Weekly global economic update

What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.

Ira Kalish

United States

China GDP accelerates while other indicators show weakness

  • In the first quarter of this year, the Chinese economy grew faster than had been anticipated. However, several other economic indicators suggested economic weakness. Thus, the recent data dump offered a mixed picture. Aside from GDP, the government published statistics on industrial production, retail sales, fixed asset investment, and exports. 

The only indicator that accelerated in the most recent month was fixed asset investment, driven by government incentives for investment in new technology and energy. This more than offset a sharp decline in investment in property. The problem with technology investment, however, is that it will only pay off if China can boost exports. Yet given China’s massive export footprint, a sizable increase might be difficult, requiring price incentives that could cause discomfort with trading nations, possibly leading to a protectionist reaction. Consequently, the main source of growth for China’s economy is riddled with potential obstacles.

Let’s look at the data. In the first quarter, real GDP was up 5.3% from a year earlier. In addition, real GDP was up 1.6% from the previous quarter, the strongest increase since the first quarter of 2023. 

Chinese industrial production increased 4.5% in March versus a year earlier. This was a sharp deceleration from recent quarters and the slowest growth of industrial output since September 2023. The manufacturing component of industrial production was up 5.1% in March versus a year earlier, down sharply from the previous month. By industry, output was up 10.6% for computers and communications, 2.5% for textiles, 0.9% for automobiles, and 9.1% for chemicals. 

Chinese retail sales were up only 3.1% in March versus a year earlier, down sharply from recent months and the slowest increase since July 2023. By category, sales were up only 3.2% for gold, silver, and jewelry, up 0.2% for furniture, up 7.2% for communications equipment, up 3.8% for clothing, and up 5.8% for home appliances. On the other hand, sales declined 3.7% for automobiles. 

The economic indicator that improved in March was fixed asset investment. It was up 4.5% in the first three months of 2024 from a year earlier. This was the strongest growth since April 2023. However, investment in property fell 9.5% from a year earlier. This included a 10.5% decline in residential property investment. In addition, housing starts fell 27.8% in the first quarter versus a year earlier, while housing completions fell 20.7%. The weakness in residential property contributed significantly to modest GDP growth. 

The latest data suggests that China’s underlying demand remains weak, and that the economy is likely being boosted by government-subsidized investment in new technologies. Meanwhile, Chinese prices are flirting with deflation, producer prices are falling, inbound foreign investment has weakened, and households are increasing savings to offset the loss of wealth due to declining property prices. Indeed, new home prices fell 2.2% in March versus a year earlier, the sharpest decline since August 2015. Prices were down more sharply in Shenzhen (down 5.5%) and Guangzhou (down 5.5%). Prices in Shanghai were up 4.3% while prices in Beijing were up 0.8%.  

Germany worries about economic relations with China

  • China is Germany’s largest export market. Yet China’s growth has slowed, political relations between China and Europe have challenges, and German companies are concerned about an influx of subsidized products from China. This is the background to the current visit of German Chancellor Olaf Scholz to China. 

Given the fraught relationship between Germany and China, the German government has urged companies to “de-risk” from China by diversifying supply chains. The government was especially worried about the supply chain implications of a conflict between Beijing and Taiwan. In addition, the Bundesbank has warned that Germany’s economic dependence on China implies that Germany’s “business model is in danger.” 

Yet, in an interview with the Financial Times, the CFO of German company Siemens said that it will take decades to unwind the China-focused supply chains that were created in recent decades. He said, “Global value chains have been building up over the last 50 years. How naive do you need to be to believe that this can be changed within six or 12 months? This is about decades.” Indeed, it is reported that little progress has been made by German companies in decoupling from China. 

On his trip to China, Scholz has several goals. These include promoting German exports to China, improving the conditions for German companies that operate in China, attempt to convince China to reduce subsidized exports lest it face retaliation, and convince China to reduce military support for Russia lest Chinese companies face new sanctions.

Powell confirms shift in outlook

  • In the United States, the conventional wisdom has shifted due to faster-than-expected economic growth and more persistent underlying inflation than previously expected. The result is that investors no longer expect a rapid easing of monetary policy by the Federal Reserve. Now, in a speech, Fed Chair Powell has confirmed that view. He said: “We’ve said at the [Federal Open Market Committee] that we’ll need greater confidence that inflation is moving sustainably towards 2% before it would be appropriate to ease policy. The recent inflation data have clearly not given us greater confidence, and instead indicate that it is likely to take longer than expected to achieve that confidence.” He added that “given the strength of the labor market and progress on inflation so far, it is appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us.”

Following Powell’s comments, the futures market implied probability of only one rate cut in 2024 increased. In addition, the futures market suggests that the most likely timing of a rate cut will be in September, rather than June as previously believed. 

US investors now expect the Fed to be the last of the major central banks to cut rates. They expect the European Central Bank (ECB) and the Bank of England (BOE) to go first. This will likely mean upward pressure on the value of the dollar versus other currencies. That, in turn, could create disinflationary pressure in the United States. However, it could undermine export competitiveness. 

Will keeping rates elevated for longer make a difference? It is not clear. So far, the elevated rates have evidently not weakened the labor market. If anything has weakened wage pressure it is the high level of immigration. On the other hand, the Fed is likely reluctant to cut rates too soon lest they cause the US economy to overheat. I suspect that they see current interest rates as consistent with strong growth and slowly easing inflation. They will not want to cut rates until they are confident that doing so will not do any harm.  

