Charts of the Week

Perilous territory for mortgage rates and house prices

Hindsight is 20/20 for 2020/21. It is now increasingly clear that both monetary and fiscal policy in the US were too expansionary during the peak pandemic years; nominal gross domestic product (GDP) surged far above trend. The Federal Reserve’s interest rate tightening cycle, the most rapid in decades, is an attempt to play catch-up.  

The chart below shows how the current situation has resulted in an unusual housing market in 2022. Generally, as monthly data points going back to 1975 show, there is a very strong negative correlation between house prices (as measured by the Case-Shiller Index) and rates; house price gains accelerated as mortgages became more affordable.

We highlight the last five months of observations to suggest that house prices are too high in an environment of rising yields and mortgage rates. 

Monetary policy has a long (and variable) lag before it affects the wider economy via the housing market – something the latest Nobel Prize winner, former Fed Chairman Ben Bernanke, has written about extensively. Some fear the Fed has already over-tightened and the US housing market is cracking under pressure. We will know by the beginning of next year.   

Mortgage rate heat map is glowing red for 2022

The heat map below shows how the surging US mortgage rates of 2022 are unprecedented compared with 31 years of recent history. It tracks the three-month change to the 30-year fixed rate in percentage-point terms. 

For most of 2022, the heat map is showing an increase above 1 percent. That exceeds the steadily “hot” (and famously disruptive) tightening cycle of 1994. Though these increases have already cooled down the housing market, more pain is likely to come.

Another measure of deteriorating home affordability

The US National Association of Realtors compiles a housing affordability index. It tracks price and income data to measure whether or not a typical family earns enough to qualify for a 30-year mortgage on a typical home.

Rate increases are highly negatively correlated with this index, as our chart shows. It tracks monthly data points going back to 1982. 

We have inverted the Y axis to highlight how the last four months show historic pressure on affordability. Monthly payments are significantly higher than just a year ago, while prices increased at a spectacular rate until this summer (as the size of the recent individual dots, or “bubbles,” shows).

Europeans are experiencing inflation differently

Everyone is suffering from inflation, but some major European countries have it worse than others, even within the Eurozone. And the differences are widening.

As the Dutch inflation rate soars toward 15 percent, inflation in France is at a much more moderate 5.5 percent. Meanwhile, Switzerland is only experiencing 3 percent inflation, as our chart shows. 

The dispersion is explained by different degrees of energy dependency and the energy mix of production. The Swiss are somewhat protected by their strong and appreciating franc, one of the major safe-haven currencies. France caps electricity prices, putting the burden on the state finances rather than the consumer. But the other countries’ consumers are more directly exposed to the energy crisis. (The Dutch combine dependence on gas for heating with a statistical quirk that boosts their reported figure.) 

Europeans are expecting inflation to last for years

The European Central Bank surveys consumers to measure their inflation expectations. As real-time inflation rises, so do consumers’ expectations of future inflation, our newly added ECB survey data shows. This is probably not surprising. 

But the major headache for the ECB is that consumers aren’t on “team transitory.” As our chart shows, Europeans expect medium-term (three-year) inflation to rise, persisting beyond the short run. This trend is broadly similar across the eurozone.

Unanchored inflation expectations are one of central bankers’ biggest fears. These data points will support the more hawkish policy makers in Frankfurt, and the view that more rate hikes are needed right away to bring inflation back down in a reasonable time frame.

Japanese households are starting to struggle

The inflation rate in Japan is one of the lowest in the OECD. But the nation’s households are still under pressure. 

As our chart shows, household spending is up more than 5 percent year-on-year in nominal terms, while incomes have slipped about 1 percent.    

To make up the difference, households might be spending money they would have saved in the past. That said, the savings rate is staying steady at about 10 percent -- quite elevated compared to the pre-pandemic “old normal.”

The underpriced Japanese yen

The Japanese yen is at its weakest in 30 years, approaching the fateful 150 mark versus the dollar. That might be the line in the sand for the Bank of Japan, which recently intervened in the currency market for the first time in decades.

The following chart tracks our simple valuation model. It’s based on high-frequency data such as interest rates and measures of Japan's terms of trade, equity prices and OECD economic indicators.

