Sharp Drop in ZEW Expectations and Eco-Conditions; But...Why?

Expectations fell sharply in August as the German reading by ZEW financial experts fell to +19.2 from +41.8 in July, halving July’s estimate of one month ago (yikes!). Macroeconomic expectations for the U.S. economy also fell very sharply to -24.9 in August from -13.5 in July. These drops are extremely sharp and would appear to have been strongly influenced by the temporary and substantially reversed market reaction to the U.S. July employment report that seems to have wrong-footed a lot of markets. For the time being, I would say that the jury is out on the sharp decline in these expectations and other assessments, simply because we don't really understand them or what might have motivated them, apart from a sharp weakening in market conditions that has since largely been reversed.

The economic situation is mixed but mostly weaker In contrast, the economic situation in the euro area improved to -32.4 in August from -36.1 in July, as Germany conditions deteriorated to -77.3 in August from -68.9 in July. In the U.S., market conditions also regressed sharply to a reading of 8.7 in August from 31.5 in July. These changes dropped the assessment of the German economic situation to its lower 13th percentile, the U.S. to its 37.5 percentile and the euro area to its 44.8 percentile of them below their historic medians (which occur at a 50-percntiel reading). For Germany, this is an extremely weak reading.

The drop in expectations The drop in expectations and contrast took the German assessment only back to about its 48th percentile in terms of its queue standing, while the U.S. queue standing fell to its 18.6 percentile in the lower one-fifth of all its historic readings. Clearly the ZEW participants substantially marked down their current assessments and their future assessments even though, at least in the U.S., macroeconomic data have continued to be formative and firm except for that one July employment report that as we now-know was flawed but was not flagged that way by the Bureau of Labor statistics in the U.S.

Inflation expectations inflation expectations are little-changed on the month but show inflation moving more towards the path of normalcy albeit still with very weak readings; for example, the queue standings range from a low of 7.4 percentile in the U.S. to a high of a 16.7 percentile in Germany. These span readings that are weak or weaker. The assessments give a euro area response in August of -39.1, up slightly from -41.1 in July. The German reading rises to -32.5 in August from -39.9 in July. The U.S. reading for August moves up to -47.7 from -55.8 in July. These changes point to less disinflation (more inflation).

Interest rate expectations (or fears vs. hopes?) Both short-term and long-term interest rate expectations, in the euro area and the U.S. for short-term rates and in Germany and the U.S. for long-term rates, move to weaker readings, something that again is in synchronization with the surprisingly weak July employment report issued by the United States. The euro area short-term expectations generated a rating of -82.0 for August compared to -80.9 in July, a small weakening. In the U.S., there is a drop to -83.9 in August from -73.8 in July, a relatively large drop for readings that are already quite weak, bringing it down to stand within the lower one percentile of its lowest reading in its historic queue of values. I have to say at this point that there is nothing in U.S. data that would seem to have justified this now. It must be that the survey week for the ZEW participants occurred during the most are tense part of the market sell-off in the U.S. because current economic statistics simply don't seem to support this kind of a view on the economy anymore- even admitting that expectations are mixed across market participants. There were draconian mark-downs in growth and expectations and in projections of central bank rates in the immediate aftermath of the release of the July U.S. job report. ZEW participants, in this survey, have set long-term rate expectations for Germany slightly lower as August fell to -23.1 from -22.9 in July. And the U.S. long-term rate expectation is even weaker at -29.9 in August, down from -21.3 in July. These readings for August leave the German expectation in the lower 4.7 percentile of its historic range while the U.S. reading is in the lower 2.2 percentile of its historic range.

The stock market knows no Kryptonite Look, up in the sky, it’s a bird! It’s a plane! No! It’s the stock market!! - An interesting contrast to all the numbers above is that when we go to look directly at the stock market, we find only small markdowns for the U.S. and for Germany as well as for the euro area. The euro area’s assessment falls to 21.2 in August from 25.8 in July. For Germany, the assessment falls to 20.1 in August from 26.6 in July. In the United States, the August reading of 19.2 compares to a reading of 23.5 in July. Thes are small moves compared to other surveyed elements. The stock market readings have queue standings in the 18th percentile for the euro area, the 13th percentile for Germany, and the 33rd percentile for the United States. These are weak but of course nothing like the kinds of drops we have seen in the market indexes (since reversed) in the wake of the BLS employment report. These responses leave me at least confused about what the ZEW experts are reacting to and what they really think is going to happen in the future if stocks are ‘fine,’ but growth is not. Stocks are already richly valued. Aren’t they vulnerable to a softened outlook?

Perspective on weakness The drop in the reading in the U.S. current conditions is the 7th worst month-to-month drop in the last 28 years> U.S. macroeconomic conditions and extremely weak reading that is hard to understand in the context of recently reported U.S. economic data. As for expectations, German macroeconomic expectations show the 11th largest month-to-month drop in August compared to the U.S. that made its 34th largest drop on the same timeline. Both are significant declines month-to-month and have relatively high standing among historic results. But the drop for Germany, of course, is much more severe and it drops Germany to a much lower position in its historic queue of data.

Summing up I still think it's important to look at the ZEW survey this month and to realize how much events in the United States seem to have turned their survey upside down. I'm far from sure that ZEW respondents, if they were to be pooled today, would produce the same responses that they produced at the time of this poll. But then, it's also true that once an analyst, or an economist, marks down a forecast even if they decide they marked it down for the wrong reason, it's hard to get that forecast back to where it was before it had been marked down. So, I'm not sure if we should view this now as a situation there has been a break in perceptions that's going to be there in the future, or whether people's responses to the survey are now simply going to be impaired because they were unduly influenced by an odd economic report that was presented poorly by the officials. In any event, we're going to learn something from this episode. It will be important to watch what the ZEW experts do with their forecasts next month.