I wrote this monetary policy brief more than a month ago. Since I didn't find a good outlet, I will just put it up here on my blog.
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In January of this year, I started a new job as Client Specialist for Macrobond Financial.
We are the key engine of Macroeconomic and financial time series analysis. We have an excellent charting tool and analysis tool for Macroeconomic and financial data and also some 120 million+ time series in our database. Since I started to write on our company blog Macro 'n Cheese, I will take a time out here as I don't have the time for both. Please follow my writings there! I haven't followed Australian economic data for a while. So I was extremely surprised to find the following chart that shows that real house prices have declined by more than 10% over the last two years. In fact, the Australian housing market seems to have peaked in early 2017. While over the last 10 years, a large number of people have proclaimed that the Australian housing market is in a bubble, these bubble calls were always pretty much nonsense. Making many wrong predictions in a row and then finally having one good call doesn't make you right. Therefore most bubble predictions turn out to be utter nonsense. Moreover, timing is everything. Even if you correctly called the Dot-Com bubble, for example, but started to short the market too early, you still would have lost a lot of money. It is basically impossible to correctly identify market turning points ahead of time, and anybody who claims otherwise is just misleading.  So the graph above does not show in any meaningful way that the Australian housing bubble is finally bursting. However, given the extraordinary house price boom that the country has experienced since the 2000s, this definitely seems to be a turning point. Going ahead, it is not clear though whether the decline will continue. Moreover, as of right now, the price decline does not seem to have significantly affected economy-side spending, which seems to hold up rather nicely as NGDP growth has only slowed down very moderately. However, this could obviously change quickly if the housing bust worsens, but this remains to be seen. What is interesting is that Australia is currently not the only country where house prices have stalled after a significant booming period that has lasted for more than two decades. This obviously raises the question whether the current global boom in real estate has finally approached an inflection point. Canada, the UK, and Sweden have also experienced in recent years a peak in the real price of housing, followed by a moderate decline. While at least in Sweden this trend might have reversed (based on Swedish data), this does not seem to be the case for Canada and the UK.  Obviously, this begs the question whether the long-awaited burst of the housing bubbles has finally arrived. While it is theoretically possible that the moderate declines indicating some kind of local or even global inflection point, this seems rather unlikely. While it is true that mortgage to GDP ratios have also steadily increased in recent years, especially in the aforementioned economies, global housing prices are not solely determined by what some have dubbed increasing fianancialization. Certainly, the effect of greater leverage might have contributed to the recent increase in price. However, there are also several real factors that have contributed to the price appreciations many advanced economies have experienced. First, the forces of economic geography have pushed up house prices around the world. Over the last couple of decades, many advanced economies have experienced rising concentration where some superstar cities have pulled ahead of many rural areas and even small to medium-sized cities. Consequently, real house prices have increased in large metropolitan areas to an even larger extent, thus putting added pressure on aggregate national indices. Second, a lot of advanced economies suffer from NIMBYism in one form or the other. Especially in large metropolitan areas where additional supply is needed the most, construction has lagged way behind. Some cities like Berlin are now even resorting to non-sensical policies like rent control, which is supposed to alleviate the pressure from rising rents but will also negatively affect residential investment and therefore simply aggravate the housing crisis in the long-run. Therefore, many large European cities have seen their housing prices appreciate considerably in recent decades. Third, low interest rates combined with a high mortgage to GDP ratios will continue to support high house price valuations in the foreseeable future. By the way, recent reports by the Bundesbank and others suggest that policy makers in Germany are increasingly worried about appreciating house prices and the emergence of a real estate bubble, which they also seem to blame on ECB policy. This is actually quite ridiculous. As I have written before, the ECB has actually little to do with low real interest rates, which can be observed globally and are determined by global macroeconomic conditions. Moreover, as you can see from the chart above to which I have added German real estate prices, Germany's experience is somewhat unique. Besides Japan, it is one of the very few countries in which real house prices stagnated for several decades (see below). Only over the last few years has the German economy seen significant real house price appreciations, and mostly in the large cities like Munich, Hamburg, and Berlin, etc. However, the recent appreciation in Germany nowhere comes close to what other advanced economies have experienced in recent decades. It therefore seems quite a stretch to me to call the German situation a housing bubble. While not denying that the housing market in cities like Frankfurt is very tight, these problems must be addressed by local policy makers.  So in my last blog post I briefly wrote something about the state of the Swedish economy. According to older data, the Swedish unemployment rate increased quite dramatically in recent months. Using the Sahm rule, I said that the Swedish economy is probably then at a brink of a recession. Well, now it turns out that QE3 real GDP growth (year-on-year) was 1.6%, which is not spectacular but definitely also not a disaster and a far cry out from an economic downturn. So Sweden's economy doesn't look like its heading for a recession as of now. What went wrong?
