Weekly global economic update has been saved
Cover image by: Sofia Sergi
In November, US consumer prices were up 7.1% from a year earlier, the lowest reading since December 2021. This measure of annual inflation peaked in June at 9.1% and has consistently declined ever since. Prices were up 0.1% from the previous month. Moreover, the average month-to-month price increase in the past five months was 0.2%. In the five prior months, the average was 0.9%.
When volatile food and energy prices are excluded, core prices were up 6% from a year earlier, the lowest since July. Core prices were up 0.2% from the previous month. Meanwhile, energy prices decelerated, rising only 13.1% from a year earlier and down 1.6% from the previous month.
Very notably, the price index for used cars was down 3.3% from a year earlier and down 2.9% from the previous month. In fact, used car prices fell on a monthly basis in each of the past five months. Recall that, in February of this year, used car prices were up more than 41% annually, accounting for a large share of total inflation. Prices of used cars had risen so much because of a shortage of new cars, which, in turn, was related to the global shortage of semiconductors. Now, the latter shortage is abating, helping to ease supply chain disruption and reduce inflationary pressure.
The subcategories of inflation that are not abating are mainly food and shelter. In fact, when shelter is excluded from core prices, inflation was only 5.1% in November. Many other categories, however, are improving. This includes apparel, with prices down 2.1% from a year earlier and up only 0.2% from the previous month; prescription drugs, down 0.2% from a year earlier and from the previous month; information technology commodities, down 11.5% from a year earlier and down 1.8% from the previous month; and airlines fares, down 0.6% from a year earlier and down 3% from the previous month.
Early in this episode of inflation, there was a sudden surge in the prices of durable goods, largely due to a surge in demand combined with disruption of supply chains. Demand has since abated while supply chains have improved. The result is that prices of durable goods were up only 2.4% in November versus a year earlier, and down 0.9% from the previous month. This is a far cry from the 18.7% annual increase in durables prices experienced in February.
The much-improved inflation picture was greeted warmly by investors. Equity prices were up while bond yields were down sharply. Many investors evidently expect that the better inflation result will ultimately lead the Federal Reserve to slow the pace of monetary tightening, thereby boosting growth prospects for the US economy. In other words, the probability of a soft landing has risen.
If, over the next year, inflation continues to decelerate at the same pace we have seen in the last five months, then inflation will be below 3% by the end of 2023. Of course, we have no idea whether or not this will happen. Still, it seems likely that inflation will continue to recede barring new events such as a sharp rebound in commodity prices. If inflation continues to decline, and assuming that wage inflation remains relatively steady (as has been the case for many months), then real (inflation-adjusted) wages will soon start to rise. This would be good news for consumers who have suffered a significant loss of purchasing power in the past year.
Meanwhile, the members of the Federal Open Market Committee (FOMC), which is the policy committee that decides on interest-rate policy, released their forecasts for the path of the Federal Funds rate (the so-called dot plot). Most of the FOMC members expect the rate to peak between 5% and 5.5% next year. In addition, most members expect the rate to fall by roughly 100 bps in 2024. In addition, the median forecast of FOMC members is for the PCE-deflator, the Fed’s favored measure of inflation, to be 5.6% at the end of this year and 3.1% at the end of next year. In other words, the Fed evidently expects inflation to continue decelerating at a healthy pace, likely due to the slowing of the economy combined with easing supply chain disruption and lower energy prices. Finally, Chairman Powell said he does not expect rate cuts until it is clear that inflation is declining significantly.
In addition, the ECB intends to begin reducing the size of its balance sheet. It had already stopped purchasing bonds but had left its balance sheet unchanged. Now, as part of the move toward a tighter monetary policy, the ECB will allow the balance sheet to shrink when bonds mature or will start to sell bonds. Either way, this creates the risk of a sharp rise in bond yields and bond spreads, thereby potentially creating financial instability. Still, the policy of tightening is meant to fully target inflation. The ECB said that it expects inflation to remain above the 2% target for the next three years—longer than the Federal Reserve expects inflation to remain elevated in the United States. The ECB said that “interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation.”
