Germany's IFO Continues Steady Gain; Still Pessimists Deride Result

A slower pace of improvement in September - The pace of improvement in the diffusion and headline index barometers for Germany’s IFO are slowing their rate of gain this month. After averaging increases of 3.3 points per month since they began to turn positive in April, this month’s headline gain in the diffusion index was 1.6. For the expectations index, similarly, the average gain has been 5.4 but this month the rise was a more meager 1.4 diffusion points.

CONTEXT! While the Sept gain is smaller than what has been on average in this nascent recovery it is also true that September’s report comes on the heels of a very strong August reading where the headline diffusion index improved by 6.1 points and expectations rose by 9.1 points. In the spirit of recognizing volatility, if we average the two months, we are ahead of what has been the average. There are in fact past experiences in this cycle that have seen a slowdown followed by a spurt. For example in June, the IFO expectations diffusion index soared by 7.1 points only to rise by just 1.7 points in July but then to spurt again by 9.1 points in August. So, why make so much of a one month partial stumble?

Separating the wheat from the chaff has always been hard - What is hard in these early recovery periods to separate volatility from trend. In this business cycle in both in the US and in Europe there seems to be a lot of pessimists that are eager to grasp the first sign of bad news and to extrapolate it. I would warn against that here.

Rolling up our sleeves…the recovery trends show us - The diffusion values are somewhat more telling when looked at by sector. Three of five sectors have had their largest in-recovery gain in August. Even so two of those three still posted about as large gain in September as they had in July before the August spurt. Manufacturing is one exception to that and it still had a 2 diffusion point gain in September after an August gain of 7.7 points. Services and wholesaling displayed the strong resilience of spurting in August and still posting a September value about as strong as they had before the spurt in July. Retailing has been fickle in the recovery with its largest diffusion gain in June followed by an outright drop in July which was then followed by two solid-to-strong increases of more than two points in each of August and Sept. Lastly, the construction sector is simply erratic. In the seven months that the other indicators have been increasing almost without fail, the construction index has dropped four times. Among the other four sectors there is only one monthly set-back (in retailing) for all of them.

Summing up - On balance given that the recovery cycle is still young it is hard to look at this month’s IFO sector recovery patterns and to become a pessimist even on the likely speed of recovery. Recovery itself is still in train and we saw improvement in four of five key sectors on their diffusion gauges. The pace of recovery did slow when compared to the previous month but that month was a spike for many sectors. When placed in context, the recovery speed still seems to be quite good with only the one-month result to be a harbinger of a slowdown - and we all know how dangerous it is to base assessments on one single data observation. That the Zew index showed the same sort of soft spot in Sept says only something about September, not about the future. So I will remain upbeat in the wake of this report despite the fact that the weight of opinion is on the other side and despite the euro taking a cue to back-off after this report. The euro back-off makes sense because the trade-weighted and inflation adjusted euro is already so strong. Recovery will be hard to sustain if the euro continues to advance has it has regardless of whether the recovery has already started to slow or not.