Charts of the Week

US labour market

Headline inflation rose to a new 40-year high this week, with the Consumer Price Index hitting 9.1% for June. This will put even more pressure on the Federal Reserve to go big on rate rises, hiking by 75bps or even more this month. This, in turn, will drive up unemployment – but as our first chart shows, the Fed still has a bit of wiggle room. 

While the US labour market has made a spectacular recovery after losing more than 20 million jobs in April 2020, employment remains below the pre-pandemic trend: about 3 million women and more than one million men are still missing from the labour force. 

US recession probability

With inflation soaring, markets are pricing in continued rate hikes for the rest of the year. That’s raising the odds of a US recession to more than 25% over the next 12 months, according to a recession risk model from the Fed. The chart below includes the TED (Treasury-EuroDollar rate) spread – the difference between the interest rate on short-term debt and interbank loans – which often widens during periods of economic crisis.

US recession indicator

Despite what the chart above shows, recent job growth numbers suggest that a recession is still some way off: non-farm payrolls in June increased by a more-than-expected 372,000. 

The Sahm Rule chart below identifies signals related to the start of a recession: when the three-month moving average of the national unemployment rate (U3) rises by 0.5 percentage points or more relative to its low during the previous 12 months. As you can see, we are nowhere near approaching a significant decline in the labour market. 

Bank of Canada rate hike

North of the border, the Bank of Canada is also wrestling with inflation. This week, it raised its policy interest rate by 1% – the biggest hike since 1996 – to 2.5%, the highest since 2006. 

Supplier delivery times

Supply-chain disruptions wrought by the pandemic and exacerbated by a swift global recovery that swelled demand for goods significantly extended delivery times over the past couple of years. But we are starting to see some improvement, as the Purchasing Managers’ Index heatmap below shows. Still, most countries have a reading far below 50, indicating a contraction of business conditions as reported by supply chain managers. 

Household consumption as share of GDP

Europe’s biggest economy has outperformed many of its neighbours since the 2008 financial crisis. But that resilience comes with a trade-off: wage restraint. Weak wage growth helps to boost Germany’s competitiveness in the euro area, but it also discourages spending. 

In the chart below, we used Macrobond ratios to calculate household consumption as a share of GDP. As you can see, Germany has been following a downward trend for more than a decade.

Euro area trade balance with Russia

The euro area’s trade balance with Russia has plunged in recent months as sanctions discourage exports to the country. The shrinking Russian economy is also curbing demand for goods. 

While the volume of imports from Russia has also fallen, their value has risen to a record thanks to high commodity prices. 

Euro area trade balance with Russia, Norway and China

This next chart shows the correlation between the eurozone’s trade deficits with major trading partners and commodity prices. Whenever prices spike, the deficit with Norway and Russia – where the EU gets much of its gas and oil – widens. 

The trade deficit with China has also swelled over time as Asia’s largest economy cemented its position as a global manufacturing centre. A slowdown in China and a recovering euro economy further widened the gap this year.

Euro area trade balance and euro-dollar exchange rate

Commodity prices are not the only factor behind the euro area’s plunging trade balance; the weakening currency is also to blame since many commodities are priced in US dollars. 

Australia retail trade

Lastly, a look at Australia’s thriving retail trade. Sales rose for a fifth consecutive month in May, increasing 0.9% to a record A$3.4 billion. That’s despite soaring consumer prices that have prompted the Reserve Bank of Australia to lift its cash rate by 125 bps since May.

Global inflation

We start the week with a heatmap showing the extent of the global inflation epidemic. The Harmonised Index of Consumer Prices (HICP) measures changes over time in the prices of consumer goods and services. As the chart shows, inflation is significantly above its 10-year historical average for all countries. Food, housing and utilities, furnishings, transportation, and hospitality are experiencing the highest inflation, driven by a surge in global food and energy prices. 

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US inflation expectations

In the US, inflation expectations have eased but remain significantly above target for the next two years, according to a chart we created using data from the Federal Reserve Bank of Cleveland and ICAP. It shows market expectations have shifted lower to be more in line with the Cleveland Fed’s model, even falling below its 2% target in the longer term. 

US inflation expectations using breakeven rates

The next chart, courtesy of David Beckworth, Senior Research Fellow at Mercatus, calculates inflation breakeven rates – a market-based measure of expected inflation. It is the difference between the yield of a nominal bond and an inflation-linked bond of the same maturity.

The two-year breakeven rate (solid blue line) shows there was a huge increase in short-run inflation expectations for this year that has since eased.