US retail sales demonstrate strong consumer economy

  • Retail sales in the United States continued to grow in March. The government reported that, in March, retail sales (not adjusted for inflation) were up 0.7% from the previous month and up 4% from a year earlier. This follows month-to-month growth of 0.9% in February. 

There was a sharp 0.7% decline in spending at automotive dealerships. Excluding this, retail sales were up 1.1% from the previous month. On the other hand, gasoline sales increased 2.1% due to rising gasoline prices. When automotive and gasoline sales are both excluded, retail sales were up 1% from the previous month—a strong performance. 

Some categories performed poorly. For example, sales at electronics and appliance stores were down 1.2% from the previous month. Likewise, sales at clothing stores fell 1.6% while sales at department stores fell 1.1%. On the other hand, sales at non-store retailers were up 2.7%, sales at general merchandise stores (which includes department stores as well as large discount stores) were up 1.1%, and sales at building materials stores were up 0.7%. 

The strength of retail spending in March reflected growing employment, rising real (inflation-adjusted) wages, and a willingness to dip into savings and take on more debt. On the other hand, it likely had little to do with inflation. That is, recent inflation data shows that most inflation now involves services, and retailers mostly do not sell services. Goods prices have been relatively stable, with prices of durables falling and prices of non-durables rising modestly. The strength of retail sales in both February and March will likely have a positive impact on GDP growth in the first quarter. 

Biden proposes new tariffs

  • There is no question that Joe Biden and Donald Trump have dramatically different views on economic policy. However, there is one area where there is some similarity. That is trade. President Biden retained the tariffs that Trump imposed during his time in office and added new restrictions on trade and investment with China. Now, Biden is calling for a tripling of tariffs on Chinese steel and aluminum. The current tariff is 7.5%. This is likely meant to appeal to union members in Pennsylvania, a state of critical importance to Biden’s reelection. This is the second major policy initiative aimed at Pennsylvania workers. The first was Biden’s opposition to the takeover of US Steel by a Japanese company. 

In the case of steel and aluminum, the Biden Administration claims that Chinese government subsidies for state-run companies create an uneven playing field for US producers. The director of Biden’s National Economic Council, Lael Brainard, said: “We must invest in American manufacturing, but we also have to protect those investments and those workers from unfair exports associated with China’s industrial overcapacity.”

When measured in US dollars, China’s exports declined in the first quarter of this year. Yet that was due to a sharp decline in export prices. The volume of Chinese exports increased sharply. This implies that Chinese government subsidies are boosting exports. The US is not alone in its concern about this. The European Union has opened investigations into Chinese trade practices. Moreover, it is not simply about steel and aluminum. There is great concern that China is dumping electric vehicles and other leading-edge products. 

The problem with tariffs, however, is that they are paid by consumers in the country that imposes the tariffs. They raise prices paid by consumers and businesses for imports, thereby easing competitive pressure on domestic producers and allowing them to raise their prices. This can both contribute to inflation and reduce aggregate demand. Moreover, higher-priced steel and aluminum can worsen the global competitiveness of companies that depend on these as inputs.

In the past, the best way to deal with the impact of another country’s subsidies was to challenge them at the World Trade Organization (WTO). Unfortunately, the effectiveness of the WTO has been decreased by the United States. Thus, there is no longer a strong method to enforce the rules-based trading system. As such, countries appear free to do as they please, thereby increasing the risk of protectionist measures that undermine economic efficiency.

US inflation persists and investors shift expectations

  • In the United States, equity prices fell sharply, bond yields increased, and the value of the dollar surged following news that inflation in March was higher than expected. Many investors were already jittery following higher-than-expected inflation in January and February. Last week’s report puts a nail in the coffin of expectations of a rapid easing of monetary policy this year. Before the inflation report was released, investors were pricing in a 98% probability of a rate cut by July. After the report, that probability dropped to 50%. If, as investors now expect, interest rates remain high for longer, that implies higher bond yields as well. 

Let’s look at the data and see why investors are so vexed, and if their viewpoint is warranted. First, the consumer price index for the United States was up 3.5% in March from a year earlier, the highest rate of annual headline inflation since September. Prices were up 0.4% from the previous month, the same as in February and the highest since September. However, when volatile food and energy prices are excluded, core price inflation did not accelerate in March. Specifically, core prices were up 3.8% from a year earlier, the same as in February and the lowest core inflation since May 2021. Still, it appears that core inflation is stalling, having been 4.0% in October. Core prices were up 0.4% from a month earlier, the same as in February.

Now let’s look at some of the details behind the inflation report. First, energy prices are rebounding, which explains the rebound in headline inflation. Energy prices were up 2.1% from a year earlier and up 1.1% from the previous month. This partly reflects the sharp increase in crude oil prices since the start of the year. Also, US electricity prices were up 5.0% from a year earlier.

Some categories saw either very low or even negative inflation in March. Prices of new cars were down 0.1% from a year earlier while prices of used cars were down 2.2%. Prices of apparel were up only 0.4%, the price of food eaten at home was up only 1.2%, and the price of airline fares was down 7.7%. On the other hand, the price of shelter (housing) was up 5.7% from a year earlier, contributing substantially to overall inflation. When shelter is excluded, consumer prices were up 2.3% from a year earlier. The good news is that shelter inflation has been gradually receding since it peaked in March 2023 at 8.2%. 

Inflation remains mostly a problem involving the prices of services. Prices of durable goods continued to decline in March, down 2.1% from a year earlier. This included a decline of 6.9% for televisions and a drop of 6.6% for information technology goods. The latter, in turn, included a 9.0% decline for smartphones. Prices of non-durable goods were up a modest 1.7%. 

