Economic aftershocks of the pandemic

The corona crisis can certainly be called an earthquake for the global economy. Now that the pandemic seems to be behind us at least in our kind of countries, we are still experiencing unprecedented aftershocks. Some of them are negative, others positive.

In China, the virus has not yet been contained, according to the authorities and there are still strong restrictions in public life, although these are now being scaled back. The effects on the Chinese economy are evident. In April, manufacturing production was 2,9% lower than a year earlier, after +5,0% in March. Retail sales are also taking a hit. Turnover in March was already 3,5% lower than in March 2021, in April it was -11,1%. Not all that much better than just after the pandemic broke out. It is inevitable that we will notice this in the form of new problems with deliveries from China.

The Chinese economy has already cooled without the lockdown measures of recent months. The number of homes under construction, long an important growth engine, has been declining for some time. The number has been lower since August last year than a year earlier. In April, that counter stood at -28,4%. Sales in April were 32,2% lower than in April 2021. The mood indicator for the real estate market has also fallen sharply in recent months. It is therefore not so surprising that the Chinese central bank cut its benchmark mortgage interest rate for the second time this week.

Opposing signals from the US
The US economy also appears to be experiencing aftershocks. Everyone knows that inflation has risen sharply and remains stubbornly high. The following chart shows that rapidly rising mortgage rates are already taking their toll on the housing market. The number of existing homes sold has fallen since the beginning of the year from about 6,5 million per month (annualized) to about 5,6 million, a decrease of just under 15%.

Not surprisingly, then, the NAHB index, which measures sentiment among homebuilders, fell for the fifth consecutive month in May: 69 from 77 in April and 84 in December 2021. The organization's chief economist said: "The housing market is building materials cost is up 19% from a year ago, mortgage rates have risen to their 50-year high in less than three months, and based on current affordability, less than XNUMX% of selling new and existing homes affordable for the average family."

The first indications of how producer confidence is developing are not positive. Both the Empire State index (New York Fed) and the Philly Fed index fell in May. The Philly Fed index came in at 2,6, its lowest level since May 2020, from 17,6 in April.

On the upside, there was also something to note in the US this week. Retail sales, for example, continued to grow strongly in April, although the picture is distorted by the rise in inflation. Production in the processing industry is also steadily increasing. I find the following chart quite intriguing. In the six years before the pandemic, manufacturing output in the US barely grew on balance and the index hovered around 100 throughout the period. Obviously, production fell sharply when the pandemic broke out and the economy closed down. Recovery followed after April 2020. It then took more than a year before the old production level was reached again, but now the increase in production seems unstoppable. Somehow, there seems to be a lot more dynamism in US industry than before the pandemic.

Stagnation of the Dutch economy in Q1 is too negative
The Dutch economy more or less stagnated in the first quarter. Real GDP in euros increased by a negligible 52 million. Foreign trade and investment contributed positively, while government and household consumption contributed negatively. Government consumption in particular fell sharply: -4,0% and as a result GDP was 1% lower. It must be realized that much government consumption is 'demand-driven'. Government consumption fell, among other things, because less use was made of test streets and vaccinations.

Private consumption also fell slightly in real terms (-0,1%). That surprised me and seems to be at odds with the fairly strong retail sales data. The CBS told me that the setback in household consumption was probably mainly caused by the weather. The milder weather than a year earlier and also than in the first quarter, led to lower energy consumption. That depresses family consumption.

My conclusion is that the growth figure paints too negative a picture of what was actually going on in the first quarter. This does not alter the fact that a growth slowdown is imminent, which can easily lead to contraction.

Labor market is running like a charm
At first glance, the labor market in our country is running smoothly. Unemployment fell to 3,2% in April, a record low. Before the pandemic, unemployment was 4,0%. The number of jobs increased by an average of 38.000 per month in the first quarter. The employed labor force was 9,5 million people in April. That is 3,3% more than before the pandemic. Pretty impressive. Incidentally, real GDP is now also higher than before the pandemic, at around 3,1%. These two numbers together suggest that the average productivity is not really looking to float. In the US it is clearly different. The number of workers there is still 0,5% lower than before the pandemic, but the real GDP is 2,8% higher. So they produce more with fewer people there.

The tension in the labor market is unprecedented. The number of job openings per 100 unemployed rose from 106 in the fourth quarter last year to 133 in the first quarter (190 in the US, by the way). It is said that companies post vacancies that they ultimately do not want to fill. They would do that to get or maintain a sense of the labor market.

Retailers are clamoring for the loudest due to lack of staff. According to Statistics Netherlands, nearly 40% of retailers say that their business operations are hampered by staff shortages. That's amazing. If we are not careful, staff shortages will form a wall for further economic growth. There was already a shortage of labor before the pandemic. Yet at the time 'only' about 10% of the entrepreneurs surveyed said that staff shortages hampered business operations.

I see the tight labor market, not just here, but elsewhere, and especially in the US, as a wondrous aftershock of the pandemic. It also has consequences for the supply of labour. The labor participation rate, ie the proportion of the population entering the labor market, has risen to record levels in our country (figures go back to 2003). That is not the case in the US.

Pressure on stock markets
Equity markets continue to be under pressure. So far, the main culprit has probably been rising interest rates, which are putting pressure on valuation levels. Interest rates will continue to rise, but much of the needed rise has probably already been factored into share prices. Now the exciting thing for equity investors is whether the economy will enter a recession. If that happens, corporate profits will also take a hit. Such a 'double whammy' of lower corporate earnings to which lower valuations are unleashed would be painful. I think the chances of the US avoiding a recession are very reasonable. It's a lot harder for Europe, but stock markets are more influenced by what happens in the US than what happens here.

What is the probability that we will end up in a recession?
The global economy is currently experiencing unprecedented aftershocks from the pandemic. It therefore regularly appears that various indicators are inconsistent. Consumer confidence is very low everywhere, but this is not reflected in a weakening of consumer spending, on the contrary.

Many countries are experiencing unprecedented labor shortages. The figures may exaggerate the actual shortage, but this is an enormous challenge for entrepreneurs.

Amid all the turbulence, stock markets are under pressure. The situation is uncertain. Most of the expected interest rate hike has probably been incorporated into share prices by now. A possible recession will put pressure on corporate earnings and lead to further price losses. I estimate the chance that we will end up in a recession in Europe at more than 50%, while I estimate the chance for the US at less than 50%.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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