Economy in Brief

The chart adequately depicts the economic condition in Japan. Japan’s quarterly GDP jumped to a gain of 3.1% in Q2 2024, but that was from the Q1 decline rate of -2.3%. Together there is marginal growth in the first half of the year.

Japan’s year-on-year growth rate shows the impact of these quarterly gyrations as the 3.1% annualized Q1 gain was not enough to boost year-on-year GDP growth to positive territory. Japan’s GDP continues on a declining year-over-year path.

Growth trends Japan’s quarter GDP series became exceptionally bumpy in and nearly trendless from 2021 on in the wake of the Covid disruption. GDP growth was positive with quarterly growth rates spiking as high as 4% and 5% but after Q1 2003 quarterly growth lost its zest; two of the past five quarterly growth rates have been negative. One has been about one quarter of one percentage point, with two other quarters in the 2.5% to 3% growth range. This pattern has produced a decaying year-on-year GDP growth rate pattern.

Quarterly growth Japan’s second quarter of 2004 produced a sharp reversal of weak private spending that fell 2.2% (annualized) in Q1 then rebounded at a 4% annual rate in Q2. However, there also has been four straight quarters of real private spending declines through Q1 2024. Public spending stepped back to gain just 0.3% annualized in Q2 after growing by 1.1% in Q1.

Spending on capital formation has been erratic. It fell at a 3.5% pace in Q1 then surged back at a 6.9% growth rate in Q2. However, recently in Q1 2023, the quarterly capital spending has been as strong as 9.0%. Still, in three of the last six quarters, there have been declines. Plant and equipment spending has evolved similarly. Housing spending rose at a sharp 6.7% annual rate in Q2 following a 10.1% annual rate drop in Q1 that was part of an ongoing three-quarter decline.

On the trade front, the balance of trade has been through some substantial gyrations, including two surpluses in the last six quarters. Exports rose by a solid 5.9% annualized in Q2 but only after a drop in Q1 at a 17.2% pace. Similarly imports rose at a pace of 7.1% compared to a Q1 drop at a 9.6% annual rate.

Domestic demand rose at a 3.5% annual rate in Q2 snapping a four-quarter declining streak.

Annual trends Year-on-year GDP growth has been fairly steadily slowing and has posted declines in each of the last two quarters. Private spending has been negative for four quarters running, but the weakness was trimmed in Q2. Public consumption rose year-on-year in Q2, and that was the first net gain in six quarters.

Gross fixed capital formation has been slow and slowing. Plant and equipment spending has been erratic around small gains and losses year-on-year. Housing spending has contracted year-on-year for the last three quarters.

The annual GDP net exports result has been a positive balance in four of the last five quarters but in Q2 that four-quarter change has turned negative. Exports have logged low positive growth until this quarter when the year-on-year growth rate posted at -0.2%. Imports have been declining over the previous four quarters but logged growth of 2.5% in Q2 2024 to break that string.

Domestic demand has been shrinking year-on-year for four quarters in a row. The tendency, however, has diminished; it produced a small 0.1% contraction in Q2.

Inflation in the U.K. measured by the CPIH rose by 0.3% in July after rising 0.3% in June; these two months reflect a step up from May’s increase of 0.1%. The CPI excluding energy, food, alcohol, and tobacco (core) rose by a sharp 0.5% in July after rising 0.3% in June and 0.2% in May. The pattern and path of the core inflation rate for the U.K. is much more stubborn and worse than for the headline (which, itself is high and stubborn). Nonetheless, in its last meeting, the Bank of England instituted a rate reduction amid split views among Monetary Policy Committee members. At the time, it was noted that the rate cut may turn out to be an isolated one, and it could be some time before the next reduction comes around. A number of members (MPCs) had thought it was premature to cut rates and you can clearly see why by looking at the level and trend for inflation now.

The BOE rate cut was criticized by some as having substantial political overtones and the same charge was made in Japan about its recent rate hike. Meanwhile, with presidential elections coming in the U.S., and inflation over the top of its target for over 40 months and running, the Fed has a policy that seems to be tilted toward producing rate cuts. While, so far, U.S. data seem to be ‘somewhat amenable’ towards that glide path, it still is not a locked-deal that the Fed is going to cut rates in September, although some people think so. Not only does the U.S. have a long period of inflation overshooting but both presidential candidates seem likely to further expand the already massive U.S. fiscal deficit. What exactly should Fed policy consider? Legacy misses? Prospective profligacy? Or short-term inflation that is behaving? Politics seemed to be intruding on monetary policy globally but also in response to very separate and individual national pressures. It’s ice cream everywhere, but in each country a different flavor of the month.

Sequentially headline U.K. inflation is up 3.1% over 12 months; it's up to a 3.2% annual rate over six months and steps down ever-so-slightly to a 2.9% annual rate over three months. The core rate, referred to above, is up by 4.1% over 12 months, accelerates to a 4.9% annual rate over six months, then steps back to a 4.1% annual rate over three months. The core rate is clearly an excessive rate of change, and the headline is certainly stubborn and possibly stuck at its current excessive pace.

Globally, economies have slowed in the wake of the recovery from the Covid recessions; governments are eager to try to either restore or to preserve growth quickly. The task of making monetary policy has been greatly complicated by having had COVID and having had strong responses from fiscal and monetary policy, a legacy that currently is in the late stages of producing lingering stimulus. The success of Covid stimulus in reviving growth has emboldened policy officials. In addition, as the Covid process was winding down, a war was started by Russia by invading Ukraine and that created a secondary inflation surge it has made policy more difficult. Of course, during this period, the U.K. was also undergoing a transition known as Brexit. This is just a little bit like taking all the colors on your palette and mixing them together and wondering what sort of wonderful result you'll get, and being disappointed that all you wind up with is muddy brown.

Inflation diffusion measures the breadth of inflation and shows that inflation is decelerating on a timeline in more places when it's below the 50% mark. Diffusion for the U.K. shows that monthly inflation from May to June to July, which had indicated deceleration was now transformed to acceleration as diffusion in July moved up to 54.5% after having approached the neutral 50% mark with a 45.5% reading in June. Sequential inflation, which compares inflation over three-months to six-months and over six-months to 12-months and over 12-months to the 12-months before, shows a tempered but rising trend. Over 12 months there was a significant deceleration of inflation with diffusion at only 18%, but that stepped up sharply to 63.6% over six months and this has since moderated to just below neutral for a reading of 45.5% over three months. This is not surprising since headline inflation in three-months compared to six-months is slightly weaker at 2.9%, down from 3.2%, and 3-month inflation for the core CPIH is down to 4.1% from 4.9%. So, the headline/core are pointed to some deceleration and having diffusion slightly below 50 suggests that most of the components are moving in that direction as well. That is good news. However, the movement, even though it's in the right direction, appears to be slow. Inflation is still quite stubborn at uncomfortably high levels. U.K. monetary policy is in a rough patch and seems likely to be there for a while.

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?