It turns out that according to this Reuters article, the unemployment rate data collected over the last few months is basically wrong and has been overestimated. The data I used (via FRED) showed that the Swedish unemployment over the last two months was edging up to 7.4%. Based on that figure, the recent increase would have meant that Sweden was heading for a recession, since the 3-month moving average was increasing by more than 0.5 percentage points over its previous 12 month low. However, now it turns out that this recent increase is fake. According to the Swedish Statistics office, the seasonally adjusted unemployment rate is only 6.8% while the non-seasonally adjusted figure is a little lower. While these new figures are still somewhat higher than what the unemployment rate was at the beginning of the year, the Sahm rule would not give us a recession warning based on this updated data. It is still a little unclear to me what precisely has happened over the last months and why the initial unemployment rate data was wrong to such an extent. But this error is obviously a huge problem and the agency responsible for collected the data must figure out as soon as possible what has happened since this data is also of crucial importance for domestic policy makers, including the Riksbank. Maybe the key takeaway from all this is that even current Macro data can be of poor quality at times. So beware! According to the Sahm rule, it definitely looks like it. Claudia Sahm (researcher at the Federal Reserve) devised a recession indicator based on the unemployment rate for the US economy. Whenever the 3-month moving average increases by 0.5% percentage points or more over the previous 12-month low, then the a recession is starting. The indicator seems to do a very good job, and unlike the yield curve inversion, it is both timely and also does not seem to flag any false positives. Here below we have the data for Sweden. As one can see, the 3-month moving average for the Swedish unemployment rate rose to 7.3% now while it was just 6.3% in April of this year. Obviously, the structure of the Swedish economy is extremely different from the US, being a small open economy at Europe's periphery. The Swedish labor market is also less flexible than its US counterpart, but this actually makes the recent rise even more worrying. Finally, there could be data and measurement issues and unemployment figures might fluctuate more from month to month than in the US. While for these and other reasons, the Sahm rule might not work that well for the Swedish economy, the recent rise in unemployment is obviously very concerning. The economic slowdown in Europe is surely weighing on the domestic economy, since Sweden is similar to Germany a big exporting nation of industrial goods. Therefore the economy might already be in a recession as of this quarter or will enter a recession any time soon. Consequently, the Riksbank should adjust monetary policy accordingly and probably resume QE, given that interest rates are still stuck at the ELB.  PS: I have not tested the rule for Sweden with historical data, nor have I tried it with other advanced economies. Such an exercise would probably be very interesting and useful and somebody should get on it.
A couple of weeks ago both the German government and German media basically celebrated because the country avoided a technical "recession", defined as two consecutive quarter of negative GDP growth. That is because the German economy was growing at 0.1% in Q3 (~0.4% annualized) after shrinking 0.2% in Q2 (see below).  The celebratory calls that a recession was avoided were obviously quite stupid since these growth rates are still abysmal. While not being in a technical recession, the German economy basically did not experience any growth at all for about half a year now. This is already a very severe cyclical downturn. Reasonable estimates would peg long-run trend growth at above 1% at least. So Germany's economy is already 1% below trend now for half a year and I am very doubtful that the next couple of quarters will lead to a substantial uptick in economic activity, given that Germany's manufacturing economy is extremely export-oriented and the global economy also seems to be in a cyclical downturn right now. Most data points suggest that China is slowing down substantially and US forecasts are also indicating that the economy is heading South. Both the New York Fed as well as the Atlanta Fed Nowcast models have revised their growth estimates for the Q4 substantially downward over the last few weeks: The US economy is now expected to grow at only 0.3% in the last quarter. While quarterly growth figures can be quite volatile, this is also some 1 to 1.5% below trend and might therefore turn into a more severe cyclical downturn.   I do not quite think that this is the end of the US business cycle. The Fed still has some room to cut rates and should do so rather sooner than later. Then they might be able to engineer a so-called soft landing for the first time in US history. A lot of it will depend to what extent they are willing to look at market signals rather than useless Phillips-curve type thinking. This year gives some hope for optimism as the Fed took the inversion of the yield in the beginning of the year somewhat seriously and responded by cutting rate again. While I had hoped for an even bolder response, it looks like they did enough to prevent a substantial slowdown yet. Now it will all depend on whether they will fall behind the curve or not.
