Macro Weekly – Germany, what is your problem?

by: Han de Jong

  • German PMI a big disappointment, but…
  • …still not convinced of material, sustained slowdown…
  • …as Ifo stabilises…
  • …and trade data in Asia strengthen from earlier weakness…
  • …but Trumpian risks remain
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The biggest economic disappointment so far this year is the slowdown in the eurozone economy. Admitted, growth was very strong last year and that couldn’t last. And confidence indicators were at extremely high levels, which couldn’t last either. It hasn’t lasted. GDP growth slowed in Q1 and confidence indices have come down. They are still at levels indicating decent growth, so there is no reason whatsoever for significant concern, but the drop in confidence was more than I had expected.

Looking for drivers, we quickly found that a number of temporary factors were at play: the weather, strikes, the flu and holidays. Two other factors also seemed important. Logistics data were pointing at slowing world trade growth which was confirmed by trade data, first in Asia, later in Europe as well. Asian economies are early cyclical, they are big players in world trade and they release their trade data earlier than European countries do. Another factor that may have had an impact on confidence, and perhaps activity levels, is rising (verbal) protectionism. On the whole, I thought the temporary factors were dominating and therefore, I expected an improvement in Q2.

A big blow to my confidence

When the business confidence indices for April were released last month, I was disappointed that they generally continued to soften. More recently, the May PMI for Germany was really a blow to my confidence. The April number had at least suggested that the drop in business confidence was bottoming out, but Germany’s manufacturing PMI for May dropped significantly again: 55.5, against 56.2 in April. Surprisingly, the French manufacturing PMI actually rose, for the second month running. What is going on here?

When preliminary German Q1 GDP data was released, the accompanying statement said that the external sector was an important factor in the slowdown in overall economic growth (to 0.3% qoq). When more detailed data was released recently, it turned out that the negative contribution of international trade to German GDP growth was a modest 0.1%. Of coure, if you usually benefit from trade, that is a disappointment. More important actually, was the drop in government consumption (-0.5% qoq). This is bound to be reversed in the quarters ahead given the policies of the new German government.

The fact that international trade was negative for German growth fits in with data released in Asia. But more recently released trade data in Asia suggests that global trade growth is not slowing further. In act, the data is quite encouraging as various graphs show. Korea’s export growth during the first 20 days of May recovered nicely. True, the pace of expansion is lower than early last year, but high growth rates then were flattered by base effects. Thailand isn’t the most important economy in Asia, but it has recently released its trade data for April. Export growth accelerated from 7.1% in March to 12.3%, while import growth accelerated to 20.4%, up from 9.5% in March.

 

  

The question remains why the German PMI was so weak in May and what lies ahead. While a modest downward adjustment to German and perhaps eurozone GDP growth forecasts for 2018 may be justified given the disappointments so far this year, it is too early in my view to make material downward adjustments. There are a couple of reasons to remain cautiosly optimistic. First, as indicated, the last two months show a divergence between German and French PMIs. Perhaps there is a specific German problem. Germany has had more public holidays so far this year than during the same period last year. The difference is two days, which makes a difference on just over 100 working days. The difference is even three days if one counts Corpus Christi, which is a public holiday in only a number of states in Germany. Corpus Christi was in May this year and in June last year. And sentiment among German companies is perhaps more affected by the rhetoric of trade wars. Second, the German economy may be more sensitive to fluctuations in world trade growth. The improvement in the trade data in Asia suggests that things may pick up. Third, while the German PMI was a disappointment, the (more authoritative) Ifo was a relief. The overall series stabilised as the expectations component fell marginally while the current-conditions component inched higher. Fourth, it would appear that the fiscal stimulus expected for this year in Germany is yet to come. If we are right in refusing, at this point in time, to make significant downward adjustments to GDP growth forecasts then we must see an improvement in the June confidence data.

  

US: steady as a rock

Contrary to the eurozone economic data, recent data releases in the US have been strong. The Chicago Fed’s measure of national activity rose to 0.34 in April, which corresponds with robust overall economic growth. The national PMI index for May inched higher as did two regional business confidence gauges. The Richmond Fed manufacturing index bounced back from a weak March, while the Kansas City Fed index jumped to its highest level in years.

US capital goods orders fell 1.7% mom in April, after rising 2.7% in March. This data is volatile. It is btter to look at the trend in the yoy rate, in particular of the shipments as they are an indication of actual corporate investment. The yoy growth rate of capital goods shipments (non-defence, ex-air) amounted to 9.9% in April and has averaged 8.6% in the first four months of the year. This is a reflection of the fact that business spending on capex is continuing to grow at a healthy clip.

Global economy looks all right, but a lot of other stuff is going on

While the overall world economy thus looks fine from a cyclical perspective, various other developments occupy the mind. The new Italian government is likely to embark on an unorthodox combination of policies. Most important, these measures will lead to a significant deterioration of the public finances while these are already in a precarious state. If implemented, the new Italian government will face confrontation with their European partners. It is impossible to say how this will pan out, but bond markets don’t like it.

Then there is, of course, Donald Trump. The cancellation of the Singapore summit with North Korea’s Kim Jung-un is a disappointment, but things can change fast. The announcement of an investigation into the national security aspects of car imports is perhaps an bigger immediate economic worry. The national security aspect is brought in so the US feel free of WTO rules. But for car exporters to the US, this creates a lot of uncertainty.