Meanwhile, the European Union released the latest data on inflation in the Eurozone. It appears that inflation started to recede in November, but it is too early to say if this is a trend. In fact, Ms. Lagarde has warned that inflation could rebound in 2023. She said that “there are countries where the prices have not yet passed through fully to the retail level and people have not seen the full impact yet and particularly in energy.” In any event, the EU reports that consumer prices were up 10.1% in November versus a year earlier, down from 10.6% in October. Prices were down 0.1% from the previous month. When volatile food and energy prices are excluded, core prices were up 5% from a year earlier, the same as in October. Core prices were unchanged from the previous month.
The British economy, meanwhile, is already likely in recession. In fact, the government said that the volume of retail sales (adjusted for inflation) fell 0.4% from October to November.
Meanwhile, inflation in the United Kingdom eased slightly in November, due to a deceleration in energy prices and a decline in used car prices. According to the British government, consumer prices were up 10.7% in November from a year earlier, down from an increase of 11.1% in October, which had been a 41-year high. Prices were up 0.4% from the previous month, the lowest monthly increase since January. When volatile food and energy prices are excluded, core prices were up 6.3% in November versus a year earlier, the lowest since August. Core prices were up 0.3% from the previous month. The good news was partially offset by continued and accelerating inflation for food. In fact, food prices were up at the fastest pace since 1977.
It is too early to say this is a trend. Moreover, inflation remains ruinously high, much higher than the rise in wages. Indeed, in the three months ending in October, average weekly earnings (including bonuses) were up 6.1% from a year earlier. As such, households continue to experience a sharp decline in real purchasing power.
Meanwhile, Chinese industrial production was up a modest 2.2% in November versus a year earlier, the slowest increase since May 2022. This weakness was also due to COVID-19 restrictions and troubles in the property market. Output of electricity and communications were down while output from mining and production of raw materials was up sharply.
Finally, Chinese fixed asset investment in the first eleven months of 2022 was up a modest 5.3% from the same period in 2021. Investment in property fell sharply in line with troubles in the residential market. Investment in infrastructure accelerated as government entities sought to stimulate the economy. Investment in manufacturing decelerated.
Now that the government is rapidly easing COVID-19–related restrictions, it will be interesting to see if this has a positive impact on economic data in the months to come. Data could be poor initially due to a sudden increase in infections. However, in the longer term, the easing of restrictions might have a positive impact on growth.
Meanwhile, the Chinese government announced that it will take steps to boost domestic demand and open the economy. It intends to create a “gravitational field of high-end international resources.” It said that the plan is meant to offset the impact of “unilateralism,” “protectionism,” and “bullying.” A government spokesman said that stimulation of domestic demand and integration into the global economy are related. He said that, if China’s domestic market reaches a critical size, then other countries will be dependent on China and less likely to take hostile actions against China. That is, China will have a gravitational field that will pull in external players.
Meanwhile, the chip industry is on the verge of a potential new diversification. For example, Indian conglomerate Tata now says that it intends to make a massive investment in producing semiconductors, likely in collaboration with an existing company from Japan, Taiwan, South Korea, or the United States. Tata’s chairman said that the company will “look into the possibility of eventually launching an upstream chip fabrication platform.” That is, it might start with assembly but later move toward the more complex process of fabrication. If successful, this could potentially be a game-changer for the industry, driving further diversification away from East Asia. It could make India a player in this key industry. It is already a major player in software and technology services.
Meanwhile, one of the world’s largest and most important fabricators of semiconductors, Taiwan Semiconductor Manufacturing Company (TSMC), is boosting its investment in a fabrication factory in Arizona, with plans to spend US$40 billion. This will contribute to a sizable increase in US capacity. In addition, a major US-based chip manufacturer is investing in semiconductor facilities in Ohio, with an initial investment of US$20 billion possibly being boosted to US$100 billion. These investments were driven, in part, by the US CHIPS Act, which provides financial incentives.
