Charts of the Week

The most down days for equities since the 1970s

“Worst since 2008” is an oft-used descriptor in the financial world. It might not surprise the reader to learn that, indeed, in 2022 the S&P 500 posted its steepest decline (19.4 percent) since the year of the global financial crisis. 

If we measure the bear market by the number of down days, we have a stronger superlative, as our chart shows. 

As markets digested surging inflation, a tighter tightening cycle than expected, and Russia’s war on Ukraine, the benchmark US stock index had 143 negative trading days in 2022. That’s the most since 1974 – and matches the Great Depression year of 1931.

The World Bank is more pessimistic

The World Bank cut its global economic growth forecast this week and is expecting a more stagnant 2023 as countries tighten monetary policy. As our table shows, the international institution now foresees GDP will increase just 1.7 percent, down from the 3 percent pace it projected in July. (It’s also not ruling out an outright recession.)

The World Bank became only mildly more pessimistic for 2024, perhaps indicating faith in central bankers’ attempt to engineer a soft landing. 

Nowcasting US GDP with Macrobond

Understanding what’s happening in the economy in real time is important. Nowcast models aim to “predict” the present, given there is a lag before data becomes available, and keep investors ahead of the curve. 

Macrobond provides customers with well-known Nowcasts from institutions such as the OECD and the Atlanta Fed. But why not construct your own? 

The following chart was generated from a template we constructed. It gathers time series ranging from industrial production and the labour market to business surveys and financial data. It uses built-in principal component analysis (PCA), together with a vector auto regression (VAR), to estimate real-time GDP. 

Macrobond users can change any of these input variables to create their own Nowcast.

(At the moment, our template is Nowcasting a growth slowdown for the US that stops short of a contraction.)

Growing and shrinking slices of the Eurozone inflation pie

Macrobond now offers pie charts (requires version 1.26). We have applied this functionality to analyse trends for various components of inflation in the eurozone.

Inflation remains elevated overall, posting a 9.2 percent year-on-year gain in December, though that was lower than expected and marked a slowdown for a second consecutive month.

This pie chart is a visualisation of hot and cold categories that make up the Harmonised Index of Consumer Prices (HICP). Prices for some line items in a household budget are rising ever more rapidly, while other spending categories are leveling off. (Here’s a link to a recent heatmap of inflation hotspots, as organised by sector.)

More than 46 percent of HICP components are posting price increases that are below 5 percent and decreasing (the green – and largest – part of the pie), bolstering the argument that inflation is tapering and might result in a less hawkish ECB. But the red tier – components where inflation is above 5 percent and increasing – is almost as large.

Warm winter and preparation help Europe avoid a natural gas crisis

Amid concern that Russia would weaponise gas supplies to Europe, the EU set targets for member states to fill their storage capacity to at least 80 percent by November. (Last year, we published a chart showing how Russian gas shipments were dwindling). Member states turned to the LNG market; some observers were fearful that shortages and rationing could result.

As a result of the EU’s caution and what has turned out to be an unusually warm European winter, gas storage is still above that target level in a month normally known for peak energy demand. As the first chart shows, storage levels were about 83 percent in December, higher than they were at the same point in both 2021-22 and the generally chillier 2020-21.

The second chart, tracking weekly changes to the storage levels over those winters, shows that for part of December 2022, gas storage levels actually increased.

German trade balance remains under pressure on expensive energy

This chart of Germany’s trade balance shows the importance of expensive energy imports to the world’s no. 3 exporting nation. 

The trade balance weakened in October but remained in positive territory. Key German export markets were hit by inflation and supply-chain issues. 

China was still implementing zero-Covid, disrupting trade with another key partner. As the strictness of that policy is unwound, Germany’s non-energy trade balance has potential to improve, but it still faces the possibility of a US-led global recession.

The trade deficit in energy is slowly shrinking, but remains strongly negative as the nation replaces Russian gas with pricier LNG.

Hiring is a vicious circle in the tight US labour market

The post-pandemic US labour market has stayed robust in the face of a historic tightening cycle, with an unemployment rate of just 3.5 percent as of December. 

