Still waiting for the US cavalry

Key points

  • As the US labour market is stalling, a new layer of fiscal stimulus is urgently needed. We are still waiting.
  • In the Euro area deflationary risks are getting more material. Christine Lagarde’s speech last week was dovish, very much in the Draghi tradition, but there was no “bridge” to current challenges hinting at imminent decisions. We expect PEPP to be extended in December.

The Payroll data for September confirmed that the recovery of the US labour market is stalling. The fact that employment failed to grow outside the hospitality sector suggests the difficulties go well beyond the direct impact of Covid-fighting restrictions. Labour income is also likely to stall and this is less and less offset by government transfers. The equity market rebounded last week on expectations of a deal between Democrats and Republicans in Congress on a new stimulus package which failed to materialize. The news of Donald  Trump’s illness, adding an extra layer of anxiety, may focus minds and negotiations are continuing, but the US economy is entering Q4 with little support. Beyond the immediate challenges, we explore the chances of accommodative fiscal policies after the elections. In our view a Biden victory would raise those odds, given a high probability for the Democrats to retain their majority in the House and the former VP’s strong track record on reaching across the aisle to cut bi-partisan deals if the Republicans retain control of the Senate.
In the Euro area, focus is on deflation risks. The year-on-year change in consumer prices was negative in September for a second month in a row. There were some one-offs pushing prices down, but the trend is clear. Crucially, the balance of opinion on future price trends is now one standard deviation below its long-term average for households as well as for businesses. We are also concerned with the high preference for saving expressed in the confidence surveys. There could be a self-fulfilling mechanism settling in: precautionary saving, fuelled by a deteriorated labour market outlook, restricts consumption which depresses consumer prices further, in turn validating the preference for saving since it becomes rational to postpone spending.
In such an environment, the signals from central banks are crucial. Christine Lagarde last week shed some light on the ECB’S strategy review. We were reassured to see that Draghi’s intellectual legacy lives on. All the central tenets of his macroeconomic approach were well defended in her speech. The “new Keynesian” conversion of the ECB is alive and well. However, what was lacking was a “bridge” to the current challenges, a sense of urgency. There is an aspect of “draghism” which seems to be missing in the new ECB: a readiness to “push” the Governing Council into bold decisions before a wide consensus is reached.  We expect PEPP to be extended in December, but a more permanent shift in the ECB arsenal is difficult before the strategy review concludes.

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