Is more optimism about the economy in order?

Business confidence in Europe continues to increase, as does the chance that we will avoid a recession. Mainly thanks to a falling European gas price, the easing of supply problems and the end of the Chinese lockdowns. Industrial activity is holding up, but there are major differences between sectors. The US economy is stronger than expected, but risks remain.

The global economy is doing better than I expected. Well, I mean mainly in Europe and the US. Not that things are worse elsewhere, but I'm just focusing on Europe and the US here. I've been pretty pessimistic for the past few months. I'm debating whether it's time—or well overdue—to shake off that pessimism and unleash my natural optimism. Business confidence in the Eurozone has been improving for several months now. The important German Ifo index, which measures business confidence in our eastern neighbours, rose for the fourth month in a row in January: 90,2 against 88,6 in December. Within that index, economists attach particular value to the expectations component. It rose sharply: from 83,2 in December to 86,4 in January.

Our own CPB reports monthly on the growth of world trade. Putting those numbers together is painstaking work. The margin of uncertainty is undoubtedly wide and the figures are a few months behind, but they are certainly interesting figures. The most recent figure concerns the month of November. In that month, the volume of world trade (measured by the import volumes of countries) fell by 2,5% compared to October. There was also a decline in October: -1,4% month-on-month (mom). China was clearly the weakest link, with import volumes down 6,2% mom in November. But now the lockdowns in China are over and a decent recovery in activity and trade can be expected.

This is also reflected in the German Ifo survey. After six months of increasing gloom, export expectations improved slightly in January. Interestingly, entrepreneurs in the chemical and automotive sectors in particular see improving export opportunities. With regard to chemistry, this is undoubtedly related to the now sharply reduced European gas price (€53/MWh at the time of writing, compared to approximately €15 to €20 before the pandemic, around €340 at the end of August 2022 and approximately €90 exactly one year ago). And the automotive sector benefits from the disappearance of chip shortages. I was actually surprised that, on balance, industrial activity has held up reasonably well in Europe. In addition, energy consumption has been noticeably reduced. This raises the question of how easily we can reduce our (industrial) energy consumption. A wonderful analysis here to find.

My good friend Carsten Brzeski and his colleague Bert Colijn (both from ING) identify three remarkable groups within the industry in that publication. Energy-intensive companies have cut their production very sharply, by more than 10%. The companies that have benefited from the pandemic and the lockdown (pharma, some ICT subsectors) continue to expand their production for the time being. In addition, there are companies that benefit from the end of the lockdowns and the disappearance of logistical problems (such as the car sector). For example, large parts of the industry are still strongly influenced by special factors. This makes the future unpredictable. Incidentally, the fall in industrial energy consumption appears to be mainly caused by a shift in production from energy-intensive sectors to sectors with much lower energy consumption. Carsten and his colleague Bert Colijn speculate that it may also be due to the thermostat of the heating, which according to both gentlemen has been turned down slightly.

Less reason for pessimism, more for optimism
On balance, I see reason not to look too pessimistic about the near future. Perhaps downright optimism may even be in order. For me there are three main factors at play here. The first and most important is the sharp drop in European gas prices since August. In joint second place are reduced global logistics disruptions and China's opening up. The chance of avoiding a recession has therefore increased considerably.

According to preliminary figures, the US economy grew by 2,9% in the fourth quarter of last year compared to the third quarter (annualised). That was fractionally better than expected. Growth for the year 2022 as a whole now stands at 2,1%. But much of that stemmed from strong growth in 2021. The volume of US GDP in the fourth quarter was only 1,0% higher than a year earlier. So you could also say that the economy has only grown 2022% in 1,0.

The composition of growth in the fourth quarter was also less than impressive. Inventory building contributed 1,5 percentage points to the total of 2,9% and foreign trade contributed 0,6 percentage point. The latter was undoubtedly due to reduced imports from that country caused by the Chinese lockdowns. We'll see how it goes. I must say, so far, so good. For now, the US economy appears to be heading for a soft landing, ie a gradual but steady reduction in inflation without slipping into a nasty recession.

There remains a certain vulnerability
Things can still go wrong and the economy will still end up in a recession. The Fed will undoubtedly raise official interest rates further next week, most likely by 0,25%. It would not be the first time that the Fed goes too far with rate hikes and then triggers a recession. The interest-rate-sensitive sectors have already suffered significant blows. This mainly concerns construction and the housing market. For now, there is no change in sight. The number of building permits issued for homes, for example, continues to decline. It should be noted that capital market interest rates have been falling for some time and mortgage interest rates (fixed for 30 years) have fallen by almost a full percentage point since their peak in October/November. The US housing market and construction sector usually react quickly and strongly to fluctuations in interest rates. So it could be that the capital market is correcting a possible 'mistake' by the Fed. We will see.

Another notable development in the US economy is that households are saving significantly less from their current income than before the pandemic. Admittedly, during the pandemic they were able to spend less than usual and that is how substantial savings have been built up, just like with us. The fact that private consumption can still grow somewhat in volume despite high inflation is due to the low savings rate. It is impossible to predict how sustainable this low savings rate will be. We have never experienced this before. Who knows may say. It is conceivable that the savings rate will rise and that consumption growth will weaken as a result. But it is also possible that inflation will fall further, boosting real income growth and keeping the savings rate low. This could actually boost consumption growth.

Closing
I've been pretty pessimistic the last few months for me. Several people have approached me about this. Not that that's why I'm considering 'going'. Undeniably, the various economic indicators and business sentiment in Europe and the US have been better than expected recently. In my view, the explanation for these windfalls is threefold: the much lower European gas price, which lowers the cost price, the reduced supply problems, which means that production gains momentum, and the end of the Chinese lockdowns, which means that world trade will probably pick up.

There is also still reason for some caution with regard to this optimism. The central banks, for example, are continuing to raise interest rates, while interest-sensitive sectors have already suffered significant blows. In addition, the figures on industrial activity certainly do not look bad, but behind these figures there are major differences between sectors, the further development of which is difficult to predict. The opening of the Chinese economy will also undoubtedly take place in fits and starts. This could lead to new bottlenecks and higher inflation. Finally, private consumption is holding up well in the US, but this is partly driven by a low savings rate. Should it unexpectedly rise, the foundations of economic growth in the US will become weaker. On balance, I tend to shift a bit from pessimism to optimism.

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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