Overview of the week commencing 29 May
Graham Cross, CEO
This week, we look at German business sentiment and US Federal Reserve minutes.
The CES ifo Business Climate index rose in May to 114.6. According to the CES ifo Group ‘the mood among German business was euphoric’. Confidence stands at the highest level recorded in a survey series that began back in 1991.
An improving economic outlook has coincided with much reduced political uncertainty. (The betting markets attach an 85 percent probability that Angela Merkel will remain in her post come the election in September).
Indeed, such ‘unwavering optimism’ is indicative of ‘brisk economic activity’ during the second quarter. So much so that the current index level is consistent with growth in the region of 0.6 percent during Q2, matching the estimate for growth in Q1. That would likely put Germany among the fastest growing major developed market nations.
There is nothing in the Fed meeting notes to suggest that a June rate rise is anything but ‘very likely’. We are in step with a market-implied 83 percent likelihood, up from 74 percent before the minutes were published.
As it stands, we are happy to commit to a baseline forecast that sees tighter monetary conditions in June, in September and then again in December. Small rate rises will settle the June and September accounts. December’s tightening will be different. That one, we think, will take the form of a shift toward a more ‘normalised balance sheet’. The Federal Reserve has around $2.5 trillion of treasury bonds on it’s balance sheet, originally purchased in three rounds of ‘quantitative easing’. At present, the Fed rolls the proceeds from maturing bonds into more purchases to keep the total stable. Come December, we may see a cap on the level of reinvestments the Fed instructs, thus beginning a wind-down of sorts.
Assuming that the US economy recovers from it’s Q1 wobble, higher long term interest rates are on the way.
In the UK, if 0.3 percent wasn’t bad enough, the Office for National Statistics’ second estimate for Q1 growth comes in at 0.2 percent. A downward revision is owed to conditions which were weaker-than-expected in the services sector; particularly in retail and accommodation. Unhappily, we are more and more convinced that the UK economy is in for a rough ride this year.