Prices of services, however, were up 5.3% from a year earlier. Even when shelter is excluded, prices of services were up 4.8%. The problem is that services tend to be labor-intensive, the labor market is tight, and wages are rising. Moreover, there is no sign that labor market conditions are easing. Employment grew at a blistering pace in March. Only a spurt of immigration, which boosted labor supply, has prevented even bigger increases in the prices of services. 

For the Federal Reserve, the tightness of monetary policy is meant to weaken the labor market, thereby reducing wage pressure. Evidently, this has not yet been accomplished. It is not clear if keeping rates high for longer will accomplish the Fed’s goal. However, the Fed will likely be reluctant to cut rates if it perceives the economy to be overheating. Thus, investor expectations have shifted substantially. 

  • What the Federal Reserve does, or doesn’t do, not only influences economic and financial conditions in the United States, but also has an impact around the world. As investors change their expectations for Fed policy, the calculations of other central banks and of investors in other countries shift accordingly. If US interest rates remain high longer than previously expected, this puts upward pressure on the value of the dollar. Hence, the Japanese yen fell sharply to 152.9 yen to the US dollar, the lowest level since 1990, after release of the US inflation data. Since the start of the year, the dollar has appreciated significantly not only against the yen, but also against the Canadian dollar, the euro, and other currencies. 

Moreover, the depreciation of the yen comes even after the Bank of Japan (BOJ) ended its easy monetary policy. Consequently, the BOJ is now saying that it will consider further tightening to stem the decline in the yen. Specifically, BOJ Governor Ueda, in response to a question about the value of the yen, said “if there is a risk that a virtuous cycle of wages and prices strengthens more than expected and underlying inflation rises above 2%, we need to consider changing monetary policy.”

For other central banks, especially the People’s Bank of China (PBOC), the US inflation report and its implications for Fed policy will likely deter further easing of monetary policy. For example, the PBOC faces a Chinese environment of near-zero inflation and weak economic growth. Yet, with the Fed likely to keep rates high for longer, a Chinese decision to cut rates would put downward pressure on the value of the renminbi, something the PBOC is not likely to do.

On the other hand, the expectation that the Fed will wait to cut rates is due, in part, to the surprising strength of the US economy. If the US economy continues to do well, it will boost demand for products from trading partners, including China, Japan, and Southeast Asia. That, in turn, will mean strong export growth for those countries, thereby contributing to stronger economic growth. 

Finally, the expectation that the Federal Reserve will wait longer to ease monetary policy implies that US bond yields will remain high longer. As such, it is reported that large investors are now selling US Treasury bonds and purchasing European sovereign debt. They evidently expect that the European Central Bank (ECB) and the Bank of England (BOE) will start to cut rates sooner than the US Federal Reserve. This implies that European bond yields will decline sooner, thereby boosting the value of those bonds. As such, European bonds are becoming an attractive asset. In fact, the spread between US and German government bonds increased to the highest level since November.

Meanwhile, in the eurozone, the European Central Bank (ECB) leadership has indicated that it will follow a policy not based on what the Fed does or what happens in the United States. An ECB official said, “We are not Switzerland. We are the euro area and can operate independently without worrying about the exchange rate.” Yet, regardless of what drives its policy, the outcome will be influenced by the United States. As the Fed keeps a tight policy longer than previously anticipated, any easing of policy by the ECB will necessarily lead to further depreciation of the euro. That, of course, would be inflationary. Thus, it seems likely that the ECB will keep one eye on US events as it deliberates in the months to come.

  • Investor expectations in the United States are shifting once again, driven by a stronger-than-expected US economy and increased fears that the decline in inflation is stalling due to a tight labor market. Based on futures prices, investors are now largely expecting two Federal Reserve rate cuts in 2024, with an only 50% chance of a third rate cut. This is a significant shift from late last year when investors appeared to be confident of a significant and rapid easing of monetary policy in the United States in 2024. Moreover, after investors were more optimistic than Fed officials about the pace of monetary easing last year, they are now more pessimistic, expecting fewer rate cuts than the Fed is currently signaling. 

The shift in investor perception is largely related to the unexpected strength of the US economy and persistent core inflation. As of late last year, many people were forecasting a soft landing in 2024, with some even expecting a recession. Now many are suggesting no landing at all. Rather, they expect continued strong growth. This implies that the economy can sustain strength even with interest rates at a relatively elevated level. In other words, we could be returning to the environment that existed in the 1990s when the economy was strong and interest rates were higher than today. Also, inflation was higher. 

On the other hand, the Federal Reserve has indicated a strong desire to achieve its 2.0% inflation target, even if it means keeping rates higher for longer. If the Fed is successful in bringing inflation closer to its target, that would imply that interest rates can follow—gradually. But if the labor market remains very tight, thereby fueling accelerated inflation, one can imagine a plausible scenario in which the Fed chooses to increase rates once again. Still, I think this is unlikely. 

The counterargument to sustained tight monetary policy is that a high level of immigration combined with strong productivity growth is allowing the economy to grow more rapidly than expected, even without generating inflationary pressures. If this is true, then the Fed can comfortably ease policy without fear of igniting inflation. It is too soon to know if this is true. However, there are indications that inflationary pressures are worsening in the face of strong demand combined with a tight labor market.

Eurozone credit conditions worsen while ECB waits longer

  • Credit conditions in the eurozone worsened in the first quarter of 2024, according to the latest survey of credit conditions by the European Central Bank (ECB). The new report finds that credit conditions for both businesses and households worsened, leading to a drop in demand for credit by businesses. This does not bode well for economic activity in the months to come. It also will likely boost pressure on the ECB to loosen monetary policy soon. 

