ECI and ECB

Episode Summary

Executive Summary: The episode centered on a strong but uneven global recovery and the policy response needed to sustain it. The hosts highlighted booming U.S. and Eurozone GDP, a sharp U.S. inventory drawdown, elevated but partly transitory U.S. inflation, very low Eurozone core inflation, and improving labor markets. The main debate: how the Fed and ECB handled the pandemic, how quickly they should taper QE, and when rate hikes might begin.

Main Topics: U.S. GDP and the inventory shock (Priority: 5/5): Ryan argued the 2Q U.S. GDP miss was mostly an inventory story: a huge drawdown depressed measured growth, but underlying domestic demand was strong and should support a rebound as inventories are rebuilt. Eurozone growth divergence (Priority: 4/5): Camille noted Eurozone GDP surged 2% q/q, with Italy and Spain outperforming while Germany lagged. Tourism, mobility, and country-specific composition helped narrow regional performance gaps. Inflation and labor market signals (Priority: 5/5): The panel compared U.S. core PCE inflation at 3.5% and wage growth at 3.5% with Eurozone core inflation at just 0.7%. They also discussed falling unemployment and strong labor market indicators in both regions. Fed and ECB pandemic performance (Priority: 5/5): The hosts graded the Fed very highly for rapid rate cuts, liquidity facilities, and QE, while Camille gave the ECB a lower grade due to its early communication stumble and persistent undershooting of inflation. QE, tapering, and central bank exit strategy (Priority: 5/5): The discussion covered QE as an effective crisis tool, the Fed’s new standing repo facility, and concerns about how and when to taper bond purchases without disrupting markets or asset prices. Timing of rate hikes (Priority: 4/5): Camille projected ECB rate hikes no earlier than 2024, while Ryan said the Fed’s official forecast is early 2023 but he personally expects late 2023 if Powell remains chair.

Key Arguments: The U.S. GDP shortfall was not a demand problem; it reflected a large inventory drawdown that should reverse into future growth. A widening U.S. trade deficit is consistent with strong fiscal stimulus and robust domestic demand, not necessarily a warning sign. Eurozone growth was broad but uneven: tourism-heavy countries like Italy and Spain benefited, while Germany lagged, likely due to autos and supply constraints. U.S. inflation above target is partly a reopening/base-effects phenomenon; some of it should fade as the economy normalizes. Eurozone core inflation remains far too low for comfort, so the ECB is not yet under strong pressure to tighten. The Fed handled the crisis well by acting quickly, reopening facilities, and using QE; the ECB improved after an early communication misstep but remains more constrained by its framework. Negative rates helped marginally in Europe, but the bigger issue is policy credibility and the inflation framework, not just the tools themselves. QE likely supported markets and liquidity, but some analysts overstate its role in driving asset prices; correlation is not the same as causation. The Fed’s new standing repo facility is a useful backstop that may ease future tapering and reduce liquidity stress in funding markets. The Fed is likely to begin tapering QE first, then eventually raise rates once employment and inflation are consistently closer to target.

Data Points: U.S. Q2 GDP: 6.5% annualized - Ryan discussed the first estimate, which came in below Moody’s forecast but still showed strong growth. Moody’s U.S. Q2 GDP forecast: 7.5% annualized - The model forecast was above the reported print, mainly due to the inventory surprise. Consensus U.S. Q2 GDP forecast: 8.5% annualized - The market had expected an even stronger U.S. GDP release. Change in U.S. inventories: -$166 billion - A massive drawdown that was the main reason measured GDP underperformed expectations. Eurozone Q2 GDP: 2.0% q/q - Camille highlighted unexpectedly strong Eurozone output, with notable country-level divergence. Italy Q2 GDP: Almost 3% q/q - Part of the Eurozone’s strongest performers, helped by tourism and reopening. Spain Q2 GDP: Almost 3% q/q - Another strong performer, also supported by tourism and mobility. Eurozone unemployment rate: 7.7% - Camille said the rate fell from 8.0% as labor force participation improved and employment rose. U.S. unemployment rate: 5.9% - Used as the backdrop for a discussion of the July jobs report and labor market recovery. Core PCE inflation (U.S.): 3.5% y/y - A key U.S. inflation reading discussed as elevated but partly transitory. Core CPI inflation (U.S.): About 4.5% y/y - Referenced as a CPI comparison and base-effects example. Core inflation in June 2019 to June 2021 (U.S. CPI context): Closer to 3% annualized - Used to show how weak pandemic-era base periods amplified recent inflation readings. Employment Cost Index, private workers: 3.5% y/y - Chris identified this as a strong gauge of wage growth and labor market tightness. Conference Board labor market differential: 44.2 - A very high reading indicating plentiful jobs relative to hard-to-get jobs. Initial unemployment claims: 400,000 - Chris noted claims fell by 24,000 week over week but remain elevated versus history. Continuing claims: Ticked up - A small concern noted despite the overall improvement in initial claims. 10-year Treasury yield: 1.23% - Ryan said the yield fell after the PCE data, reflecting softer inflation expectations. U.S. PCE consensus vs. actual: Consensus 0.5%-0.6% m/m; actual 0.4% m/m - The lower-than-expected core PCE print helped markets. Eurozone core inflation: 0.7% y/y - Camille emphasized this is far below the ECB’s target and inconsistent with immediate tightening. Federal Reserve asset purchases: $120 billion/month - The ongoing QE pace discussed was $80B Treasuries plus $40B MBS. Fed Treasury purchases: $80 billion/month - Part of the Fed’s monthly QE program. Fed MBS purchases: $40 billion/month - Part of the Fed’s monthly QE program. Federal infrastructure plan: $550 billion - Mentioned as part of coming fiscal support. Democratic social spending package: $2.5T-$3.5T - Discussed as additional prospective fiscal stimulus. U.S. China/Europe labor market and housing references: No exact number - Several side discussions referenced broad market conditions, travel, and asset prices. Copper price: $4.50/lb - Mark cited copper as a proxy for global demand and inflation pressure. Coffee prices: Dropped sharply - Mentioned as a recent reversal after earlier spikes tied to Brazil drought concerns. U.S. case growth: +153% over two weeks - Chris used this as his statistic of the week to highlight worsening U.S. COVID conditions. Czech Republic case growth: -26% over two weeks - Chris contrasted the U.S. with improving pandemic conditions in the Czech Republic. ECB inflation target change: 2% symmetric target - Camille referenced the ECB’s recent strategic review and target adjustment. ECB inflation projection for end-2023: 1.5% - Used to argue the ECB remains too complacent given prolonged undershooting. ECB unemployment trajectory: Around 7% or slightly below - Camille projected the euro area could return near its natural rate in coming years.

Pivotal Quotes: "The most important number of the week and may cause us to have to change our forecast for the second half of this year. Minus 166." — Ryan Sweet: On the huge U.S. inventory drawdown that distorted second-quarter GDP. "We are in a very, very different situation." — Camille Kovar: On Eurozone core inflation being only 0.7% and much weaker than the U.S. inflation narrative suggests. "There is no other grade than an A." — Ryan Sweet: His assessment of the Fed’s pandemic response, emphasizing rapid and effective crisis management.

Implications: Listeners should expect strong but uneven recovery to continue, with inventory rebuilding and fiscal support lifting growth. The Fed is likely to taper first, while the ECB remains more dovish for longer. Asset prices, inflation, and labor-market strength will keep policy debate intense.