Economy in Brief

There will be no hearts and flowers for GDP growth in the European Monetary Union on Valentine's Day. However, the revisions to GDP have kept the growth rate from turning negative in the fourth quarter (Q/Q measure). The third quarter negative number for Q/Q growth gave rise to concerns that the revision to GDP could take forth quarter growth into negative territory and that would trigger the analysis that the economy had dipped into recession.

Really?

‘Technical’ recession? Ha! You may read articles saying that the economy has avoided ‘technical’ recession. However, I don't know about you, but since very early elementary school I haven't thought of 1 + 1 equaling 2 being ‘technical’ for quite a while. The notion that two consecutive quarters of negative GDP growth are recession is anything but a technical definition of anything. Instead, that is a ‘rule of thumb’ definition of recession. And a rule of thumb is anything but technical, it is ‘one-off,’ ‘on the fly,’ a ‘quick study.’

The notion of two consecutive quarters as a recession I believe has been popularized because it can take the official agencies that designate periods as recessions quite a while to make the call that the economy is in recession. And the notion that two consecutive quarters of negative GDP growth mark a recession is something that's simple and can be known immediately.

On the other hand, taking a rule of thumb like this as something that is literally true obviously has shortcomings. There are also good reasons not to have a knee-jerk fast declaration of recession. European Monetary Union GDP fell by 0.5% at an annual rate in the third quarter of 2023; it's now risen by 0.2% at an annual rate in the fourth quarter. Had it been three tenths of a percentage point weaker (at an annual rate in the fourth quarter) would it really have made that much difference to anything?

I don't think so.

One bullet dodged The U.S. has already, in the post COVID period logged two consecutive quarters of negative GDP growth without having anyone (except a few with a political axe to grind) seriously suggesting that the U.S. economy was in recession during those two quarters. The declines in GDP for the U.S. were modest and at the same time job growth was enormous during those quarters.

What recessions are Recessions are special periods; and, while the extreme economic weakness in the U.S. economy during COVID was barely three months long, that period has been designated a recession. It should not be a poster child for recession dating. The point is that the COVID period was very unusual. The decline in GDP was extremely severe, and it was broad across the economy. However, the period was also extremely short. When recession daters look at recessionary candidate periods, they're looking to find economic activity that has been (1) severely impacted, (2) that has affected the economy broadly, and (3) that has lasted for a sufficiently long period of time to disrupt the economy and earn the designation as a recession. This is why it generally takes recession-dating experts some time before they pull the trigger on calling a period a recession or not. The COVID period is a notable example of a period that was very short and did not fulfill the length criterion but had impacted the breadth and the depth criteria so deeply that it was construed as a recession anyway. The main reason for this is probably the severe increase in the unemployment rate that occurred even though that unemployment rate during recovery came down quite rapidly.

The trappings of recession In Europe, we see none of the trappings of recession. The sense already is that inflation has flared and is starting to come down. We are not left with the opinion that the central bank is going to have to keep pounding interest rates higher until the economy is pulverized. Unemployment rates throughout the European Union remain extremely low and among the the lowest as a group that the Monetary Union has had since it was formed. But there are still a lot of economic risks and things that could go wrong. But the economy simply does not exhibit a lot of the characteristics we would need to see to support the call of recession. Financial distress is mostly absent.

Soft growth and political pressure However, the European economy is in a definite soft spot, a flat spot, and it's underperforming. The proximity of the European Monetary Union to the war in Ukraine is one of the main reasons. And now with more conflict in the Middle East with the Suez channel shuttered, there is another blow that the European economy will have to deal with. Europe, like the U.S., is beginning to creak under the burden of supporting the war in Ukraine. And there has been political backlash from this support in the U.S. in the form of concerns about all the spending that helps people on foreign shores. While in the European Monetary Union, the most immediate recent impact has been on farmers who are concerned about cheap Ukrainian grains in the EMU and the removal of gasoline subsidies to the farm sector that is already under pressure.

Growth data have some positives The table shows both quarter-to-quarter data for the most recent three quarters and year-over-year data for the previous four-quarters. Year-over-year data show only one country’s growth rate observation in Q4 is decelerating compared to the year-over-year growth rate in the third quarter. GDP on a year-over-year basis is not broadly decelerating in the European Monetary Union or across most of its early reporting members- the Netherlands is the lone exception. This is a far more important observation than the fact that 0.2% is a positive number and it's not -0.1%. Similarly, quarter-to-quarter growth shows broader increases in Q2 compared to Q1 and broadly increases in Q4 compared to Q3, while the third quarter shows widespread growth decelerations that appear now be a one-quarter phenomenon- peak weakness was Q3.

The U.S. as bellwether If the U.S. is an indication, the global economy is beginning to pick up. Global PMI data already are showing indications that the service sectors have stopped slowing and the manufacturing sectors - on whatever metrics they have been reporting - are not getting weaker.

The current macroeconomic situation The assessments of the ZEW experts on current macroeconomic conditions show conditions moving in opposite directions in the United States versus Germany and Europe. In February, U.S. conditions are improving as the economic situation moves up sharply to a reading of 34.0 from the previous reading of 15.3. For Germany, conditions worsen from a January rating of -77.3 to a reading of -81.7 in February. For the euro area, conditions do improve slightly, moving from -59.3 in January to -53.4 in February. However, the chart shows that broadly, conditions in the U.S. are moving up sharply as conditions in Germany and Europe have been deteriorating even with the euro area making a small move toward better conditions in February.

Expectations Expectations in Germany, however, improved slightly, moving up to 19.9 in February from 15.2 in January. In the U.S., there's a small improvement in expectations from -8.3 in January to -6.1 in February.