For businesses that want to borrow, credit standards in the eurozone worsened slightly in the first quarter of 2024, entirely due to a worsening in Germany. In the rest of the eurozone, credit standards for businesses remained unchanged. Meanwhile, the ECB reported a “substantial” decline in loan demand by businesses, boding poorly for investment spending in the coming months. 

Regarding credit for households, the ECB reported that, “for the first time since the fourth quarter of 2021, banks reported a moderate net easing of credit standards for loans to households for house purchase.” On the other hand, the ECB said that “credit standards for consumer credit were tightened further.” For the eurozone, there was a slight increase in demand for consumer credit, with a strong increase in Germany offset by a strong decline in France. 

  • In recent months, there has been a significant deceleration of inflation in the eurozone. In addition, demand has remained weak. Thus, there was an expectation that the European Central Bank (ECB) will soon start to cut its benchmark interest rate. That expectation remains but will have to wait another two months. Last week, the ECB chose to keep the benchmark rate unchanged at an historic high of 4.0%.

It was not a unanimous decision. According to ECB President Lagarde, a minority of committee members voted for an immediate interest rate reduction. On the other hand, Lagarde said that there was broad agreement that a rate cut will be considered at the June meeting.

The decision was not unexpected. Consequently, asset prices did not move significantly.  Interestingly, inflation in the eurozone has declined faster than in the United States. This has led investors to expect more rate cuts in 2024 in the eurozone than in the United States. Currently, investors are pricing in 75-basis points of cuts in the eurozone but less than 50-basis points in the United States. Also, Lagarde said that ECB decisions will not depend on what the US Federal Reserve chooses to do. She said that “we are data-dependent, not Fed-dependent.” She added, however, that “the ECB will probably cut first but may then move more slowly if the Fed delays cuts.”

Chinese inflation remains close to zero

  • A combination of weak demand and excess supply continues to suppress inflation in China. In every month from October to January, consumer prices fell from a year earlier. Then, in February, inflation rebounded strongly, leading to hope that the brief era of deflation was over. However, in March, consumer prices were up only 0.1% from a year earlier, leading to renewed fears of deflation.  Moreover, consumer prices fell 1.0% from February to March, the sharpest month to month decline since March 2020 when the pandemic began. 

When volatile food and energy prices are excluded, core consumer prices in China were up a modest 0.6% in March versus a year earlier. Thus, underlying inflation remains close to zero.

China is in a unique position compared to other major economies. Every other large economy continues to face relatively high inflation, although it has eased in the past year. The big question in the other countries concerns the timing of monetary policy easing. In China, on the other hand, there appears to be risk of deflation. Monetary policy has been eased, but mostly to no avail. Thus, the big question is what else the government will do to boost demand and/or reduce excess supply. So far, the government does not appear keen to boost consumer demand through fiscal measures. Rather, it wants to invest heavily in new technologies that can be exported. The problem with that strategy is that it can lead to excess capacity, especially if exports fail to rise sufficiently or face protectionist restrictions. That, in turn, will put downward pressure on prices. 

On the other hand, there are indications of a modest strengthening of the Chinese economy, as evidenced by better purchasing manager’s indices. Notably, the price of copper has hit a one-year high on expectations of increased Chinese demand. This reflects a modest revival in manufacturing, driven in part by rising US demand, and partly driven by strong growth of output of electric vehicles. China accounts for 50% to 60% of global demand for copper.

Still, Chinese producer prices continue to fall. In part, this reflects weakness of some commodity prices.  Yet, it might also reflect continued investment in boosting industrial capacity. In March, producer prices were down 2.8% from a year earlier.

Tight US jobs market demonstrates resilience of economy

  • For many months, the conventional wisdom has been that, in 2024, the economy will decelerate after breakneck growth in 2023. Yet the data released so far suggests otherwise. Last week, we learned that the job market in the United States was on fire in March after strong growth in both January and February. In the first quarter of this year, over 800,000 new jobs were created, an annual rate of over 3 million. Moreover, despite a tight labor market, wage pressure evidently eased in March. Let’s look at the numbers:

The US economy releases a monthly employment report that encompasses data from two surveys. One is a survey of establishments; the other is a survey of households.  First, let’s consider the establishment survey. In March, 303,000 new jobs were created. Plus, job growth was strong in every month since December. In fact, job growth accelerated in recent months compared to previous months. Plus, it appears that, in March, a rising share of new jobs were full time as evidenced by a rise in the average number of hours worked.

By industry, there was no change in employment in manufacturing. In addition, there was almost no growth of employment in transportation and warehousing, information, financial services, or professional and business services. Instead, the lion’s share of job growth came from construction, leisure and hospitality, healthcare and social assistance, and state and local government. Those four categories accounted for 231,000 new jobs, or 76% of new jobs created. This suggests that, despite strength, some pockets of the economy are weak.

Interestingly, despite the acceleration of employment growth in March, the number of intended job dismissals continues to rise. A survey conducted by Challenger, Grey, and Christmas found that, in March, US-based companies intended to dismiss 90,309 workers, the most in 14 months. On the other hand, this partly reflected Federal government intentions to dismiss 34,000 workers. Still, clients often ask me how I can say there is a tight labor market when so many dismissals are taking place. The answer is that there is plenty of churning in the job market, with jobs being eliminated while others are created. Moreover, the lion’s share of new job creation takes place in small- to medium-sized businesses while many dismissals take place in larger organizations. 

