Consumer Climate Experiences Global Warming in Germany; Can It Continue?

The GfK consumer climate index for Germany that projects climate from March has improved to a reading of -30.5 from -33.8 in February. This marks the 5th month in a row that climate in Germany has improved. So far, the steps are small, but they are persistent. Economic expectations, a survey that lags by a month, have four improving months in a row; income expectations, also on a one-month lag, have five improving months in a row. The propensity to buy, another lagging component, however, is only just improved in February from January whereas in January had deteriorated compared to December. Propensity to buy readings are hovering closer to their cycle lows although the cycle lows are nowhere near global lows for this series, as they are for climate and income expectations.

The context for this month: History- Despite the rather widespread and now nearly half-year trail of improvement, the path of improvement is a shallow one and the current readings for climate and most components remain stuck at historically low levels. Climate has been lower than its March reading only 2.7% of the time on data back to January 2002. Economic expectations fare the best of the lot, with a 48.4 percentile standing as of February, marking it is quite close to its historic median level (which would be marked by a 50-percentile standing). Income expectations have a very weak, 3.5 percentile standing; they are weaker only 3 ½% of the time. Consumers’ ‘propensity to buy’ is weaker than its February reading only 20% of the time. Climate alone has a March reading; the components have readings that are up to date as of February.

Elsewhere in Europe- In addition to the improvement in Germany, the U.K. logs an improvement (on data current through February). France posts a February setback but on readings that have been rather stable over the last five months. Italy's most recent reading is in January; it marks a decline to 100.9 from a level of 102.5 in December. But each of those two readings is still the strongest reading on Italian confidence since May 2022.

Why the optimism? Given the conditions in the global economy, continuing challenges for supply chains, the ongoing and still very intense war between Russia and Ukraine, as well as escalatory rhetoric, and what continues to be some very stubborn inflation, consumer expectations have continued to move up or stabilize. It’s unusual.

Follow-the-leader-globalism- I think it's fair to say in this cycle the round of extreme interest rate increases was triggered by action at the Federal Reserve after a delay as it watched inflation rise for a year in a state of denial. That combined with an early strange statement in the U.S. tightening cycle from Fed Chairman Powell, at one time calling the federal funds rate neutral (article here), when it seemed to be anything but neutral. This has encouraged markets to think that the Federal Reserve is close to pivoting and turning rates lower. Were the Federal Reserve to do this, it would probably turn the entire global rate cycle lower. In fact, in the wake of the Federal Reserve’s recent action to reduce its pace of tightening, we have seen other central banks around the world also reduce their pace of tightening at the same time. It is true that countries are experiencing a lot of the same conditions, but this timing among central banks has more to do with shadowing the Fed and worries about exchange rates, than it has to do with targeting specific domestic events- that is except for Japan. In Japan, the rise in inflation has been, in some sense, welcomed. The rise in inflation is treated there with the special kind of warmth with skepticism because it had such a hard time getting inflation anywhere near its 2% target after chronic undershooting. For this discussion, we put Japan in a separate box and set it aside.

Pit current inflation against current optimism; They are oil and water- Today's inflation report from the U.S. on the Federal Reserve’s preferred gauge of inflation (the PCE) was stunning and unexpected. This report could restart a period of accelerated rate hikes in the U.S. What is clear is that inflation is not behaving on its own as many market participants have seemed to believe and as the Federal Reserve itself claimed when inflation first showed up in the U.S.

Team transitory hits another pothole on the road to optimism- People on this policy bandwagon were known as members of ‘team transitory.’ Team transitory had to eat crow when inflation remained stubborn and accelerated. But, more recently, there has been a revival of the movement with global dimensions. Many have looked for other central banks to slow the pace and possibly stop raising interest rates relatively soon on the belief that inflation was already receding and that perhaps enough had been done. And this has happened- to some extent.

Premature celebration is a disease- I have compared this to popping the champagne cork in the third quarter of a sporting event with the fourth quarter yet to be played and the home team still behind but narrowing the gap. There really aren't too many people who would celebrate in that circumstance in a sports event. It's surprising how many people celebrate in that way in financial markets these days. Interest rates remain well below inflation rates and central banks continue to talk as though they have interest rates back to neutral or as if too-low interest rates are restrictive. I think this has encouraged people to think that the turning point for policy is close and I think it's one of the things that we see when we observe consumer confidence rising.

Summing up and a warning- There is some strange newfound hope that perhaps a soft landing can be achieved. But some news from the U.S., and in some sectors in Europe, shows the economies have been reinvigorated. Sectors revival is now an issue. And inflation has reaccelerated and/or is hovering well above the level of short-term official interest rates, suggesting that if inflation is going to be controlled, interest rates will need to go up considerably more. That, once again, is going to cast a disparaging light on the concept of soft landings, pivots, team transitory, and other sugar plums that dance in the heads of the optimists. Moreover, that analysis will spread globally. This is my cautionary tale for interpreting the ongoing improvement in consumer climate this month and for the month ahead. Is it real? Can it be sustained? Or is this temporary? And possibly, is it even an economic illusion? Optimism has dissuaded central bankers from staying-the-course and raising rates apace. Why are they so eager to stop hiking and willing to risk extending or worsening inflation? These are questions we need to entertain in the coming months. As always, keep your eye on the data, and I would encourage looking at the data much more than looking at the market reactions and thinking that the markets know something. Everything we see out there should convince you that the markets, like John Snow, know nothing. Markets should know better than to trade on any four-letter word even if that word is ‘hope.’