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Economy in Brief

ZEW's Assessment of EMU Is in Flux
by Robert Brusca  September 7, 2021

The ZEW financial experts' assessment of various economic and financial conditions is a survey that has been collapsed in recent months to focus on EMU, the U.S. and Germany, excluding individual assessments of France, Italy, the U.K., and Japan. The graphic shows clearly that the EMU current economic sentiment has been swinging higher for a series of months while the macroeconomic sentiment has been slipping. Of the 16 assessments in the descriptive momentum assessment table only six are stronger; two are for the economic situation and three for interest rate expectations.

The month-to-month expectations are shifting in a way that is not wholly satisfactory. Economic expectations in the U.S. and Germany are both weaker month-to-month. Inflation expectations are weaker for both as well (along with the EMU). U.S. short-term rate expectations are weaker (that is consistent) but euro area short rate expectations were lifted this month. And long-term rate expectations for both the U.S. and Germany have been lifted …amid expectations for a weaker economy lower inflation expectations. Maybe in the U.S. with short rate expectations falling, there is some logic in the longer rates rising to steepen the curve further as rates fall. But in Germany, with weaker expectations, weaker inflation, and stronger short-term rates expected from the ECB, the hiked outlook for long rates is a curiosity. And in Germany, the U.S., and the EMU all outlooks for equites weakened on the month. The one thing I left out was the stronger current assessments for Germany and the EMU and the weaker current assessment for the U.S. But I would consider those 'trumped' by the weaker economic expectations and weaker inflation outlook.

In any event, we can try to tell any number of stories to find logic and consistencies in the survey value shifts by the ZEW experts month-to-month. But sometimes there is not a collection of mutual adjustments as much as a shift in the view about what is going on and perhaps some 're-benchmarking' of old views. In the case of central banks, both the U.S. Federal Reserve and the European Central Bank are presiding over rates of inflation that are historically not only 'uncomfortable' but that in the past would not have been tolerated without a policy response and rate hikes. In both cases, there does not need to be a reason for a rate change to be expected as rate changes seem overdue. Both central banks are sitting on the sidelines 'forecasting' an unwinding of current inflation pressures to happen all by themselves. It could happen; there are a lot of unusual COVID stresses in progress and the disease itself is still percolating without any clear sign of what happens next. But that is a very weak spot in the outlook since choices made by central banks could shift unexpectedly depending on events. For now, they seem hide-bound in their choices.

The momentum table also flags in red text six items where the underlying index is below its historic median value. This condition applies to U.S. and German inflation expectations, short-rate expectations in the U.S., and stock market expectations all-around. The high level of current inflation makes the lower inflation expectations less of interest. I don't think many people anywhere expect U.S. or EMU inflation to rise from where they are now, since in both places inflation is so elevated - the real questions are: How fast will inflation dissipate? Where will it settle? These points also make it clear how these sorts of surveys can give false signals. One must be very clear about when the survey was taken to understand what its assessments mean. In the case of stocks, the Europe languishes. In the U.S., stock performance has been so exceptional and missed so badly by the experts that the stock market is believed to have 'borrowed from the future' hence the lower U.S. view in the outlook.

Table 2 provides the actual percentile standings of the various metrics, and some references to the average index changes and levels by category. There we see that the increase for the current situation generated a minor bump up for the average while economic expectations were cut sharply by an average of 14.6 points. Inflation expectations also were cut substantially. Short rate expectations only edged lower on average holding onto weaker overall diffusion survey values. Long rate expectations rose more solidly and held to mid-diffusion values although those translated into somewhat elevated queue percentile standings. Stocks on average fell sharply on the month having weaker diffusion levels and low standings.

On balance, the ZEW survey in some sense supports itself on its relatively high assessments of the current standing. Expectations are at a mid-range average with weaker inflation and short-term interest rates in the outlook. Longer rates are firm and firming while the stock market assessment is poor measured on just about any scale. This survey is not an upbeat assessment. It is only the relatively firm/firming current economic assessment that really supports the survey to give it stability. The rest of it suggests that that there are a lot of bad events or expectations in play. The hair trigger increases on expected interest rates this month are an example of this.

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