Charts of the Week (Mar 10, 2023)

The US labour market Incoming data this week continue to suggest that the US labour market is tight and certainly too tight for the Fed’s comfort. Still, there are some early signs that employment growth may be cooling off. For instance, the details of this week’s ADP report for February reveal that small companies have been shedding labour for the past five months (see chart 1 below). While the history of this survey is admittedly not that long, the details nevertheless suggest that employment activity in the small company sector tends to lead activity in the broader US labour market.

The global business cycle At the broader global level, there was some tentative evidence too from this week’s sentix surveys to suggest that growth momentum is cooling. Having posted four consecutive monthly gains from last November through to February, the forward-looking expectations component from the global aggregation of these surveys slipped back into negative territory in March. Combined with a still-weak current situation index, this suggests the world economy may be turning down again, as our business cycle clock in chart 2 below suggests.

Global growth momentum There has, however, been some disconnect between sentiment data and harder economic data in recent months. GDP growth in Q4 2022, for example, was very weak in a number of major developed and developing economies even as sentiment data were beginning to strengthen. Indeed, outright contractions in output were recorded in the likes of Germany, Italy Brazil, South Korea, India, and South Africa. The relative resilience of the US economy in Q4 against that data is placed in some context in chart 3 below.

China and the world economy With the US economy now expected to lose momentum in the coming months under the weight of tighter Fed policy, a key question is whether or not China can take over the mantle of global growth leadership. From 2010 through to 2019 China accounted for roughly one-third of global GDP growth (measured at PPP-adjusted exchange rates). But during its COVID era, from 2020 to 2022, China’s average contribution was less than one-tenth of the total (see chart 4 below). Whether China can now re-establish its pre-COVID contribution in the year ahead, however, remains to be seen, not least following the announcement this week of an underwhelming GDP growth target for this year of 5%.

Inflation expectations in the euro area On a brighter note, medium-term inflation expectations have declined sharply in the euro area according to the ECB’s January Consumer Expectations Survey. Three-year ahead expectations specifically fell to just 2.5% in January from 3.0% in December (see chart 5 below). On a country-level basis, moreover, median inflation expectations three years ahead are now at the 2% target for Germany and only marginally above for France. It almost goes without saying that this is good news for the ECB’s doves.

Financial markets Our final chart this week illustrates the continued importance of monetary policy for the broader financial market outlook. Longer-term US real yields, which are heavily influenced by expectations for Fed policy, have been highly correlated with global equity markets over the past few years (see chart below). But based on that relationship, equity markets appear richly valued at present relative to prevailing levels of real yields (see chart 6 below). That means that equity investors could be more relaxed about the interest rate outlook than bond investors. But another possible scenario is that expectations for profitability have stepped up in recent months thanks to improving supply-side conditions and even though the Fed has become more anxious about inflation.