The following “circle” tracks employers’ search for workers – and how different the trend has been since 2021. It uses CEO surveys from the Conference Board to plot quarterly data points.

The X axis shows the percentage of CEOs that think they will expand their workforce more than 3 percent. The Y axis shows the percentage who feel it is difficult to attract qualified people. 

Both figures soared compared with the pre-2021 period, but have roughly returned to historic averages recently. The resilience of the labour market will be tested in 2023.

Historic bear markets were tougher than this one

As we showed in our first chart, last year was tough for US stocks. But compared with past slumps, the S&P 500’s decline is not especially punishing – yet. Will a US recession make this bear market more historic? 

The chart below graphs the last 60 years of bear markets in terms of both depth and time. Stock markets that peaked in 1956, 1966 and 1980 fell more than 20 percent thereafter, exceeding the 19.4 percent drop in the current bear market. 

After the peak of 1968, the S&P 500 posted a decline of more than 30 percent, as it did after the 1987 and 2020 crashes. The bear markets beginning in 1973 and 2000 approached 50 percent. 

Unsurprisingly, the most extreme move was during the global financial crisis: the S&P 500 fell more than 50 percent during the 15-month bear market that started in 2007.

130 years of history also suggest a recession is not priced in to US stocks

Many observers expect a recession this year as leading indicators in manufacturing and services flash red. Both CEO and small-business confidence are near record lows. But is a recession priced into the stock market?

A historic valuation barometer that may shed some light is the Shiller price-earnings ratio, which can be measured back to 1893. Our chart graphs this historic ratio against a smoothed-out, 12-year moving average. 

One might expect a discount versus the long-term average if we were going into recession. But the latest figure shows a P/E ratio of 28 – a small valuation premium relative to the 12-year average.

Home transactions plunge as Fed hikes stamp on the brakes

As expected, the Fed’s rapid tightening is having a strong effect on the US housing market. (We considered this from multiple angles in October.) 

The effect on transaction volumes has been particularly notable.

This chart tracks home sales in different Fed tightening cycles. Transactions have taken just six months to drop 30 percent – more quickly than in any other cycle over the past 50 years.  

A measure of geopolitical risk spikes

Featured in: Charts of the Week on March 4

We first published this chart just after Russia’s escalated invasion of Ukraine in February.

It uses a measure of risk from Economic Policy Uncertainty,an academic group that creates indices relating to policy challenges ranging from infectious diseases to wars.

Their geopolitical risk index tracks newspaper archives going back decades. Peaks occurred around 9/11 and the collapse of the Soviet Union. While tensions between Russia and the West remain elevated, geopolitical tensions are generally taking up less space in the media; the index is welldown from its March peak.

The evolution of global tightening

Featured in: Charts of the Week on April 1

We were at the beginning of the tightening cycle when we first published this dashboard. Emerging markets had been most hawkish,anticipating Fed tightening. But Japan was the only major economy where inflation was significantly below target and its central bank opted to swim against the tide, repeating its commitment to keep long-term yields low via yield curve control.

Since then, many more central banks started hiking, while those that were already tightening became more aggressive. The doves that stand out in the dashboard today are China, Russia and Turkey. Asfor Japan, its key rate stayed negative – alone among central banks – but it recently shocked markets by widening the acceptable range for bond yields, suggesting a greater policy shift could follow.

Inflation rips across the Eurozone

Featured in: Charts of the Week on June 24

When this heat map was first published, inflation for the euro area was 8.1 percent year-on-year. That has worsened to 10 percent.

Since then, inflation has continued its broad advance and there are fewer cooler areas on the heat map than there were in May. The only category where prices are shrinking is communications;transport price growth “slowed” to 10 percent year-on-year from early 2022’s prints of 14 percent or more.

Inflation ravages real wages in Europe

Featured in: Charts of the Week on August 26

In the euro area, negotiated wages are falling sharply in real terms – i.e., any increase is being more than outpaced by inflation. This was the case when we published this chart, and it’s still generally true – and often even worse today, depending on the country. The Netherlands and Spain have seen a slight rebound.