Using the two-year and five-year breakeven rates, we calculated the two-year and three-year inflation expectations for the period starting two years from now. It shows that medium-term inflation expectations are close to the Fed’s 2% (PCE) target. (Subtract 40bps from the breakeven rate to adjust from CPI to PCE inflation) 

CPI vs PCE

The difference between PCE (personal consumption expenditure) and CPI (consumer price index) has widened to a record. The spread is typically about 40bps but has since expanded to more than 200bps as CPI soars to 8.52%. CPI puts a larger weight on shelter, food and gas and is therefore a better indicator of consumer sentiment.

GDP revisions debunk recession definition

A technical recession is often defined as two consecutive quarters of negative economic growth. However, our chart looking back at GDP revisions prior to the 2001 recession debunks that rule. 

We know today that the downturn lasted from March to November 2001. However, we can see in the chart below that the first Q2 GDP figure (released in July 2001) did not record any decline in economic activity. In fact, this does not appear until August 2002, after several revisions. By then, the data showed there had been three consecutive quarters of negative GDP growth before March 2001. 

That GDP data has since been revised again, and today we can see that only Q1 and Q3 2001 recorded negative growth. Perhaps we should follow the lead of the National Bureau of Economic Research instead. Rather than relying on the two-quarter rule, the NBER considers a variety of macroeconomic indicators, especially those related to the labour market, for its recession calls. 

GDP Q2 nowcast

Now let’s look at US GDP revisions for the present day. Using our Revision History data, we created a chart on the evolution of the Q2 GDP forecast based on the Federal Reserve Bank of St Louis’s nowcast model. Unlike the Atlanta Fed nowcast, which predicts a contraction for Q2, the St Louis Fed expects relatively high growth. Given the many conflicting data points, it is still too early to call a recession.

US financial stress

All that conflicting macroeconomic data is being reflected in US financial stress indexes. 

Conditions have clearly tightened amid rising interest rates and falling stocks and the Chicago Fed and Kansas Fed indices show an increase in stress. On the other hand, the St Louis Fed index shows an easing of conditions. What does this tell us? That it’s down to differing methodologies? Or that financial conditions are not quite as tight as they seem, given that nominal spending remains elevated.

German inflation

The subcomponents of Germany’s inflation data are always released with a delay of several weeks. 

But there is one way to get an early estimate.

As the largest German states publish their data a few weeks before the national data is released, we can take a weighted average of state GDP numbers to obtain an early ballpark figure for the various contributors to national CPI. 

The following scatter plot shows the relationship between the actual May value of the national CPI and the forecasted June values based on state-level data. Components below the green line are expected to have a lower inflation rate in June compared to May, whereas those above the line are forecasted to be higher. See how it shows components such as transport prices soon declining, while most everything else continues to rise. 

German inflation contributors

Now let’s look at the actual German CPI data together with estimated contributions based on state-level data. As you can see, the estimated contributions almost perfectly add up to the total aggregate CPI, meaning the tactic of using state data to get an early estimate for subcomponents can yield impressively accurate results.

Swedish CPI

Finally, let’s look at inflation in Sweden. Our last chart compares Swedish CPI and the Riksbank’s 2% inflation target. As you can see, the central bank has continuously undershot its own target since the late 1990s, and even more so after the 2008 financial crisis. Judging from this chart alone, it seems the Riksbank has been treating 2% inflation as a ceiling rather than as an average with symmetric deviations above and below.

Nominal US yields

As inflation spurs central banks to raise interest rates, it is interesting to see how high we can still go compared to previous decades. 

Our first chart shows the evolution of US 10-year yields with decennial averages. The nominal rate peaked in the early 1980s when the Federal Reserve kicked off a series of sharp rate hikes to bring down ultra-high inflation. Since then, a prolonged period of disinflation has led yields to decline continuously – from more than 10% in the 1980s to just over to 2% following the 2008 financial crisis.

Real US yields

Inflation-adjusted yields also fluctuated wildly over the same period – spiking at almost 10% in the 1980s before slipping to a low of -2.4% in the last couple of years. Empirical and theoretical studies have attributed the decline in real rates to a range of factors including adverse demographics, low productivity growth, falling price of investment goods and rising inequality and monopolisation, as noted by former US Treasury Secretary Larry Summers in his secular stagnation hypothesis. 

Business confidence and earnings revisions

Business confidence takes a hit when earnings are revised down. This next chart shows the extent of that correlation. Given the current plunge in expected earnings – towards levels last seen at the start of the pandemic – we can expect a huge drop in business confidence in coming months. 

