For some time there has been a very large gap between the euro economic surprise index and the US economic surprise index. This reflects the euro area data consistently beating expectations in early 2015 whereas the opposite has been the case in the US where data have disappointed. However, the surprise gap has started to narrow and we expect this trend to continue over the coming months.
In the case of the euro area, we have already seen the surprise index come down this week as data on German ZEW, euro consumer confidence and Euro Flash PMI undershot expectations, breaking the long string of upward surprises. We see two factors behind this. First, expectations have been raised for economic data making it harder to beat. Second, euro area surveys have now reached quite high levels making it harder to deliver further increases, especially as GDP growth probably peaked in Q1 when the economic tailwind was at its maximum.
The positive growth impulse of the substantial oil price decline was greatest in Q1 and is fading from here as oil prices (in euro) have now reversed half of their decline. The Brent oil price dropped from EUR80/barrel last summer to EUR40/barrel in January. It has since increased to EUR60/barrel. This is likely to dampen private consumption growth in coming quarters from the current elevated levels.
While we still expect robust growth in the euro area driven by substantial euro weakness, low bond yields, easing credit and recovery in US and China, we believe the majority of upward surprises on the euro data front is now behind us. We still look for upward revisions to consensus euro area growth, but mainly because this tends to lack surprises.
When it comes to the US we look for the surprise index to climb higher from the very negative levels currently. While it was to some extent expected by us that US manufacturing would face headwinds in Q1 from the stronger USD and the hit to the energy sector, the real disappointment has been in private consumption. Consumers failed to raise spending in Q1 in response to the decline in gasoline prices, robust employment growth and continued significant wealth gains. However, we believe this consumer softness is temporary due to: (1) pay-back from very high spending last year, (2) negative effects from unusually bad weather over the winter and (3) the above-mentioned strong consumer fundamentals. Looking ahead we expect consumption growth to rise, driving a US recovery in the coming quarters and delivering fewer negative data surprises.
It would also underpin a further widening of the spread between US and German bond yields. US yields should see upward pressure from the Fed hike closing in, whereas a decline in the euro surprise index would reduce speculation that the ECB will start an exit of the QE program earlier than currently scheduled.
Finally, a closing of the surprise gap would mean that there will be less cyclical tailwinds to the outperformance of euro stocks versus US stocks. Of course relative monetary policy (ECB QE vs. Fed hikes) should still support European assets versus US assets. But the sweet spot for euro equity outperformance seen in Q1, driven by the very large ECB QE program and consistent positive data surprises, will probably not be as sweet going forward.
The bottom line is that inflation and wage developments are underpinning a rate hike in the June-September window and we still see September as the most likely time for liftoff. What will be important is how growth and the labour market develop in coming months. A recovery in US growth and continued decent job gains would pave the way for the first rate hike.
In the case of the euro area, we have already seen the surprise index come down this week as data on German ZEW, euro consumer confidence and Euro Flash PMI undershot expectations, breaking the long string of upward surprises. We see two factors behind this. First, expectations have been raised for economic data making it harder to beat. Second, euro area surveys have now reached quite high levels making it harder to deliver further increases, especially as GDP growth probably peaked in Q1 when the economic tailwind was at its maximum.
The positive growth impulse of the substantial oil price decline was greatest in Q1 and is fading from here as oil prices (in euro) have now reversed half of their decline. The Brent oil price dropped from EUR80/barrel last summer to EUR40/barrel in January. It has since increased to EUR60/barrel. This is likely to dampen private consumption growth in coming quarters from the current elevated levels.
While we still expect robust growth in the euro area driven by substantial euro weakness, low bond yields, easing credit and recovery in US and China, we believe the majority of upward surprises on the euro data front is now behind us. We still look for upward revisions to consensus euro area growth, but mainly because this tends to lack surprises.
When it comes to the US we look for the surprise index to climb higher from the very negative levels currently. While it was to some extent expected by us that US manufacturing would face headwinds in Q1 from the stronger USD and the hit to the energy sector, the real disappointment has been in private consumption. Consumers failed to raise spending in Q1 in response to the decline in gasoline prices, robust employment growth and continued significant wealth gains. However, we believe this consumer softness is temporary due to: (1) pay-back from very high spending last year, (2) negative effects from unusually bad weather over the winter and (3) the above-mentioned strong consumer fundamentals. Looking ahead we expect consumption growth to rise, driving a US recovery in the coming quarters and delivering fewer negative data surprises.
Closing of the surprise gap to have impact on financial markets
As the surprise gap closes this should give more impetus to a lower EUR/USD. A gradual strengthening of US data would raise expectations of Fed lift-off in September - 3-4 months earlier than the market is currently pricing in.It would also underpin a further widening of the spread between US and German bond yields. US yields should see upward pressure from the Fed hike closing in, whereas a decline in the euro surprise index would reduce speculation that the ECB will start an exit of the QE program earlier than currently scheduled.
Finally, a closing of the surprise gap would mean that there will be less cyclical tailwinds to the outperformance of euro stocks versus US stocks. Of course relative monetary policy (ECB QE vs. Fed hikes) should still support European assets versus US assets. But the sweet spot for euro equity outperformance seen in Q1, driven by the very large ECB QE program and consistent positive data surprises, will probably not be as sweet going forward.
Higher US core inflation adding to Fed confidence
The recent data on US core inflation surprised to the upside as short term momentum (3-month change) has moved quite a bit higher. This is quite important because one of the conditions that the Fed has outlined for ‘lift-off’ is that it is ‘reasonably confident that inflation will move back to its 2 percent objective over the medium term’. This week FOMC vice chairman William Dudley stated that ‘most of the impact from the decline in energy prices that has weighed down overall inflation is likely over’ and that ‘the level of slack in the labour market has diminished sufficiently so that one might expect firmer wage gains going forward’. Last week the Fed vice chairman Stanley Fischer said that he saw signs of a pick-up in US wage growth.The bottom line is that inflation and wage developments are underpinning a rate hike in the June-September window and we still see September as the most likely time for liftoff. What will be important is how growth and the labour market develop in coming months. A recovery in US growth and continued decent job gains would pave the way for the first rate hike.
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