Charts of the Week (May 19, 2023)

The US yield curve The shape of the US Treasury market yield curve still suggests very high odds of a US recession in the period ahead. Front-month yields are still well above longer-dated yields, for example, and even more so at present relative to three months ago (see chart 1). Investors are, in other words, assuming the US economy will respond much more negatively to the Fed’s prior tightening campaign in the immediate months ahead and that this will, in turn, prompt a pivot toward easier monetary policy by the end of the year.

Private sector de-leveraging The pace at which households and companies deleverage their balance sheets will be key for resolving the hard versus soft landing debate in the period ahead. A steep climb in private sector savings balances is, after all, usually a key channel via which recessionary forces take hold. That these balances have started to creep up over the last few months, as savings propensities have climbed, is therefore of some concern (see chart 2 below). With banks now also more actively tightening lending standards and thereby choking off the supply of credit, this deleveraging process may have further to run in the coming months.

China’s economy Turning to China where this week’s data were disappointing, to say the very least. April’s industrial production and fixed asset investment growth, for example, both fell well short of economists’ expectations. Retail sales growth was admittedly much stronger, climbing by 18.4%y/y in April, after 10.1% in March. But those numbers too disappointed the consensus. Most of that growth, moreover, can be traced to services (e.g. restaurant dining); spending on goods - which would have bigger domestic and global spill-overs - was much weaker. That China’s inflationary pressures have remained dormant in recent months, even as a reopening phase should have unleashed firmer demand, is perhaps no surprise against this backdrop (see chart 3 below).

Japan’s economy That absence of international spill-overs from China’s recovery phase may be one reason why Japan’s economy has not picked up more pace in recent months. In fairness, Japan’s GDP grew by 0.4% q/q in Q1, a relatively impressive pace compared with expectations (which were centered on growth of 0.1%). Growth would have been much stronger than this, however, were it not for a big drag from net trade. As chart 4 below suggests, net trade has derailed Japan’s economic growth over the past few months, in part because of the weakness of China’s import demand. Note: The inventory contribution for Q1 2023 is unavailable and therefore excluded from the calculations in this chart

The UK labor market Another high profile data release this week concerned labor market activity in the UK. And on the whole, this was an inflation-friendly report, which provided some welcome news for the Bank of England. Most gauges of activity, for example, suggested that a lot of heat is now coming out of the market. And the same could be said of the gauges for wage pressures as well.

Inflation, demand and profits Unsurprisingly there is an active debate at present about the causes of stubbornly high inflation. Some economists, for example, have been emphasizing the leeway for companies to lift prices beyond what might be construed as normal relative to their unit costs in order to ramp up profitability. The latest evidence from the Atlanta Fed survey of companies’ inflation expectations, however, does not sit neatly with this narrative. Profit margins, for example, are not deemed to be that high at present relative to the averages that have prevailed over the last 10 years. It is noteworthy too, incidentally, and relative to another narrative that concerns the role of loose policy and demand pressures, that there is also little evidence to suggest that heightened sales activity (i.e. additional demand) has been a key cause of higher inflation either.