Viewpoints

The Composite PMI and the Service Sector The PMI readings globally are not as comprehensive a set of data as for manufacturing. Still, there is a broad rather representative group of data we can observe to track the overall PMI and the global service sector. In January, among the twelve reporters of service sector data, eight weakened showing that weakening members outnumbered strengthening members two to one. That is decisive. In December, nine members weakened month-to-month. That compared to eight weakening in November.

The service sector globally These monthly changes demonstrate (data not shown separately) that the service sector has been under siege over the last three months with declining sectors outnumbering advancing sectors by a factor of at least two to one for three months running. That is 'impressive' in a negative way.

The chart shows that among the countries and the EMU region whose data are plotted there, the U.S. has been a very different animal with the service sector building to a crescendo while the other service sectors ran either a more restrictive cycle (like the EMU) or simply waffled while moving mostly sideways (Japan shows a bit more uptrend than the EMU or China).

The service sector ranks below its median (on data from January 2018 to date) in eight of twelve sectors with those below their median outnumbering those above their median by two to one again. The relative strongest service sectors are in Brazil (83.7%) and Canada (72.2%). Among the world's four largest economies (the U.S., China, Japan and Germany, the strongest standing for a service sector is Germany at its 36th percentile). Among the twelve global service sectors, eight of twelve have weaker PMI values than their level before the Covid virus stuck in January 2020 (one country, Brazil, is unchanged). The only countries with higher service sectors on that timeline are Canada, France, and the U.K.

The Composite PMIs The service sector usually dominates the composite reading but the composites are more comprehensive, and more countries report a composite PMI than report both individual sectors. Twenty countries report an up-to-date composite PMI in the table.

In January, the composite PMI slows month-to-month in 16 of 20 jurisdictions but dips below 50 (the diffusion boom-bust line) in only six (30% of reporters). The median reading is 51.0, a skinny gap between the median and the boom-bust line.

There has clearly been a worsening in the last two months when the proportion of reporters showing deterioration has risen sharply and stayed high. This is probably a result of the highly transmissible Omicron virus, although some health experts are now concerned that Omicron may not have spread as widely as initially suggested and there may still be a good deal of Delta in the mix. This just points out how much health authorities are stabbing in the dark at a moving target. The U.K. does a great deal of detailed testing. The U.S… not so much, and the tests that the U.S. deploys often only test for 'Covid-19' not for the particular variant. And lot of what we 'know' about the virus is still derived from models and if there is anyone who knows how dodgy depending on a model can be, it's an economist. The initial 'model results' given around Christmas by a U.K. group for the spread of Omicron in the U.S. appears to have been 'overstated.' So, we will have to listen to the health authorities to see what they tell us. Whatever is going around, it is spreading fast and it may be a mix of Omicron and Delta.

A world of 'hurt' Whatever is going on in the world of virus, it is affecting the world of economics and has had a large impact over the past two months. Infection curves are now dwindling (GOOD NEWS!) and although deaths are low relative to infections the infections have been so broad-based that in raw numbers the deaths have been high.

Virus impact on economy Obviously, what happens next is going to depend on what the real virus facts are and where we go from here. The virus has an outsized impact on the service sector since that sector puts a premium on face-to face contact and people who are engaged in heavy mitigation strategies simply avoid as much contact as possible. They stay home. They let other people shop for them. They use the internet, and so on… I live in NYC on the Upper West side of Manhattan, a densely populated area. I see a less grocery store shopping, less traffic on the streets, fewer people on the street, a less crowded subway system. People are mitigating or maybe migrating or even hermitting. Even though they still shop, that behavior hurts growth.

Diffusion data, queue rankings and high-low percentile readings The global composite PMI data show several interesting trends. I just wrote on the deterioration in the last few months. But note the queue standing column in the table…what is going on there? An average standing of 43% means that on average reporters are significantly below their median (medians occur at a queue ranking of 50). Now this is different from the median of the diffusion data which is at 51 and shows a very small tendency to expand (PMI values above 50 signal expansion; values below 50 signal contraction; on the queue ranking data 50% identifies the MEDIAN value of the underlying diffusion value). But these two readings are not incompatible -in fact together they enhance our understanding of events. As a final matter, the column labeled percentile provides the percentile standing of the month's observation in its range- between the sample high and low. A 50% reading on that is simply the middle of the high-low range.

