German and French Sector Confidence Slip

Business climate in Germany, as measured by the IFO index, has been on the rise, but it suffered a setback in February. Similarly, the French INSEE survey for manufacturing and for services has been on the rise, but each of these measures hit an air-pocket in February.

While these surveys still point to solid growth, there is a sense of backtracking. The French services climate indicator is at its lowest reading since May of last year. The French manufacturing trend has essentially been a one month stumble. The German IFO reading was last weaker in September of last year but has only been consistently weaker since June of last year.

The rankings of the various IFO segments continue to be exceptionally high. The weakest sector is retailing at its 93rd queue percentile standing. The overall business situation, as evaluated by the IFO, has been this good or better only 0.6% of the time while the queue standing for expectations is only in its lower 80th percentile decile at 81.7% (lower nearly 18% of the time).

For France, the INSEE survey puts the industrial climate in its top 2.5 percentile- another extremely strong reading. The manufacturing production trend is in its top 1.5 percentile. However, the recent trend and likely trend for production are somewhat weaker, a similar phenomenon to the IFO expectations standings that are weaker than its current readings. French orders and demand are still very strong. The price outlook is elevated with a strong reading in the mid to low 80th percentile range for manufacturing prices and the likely sales price trend.

The French services sector turns in a substantially weaker view of conditions with a climate ranking in only its 65th percentile. This is much weaker than the queue standing for the French services PMI from Markit also released this week. In this case, the difference in the two rankings owes to the selection of the time period. If we evaluated the INSEE services on the same timeline as Markit (five years), the service sector rankings rise to their mid 90th percentiles or higher for the components in the top of the table. The headline itself rises to its 88th percentile. Much of the very high French ranking for services we see in the Markit PMI is a function of the extreme weakness for services in France over the last five years. When we evaluate French services on a broader timeline, we get more of a sense of the service sector's mediocre performance. Of course, this is not true of manufacturing, which even over the broader period continues to rank at a standing comparable to the ranking from the Markit PMI metrics applied over just the past five years.

The French services sector on this broader time span shows weaker prices with readings for expected prices substantially below their median in the 41.9 percentile (the median is at the 50th percentile). Expected sales are only in their 53rd percentile while observed sales over three months have a much stronger 80th percentile standing. Employment has a 96th percentile standing, but the outlook for employment has a much weaker 66th percentile standing. Do you see a trend here?

Implications...

The bottom line is that there is some weakness creeping into even these strong readings. The German IFO index has weakening expectations- still at a strong level but much weaker than the standings for current observations. In France, we see solid and strong manufacturing readings with a service sector reading that is exaggerated by comparison with recent weak conditions and that suffers further when we step away from current readings to ask about expectations.

Also on the day, the U.K. released a Q4 GDP estimate that showed growth trimmed back by a tick to a quarterly gain of 0.4% instead of 0.5% and year-on-year growth of just 1.4%. Moreover, a quarterly 'distributive trades' survey for the U.K. has showed weaker retail sales expectations there.

Of course, monthly data ebb and flow. I cite theses various elements to counter the still growing belief that the global economy is gathering momentum. Conditions are improved from what they were one-and two-years ago. But what I fail to see is the sense of ongoing acceleration. As such, I still tend to see current growth as relying upon and being helped by the degree of accommodation in monetary policy. The lack of building inflation pressures and repeated softness in retail measures suggest that demand is still not on track. Perhaps the biggest misjudgment about demand being put back on track is in the U.S. where hurricane damage put a brave face on consumer spending, but now a lower saving rate and fading real earnings trends offer a starker view of the future.

Central bankers are quick to switch their worries over to inflation-fearing. They know that they will not get the credit for extending growth but will be blamed if they let inflation prop a foot in the door and gain entrance. But the largely unasked question is whether this sort of bias still suits the global economy well. Inflation and episodes of hyperinflation can color memories and dictate policies. But history is also replete with long episodes of stable prices. Central bankers are not asking themselves if they are making policy in a different risk regime from the pre-great recession predecessor periods. Essentially no one is asking the right questions. During a period in which academics in the U.S. have scrutinized inflation models and concluded that there is no model that has worked consistently well, the Federal Reserve continues to make policy that relies on its forward-looking beliefs. We should ask ourselves if this means that economics has become a religion instead of a science.