Uncertainty of the economy to make you dizzy

Can you still track it? I'm having a lot of trouble. US Treasury Secretary Janet Yellen said this week that the economic outlook has improved quite a bit compared to a few months ago. Larry Summers, one of Yellen's predecessors, said that the outlook for the US economy is bad.

Summers even said that the Americans are heading for a Wile E. Coyote moment. Wile E. Coyote is the famous cartoon character who runs over the edge of a precipice, hangs in the air for a moment while his legs continue to thrash in search of solid ground, then plummets inexorably. Jamie Dimon, the CEO of JP Morgan Chase, also gave an interview this week. He seems to be in the Summers camp rather than the Yellen camp. In any case, it is clear that the uncertainty about the course of the economic cycle is very high.

There are also many unusual developments. Think of the reopening of the global economy after the pandemic, with a special role for China, the war, the huge increase in the European gas price until the end of August, followed by a remarkable and very significant drop, inflation, the strong wage increases, the unprecedented tightness in labor markets and the strong interest rate hikes by central banks. Of these central banks, most have ended quantitative easing (QE) (but not Japan) and replaced it with policies that result in their balance sheets being shortened.

To be honest, I find it very difficult to make a clear assessment of the economic outlook. I understand Yellen. Energy prices, especially the European gas price, have unexpectedly fallen sharply in recent months. In addition, China has stopped the many lockdowns and activity in that country is set to recover strongly. Although it may take some time before the economy is up and running again. In addition, international freight rates have fallen sharply in recent months and problems in supply chains have more or less disappeared. But I can also follow Summers' argument well. He says the latest economic indicators are strong, but several forward-looking signals are much less favorable. He notes, for example, that entrepreneurs are not very positive about their order books, that companies may be employing too many people for the level of their production, that consumers are quickly using up their savings buffer and that companies are building up stocks strongly.

Stock building is important in the business cycle
As for stock building, the question is always whether it is voluntary or involuntary. The difference is that voluntary inventory building is driven by expectations of sales growth – a positive sign – and involuntary inventory building happens to entrepreneurs when demand is unexpectedly weak – a less favorable sign. In the latter case, a reduction in production volume usually follows.

The most recent GDP figures for the US economy show that growth in the fourth quarter was 2,7% (annualized) compared to the third quarter. (Calculated our way, the figure would have been 0,7%). Inventory building at companies contributed no less than 1,5% to that growth figure. If inventory building was largely involuntary, then the total GDP growth figure is quite flattering. My point is that things are going pretty well for now, but the risk of a recession later this year or in the first part of 2024 cannot be ruled out. The US yield curve has been inverted and firm for some time now. The effective yield on two-year government bonds is about 0,8% higher than on ten-year bonds. If a recession does not materialize, it will be the first time in more than 50 years that an inverted interest rate structure is not followed by a recession.

Another factor is that central banks have already raised interest rates sharply and are clearly not going to stop raising interest rates anytime soon. It will take some time for the full impact of such policies on the economy to manifest itself. The total effect is only felt with a delay of 12 to 24 months. It is therefore quite possible that the economy will continue to heat up nicely for the time being, only to fall into a recession later on.

German economy is shrinking
While our economy grew by 0,6% in the fourth quarter, according to Statistics Netherlands, the German economy contracted by 0,4%. That figure was helped by strong corporate inventory builds (as in the US) and a nearly 25% increase in car sales from the third quarter as buyers benefited from lower taxes before the end of the year . Private consumption and investment in machinery fell by 1,0% and 3,6% quarter on quarter respectively. Nevertheless, German entrepreneurs are gradually becoming more optimistic. The Ifo index, which measures business confidence, rose from 90,1 in January to 91,1 in February as the following picture shows. It is striking that expectations improved strongly, but that the assessment of the current situation fell back slightly. Economists tend to place more value on expectations.

Looking at the picture, I noticed that the gap between the expectations component and the assessment of the current situation became very large last year. The following picture shows the difference between the two series. And indeed, in the last 18 years, the gap has never been larger than in September last year. It must be no coincidence that an improvement has occurred since the European gas price started to fall.

It is significant to note that Dutch consumer confidence also reached a low point in September last year and has since improved somewhat. The gas price will also have played an important role here. I actually expect that the positive development of consumer confidence will continue in the near future. The collective labor agreement wage increase continues to accelerate and the purchasing power support measures taken by the government are being felt in full.

Earlier this week I spoke to an acquaintance who is on unemployment benefits. Her husband receives an ABP pension. She was pleased with her finances. Due to the increase in the minimum wage, her benefit had gone up and the ABP has significantly increased the pensions. She said she had rarely experienced such an increase in her income (although she may be suffering from a bit of a "money illusion," meaning she may not be taking inflation into account enough). Another acquaintance was surprised that the health care allowance he receives for his three children has risen so sharply. He actually works for Goldman Sachs and was not really eager for the extra money. And yet another acquaintance was surprised that in November and December he had received 190 euros per month not only for the house in which he lives because of the increased energy prices, but also for his second home. He also didn't really need that money to keep his head above water. The moral of this story is that the measures to support purchasing power may be a bit too generous (or too little specific). There is no doubt that they will support consumer spending.

Closing
The immediate economic outlook has improved significantly in recent months. The spectacular fall in the European gas price plays a leading role in this. The reopening of China is also of great importance. Furthermore, the reduction in international container rates and the resolution of supply chain disruptions are helping. In our case, it also applies that the accelerating wage increase and the government's purchasing power support measures are giving a strong impulse. Still, we cannot rule out recessions in the US and/or at home later this year or in 2024. The higher interest rates will still be fully felt while the central banks are far from done with interest rate hikes. Naturally, energy prices could also rise sharply again. But, it must be said, so far, so good.

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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