Daily Economic Briefing: February 18, 2010

Daily Economic Briefing: February 18, 2010

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Page 1: Global data summary
• The Fed raised the discount rate from 1/2% to 3/4%. The move was advertised in advance and the accompanying statement took pains to say that the action did not signal any change in the outlook for the economy or monetary policy.

• US initial jobless claims jumped 31,000 to 473,000, returning to a level that our models suggest is consistent with little or no job growth. The volatility of weekly claims is frustrating our ability to discern whether companies are transitioning to positive net hiring as forecast. It is possible that the East Coast snowstorms pushed up claims but the Labor Department said that no state cited weather as a factor.

• The February Philly Fed manufacturing sector was positive, with the ISM-weighted composite rising from 52.5 to 55.1. This survey recently has tracked the national ISM survey better than the NY survey, which dipped on a composite basis. On balance, the surveys depict a manufacturing sector that continues to deliver strong gains in output, and this is encouraging (or compelling) companies to boost hiring, inventories, and capex. A similar phenomenon is playing out across much of the globe. We continue to expect robust global IP growth of about 7% annualized in 1H10.

• Canada’s headline inflation rate rose to 1.9%oya while its measure of core reached 2.0%. With inflation near the 2% target and the economy recovering, we look for the BoC to begin raising rates in July. Sweden’s CPI bucked the trend of rising headline (due to positive base effects from energy), easing from 0.9% to 0.6% on lower mortgage costs. More important, Nicola Mai’s calculations suggest that core inflation (that is, excluding mortgage costs, energy and food) may be slowing more rapidly than the Riksbank is anticipating. Our expectation of a rather steep fall in core inflation this year is key to our view that the Riksbank will stay on hold until early next year, rather than hike "in the summer or early autumn" as it recently communicated.

• Norwegian mainland GDP rose 1.3% at an annual rate in 4Q, well below our and the Norges Bank’s expectations. The negative surprise was reinforced by downward revisions to growth in the previous two quarters. Today's report suggests the recovery has been less vibrant than expected and thus eases pressure on the central bank to tighten. We are staying with our call for the next rate hike to occur in March, but this is now a close call and the central bank may decide to wait until May.

• Whereas many economies are struggling to generate new jobs, Brazil is at the forefront of the global labor market recovery. On a seasonally-adjusted basis, the Caged payroll report showed that “formal” employment rose 235,500 in January and by almost 1.3 million in the last 12 months.

Page 2: Beware PPP weights

The JP.Morgan global GDP forecast is often compared to outside forecasts. However, in doing so, it is important to recognize that differences in aggregation methodology can lead to contrasting outcomes that are, in some cases, contrary to the underlying country growth forecasts. This is most clear in comparing the J.P.Morgan global GDP forecast to that of the IMF. Although the J.P.Morgan 2010 GDP forecast is stronger than the IMF forecast for both the developed and emerging market regions separately, the IMF global growth forecast is stronger than J.P.Morgan’s. The seeming contradiction owes to differences in weights.

Aggregating economic concepts across countries is typically done by weighted averages where the weights reflect some type of relative importance. Most often, the weights are nominal GDP shares. For aggregate global GDP growth, summing across real growth rates for each country using nominal global shares is optimal. But even when comparing other aggregates, the nominal GDP share is a reasonable importance-weight, if not optimal.

The exercise then becomes one of choosing the proper exchange rate to convert nominal GDP in local currencies to a common currency (usually USD, but this does not matter). All J.P.Morgan economic aggregates are created using global GDP share weights based on market exchange rates. The IMF uses PPP exchange rates. These exchange rates compare the prices of the same basket of goods and services in different currencies The relative values then provides the appropriate exchange rate under the law of one price, i.e. all goods should cost the same. The relative value of prices can differ considerably from market exchange rates because PPP prices cover both traded and nontraded goods and services. The wedge is largest for China and India, where nontraded goods and services are considerably cheaper than the same products in the US (converted to Renminbi at market exchange rates).

Because PPP exchange rates give a larger weight to nontraded goods and services, which are typically more labor intensive and so cheaper in the EM, it points to a stronger currency than the market exchange rate. In turn, it boosts the EM’s share of global GDP. This is most pronounced in China and India, where the implied share of global GDP more roughly doubles in both cases when using PPP exchange rates. In whole, the 26 EM countries tracked by J.P.Morgan account for roughly 25% of global GDP as of 2009, based on market exchange rate weights. However, this share jumps to over 40% when using PPP exchange rate weights. These differences completely account for the seeming contradiction in the J.P.Morgan and IMF global growth forecasts. Indeed, is the IMF forecasts are aggregated using market exchange rate weights, global GDP growth in 2010 is roughly 1%-point less than the J.P.Morgan forecast rather than 0.5%-point stronger.

PPP-based weights for computing global aggregates have a number of attractive properties, including their relative stability and more accurate representation of overall well-being. However, one of the main advantages of PPP rates—that they reflect the value of both traded and nontraded goods and services—is also a disadvantage in that they are not relevant for the tracking global financial flows. Market exchange rates reflect the interaction between the supply and demand for goods and services that are traded in the global economy along with the supply and demand for financial assets traded across borders. Combined with the extreme difficulties and thus, potential errors in measurement, we have long held that PPP exchange rates are less useful.

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ENDS

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