Update: The Nowcast estimate by the NY Fed edged up to 0.71%. This is still extremely low though and well below trend. Larry Summers' theory of secular stagnation has been, in my opinion, the biggest and most influential contribution to modern macroeconomic theory in recent times. I therefore wrote an article about it, which is now live at Econ Journal Watch:
Lawrence Summers Deserves a Nobel Prize for Reviving the Theory of Secular Stagnation Abstract: Lawrence Summers produced a big upset within the economics profession when he revived Alvin Hansen’s theory of secular stagnation, which had been thought of as an old-Keynesian fallacy. While some economists like Brad DeLong and Paul Krugman instantly recognized Summers’s contribution, a large share of the economics profession remained skeptical at first. Whereas most New Keynesian models allow for macroeconomic shocks to have only transitory effects, Summers argued that the global natural real interest rate has fallen into negative territory. Furthermore, he suggested a number of reasons why this equilibrium might not be only transitory in nature. This also led Summers to believe that economies could be more prone to financial bubbles and persistent shortfalls in aggregate demand. I summarize the secular stagnation debate and outline the main empirical support of the secular stagnation interpretation, including falling real interest rates, lower productivity growth, increasing inequality, and rising asset prices. Ever since Summers first outlined his theory, global growth has been extremely anemic and interest rates have declined to even lower levels. Given that many aspects of the secular stagnation debate now find increasing empirical support, I argue that Summers deserves to win the Nobel Prize in economics on the grounds of reviving a once-dismissed theory and initiating the most important macroeconomic debate of our times. I recently wrote an article for The Conversation on how the yield curve has historically been one of the more reliable predictors of an upcoming recession, especially for the US economy. An inversion of the yield curve means that interest rates on long-term bonds have fallen below short-term interest rates, which tends to happen about one or two years before an economic downturn in the US. For other advanced economies, yield curve inversions also seem to happen before economic slowdowns, but the signal might not be as strong as for the US. I just saw on Scott Sumner's blog The money illusion a very interesting chart on the US yield curve pre-World War II. Using Robert Shiller's data, I have reproduced the US yield curve for that time period. And indeed the data suggests that long-term rates were usually below short-term rates for almost the entire time period. While long-term government bonds were available for the entire time period, short-term government bonds didn't exist until the 1930s. For the time period before, interest rates on commercial paper were the best proxy for short-rates. And herein already lies the first problem. Commercial paper is obviously much riskier than short-term government debt, meaning that there can be a substantial risk premium at times, which might explain why short-rates were substantially higher than long-rates for the mentioned time period.  In order to double check this result, I also calculated the US risk premium based on the Jorda, Schularick, and Taylor (JST) Macrohistory database. And big surprise, I get vastly different results. I also included yearly NGDP growth in the chart (axis on the right-hand side).  The chart shows that NGDP growth was highly volatile before WWII and that recessions were a quite common phenomenon. According to the JST, the yield did invert relatively often, but certainly not as often as in the previous data set.
One can see that the long-term interest rate by Shiller and JST are similar, based on historic long-term government bond yields. The short-term rate, on the other hand, is extremely different. There are some 32 inversions during those 70 years in the JST data. While this is still extremely frequent, one should also note that recessions were extremely common at the time and the also featured 21 years of negative nominal GDP growth (real GDP growth might still have been positive at times since the US economy and other advanced economies also experienced moderate deflation during parts of the late 19th century). While I am not exactly sure to why the two data sources have strikingly different data, there are several potential explanations. First, it might be that one of the series is simply "wrong", meaning an error in the raw data itself. This would be actually quite worrying because I have used the JST data for my own research, such as for my article on global interest rate from 1870 to today. What is more likely though is that the authors have simply used different data sources and different methodologies to construct the short-term interest rate series. While I do not have time for a detailed analysis right now, a more careful study of the appendices of the two data sets would surely reveal why there is such a striking difference. Based on a first look at the data, it looks like JST have used deposit rates for historic short-term interest rates whereas Shiller's data is based on interest rates of commercial paper, which might very well explain the difference. For now, suffice it to say that you should be extremely careful using macroeconomic data in general, and macroeconomic history data in particular! The quality of the data is arguably extremely poor at times, which is obviously not very surprising.