Our model tracked the value of the yen quite well until a few months ago. But there is now a record gap between the currency’s predicted value and the much weaker actual exchange rate.

Based on fundamentals, there is room for the yen to rebound.

US Democrats improve their electoral chances but it is likely not enough

The US midterm elections are less than a month away. Many Americans think they are already experiencing a recession and are unhappy with the spike in inflation. That’s bad news for President Biden’s party.

Our chart tracks Fivethirtyeight (whose model is essentially a polling aggregator) and PredictIt, a market that allows people to bet on election outcomes. 

The Democrats have improved their chances over the summer. Even so, PredictIt gives the Republicans a roughly 80 percent chance of winning the House of Representatives. Fivethirtyeight is slightly more optimistic for the Democrats, but still gives the GOP a 70 percent chance of controlling the House.

Norwegian oil riches

The surge in oil and gas prices has massively improved Norway’s fiscal position. 

As our chart shows, the government’s revenue from petroleum activities is expected to surpass 20 percent of GDP this year and next. 

It’s interesting to track the net transfer to the nation’s famed sovereign wealth fund. During the worst of the Covid-19 crisis, that net transfer was slightly negative as the government withdrew funds to pay for pandemic relief measures. Positive transfers have resumed again and are expected to exceed 1 trillion kroner (USD 90 billion) this year. 

Credit Suisse is stressed but not the new Lehman

Speculation about the future of Credit Suisse was rampant over the past week. Swiss central bankers said they were monitoring the situation.

On Oct. 7, Credit Suisse responded with a debt buyback to reassure the markets while it plans a major overhaul.

As the chart below shows, this year, the bank’s credit-default swaps (CDS) have spiked along with the European Central Bank’s Composite Indicator of Systematic Stress (CISS). It’s worth noting that the two stress measures moved more or less in tandem until about 2013, before and during the global financial crisis and the subsequent European debt crisis. Perceived risk for European banks generally stayed higher thereafter. 

Capital requirements for banks are much higher than before the GFC, and policy makers are very unlikely to allow another “Lehman moment” where a financial institution gets into trouble and contagion spreads to the others. It’s worth noting that banks were relatively unscathed by the pandemic as central banks provided markets with an enormous amount of liquidity.

Semiconductor stocks have a rough 2022

The Philadelphia Semiconductor Index (SOX) includes the 30 largest US companies in the sector. It’s closely watched because chipmakers are considered particularly sensitive to the economic cycle.

As our chart shows, chip stocks are seeing a substantial drawdown. The SOX is down almost 40 percent this year, putting 2022 on track to be one of its three worst yearly performances.  

With central banks continuing to hike and tech companies announcing hiring freezes, there might be more pain to come.

South Korean chip production cools

It’s not just the US chip sector: the following chart shows how South Korean semiconductor production is slowing. 

South Korean trade data is often regarded as a “canary in the coal mine” because the country exports so many high-tech products to the rest of the world. When Korean exports stall, this usually indicates a period of cooling global demand. 

Domestic inventories of chips have increased significantly since the end of last year, while shipments have declined. That could well indicate bad news for the global tech sector. 

Autumn is the season for end of year rallies

Data indicates that stock markets display seasonality, and we’re heading into a historically bullish period. 

August and September are notoriously difficult months for US equities. Those “autumn blues” are often followed by a recovery. 

The following chart tracks the historic October-December performance by the S&P 500. On average, stocks go up about 2.5 percent in the fourth quarter. The distribution of outcomes is extremely wide, however. (A couple of famous October stock-market crashes come to mind.)

October of 2022 has already been particularly striking. The S&P 500 is up 5 percent, though it’s still more than 20 percent down for the year.

Simultaneous stock and bond slump bucks the historic correlation

Most of the time, equities and bonds are negatively correlated: stocks slump, investors move to relative safety in fixed income. Risk-off days. However, it’s well-known that this correlation shifts over time and is dependent on the macroeconomic regime. 

The chart below shows S&P 500 drawdowns are often accompanied by substantial returns in the bond market. (Most notably in this chart, at the outbreak of the pandemic.) 

The current macro environment is very different: we’ve seen equities and bonds slump simultaneously. That’s due to a combination of high inflation and rapidly rising interest rates. 

