By Sophia Campbell, Nasiha Salwati, Louise Sheiner
What’s the latest thinking in fiscal and monetary policy? The Hutchins Roundup keeps you informed of the latest research, charts, and speeches. Want to receive the Hutchins Roundup as an email? Sign up here to get it in your inbox every Thursday.
A warmer planet due to climate change will make severe economic downturns more likely, finds Michael T. Kiley of the Federal Reserve Board. Using data on temperature and annual real GDP per capita in 124 countries from 1961 to 2021, the author shows that the effect of temperature increases on growth is 50% larger on the lower decile of the growth distribution than on the median—implying that a warmer planet may be characterized by more frequent and severe fluctuations in economic growth. These effects are likely to vary across countries, the author notes; a case study of a high emission scenario for the United States, a high income and relatively temperate country, saw “relatively modest” impacts on the median and tail ends of percent change in real GDP per capita. Nigeria and India, on the other hand, saw real GDP growth per capita lowered by as much as 3.5 percentage points at the 10th percentile of growth, and smaller but still sizable declines at the median and 90th percentile— lowering the overall pace of economic growth and increasing the likelihood of downturns for these countries.
Using a randomized control trial of over 9,000 U.S. consumers, Francesco D’Acunto of Boston College, Andreas Fuster of the Swiss Finance Institute, and Michael Weber of the University of Chicago find that the gender and racial diversity of the Federal Open Market Committee (FOMC) make it more effective in guiding consumers’ macroeconomic expectations. For instance, the authors find that 52%-56% of white female respondents exposed to female or Black FOMC members form expectations within the range of the FOMC’s unemployment forecasts, compared to 48% of those exposed to white male members. Exposure to diverse members especially helps anchor the expectations of Black women, the authors find, and boosts the trust underrepresented groups have in the Federal Reserve’s effectiveness. The expectations of white men, who are overrepresented on the FOMC, do not respond differently based on the perceived diversity of the committee, the authors find. “Higher diversity might thus increase the ability of FOMC communication to influence consumers’ expectations and lead to more trust in the Fed, especially on the part of underrepresented consumers, who are often part of the most vulnerable communities,” they conclude.
Increasing burdens of disclosure and governance regulations are often cited as the reason that the number of public firms in the U.S. has been declining in recent decades. Using the fact that many public firm regulations apply only to firms whose float (the value of shares held by public investors) exceeds a certain threshold, Michael Ewens of the California Institute of Technology, Ting Xu of the University of Virginia, and Kairong Xiao of Columbia University examine the bunching of firms around these thresholds to infer the costs of regulation. Using public float and regulatory compliance data of public firms over the 1994-2018 period, the authors estimate that regulatory costs are quite substantial—costing the median U.S. firm 4.1% of its equity value. However, using a sample of venture capital-backed private firms, the authors find that regulatory costs explain only 7.4% of the declining likelihood of such firms going public since 2000, and have no effect on the decision of public firms to go private. Overall, their findings suggest that non-regulatory factors played a more important role in reducing the number of public firms in recent years, the authors conclude.
Chart of the week: The fraction of small businesses that expect economic conditions to improve declined sharply in recent months
“I am a little worried that asset prices and particularly housing prices are a concern that we should be thinking about… If you’re thinking about housing prices and you can’t get housing materials, and you can’t get construction workers to come back on the site, but we do increase demand for housing, then it doesn’t do much for our employment mandate, but it does increase housing prices more than it otherwise would. And what I don’t want to have is a boom and bust cycle in housing that is encouraged in part by monetary policy action,” says Eric Rosengren, President of the Federal Reserve Bank of Boston.
“This is a long way of saying that I would take a somewhat different strategy as we think about tapering. And this is my own personal view, which is I would reduce both the MBS [mortgage-backed securities] and the Treasuries by the same amount. As you know, we’ve been purchasing more Treasuries than MBS. So that would imply that the MBS would end before the Treasuries. And would also hope that if we continue to see strong economic outcomes toward the middle of next year, that we’re done with the tapering program, again that’s dependent on how the data comes in, but that gives you a rough idea of the timeline.”monetary reserve policy fed monetary policy
August Avoids Zero In JGB’s
Central banks and their staffs have long been accused of trying to hide inflation. This allegation had been a staple of their critics, those charging reckless…
Central banks and their staffs have long been accused of trying to hide inflation. This allegation had been a staple of their critics, those charging reckless monetary policies for creating “too much” money that had allegedly been causing price imbalances all over the financial map. The most famous example the Federal Reserve discontinuing M3 early in 2006 – just as the US housing bubble was reaching its most insane proportions.