I recently wrote an article for The Conversation about the inversion of the yield curve, which has historically been one of the more accurate recession predictors, especially for the US. Yield curves have basically inverted across all large advanced economies, which is obviously pretty bad news. Global bond yields have also declined significantly and there is now a record of 15 trillion USD in bonds around the world that have a negative nominal yields.
The decline in yields for the most part reflects lower growth expectations and lower inflation expectations for the future, a global synchronized downturn in economic activity. The decline seems to be especially severe in Germany, which is now expected to grow only at some 0.7% this year according to some forecasts, and therefore slower than the Eurozone as a whole. Frankly, it is sheer stupidity that the German government is not considering a large infrastructure program right now as the economy is slowing down and the government can borrow at negative nominal yields on a 30-year horizon. And Draghi has recently stated that a more expansionary fiscal stance, especially in Germany, would also make the life of the ECB easier, given that they are constrained by the ELB. Similar to market monetarists, I believe that market indicators are the best warning signs of upcoming recessions and they can also give us an indication of the stance of monetary policy. Since GDP estimates are only available with a time lag, one has to consider macroeconomic indicators that are available at a much higher frequency. This could be asset prices, for example: bond yields, stock prices, inflation expectations based on interest rate spreads, etc. Well, as I dais above, the bond markets and the yield curve are flashing severe warning signs. Stock prices are going down too, also in the US, as Trump's stupid trade war is starting to take its toll on the global economy. Now, another pretty cool indicator is giving us more to worry about it. Google trends is showing us that searches for the word recession on Google (Rezession in German) have been more than doubling in recent months. If that is not something that should give us concern, then I don't know what is. I have also plotted the same graph for Spain, Great Britain, and the UK. The slowdown in Spain seems to be less severe as of now, which is also in line with macroeconomic forecasts. The Spanish economy is still doing quite well. For the UK, the graph is somewhat dwarfed by the extreme spike that happened in 2016 right after the Brexit referendum happened. For the US, one can also see that searches for the word recession have increased, especially over the last couple of months. The Fed has lowered its interest rate again for the first time in 10-years and financial markets expect more rate cuts to follow by the end of this year. Overall, I would say that the global economy is slowing down considerable and we can expect some difficult times ahead in the next one to two years unless Central Banks start with significant rounds of monetary easing to fight the downturn. Stay tuned!
Germany
Spain
Great Britain
USA
So I am seeing a lot of analysis on Bloomberg and other media outlets how last quarter's GDP figures in the US defied expectations (true) and how this now calls into question the Fed's desire to ease monetary policy (false).
This is nonsense for several reasons. It is true that Q2 GDP growth of 2.1% in the US was above expectations. The Atlanta GDP Nowcast, for example, had a forecast of only 1.3%. So while this Nowcast estimate has historically produced relatively good estimates, they were off the mark for this quarter. However, it should be noted that quarterly GDP figures are actually quite volatile. It is therefore extremely misleading to make inferences about the state of the economy based on one quarter's GDP figure. Second, quarterly GDP figures are often subject to substantial revisions. Until a couple of days ago, we actually thought that the US economy was growing at the rate of 3% last year. Well, it turns out that actual growth was more like 2.5%, meaning that Trump's policies, including the enormous tax cut, did actually deliver even less than what the administration actually suggested. The impact of the tax cut on business investment is barely noticeable. The downward revision for last year came about a revision for Q2 from 4.2 to 3.5% and an even greater revision for Q4 from 2.2 to 1.1%. All of this is obviously bad news. And it also means that the current estimate of 2.1% for last quarter is relatively meaningless and it definitely does not imply that the Fed should not go forward with interest rate cuts. In fact, I believe that a 50 basis points rate cut would be actually more appropriate than a simple 25 bps rate cut for several reasons. First, it looks like the natural rate of interest is trending downward sharply, both in the Eurozone but also in the US. This means that the Fed needs to cut rates just to keep monetary policy neutral and NGDP growing at a stable rate. Second, financial markets expect about 2 to 2.5 rate cuts by the Fed by the end of this year. So why not simply cut 50 bps right now, deliver a dovish message and get it over with instead of being more prudent. It does not make sense to delay the inevitable. The US economy's interest rates are actually quite high from a global perspective and this divergence was unlikely to continue. Given that the economic slowdown in the Eurozone is even more pronounced and that the ECB is expected to go even more negative and resume QE in a few months, it makes sense for the Fed to cut rates and prevent the dollar from appreciating, which would put further pressure on the domestic economy. |
AuthorMy name is Julius Probst. Archives
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