Insofar as central banks are trying to cool demand with their rate hikes, they are probably succeeding by creating a huge negative wealth effect, i.e. slumping asset prices.

China seems less likely to catch up with US gross domestic product

The China-US GDP gap is widening again – in fact, reaching its widest in 12 years. 

China watchers have long speculated about when the Asian nation will overtake the US to become the world’s biggest economy. Indeed, when adjusting for purchasing power parity, the Chinese economy is already larger given the nation’s much lower consumer prices.

Of course, to truly measure an economy -- by its share of global GDP -- one must look at total output in nominal terms.

 While China had been catching up for decades, the gap started to widen rather than narrow this year, as our charts show. US nominal GDP is forecast to grow more than 7 percent this year, almost double China’s 4 percent pace. Meanwhile, the dollar is strengthening against almost all currencies, including the Chinese yuan.

That means China’s GDP is actually contracting in dollar terms. Given the nation’s severe slowdown, driven by the real-estate crash, and its very adverse long-term demographics, China might never overtake the US economy in dollar terms.

Asia is aging

Asian economies are seeing their population age rapidly, most famously in Japan, where the share of people aged 65 and over is approaching 30 percent. That’s up from 20 percent in 2002.

South Korea and Singapore are experiencing a very similar albeit less extreme trend. The share of people aged 65-plus now exceeds 15 percent of the population in both economies.

Even though China’s GDP per capita is significantly lower than these countries, it now has an age profile very similar to that of South Korea as a result of the strict one-child policy implemented decades ago.

China watchers are concerned that the aging population will strain the pension system to its limit well before the nation becomes an advanced economy. 

The importance of watching data revisions

Economic data is often revised, and when it is, historic anomalies can evaporate.

Earlier this year, we examined the perplexing gap between US GDP and GDI (gross domestic income), which reached a record 4 percent. We published a chart showing the record divergence between the two measures, and argued that the US was very unlikely to be in a recession even as GDP declined for two consecutive quarters. GDI growth was significantly healthier at the time. 

The Bureau of Economic Analysis released revised data on Sept. 29. As our chart shows, this revealed that the GDI-GDP gap has narrowed significantly to its usual pre-pandemic level of about 1 percent.  

Firstly, GDI was significantly revised downward. Secondly, GDP was significantly revised upward – mostly for pre-2022 data, as the first half of this year still shows two quarters of negative growth.

Social progress versus GDP per capita

We recently posted a chart showing the strong correlation between corruption and GDP per capita. There is a similar correlation between income per head and broader measures of social progress. 

Our final chart tracks an index from Social Progress Imperative. It comprises 50 measures related to basic human needs (shelter and nutrition), the foundations of wellbeing (health and environment), and inclusiveness (equality and access to education).

It’s easy to explain why a positive correlation emerges over time. Rich countries have the capacity to invest in a cleaner environment and better education and healthcare, while striving for a more equal and progressive society in general. Poorer countries often lack the means to achieve progress in any of these areas.

Progress on education, inclusiveness, and the environment also pays off in terms of higher long-run economic growth rates. The causality relationship between GDP per capita and social progress likely works both ways.

Norway and LNG boats are ever more crucial for European gas

“Energy security” usually refers to the uninterrupted availability of energy sources at an affordable price. At least that’s the International Energy Agency’s definition. 

However, the phrase can be defined more literally in the wake of suspected sabotage that damaged the Nord Stream gas pipelines between Russia and Germany. Norway has deployed its military to protect its gas installations in the incident’s wake. Lithuania has taken steps to bolster security around its own liquefied natural gas (LNG) terminal.

As our chart shows, Norway and LNG are ever more important to the European Union’s energy mix. The 12-month graph shows how gas shipments peak in the cold winter months. The steadily shrinking green section shows the gas supply that reaches the EU from Russia – including the now seriously damaged Nord Stream pipelines. 

Shrinking Russian pipeline shipments

As our next chart shows, Nord Stream 1’s gas flows were halted at the start of this month, when Russia cited a need for repairs. This pipeline accounted for almost half of Russia’s gas shipments to EU markets a year ago. 

However, Russian gas travels along different export routes, including the Yamal pipeline from the Arctic to Poland via Belarus. Other pipelines arrive at the EU’s eastern border via Ukraine, which still receives gas Russian transit fees despite the war. Only TurkStream, which heads to Bulgaria and Greece via the Black Sea and Turkey, is delivering a quantity of gas similar to a year earlier.

