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To Make You Dizzy


  • Yellen and Summers contradict each other
  • So far so good, but a recession cannot be ruled out
  • Drop in European gas price crucial for economic development
  • German economy is shrinking
  • Several of my acquaintances have been helped unnecessarily by purchasing power support measures

Google Translated from Dutch to English. Here is the link to the original article in Dutch. The article was originally published on 24  February 2023. 

 

Can you still track it? I'm having a lot of trouble. US Treasury Secretary Janet Yellen said this week that the economic outlook has improved quite a bit compared to a few months ago. Larry Summers, one of Yellen's predecessors, said that the outlook for the US economy is bad. He even said that the Americans are heading for a Wile E. Coyote moment. Wile E. Coyote is the famous cartoon character who runs over the edge of a precipice, hangs in the air for a moment while his legs continue to thrash in search of solid ground, but then falls inexorably down.

Jamie Dimon, the CEO of JP Morgan Chase, also gave an interview this week. He seems to be in the Summers camp rather than the Yellen camp. In any case, it is clear that the uncertainty about the course of the economic cycle is currently very high. There are also many unusual developments. Think of the reopening of the global economy after the pandemic with a special role for China at the moment, the war, the huge rise in the European gas price until the end of August, followed by a remarkable and very significant fall, the inflation, the strong wage increases, the unprecedented tightness in labor markets and the strong rate hikes by central banks, most of whom have now ended their QE policies (but not Japan) and replaced them with policies that result in the shortening of their balance sheets.

To be honest, I find it very difficult at the moment to make a clear assessment of the economic outlook. I understand Yellen. Energy prices, especially the European gas price, have unexpectedly fallen sharply in recent months. In addition, China has ended its many lockdowns and activity in that country will recover strongly, although it may take some time for that economy to get back to full speed. In addition, international freight rates have fallen sharply in recent months and problems in supply chains have more or less disappeared.

But I can also follow Summers' argument well. He says the latest economic indicators are strong, but several forward-looking signals are much less favorable. He notes, for example, that entrepreneurs are not very positive about their order books, that companies may be employing too many people for the level of their production, that consumers are quickly using up their savings buffer and that companies are building up stocks strongly.

 

Stock building is important in the business cycle

As far as stock building is concerned, the question is always whether it is voluntary or involuntary. The difference is that voluntary inventory building is driven by expectations of sales growth – a positive sign – and involuntary inventory building happens to entrepreneurs when demand is unexpectedly weak – a less favorable sign. In the latter case, a reduction in production volume usually follows.

 

 

Finance4Learning | US: GDP growth (%)

Source: Macrobond

 

The most recent GDP figures for the US economy show that growth in the fourth quarter was 2.7% (annualized) compared to the third quarter. (Calculated our way, the figure would have been 0.7%). Inventory building at companies contributed no less than 1.5% to that growth figure. If inventory building was largely involuntary, then the total GDP growth figure is quite flattering.

My point is that things are going pretty well for now, but the risk of a recession later this year or in the first part of 2024 cannot be ruled out. The US yield curve has been inverted and firm for some time now. The effective yield on 2-year government bonds is about 0.8% higher than on 10-year bonds. If a recession does not materialize, it will be the first time in more than 50 years that an inverted interest rate structure is not followed by a recession.

Another factor is that central banks have already raised interest rates sharply and will clearly not stop raising interest rates any time soon. It will take some time for the full impact of such policies on the economy to manifest itself. The total effect is only felt with a delay of 12-24 months. It is therefore quite possible that the economy will continue to heat up nicely for the time being, only to fall into a recession later on.

 

German economy is shrinking


While our economy grew by 0.6% in the fourth quarter, according to Statistics Netherlands, the German economy contracted by 0.4%. That figure was helped by strong corporate inventory builds (as in the US) and a nearly 25% increase in car sales from the third quarter as buyers benefited from lower taxes before the end of the year . Private consumption and investment in machinery fell by 1.0% and 3.6% quarter on quarter respectively.

Nevertheless, German entrepreneurs are gradually becoming more optimistic. The Ifo index, which measures business confidence, rose from 90.1 in January to 91.1 in February as the following picture shows. It is striking that expectations improved strongly, but that the assessment of the current situation fell back slightly. Economists tend to place more value on expectations.

 

Finance4Learning | Germany: Business Confidence (Ifo)

Source: Macrobond


Looking at the picture, I noticed that the gap between the expectations component and the assessment of the current situation became very large last year. The following picture shows the difference between the two series. And indeed, in the last 18 years, the gap has never been larger than in September last year. It must be no coincidence that an improvement has occurred since the European gas price started to fall.

 

Finance4Learning | Germany: Ifo index ‘current situation’ minus ‘expectations

Source: Macrobond

It is significant to note that Dutch consumer confidence also reached a low point in September last year and has since improved somewhat. The gas price will also have played an important role here. I actually expect that the positive development of consumer confidence will continue in the near future. Collectively agreed wage growth continues to accelerate and the purchasing power support measures taken by the government are currently being felt in full force.

Earlier this week I spoke to an acquaintance who is on unemployment benefits. Her husband receives an ABP pension. She was pleased with her finances. Due to the increase in the minimum wage, her benefit had gone up and the ABP has significantly increased the pensions. She said they had rarely seen such an increase in their combined income (although she may be suffering from a bit of a "money illusion," i.e., she may be underestimating inflation). Another acquaintance was surprised that he will receive a lot more child benefit this year. He actually works for Goldman Sachs and wasn't really keen on the extra money! And yet another acquaintance was surprised that in November and December he had received 190 euros per month not only for the house in which he lives because of the increased energy prices, but also for his second home. He also didn't really need that money to keep his head above water. The moral of this story is that the measures to support purchasing power may be a bit too generous (or too little specific). There is no doubt that they will support consumer spending.

 

Finance4Learning | NL: Consumer Confidence

Source: Macrobond

Closing

The immediate economic outlook has improved significantly in recent months. The spectacular fall in the European gas price plays a leading role in this. The reopening of China is also of great importance. Furthermore, the drop in international container rates and the resolution of supply chain disruptions are helping. In our case, it also applies that the accelerating wage increase and the purchasing power support measures of the government provide a strong impulse.

Still, we cannot rule out recessions in the US and/or at home later this year or in 2024. The higher interest rates will still be fully felt while the central banks are far from done with interest rate hikes. Naturally, energy prices could also rise sharply again. But, it must be said, so far, so good.