European gas worries before and after Nord Stream sabotage

Featured in: Charts of the Week on September 2

We first published this chart just weeks before the Nord Stream pipelines taking Russian gas to western Europe were damaged in an act of suspected sabotage. Even before that incident, flows from Russia were shrinking, as the chart shows; Nord Stream was taken offline for repairs. That stirred concern that Europe would have trouble filling its gas reserves in time for winter.

Even in early September, some observers had warned that Nord Stream might not reopen given the tensions with the West over Ukraine. As the updated chart shows, those voices were prescient. Europe turned to the LNG market for gas supplies and has been fortunate to experience a warmer-than-usual winter so far.

Markets changed their view on whether the Fed would be out hiked by the BoE

Featured in: Charts of the Week on September 9

When this chart was first published, just four months ago, futures markets believed the Bank of England would be forced to hike rates a half-percentage point more than the Federal Reserve through 2023 in order to tame rampant inflation.

Today,that gap has reversed; as inflation persists, traders foresee UK rates peaking above 4.5 percent, but they believe the Fed is headed to 5 percent. Rate hikes are expected from the ECB too, but with a far lower peak rate.

Central bank balance sheets keep shrinking

Featured in: Charts of the Week on September 9

After the huge round of stimulus during the pandemic, central banks’ balance sheets started shrinking in 2022 amid a major tightening cycle to combat inflation. The shrinkage has continued since we first published this chart.

Comparing oil shocks in the wake of the Russian invasion of Ukraine

Featured in: ‍Charts of the Week on March 11 

We published this chart as markets reacted to Russia’s invasion of Ukraine. As crude prices increased sharply, we drew parallels with famous oil shocks (and recessions) dating back to the famous OPEC embargo crisis of 1973. 

Since March, oil prices have fallen back below their long-term trend, but all eyes are on prospects for a recession in 2023.

The credit impulse wanes from US to China

Featured in: Charts of the Week on March 25 

The ‘credit impulse’ represents the flow of new credit from the private sector as a percentage of gross domestic product. In March, we created a credit impulse measure for the US, China, and Eurozone (G3). We found a correlation that suggested a measure of global sentiment was set to decline. 

Thanks to feedback from our community of users, several adjustments have been made to this chart since it was first published. Credit impulse is now measured more accurately and has rebounded since March. 

This indicator is positively correlated to the US ISM Manufacturing Purchasing Managers Index (0.67, with 14 months of lag). This correlation implies US PMI should rebound above 50, indicating the manufacturing economy is generally expanding. 

Comparing Fed tightening cycles

Featured in: Charts of the Week on May 27 

By May, Chairman Jay Powell was determined to tame inflation, but markets were not fully anticipating the severity of the tightening cycle that followed. 

The version of the chart below published in May anticipated that the Federal Reserve’s key interest rate would peak at 3 percent, as predicted by Fed funds futures. As we can see, the market now anticipates a terminal rate of about 5 percent in a few months’ time. 

The predicted pace and length of the cycle has not changed that much from perceptions in May, however: both show a peak reached 18 months after the start of the cycle.

Natural gas inventory worries in Europe

Featured in: Charts of the Week on July 29 

Natural gas inventories were in the headlines all summer amid grave warnings that Europe might face a winter shortage. In July, only four EU countries exceeded the bloc’s storage targets.

European countries subsequently rushed to buy gas on the market and found alternatives to Russian shipments. This led to record prices (especially for the benchmark Dutch TTF gas futures). Today, almost all EU countries are above the 80 percent capacity threshold set by the European Commission in the summer, as the chart now shows.

Inflation matched the worst case scenario

Featured in: Charts of the Week on August 19 

In 2022, were you on “team transitory” or were you concerned inflation would persist?

When we first published this chart, our idea was to display several scenarios for the year. We showed that even assuming consecutive growth rates of zero month-over-month, US inflation would still be above 5 percent on an annualised basis at the end of the year. 

It turns out that reality was roughly in line with our more pessimistic August scenarios: the latest inflation print was above 7 percent. 

