ZEW Experts Increase Their Negativism in July

If you were to accentuate the positive and eliminate the negative this month, there would be almost nothing left of the ZEW survey. In July, the ZEW assessments have generally weakened across the board except, of course, their perceptions of inflation which are stronger. A look at the chart at the top shows how much since COVID has struck the fortunes of the euro area have aligned with the assessments for Germany. Since COVID struck, the tracking of the two conditions indexes is extremely close, much closer than in the pre-COVID period.

The disease
Table 1 provides verbal descriptions of the month-to-month changes of the various entries. Color coding is used to demonstrate whether the underlying reading is above its median or not. The color 'black' indicates an underlying rank reading (value in Table 2) that is greater than a 50th percentile standing which notes in each case the historic median value. Values in 'red' denote weaker-than-median standings. Bad news, if not weakness is expected everywhere, short-term rate expectations, and a weaker euro-the currency rate (stronger dollar), lower long-term rates, a weaker stock market performance except for stock prices in the U.S., and higher inflation all around (the exception to 'weakness but not to 'bad news'). Only short-term rates, long-term rates in Germany and the dollar (not the euro) have stronger-than-median percentile standings underlying their month-to-month readings.

Table 2 below displays the percentile standings for the categories where there are surveyed. Observations for the euro area, Germany, and the United States are presented. The economic situation in all three of these jurisdictions hovers in its 30th percentile, indicating something close to a bottom one-third standing or assessment of the economic situation as uniform. That's weak and it also represents a weakening from the previous month.

Economic expectations are even worse with a 2% standing in Germany and an 8% standing in the U.S. These are not only extremely weak, but they also worsen month-to-month.

The cure...
Despite these developments of having weak growth that has gotten weaker and expectations for weaker growth that has also gotten weaker, inflation expectations are slightly stronger in the euro area, Germany, and the U.S. However, the standings for these expectations are extremely low; they have a lower 20th percentile standing or lower. This is because inflation is already so high. Given high inflation, expectations are not set for inflation to go a lot higher but only a little higher. The expectations for inflation to go higher is a challenge to the monetary authorities. Very clearly one message from the ZEW experts is that inflation is not going to cure itself and that central banks must act (raise short-term rates- and this is something the ZEW experts expect to happen).

Still, short-term rate expectations weaken slightly month-to-month for both the euro area and for the U.S. although this is a case in which the percentile standings continue to hold to very high levels (average 92%). This is the opposite of the inflation situation described above. In this case, expectations for rate hikes are already very high and some of those expectations were trimmed on the monthly period. But expectations continue to be very high in a 96.4 percentile for the euro area and for an 87.7 percentile for the Federal Reserve in the U.S. They may be slightly weaker month-to-month, but they are still very high.

Long-term rate expectations are somewhat weaker month-to-month in both Germany and in the U.S. However, the German long-rate expectation currently stands above its median at a 64.5 percentile standing while the U.S. is below its median at a 41.8 percentile standing; the fact that both weaken month-to-month is significant because short rates also weaken month-to-month and yet inflation expectations firmed slightly month-to-month. The ZEW experts have some complicated future sorted out in their minds that doesn't clearly link monetary policy and inflation with short- and long-term rates. Part of that might be related to their pessimism about growth and economic expectations and the broad view that short rates will rise. Their ongoing assessment of long rates probably reflects some of the same confusion we see in markets where long-term rates seem surprisingly comfortable and rest well below the levels being run by current inflation.

Stock market expectations are weak everywhere. They have a 1.4 percentile standing in the euro area and in Germany, while in the U.S. they have a 30th percentile standing; that is still weak. However, in the U.S. expectations improved slightly a month-to-month. That probably reflects the minor bounce that stocks have had in the U.S. although the expectation values remain extremely low; they're just not as low this month in the U.S. as they were the month before.

The future
These ZEW experts clearly have concerns about economic performance. Their expectations and assessments of the economies are dismal. Expectations for inflation are not reassuring and they see a continuing high interest rate environment and a situation in which stock market performance is going to be poor. They clearly see central banks with work to do and it would be charitable to interpret them as thinking that soft landings were even feasible.

Quite apart from this survey, central banks are on a path to raise rates and that is clear. There are several signs that growth is slowing; they range from the S&P Global PMI surveys, to the OECD leading indicators, and to other topical economic reports. In the U.S., job growth has been somewhat resilient, but the inflation news has yet to turn up anything that is encouraging. In this environment, the assessments of the ZEW experts appears to be spot on with the expectations in general commentary that we see in markets. Their motto for this month might be something like this, 'we have seen the future and it is dismal.'