Also, the establishment survey provides data on wages. Average hourly wages in March were up 4.1% from a year earlier, the lowest increase since June 2021. In other words, despite a tight labor market, wage growth is decelerating. Still, wages are rising faster than inflation, providing households with an increase in purchasing power.  The deceleration in wages offers hope that wage pressure may ease sufficiently to enable a further reduction in inflation. 

The separate survey of households found that the number of people participating in the labor force increased far faster than the working age population. Consequently, the participation rate increased—although it remains below the pre-pandemic level. Moreover, the number of people working increased faster than the labor force, thereby reducing the unemployment rate from 3.9% in February to 3.8% in March.

Finally, if labor productivity continues to rise as rapidly as it did in recent quarters, inflation will likely decelerate even faster. After all, rising productivity enables companies to pay higher wages without having to raise prices commensurately. Another factor that could help to further reduce wage pressure is immigration. In fact, it is likely that the continued deceleration in wages partly reflects a high level of immigration which has boosted labor supply. Productivity and immigration will be factors that the Federal Reserve considers as it decides when to start cutting interest rates. Yet, for now, the strong job numbers suggest that the Fed can wait, that the economy can thrive with relatively high interest rates. Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, said that he had been leaning toward two rate cuts this year, but now wonders if any are needed. 

The financial market reaction to the employment report was interesting. Following the release of the jobs report, there was an increase in equity prices and an increase in bond yields, an unusual combination. On the one hand, the strong jobs report and the deceleration in wages suggest strong demand and a likelihood that interest rates will decline. These factors influenced equity traders. On the other hand, the strong job market also signaled that the Fed can probably wait longer, thereby putting upward pressure on bond yields. 

  • Meanwhile, the US job openings rate (the share of available jobs that remain unfilled) was 5.3% in February for the third consecutive month. The number of openings was up slightly from January to February. In addition, the number of hires was up significantly from January to February and the hiring rate was up from 3.6% in January to 3.7% in February. Finally, the separation rate was unchanged in February at 3.5%. Overall, this data, which comes from the government’s Job Openings and Labor Turnover Survey (JOLTS), indicates a relatively strong job market. 

The most important indicator, the job openings rate, is down considerably from its peak of 7.4% in March 2022. However, compared to the pre-pandemic period, the current rate of 5.3% is the highest ever. In the decade prior to the pandemic, the job openings rate had peaked at 4.9% in January 2019. Thus, the current job market remains historically tight. That, of course, is a concern for the Federal Reserve which worries that a tight labor market will continue to drive up wages, thereby boosting inflation for labor-intensive services. 

By industry, the highest job openings rates were in healthcare and social assistance (7.8%), financial services (6.8%), professional services (6.4%) and leisure and hospitality (6.4%). The lowest job openings rates were in wholesale trade (2.8%), retail trade (3.2%), information (3.7%), transportation/warehousing/utilities (4.0%), and manufacturing (4.3%).  

US investor perceptions are changing

The surprising strength of the US economy and higher-than-expected inflation numbers in the first two months of the year led investors to upwardly revise their expectations of inflation. One result is that the yield on the Treasury’s 10-year bond has risen to the highest level in four months. 

Meanwhile, investors have revised their expectations regarding the timing of interest rate cuts by the Federal Reserve. Until recently, investors were pricing in 75-basis points of cuts in 2024. Now, that is down to 68-basis points, indicating that a growing number of investors now expect the Fed to cut rates by a quarter point only twice this year rather than three times. 

Investors also expect the Fed to ease monetary policy more gradually than the Fed policymakers themselves have signaled through their own interest rate forecasts. For example, the futures market indicates that investors expect the Fed to hit a Federal Funds interest rate of 3.6% in 2027. The members of the Fed’s policy committee offer a median forecast of 2.6%. Thus, investors have become more cautious than the Fed policymakers. This is a change from late last year when investors were very optimistic about rapid rate cuts. 

Why have investors shifted to a view of more gradual monetary easing? First, the economy has shown more resilience than previously expected. Second, investors likely expect stronger growth going forward, in part due to optimism about labor productivity.  Productivity grew surprisingly fast in the most recent three quarters. Many investors likely expect this to continue as businesses invest furiously in labor-saving and labor-augmenting technologies. Third, investors are likely surprised at the resilience of the labor market.  Thus, they possibly expect wage pressure to be persistent even as the Fed keeps interest rates elevated. As such, they likely believe the Fed can keep rates high without damaging the economic recovery. 

As for the Fed itself, Chair Powell offered new comments at an event today at Stanford University. Regarding the recent acceleration in headline inflation, he said that “it is too soon to say whether the recent readings represent more than just a bump. We do not expect that it will be appropriate to lower our policy rate until we have greater confidence that inflation is moving sustainably down toward 2%. Given the strength of the economy and progress on inflation so far, we have time to let the incoming data guide our decisions on policy.” In other words, the Fed is evidently in no hurry to adjust policy, especially given that the economy is not at risk of a significant downturn. 

Finally, gold prices have soared lately on expectations that US inflation will be stickier and take longer to suppress. The price of gold is now at an historic high. In recent months, it has been a good investment. It tends to do well when real (inflation-adjusted) interest rates are low. With rising expectations of longer-term inflation, implied real interest rates are declining. Thus gold, which offers no return, becomes more attractive. On the other hand, it was never a good long-term investment, trailing far behind the performance of broad measures of equity prices. Plus, the price of gold is vulnerable to decisions made by gold-producing countries such as Russia and South Africa, and countries that purchase lots of gold such as China and India. 

