Economy in Brief

Japan's economy watchers are not in a state of bliss, but they have gradually been improving their outlook after suffering a severe setback when the attacks on Iran began.

The current index for economy watchers, which is a diffusion index, at 46.4, is below 50 and therefore indicates some deterioration in attitudes about the economy. However, the reading reflects an improvement, and there has been an ongoing improvement in the current situation.

The future reading, similarly, has been improving; in August, the future index is at 48.3, also indicating some deterioration, but less than a month ago, with an ongoing improvement visible there as well.

Standings The percentile standings of the current index and the future index show slightly stronger readings for the future than for current assessments. The future index has a 49.4 percentile standing, placing it near its median for the evaluation period that goes back to August 2005. The current situation has a standing at its 43rd percentile, about 7 percentile points below its median for that period.

Current Index The current index shows three readings above their 50th percentile standings: eating & drinking places, corporations, and corporate manufacturers. However, even so, all of the current readings in August have diffusion values below 50, indicating that all are showing deterioration, although less deterioration than in the previous month.

Future Index The future reading itself is below its 50th percentile; however, six components are above their 50th percentiles. These include the overall assessment of households, the reading for eating & drinking establishments, services, corporations, including both manufacturers and nonmanufacturers as separate readings. The future reading for housing is extremely weak, with a 29.2 percentile standing, and employment has only a 36th percentile standing in the future index; that's similar to its weak 33rd percentile standing in the current index.

The lagging performance of employment in both indexes is certainly worrisome because that's the basis for jobs and spending. On the other hand, the future reading for households is above its 50th percentile. Households in the current index show a 44.7 percentile standing, below their median as well as below 50 overall, but not weak in a way that is especially worrisome.

The graph shows that there is an ongoing improvement in the assessments by the economy watchers. Their assessments dropped very sharply at the time of the Middle East conflict and the threat to oil supplies. Those assessments have since been recovering quite steadily and have moved to positions back closer to neutral, although still not to the point of registering growth. Among the current and future readings, only the reading for the service sector of the future shows a diffusion value in August above 50, indicating actual expansion; at least there's one, and that's a start.

In this week's Letter, we weigh Asia's building supply-side inflation risks against the AI export boom still powering regional growth. The US-Iran conflict has escalated once again, lifting crude prices and keeping geopolitical risk elevated (chart 1). Should oil hold at current levels without advancing further, base effects should eventually pull that impulse out of inflation. A second price risk is now building, and it is El Niño, an event already under way (chart 2). Drier conditions in parts of Southeast Asia and redistributed rainfall elsewhere stand to disrupt crops and lift food prices. Markets have started to price these risks in through higher yields. Japanese government bond yields have surged alongside global peers, also pushed by fiscal concerns as the budget is drawn up. Domestic buyers have reduced their net sales of JGBs, with the 10-year yield now flirting with 3% (chart 3). Set against these pressures, advanced Asia's AI buildout continues to run apace. Producers of critical AI chips in Japan, Taiwan and South Korea are posting double and triple-digit export growth (chart 4). The focus is also broadening from AI infrastructure towards physical applications such as humanoid robots. China has benefited too, with integrated circuits and computer equipment contributing about half of its export growth (chart 5). The remainder has come from other goods, including EVs, amid a still-robust overall export trend. By region, ASEAN-6 and India have driven that growth, offsetting the steep fall in shipments to the US (chart 6). That success, however, has again deferred China's longer-term rebalancing towards consumption.

US-Iran tensions: No let up The US-Iran situation has escalated once again with a familiar headline, as both sides traded strikes over the weekend, with no clear resolution in sight. The latest strikes have brought the conflict well into its sixth month, pushing crude oil prices higher and keeping measures of geopolitical risk elevated (chart 1). All of this continues to give policymakers reasons to worry. With that said, while elevated oil prices have been pushing inflation upwards, that impulse should eventually fade. If prices stay at current high levels for at least another six months without advancing substantially further, base effects will pull them out of inflation calculations.

The total PMIs from S&P improved in August, with only eight of the reporting jurisdictions showing month-to-month backtracking. Only seven of the reporters in the table show readings below 50, indicating a contraction of output in the reporting country or unit.

The average and median readings for the full table show improvements, by and large, month to month in the total PMI readings. The sequential progression is more complicated, with a weakening in pace over six months and an improvement over three months compared to six months.

France, Ghana, Egypt, and Qatar show persistent levels of activity below a diffusion value of 50, indicating ongoing contraction over three months, six months, and 12 months, in addition to recent monthly readings that remain below 50 (except for Ghana in the latter case).

Nine of these 25 regions have percentile standings, depicted in the far right-hand column, below the 50% mark. These represent rankings of the August values among all observations back to January 2021. Readings below 50% indicate values below their respective medians on this timeline. So, 9 of 25 countries or reporting units as of August are showing readings that are below what they produced as a median over the previous approximately 4½ years. Among some of the larger countries, this includes France, the BRIC member Brazil, and Hong Kong, which has traditionally been a strong-performing unit when it was the British Crown Colony of Hong Kong.

Over three months, only five of the reporting areas have weakened compared to their averages over six months, and only seven of the reporting units show contraction over three months.