Sterling gets pounded

King Dollar is crushing currencies everywhere, but Britain presents a special case. Market turmoil in the wake of the UK’s tax-cutting plan is pushing the pound towards parity with the greenback.

As our chart shows, 2022 marks one of the most severe devaluations that sterling has ever experienced versus the US dollar. Only recessionary 1981 and the bank-bailout year of 2008 surpass it (for now).

Those years were also marked by tight US monetary policy, especially in 1981, which saw Federal Reserve Chairman Paul Volcker willingly engineer a downturn to tame inflation. In 2008, monetary policy was also extremely tight, but more by accident than anything else. As we have said previously, Fed chair Jerome Powell may be channeling his inner Volcker in 2022-23.

The unfunded Truss tax cuts shatter UK financial markets

Liz Truss’s government shocked markets with a mini-budget that included increased borrowing to fund tax cuts (and the cancellation of tax increases planned by her predecessor). The measures, which will disproportionately benefit higher earners, come amid a macroeconomic environment of elevated inflation and low growth in the wake of the pandemic – which had already stretched public finances. 

The pound and bond yields saw some of their most extreme movements in decades. Five-year yields moved 90 basis points higher in a matter of days. That’s a 7-sigma event (translation for non-statisticians: an occurrence that’s incredibly rare). Sterling slid about 5 percent against the dollar. 

Our scatter chart plots the weekly movements of the exchange rate and five-year yields since 2005. The dot for last week doesn’t have many neighbours. It’s a data point showing moves usually associated with emerging markets, not developed economies. 

UK international investment position in focus

A country’s net international investment position (IIP) is a key metric of national wealth. It also gives an idea of the risks a nation is running should international investors flee. That’s the kind of incident associated with emerging markets, but the European debt crisis showed developed economies are not immune. 

Most high-income countries have positive net IIP as their external assets exceed their liabilities. The US is the notable exception, but it generates net positive income because the return on its assets is higher than the return on its liabilities.

As our chart shows, this does not seem to be the case for the UK. A two-decade trend has resulted in negative IIP combined with net negative primary income on international investments. (Note the orange section, showing the deterioration in the net direct investment position from around the time of the Brexit vote.) This leaves the country more vulnerable to an external shock – such as an international loss of confidence in UK assets.

While the UK is not in a full currency crisis yet, it is clear that investors want a higher risk premium to hold UK assets following Truss’s tax cuts. Sterling’s safe-haven days are long in the past.

Emerging market heat map shows signs of macro trouble

The US dollar is at its strongest level in decades. And dollar strength is usually accompanied by emerging-market weakness and stress elsewhere. 

The following heatmap, which uses a variety of national and international sources, tracks key metrics of internal and external macroeconomic stability. They’re commonly used to assess country risk in emerging markets.

Every single emerging market currency is down against the dollar, most by more than 10 percent. Interest rates have gone up, approaching or exceeding 10 percent in many countries. Most EMs are also simultaneously experiencing current account deficits and a negative fiscal balance. This twin deficit is usually a harbinger of a balance of payment crisis, especially when accompanied by large external debts in foreign currency.  

Emerging market equity valuations are historically low

It’s not just macroeconomic indicators: dollar strength and the Federal Reserve’s rapid tightening cycle has weighed on emerging-market equities as well. 

As our chart shows, the forward price-earnings ratios for most emerging markets are severely depressed compared to recent historical ranges.

Moving like clockwork towards a German recession

Many economists are expecting a recession for Germany in early 2023 as rising commodity prices and surging inflation hurt the country’s industries.

Our chart shows the famous “clock” created by Munich’s Ifo Institute for Economic Research. It surveys companies, asking them about their view of the current situation (x axis) and their sentiment about the near future (y axis). The monthly data points have done an entire circle since the start of 2020, going through all four stages of the business cycle. 

Germany exited the boom phase last year. The direction of travel is to the “recession” quadrant -- last entered when the pandemic went global.

Consumer sentiment as a recession indicator

‍Macroeconomic research suggests that downturns can be predicted by changes in consumer sentiment. 

