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Economy in Brief

ZEW Macroeconomic Expectations Break Lower in October
by Robert Brusca  October 12, 2021

The ZEW financial experts cut their assessments of the economic situation in the United States, Germany and the EMU for October. The reduction in the outlook among these three regions left the average assessment lower by 9.4 points taking the average percentile standing to its 68.5 percentile. Among the three regions, the U.S. has the weakest percentile standing at 61.9% compared to the EMU at 78.8% which is the strongest.

Economic expectations for the U.S. and Germany were split October as the U.S. was seen getting stronger while prospects in Germany weakened. In terms of the percentile queue standings, U.S. expectations are just a few ticks stronger than expectations for Germany.

Inflation expectations moved to weaker readings in Germany and the EMU as the inflation situation in the U.S. was assessed as worsening. The German and EMU expectations fell by about one-point for Germany and three-points for the EMU while the U.S. situation worsened by about twenty-one ½ points. None of those moves was very dramatic. Inflation remains uncomfortably high but is off its peak readings of this cycle. Central bankers and market participants are trying to handicap how long inflation will remain elevated. For the time being, central bankers are professed believers in inflation being a transitory phenomenon. But they are waiting to see how it plays out. For now, central bankers are treating inflation like the weather: everyone talks about it, but no one does anything about it. However, if inflation remains elevated or worsens, that approach will have to change.

On balance, expected inflation shifts and growth developments have allowed short-term rate expectations in the U.S. and in EMU to drift higher. The average change here is a gain in the short-term assessment of ten points. With only modest changes in inflation expectations on the table and with the economic situation have worsened across the board, the move up in short-term rate expectations is interesting. It may be less related to developments over the last month and more a reflection of concerns that policy must begin to get back to more normalized rate structures in markets.

Long-term rate expectations have moved higher in both Germany and in the U.S. in October. The average rise in the rate expectations index is a gain of 8.1 points, which is sizeable. We balance this gain against split economic expectations, a weaker economic situation and rising short-term rate expectations. We seem to have a formula for the ZEW experts who are starting to worry less about signs of weakness and are becoming more concerned about entrenched inflation even if it does not change by much.

The U.S. row of responses is unique for having stronger responses across the board apart from the weakening in current economic activity. Germany has weaker assessments on current conditions, macro-expectations and on expected inflation and yet has higher short- and long-term rate expectations. The euro area has a weaker economic situation, weaker inflation expectations and stronger short-term rates expected. Yet, each of these three regions also has expectations for a stronger stock market this month. And while that is true, it is a very mild ‘coincidence’ since the average improvement is only 1.8 points month-to-month.

On balance, ZEW financial experts are doodling with the fine points of the forecast and responding to short-term changes in events, but they seem to see a future with higher rates regardless of other things that change. Growth expectations are mixed this month, but with such a view growth can be expected in the future to come on strong and with that some stock market improvement seems likely as well. Of course, that statement is not withstanding the apparent overvaluation of stocks currently in the U.S. It is always hard to make blanket statements from macroeconomic conditions to their expectations for markets. Economic fundamentals change slowly and may reveal themselves at their own speed; yet, markets can and do turn on a dime.

One interesting finding is the extent to which the U.S., EMU and Germany’s macroeconomic expectations have fluctuated together. Since 2011 there has been no major move in expectations that has not embraced all three regions. And they are moving together again. And despite the ZEW experts looking to higher interest rates, macro expectations are moving lower and are not strong. The average inflation expectation has a 38.5 percentile standing and yet the average long-term interest rate expectation has a 93.6 percentile standing. Yet, in a broad look at history, inflation actually is high and long-term interest rates are low. So where do those assessments come from? The forecast comparison of rates vs. inflation this month is about long-term normalcy being projected not about interest rates responding to inflation. Economic expectations have a very modest 51.4 percentile standing average, while the current economic situation evaluates as one of the stronger measures at a 68.5 percentile standing; it is only firm. These data point strongly to the notion that ZEW experts are not projecting rates from economic performance but rather from a feeling that it is time to get market rates, and to nudge forecasts, back to ‘normal.’ Are they right?

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