Rankings for the diffusion metrics In terms of rankings, the queue positioning of the U.S. and Germany on these two important macroeconomic statistics are quite different. The U.S. has an economic situation that ranks in its 51st percentile, above its historic median. Germany’s queue percentile reading is in its 9.6 percentile and the euro area reading is in its 30th percentile for the economic situation. In terms of expectations, the German expectation is higher at its 49th percentile, near its median standing, while U.S. expectations stand at their 40th percentile, still below their median. U.S. economic performance may be strong and trending higher, but expectations are not hitched to that rising star.

Inflation is subdued Inflation expectations are still low everywhere; they weaken in the euro area and in Germany. Expectations for inflation rise slightly in the U.S. to -58.6 in February from -64.6 in January. However, these are diffusion indexes that, in these ranges, don't have a lot of meaning, since the U.S. ranking for inflation expectations is in its lower 5-percentile, for Germany it's in the lower 9.6 percentile, and for the euro area expectations are in their lower 6-percentile. All these are very weak readings for inflation expectations. The ZEW experts continue to believe inflation is under control.

Interest rates For interest rates the readings for both the euro area and the U.S. weakened as in both areas the ZEW experts are looking for easier monetary policy. The readings for long-term interest rates also eased to lower levels as well in the U.S. and Germany. And for the U.S. and the euro area and monetary policy as well as for the U.S. and Germany for longer term interest rates, all the rankings run in their lower 10-percentile, continuing the outlook for low rates.

In this week's letter, we shift our focus to Japan, covering topics such as monetary policy, inflation, wages, the property market, and recent movements in asset prices. We first note recent investors’ views on the forthcoming actions of the Bank of Japan (BoJ), taking into account recent communications and inflation trends. We then delve into inflation disparities within the regions of Japan. We next examine Japan’s residential property market, and acknowledge the recent acceleration in sales prices and rental rates. We then discuss developments relating to the upcoming spring wage negotiations, highlighting key announcements and commitments made so far. Finally, we examine the latest trends in Japanese equities and the yen, observing the ongoing rally in stocks amidst a renewed decline in the currency's value.

Monetary policy The Bank of Japan (BoJ) left its policy settings unchanged in January, as widely expected. The central bank also revealed updated economic forecasts, indicating expectations of slightly firmer GDP growth and lower CPI inflation (excluding fresh food) for the fiscal year ahead. Perhaps more interestingly, the BoJ noted that the likelihood of realizing its price stability outlook has gradually risen. Some analysts interpreted the remarks as hints at imminent policy normalization, with a few now seeing BoJ rate hikes commencing from as early as March. Others, however, remain skeptical of substantive BoJ policy rate hikes soon, noting factors such as the lingering economic damage from Japan’s recent earthquakes. With that said, recent central bank messaging has lately hinted at possible tightening moves via the ending of risky asset purchases, but leaned against rapid interest rate hikes.

Portugal’s inflation data trends paint a mixed picture if looked at strictly. However, looked at more broadly, it is clear that the minor inflation backtracking is the exception while inflation falling and behaving is the rule.

Portugal’s HICP index in January rose by 0.5% month-to-month after being flat in December and falling 0.3% in November. Portugal’s national CPI also rose relatively sharply on the month, gaining 0.6% month-to-month in January after rising by 0.1% in December and being flat in November. The core rate in the national CPI rose by just 0.2% in January, the same as December, compared to a November performance that was flat month-to-month.

Inflation trends The overall HICP measure shows inflation decelerating despite the month’s jump. Twelve-month inflation is up 2.6%, over six months it rises by 1.9%, and over three months the inflation rate is at a 1.0% rate. The national CPI is more equivocal, rising by 2.3% over 12 months, accelerating to a 2.9% pace over six months, and settling at a 2.8% annual rate over three months. Despite that slight acceleration and stickiness for the headline, the core for the national CPI shows clear deceleration from a 2.4% gain over 12 months, to 1.7% at annual rate over six months, to a 1.4% annual rate over three months. On balance, inflation trends in Portugal seem to be in good shape and not only are the three-month and six-month inflation rates homing in on the ECB's target, but the 12-month inflation rates also are only a stone’s throw from the target set for the euro zone established by the European Central Bank.

Inflation acceleration/deceleration Inflation diffusion in January shows month-to-month inflation across categories accelerating in half of them, the same as in December. Despite the weaker November headline performance, inflation accelerated in 58% of the categories in November.

Looking at inflation acceleration trends sequentially on broader periods, we have a much more satisfying result. Over 12 months inflation accelerates in 25% of the categories, while over six months inflation accelerates in 41.7% of the categories. That's a step up in the proportion accelerating but still less than 50% of them. And over three months, inflation is back to accelerating in only 25% of the categories. All of this is descriptive of an inflation rate that is coming to heel and doing so consistently.

Price declines Looking at the 12 categories in the national CPI rate in January, six of them showed declines in prices month-to-month; that compares to only two that declined month-to-month in December and seven that showed month-to-month declines in November.

The broader sequential data show prices declining over three months in six of the categories; over six months, prices decline in four categories; over 12 months prices decline in only two categories.

It's not that surprising to see fewer price declines over 12 months than over three months because the shorter-term data are intrinsically more volatile. However, there's also a powerful sense of trend here in which inflation is behaving and part of that behavior has prices not just decelerating but declining. Over three months there has been a double-digit decline in prices measured at an annual rate for clothing & footwear. There is a decline of 2.7% at an annual rate for household furnishings and a decline of 2% at an annual rate for transportation as well as a 1.9% drop at an annual rate for recreation & culture. Inflation is falling at a 1.6% annual rate for alcoholic beverages & tobacco.