The expert magazine of Ostrum AM

Macroeconomic momentum has taken a severe downturnsince the summer of 2018, as shown by the sharp and sudden slump in world trade since the start of the fall.

Trade contracted slightly in January 2019 from a previous yoy growth figure of 4% at the time. This very drastic downtrend is primarily attributable to Asia, as the region’s imports and exports have taken a clear plunge over the past several months. Meanwhile, other regions are
seeing less dramatic trends and have not necessarily experienced this same deterioration in profile.


The speed of this trend suggests that it is mainly due to US trade policy moves and the country’s conflict with China. However, we do not think that the two countries will come to an agreement any time soon, as the real issue at stake here is technological leadership, and neither side wants to play second fiddle.

 

More volatile indicators in the US

 

However, from a short term standpoint, we note that indicators produced by March surveys (Markit) staged a recovery, albeit not reflecting a surge in activity across the board. Figures improved slightly in China – with surveys in the country giving an index above 50 – while they are no longer sliding as quickly as before in Taiwan, South Korea and Japan. However, it is still too early to declare that there has been a sustainable turnaround in trend. The US continues to enjoy robust growth with its very vast and extremely powerful domestic market, although the pace has not been quite so brisk since the end of 2018. Indicators have become much more volatile and therefore provide a much more contrasting view on the outlook, as seen on the labor market as well as in real estate. This may point to a lackluster economy,
supporting the possibility of a more marked downturn in activity over the months ahead. Against this backdrop, the Fed made an about-turn, voting not to commit to potential rate hikes and balance sheet pruning. The central bank does not want to tie itself in a straitjacket, as it aims to keep the leeway required to react swiftly and flexibly if it runs up against a tricky situation.

The speed of this trend suggests that it is mainly due to US trade policy moves and the country’s conflict with China.

So when it comes down to it, the euro area is the most affected region. Its economy is more open than the US and so it is harder hit by any external trade shocks. The decline in trade in Asia hampers German trade to the region and makes for a sharp contraction in the manufacturing industry in Germany. Yet economic policy will be unable to cushion this shock, and this can be seen by a primary budget surplus. So even if monetary policy remains accommodative, the policy mix is damaging for growth. The euro area internal market lacks the wherewithal to cushion this shock and current policies do little to reverse this trend.

 

The decline in trade in Asia hampers German trade to the region and makes for a sharp contraction in the manufacturing industry in Germany.

No policy changes ahead

 

Our questions on the euro area are also a result of the region’s weaker productivity gains. All developed countries face the same issue, but the euro area economy is more open to outside influences, so it feels the force of any shock all the more. Productivity reflects an economy’s ability to stage self-sustaining growth, so strong gains reflect robust economic momentum and negative shocks can be absorbed quickly and subsequently disappear. However, when productivity gains are sluggish, economies have a much harder time dealing with shocks, and difficulties can last longer and have a sustainably damaging impact on the economy This is when an accommodative policy mix can come in useful.

However, this is not the case for the euro area as has been shown, and there is little chance that the situation will change. Recent discussions between Emmanuel Macron and Annegret Kramp-Karrenbauer (also referred to as AKK, replacing Angela Merkel as leader of the CDU party) on their views on the role of Europe suggest that the two points of view are incompatible, with one side seeking greater sharing and pooling than the other. But with Germany steering euro area fiscal policy since 2011, it is
highly unlikely that this will change.

One immediate effect is that in the absence of inflation, the ECB will not take the risk of triggering a shock on the economy by suggesting a potential tightening in monetary policy, even for a later date. Mario Draghi made the ECB’s long-term accommodation very clear during the press conference in March, so in other words, interest rates are unlikely to change over the next two years.

In the UK, the government has still failed to come up with an answer to the Brexit conundrum. So now we sit tight and wait, although every additional extension comes at a cost for growth in the UK – where the effect is strongest – but also in Europe.

In the absence of inflation, the ECB will not take the risk of triggering a shock on the economy by suggesting a potential tightening in monetary policy, even for a later date.