US corporate bond market sees rise in both supply and demand

In recent months, there has been a substantial increase in the supply of corporate bonds as well as increased investor demand to hold such bonds. Here is what is happening:

First, many US companies have chosen to frontload borrowing ahead of the election. Bond issuance in the US is 40% ahead of the same period last year. In the first three months of this year, the volume of bond issuance was 40% of last year’s annual total. One possible explanation is that many companies are worried that, as the election grows closer, there could be a rise in borrowing costs related to perceived political risk.  Another explanation is that risk spreads are currently historically low. Thus, although government bond yields remain elevated compared to a few years ago, corporate bond yields are low compared to government borrowing costs. Investors might be betting that low spreads will not endure. If so, now is a good time to borrow. 

Second, there is a bull market in corporate bonds as investor purchases of such bonds have soared. Thus, as companies rapidly issue bonds, they are having no trouble finding buyers.  One explanation for investor interest is that they expect the Fed to cut interest rates later this year, leading to lower bond yields. Thus, investors seek to lock in high yields.  Moreover, if yields decline, that means that valuations will rise. 

Meanwhile, the surge in demand for bonds has resulted in a decline in risk spreads.  For example, the spread between the yields on Treasury bonds and high yield (junk) bonds is now at the lowest level in three years. In addition, the spread between yields on BBB-rated bonds and those of A-rates bonds is near a record low. This pattern, in turn, is fueling interest in issuance of bonds. 

Eurozone inflation continues to recede

The European Union (EU) has released data on inflation in the 20-member eurozone and it was good news. In March, consumer prices were up 2.4% from a year earlier, the lowest since November 2023. Prices were up 0.8% from the previous month. When volatile food and energy prices are excluded, core prices were up 2.9% from a year earlier, the lowest since February 2022. On the other hand, core prices were up 1.1% from the previous month. 

As has been true for several months, the lion’s share of inflation is in the realm of services. Prices of non-energy goods were up only 1.1% from a year earlier. Prices of energy were down 1.8% while prices of food were up 2.7%. Yet prices of services were up 4.0% from a year earlier, the same as in each of the last five months. In other words, service price inflation has stalled at an elevated level.

The problem with services is that they are labor-intensive. Moreover, Europe’s labor market remains relatively tight with wages continuing to rise at a brisk pace. So long as this is true, and so long as wage gains are not being offset by productivity gains, inflation is expected to be sticky. Thus, the European Central Bank (ECB) is keen to see the labor market weaken so as to suppress wage inflation. That is why it is currently holding interest rates at a high level. On the other hand, the ECB recognizes that the eurozone economy is weak. Thus, further tight monetary policy risks pushing the economy into recession. For the ECB, this is a balancing act. 

Currently, the conventional wisdom among investors is that the ECB will wait at least until June before cutting interest rates. By June, it will probably want to see evidence that wage pressure is easing. If not, it might choose to wait longer before cutting rates. Meanwhile, perhaps the most worrying aspect of today’s inflation report was the very big month to month increase in prices. If this persists, it will lead to an acceleration in annual inflation.  The hope is that this is simply a one-off event and will not be repeated. 

By country, inflation varied in March. From a year earlier, prices were up 2.3% in Germany, 2.4% in France, 1.3% in Italy, 3.2% in Spain, 3.1% in the Netherlands, 3.8% in Belgium, 1.7% in Ireland, and 3.4% in Greece. Keep in mind that these numbers are based on a harmonized method of measuring inflation across the eurozone. Numbers reported by individual countries might be slightly different due to differing methods of measuring inflation. 

Meanwhile, the EU also released data on the labor market. In the eurozone, the unemployment rate in March was 6.5%, the same as in every month since November. Thus, the labor market has stabilized at a relatively low level of unemployment. In fact, with the exception of November 2023, the unemployment rate has been 6.5% in every month since March 2023. Moreover, this is the lowest unemployment rate for the region since records began in 1995. 

By country, the unemployment rate in March was 3.2% in Germany, 7.4% in France, 7.5% in Italy, 11.5% in Spain, 3.7% in the Netherlands, 5.5% in Belgium, 4.2% in Ireland, and 11.0% in Greece. 

Bridge collapse near Baltimore not likely to be hugely disruptive

Last week, a very large container ship (carrying 4,700 containers) lost control and ran into the Francis Scott Key Bridge near Baltimore, causing the bridge to instantly collapse. The debris from the collapse will block transportation in and out of the port of Baltimore for at least six months if not many more. Headlines in the press have asked about the potential global impact of this disruption to an important part of the supply chain. 

The reality is that the global or even US impact will be minimal. Instead, there will likely be a moderately negative impact on the economy of the Baltimore region as well as on specific industries. The port of Baltimore is the 17th busiest in the United States, with far less activity than the larger ports in Southern California or Texas and Louisiana. Moreover, many container ships that were bound for Baltimore have already reserved space at other East Coast ports including Portsmouth, Philadelphia, and New York.

Thus, supply chains in most industries remain viable, facing only modest disruption. For the Baltimore economy, however, this is expected to be problematic for several months, rendering many port workers and those in related industries unemployed. According to the state of Maryland, the port directly and indirectly affects about 150,000 jobs in the local economy. Thus, the shutdown will likely have a significant negative impact on the local economy. Still, it is reported that the port accounts for about 0.5% of local economic activity.

There are two industries, however, that will experience more significant disruption due to the closure of the port of Baltimore. First, Baltimore is the most important venue in the United States for exporting coal, accounting for about 25% of US coal exports. The coal mainly comes from nearby states such as West Virginia, Pennsylvania, and Ohio. It is exported largely to India, China, and Europe. US coal exports account for 5.5% of global coal trade. Moreover, the port of Baltimore has specialized facilities meant to process coal exports. Thus, the shutdown of the port could have an impact on the coal industry—at least temporarily.