While it was never the case in the pre-crisis era (especially with M3; central banks weren’t hiding anything, on the contrary they were admitting they couldn’t keep tabs on the shadow monetary system), it has been open and shut thereafter. What I mean is, in the post-2008 period central bankers are desperate to show that their huge “monetary” policies are effective.
They now want inflation, the more the better, and have been trying to get it for more than a decade. Rather than hiding, they’d prefer to cheat in the other direction if they could.
How unfortunate, therefore, for those at the central bank in Japan. Worse off than its peers, the Bank of Japan has been trying to boost consumer prices going back more than thirty years. Having first experimented with QE, BoJ has since thrown every form and scale of LSAP at the problem thus far to no avail.
Over the last year, with economic conditions that much more threatening, Japan’s central bank upped its latest QE’s (25 & 26, by my unofficial count) to the most ridiculous asset purchase pace of all. The purpose was to restart the already-recession Japanese economy being hit even harder by COVID; get some inflationary pressures pumped into it to begin the reflation process.
A year and a half later, BoJ has added yet another ¥142 trillion in assets (through August 2021), yet consumer price behavior still registers outright deflation thanks to the government’s pre-planned transition from base 2015 consumer buckets to the current base 2020. The old index at least had consumer prices back on the plus side whereas the updated stats have gone further in the wrong direction in the latest update.
What they wouldn’t give to go back to the old index, though this would be too obvious for one of Haruhiko Kuroda’s final act requesting the government scratch the 2020 benchmark. It would, though, set the record straight about in which direction consumer prices have been “hidden” and then point out some reasons why (if you have to cheat to get some positive numbers, no useful can have been printed).
The most so far is the core rate – meaning CPI less fresh food – for August 2021, and it was zero; average prices thought to be exactly the same as in August 2020.
Some tiny amount of progress back toward the plus side hardly represents the successes of ¥142 trillion in new “money printing”; especially as the headline CPI rate dropped 0.5% year-over-year, while the other core rate which takes out both food and energy was also down 0.5%.
So, “it” is not about the Bank of Japan nor some roaring Japanese comeback. The “it” I am referring to means bond yields, including JGB’s. Not surprisingly, despite ongoing and continued outright deflation along with suspiciously little of economic recovery there, JGB yields have come up from very nearly having signaled much worse just over a month ago.
The recent bottom for the JGB curve was so close to that serious zero line for the 10-year maturity – on August 4, less than 1 bps in yield though not quite all the way down to nothing. Ever since, Japanese rates have ticked modestly upward; the JGB curve slightly steeper while doing so.
If August 4 sounds weirdly familiar, that’s because it was the same day for the same thing in UST yields.
This can only mean the global bond market has turned around in near-lockstep fashion in the same if opposite way from when it had confounded reflation trading late in February. With JGB 10s having avoided any negatives along the way, never triggering that specific alarm, was this just a close call? Powell’s taper all clear?
While that’s a possibility, nothing is impossible, more likely is how it’s just Autumn again. Nothing ever goes in a straight line.
The best example of this may be late in 2017. On September 8, 2017, these JGB 10s would actually puncture the zero lower bound if only on that one single day. This was in the wake of some fireworks in other global eurodollar indications (upset in T-bills, CNY-HKD etc.) a few days before.
And though global yields would quickly resume their usual upward Autumn, the die had been cast, so to speak, on what would eventually become Euro$ #4 amply hidden in terms of global yields going upward overall. The short run experience at and near zero for those 10s was an indication about timing and fragility – the underlying eurodollar pressure was real though not quite yet obvious and serious enough.
The global system had begun to roll over, though closer to the beginning of that turn than full inflection.
As noted here, there has been and still is quite a lot that’s the same about Autumn 2021 which reminds me of Autumn 2017 including JGB 10s. Had they gone under the zero line before early August, that would’ve suggested a condensed rolling over process. Now that this has been avoided, for now, it’s more likely like previous periods.
There was no growth part, just globally synchronized.
This remains the case today. The JGB 10s didn’t quite reach zero during the mid-2021 slump, but the fact they got close, and Japan’s CPI can’t get out of its own way, already suggests too much still the same. Yields may be rising globally, but if that’s only Autumn then JGB isn’t yet out of range of zero, meaning quite a lot more than that.
Maybe More Autumn Than Strictly August
Barely more than two weeks. That’s all was needed for the headlines to scream “bloodbath”, “end of the bull market”, and the always popular BOND…
Barely more than two weeks. That’s all was needed for the headlines to scream “bloodbath”, “end of the bull market”, and the always popular BOND ROUT!!! The 10-year Treasury yield had bottomed out in August and by mid-September 2019 this key benchmark rate screamed upward by 43 bps in just seven sessions.
