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Economy in Brief

ZEW Experts Cut Back Assessments As Virus Spreads and Japan Sinks
by Robert Brusca  February 18, 2020

The ZEW graph on macroeconomic expectations does not summarize the whole ZEW report, but it does provide a clear picture that offers a good overview. The data plot shows expectations for future macroeconomic conditions losing ground in 2018, sinking to a low in middle-to-late 2019, then moving up to a more constructive outlook and finally to a positive outlook at least for the United States and Germany. Japan continues to see progress but did not reach the point of expansion. Now with the February assessment and the trade roller coaster (somewhat) behind us, the ZEW experts are beginning to handicap the impact of the coronavirus. On this news, the next gains that ZEW experts were profiling for February have been cut back in the U.S. and Germany. Japan's 'trend' move shows little change. The bottom line for the ZEW experts is that their view of a road back to growth has been dealt a significant blow. But we are still- in their view- looking at much better prospects than they thought from at least mid-2018 onward. Is that the right place to be on the outlook now? In the U.S., the Federal Reserve, despite all the risks, continues to say that the U.S. economy is in a good place.

ZEW experts seem to have 'missed' on Japan
The ZEW experts have not thrown out the 'baby with the bath water' in setting a new outlook. In fact, they seem to be hanging onto the bath water itself in many respects. While Japan's actual GDP report was not available to ZEW experts when they made their forecasts, the Friday release of Japan's GDP showed a 6.3% annualized decline in Q4 coupled with a year-over-year decline for GDP in the fourth quarter of -0.4%. Japan's consumption tax hike hit the economy hard. Japan, in fact, is doing much worse than anyone was expecting and the ZEW numbers show us that they did not expect that either. Japan's hit to Q4 growth is completely separate from the coronavirus effect which, based on scattered newspaper reports, seems to be hitting Japan's Q1 growth very hard.

Characterizing the ZEW results
The table right below shows that excluding foreign exchange assessments, conditions weakened month-to-month in over two-thirds of the assessments made by ZEW experts. Among the 35 non-F/X assessments these experts made, only 14% reside above their respective historic median readings. To summarize the ZEW results: (1) the current situation was mixed with more reporting stronger (slightly stronger for the most part) readings; (2) economic expectations were mostly weaker; (3) inflation expectations are weaker across the board this month; (4) short-term rate expectations are lower except in the U.K. that continues to have separate Brexit-related circumstances; (5) long rates are expected HIGHER across the board; that implies a steeper yield curve as short rates are expected lower. While that is logical enough, it is also peculiar that long rates are so uniformly higher with inflation expected lower and with inflation below its median assessment everywhere except the U.K.; and (6) Stocks are expected lower across the board.

Some specifics
The U.S. has the strongest (current) economic assessment with a 69.1 percentile standing. France also gets an above median rating as does Japan which is odd considering the 6.3% decline in GDP it has logged in Q4 2019 and the clear impairment it is suffering as its nearby-neighbor with which it has close ties and lots of physical interactions has put the coronavirus in play. Nissan has shuttered a factory in Japan because of parts shortages. There may be other supply chain effects. Chinese tourists have stopped coming to ring the Tokyo area department store cash registers sending sales sharply lower. And the impact on world trade is clearly negative as the Baltic freight index has remained extremely weak. As an important international trading country and one whose main trade partner is China, Japan is on a surprisingly hot seat that does not seem to be appreciated by the ZEW assessments.

Expectations are below their medians everywhere and conditions have slipped further in the month for Germany, Japan, France and Italy.

Inflation assessments are cut everywhere and are tame (below their historic medians) everywhere except in the U.K. The average fall on this index for the month is nearly 10 diffusion points. Inflation expectations in February are roughly at their 12-month averages for all countries.

Short-rate expectations turned lower in February and now stand more or less where they were three months ago. The U.K. is an exception with its short-term rate expectations showing less weakness than in January.

Long-term rate expectations turned substantially higher in January and have built on those gains in February –across the board. The diffusion readings are higher than their 12-month averages across the board, but they are well below their levels of 12-months ago.

The stock market assessment that has seen stocks been creeping back toward favor took a sharp write down in February with the January reading generally being cut by 50% or more. The U.K. and Italian markets are exceptions and now have outright negative expectations in February. Queue percentile standings are below their 25th percentile (lower quartile of their queue of values) for all countries except the U.S. where the rating is at its 26.5 percentile- only slightly out of that graveyard range.

Summing up
On balance, ZEW members still seem to be getting their footing and learning about what impact the virus will have. I would judge this to be a half-way effort. In the case of Japan, they seem to be missing the assessment substantially. In the matter of long-term interest rates, they seem to have made their mind up a month ago or so that rate levels globally need to move higher and the actual circumstances are not changing their mind. It is hard to see why the global economy now needs higher real rates judged from long-term yields. We will watch to see how durably they hold that particular view.

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