Updating our chart to peer into 2023, only a scenario of consecutive month-on-month decreases of 0.3 percent or more could bring inflation back to the Fed’s 2 percent target within the next six months.  

US inflation hotspots and correctly anticipating a cooling trend

Featured in: Charts of the Week on August 26 

When we first published this heat map, we had no way of knowing that inflation had reached its peak (at least temporarily). But there was a patch of cool blue indicating a broad-based decline in commodity prices was underway. 

The updated heat map clearly indicates how this trend has spread: all of its indicators have slowed over the past four months. 

European electricity market settles down after summer panic

Featured in: Charts of the Week on September 2 

Luckily for Europeans, electricity prices didn’t follow the futures curve we drew back in September. Prices dropped in October amid balmy temperatures and are returning to levels roughly in line with winter 2021. 

That’s still historically high, but it seems that the worst is behind us.

There are still very few doves on our central bank tracker

Featured in: Charts of the Week on September 9 

There has been no paradigm shift since we first published this chart three months ago. Countries that were tightening kept on hiking rates.

However, it is worth noting that among the four exceptions to the trend (China, Japan, Russia and Turkey all decided to cut rates in 2022), there has been only one nation that has loosened policy very recently. Turkey cut its key rate in November, while the other three economies kept their key rate unchanged. 

Looking back at winning and losing growth and value sectors

This table ranks winners and losers among US equity sectors for every year between 2015 and 2022. Two distinct eras jump out.

The Covid year of 2020 was defined by recession, anemic inflation, low interest rates, low commodity prices and elevated risk aversion. It was the perfect environment for growth stocks in sectors like IT and communication services. (Interestingly, 2019 equity trends were similar.)  

The second era is the 2021-2022 “post-Covid” period: stronger growth, stronger inflation, higher rates and commodity prices, and lower risk aversion. It was the sweet spot for value stocks, such as energy and financials.

The change of leadership from growth to value has been extreme. In 2023, we will probably see more balanced returns from the two investment styles, as both economic growth and inflation expectations are cooling.

Watching Germany as its biggest trade partner relaxes Covid zero

The following chart is a version of the European Commission “clock” that tracks economic progress through the business cycle, divided into four quadrants: contraction, upswing, expansion, and downswing.

Germany’s economy has deteriorated more quickly than France, Italy and Spain, as our chart shows. That’s due to the knock-on effect of China’s Covid-zero policy and a greater impact from this year's energy crisis.

Growth in Europe’s largest economy has long been export-driven, and China is Germany’s biggest trading partner. As China loosens the Covid-zero policy, Germany may benefit. But the experience of other countries suggests cases may surge, and it’s not guaranteed that supply-chain and trade disruptions will disappear. 

Cold European winter is as much of an outlier as the warm autumn

After a mild autumn, many Europeans are shivering in a much-colder-than usual winter. 

The cold snap is important because of the potential for energy shortages. German regulators recently warned that firms and households must save much more gas to avoid winter rationing or outages. 

The chart below shows how temperatures in Germany, as tracked by the purple line, have plunged below not just the historic average but the 10 to 90 percentile range of previous years.

The opposite was the case as recently as mid-October – when we wrote that Europe was taking advantage of balmy temperatures to refill its gas storage facilities. 

Europe’s energy needs have been in focus this year after Russia slashed gas deliveries, increasing scrutiny of previous German policy to phase out nuclear plants.

Visualising the growth and value eras

As we pointed out in our first chart this week, value stocks drastically outperformed growth stocks over the past year. The first of the two charts below is a different visualisation of this trend. 

Blue areas denote periods of outperformance by growth stocks, as defined by FactSet. Green areas show when the value style outperformed.

The second chart shows that growth, relative to value, is now trading at a valuation discount versus its long-term average (the red line). Not long ago, price-earnings ratios were almost 60 percent higher for growth stocks, a differential last seen in the 2000 dotcom bubble.

Relative profit expectations for growth stocks have rebounded from their record low in September. As we said previously, 2023 could be a balanced year for growth versus value.

