Dismal Economic Data Out of Germany
Economic news and commentary for August 25, 2023
Germany GDP & Ifo Survey
The German economic struggles are more clear-cut than ever after another round of data showed stagnation last quarter and now points to further sluggishness in the third quarter. Since the pandemic ended and gave way to an energy crisis in Europe, Germany has limped forward toward normalcy with a crippled industrial sector and sharply higher consumer prices. Now, it faces a new set of headwinds in the form of higher borrowing costs and tighter financial conditions as a result of the ECB’s unprecedented hiking cycle. The effects of those headwinds are making themselves known in 2023.
German GDP growth has suffered greatly in the first half of the year unlike the first half of 2022 which included a quarter with a 1.0% QoQ expansion in Q1 2022. The latest report from Destatis confirmed that Q2 2023 GDP growth was nonexistent following a slight contraction in GDP in Q1 2023 of -0.1% QoQ. Household consumption was also nonexistent following two quarters of declines in spending, and the government provided very little help with just 0.1% QoQ growth in the quarter. Gross capital formation was the segment with the strongest gain, 2.1% QoQ, but the underlying details of the increase are weak. A strong deterioration in -1.7% QoQ in Q1 set up Q2 with a low base where an 0.4% QoQ recovery in inventories could make a substantial contribution. All of that was offset by a decline in net exports of -0.6% QoQ where exports fell -1.1% QoQ and imports were unchanged.
The industry breakdown of growth suggests that the last bit of momentum that was in the service sector has fallen away. Major services industries such as trade, transport, accommodation and food services (-1.4% QoQ), financial and insurance activities (-2.1% QoQ), and business services (0.0% QoQ) all combined to be a drag on Q2 growth as contractions accelerated in each area. In 2022, the dynamics in these service sectors were much healthier as there was still some lingering demand from the post-pandemic lifting of restrictions. As that fades away and consumers’ excess purchasing power is eroded by the cost-of-living trends in the past two years, sticky services inflation will continue to construct the sector’s growth prospects. There is no help from the industrial sector of Germany as that segment fell -0.6% QoQ in Q2, the third straight contraction.
The latest data paints an even worse picture of the German economy in the current quarter. The first was a very weak Flash PMI of 44.7 for the month of August which is the lowest in 39 months. This included a Flash Manufacturing PMI Output Index at a 39-month low of 39.7, and a Flash Services PMI where the Business Activity Index indicated the sharpest rate of decline since November 2022. The most recent ifo Business Climate Survey compounded the pain. The headline Business Climate Germany index fell to the lowest since October 2022 at 85.7. The notable movements within that index were the manufacturing subindex falling to the lowest since October 2020 (-16.6), and the services sector subindex turning negative for the first time this year (-4.2).
According to the ifo Business Cycle Clock, Germany’s economy is nearing the crisis levels last seen during the early pandemic months. There does not appear to be a way out of this black hole in the near term. Headwinds from tighter financial conditions and the lingering conflict in Ukraine are not going away soon. An economically weak China and a belligerent Russia were two stable trading partners before the pandemic, and they have been compromised (albeit in different ways). Domestically, the gradual easing of inflation is a headwind for consumers, and a soft industrial underbelly is further bad news. All roads are pointing to further weakness in Europe’s largest economy and the real possibility of a recession.
Still to come…
10:00 am (EST) - US Consumer Sentiment
Morning Reading List
German GDP & Ifo Survey
German stagnation in the second quarter confirmed (ING) - The second estimate of second-quarter GDP growth confirms the stagnation of Europe's largest economy and will do very little to end the 'sick man of Europe' debate.
Latest Ifo index adds to Germany’s economic woes (ING) - Another sharp drop in Germany's most prominent leading indicator suggests that the economy is in for a longer period of stagnation than previously expected
US Durable Goods Orders
Durable Goods Hit Some Turbulence (BMO) - Although Chair Powell will likely take comfort from cooling business spending when he speaks at Jackson Hole on Friday, the continued resilience of the U.S. economy signals that his speech is likely to reinforce the theme that the FOMC may keep rates higher for longer.
July Durables Data Weak Even Looking Past Headline Plunge (Wells Fargo) - The 5.2% plunge in July durable goods orders reflects a reversal in aircraft orders after a temporary surge a month earlier. Orders excluding transportation were much more stable. It's early yet for quarterly growth, but the shipments data suggest a weak start to Q3 equipment investment.
New Orders for Durable Goods Fell 5.2% in July (First Trust Portfolios) - A mixed bag for durable goods in July, as transportation orders continue to muddle the headline readings, but orders in core categories continue to trudge higher. Orders for commercial aircraft plummeted 43.6% in July after soaring 71.1% in June. But strip out the typically volatile transportation category and orders rose a moderate 0.5% in July (+0.2% including revisions to prior months), with gains across most major categories.
US
The State of Hiring in the Fifth District (Richmond Fed) - The past two years have been marked by a historically tight labor market in which many firms have had difficulty hiring and retaining workers who possess the necessary skill sets. In a recent post, we explored evidence from our business surveys that suggests that the labor market may be cooling somewhat. Our employment and availability of skills indexes have returned to pre-pandemic levels, and our estimates of wage growth have come down from their 2022 peak.
