Has the Worm Turned? Is the Worm Turning?

The European Monetary Union (EMU) reached a peak unemployment rate of 11.7% early in the 2013 period. Since that point, the unemployment rate has been declining steadily, consistently across the European Monetary Union in the wake of the global financial crisis. And then COVID struck early in 2020; with COVID in play, the unemployment rate jerked back up to a peak of 7.8%, but has since returned to its downward path, and in fact, is carving out new lows. The unemployment rate in the EMU fell in March to 6.8% from 6.9% in February. The ongoing decline is good news and if it weren't for the virus, we would be on an extended long glidepath to lower rates - of consistently declining unemployment rates across the euro area.

However, in March there are some indications that the worm is starting to turn. March brings with it an increase in the rate of unemployment in four of the earliest members of the European Monetary Union: Spain, Ireland, Greece, and Portugal. All report increases in their unemployment rate in March. In Spain, the unemployment rate ticks up by one tenth of one percentage point to 13.5% from 13.4%. In Greece, it ticks up by one tenth of one percentage point to 12.9% from 12.8%. In Portugal, it ticks up by one tenth of one percentage point to 5.7% from 5.6%. But in Ireland, the unemployment rate rises to 5.5% from 5.2%. These are mostly small increases in the unemployment rate, perhaps no more than technical adjustments. However, Spain, Ireland, and Greece also post increases in their unemployment rates over the last three months. Ireland logs an increase in its unemployment rate over six months as well.

For the euro area as a whole, unemployment rates are continuing to fall, and these four countries are anomalies of sorts - but there are four of them - and these are among four of the weaker economies that are more likely to show economic distress sooner if conditions are changing. Consider them as the canaries in the coal mine…

Global conditions continue to be under a great deal of strain. The COVID virus is still circulating and creating issues that are being handled differently in different countries. Infections have spread, but that hasn't always increased hospitalizations or increased hospitalizations in a way that is alarming. There are ongoing dislocations stemming from when the COVID crisis is more severe, through its impact on supply chains. These are still being repaired. And even as these are being repaired, the supply chains are still being challenged anew by war in the Ukraine and by the economic sanctions that have been imposed on Russia. Russia seems determined to escalate the conflict and to intensify the combat if it can find the right cover to do so. The sense of risk is palpable.

Russia has started to cut off gas supplies to some of its customers in Europe; so far Bulgaria and Poland are on that list. Hungary, a country that tends to foster closer relations with Russia, has agreed to make its energy payments in rubles and has met with favor from Russia. It does not face the threat of having its energy cut off. However, even Germany is now making plans to decouple itself from the great intravenous pipeline flowing from Germany bringing the life blood of energy to its economy.

The European Monetary Union has seen the overall unemployment rate fall by 1.4 percentage points over the last 12 months; the number of unemployed in the monetary union has fallen by 14.6% and fallen by about the same amount (by 15%) in the larger group, the EU.

Unemployment over the last year has fallen the most sharply in Greece by 3.9 percentage points, in Austria by 2.4 percentage points and in Ireland by 2.2 percentage points. Unemployment has fallen by less than one percentage point in Portugal and France, and by one percentage point in Germany. The unemployment rate over the last 12 months is higher by one percentage point in the Netherlands.

The EMU is experiencing a bevy of responses across the members listed in this table. However, the unemployment rate has been falling rapidly although March begins to raise some question marks about whether that trend will remain in force and whether conditions are starting to change.

This is a particularly important question as central banks are shifting gears to try to fight inflation which has risen sharply in the wake of COVID. The United States and the United Kingdom have embarked upon programs to raise interest rates and the U.S. is planning to make a bigger step this week. However, these plans have been taken by surprise by the first quarter decline in U.S. GDP. Now we see some backtracking for unemployment rates in Europe as well.

It's reasonable to ask the question of how strong the economies really are and whether they are prepared to hold up under the kinds of strains that economists have - at least - put on paper in terms of what they expect from central banks raising interest rates over the next year and more. Certainly, the decline in U.S. GDP raises questions about whether the Federal Reserve is going to be able to raise rates as high as some people think it will need to.

I think the real question is whether economic growth will be able to sustain itself in the face of these sorts of rate hikes. Growth should not be taken for granted, just because some think huge rate hikes are needed. Are interest rates going to get anywhere close to the kinds of numbers that economists are projecting without throwing the economies into recession?

If an economy is already showing some signs of dodgy growth with interest rates as low as they are and with yield curves so flat, what is going to happen when central banks begin to raise rates by one, two or three full percentage points? What will this do to the yield curves? What will this do to growth? The notion that interest rates will rise to historic marks that we've seen in the past to stop inflation may turn out to be wholly unrealistic.

This is something we need to prepare for. The reality may be that with all the changes the economies went through because of the pandemic, they have not really gotten stronger and that, in fact, they are still relatively fragile. In the U.S., the pandemic seems to have come with some sense of entitlement. Workers seem to feel they have a right to work at home and are owed higher pay. While the U.S. certainly offered the most special support to people during the period of COVID, it's far from clear that the resources transferred to individuals have been kept and are still in place to cushion the shock of new interest rate increases. Nor is it clear how robustly businesses will absorb dislocations from rising interest rates and weakened sales after everything they have been through. Will home delivery of food and the ‘Uberization’ of America still hold sway as economic dislocation sweeps through America? And what of Europe? It is very clear that COVID has changed a lot of the way that the economy functions. It is much less clear to what extent economies have retained any resiliency and this is something that is about to be tested. The simple fact is that we do not know – and we do not know what we do not know...

Commentaries are the opinions of the author and do not reflect the views of Haver Analytics.