US growth and inflation expectations are sliding

The following chart graphs the progress of US inflation and growth expectations since January 2021, as measured by the five-year breakeven rate (inflation) and the composite Purchasing Managers Index (growth).

Amid criticism of its past hesitancy to raise rates, the Federal Reserve’s tighter policy successfully resulted in falling inflation expectations this year, as our chart shows. But growth expectations are declining too.

The PMI fell to 46.3 in November; numbers below 50 indicate contraction. As investors debate whether the Fed will avoid a hard landing and “pivot” to rate reductions in 2022, the PMI reading suggests a recession in the first half of 2023 is very possible.

M2 suggests US inflation will tumble

Many people got it wrong on inflation over the past two years. In early 2021, some analysts took a micro approach – focusing on used car prices or specific bottlenecks. 

In our view, it’s become clear that much US inflation is demand-driven and reached all sectors of the economy, caused by excessively easy monetary policy combined with generous fiscal support.

We can consider monetary aggregates like M2 – cash, chequing deposits, and assets that can easily be converted to cash – to examine inflation. (This is appropriate now that the US is no longer in a liquidity trap; the relationship breaks down with interest rates at zero. And to be sure, velocity of M2, not just supply, matters for how inflation behaves.) 

Our chart shows the correlation between M2 money supply, pushed forward by 18 months, and the consumer price index. Excess money growth in 2020-21 contributed to peak inflation this year.

If money growth falls off a cliff, can we really expect inflation to also decline quite substantially in the coming months too?

Americans are switching jobs to get big wage increases

If you want to get a big salary boost in the US, you should switch employers – at least according to data from the Atlanta Fed.

The following chart tracks nominal wage growth for people who stay in the same job versus people who join a new company. 

In the US, nominal wages are growing at their fastest pace since the late 1990s. And the differential between job stayers and job switchers recently touched the highest level ever recorded. 

The Bank of England has been overly gloomy on unemployment

Britons may well hope the Bank of England keeps up its past record of overestimating unemployment.

The following chart tracks the actual UK unemployment rate against different vintages of the BOE’s forecasts for joblessness. 

In 2021, the BOE initially expected unemployment to be much stickier than what actually occurred post-lockdown. And it overestimated unemployment throughout 2022 by one to two percentage points; the rate plunged to 3.5% this summer.

However, the outlook is considerably less bright as the BOE forecasts a brutal recession that lasts from early 2023 until potentially mid-2024. 

The BOE recently revised its unemployment forecast upwards. Amid a darkening outlook, the BOE expects the jobless rate to almost double, reaching 6.5 percent by early 2026.

The correlation between UK house prices and unemployment

Perhaps unsurprisingly, UK house prices and unemployment are tightly correlated.

Several economists, most notably Roger Farmer, have examined this relationship. Asset-price declines affect private-sector confidence and induce a negative wealth effect, both of which are obviously detrimental to the labour market. 

The causality goes the other way, as well. A negative shock to the labour market hurts house-price fundamentals.

As our chart shows, UK house-price growth slowed markedly over the course of 2022. And unemployment is edging up as the UK recorded negative third-quarter growth. 

Going forward, expect further pain for property prices and unemployment. Perhaps counter-intuitively, real estate is the leading indicator – by about five months, as our chart shows.

China relaxes Covid zero as cases rise

At long last, China is relaxing the Covid-zero policy, which saw regional lockdowns constrain economic growth and disrupt global supply chains. 

Coronavirus cases are on the rise, as our chart tracking notable Chinese regions shows.

It is notable that Shanghai experienced an earlier surge and plateau of cases than the other regions.

US financial conditions are easing

Despite the rate increases, US financial stress is easing again.

This chart shows a financial conditions index that we constructed at Macrobond. It applies a principal component analysis to several financial time series, including the policy rate, equity prices and volatility, the exchange rate and credit conditions. 

The spike during the crisis of 2008 is obvious, as is the somewhat smaller shock during the early days of the pandemic. (The Federal Reserve’s monetary policy response was much more aggressive.) 