The following chart is a variation on the usual way of measuring that sentiment. It uses the spread between consumers’ assessment of their current situation versus future expectations.

When the spread is in positive territory, it indicates consumers believe their current good times won’t last. The same applies in reverse: a negative value indicates that consumers see a light at the end of a dark tunnel, so to speak. 

The chart illustrates that when enjoyment of the present was combined with pessimism about the future, the economy entered a recession shortly thereafter. When that recession occurred, the spread rapidly reversed, with consumers believing things could only get better.

This spread rarely exceeds positive 75, which happens to be where we are today. That’s a recession signal flashing bright red. Caveats apply: the post-pandemic economy has been quite different from anything we have seen in recent decades, and historic correlations may not hold. 

Youth unemployment is a multiple of adult levels

It often takes a while for young people to “stick” in the job market. 

According to research by the Organisation for Economic Cooperation and Development, there are several reasons for this. Employers often look for job experience, and people entering the workforce don’t have it. And there’s also the tendency for the young to “shop around” as they choose a career.

This chart shows the relationship between youth (age 15-24) and adult (age 25-64) unemployment in OECD countries. In all countries, youth unemployment is higher. In countries with a high rate of adult joblessness, such as Italy and Brazil, youth unemployment approaches a staggering 30 percent.

King Dollar is defeating almost all challengers in our heat map

The dollar has strengthened mightily this year as a historically rapid rate-tightening cycle by the Fed combines with the greenback’s safe-haven status in a volatile world. 

The following heat map shows just how few currencies have made gains of any kind against the dollar in 2022. Blue denotes a currency that has strengthened against its US counterpart, while the much bigger red zone indicates currencies that have weakened. 

It's notable that some Latin American “commodity currencies” showed some strength against the dollar early in the year, beneficiaries of the inflation that has seen energy and metal prices rise. However, advances by the Colombian and Chilean pesos have reversed, leaving the Brazilian real as one of the only gainers against King Dollar.

(Brazil’s experience, which is driven by an aggressive central bank rate-hiking cycle of its own, informs our subsequent series of charts.)

Most bets are on Lula in Brazilian election

Brazil’s general election is scheduled for Oct. 2. As of today, Luiz Inacio Lula da Silva has an 80% probability of regaining the presidency he held from 2003 to 2010, according to PredictIt, a New-Zealand based election-betting platform. 

The PredictIt market has shown Lula steadily gaining on incumbent Jair Bolsonaro, as our chart shows. A Lula win, which would follow Latin America’s broad leftward trend, would mark an impressive comeback for the former president, who was once jailed for money laundering and corruption. Those convictions were nullified by the nation’s supreme court last year. 

The candidates differ on many issues, including the Amazon rainforest, which has seen an increase in deforestation under Bolsonaro. The incumbent has also faced various scandals and criticism over his handling of the pandemic. 

Unlike many economies, the inflation environment has been relatively positive for the incumbent, as our subsequent charts will show.

Brazilian inflation is broadly easing

While inflation is a hot political issue in many countries, it is perhaps somewhat less so in Brazil. 

Brazil is the world’s fourth-largest exporter of commodities, whose prices have soared. That’s made the real one of the few currencies in the world to appreciate against the US dollar, pushing down the cost of imports. Its central bank also started hiking rates in March 2021, and only recently halted what had been the world’s most aggressive tightening cycle.

Nevertheless, inflation remains a key electoral topic. As our chart shows, it peaked at 12 percent year-on-year in April, a 19-year high. However, it has been steadily easing since then as fuel prices decline (expressed in the orange “transport” segment of the chart). 

It’s also worth keeping an eye on food and beverages, in dark blue. This segment disproportionately impacts lower-income Brazilians and has seen year-on-year inflation of about 13 percent.

Full Brazil hydro reservoirs mean no energy crisis is likely

Not all nations are experiencing a historic energy crisis of the kind seen in Europe. Brazil benefits from being the world’s second-largest hydro-electric power producer by installed capacity – as one might expect for the Amazon River nation. Hydro generates enough power to meet two-thirds of the nation’s electricity demand.

Brazilians thus watch the levels of their reservoirs carefully. The rainy months – December to March, usually – are critical.

