The recovery begins

  • Economic data remains weak and Q2 GDP numbers will be awful almost everywhere
  • But confidence is rising, if from low levels and frequently rising more than expected 
  • It is difficult to spot real time turning points, but it does seem that the recovery has begun

Q2 GDP data will begin to hit headlines in July, probably beginning with China, then the USA, the UK and eventually Japan and the EA with a host of smaller economies. The numbers will be horrendous. But GDP is a lagging indicator — it tells us where we were (and notwithstanding those who continue to urge central banks to switch to nominal GDP targeting, a bad idea if there ever was one) not where we are heading. For that, we need leading indicators.

My two most recent Comments looked at what I consider to be the most important leading indicator, namely broad money. I am not going to talk about that here, for two reasons. First, because broad money is a more long-term leading indicator and this Comment is about the very near term. Second, because the really interesting broad money data now will be the trends that develop over the summer. In other words, will monthly broad money growth suddenly slow down sharply after the surge in Q2; or will recent rapid growth rates be prolonged? I will return to this in the future.

At the moment, however, the most important near-term issue — apart from whether or not there will be second and third waves of the pandemic — is whether the recovery has already begun. Here, we have a problem. Upturns and downturns both tend in retrospect to have begun well before they are noticeable to everyone. (That, by the way, was true of the pandemic as well!) Yet, there are a number of reasons to believe that we are already in the very early stages of a recovery. 

The first one is self-evident: many countries that have been in lockdown are now opening up again. Shops are reopening, travel is beginning again and larger gatherings are being allowed. All of this will mean more consumer spending. The reopening of work places will boost activity in business; and foreign trade should pick up. This may be anecdotal evidence so far; but it is backed by business and consumer surveys. 

The survey results are important because these are the most reliable very near-term leading indicators. This is particularly true for surveys of small and medium-sized enterprises, whose owners tend to be very much on top of near-term developments, (otherwise, they would not survive). However, there are different types of indicators. In a previous Comment, I made the point that current inflation data is all but meaningless, since the Consumer Price Indices of different countries reflect the pre-pandemic normal or standard purchasing pattern, but not the post-pandemic lockdown spending. 

Similarly, the key surveys to look at when gauging a recovery will be those measuring industry and consumer confidence. Industry is crucial because it is so volatile. While the service sector in every advanced economy is considerably larger than industry, a good rule of thumb is that somewhat less than half of services are services to industry, and hence dependent on industry developments. Consumer confidence is important because much of government policy to cope with the pandemic has by necessity involved scaring households (whether locked-down or not) and the state of consumer confidence will therefore tell us whether those same households are prepared to go out and spend once the health situation improves. 

At the moment, it seems that we are seeing two trends. The first, which is general across most major economies, is that confidence is improving, albeit from very weak levels. The second trend, which is not as clear, is that confidence is not only improving, but improving by more than expected. This is true of key US surveys such as the ISM manufacturing survey and the NFIB small business indicator (as well as the NAHB housing market index). The message from the University of Michigan consumer sentiment survey is less clear, but expectations improved in June from a low point in May. In other economies, the German Ifo index reached a four-month high in June, and crucially, the gap between the ‘current situation’ and the ‘future expectations’ sub-indices widened in favour of the latter, a clear sign that confidence will continue to strengthen. For the EA, the European Commission’s Economic sentiment Index (ESI) rose to a three-month high in June, a trend mirrored among most major members with the significant and unsurprising exception of Italy. More importantly, there was also a pick-up in industry and consumer confidence, (again with Italy a laggard among the major economies). 

In China, which of course had a head start, both into the pandemic and (hopefully) out of it, purchasing managers’ indices are edging up. The major exception to these (moderately) favourable news is Japan. Although Japanese consumer confidence and the Economy Watchers’ Index are both picking up, the quarterly Tankan survey for Q2 came in both worse than in Q1 and below expectations, and with an even more pessimistic outlook for Q3.

Is it too early to call the recovery? Could not improving confidence be reversed? Of course it could. Certainly, renewed major outbreaks of COVID-19, with widespread local or regional lockdowns (even if reimposed national lockdowns are less likely except in very small countries) could reverse the trend.  Moreover, the road out of the pandemic depression will be bumpy and it will almost certainly take a number of years before we recover pre-pandemic output levels. However, the direction is now clear and when one day, the bookend of the pandemic depression is determined by economic historians or the NBER, it will turn out to be right about now. Even the Bank of England thinks so, according to the main story of today’s The Times. The Bank is also forecasting a V-shaped recovery, something I have argued for in previous Comments as the most likely near-term development (although in my view, the recovery will eventually trail off).In turn, that would be good news for financial assets, which in any case will benefit (already have benefited) from the massive monetary and fiscal stimuli.

Gabriel Stein