To think, the financial media has made the last few trading days in the bond market seem like some uniquely gigantic earthquake never before witnessed in all of modern investment history. Less than 20 bps higher, somehow this is the final warning behind the Federal Reserve’s mighty, irresistible tapering.
In reality, the past few days barely rate for what I wrote on Friday has become a regular feature (though some exceptions) of the current calendar landscape.
As we know, there was no “taper” drama let alone a tantrum released by it two Septembers ago. Quite the opposite; back then, at the start of this prior “bloodbath” had been a reanimated European QE on top of one Federal Reserve rate cut about to become two (and then later three).
Those were rudely interrupted by repo, which only pushed Jay Powell’s dazed FOMC to do even more, toward eventually not-QE5.
Maybe September just isn’t the month to be in UST’s. Spring is supposed to be the season for rebirth and regeneration, when the darkness of winter is cast off for the warming sunshine of seasonality representing the always eternal unwritten future; the chance for a do-over, maybe for once something will actually go right.
For the world’s key collateral marketplace, this sort of revival seems to register each year – almost every year – after August. Autumn, not Spring, that’s when hope resprings and bond bulls die.
Well, they don’t die, obviously. Like bears (pun intended) they only ever hibernate for a few months, sometimes less, before coming out of their slumber as pessimistic as ever. This is certainly what happened before the end of 2019, even before COVID would become a household term.
The variability in this seasonal pattern seems to be in its length. September and October aren’t good months for the safe and liquid, even when safe and liquid might otherwise seem to be the wisest choice for financial participants relying on those characteristics to maintain their very survival.
An example of the shortest: 2014.
As Euro$ #3 dug deeper into the shadows, yet again this same hiccup in the Treasury market. A low point in late August, the 28th this time, followed immediately by the early September BOND ROUT!!!
That particular year, while the Fed was tapering its QE’s down to termination, the ECB would take center stage early in September 2014 (T-LTRO’s and rate cuts). Our benchmark UST 10s would rise 29 bps in yield in the same blink of an eye as 2019.
Afterward, though, it was more like in late 2018, this short-lived 2014 “bond bloodbath” instead quickly interrupted by first the collateral destructivity of October 15, kicking off Euro$ #3’s own landmine and from there back to declining rates as if there was never anything good along the way (there wasn’t).
That landmine was much the same as three years before then, after Euro$ #2’s landmine in late July/early August. The 10-year Treasury yield had bottomed out on September 22, 2011. While not specifically August in this instance, still clearly in the same ballpark.
On September 21, the Federal Reserve had announced it would take on Operation Twist after the ECB and Swiss National Bank (euro peg) had come into the global picture earlier in the same month. From those onward, several intense weeks, lasting to the end of October, when UST 10s added a far more robust 70 bps to their low yields.
In yet one more calendar year example, the very next year, 2012, pretty much the same pattern plays out. And that one is perhaps most eerily similar to the current one. Though the low point for the 10s fell on July 25 back in 2012, that’s actually even closer to our recent August 4 for 2021.
While tapering QE’s would be something for markets in 2013 to deal with, before they could, in 2012’s recessionary climate (Euro$ #2 hitting the world hard despite all that stuff late in 2011), there would first need to be some QE’s.
Then-Chairman Ben Bernanke had obliged first with QE3. When? Announced in September 2012 (followed by a fourth QE that December). Before those, then-ECB Governor Mario Draghi had already stolen his thunder by making his (in)famous “promise” on July 26 – meaning our 10-year UST yields had reached their lows the very day before.
Almost every September (including 2010’s; not discussed here) seems to be a bad time at the middle and long end of the Treasury curve. Whichever annual “bloodbath” extends more often than not into October and has frequently enough lasted longer in a few of these calendar years.
All of them, they make the current move in UST’s seem like child’s play when having done so.
Not a single one has meant huge inflationary potential, or the brokest human institution ever to grace our fiscal nightmares, Uncle Sam, reaching its vigilantism limit. On the contrary, though these are all, or nearly all, following along the same calendar regimes none of their BOND ROUTS!!! have ever represented anything more than a temporary waypoint in between the way down in yields.
Markets don’t ever go in a straight line, and there’s a regular bend or rebound in it each Autumn. It’s not really about the tapering of, nor the onset for, QE’s.
Still, this can’t be all random coincidence. There is definitely “something” about August, September, and nearly every post-2008 Autumn (2013 no exception, it just got started earlier).
Hope springs eternal, and for our cases that’s not in Spring.