As our chart of stored hydroelectric energy shows, more than halfway through the nation’s dry season, Brazil appears to be in the clear. The orange line indicates that 2022 has been near the top of the range for fill levels. This compares with 2017 (purple) and 2021 (red), where droughts created an energy crisis.  

This is a good sign for consumers’ electricity bills (and inflation). It’s also a positive indicator for water-hungry agriculture, one of the main pillars of the economy; Brazil is the largest crop producer in the world.

Japanese trade deficit hits a historic high

Moving from one of the world’s best-performing currencies to one of the worst, we examine Japan’s trade deficit and its effect on the sinking yen.

As the yen slides to a 24-year low against the dollar, the nation’s imports have become more costly. Combined with ever-rising energy prices, the nation’s trade deficit has reached a historic high of 2.82 trillion yen. 

As our first chart shows, imports are rising at more than double the pace of export growth. The nation has posted 13 consecutive months of trade deficits, as our second chart shows – the longest streak since the mid-2010s.

Middle East energy imports are a burden for Japan

Breaking down Japan’s trade deficit by region in our next chart shows how surging energy costs aren’t being matched by an offsetting uplift from traditional export markets.

The bar representing imports from the Middle East has been widening, reaching more than 1.4 trillion yen. Net exports to the US have dropped more than 8 percent month-on-month; exports to Asia excluding China more than halved month on month. Japan has a 577-billion-yen deficit with China, its biggest trading partner.

Yen devaluation boosts Japan export values but quantities shipped stagnate

Both Japan's import and export figures are inflated by the rapid yen depreciation, as our chart shows.

The Bank of Japan has not joined the global monetary tightening cycle; in fact, it hasn’t changed its policy rate since 2016. The central bank could begin hiking rates to remedy the loss of foreign reserves, but policy makers could be reluctant to do so given current domestic economic conditions.

Covid-19 snaps 27-year Chinese trade deficit with South Korea

It’s a throwback to the earliest days of China’s economic boom, when Jiang Zemin was in charge.

In May, China snapped a 27-year, nine-month streak of trade deficits with South Korea, as our chart shows. Before August 1994, it was South Korea that ran a trade deficit with China.

This reversal is driven by several factors. But one root cause is China’s “zero Covid” lockdown policy, which has slowed the economy and constrained movement. China is also more self-sufficient in goods it used to import from South Korea.

Wealthier societies are correlated with lower corruption

Institutions matter! That’s the conclusion of “Why Nations Fail.” The influential 2012 book by Daron Acemoglu and James Robinson linked long-run prosperity to integrity in economic and political institutions: good governance, the rule of law and rooting out corruption. 

Our chart below bears witness to this linkage. It uses the well-regarded “Corruption Index” compiled by Transparency International, which assesses perceptions of a nation’s public sector. (An important note: a higher value means that a country is in fact less corrupt.)

A 20-point increase to a nation’s corruption index score is associated with a lift to per capita income of at least USD 10,000. 

While correlation does not imply causation, many other governance indicators show an equally strong linkage to prosperity. To the extent that many emerging markets have made little progress in recent decades, the middle-income trap might simply be a bad institutions trap.

German summers are getting ever hotter

Europe saw its hottest summer on record this year and experienced severe droughts. 

The following chart shows just how much German temperatures have exceeded even recent averages through most of 2022. It graphs the average temperature since 1881, the (hotter) average since 2000, and a “normal range” as expressed by the historic 25th to 75th percentiles in the shaded area.

German gas usage in mild versus cold winters

As Europe confronts the shutdown of the Nord Stream pipeline, limiting the supply of Russian energy as autumn begins, it’s worth assessing how scenarios for natural gas use in cold and warm winters differ.

The following charts track the level of natural gas stored in Germany and the nation’s average temperature. Each 12-month period is graphed from July to June, demonstrating how the peak winter season depletes stocks. 

The chilly winter of 2017-18 stands out in red, showing how gas stocks were almost completely drawn down by February. The balmy temperatures and limited gas use indicated by 2019-20’s light blue line are notable as well. So far, 2022-23, in green, is on track to be a relatively warm year.  

The ECB is making major adjustments to its inflation outlook

Soaring inflation prompted the European Central Bank to make its first ever 75-basis-point hike this September. The ECB also made large adjustments to its projections for inflation and growth.