Not everyone is pleased with the direction of things. This includes the founder of TSMC, Morris Chang. He warned that “globalization is almost dead and free trade is almost dead. A lot of people still wish they would come back, but I don’t think they will be back.” Chang, like others, is concerned that the troubled relationship between China and the West will lead to a technological decoupling. This, in turn, could stifle innovation, boost costs, and reduce productivity growth. He could be right about the direction of the semiconductor industry. However, my view is that globalization in the broader economy will likely continue.
On the other hand, supporters believe that diversification enables the business world to effectively purchase an insurance policy against geopolitical risk. The CEO of a leading US-based tech company said that “the entire semiconductor ecosystem is ready to step up and work together. The industry has been through so much in the past few years. Having more geographically diversified capacity is so important. At the end of the day, what we want to do is ensure that our most important chips have a resilient supply chain.” Currently, about 90% of the world’s most sophisticated chips are made in one factory in Taiwan. That kind of concentration, while contributing to low costs and high efficiency, creates risk.
Finally, supporters of diversification worry that the pace of change is insufficient, in part because they believe that the government incentives are too small. Critics have said that the US CHIPS Act, as big as it is, might not be big enough to truly transform the industry. Meanwhile, critics say that such industrial policy goes against the efficiency goals of a truly market-based economy.
The decline in exports likely reflected weakening global demand as well as the disruptive effect on production and distribution stemming from pandemic-related restrictions. Indeed, shipments of smartphones were down 25% from a year earlier, having been disrupted by lockdowns at key factories. The drop in imports, much of which includes inputs used by manufacturers to assemble exportable products, likely reflected the weakness of exports as well as weak domestic demand stemming from COVID-19 restrictions. Notably, the volume of semiconductors imported fell by more than 30% from a year earlier. This might also have been influenced by new US restrictions. The weakening of trade meant reduced demand for shipping services. The result was that the cost of shipping containers from China to the United States fell 21% from October to November.
The trade data, as well as recent purchasing managers’ indices, suggest that the economic cost of the COVID-19 restrictions is substantial. Moreover, recent protests in multiple Chinese cities indicate that citizens are becoming frustrated in a way not seen in decades. Thus, China’s government announced that restrictions are being eased. Notably, home quarantining will now be permitted, rather than sending people to centralized quarantine facilities. In addition, people will not have to show proof of negative tests before being permitted to enter public facilities.
Moreover, the government appeared to shift away from an all-out assault on the pandemic toward a more nuanced approach that recognizes the importance of economic stabilization. The new measures do not mean a complete end to all restrictions. Rather, they represent a move in a new direction. A lessening of restrictions on mobility will likely boost consumer spending, which has been stifled. That is important, especially given the weakness of the global economy. A renewal of domestic demand can help to offset negative external influences.
Advanced economies tend to have higher levels of debt, but China’s is still relatively high. For example, the debt-to-GDP ratio is 264% in the United States, 257% in the United Kingdom, 263% in the Eurozone, and 426% in Japan. Thus, China has one of the highest ratios in the world. Moreover, while China’s debt-to-GDP ratio has risen since 2020, many other countries have seen a substantial decline since 2020, including the United States, the United Kingdom, and Eurozone.
The good news is that most of China’s debt is not external debt. That is, there is no currency risk associated with the debt. It is mostly a case of Chinese households, businesses, or government entities owing to other Chinese. Still, high levels of debt can be challenging to service if economic growth is not strong. Given China’s declining working-age population, rising number of elderly citizens, struggling property market, and an economy distorted by excessive reliance on investment and exports, the current level of debt could become a problem. It might limit the ability to fund pensions and health care, continue infrastructure investment, and resolve property-market imbalances.
The BIS says that the main culprit for the recent sharp rise in debt is government borrowing. Since 2020, the volume of debt owed by consumers and businesses is down. Instead, the increase in debt was due to the government. This partly reflected the cost of dealing with the pandemic and the cost of stabilizing the economy by investing in infrastructure. In addition, although lending to the private sector has been weak, lending to state-owned enterprises has recently grown strongly.
