Paul Donovan Global Economist from UBS Keynote Address at RMC

Paul Donovan, the Global Economist from UBS delivered a speech titled, “As good as it gets?” to start the day in Geneva for the European version of CBOE’s RMC Conference today.

Donovan began his session talking about the US economy which he says is relatively strong. He notes that the labor market in the US is seeing an increase in pay for semi-skilled labor which is about 40% of the labor in the US. He notes that 30% of the labor force in the US can be defined as unskilled labor which is not seeing a pay increase. The semi-skilled group appears to be seeing increased wages and this group will be the driver of economic growth in US.

He discussed inflation and notes that the driver of inflation is normally labor costs. With respect to inflation he addressed the price of oil and notes that gasoline prices have not dropped as much as the price of oil. He attributes this to the increased labor costs that influences the price of gas relative to the price of oil.

While discussing the UK he notes that the number of companies has increased by 25% since 2007 but the amount of capital spending has not increased.   He notes this is because a large number of these new companies employ a single person. Spending by a single person company would actually be recorded as consumer spending. For examples a single person company buying a computer or iPad for business use would be recorded as a consumer purchase, not a capital purchase.

His current forecast is for the Fed to raise rates at the December meeting. He notes that there is no press conference in October so they may not raise rates. Raising rates only when there is a press conference scheduled at the end of the meeting would create more certainty of when changes in rates will occur. He also notes there will be solid CPI data to work with when the December meeting comes around.

Something that may put pressure on CPI is the housing market or more specifically the impact of the rental market on housing costs. The housing cost component of CPI is 32% of the index and is actually calculated using rental market data. This could put unexpected pressure on CPI, which would justify a rate hike by the Fed.

He discussed China and notes that the government is aggressively taking action to maintain GDP growth in the 6.5% range. He notes this may catch up with them in the long run, but will probably result in a year or two of continued growth.   He believes the commodity markets may not necessarily come under pressure due to internal problems in China. He notes that only 1.6% of US CPI is influenced by products that come from China. The global impact of China is not as great as headlines may lead you to believe.

In the Eurozone he starts off noting that bank lending growth is negative. This means that economic growth is difficult at best. We have just recently seen bank lending growth turn positive in Germany. This is an encouraging development.   Despite the Euro dropping versus the dollar there has not been an increase exports to the US. What the Eurozone companies have done is maintained prices despite the current weakness. They are using this excess capital to extend more credit to customers which is a boost to domestic economic growth in the Eurozone.