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Economy in Brief

German IFO Climate Reading Backs Off
by Robert Brusca  July 26, 2021

Climate
Germany's IFO climate reading backed-off in July, edging down to 21.3 from June's 22.6. Of the five sectors, four saw deterioration with construction as the lone sector showing improvement. Long-dated percentile standings show most sectors with headline ranking in the mid-70th percentile to mid-90th percentile range with services as a notable exception on a rank standing of 38.9%, well below its historic median (…a median which occurs at a standing of 50%).

Climate standings and progress
Compared to pre-Covid climate levels, all sectors are stronger except construction where climate is lower by 7.7 points. Services that gave back 2.7 points in July are only 0.8 points above their January 2020 level. The largest gains are made by manufacturing (+29.8) and wholesaling (+17.2). Retailing is only 8 points higher than January 2020, but retailing has the highest percentile standing for climate among all sectors.

Current business conditions vs. expectations overview
Overview: The current business situation improved in the month by 1.5 points while expectations fell by 5.3 points. Both have mid 70s percentile standings. The current business situation is up by only 2.6 points compared to January 2020 while expectations are much improved up by 18.7 points.

Current business situation
The current situation is improved month-to-month and is mildly stronger in July 2021 than it was in January 2020. Four of five sectors improved month-to-month with retailing as the exception, falling by just less than a point month-to-month. Even so, retailing is one of the strongest sectors with a rank standing at 96.9% just below wholesaling at 97.4%. Manufacturing logs a strong 87.1% while construction pops a top 20th percentile standing at 83.5%. What is lagging and holding back the assessment of the current business situation overall is services where the rank standing is just out of its bottom quartile at 26.3%.

Covid and the recovery
Covid came and hammered the German economy then there were a series of recoveries and setbacks with more recoveries. On balance, the largest lasting recovery by sector is in manufacturing where the current index is some 35 points above its January 2020 level. Wholesaling is 20.7 points above its January 2020 level. Retailing is stronger by only 4.7 points but with a very strong overall standing. Momentum weakness is still present in construction (-11.9) and in services (-17.2). We identify construction more with investment and services more with jobs. And certainly jobs have lagged coming back. Investment trends seem mixed which fits right in with sector performance. However, one thing that the virus seems to have done is to have hammered a bit more on real estate with more people staying home and afraid to go out; that has siphoned a lot of business away from traditional places - especially in the hospitality industry and for tourism. It is not surprising that construction remains hard-hit.

Expectations
Expectations are a different story, but that story is changing from what it once was. Expectations led the IFO recovery higher but now is being surpassed by current conditions and by actual improvement. Two factors operate here. One is that the business situation has improved as expected and so expectations for even more improvement subside, in a more-or-less natural response. The other aspect is that there is still a lot of economic repair that is needed; it is too soon for expectations to stumble, but stumbling they are. The ‘last mile' of repair now appears to be a more difficult thing to accomplish.

Expectations, their standings and their meaning
Expectations have no stellar sectors in terms of standings. In fact, the highest standing is the 86.6 percentile reading for services; that certainly has a lot to do with the fact that the business conditions reading in the sector is only 26.3 percent. It is not that the sector is expected to fly, but that it is heavily expected to pick up from its lower quartile boundary especially with better readings all around from other sectors. Manufacturing expectations have a solid 79.9 percentile standing despite the solid current standing. The sector is a clear bright spot in the economy. Retailing, too, with an impressive current standing has a 71.6 percentile standing for expectations. The good times in retailing apparently are still expected to roll. But construction and wholesaling have sub 50th percentile readings for expectations, below their respective historic median readings. And construction at a 23.2 percentile standing is lagging more than wholesaling at a 46.9 percentile standing. That means the good times in wholesaling are less expected to endure and the same goes for construction where expectations are even weaker and current performance has not been as strong.

Progress in expectations
For expectations all sectors show a rise from January 2020 except construction. And all rising sectors have double-digit gains from January 2020. Among sectors manufacturing and services have the strongest point gains in expectations from January 2020, but those gains seem to mean different things. For manufacturing it is a vote of confidence in the current high level of performance continuing whereas for services it is a vote of confidence that the sector will not continue to languish in the bottom scraping fashion that it has.

No surprises in July but the variant is stalking...
As such the IFO survey is not very surprising this month despite the facts that there was a drop off in climate. Current conditions did continue to edge higher. There is a reignition of the virus globally on the back of the delta variant. It is not clear how much that will interrupt economic performance in Germany since people are tired of lockdowns and governments are besieged by protests when they order new ones. While the D-variant is more communicable, it is less toxic in general (which is the ‘modus operandi' of most viruses). Also, more people have been vaccinated so while there may not be a high enough proportion vaccinated to create herd immunity based on the heightened infectious rate of the new variant, there is enough to buffer the spread and to keep outbreaks local and confined to pools of unvaccinated persons.

Summing up
Where this goes next is hard to tell. Some seem far more afraid of variant-D than they should be. I live in NYC in an area where vaccination levels are very high and, recently, I am impressed by how many people are, on their own, choosing to wear masks in public and not just as mandated on public transit. There is a certain level of fear in play here in NY. And there are the usual scare mongers looking ahead to the coming (well…eventually- never too early to worry, you know) cooler weather. Currently in NY weather is hotter and hotter and extremely humid so yeah, let's worry about when cooler weather comes… And let's worry (now!) about the prospect for more spreading because of more indoor activity then. And then there is worry that a newer variant that is even more lethal might emerge (to say nothing of the possible appearance of Big Foot!). Fear springs eternal. I guess we'll have to wait to see what damage it does. So far in Germany (see the chart), it only seems to have blunted the rise in expectations and has not hammered them lower. Just when we seem to have the virus corralled, like a wet and slippery bar of soap it squirts from our grasp into the unknown. But it seems to have fewer and fewer place to go and fewer ways to work its mischief barring some unlikely turn of biological events. But let's face it: one of the hallmarks of this pandemic has been overreacting to the small probability of a bad event and to the even smaller and very tiny probability of a catastrophic event. At the end of the day, this virus really is not much of a risk to healthy people vaccinated or not yet healthy, vaccinated, people are on the run again... What the impact will be, well…your guess is as good as mine. Whatever it is, it does not even need to make sense to be true. Fear follows its own rules, it does not follow science.

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