Making the metrics work together One of these metrics, the median, points to a barebones expansion; the other (queue standings) says that countries are posting results well below their historic medians. These two findings are quite compatible; in fact, a barebones 'skinny' PMI level just above 50 is also below most nations' medians (in almost all cases). We can also see that the percentile column shows an average across reporters of 78% and a median of 82%. Again, that is compatible with the other two results. What the table shows is that there is only one reading in the top 10 percentile of its historic high-low range of values (Sweden). However, there are 12 of 20 readings that are in their top 20th percentile on this gauge. While there may be broad queue percentile standing weakness, there is not deep high-low weakness.

Table 1

Manufacturing PMIs have peaked and have been sliding lower for some months. The peaking and slippage are a slightly different horizon for each country, but all of them are now on downslopes.

In January, the deteriorations exceeded the 'better' responses by a factor of 8-to-5. The change from three months vs. six months shows a nearly equal improvement vs. deteriorating trend. The change from 12 months to six months shows deterioration dominating improvements by a factor of more than 2 to one. But over 12 months compared to a year ago, improvement is the order of the day with 11 improvements logged vs. only 2 deteriorations… Longer term, the beat goes on.

Covid rears its ugly head Once again, the Omicron variant seems to be behind the worsening trend in manufacturing as the less virulent but much more transmissible variant has swamped hospitals with infected people despite its lesser virulence. In this case, transmissibility has trumped virulence to create a potent viral attack on the populations globally. While vaccination helps to mitigate the impact of infection, it does not stop it. As a result, Omicron has been very widespread and even quite dangerous. It is a lesson about how one should view danger.

Vaccines to the rescue...oops not... I suppose one thing we should at some point begin to wonder about is the economy's recuperative capacity after a bout with yet another variant of Covid-19. When Covid first struck, draconian measures were taken by health authorities who were more scared than knowledgeable about what to do. Over time the mRNA quasi-vaccines were developed and for a while they became the path to stronger growth. Eventually health officials discovered that the inoculations had a short 'effective life,' and 'vaccine-boosters' were thought to be needed after six or eight months. It is now understood that the inoculation's immune system stimulants begin to drop sharply after just four months. That is probably not a 'New Reality' as much as it is scientists discovering the real reality. Discovery of this reality makes the quasi-vaccines much less of the backbone of a response system and critics of the CDC complaint that the CDC, which tends to lead the Covid fight globally, did not devote enough resources to other potential treatments. If you put all your eggs in the vaccine basket, that basket better carry the day. (This not an opinion-it is a fact. See Scott Gottlieb at the 39-minute mark of Face the Nation 1/16/22 . - here Gottlieb, who is on the Board of Pfizer notes the failure of the vaccines to prevent transmission. He also blames the CDC – a significant statement from a high-profile industry expert and a former FDA Commissioner.)

Damped recovery prospects? In the past after a bout of virus, there were government support programs and some of those are still in circulation in various places. But government assistance and income supports are now much less common. After this round of Covid, manufacturing and services are going to have to rise back based on whatever organic demand has been built up. There is reason to believe that such build-ups in demand occur after a period of disruption. But the snap back may not have the same 'snap' as in previous episodes of infection followed by recovery.

The state of play for manufacturing The queue or rank standings find only China and Brazil below their historic medians, but these two are below by a huge margin with standings below their 5th percentile in each case. The median occurs at a percentile queue standing of 50%. These are readings far from where they belong.

