Macro Battleship with Christopher Wood

An interesting article appeared in the London-based Financial Times last month (“French central bank chief says ECB should not be driven by markets, July 16, 2019). It reported a speech made by the senior French central banker at the ECB which seemed to suggest that there was no reason for the ECB to ease monetary policy. Speaking at a conference in Paris in July to mark the 75th anniversary of the Bretton Woods agreement, Banque de France governor François Villeroy de Galhau said:

So we (central bankers) take account of market indications, but we must not be market dependent; this includes not relying too exclusively for inflation expectations on market-based measures. We are data dependent and I say this in particular for the ECB: in our coming Governing Council meetings, we will assess actual economic data and we will act accordingly if and when needed.

The reason why these comments are interesting is because it was generally assumed at the time that the ECB would amend its forward guidance at its July 25 meetings marking the end of the attempt to normalize monetary policy and paving the way for renewed further rate cuts and additional quanto easing to be announced at the meeting on Sept. 12. This was indeed what happened. Market expectations are now of a further 10-15bp rate cut, which would mean ever more negative rates, some form of “tiering” of the negative rate to mitigate the now admitted negative impact on the Eurozone banking system, and an increased QE program incorporating purchases of both private sector and public sector securities.

There is now likely to be more buying of private sector securities under the ECB’s version of QE2, in part because of the shortage of German bunds to purchase under current ECB rules which limit it to hold no more than one-third of any country’s government bonds outstanding. The ECB has so far bought a net €518 billion worth of German government securities or almost 33% of the outstanding. Meanwhile, the ECB’s balance sheet totals €4.68 trillion, or 40% of Eurozone GDP (see following chart).

ECB Balance Sheet

Source: ECB, Bloomberg

It is also the case that with the 10-year German bund yield currently a negative 0.58%, an even more negative yield as a result of ECB buying can only have further unfortunate consequences for German savers, not to mention German pension funds. On this point, the 10-year German bund yield has now fallen below the ECB deposit facility rate of a negative 0.40% (see following chart). It should also be noted that the precise details of the next wave of easing in the ECB will still be presided over by Mario Draghi, who has two more monetary policy meetings before he hands over to his designated successor Christine Lagarde at the end of October. And Draghi seems to share the same obsession with market-driven inflation expectations as the Bernanke clones at the Fed.

German 10-year Bund Yield and ECB Deposit Facility Rate

Source: Bloomberg

The potential significance of the Lagarde appointment has been commented on here before (see Eurozone fiscal integration – The escape valve for European banks, July 29, 2019), and that view is maintained. Still it is also worth asking the question that the French central banker de Galhau is also raising, and it is worth noting that de Galhau was once seen as the candidate to replace Draghi before Lagarde’s appointment. And that question is why the ECB is easing at all. For it is the case that the economic data in the Eurozone is, for now at least, simply not that bad.

One point to note is that there is not much evidence, as yet, of German domestic demand data weakening in response to the undoubted external slowdown. Real household consumption rose by 1.2%QoQ and 1.6%YoY in 1Q19, while real gross fixed capital formation rose by 1.1%QoQ and 3%YoY (see following chart).

Germany Real GDP Growth and Domestic Demand Growth

Source: CEIC Data, German Federal Statistics Office

The preliminary 2Q19 GDP data will be released on Wednesday. German retail sales were up 3.3%YoY in nominal terms and 2.5%YoY in real terms in 2Q19 (see following chart), which is hardly a collapse. It is also the case that the Eurozone is not just about Germany, which is clearly the economy most geared in the Eurozone to ongoing negative fallout from the US-China trade dispute.

Germany Retail Sales Growth

Source: CEIC Data, German Federal Statistics Office

German exports to China declined by 0.1%YoY in U.S. dollar terms in the first five months of 2019, while total German exports declined by 6.1%YoY in U.S. dollar terms in 1H19 (see following chart). Exports to China now account for 7.2% of total German exports, up from 1.6% in 2000. Longer term, it is also the case that Germany’s all-important auto sector faces a formidable structural challenge in the form of the threat posed to its engineering-driven dominance by the double whammy of electric cars and regulatory-driven carbon hysteria.

