EMU PMI Readings Scrape 66-Month Low

Global Growth Crawls on Its Belly

The EMU PMI composite index is at a 66-month low. The EMU diffusion reading, as well as each sector reading for manufacturing and services, has a value of 50 plus ‘change’. A value of 50 in diffusion terms marks a sector as dead in the water, output neutral, zero growth. And the EMU is perilously close to being that right now across the board.

Country by country from weakness to moderation
France posts a composite reading below 50, a reading that has been affected by its ongoing ‘Yellow Vest’ protests that has also sapped strength from the Macron government. France shows some industrial expansion (reading of 51.2 for manufacturing), but the service sector reading at a diffusion value of 47.5 is very weak and shows sector contraction for the second month in a row.

Germany manages to log an overall expansion with a reading of 52.1 on its composite. But that is still a low point for the past five years. German manufacturing is showing the smallest of contractions with a sector reading of 49.9. German services with a reading at 53.1 is still expanding, but in the lower 10% of all readings in the past five years. That is not exactly a tour-de-force of strength.

Japan’s manufacturing sector also plunged to dead neutral in January. It is in the lower 14% of all reading over the past five years.

The United States shows a more strength but not much momentum. And while the U.S. queue percentile ranks are much higher than in Europe or Japan, the U.S. composite reading is below its four-year median and that has only produced growth of 2.3%.

Response to weakness-stay the course, cross the fingers
Central bankers in the U.K. and Japan have just met and their decisions have been to stay the course. Policy is not reacting to the new news of weaker economic signals. Only in the U.S. where the Fed has been actively raising rates since end-2015 has the central bank engaged in anything like a policy change by seeming to have adopted a flatter rate profile for the period ahead than the one it had preciously endorsed for most of last year. Various policymakers in the U.S. also suggest that the Fed could be willing to sit on the sidelines for some time. But in the EMU and Japan, rates are still exceptionally low. The ECB has terminated its asset purchase program and so its policy of ‘unchanged’ means it is sticking with the less stimulative policy that previously was adopted.

Central bankers not recoveries die of old age
Central bankers are wary of the economy since recovery has been in train for some time and current growth signals are less vibrant. Policymakers are fond of saying that recoveries do not simply die of old age. In an interview in the U.S. recently, former Fed Chair Ben Bernanke wryly noted that recoveries do not die of old age rather central banks more commonly murdered them. So in the U.S., the Fed has backed off its past path of rate hikes. That backing off has allowed markets to recover and slow the flattening of the yield curve that had really gone into overdrive around yearend. In Japan and the EMU, policies are simply staying put and market reactions to actions are muted as the bankers have done what markets expected...mark time.

Praying for deliverance instead of policy that delivers
Central bankers are hoping that this fit of weakness will pass. Interest rate levels in Japan and the EMU already are extremely low. Bankers do not want to be put in a position of having to create new stimulus under these conditions. And the current weakness is still more like growth moderation and does not necessarily require action. Although I dare say, if rate levels were higher and conditions are weak enough, it is likely that we would be seeing some central banking response. But bankers now simply lack the flexibility to act. The fact is that the ‘heights’ of growth are not as high as they once were, leading GDP and other metrics to drift more commonly and to languish in the low-growth portions of their ranges and that always makes for some nervousness.

Are we lacking shocks?
It is not as if the global economy is devoid of shocks, or their potential, an important thing to remember since it is often said that it takes some sort of jolt or shock to create a recession. In the New Year, Italian banks have been in the news in a bad way. The U.K. is still trying to come to grips with Brexit and despite all the negotiations it is not clear that it is any closer to a real decision be it hard Brexit or not or even a new referendum for the masses. There is the potential for a shock there. Debt levels have crept up globally. And while all eyes are on China, its debt levels are so high that debt is no longer as effective a prod for growth as it once was. China currently is laboring under tariffs imposed by the U.S. and negotiations between the US and China are under the pressure of a deadline and the threat of even greater tariffs. While President Trump has just said that U.S.-China trade negotiations are going well, Commerce Secretary Wilbur Ross has just noted that the U.S. and China are ‘miles apart’ to use his phrase. When/if the U.S. and China get a deal, the U.S. and the EU have negotiations and it seems clear that judging from how the EU treated the UK, the EU is not of much of a mind to bend very much on trade but that remains to be seen.

Kicking the tires on global growth and recession prospects
On balance, the global economy has decelerated. The IMF has trimmed its outlook, but shaving a few tenths of a percentage point off of annual growth rate forecast is not a draconian thing; it is more of a signal than an event per se. The IMF is warning us where the risks lie – just in case we have not figured it out for ourselves. We all know that economies too quickly and easily seem to slip from performing what seems like ‘well’ into an unexpected recession – since nearly every recession is unexpected. Still, there are usually events before recessions like central banks hiking rates (check, in the U.S.) or engaging in other administrative tightening (check U.S. and ECB balance sheets; China has gone the other way to ease reserve requirements again). Markets usually get out ahead of recessions with some sort of kerfuffle (check equity markets; check flattening yield curve in the U.S.). No, the U.S. yield curve has not turned on its very reliable inversion signal, but that switch is not far from being flipped. It could be switch on in the period of less than a week were conditions to sour. So, on balance, I would warn that while recoveries do not die of old age, this one is showing some of the signs of diminished health. And while the Fed has not clearly killed it, the Fed has clearly been at least kicking it in the shins. Now some counter-argue that interest rates are still historically low. But so is inflation and so has been growth. Global trade tensions are historically high as are geopolitical tensions. There is plenty in the pot to make something good to stew over. So let’s not folderol around and pretend everything is fine when we know it is not. This may not be a spot so tight that we need the Great Houdini to get out of it, but we do need for policymakers to get a few a things right and to avoid making some crucial mistakes. My reading is that policymakers in the U.S., the U.K. and the EMU are divided over their respective ‘domestic’ issues let alone over issues where they need to meet and strike a bargain with another nondomestic entity. And I am suspicious of the state of uniformity on policy within China- always more of a black-box. So let’s all have a healthy respect for the risk. You can ‘forget’ the Federal Reserve’s assessment that risks are balanced- that is more foolishness than I have time to dispel here.