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Economy in Brief

Zew Current Index Deteriorates, Outlook Remains Weak
by Robert Brusca  October 18, 2022

The Zew economic indicators for the macro economy for the Euro-Area, for Germany, and for the US decline significantly in October. The Euro-Area diffusion reading fell from -58.9 in September to an October reading of -70.6. In Germany, the diffusion index deteriorated to -72.2 in October from -60.5 in September. And the US deterioration was from a +1.2 reading for September to -13.4 in October. These are substantial deteriorations. They have left the Euro-Area with a queue standing in it's 18.9th percentile, Germany in its 19.1 percentile, and the US and its 31.4 percentile. These are reading that have been lower only one third to one-fifth of the time (The US has the less weak standing).

Economic expectations for Germany and the US showed mixed trends. For Germany, the macroeconomic expectation reading improved very slightly to -59.2 in October from -61.9 in September. This reading still leaves it below the August-22 level. And the US the macroeconomic outlook deteriorated to 45.6 in October from 39.6 in September. Both the German and the US queue standings post October readings that are extremely weak. The German reading has been this weak or weaker 1.4% of the time; the US reading has been this week or week or 5.7% of the time – not much difference.

Inflation expectations that had revived a little bit in September have been sharply reduced in October as their trend decline continues. The Euro-area inflation expectations reading fell to a -35.8 diffusion index reading in October from -12.1 in September; in Germany inflation expectations fell to -35.2 in October from -9.7 in September. In the US inflation expectations fell to minus -71.0 in October from -50 in September. The Zew financial experts are coming to fear inflation less as they come to recognize weaker macroeconomic conditions and as they continue to hold extremely weak expectations for future growth. Inflation expectations have been reduced to a 4.4 percentile standing in the Euro-Area, to a 14.8 percentile standing in Germany and to a new all-time series low in the US. This does not mean inflation is going away; but it means the assessment is that there is a high probability that inflation has peaked. At some point diminished economic activity and poor expectations for the future must result in less inflation pressure.

However, on the interest rate front for the Euro-Area we see a diffusion reading of 92.6 in October compared to 93.3 in September it's a small reduction that probably doesn't really mean anything because the readings are still so high- in the 90th percentile. Clearly the Zew experts continue to see the ECB raising rates. And in the US also there's a slight diminution of pressures in short term rates as the October diffusion index falls to 87.3 from 89.7 in September. That's another very modest and not noteworthy change in expectations. And the case of the Euro-Area, that diffusion reading is in its 98.9th percentile. For the US, the reading is in its 91st percentile. In both cases expectations for higher short-term rates are extremely strong. And that is more the point than that there was some very modest backing off.

Moving on to long-term rates, we see pressure coming off long term rates expected in both Germany and in the US. In October, the German diffusion index falls to 48.7 from 55.2 in September. In the US, the reading falls to 40.6 in October from 50.7 in September. The lower diffusion readings imply less pressure on long term interest rates. In Germany, the standing of that diffusion index is in its 60.9 queue percentile, showing that expectations for long rate increases are above their historic median ( the median occurs that at a queue standing at the 50th percentile). In the US, the queue standing is at its 41st percentile, below its historic median.

Stock market expectations have improved slightly for the Euro-Area area and in Germany; they are marginally weaker in the US. In the Euro-Area stock market expectations flip from a - 5.2 reading in September to a + 2.5 reading in October. Similarly, in Germany, the October reading flipped to a +1.2 reading from a -5.9 reading in September. The US the October diffusion reading edged down to 11.7 from a September reading of 12.5. The Euro-Area and German readings are still both in the lower two percentile of their historic queues of observations for stock market expectations. And in the US the reading is a bottom 25 percentile reading at its 25.7 percentile mark. These are weak queue percentile standings for all three areas; however, the weakest standings are for Germany and the Euro-Area.

Summing up
The summary table shows diffusion readings and is looking at the unweighted averages for changes in the respondents in each category. Note that this month changes are weaker for every single category except for stock market expectations. These trimmed expectations are not entirely unwelcome news… The weaker economic expectation is bad news, the weaker economic situation is bad news too. But those things combine to lead to weaker inflation expectations, and that's good news; they also lead to less pressure on short-term and long-term interest rates, and those changes are both good news, too. In the case of the stock market there's simply an improvement, possibly because monetary policy is looked upon in this framework as being able to see the end game for rate hikes based on reduced inflation concerns and weaking growth. These changes are consistent with the idea that recession lies ahead, an increasingly common forecast.

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