The chart below graphs the ECB’s revisions to its forecast Harmonised Index of Consumer Prices, or HICP, as well as gross domestic product (GDP). Comparing the March projections with the June and September revisions reveals the central bank’s gradually deteriorating economic outlook. The ECB now expects inflation to surpass 9 percent this year, while the inflation forecast for 2023 has been revised upwards by more than 1 percentage point since March.

As for economic output, the ECB now expects significantly lower GDP growth both this year and next, with downward revisions exceeding 1 percentage point.

Many more Germans have become concerned about inflation

The Bundesbank compiles surveys of households to assess inflation expectations. These surveys indicate that more and more Germans expect consumer prices to surge.

As our chart shows, the share of Germans who expect inflation will somewhat or strongly increase is significantly higher than it was two years ago. This should be cause for concern at the ECB, which is increasingly worried about unanchored inflation expectations.

It’s still open to debate how much inflation expectations are a self-fulfilling prophecy, and to be sure, concern about rapid inflation has eased somewhat from its peak in March. However, central banks are monitoring this measure of consumer psychology closely.

A mighty dollar but weaker profits

The dollar tends to appreciate during a global economic slowdown, usually because the Federal Reserve is in the process of tightening monetary policy. Such slowdowns often simultaneously weigh on American corporate earnings. 

The following chart shows the negative correlation between US earnings revisions -- as measured by FactSet and Macrobond -- and the Dollar Index, which tracks the greenback against a basket of currencies. Note that the time series for the Dollar Index has been pushed forward by 20 days to display the most significant correlation.

An unusual disconnect between US inventories and consumer confidence

Usually, if companies are building up their inventories, it reflects a general confidence in the economic outlook. Firms don’t stock up on goods if they’re worried they can’t sell them. But whether it’s due to the effect of expensive gasoline on consumer psychology or companies’ own concerns about disrupted supply chains, this historic correlation has been broken in the US.

As our chart shows, inventories are surging as the widely watched University of Michigan consumer sentiment index sinks – a record divergence. That’s at odds with historic data, and as a recent ECB note argues, inventories tend to be pro-cyclical. 

One theory is the bullwhip effect, which posits that companies hoard inventories in an environment of high demand and uncertain supply. Given the importance of gasoline prices to American drivers, pricier oil is likely responsible for the depressed confidence figure – a disconnect to the real economy, given the US labour market has remained very strong.

Inflation swaps show the UK and Eurozone have a problem the US is likely to avoid

The eurozone and the UK likely have a bigger long-term inflation problem than the US does. 

The chart below shows the inflation expectations curve for the three economies. Financial markets are seeing considerably higher inflation in the UK for years to come. The euro area is expected to fare better than Britain, but is still likely to have much higher inflation than the US for the next two years.

US job openings show an attempted hiring frenzy by smaller companies

The US labour market is very tight, with job openings surging to a record high in the aftermath of the pandemic. The vacancy ratio is at its highest level in history versus the employment rate.

As the chart below shows, a massive share of the increase in job openings is driven by firms with fewer than 49 employees. The number of total vacancies at those small firms is so large that it currently exceeds the total number of vacancies for all firms pre- 2015. 

Job gains and losses by industries in the pandemic era

The US economy has regained all 20 million jobs lost during the early days of the pandemic. But the employment picture has been significantly reshuffled across industries. 

The chart below shows job gains and losses by industry since March 2020, when Covid-19 became a global pandemic. 

Leisure and hospitality employment shrank enormously and has yet to snap back. Transportation, warehousing and professional and business services have added close to a million jobs.

Another Chinese city grinds to a halt

There’s more bad news coming out of China, which is shutting down more cities due to its strict zero-Covid policy. This is weighing heavily on the Chinese economy. And a slower Chinese economy means slower global growth.

Even before the current wave of lockdowns, China was forecast to grow only about 3% this year, according to the IMF. That would be the slowest pace in 40 years.

Our first chart tracks plummeting road and rapid-transit use in Chengdu, the mega-city that recently had its lockdown extended indefinitely. More urban areas could follow, as our second chart shows: an increasing number of regions are being classified as medium- or even high-risk areas for Covid-19 outbreaks. 