The deceleration of inflation, despite easy monetary policy, reflects two major factors. These are a decline in global commodity prices, including energy prices, in recent months. In addition, China’s domestic economy has been weakened by pandemic-related restrictions, which reduced domestic demand, thereby limiting price increase.
With the government now simultaneously reducing pandemic-related restrictions and easing monetary and fiscal policy, the hope is that growth will accelerate in 2023. With inflation still very low, the central bank has plenty of room to engage in aggressive policy in the months to come.
However, the Japanese government is now pursuing a fiscal policy meant to stifle inflation by providing subsidies that stabilize energy prices. This policy is meant to cut 1.2 percentage points from inflation. Japanese Prime Minister Kishida said that “we will do our best to ensure that Japanese people will benefit from our efforts, including cutting electricity prices, as soon as possible.” This will involve more than US$200 billion in subsidies. Also, 10 Japanese electric utility companies have already applied for rate decreases.
In any event, inflation has risen sharply. In October, consumer prices were up 3.7% from a year earlier, the biggest increase since January 1991. Core consumer prices were up 3.6%, the highest since February 1982. Consumer prices were up 0.6% from the previous month, an unusually high increase.
One of the factors that had held back inflation in the past several decades was the expectation that inflation would remain low. This affected the behavior of market participants in ways that reinforced low inflation. Businesses were reluctant to raise prices because consumers expected stable prices. Workers were satisfied with stable wages because prices were not rising. Yet now, with inflation becoming a factor in daily life, expectations of inflation are changing, which could lead to changes in labor-market behavior. BOJ Governor Kuroda has said that “monetary policy will become more effective as deflationary expectations weaken. Working on expectations will be very important when engaging in quantitative easing and making short-term interest rates zero.”
With inflation now significant, the question is whether the BOJ will continue with its easy monetary policy. Given that the government is attempting to cool the inflationary impact of high energy prices, it might put pressure on the BOJ to shift policy. Yet a shift would mean a tightening of policy that could potentially have a negative impact on growth. In addition, it could strengthen the value of the yen. That, in turn, would be disinflationary and would help to ease the cost of imported commodities. But it would also potentially hurt the competitiveness of Japanese exports.
Here is what we know so far. In June, the EU pledged that, by December 5 (last week), it would ban imports of Russian oil sent by ship (which accounts for about 40% of Russian oil exports) unless the oil is priced below a cap of US$60 per barrel. In addition, the EU is banning European companies from shipping Russian oil to non-EU buyers, as well as providing insurance for such shipments, unless the oil is priced below a cap of US$60 per barrel (the current market price is roughly US$85 per barrel). This would allow oil to flow but would limit the revenue that Russia would accrue. However, given that the price cap would be above Russia’s cost of production, Russia will still have an incentive to continue producing. Some countries, such as Poland and Ukraine, have objected to the US$60 cap saying it is too high and allows Russia to receive too much revenue. The EU hopes that this policy will help to ease inflationary pressures in Europe while also hurting Russia’s ability to wage war. Since the war began, EU consumption of Russian oil has fallen sharply but Russian revenue from oil has been relatively steady.
Meanwhile, Russia has said that it will not accept the price cap and will not sell oil below the market price. It has started to amass a fleet of oil tankers meant to distribute oil without the help of European shippers or insurers. However, it remains unclear if this will have any impact. After all, Russian oil exports to Europe are already down sharply. This has partly been offset by increased shipments to other countries such as China and India, but often at a discount. Recent oil-price volatility reflects uncertainty about whether the new EU policy will suppress or boost oil prices.
Also, several events are adding to uncertainty. For example, Japan announced that it will impose a US$60 per barrel cap on the price it pays for Russian oil, aligning with the EU, G7, and Australia. Also, the Organization of the Petroleum Exporting Countries announced that it is prepared to take “immediate” action to offset the impact of EU actions if prices start to decline. In any event, it will take some time to determine the net impact of the new EU policy. Furthermore, it will be hard to identify the impact on oil prices from the EU policy given that other factors, such as the state of global demand, will also drive prices.
