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Economy in Brief

OECD LEIs swing higher- will it continue?
by Robert Brusca  April 10, 2013

The OECD's leading economic indicators show ongoing improvement among the major industrial economies. United States, Japan, and China, in particular, show significant upward movements in February from their January readings. Those three countries along with the UK, Finland, Greece, Ireland, Spain and Portugal show amplitude adjusted (ratio-to-trend) readings for the leading indicators that exceed 100, a position that indicates that a mild expansion is underway. All of those countries' ratios have improved over six months, further promoting the notion that growth is improving in those nations. Should these signals be taken as valid projections?

Looking at the original 11 European monetary union members for which we have OECD metrics, only five display amplitude adjusted indicators that exceed or equal 100. Belgium lags the most, Italy the second-most, and France the third most. Looking at the ratios to six months ago, as of February, Belgium is weaker and France is weaker. The OECD data flagged these two countries as growth challenged.

US and Ireland post the strongest amplitude adjusted ratios in February; Ireland is just a tick stronger than the US. Reviewing the changes over six months, the US ratio at 100.9 exceeds Ireland's ratio of 100.4. But Portugal, with a ratio of 101.8 shows the strongest increase over six months. Greece with the ratio of 101.2 shows the second strongest ratio. Finland with the ratio of 101.0 is the third strongest behind them the US at 100.9 is the next strongest. Do we believe such rankings? Is Portugal, a country whose inflation rate has started to rise and whose austerity program has been dealt a severe blow and will require further cuts, really so well off?

The OECD data comprise a number of metrics from national economic statistics that have a forward-looking nature to discern what these economies will be doing in the near future. We can see from the tables below that these are different metrics than what we would get from looking at the usual activity variables such as industrial output or PMI metrics.

Looking at trends among the longest standing members of the European monetary union and a few members of the European Community we find Finland, Spain, and Greece have the weakest industrial output in February. Meanwhile, those same three countries that appear on the OECD list of those with some of the strongest amplitude adjusted readings in EMU. Over three months Finland, Greece, and Spain also demonstrate the largest declines in industrial production.

Turning to the PMI metrics for the services sector within EMU, France and Italy have the weakest readings when we assess them relative to their historic norms (the queue percentiles). The OECD data flagged France as a slowdown candidate based upon its amplitude adjusted reading which been falling over six months on balance. Italy, however, has an OECD reading that is up month-to-month and is higher on balance over six months.

The OECD attempts to gather economic statistics among categories that are the most sensitive to the changing economic conditions. It looks to find transformations of these data that have the strongest correlations with future economic developments. In doing this the OECD selects its time series carefully...based on historic relationships.

The OECD data will be most effective in an environment in which ordinary economic forces are driving changes in economic growth. However, in the event that economic stimulus or retardation stems from a nonconventional source, the possibility lingers that the OECD data will not effectively portray future developments. Presently such 'non-economic forces' dominate the environment. Political developments and special issues regarding economic governance have become extremely important in Europe and in the United States as well as in China. Japan has just adopted a variant of the Fed's 'QE' strategy that, because it is working through the exchange rate mechanism, will probably be effectively picked up by the OECD framework. But in the Economic Community itself the tremendous challenges of governance, the banking sector problems, the political issues, and other tensions may not be adequately filtered in the OECD framework. Already what we see is that the OECD framework is favoring developments in some of the weaker austerity-afflicted countries partly because they were previously driven to lower lows and have made 'some improvement' from those depths. In this case 'improvement' may be a reduction in the rate of contraction. But many of the austerity countries still face challenges. Unless the political situation changes in Europe they will continue to labor under the yoke of austerity which will restrain them from further economic improvement.

In the US the extreme tensions between Republicans and Democrats over budget issues dominate the economic landscape; a new budget proposal is being put in play by the Obama administration today. The budget fight in the US is substantially over the treatment of future governmental liabilities. It makes a big difference to the outlook whether the government looks to pare back the promises it had made historically or whether it tries to step up and meet those promises by raising taxes in some fashion. There is nothing in the OECD framework to capture something like this. Of course, once politics or geopolitics change there are impacts on markets, on exchange rates, and on expectations, as well as on current activity. Factors we can consider to be external to the OECD process will impact the variables of the OECD process but might impact those variables differently than would a traditional purely economic-issue induced economic cycle. That is the risk of trusting the OECD methodology at this time.

Clearly Europe is showing a great deal of weakness. The forecast of an upswing has a great deal of fragile components. We have seen in this economic cycle again and again the failure of economic variables to turn the corner and to grow the way they typically have in the past after periods of economic repression. To the extent that the OECD is looking at the upturn in some of its key forward-looking variables and assuming that this upturn will continue by assuming that relationships to economic growth will be what they have been historically, there may be some disconnect in the OECD's projections with respect to accuracy. For the moment this remains a tentative hypothesis.

Thus far in this cycle the OECD's variables show that they did begin declining before the financial crisis struck. But they did not get truly week until the crisis was well underway. The OECD LEIs for the OECD Area and for the US and for EMU did not dip below 100 until July of 2008, well after the crisis was upon us. The OECD metrics reached their lows In Jan 2009 for EMU and March 2009 for the US, ahead of the end of the US recession in June 2009. The US and EMU metrics did not make a 6-month gain, however, until the very start of recovery in July of 2009. The EMU metric rose above 100 in January 2012 ahead of the US which did not do that until April of 2010 (but only fleetingly). The US metric made its sustained move (good for eight-months in a row above 100) in November 2010. It broke below 100 again on June 2011. In June 2011 the OECD metric for Europe fell for the first time in the expansion on a six month basis. The OECD metric for Europe reached its mini-cycle low in September and October of 2012. The US, after falling back below 100 in June 2011 rose back above 100 in December 2011 and has made (more or less) steady and slow gains (very minor back-tracking) since then. The US reading is higher of six month on balance for five months running.

The OECD did diagnose recoveries in the main economic regions; the OECD diagnosed declines in the monetary union in the recovery period, as well as extreme flatness in Japan and relatively better recovery in the United States. All of those diagnostics were roughly correct but they were 'diagnostics' that were more 'coincident' than they were 'leading.' So let us bear that in mind. The question now is whether EMU with still very weak metrics and unconventional challenges is going to continue to swing higher or not. The US has been swinging higher but has recently lost some momentum. Japan continues fairly flat with a hint of recovery but is strongly supported by economic policies attempting to pry growth up to a higher level. These are the trends that we need to continue to monitor very closely. The OECD has been better in tracking the changes than it has been in predicting the future. I think this is because the disturbances have not generally emanated from traditional economic sources. Nor are they doing so now.

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