Commodity price disinflation

After surging to near historic highs at the start of the year, commodity prices have finally settled as demand weakens amid a global and Chinese economic slowdown. This chart shows the trajectory of commodity prices this year against previous years. 

Commodities drawdowns

The next chart shows drawdowns across commodity classes. Industrial metals and agricultural products have fallen by the most from this year’s peak while energy has fallen by the least. Given the decline in overall commodity prices, we can expect some disinflationary pressures on prices in the months ahead.

Cotton prices

Commodity prices are volatile and prone to overshooting. The correction for cotton has been particularly striking, with the price dropping by more than 20% over the last couple of weeks. 

Chinese exports vs US inventories

US manufacturers rely heavily on China for materials and the following chart displays that interdependence. It compares US factory inventories and Chinese exports five months earlier. Inventories often serve as a good indicator of the business cycle, with more goods in stock during periods of economic growth.

The following chart shows that Chinese exports have been declining. In line with that, US inventories will most likely fall if the US economy starts to contract.

Yen exchange rate: fair value model

The following graph shows the value of adding high-frequency indicators to financial variables when modelling exchange rates. 

We created a fair-value model for the nominal broad Japanese exchange rate using the following variables:

• The Citi Surprise Index 
• Terms of Trade Index for Japan 
• The global Citi Macro risk index 
• The spread between 2-year and 10-year yields for Japanese government bonds
• The OECD weekly economic tracker

The OECD economic tracker uses Google trends data to estimate economic activity at a much higher frequency than traditional macro indicators. This indicator significantly improves the fit of our model, thus showing how high frequency indicators can be a useful addition to forecasting macroeconomic time series like exchange rates.

Our model tracks the Japanese exchange rate fairly well over time, including most of the recent depreciation. As of right now, the Yen is slightly undervalued compared to our fair value exchange rate model.

Germany temperatures

Here’s a graph that proves global warming is real. It shows average temperatures in Germany throughout the year dating back to 1881 – with temperatures this year rising far above historical averages. 

Impact of Roe v Wade ruling on US Congress

Finally, let’s take the temperature of the US political landscape. 

Democrats have been given a boost following the Republican-heavy Supreme Court’s controversial decision to overturn Roe v. Wade. States now have the right to ban abortions. 

Data from online betting market PredictIt show the odds of Democrats dominating the Senate have increased from about 25 cents to 34 cents on the dollar. Their odds of controlling the House of Representatives have also improved marginally, though they remain slim. 

Euro area inflation

Inflation is ripping through the euro area, having jumped to a record 8.1% in May as energy and food prices stoked by the war in Ukraine roiled the continent’s economy. Our first chart this week shows the extent of the consumer price rises. As you can see, most items are now far above their historical averages. 

US house prices vs population change

The Covid-19 pandemic has triggered a giant shift in the US property market. First, prices appreciated significantly as remote work turned housing into an even more sought-after commodity. Second, Americans moved away from populous states such as California and New York to seek out more affordable lifestyles in places like Florida and Texas. 

The chart below shows the positive correlation between population change and the house price index. Prices rose most in states where populations have grown fastest – showing the extent to which constrained supply drives the market. 

US monetary policy

The Federal Reserve hiked its benchmark policy rate by a whopping 75bps this month as it stepped up the fight against inflation. This chart shows how unusual that is. As you can see, the Fed has historically preferred to adjust monetary policy gradually – by raising or cutting rates by 25bps at a time. 

US coincident index

The extraordinary rate hike makes it harder for the Fed to pull off a soft landing. But just how big is the threat of recession? 

The Federal Reserve Bank of Philadelphia produces a monthly coincident index for each of the 50 states, which combines four state-level indicators to show current economic conditions in a single statistic. At least six states need contract for about six consecutive months to trigger a US recession. As the chart shows, not even one is currently experiencing slowing growth – yet. Keep an eye on this indicator and start worrying when the series falls by six points. 

New York Fed DSGE model

The Federal Reserve Bank of New York, on the other hand, has shared a forecast that puts the probability of a US recession this year at 80%. 

That outlook was generated through the New York Fed’s DSGE (dynamic stochastic equilibrium) model, which predicts negative GDP growth by Q4 and throughout 2023.

The graph displays the evolution of estimates for both GDP growth and the natural rate of interest. It shows that the latter will rise to almost 1% in the coming years – much higher than the current inflation-adjusted policy rate. This partly explains why the Fed is hiking rates so aggressively now. 

US GDP forecast via Indicio

DSGE models are based on micro foundations that establish relationships between variables based on macroeconomic theory. They often impose restrictions on certain parameters to make the model work. 

