Recent developments remind us that policy actions will have consequences and that political actors remain difficult to predict. Such uncertainties will exacerbate the usual late-cycle volatility: this is not the time to relax.
1. In the U.S., recent housing data reminds us that monetary tightening will not be entirely pain free.
Forecasts must avoid the trap of assuming that the current economic backdrop will continue indefinitely: things change. So, while repeated Fed rates have so far had little impact on overall U.S. economic growth, one should not assume this in future. In fact, this week’s timely National Association of Home Builders (NAHB) data, discussed on page 2, suggest that higher U.S. mortgage rates are already having an impact on consumer behaviour, despite average hourly earnings trending higher. This is of course what conventional economic theory teaches us – it is just that, after nearly a decade of unconventional monetary policy, we may need reminding that the usual rules still apply.
2. In Italy, markets may soon grow less relaxed about the Italy vs. European Commission budget showdown.
Forecasts are also obviously vulnerable to political actors, whose behaviour may be more difficult to predict than policy makers. One danger is that, while it can be difficult to decipher political machinations, lack of obvious direction does not equate to a lack of danger. So, while the market’s relaxed response to initial steps by the European Commission to the launch an excessive deficit procedure against Italy is understandable, the risk of an escalation in yields remains a real one.
3. And do not assume that the EU Council meeting this weekend will wrap up the Brexit debate: it can’t.
Brexit developments provide a powerful example of how markets can struggle to keep abreast of difficult-to-predict, essentially political, developments. GBP has reacted strongly to the high political drama around the passage of draft EU legislation through the UK government’s cabinet and subsequent excitements. So the temptation may now be to assume a smooth progression of these proposals through Sunday’s EU Council Meeting and then the UK parliament. The outwards signs appear reassuring: the UK government has now agreed a broad-brush “political declaration” with the EU and Mrs. May has been busy talking to other European leaders to ensure support for the proposed package. But, even assuming that the Sunday meeting goes according to plan (not guaranteed), complacency is not advised. In many ways, the “political declaration” is vaguer than documents that have preceded it (e.g. the Chequers plan) and the UK parliamentary vote remains a significant hurdle to overcome, even though MPs may be sorely tempted for this deal rather than risk a “no deal” alternative. The actions of the main opposition Labour Party also remain difficult to predict. So stay on your toes.
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