Goldman Cuts China’s Q3 GDP Growth To 0% As A Result Of Growing Energy Crisis
Goldman Cuts China’s Q3 GDP Growth To 0% As A Result Of Growing Energy Crisis
It’s not just Europe that is suffering the mother of all commodity…
It's not just Europe that is suffering the mother of all commodity and energy price shocks: slowly but surely a similar fate is befalling China, where a perfect storm of increased regulation, extremely tight global energy supply, the escalating trade spat with Australia, surging coal prices and a crackdown on carbon has led to energy shortages first at factories and manufacturers and more recently, mass blackouts hitting tens of millions of residents in at least three Chinese provinces (as we discussed earlier).
In our commentary to China's growing energy problem we said that "while the blackouts starting to hit household power usage are at most an inconvenience, if one which may soon result in even more civil unrest if these are not contained, a bigger worry is that the already snarled supply chains could get even more broken, leading to even greater supply-disruption driven inflation."
But there's more than just supply chains: as Goldman's China strategist Hui Shan writes in a note published late on Monday, "the recent sharp cuts to production in a range of high-energy-intensity industries add to the already significant downside pressures in the growth outlook."
While the Goldman strategist explains more in detail further, the production cuts are due primarily to increased regulatory pressure on provinces to meet energy use targets for 2021 but also reflect surging energy prices in some cases. He notes that the NDRC issued ratings in mid-August showing nine provinces as performing poorly based on H1 energy usage, and reportedly intensified its efforts to bring underperformers into line in mid-September.
Based on the number of provinces (9 in NDRC ‘red’ classification) and share of industrial activity affected (Goldman estimates 44%), as well as informed assumptions about the extent of the cutbacks, the bank has estimated the hit to industrial production and overall economic activity for the remainder of the year. The bank's initial estimate is roughly a 1 percentage-point annualized hit to Q3 GDP growth and double this impact on Q4 growth. The bank then also adjusted its fiscal deficit estimates to reflect a smaller augmented deficit
for 2021 (11.0%, vs 11.6% previously), accounted for by a lower deficit in the second half of the year: "This trims our growth assumption by about 25bp in Q3 and 50bp in Q4, given a relatively low multiplier and typical lags."
Putting it all together, Goldman's new growth forecasts for Q3 shrink to flat, or 0% qoq (4.8% yoy), for Q4 to 6% qoq ann (3.2% yoy), and for 2021 as a whole to 7.8% (down from 5.1%, 4.1%, and 8.2% yoy previously.) Here, Goldman caveats that "considerable uncertainty" remains with respect to the fourth quarter, with both upside and downside risks relating principally to the government’s approach to managing the Evergrande stresses, the strictness of environmental target enforcement and the degree of policy easing. In short, how Beijing responds will impact the forecast. Regardless of said response, however, Goldman also takes down its 2022 GDP growth forecast to 5.5% yoy, well below China's new redline in the 6% range.
* * *
Elaborating further, Goldman writes that in recent weeks markets have been focused on developments with respect to Evergrande, its real estate development business, and risks to the broader Chinese property sector. The downward pressures on property sales and construction have added to a myriad of other headwinds for the economy including a relatively tight macro policy stance (epitomized by a balanced official fiscal budget in H1), Covid-related restrictions to counter local outbreaks, and regulatory tightening across a range of other sectors.
To this, we can now add a "new but tightening" constraint on growth from increased regulatory pressure to meet environmental targets for energy consumption and energy intensity (the so-called “dual controls”). As part of the country’s longer-term goal to reach peak carbon emissions by 2030, policymakers formulated shorter term targets for 2021 in March’s Government Work Report – including a 3% reduction in energy intensity of GDP this year. The National Development and Reform Commission (NDRC) monitors these at the provincial level on a quarterly basis. In August, it released a report classifying 9 provinces as category “red” – having missed their H1 targets, including Qinghai, Ningxia, Guangxi, Guangdong, Fujian, Xinjiang, Yunnan, Shaanxi and Jiangsu (Exhibit 1). Another 10 provinces were classified as “yellow”. In mid-September, the NDRC published a plan for “dual controls” and was reported to pressure provinces that had lagged behind to curb energy use.
Why did the energy use targets become binding so soon after being implemented?
While it presumably was not the intention of policymakers to provoke a sharp tightening, at least when the goals were initially formulated, the peculiar nature of the Covid shock has made the economy more energy-intensive, at least temporarily. The boom in exports has boosted energy-intensive manufacturing industries (Exhibit 2), while Covid-related restrictions have primarily affected interaction-intensive service businesses. Meanwhile, efforts to reduce coal-fired related emissions and a reduction in coal imports have affected supply levels at least on the margin, contributing to the sharp increase in prices discussed earlier.