Meanwhile, other Fed leaders have said that the cost of not tightening remains higher than the cost of tightening. Fed Vice Chairman Lael Brainard said as much recently. In addition, Loretta Mester, president of the Federal Reserve Bank of Cleveland, said that “to be so far away from price stability really distorts investment decisions and peoples’ investments in their own education, and that has implications for the long-run health of the economy. If we allow inflation to continue at high levels, inflation expectations could start moving up again in the long-run horizon. And that would then raise the cost of getting back to price stability.” She placed considerable emphasis on the Fed’s role in anchoring expectations of inflation. This is important because, if expectations get out of hand, it can lead to changes in behavior that exacerbate inflation. Thus, Mester’s view appears to be that there is greater risk in pausing and avoiding recession than in continuing to tighten and causing a recession.
This viewpoint is not unique to the Federal Reserve. Christine Lagarde, president of the European Central Bank (ECB), said that the ECB is “not done” raising interest rates and that high inflation “still has a way to go.” Although eurozone inflation has not evidently peaked, there is hope that this might happen soon given a sharp decline in natural gas prices and evidence of easing supply chain difficulties. Yet Lagarde is clearly not yet moved by these events. She said that, although the ECB has already raised interest rates rapidly, they remain too low. Specifically, she said that current monetary policy remains accommodative and that only further rate hikes will likely suppress aggregate demand in the economy. That is because rates remain historically low. In addition, she noted that, although spot gas prices have fallen sharply, prices on futures markets have not. Thus, energy disruption remains a risk.
First, a look at the employment report. There are two reports; one based on a survey of establishments, the other based on a survey of households. The establishment survey found that 263,000 new jobs were created in November, less than the 284,000 created in October, but still a healthy pace of expansion. Employment is up 3.2% from a year earlier. Most of the job growth was in services. Yet some services sectors experienced a loss of jobs. This included retail (especially department stores) as well as transportation and warehousing. Our own sector of professional and business services had very modest job growth. There was strong growth for leisure and hospitality, healthcare, and government.
The report also found that average hourly earnings for all workers were up 5.1% in November versus a year earlier, the second slowest pace of increase since 2021. This affirms that, although the labor market remains unusually tight (as evidenced by a high vacancy rate—see below), it is not generating an acceleration in wages that could be inflationary. On the contrary, annual wage gains are decelerating and remain well below inflation. On the other hand, wages were up 0.6% from the previous month, the strongest monthly gain since January 2022. This contradictory data suggests caution in interpretation.
Meanwhile, the government released its Job Openings and Labor Turnover Survey (JOLTS) for October. It found that the number of job openings fell from 10.687 million in September to 10.334 million in October. The vacancy rate (the share of available jobs not being filled) fell from 6.5% in October to 6.3% in November. The number and rate of vacancies is down sharply from a year ago, but both remain very high compared to recent history. Thus, the job market remains historically tight, but does show signs of easing.
The vacancy rates fell sharply for manufacturing, professional and business services, and for the Federal government. The vacancy rate increased for mining, wholesale trade, retail trade, and financial services while it remained unchanged for restaurants and hotels.
The separate survey of households, which includes self-employment, found that the size of the labor force declined modestly in November and that total employment declined as well. The unemployment rate remained unchanged at 3.7%, one of the lowest rates in the last half century.
Next, let’s look at the data on income and spending. In October, real disposable personal income increased 0.4% from the previous month. In addition, the household savings rate fell from 2.4% in September to 2.3% in October. The result was that real consumer expenditures increased 0.5% in October versus the previous month. Notably, this included a 2.7% increase in spending on durable goods, a 0.3% increase for nondurables, and a 0.2% increase for services.
The government also reported data on the Federal Reserve’s favorite measure of inflation, the personal consumption expenditure deflator, or PCE deflator. This measure was up 6.0% in October versus a year earlier, the lowest annual rate since December 2021. Prices were up 0.3% from the previous month. Excluding volatile food and energy prices, core prices were up 5.0% in October versus a year earlier, down from 5.2% the previous month. Core prices were up 0.2% from the previous month. This is consistent with data from the consumer price index which also indicates an easing of inflation. It is probably safe to say that inflation in the United States has already peaked.