The Mechanics of Fed Balance Sheet Normalization (St Louis Fed) - The Federal Open Market Committee (FOMC) began reducing the size of the Federal Reserve's balance sheet in June 2022. This policy, termed balance sheet "normalization" or "quantitative tightening" (QT), is designed to drain excess liquidity from the banking system. QT is the opposite of quantitative easing (QE). This essay looks at where the Fed stands in terms of QT and what should be considered going forward.
Europe
Turkey’s central bank announces surprise rate hike (ING) -The Central Bank of Turkey (CBT) has surprised markets by hiking the policy rate by 7.5ppt to 25% versus the consensus of 20%.
Belgian house prices set to fall as demand plunges (ING) - Demand for mortgages has fallen to its lowest level since 2007 in Belgium, and while house prices are holding up surprisingly well, they may paint too rosy a picture of reality. We expect to see prices drop in the second half of the year, although a major correction seems ruled out for now.
China
What Would a "Hard Landing" in China Portend for Other Major Economies? (Wells Fargo) - Concerns about the amount of debt in the Chinese property sector are front and center again. Some observers worry that the Chinese economy is headed for an economic "hard landing" due to this debt build-up.
The gap between China's growth and profits (DWS Group) - Officially published economic figures are regularly criticized, especially when it comes to China. Taking a look at corporate profits shows why.
PMI
Flash PMI signal developed world contraction as higher interest rates exert a growing toll (S&P Global) - Early PMI survey data for August from S&P Global showed the major developed economies collectively slipping into contraction for the first time since January. Falling business activity in the Eurozone and UK, and a near-stalling of growth in the US, contrasted with robust growth in Japan and underscored how tighter monetary policy in the west is dampening demand.
Real Estate
Multifamily Absorption Rates Move Higher (NAHB) - Data from the Census Bureau’s latest Survey of Market Absorptions of New Multifamily Units (SOMA) indicates that demand for newly completed multifamily units remains solid as mortgage rates continue to climb. Only an estimated 39% of the 82,310 unfurnished apartment units completed in the first quarter of 2023 are available for rent three months past construction completion. For condominiums, an estimated 792 units remain available after 4,398 were completed in the first quarter of 2023.
Energy
Fossil Fuel Subsidies Surged to Record $7 Trillion (IMF) - Scaling back subsidies would reduce air pollution, generate revenue, and make a major contribution to slowing climate change.
Australian supply risks hang over the gas market (ING) - The last month has been a volatile period for gas markets, particularly in Europe. A combination of extended maintenance in Norway and uncertainty over potential strike action at Australian LNG facilities has left the market nervous. However, European storage is comfortable and we'd need to see prolonged strike action in order to be overly bullish.
FX
BRICS expansion: The Saudi surprise adds momentum to the de-dollarisation debate (ING) - The big surprise from the BRICS summit in South Africa is that Saudi Arabia has been invited to join the group of major emerging countries. And that’s adding fresh impetus to the de-dollarisation debate, which is a potential challenge to the dominance of the US dollar in global trade.
Outlook
Why commodities may shine in an era of stagflation (Saxo Bank) - In a recent analysis, Saxo's CIO outlined why we have adjusted our 2024 outlook for the US economy from non-recession to a milder form of stagflation, termed 'stagflation light', categorised by sluggish growth paired with persistant inflation. Historically, during stagflation periods, specific commodities attract heightened attention due to several factors, the most important being described in this update which also take a closer look at how to invest in the sector.
Global manufacturing PMI, US payrolls and eurozone inflation (S&P Global) - The US August labour market report will be released next week alongside comprehensive manufacturing PMI data across the world. Additionally, the focus will be on inflation numbers from the eurozone, Germany and parts of Asia. India will also be releasing their GDP data for the April to June quarter.
US economic outlook: August 2023 (EY Parthenon) - Our outlook for the US economy has improved materially as unique post-pandemic economic dynamics appear to be making a soft-landing scenario more plausible. The labor market is gently cooling, with the unemployment rate still sitting near all-time lows while inflation has rapidly declined. With real wage growth turning positive, this has led to a gradual slowdown in consumer spending despite ongoing headwinds from elevated prices and interest rates and tightening credit conditions. The latest GDP figures showed the economy continued to grow at a healthy clip in Q2, and high-frequency data confirms a recession isn’t on the near-term horizon.
Rates Scenario for August 24, 2023 (BMO) - Our forecasts for Federal Reserve and Bank of Canada policy rates have not changed since our prior Rates Scenario (July 13). We reckon last month’s rate rises marked the last ones in the tightening campaigns and look for rates to remain at current levels through Q2 of next year, before cautious rate cuts commence. While we still judge net upside risks surround our forecasts, compared to before, FOMC risks have risen reflecting resilient economic data. This partly explains the higher bond yield projections on both sides of the border.
Research
A Theory of Capital Flow Retrenchment (Dallas Fed) - The empirical literature shows that gross capital inflows and outflows both decline following a negative global shock. However, to generate a positive co-movement between gross inflows and outflows, the theoretical literature relies on asymmetric shocks across countries. We present a model where there is heterogeneity across investors within countries, but there are no asymmetries across countries. We show that a negative global shock (rise in global risk-aversion) generates an identical drop in gross inflows and outflows. The within-country heterogeneity relates to the willingness of investors to hold risky assets and foreign assets.
Exchange rate misalignment and external imbalances: what is the optimal monetary policy response? (ECB) - How should monetary policy respond to excessive capital ináows that appreciate the currency and widen the external deficit? Using the workhorse two-country open-macro model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, and solve for the optimal targeting rules under cooperation.
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