On the other hand, Indicio – a forecasting platform now available to Macrobond users – takes a purely data-driven approach, using dozens of univariate and multivariate models to create an aggregate forecast. 

We wanted to test whether a forecast generated through Indicio would yield the same results as those from the DSGE. The image below shows how Indicio ranks inputted variables by their relevance, or ‘influence coefficient,’ to the main variable – in this case, US GDP. 

The next chart shows the output. The black line indicates the aggregate forecast generated by the model without any restrictions. The green dotted line factors in the Fed’s so-called dot plot, a signal of the central bank’s outlook for interest rates. 

As you can see, both the general and conditional forecasts confirm the New York Fed’s bleak outlook: The former predicts a major slowdown, with growth declining to zero by the end of 2023, while the latter foresees negative growth for the end of 2022 and the first half of 2023. 

US equities vs interest rates

Our last chart on the US looks at the impact of the Fed’s monetary policy on US stocks. It shows that long-term equity performance typically remained positive through both hiking and cutting cycles – with one exception: The S&P 500 delivered negative returns during the rate hike cycle of the early 2000s when the dot-com bubble burst.

Australia labour market

The Beveridge Curve depicts the relationship between job vacancies and unemployment and is seen as a measure of the health of the labour market. In a recession, unemployment rises as vacancies falls. When vacancies rise without any change to the unemployment rate, the curve shifts outward – an indication of decreased labour market efficiency. 

The chart below uses the Beveridge Curve to show the impact of the Covid-19 pandemic on Australia’s labour market. Just as in the US, it has shifted outward quite significantly since July 2020 – suggesting a large decrease in labour market efficiency, which in turn will have a negative effect on growth.

Bank of Japan bond purchases

We wrap up the week with a look at the Bank of Japan’s desperate efforts to defend its yield peg via a bond buying spree. 

As our last chart shows, the BoJ has been snapping up more than four times as much debt as it has historically purchased. It now holds close to 50% of all Japanese government bonds. 

US equity fundamentals

The Shiller CAPE (cyclically adjusted price-earnings) ratio is one of the most common indicators used to assess whether equities are under or overpriced relative to long-term fundamentals. The following chart displays the correlation between core inflation and the CAPE.

The period from 1990 to 2009, and the decade after the financial crisis, were marked by rather low inflation rates combined with high equity valuations. 

With inflation surging to levels not seen since the 1970s, current equity valuations are thus far too high, based on the relationship mapped out below. We can therefore expect further declines in the US stock market over the next year.

Fed fund futures

With annual inflation rising to 8.6% in May, it was hardly surprising the Federal Reserve raised its benchmark policy rate by 75bps – the first time in three decades – to 1.75% on 15 June. 

Our chart below looks at Fed fund futures to calculate where investors thought rates would be over the next 12 months. It shows they anticipated another 10 rate hikes, followed by two rate cuts. Bond traders evidently expect an economic slowdown or even a recession in 2023.

US two-year yield

US two-year yields have risen by more than 200bps in the past year, from below 0.5% to almost 3.5%. In the last few days, they have jumped by some 20bps every day – an extremely unusual occurrence for the liquid US bond market – on expectations interest rates may rise faster and further than anticipated. 

US yield curve inversion

The surge in the two-year yield was such that it rose above 10-year borrowing costs on 13 June, causing the yield curve to invert – often seen as a harbinger of recession. 

The next chart shows the extent to which yields on short-term debt have exceeded those on long-term securities. The higher the percentage, the higher the likelihood of recession – as indicated by the drop in the S&P 500 following historical spikes. As you can see, we are currently approaching dangerous territory. 

Equity/bond correlation

Until the late 1990s, bond and equity market movements were negatively correlated. But as the following chart shows, that relationship inverted with the dot-com bubble and became even more positive after the financial crisis. The most likely explanation is that the US economy fell into a secular stagnation regime after the financial crisis, which fundamentally changed the relationship between stock prices and expected inflation (and thus also bond prices) due to the liquidity trap (interest rates stuck at zero).

OECD growth forecast revisions

The Organization for Economic Co-operation and Development (OECD) is anticipating a significant global economic slowdown. As the chart below shows, it now expects almost every country to grow at a much slower pace than previously forecasted. This is particularly true for many European countries hit by rising commodity prices fueled by the war in Ukraine.

UK GDP

After more than a year of relatively strong growth, the UK economy unexpectedly contracted in April, shrinking 0.3% after falling by 0.1% in March – the second consecutive monthly decline since the start of the pandemic. 

