summer. This is partially a reflection of expected central bank actions down the line, and partially a statement that monetary policy effectively _has_ tightened due to the increase in borrowing costs.
• Fourth, the world’s bellwether central bank – the U.S. Federal Reserve – long-ago finished actively buying bonds, and has now raised its policy rate twice. Another two increases seem conceivable for 2017, and a serious discussion about outright shrinking the Fed’s balance sheet should commence as the policy rate nears the symbolic 1.00% level.
• Fifth, other developed-world central banks such as the European Central Bank are actively tapering their own bond buying operations this year, and the Bank of England is very likely to follow suit.
• Sixth, even if they wanted to deliver more stimulus, central banks and economists alike are increasingly skeptical that negative rates work: the resulting distortions are not worth the effort.
• Seventh, emerging market economies are beginning to grow more quickly and are also facing higher inflation and capital outflows. All of these could necessitate tighter emerging-market monetary policy.
• The main implication of this shift is that the low in government bond yields has probably already been achieved. The increase in yields to date is largely justified, and yields may drift higher over the coming years. However, a return to historically “normal” yields is unlikely given a very different rate of sustainable economic growth today, and because debt loads are much more burdensome.

Central banks ahead:

• Federal Reserve: We anticipate little change at the Fed meeting later this week. The policy rate should be left unchanged as the Fed is very likely to seek more clarity from fiscal policy before continuing its slow march higher. March is theoretically in play for a rate increase given its pairing with a press conference, but May or (especially) June are more likely as they provide a greater opportunity for the fiscal dust to settle. The Fed’s balance sheet will eventually be discussed, but we think this is unlikely at the February meeting.
• Bank of England: The Bank of England should keep its various policy tools unaltered this week, but is undeniably in a position to think about tightening policy over the coming months given the British economy’s surprise outperformance, the falling pound and the prospect of rising inflation. That said, Brexit uncertainties continue to loom. A hawkish tilt to the proceedings is likely but not certain.
• Bank of Japan: We assume the Bank of Japan upgrades its economic forecast but stops well short of raising its yield target or reducing the extent of monetary stimulus just yet. Too many economic and inflation goals have yet to be achieved, and the country is precariously reliant on a weak yen.

Trump’s first days:

• The Trump administration is now more than a week into its four-year term, and has hit the ground running.
• Although confirmations are dragging, the number of executive orders delivered has been considerable.
• These include hot button actions such as cancelling the TPP trade deal, approving the Keystone XL pipeline, beginning to roll back Obamacare, constraining the inward flow of legal immigrants from certain countries, and cracking down on illegal immigrants.
• A few thematic generalizations are possible.
• First, President Trump continues to defy the historical convention of tacking toward more centrist public policies once elected – he remains committed to the populist promises delivered on the campaign trail.
• Second, there appear to be more restraints on immigration on their way than we had anticipated in our initial U.S. economic forecasts.
• Third, and related to the second point, the Presidential actions taken so far have tended to tilt more toward the “GDP-negative” column than the positive column. We refer primarily to protectionist actions and the prospect of diminished immigration. However, there are certainly partial offsets to this claim: short-term economic positives include confirmations of fiscal stimulus (military spending), deregulation (faster environmental assessments) and “draining the swamp” (tighter lobbying rules). Furthermore, it is important to understand that the largest economic positive expected from the Trump administration – tax cuts – requires Congressional action, which will take some time.
• Of course, it will be months before a more comprehensive assessment of the new administration’s policies can be made, and then years before their full effects will be fully appreciated. In the meantime, we still assume a short-term economist boost over the next two years, followed by a longer period of economic drag.

Data run:

• U.S. GDP recap: Fourth-quarter U.S. GDP was formalized last week, with a moderate 1.9% annualized rate of growth. Although this seems feeble upon first glance, it is actually roughly “normal” for the post-crisis era. Most importantly, it does not give us any particular cause for concern, coming on the heels of an outsized prior quarter, and given the rude health of a slew of leading indicators (as discussed in the next two bullets).
• U.S. ISM Manufacturing preview: Our U.S. PMI modeling lands more or less on consensus with the prediction of a stable 54.8 reading in January. Although this represents an approximately unchanged level, it remains consistent with robust economic growth on a trend basis. The U.S. economy is chugging along nicely in the early going of 2017.
• US payrolls should manage strength: U.S. job creation could tick higher in January, with the potential for 200K-plus net new positions. This forecast is grounded in solid economic signals, rising confidence and falling jobless claims. If delivered, this would beat the consensus and represent a truly robust pace of job creation. Wage growth should also be strong, in part due to diminishing economic slack, in part because of another round of state-level minimum wage increases.

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