Second, Baltimore is the principal venue for importing cars into the United States other than across the borders with Mexico and Canada. About 750,000 automobiles arrive from Europe and Asia, accounting for 42% of port imports. It will be challenging to find alternative venues with sufficient excess capacity and specialized facilities. As such, this incident could temporarily limit the volume of cars arriving in the United States by sea. That could have a spillover effect on the automotive industries and supply chains of Germany and Japan.  

Also, the Key Bridge that collapsed was important for trucks (lorries) traveling up and down the East Coast of the United States. They will now have to be diverted, potentially causing traffic problems in the region while delaying deliveries. Finally, there will be insurance payouts for this disaster, but the amounts being discussed will not be dramatic or especially onerous for the insurance industry overall, especially compared to the payouts for such disasters as floods and hurricanes. 

Despite these specific issues, the overall economic impact of the bridge collapse is likely to be insignificant to the US and global economy. The main disruption will take place while debris is cleaned up. After that, the port can resume activity even while a replacement bridge is being constructed, which will likely take several years.

Underlying US inflation moves in the right direction

The Federal Reserve’s favorite measure of inflation, the personal consumption expenditure deflator (PCE-deflator), accelerated slightly in February, similar to the better-known consumer price index (CPI). Yet underlying inflation continues to decelerate. When volatile food and energy prices are excluded, the core PCE-deflator continued to decelerate, with core inflation hitting the lowest level in three years. Thus, despite newspaper headlines warning that inflation is rising, the reality is that underlying inflation continues to improve.  This data comes from the government’s report on personal income and personal consumption expenditures. Let’s look at the data:

First, using the PCE-deflator, headline prices were up 2.5% from a year earlier in February, up from 2.4% in January. Core prices were up 2.8% from a year earlier, the lowest in three years. Both headline and core prices were up 0.3% from the previous month. Notably, energy prices were down 2.3% from a year earlier while food prices were up only 1.3% from a year earlier. The latter is significant following a long period of sharp increases in food prices. 

From a year earlier, prices of durable goods were down 2.0% while prices of non-durable goods were up only 0.8%. The drop in prices of durables reflects an easing of supply chain disruption. Inflation was mainly due to services where prices were up 3.8% from a year earlier and up 0.3% from the previous month. Services tend to be labor-intensive, the labor market is tight with rising wages, so the Federal Reserve is mainly intent on weakening the labor market to bring inflation down to the 2.0% target. Thus, the Fed has signaled an intention to keep interest rates elevated for several more months in the hope that the labor market will weaken. The Fed’s calculus is based on the knowledge that monetary policy acts with a lag. Therefore, the actions taken in the past year are likely to have an impact in the coming months. 

However, given that shelter (housing) accounts for a large part of the services component of the price index, and given that the lagged impact of stable house prices will feed into the shelter component of the index in the coming months, there is reason to expect inflation to ease further, even absent a weakening of the labor market. That, in turn, augurs well for the Fed choosing to cut rates by June. 

Today, Fed Chair Jerome Powell said that the Fed is being criticized from both sides: by those who want higher rates, and by those who want lower rates. He said that “we are at a place where the economy is strong. The labor market is at a good place.” He added that the US is not in a recession. Moreover, he said that the Fed will take its time in deciding on a next move “because we can.” As for inflation, Powell said that the February report was “pretty much in line with expectations.” He was not alarmed that headline inflation accelerated and said that the Fed will not be “overreacting” to short term data.

Now let’s look at the income and spending data: real (inflation-adjusted) disposable personal income fell 0.1% from January to February, mainly because there was a surge in tax payments, thereby more than offsetting rising wages. Yet households chose to save less, with the personal savings rate falling from 4.1% in January to 3.6% in February. The result was that real personal consumption expenditures were up 0.4% from January to February. By category, real spending on durables was up 1.2% while real spending on non-durable goods was down 0.6%. Real spending on services was up 0.6%. The spending data bodes well for first quarter GDP growth, given that consumer spending accounts for about 70% of GDP.

After Bank of Japan raises interest rates, yen still appreciates

For many months, the Bank of Japan (BOJ) was reluctant to raise interest rates for fear that this would lead to a sharp rise in the value of the yen, thereby hurting Japan’s export competitiveness. Recently, however, the BOJ finally acted, raising its benchmark interest rate while ending the policy of yield curve control. And then, to the surprise of many, the yen depreciated. Why?

One explanation is that many investors have revised their expectations for US interest rates based on the strength of the US economy. They increasingly expect US rates to remain higher than previously anticipated, thereby putting upward pressure on the value of the dollar.   

In addition, another explanation is fear of US protectionism. That is, many investors believe that a boost to Japanese exports would only intensify protectionist sentiment in the United States, leading to new trade restrictions. Moreover, in anticipation of his race against Donald Trump, US President Biden has pivoted toward a more protectionist sentiment. The fear of protectionism will likely lead to more investment in creating capacity within the United States as a substitute for imports. This means increased demand for dollars and, consequently, upward pressure on the value of the dollar. 

Meanwhile, the yen declined last week to the lowest level against the dollar in 34 years. Now there is discussion about a potential currency market intervention by the BOJ or the government to stabilize the value of the yen. Indeed, Japan’s Finance Minister said that he would consider taking “decisive steps” to boost the value of the yen. Moreover, it is reported that leaders from the BOJ, the Finance Ministry, and the Financial Services Agency had an emergency meeting to discuss currency policy. News of the meeting contributed to a modest rebound in the yen. 

