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Economy in Brief

ZEW Survey: The Death of Optimism
by Robert Brusca  May 10, 2022

The ZEW Economic situation index for May fell to -35 for the euro area from -28.5 in April. The reading for Germany fell to -36.5 in May from -30.8 in April. The reading for the United States fell to 24.3 in May from 27.9 in April (these are raw diffusion scores; the table below presents percentile standings for these values). These observations are substantially lower over three months. They already had weakened over six months and their readings over 12 months already were poor. The simple summary is that very bad conditions meet poor expectations and slipping momentum for both.

Macroeconomic expectations for Germany and the U.S. continue to give deep negative readings. For Germany, the diffusion reading (not in the table) improves slightly on the month to -34.3 in May from -41.0 in April. The U.S. diffusion reading slips month-to-month to -28.8 from -24.7. However, conditions in Germany measured on a relative yardstick are not better than they are in the United States. The queue standing of the diffusion readings show the German standing in the bottom 8.5% when ranked among all German readings back to late-1991. U.S. indexes stands in the 13.1 percentile of its own data queue, slightly better, but still a very weak reading, on that same timeline. There is nothing to cheer about.

Reality check!
There's nothing in this report that is reassuring or good news causing me to put the headline on this report as ‘The death of Optimism.’ It's not that anything so dramatically bad has happened this month; it's that what has been happening in this report has continued to happen and it's important to acknowledge that as well as the prospect for it to continue. The economic and geopolitical conditions that have caused these readings to come about continue in play and in fact the super support mechanisms that countries have used ranging from fiscal policy to monetary policy have been leaned on so long that these crutches have been bent to configurations that put them beyond usefulness. Fiscal measures to support economic activity have been cut or are being cut. Monetary policy assistance is being reduced and policies of restrictiveness are either in play or in train.

The lingering malaise of virus
At the same time, the virus that was responsible for creating the recession and the lockdowns and the panics… continues to circulate albeit in a less fearsome form. Countries continue to make their own peace with the virus. Some, like China, continue to have severe episodic lockdowns; others all but ignore it while health officials keep a wary eye on it. The supply chains that were so disrupted during the pandemic are still disrupted; they're in the process of being fixed, but this process is a long one. Maybe this will be viewed as ‘transitory’ by historians, but not to a real-time policymaker.

Disruptions continue
Global trade has been severely disrupted. There continues to be long lines at ports although there is also evidence that this situation is being gradually rectified. Many firms simply went out of business and will never return. Others have undergone severe damage and they are shadows of their former selves. Yet, others are still in business and are trying to adopt new ways of operating given the new realities of a world with a pandemic and people who are concerned- perhaps overly concerned- about the potential for its to return.

The current crisis has its own special sauce
At the same time, there is a new ingredient that threatens global prosperity and that is Russia's attack on Ukraine. This attack is not only devastating for the people of Ukraine whose lives have been terminated, whose country is being destroyed, whose cities are being decimated, but there's also an adverse impact to the world from economic activity disrupting the normal flow of commerce that would come out of that region to the world. In addition, there are sanctions on Russia for starting this conflict. Some important trade flows have been lost. Ukrainian wheat shipments to the world have been impeded and halted. Russia is stealing Ukraine’s grain and stealing Ukraine's farm equipment. Russian fertilizer exports to the world have stopped and because of this global agricultural is worse off. Farmers no longer have the fertilizer that they have used in the past to enhance crop yields. The potential for a global food crisis and for much higher food prices is on the table. Yes, the crisis may be on the table, food may not be.

The summary table offers little good news
A look at the summary table shows that German and the U.S. economic situations have rankings below their historic medians (below rankings of 50). Economic expectations are below their historic medians and extremely weak, to boot. We see that inflation expectations also have low standings, but that's mostly because inflation is so high forecasters are not expecting inflation to accelerate but rather to decelerate although whether inflation will decelerate to a level that is within central bank target areas anytime soon is simply a matter for speculation. To underscore that, short-term interest rate expectations in the euro area and in the U.S. are in their 90th percentiles, extremely high. Long rate expectations are high, in their 88th percentile for Germany and moderately high, in their 66th percentile for the U.S. For some reason, forecasters living with a reality of extremely high inflation and expecting short rates to move up very strongly do not have much of a long-term rate expectation for the U.S. That's a curious situation and it's not clear what theory or belief it's grounded in. Against this background, stock market expectations are well below their medians at the 2.8 percentile for the euro area, at the 1.9-percentiel mark for Germany and in the bottom 22nd percentile for the United States.

Widespread bad news for economic conditions and markets
The assessment of current economic activity is poor; the assessment of economic expectations is worse. The existence of inflation is clear and it's very high. Forecasters, therefore, expect central banks to attack it with extremely high short-term rates and because of that their inflation expectations hold that inflation will be lower in the future than it is today (by some unspecified amount). The outlook for long-term rates is curiously mixed while the outlook for the stock market is consistently poor.

If things are so bad why are markets not yet worse?
Looking at markets today perhaps this is not what you would think is priced into them. We see complaints, stocks are falling in the U.S., but after their long-strong run-up it’s hard to look at stocks as fully valued to this outlook… But this is what these experts from ZEW see and what they expect. They have handicapped economic activity for the euro area, Germany, and the U.S. What they see is a dismal set of tradeoffs. However, this is not a worst-case scenario. Things could get much worse depending on what happens with the war in Ukraine. So, however you look at this situation, do not dismiss it. This is not a fantasy forecast. This is not an assessment by a bunch of pessimists. These are forecasts by financial experts that have long experience in financial markets and who see a grim future ahead.

Commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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