ZEW Survey in January Sees Mixed Momentum and Higher Interest Rates

The ZEW experts' macro conditions readings for January show deteriorations for Germany, the EMU, and the United States. The German reading logs in at -10.2 in January while the EMU logs a reading of -6.2. In sharp contrast, the U.S. logs a reading of +41.1 (diffusion readings for individual reporters are not shown here). Germany has a 44.6-percentile queue standing, the U.S. has a 57.4-percentile queue standing and the EMU has a 64.3-percentile queue standing. Among the three assessments, only Germany, with a standing below its 50th percentile, is performing at a pace below its median.

Economic expectation readings are available for Germany and the U.S. Germany has the higher diffusion reading at +51 (not shown) while the U.S. has a +22-diffusion reading. This translates to a 72-percentile queue standing for Germany and a 60.5 percentile queue standing for the U.S. Both are above their respective medians for the period (the median occurs at a ranking of 50). And the diffusion reading for both Germany and the U.S. rose sharply on the month.

The early take on the ZEW outlook is that expectations have held their ground in January even has macro conditions assessments have slipped a bit. This may be an acknowledgement that the virus set back some activity in January but is not expected to continue to have that effect going forward.

Inflation expectations are negative in January and are lower on the month in the EMU, Germany, and the U.S. This is an interesting finding since inflation has been flaring and it is and has been troubling and excessive relative to the ECB target as well as the U.S. inflation target. However, what inflation is and what it is expected to be are different things. Inflation expectations peaked around March 2021 at diffusion values in their 80s for the EMU, Germany, and the U.S. In January these expectations are coalescing around a diffusion value of -40… as actual inflation has flared expectations have pulled back. While central bankers have played dumb about inflation (see no inflation, hear no inflation, speak of no inflation – and expect it to go away on its own), the ZEW experts were right on (prescient) and foresaw this blast in the making. The ECB for now seems unconcerned and is of the belief that no policy change is required, and that inflation will simply deflate. Or maybe even Godot will show? In the U.S., the central bank is making preparations to hike rates by winding down and eliminating asset purchases and signaling that it expects to raise rates multiple times in the year ahead.

Not only were ZEW expectations on inflation elevated earlier, but ZEW respondents now see central banks as closer to acting to contain it (I guess that would be despite some official pronouncements to the contrary). We can compare responses to the levels of those same responses of last year when ZEW inflation expectations were elevated. At that time, short-term interest rate expectations hovered near 10 for the U.S and the EMU. The expectations for the EMU are up to a diffusion value of 25 while the U.S. is up to 81. A net rise of over 70 points for the U.S. and a net rise of about 13 points for the EMU. So it appears that the ECB's declaration on rates is holding back ZEW expectations. Still, the ranking for rate hike expectations in the U.S. and in the EMU are high at the 74% mark in the EMU and the 84-percentile level in the U.S.

Turning to longer term rates, there are extremely high percentile standings for long-term rate expectations in both the U.S. and Germany. However, the average shift in expectations is smaller for long-term rates (+10) than for short-term rates (+20). This suggests – and the above responses are consistent with this - that ZEW experts expect rates hiked at the short end to be more powerful than the rate rises in the long end or at least to be sufficient to stop inflation. And this is reflected in the way inflation expectations have been pulled back as we saw. The monthly change in long rate expectations was higher in the U.S. this month than it was for Germany.

But in this environment the stock market is no longer as favored. Stock market percentile standings are all below 50 indicating a worse than median expectations and the month-to-month decline is an average drop for the U.S., German, and EMU markets of 17 points.

Clearly there are big changes afoot and expectations have shifted significantly. The difference between inflation and inflation expectations allows us to understand better many of the changes put in place this month by ZEW experts. It is still hard to tell what they think central bankers are going to do, but they clearly expect more from the Fed where the rhetoric on rate hikes has been clearer and stronger than from the ECB where Christine Lagarde has been obstinate and consistent in saying no changes will be needed in 2022. Still, ZEW experts seem to be taking some issue with her there.

In the end, the central banks will do what they need to do. They are already late in taking way the punch bowl and like a party that has gotten out of hand there is no good way to 'undrunk' someone who has imbibed to much. So the excess liquidity will continue to slog around in financial markets and the Fed's plan to hike rates and eventually shrink its balance sheet to soak up excess will play out but under difficult circumstances. While central bankers long for a return to the pre-pandemic situation, it is no longer exists. Things change and they have.

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