German Export Growth in U.S. Dollar Terms

Source: CEIC Data, German Federal Statistics Office

All of the above is why it is worth highlighting the much stronger data of late being reported by France. Indeed, if the ECB was running monetary policy based on French data there would be no reason to ease policy at all, which is a further reason why de Galhau’s comment is noteworthy. For example, industrial production in France was up 1.6%YoY in 2Q19, compared with a 6.2%YoY decline in June and a 5.1%YoY decline in 2Q19 in Germany (see following chart).

Germany and France Industrial Production Growth

Source: CEIC Data

It is also the case that French job data shows signs of a positive impact from French President Emmanuel Macron’s important reforms liberalizing the labour market and unemployment insurance. There was an increase of 92,800 jobs in the private sector in the first quarter, up from 67,900 in 4Q18 (see following chart).

France QoQ Change in Private-sector Payroll Employment

Source: French National Institute for Statistics and Economic Studies (INSEE)

There has even been a turnaround in job generation by French industry. There were 18,800 jobs generated by French industry in the 12 months to March, after a 11,600 job increase in calendar 2018. Significantly, this reversed a 17-year trend of job losses between 2001 and 2017 (see following chart).

France YoY Change in Payroll Employment: Industry Sector

Source: French National Institute for Statistics and Economic Studies (INSEE)

At the time of Macron’s election in May 2017, I took a positive view of the potential long-term significance of him becoming president since he appeared determined to implement long overdue labour reform giving French employers, particularly those running smaller companies, greater freedom to hire and fire.

All the evidence is that he continues to move in this direction despite the unnecessary own goal of the diesel tax driven by the French president’s unfortunate obsession with “global warming”. But while the gilets jaunes began in November 2018 as a protest against arbitrary taxes on diesel hitting ordinary people, particularly owners of light agricultural vehicles in the French countryside, the protests were hijacked by the extremes on both left and right and duly lost mainstream support.

This is why it is of note that French consumer confidence has now risen for seven consecutive months, increasing from 87 in December to 102 in July, the highest level since January 2018 (see following chart). Wage data is also improving. The monthly wage index rose by 0.8%QoQ and 1.7%YoY in 1Q19, up from 1.2%YoY in 2Q17 (see following chart).

France Consumer Confidence Indicator

Source: Bloomberg, French National Institute for Statistics and Economic Studies (INSEE)

French Monthly Wage Growth

Source: Bloomberg, French Labour Office

It is also of note that credit growth in France seems in an uptrend. Credit growth to non-financial corporations rose by 7.4%YoY in June, up from 6.7%YoY in May, while loans to households rose by 5.9%YoY in June (see following chart).

French Bank Loan Growth

Source: ECB

While it may be argued that some of this positive data might be attributable to the €11 billion fiscal giveaway in December prompted by the gilets jaunes demonstrations, there would seem real evidence that something positive is stirring in France’s labour market. And, precisely because it has been so dysfunctional for so long, the positive consequences should not be underestimated. For those who remain skeptical about Macron’s commitment to reform, it is also worth highlighting that the French president has just launched a radical overhaul of the pension system (see Financial Times article: “French pension revamp risks confrontation with unions”, July 19, 2019).

Under the proposed reform, a full pension will only be available from the age of 64, two years later than now, while the intention will be to remove differences between public and private pension systems. The pension reform aims to build on the already introduced overhaul of the unemployment insurance system, which will reduce insurance payouts for high earners and require people to work for longer before claiming benefits. The aim is to introduce a bill on pension reform next year with the changes taking effect in 2025.

Macron has the time with another three years before the next presidential election. It is also the case that his support ratings have recovered from the nadir at the time of the gilets jaunes protests, rising from 18% in late November to 26% in July (see following chart).

French President Emmanuel Macron Support Rating

Source: YouGov

Macron seems to be a politician that actually wants to change things and so will not be so distracted by the media-driven noise.

Macron seems to be a politician that actually wants to change things and so will not be so distracted by the media-driven noise. It is also worth remembering that somebody who married his teacher 24 years older than him obviously does not care too much about what people think about him. This is rather refreshing. But it is also important from a Eurozone perspective given Macron’s stance on bringing greater fiscal cohesion to the Eurozone.

This brings the discussion back to the topical subject of Madame Lagarde. It would seem obvious that there is a broader agenda behind the Lagarde appointment which overtly politicizes the ECB. That should lead to much greater focus on completing the banking union, working towards greater fiscal integration and common debt issuance leading ultimately to some form of Eurozone government bond.