There is more firmness this month than strength. Japan has a 98-percentile queue standing. Russia Vietnam and the EMU have queue standings in their 80th percentile range. But Germany, France and the U.K. -the top-ranking three European economies- have standings in their 70th percentile queue standing. India and Taiwan are in their respective 60th queue percentiles. Turkey and the U.S. tally standings in their 50th percentile decile. Over 50% of the responses are at the 70th percentile standing mark or above. But still 30% are just in the first decile above their median (50

The responses this month show some mixed statistics, but clearly growth remains the operative descriptor. Yes! The growth has been more moderate than strong, and this is due to this survey being conducted in the middle of another Covid episode. Looking at the cumulative gains since January 2020 when covid struck is also illuminating. The EMU area and Germany have gained double-digit diffusion points on that horizon. The next strongest is the U.K. at +7.3 points and Japan at +6.6 points. Then rising by 3 to 4.4 points are France, Russia, the U.S., Taiwan, and Vietnam. Countries with manufacturing readings below their January 2020 levels are Turkey, India, China, and Brazil – sinking like a BRIC?

Japan's consumer confidence diffusion index eroded in January, edging down to 36.6 from December's 38.9. The index is net lower over three months and over six months, but it is up by 6.5 diffusion points over its value of 12-months ago.

So... there it is, the paradox of the central banker…How much is enough? How much is too much? How much is too little? What happened to Goldilocks?

Back in the early 1980s, monetary experimentation was rampant. I worked at the New York Federal Reserve Bank back in those early days (1977-1983). My look back at the research and experimental looks at money (M1, M1a, M1b, M2 MZM…L, etc.) leaves me with the feeling that while there was a lot of research there was more investigation than there was learning. Subsequently, the Fed left the quantity of money to the wind and focused more on the price of money by targeting interest rates. But that does not mean money does not matter. It just means that money is not targeted. In fact, the Federal Reserve in the U.S. even STOPPED PUBLISHING M2 money supply numbers weekly. Shame!

The Fed in the U.S. further loosened constraints on itself by claiming to target some (unspecified) average rate of inflation and the ECB followed suit, dropping the less-than 2% objective for a 'higher' (also unspecified) 2% 'average.' So now central banks have a known objective for inflation (2%) which they are evaluating by looking at an unknow benchmark - some average of actual inflation. This, of course, leaves markets more mystified than before because we really don't know what the central bank is looking at to make policy. Since inflation has jumped so much, there is an enormous difference in what you see for inflation depending on which average you look at. And central banks think they are doing a 'excellent job' at communication!

Can we be anything but NOT SURPRISED that all this has led to rampant inflation?

France's INSEE industry climate reading spurted to 112.4 in January to start the New Year from 109.7 in December despite an assault across Europe by the Omicron virus and some sharp words for the unvaccinated from French President, Emmanuel Macron. The French service sector, however, stepped back to 104.8 in January from 107.4 in December, marking a two-month drop of more than 13 index points, a very sharp pull back. We know that the service sector is more vulnerable to viral outbreaks, so my working hypothesis is that the virus smacked the service sector hard, but the manufacturing sector is signaling that growth is still in the groove. We will, of course, monitor French data closely to see if this is confirmed in forthcoming data releases.

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.

The evolution of consensus forecasts can often yield useful insights about the plight of the world economy. And the latest Blue Chip survey of economic forecasters, published earlier this week, is no exception. The latest January survey, for example, suggest that global growth prospects remain hostage to the COVID pandemic. But inflation concerns are also mounting in some countries and taking a toll on their growth outlook at the same time. Those inflation concerns are now mapping more into the interest rate outlook as well in some of those countries following recent hawkish communications from, for example, the US Fed and the Bank of England. The absence of any material inflationary pressures in Japan and China has been noteworthy, however, as has the relatively dovish response to recent events in Europe from the ECB. And the implications of all this for expected interest rate differentials between the US and most other major economies has had some predictable implications for consensus forecasts for the US dollar as well.

In what follows we briefly discuss some of these considerations with reference to a few exhibits.

Growth forecasts pared back in the US and Europe, lifted in China and Japan

We'll start with the outlook for economic growth. Consensus forecasts for GDP growth in most major economies for 2022 have been pared back in recent months (see figure 1 below). COVID considerations, inflation concerns and the policy response to both of these have been arguably to blame.

Figure 1: The evolution of consensus forecasts for GDP growth for 2022