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Economy in Brief

ZEW Weakens; Current Situation Worsens; Outlook Darkens
by Robert Brusca  September 13, 2022

The ZEW survey for September shows weaker readings for the current economic situation, economic expectations, and outlook for stock markets in the euro area, Germany, and the United States. The deterioration is across all three jurisdictions and for each of these measures of performance. In addition, for each of those metrics the queue standing which represents the level of the underlying index is well below its 50th percentile, and in almost all cases, in the lower one-third of their queue of ranked values historically - a number of cases display readings that reside in the lower portions of those already low ranges. With Russia crimping energy supply through the pipeline and then shutting off energy supplies to Europe altogether, concerns about growth have risen sharply in the euro area and Germany. The month-to-month deterioration finds the euro area diffusion reading in the ZEW survey falling from -42 in August to -58.9 in September. Germany drops from -47.6 in August to -60.5 in September. The U.S. reading also has weakened on the month but fell only to +1.2 from +1.7, a reading that is still in the positive zone for the diffusion but still one that ranks in the lower 40th percentile of its historic queue of values (and is one of the strongest queue standings in the table).

Table 1: Momentum Summary

To appreciate how far the current situation has deteriorated, the 12-month average for the euro area is at -19.8 in net diffusion terms; that compares to the current rating of -58.9. The 12-month average for Germany is -21.8; that compares to a current reading of -60.5. For the U.S., there is a positive 28.1 diffusion reading for the 12-month average that compares to a positive 1.2 reading in September.

Double whammy...
The double whammy this month is that not only is there a sharp decline in current conditions but that expectations that already were weak have fallen again. Expectations readings are available for Germany and for the U.S. The German reading has fallen to -61.9 in September from -55.3 in August. The U.S. reading has fallen to -39.6 in September from -36.2 in August. The German reading has a standing in its historic queue of data in the bottom one-percentile of all readings. U.S. reading is in the bottom 10 percentile of its historic readings. Both these readings are extremely weak

Inflation expectations
Inflation expectations continue to show expectations for declines ahead, but the intensity of the declines expected has abated even though the concerns about growth and growth expectations have become heightened. In some sense, this is the worst mix of change that is possible with weakened current conditions and a poorer outlook and less of a sense that inflation will decline sharply.

Interest rates
Short-term interest rate expectations already show very high readings in the euro area but have nudged up higher; the same is true for the U.S. The standings for short-term interest rate expectations in the euro area have been this high or higher only 0.3% of the time; in the U.S. they have been higher only about 4% of the time. German long-term expectations have come down slightly, a diffusion reading of 57.4 in August gave way to 55.2 in September. U.S. long-term rate expectations have come down as well from a diffusion reading of 51.3 in August to 50.7 in September. The German expectation has a 73.2 queue percentile standing, marking that reading as relatively high historically. The US expectation, at a standing at 51.6, has a near-median standing, implying that long-term interest rate expectations see conditions more-or-less in a normal balance.

Stock market
The stock market expectations show added deterioration; they turned to negative ratings in the euro area and to a net negative reading in Germany as well. There is deterioration in the U.S., but with a still-positive net value in the U.S. However, the stock market standings in Europe and Germany are both in the lower one-half of one percentile in their respective historic queue standings. The U.S. is only near the bottom 25% of its historic queue- still nothing to wrote home about unless it is a request to ‘send money.’

Table 2: Respondent Details

Summing up
The readings from the ZEW survey this month are grim. We started with already weak readings and things have gotten worse. Current conditions are bad, expectations are bad, inflation expectations have not improved even though economies are weakening, and central banks are taking steps to raise rates and are expected to continue to raise short-term rates based on the survey itself. However, ZEW financial experts are not pessimistic about where inflation is going, as evidenced by long-term interest rates. In the U.S. long-term interest rates are at a relatively normal standing while in Germany they are elevated but still only at a 73-percentile standing, indicating further increases in long-term rates probably lie ahead. But the standings don't come close to comparing with the ones for short-term interest rate expectations although they are more strikingly high in the face of such weak responses for the current economy and expectations. The individual pieces of this survey are disturbing enough but when we put the whole picture together it is more disturbing because of the entrenched nature of inflation and the policy moves that the ZEW experts seem to think still lie ahead.

What inflation is and does
In the meantime, economic performance continues to be dubious. The readings from Europe continue to be weak; however, in the U.S., the labor market has posted some still strong gains and core inflation continues to be stubborn and to rise strongly monthly. This is a good time to take a deep breath and to remember what inflation is and the toll that it takes on an economy. When inflation was low and running below target, a lot of people urged the Fed to run its policies to raise the inflation rate. Europe put some key rates below zero. There's been a lot of pressure on both the Federal Reserve and the ECB to keep interest rates low, to keep policy stimulative. And because inflation had been so low for so long and below target, the Hawks at the central banks did not have voice when special steps were taken to combat Covid. But that doesn't mean they didn't have concerns and it didn't mean that those concerns were misplaced.

Limits to policy
It's true that a series of events transpired that would have been hard to deal with even if these economies had come from more normal times. However, coming after a time of chronic inflation undershooting, the pandemic and its impact on economies and supply chains and that legacy of having undershot inflation targets, there was a pronounced complacency that stayed the hands of central bankers. This helped to fuel inflation more than should have been the case. There is a lesson here about the importance of economic prudence and the inability of policy- however well-intentioned- to raise living standards on its own. An economy through, its people, and its businesses raise living standards using hard work, technology, and the development of human capital – not through government intervention. If a capitalist system fails to develop the kind of balance we would like to see in the system, policymakers should be careful to remedy the underlying problems rather than to think that they can legislate higher living standards by ensuring outcomes. Outcomes are a product of inputs, talent, and effort. It should be quite clear what folly when governments begin to distribute monies without carefully considering the impact on outcomes and incentives. Look at where we are. Look at the macroeconomic outcomes. Look at how the range of policy choices has been narrowed by past actions. Clearly, the policies that led to this were a failure, not a success… We still have much learn if not just to remember.

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