The following chart shows monthly GDP including contributions by sector. The service sector contributed most to post-pandemic growth, but its contribution has turned negative in recent months as consumers cut spending amid a cost-of-living crisis.

Despite the poor growth outlook, the Bank of England hiked rates by 25bps this week to tame inflation that is expected to reach 10% this year.

Japanese yen and yield curve control

In an effort to achieve a 2% inflation target, the Bank of Japan adopted a yield curve control (YCC) strategy in 2016 that fixed the 10-year yield at +/- 25 bps from 0%. With global yields now surging higher and pulling the Japanese 10-year yield along with it – it recently rose 25bps above target – the BoJ is now desperately trying to defend the peg with massive asset purchases.  

Meanwhile, the yen has depreciated to a record against the US dollar as the spread between global and Japanese yields widen. Japanese policymakers are now trying to support it with verbal interventions, directly conflicting the BoJ’s other target – not a sustainable policy in the long run!

Yen-dollar exchange rate

Taking a closer look at the yen, we have built a momentum indicator of the yen-dollar exchange rate using an exponential moving average, which places greater value on more recent data points.

The moving average convergence-divergence (MACD) displays the relationship between two moving averages. 

Our chart below shows the yen to be significantly below its fundamental value. According to this metric, it is therefore expected to appreciate.

Hong Kong PMI

Finally, some good news from Hong Kong. Manufacturing and services have improved significantly in recent months, with the Purchasing Managers’ Index (PMI) climbing to the highest since March 2011. 

Residential real estate prices have also started rising again. 

While employment has dropped sharply, it may be just a matter of time before it picks up as the economy recovers. 

Central bank tightening

We start the week with a chart that shows how central banks globally are reacting to soaring inflation. 

It shows the change in the policy rate with the change in the inflation rate since the beginning of the year. As you can see, most central banks have started raising key lending rates as consumer prices climbed. The European Central Bank, Bank of Japan and Swiss National Bank are the notable exceptions so far – though the ECB may start some timid rate hikes this summer. 

Central bank tightening vs US economic activity

The next chart is one we have shared before but is worth tracking over time. It shows the negative correlation between US economic activity and global central bank tightening. As you can see, our central bank decision index – we created this by calculating the next balance of policy hikes against cuts from 115 central banks – indicates we can expect a major slowdown throughout the next year. 

US GDP vs GDI

GDP can be measured in different ways: by expenditure, production, or income. The first takes in all expenditures within an economy: consumption, investment, government spending, and net exports. 

GDI (Gross Domestic Income) measures all income within an economy: the sum of all wages, profits, and taxes – minus subsidies. 

Since any expenditure is somebody else’s income, GDP and GDI should in theory be equal. However, because of statistical discrepancies, there can sometimes be sizeable differences between the two series. 

That disparity has now widened to a record – with annualised Q1 GDP falling by -1.5% as GDP rose by 2%. It appears that while GDP is signalling a slowdown of US economic activity, GDI (and other indicators such as recent labour market figures) are sending a different message. This means we may see some large upward revisions of US GDP, as the gap between the two series will have to narrow. 

UK inflation vs wage growth

The UK is facing the biggest income squeeze in a generation. The chart below shows how inflation has outpaced nominal wage growth in the last several years. UK real wages fell for almost five years following the global financial crisis – and are falling again as inflation surges towards 10%. 

South Korean exports

As one of the world’s biggest exporters, South Korean exports are often seen as an indicator of global demand. Yet, despite a slowing global economy, South Korean exports recently picked up again, alongside imports. 

The country’s trade balance, on the other hand, has deteriorated as the global commodity price shock inflates the cost of imports. 

South Korea inflation

The following heatmap shows the consumer items in South Korea hardest hit by inflation. As you can see, the cost of food, utilities, and transport have surged the most due to rising global food and energy prices.

Global equity and bond returns

Now let’s look at the markets. 

The following scatterplot shows the relationship between annual returns for global bonds and equities since the mid-1990s. The correlation tends to be positive except during times of large macroeconomic downturns, such as those in 2001 and 2008, when equities fall but bonds rally on the back of rising interest rates.

This year is a notable outlier. Global equities are down, but so too are bonds – no thanks to high inflation rates that have led interest rates to spike. 

US equities vs bonds

Lastly, we have replicated the analysis above for the US bond market but using our core database this time. 

As you can see, the analysis for the US is quite similar to the global one. This is not very surprising given that the US accounts for more than 45% of the global equity market and the global financial conditions are highly influenced by US monetary policy.