August and September are a season of underestimated NFP job growth

Like a writer’s first draft, economic data reports are meant to be revised. Statisticians reconsider their initial estimates and provide a more accurate figure months later. 

In the case of the key nonfarm payrolls (NFP) figure, these revisions usually seem to cancel each other out over time. That means for most months of the year, there is no persistent bias, or seasonality, in the NFP number.

But there is an exception to that trend, as the following chart shows. August, and to a lesser extent September, have a history of undercounted job growth, according to our chart of monthly data from January 2000. Revisions to NFP for August are usually positive, with a mean upward increase of 40,000. 

Unemployed Americans increasingly have not been unemployed that long

Our analysis has repeatedly suggested the US economy was not in recession during the first half of the year, and that the two negative prints of GDP growth were probably incorrect (i.e., will likely be revised) for technical reasons. 

The extremely tight US labour market over the past year supports this argument. The chart below segments the unemployed by the length of the time they have been out of a job. After the initial disruption from the pandemic, the data show a steady decrease in the proportion of the longer-term jobless among those looking for work.

Or to put it another way, the proportion of the unemployed who have been out of work for only a short time (less than 14 weeks) is now at its highest since the 2008 financial crisis, hovering near levels seen in the mid-2000s – a period where some economists consider the US economy to have been operating at full employment. 

How investing differs when the inflation regime changes

This year’s inflationary spike changed the environment for investing. Many market participants have only experienced a world that assumed inflation was very low and would stay that way. 

The following chart, using data going back to 1987, shows the average monthly returns for commodity, stock and bond indices under different inflation “regimes:” high and rising, low and falling, and several scenarios in between.

As expected, falling inflation is usually better for returns than rising inflation. For the stock market, it’s historically best when inflation is low and declining.

Real estate prices by GDP growth and inflation regime

One can also apply the “inflation regime” treatment to real estate. While property is sometimes viewed as an inflation hedge, performance varies depending on the growth environment.

The following chart uses US real estate data dating back to 1970 to delineate nine different growth/inflation environments during that time period. Growth and inflation regimes are split using the 33rd and 66th percentiles.

Unsurprisingly, real estate does not do well when growth is slow. But it performs the worst when inflation is high amid a low-growth environment. The best price performance happens during a high-growth, high-inflation boom.

Central bank balance sheets are shrinking

Central banks’ balance sheets started shrinking in 2022 as policy makers embarked on a major tightening cycle to combat soaring inflation. This policy has probably contributed to the correction in asset prices.

The following chart shows the year-over-year change to the balance sheet from all major central banks. It’s notable that the Covid-19 response – a massive USD 10 trillion from all central banks combined over the course of a year – was an order of magnitude larger than the quantitative easing that followed the 2008 financial crisis.

A dearth of doves on our central bank tracker

The following dashboard tracks the central banks of G20 and OECD economies, showing each country’s policy rate as well as the most recent decision to cut or hike rates. With the notable exceptions of China, Russia, Turkey and Japan, every other economy has been tightening policy. 

Moreover, most countries have been hiking rates within the past two months, showing how monetary policy is globally synchronized.

The market believes the Bank of England will hike more than the Fed

Bank of England Governor Andrew Bailey has said that as inflation tops 10 percent, his institution must respond to one of the biggest shocks it has ever faced. Futures markets believe that response will be a tightening cycle that outpaces the Federal Reserve.

The following chart displays the trajectory of policy rates for the Fed, BOE, and the ECB since 2021. It then plots those rates’ future as financial markets see them. Markets are pricing in hikes for all three economies through the rest of 2022 and into mid-2023. 

Rates are expected to peak at almost 4.5 percent in the UK. That compares with almost 4 percent in the US, and only 2.5 percent in the eurozone. Futures also forecast slowly falling rates from mid-2023 – anticipating a major slowdown and probably a recession, at least for the Eurozone and UK. The US still has the highest odds of pulling off a soft landing.  

Indonesians up in arms as a squeezed government raises fuel prices

Indonesia has subsidized petrol prices for decades. With oil prices soaring, and Indonesia a net fuel importer, this policy was proving costly. 

The government recently raised prices by about 30 percent. Unrest quickly ensued as the local cost-of-living crisis sparks anger on the streets.