The favorable data on jobs as well as income and spending means that the likelihood of an imminent recession for the United States has eased. Modest wage gains, combined with improvement in headline and core inflation in October, bode well for an easing of the pace of monetary tightening. Indeed, Fed Chairman Powell said last week that monetary tightening could be reduced soon. Specifically, he said that “it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.” On the other hand, he said that to defeat inflation, the Fed will need to keep rates at an elevated level “for some time.” Thus, the Fed is not about to reverse policy. Rather, Powell evidently feels that, given the trajectory of inflation, the Fed has probably gone almost far enough.
In response to Powell’s comments and recent economic data, bond yields in the United States have been declining. In fact, the yield on the 10-year Treasury bond is currently at the lowest level since mid-September, or roughly 3.5%. Recall that the 10-year yield had reached 4.27% as recently as the first week in November. In part, the decline in bond yields reflects a decline in investor expectations of inflation as indicated by the so-called breakeven rate. Investors evidently feel confident that inflation will come down quickly. The 10-year breakeven rate is now 2.36%. This means investors believe that inflation will average 2.36% over the coming decade, close to the Fed’s target and well below the current rate of inflation.
Here are the numbers: the EU reports that, in November, consumer prices in the eurozone were up 10.0% from a year earlier, down from 10.6% in October. Prices were down 0.1% from the previous month, the first such decline since July 2021. The easing of inflation was entirely due to a deceleration in energy prices. Still, in November, energy prices were up 34.9% from a year earlier.
Meanwhile, excluding volatile food and energy prices, core prices were up 5.0% from a year earlier, the same as in October following many months of acceleration.
In addition, inflation decelerated in November in many important European countries. This included Belgium, Germany, Ireland, Greece, Austria, Portugal, and the Netherlands. Inflation remained stable in France and Greece but accelerated in Finland. The deceleration of inflation in Spain was especially pronounced, but core inflation in Spain accelerated.
Despite early evidence of a possible easing of eurozone inflation, the ECB remains committed to further tightening of monetary policy. Christine Lagarde, president of the ECB, is not yet ready to declare that inflation has peaked and worries that an inflationary psychology is taking hold. Moreover, she worries that the recent improvement due to a drop in energy prices could easily reverse. Still, investors evidently interpreted the news as boding a slightly less onerous tightening of monetary policy.
Meanwhile, although the eurozone economy has decelerated and will likely soon slip into recession (if it hasn’t already), there are favorable factors that are limiting the damage to the regional economy. These include large government expenditures on energy subsidies for households and businesses and a greater-than-expected decline in energy prices.
The global manufacturing PMI from Markit fell from 49.4 in October to 48.8 in November, indicating a sharper decline in activity. This was the lowest number in 29 months and the third consecutive month in which activity declined. The worsening of the number in November was largely due to a sharp drop in the United States and Japan. Both countries went from growth in October to decline in November.
Of the 30 countries polled by Markit, all but six had PMIs below 50, indicating declining activity. The six countries with above-50 PMIs were, in order, India, Russia, Kazakhstan, Australia, Thailand, Mexico, and Indonesia. The lowest PMIs belonged to Czech Republic, Taiwan, Poland, and Brazil. With the exception of India, all major countries indicated declining activity, although some saw a higher PMI than in October, indicating slower decline. The PMIs were 47.7 for the United States, 46.5 for the United Kingdom, 47.1 for the eurozone, 49.4 for China, 49.0 for Japan, and 41.6 for Taiwan. On the other hand, the PMI for ASEAN was 50.7, entirely due to growth in Thailand and Indonesia. All other ASEAN countries experienced decline, especially Myanmar.
Markit commented that “the decline in output was accompanied by a tick down in new orders as rising inventories have put the brakes on production. There was some positive news on the price front, however, as price pressures continued to ease. The delivery times index also improved, consistent with the signal from high frequency shipping cost indicators that show supply chain conditions normalizing.”
Cover image by: Sofia Sergi