Another factor that could lead to a rise in the value of the yen would be expectations regarding future BOJ action. If investors anticipate further moves to raise interest rates, this will likely put upward pressure on the yen—all other things being equal. When the BOJ raised rates last week, it continued to state that monetary policy remains accommodative, thereby offering confusing signals for investors. 

Finally, BOJ Governor Ueda said that “currency moves are among factors that have a big impact on the economy and prices.” As such, the current weakness of the yen is a concern.  A weakening currency can add to inflationary pressure. At a time when inflation remains too high, this is problematic. Moreover, an appreciating currency can help to suppress inflationary pressure. Also, although a weak currency boosts export competitiveness, this is less important for Japan than in the past. Many Japanese products are assembled in other markets. Plus, a weak currency adds to the cost of imported commodities and inputs.

Eurozone inflation likely easing

Inflation in the eurozone appears to be receding quickly, based on preliminary data from France and Italy. If the data for the larger eurozone is consistent with these two countries, it bodes well for a decision by the European Central Bank (ECB) to start cutting interest rates soon. Here is the data:

In France, the consumer prices index was up 2.3% in March versus a year earlier.  It was the lowest annual inflation since September 2021. Prices were up 0.3% from the previous month. When volatile food and energy prices are excluded, core prices were up 2.7% from a year earlier, the lowest since March 2022. Thus, there has been significant progress on the road to the 2.0% target. 

However, as in the United States, the main problem remains inflation in services, where prices were up 3.0% from a year earlier. This is largely unchanged since the start of 2023. Thus, inflation for labor-intensive services in France has settled at an elevated level and remains persistent. This likely reflects the impact of rising wages in a tight labor market. It is this fact that most concerns the ECB leadership. In fact, ECB President Christine Lagarde recently said that “we expect services inflation, for example, to remain elevated for most of this year. So, there will be a period ahead where we need to confirm on an ongoing basis that the incoming data supports our inflation outlook.”

Meanwhile, in Italy, headline inflation accelerated slightly in March but remains below the 2.0% target. Specifically, prices were up 1.3% in March versus a year earlier, up from 0.8% in February and the highest level since October. When volatile food and energy prices are excluded, core prices in Italy were up 2.3% from a year earlier, the lowest since March 2022. Even service price inflation, at 2.9%, hit the lowest level since March 2022. Thus, Italy is in a good place with respect to inflation.

German economy faces headwinds

In Germany, there are five major economic research organizations that periodically offer a joint forecast on the German economy, published through the IFO Institute. The latest forecast predicts that, in 2024, the German economy will grow a meager 0.1%. This is down from the previous forecast of 1.3% made six months ago. It follows a 0.3% decline in real GDP in 2023. The institutes noted that domestic demand has been weaker than previously expected. Moreover, they said that German industry has suffered a loss of competitiveness due to relatively high energy prices. This, in turn, has had a negative impact on exports. 

A quarter century ago, Germany was often called the sick man of Europe. Then, under Chancellor Gerhard Schroeder, a series of labor market reforms were implemented that had a significant positive impact on productivity growth, enabling the German economy to grow at a healthy pace. Now, however, real GDP is barely higher than the level just prior to the pandemic. The IFO Institute report notes that, although employment has grown, the average number of hours worked has declined (partly due to a “sharp rise in the sickness rate”), thereby meaning no increase in hours worked. Plus, productivity of labor has stagnated.

It has been argued that, once again, Germany requires a new set of reforms to adjust to the changing global economic structure. The IFO Institute economists recommend that the so-called “debt brake,” which is a constitutional restriction on budget deficits, be eased to allow more fiscal stimulus. 

In the long term, however, Germany will need to address several issues if growth is to rebound. First, the energy transition must be expedited. Second, the economy is too dependent on energy-intensive heavy industry. Germany needs to move more quickly to becoming an information-based economy. Third, there will need to be less intrusive regulation and bureaucracy and more government investment in research and development, especially related to advanced technologies. In addition, encouraging immigration of people with specific skills could help, as has happened in Singapore and Japan.  

China’s economic strategy might face obstacles

In the past few decades, a disproportionate share of China’s economic growth came from investment in property and infrastructure. Now, the government is working to limit such investment, in part to address the issue of excess debt, and in part to address the issue of excess capacity. China’s investment as a share of GDP has far exceeded that of advanced economies as well as that of most major emerging economies. The return on this investment in terms of output has been weak. Thus, China is undergoing a transition away from investment-led growth. 

The conventional wisdom among many economists and other China watchers has been that China needs to pivot toward growth based on consumer demand. Yet that does not appear to be the policy of the government. Rather, the new policy is to boost capacity to produce advanced technologies, with the goal of exporting higher value-added products. Among the new technologies on which the government is focused are electric vehicles, autonomous vehicles, electric car batteries, semiconductors, AI-related products, and biotechnology. 

The potential problem is that China is already a very big exporter. To export more could require offering new and advanced products at very low prices. To other countries, this might be considered “dumping,” thereby leading to new restrictions on imports of Chinese products. Moreover, advanced economies like the United States and the European Union also want to boost their prowess in advanced technologies and see China as a rival, not simply a supplier. Thus, China may face difficulties in boosting exports of such products, even if they are truly competitive. Failure to boost exports could lead to excess capacity.  This raises questions as to whether China’s new strategy will lead to the faster economic growth that China desires. 

Meanwhile, household consumption in China remains below 40% of GDP, an abnormally low number compared to most other major economies. Many economists note that increasing this share to offset declining investment would be a good way to boost economic growth and improve living standards.


Ira Kalish

United States


Cover image by: Sofia Sergi