Ian Shepherdson Chief Economist Pantheon Macroeconomics September 11, 2015 How will the ECB respond...

Ian ShepherdsonChief EconomistPantheon MacroeconomicsSeptember 11, 2015

How will the ECB respond to Fed tightening?

U.S. Rates and Europe:

1. Can the Fed hike when industry is weak?

2. First came the hit from collapsing oil capex…

3. …And now the strong dollar is biting, hard

4. …China’s slowdown is beginning to hurt too

5. But China’s economy is not in meltdown…

6. …Stock market lunacy did not infect manufacturing

7. U.S. Consumers, meanwhile, are awash with cash…

8. …Don’t be misled by “weak” nominal retail sales

9. Auto sales are booming

10. The housing market is recovering strongly…

11. …And non-residential construction is soaring

12. The contrast between industry and the rest is huge

13. Most people don’t work in manufacturing…

14. …And most companies don’t export anything

15. Those which do, sell more to Europe than China…

16. Unemployment is now too low for the Fed’s comfort

17. …And it hasn’t stopped falling yet

18. Even broad rate is heading for previous hike levels

19. Hourly earnings are weak; better wage data are not

20. Core inflation today is not the problem

21. Some goods prices are falling; CPI is mostly services

22. Rents likely will accelerate much further

23. Some goods prices are immune to the strong dollar

24. And Obamacare won’t depress medical costs forever

25. A small rise in rates won’t kill the U.S. economy…

26. …But the legacy of the credit boom lingers

27. Corporates also can’t cope with prior rate peaks…

28. …Gross corporate leverage remains extremely high

29. Europe is enjoying a sustainable cyclical upswing

30. Performance is uneven but rising tides lift all boats

31. Structural problems remain severe…

32. …But parts of the periphery have made great strides

33. …And their sacrifices are paying off…

34. …Though from a very depressed base

35. But the French labour market remains sclerotic

36. Deflation risks are fading…

37. …But the recovery is still fragile

38. So the ECB won’t be following the Fed

39. EZ yields will be pulled by the U.S., but not as far…

40. …So the Euro will weaken further

40. The Great U.S. Normalization is Coming

• U.S. interest rates will soon start to rise; eventually, the Fed will have to move even if markets are volatile.

• The labor market is tightening rapidly – much faster than the Fed expected – and core inflation and wages are set to rise.

• Europe still has a business cycle, and the core Eurozone will surprise to the upside next year.

• The ECB will not follow the Fed, so the euro will weaken deflation fears will fade, and long-term rates will rise.