What follows below is Goldman's attempt to quantify the impact of these production cutbacks on growth in Q3 and Q4.
First, quantifying the impact of energy-related production cuts.
Given the uncertainty associated with the degree and duration of production cuts, Goldman has made a number of simplifying assumptions to size the impact on GDP. Exhibit 4 displays these assumptions and calculations.
First, the bank categorizes affected regions by their 1H 21 energy control ratings given by the NDRC. For the nine provinces where the rating is red, the local governments need to aggressively reduce energy consumption to meet the year-end target and we assume the largest production cuts in those provinces. This means even more pain is coming.
Second, Goldman divides industries by their energy intensity. For ferrous metals, non-ferrous metals and non-metal mineral products, the NDRC labels them as “high energy intensity” sectors and they are also cited most frequently in the news related to the latest power cuts (see here for example). Therefore, the bank assumes the sharpest production cuts (20-40%) in these three industries. Petroleum, coking & nuclear fuel and chemical material & product are also labeled as “high energy intensity” sectors, and are likely to suffer medium levels of production cuts (10-20%). Mining, textile, paper making, chemical fiber and rubber & plastic product require significant energy inputs and have been quoted in news articles as well. Goldman assumes 5-10% of production cuts depending on the province for these industries.
Altogether, Goldman expects the 10 days of production cuts at the end of September to reduce real GDP growth by nearly one percentage point (annualized) in Q3. The rightmost column in Exhibit 4 shows the hit to the level of GDP in Q3 for each set of industries; these sum to 23bp, and given this is a quarter-on-quarter change, the annualized change is slightly less than one percentage point (92bp).
Assuming the production cuts continue in Q4 and affect 10 days per month, they would reduce Q4 real GDP growth by about 1.8% sequentially. Here, Goldman hands out the usual caveats: namely that there is a great deal of uncertainty in our estimates. On the one hand, the bank assumes no places outside of the red and yellow provinces and no industries beyond the 10 industries mentioned above are affected, which will likely underestimate the actual production impact. On the other hand, affected companies may resort to shifting maintenance timing in response to power cuts and production may increase in provinces with non-binding energy caps, leading to less damage to overall growth.
Cutting fiscal deficit forecast
After Chinese authorities quickly unwound the macro policy easing deployed in the first half of 2020, credit growth decelerated, excess liquidity was drained, and the fiscal deficit declined. In fact, fiscal policy normalized so quickly that the country ran an official deficit of zero in the first half of the year. Goldman had expected some reduction in the overall fiscal deficit, but the tighter-than-expected H1 caused the bank to revise its deficit estimate for 2021 lower. While there has been some fiscal easing in July and August, this partly reflects typical seasonal patterns and the deficit is tracking below these downwardly-revised estimates. Significant off-budget elements of the augmented deficit including policy bank lending, trust lending, and land sales are tracking below the bank's forecasts, and the latter in particular seems likely to continue to underperform given the ongoing property market tightening and failed land auctions seen in recent months. On the other hand, local government special bond issuance has accelerated somewhat but remains below the pace needed to fully utilize this year’s quota. Therefore, Goldman is revising a second time, and moving its forecast for the full-year augmented deficit to 11.0% from 11.6% previously.
Adjusting the new second-half deficit forecasts 1.2% lower and applying a multiplier of 0.2 (as well as a modest lag to some spending), Goldman now estimates an impact on qoq annualized growth of roughly -1/4pp in Q3 and -1/2pp in Q4.
The new GDP growth forecasts
Combining these new estimates for the impact of supply-side cuts to energy-intensive production and slightly less support from fiscal policy, Goldman cuts its growth forecasts for:
- Q3 to 0% (qoq annualized), from +1.3% previously,
- Q4 to 6.0% annualized, from 8.5% previously.
As a result, Goldman's year-over-year forecasts are now just 4.8% for Q3, 3.2% for Q4, and 7.8% for 2021 as a whole.
Finally, the lower starting point for early 2022 activity pulls the growth forecast for that year down one tenth, to 5.5%, despite modestly stronger sequential growth as restrictions become less binding and policy eases.
Uncertainties and policy response
While the third quarter is nearly over, uncertainty around the Q4 pace remains very large, and a lot of this comes down to the stance of both macro and regulatory policy, i.e., Beijing's reponse. Key drivers of the Q4 outcome will include the timing and extent of:
- government measures to stabilize housing sector activity and stretch out the deleveraging in the property sector,
- any temporary relaxation of regulatory pressures to meet energy use targets, and/or
- macro policy support.
Each of these factors could materialize on either the positive or negative side relative to these new reduced growth forecasts.
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