The tightening that occurred throughout 2022 was a result of rising interest rates and falling asset prices. But the latter effect has now somewhat reversed, easing the tension.

Tracking the world of central banks and inverted yield curves

The following table shows different nations’ policy rates, their last interest-rate move and the number of months since the last hike or cut. (Japan is notable for not having tightened in more than a decade; this is likely to change as global inflation persists.)

We have also calculated the proportion of yield spreads that are inverted in each nation – a classic warning sign of recession. The US is currently experiencing the most inverted yield curve; all longer-term debt tracked in the chart (2-, 3-, 5-, 7- and 10-year durations) is yielding less than the 1-year government bond.

Markets are thus telling us that the Fed is likely going to cut rates. Most likely, this will coincide with an economic slowdown – or even a recession.

A soft landing from the Fed could mean a bright outlook for equities

Historically, stocks have reacted quite differently when the Fed ends a hiking cycle.

The following chart tracks the S&P 500’s performance before and after various interest rate peaks. The average increase is more than 12% over the subsequent year. Outliers include 1973 (era of the OPEC oil shock) and 1995 (Alan Greenspan’s “irrational exuberance” comment was made the next year).

We graphed the current cycle by assuming rates peak in May, as the markets predict. And those same markets are already pricing in a pivot to rate cuts next year. That suggests equities might actually do quite well, provided the Fed actually achieves a soft landing.

The Powell spread and yield curves

As the Fed chairman ponders how much to keep tightening, it’s worth examining his preferred recession indicator.

The following chart displays the “Powell spread” between the yield on a three-month Treasury bill and its implied yield in 18 months’ time. We have also overlaid the proportion of yield curves that aren’t inverted (along the lines of our central bank tracker, but using more durations); with more than 80% of the spreads inverted, that’s not good news. 

The Powell spread has been one of the most accurate predictors of an economic downturn. Once a substantial share of the yield curve is inverted, a recession becomes much more likely. 

France is generating less nuclear power than usual

France is Europe’s biggest producer of nuclear energy. In theory, that made it less exposed to the energy crisis than its neighbours when Russia cut gas shipments. However, many French reactors were shut down this year amid maintenance issues. 

The following chart tracks French nuclear electricity output week-by-week in 2022, showing how it was well below the range of production from 2014 to 2021 

In recent weeks, output has picked up in time for winter as plants under repair return online.

Reserve assets are melting in Asia

Asian countries continuously accumulated reserves before the pandemic; after the onset of Covid-19, they surged. As nations use reserves to defend their currencies against King Dollar, that trend is over now.

As our chart shows, it’s historically unusual for Asian reserves to decline so much. The Fed’s tightening cycle has led to rising interest rates around the globe, while most currencies have depreciated quite substantially against the dollar. 

The Bank of England’s tough recession prediction

The Bank of England’s forecasts suggest the UK’s central bank might engineer a more prolonged recession than necessary. 

The following chart shows the BOE’s forecast for nominal gross domestic product: the sum of real GDP and inflation. It suggests one of the longest recessions in UK history, with the economy contracting throughout 2023 and 2024. 

The BOE sees inflation well below 2% in 2024 while real output declines, implying below 2% nominal growth. Such a low figure is associated with lower wages and falling asset prices – a tough economic prescription associated with lower wages, falling asset prices and debt deflation. 

One is reminded of Japan’s “self-induced paralysis” of the 1990s, as Ben Bernanke put it.

‍Russian shipments of cheap oil to India and China are rising

As Western nations impose sanctions on Moscow and restrict oil purchases, India and China have been buying much more Russian crude.

It’s cheaper for those nations. The following charts show the change in purchases while demonstrating how the Urals oil price has been trading at a discount to the Brent crude benchmark. 

‍Falling productivity is a recessionary sign

Our final recession indicator considers productivity.

The following chart uses the composite purchasing managers index (PMI) minus employment PMI as a proxy for productivity growth. We calculated it for the G3 economies, weighting the US, eurozone and Japan by their respective GDP series. 

Our constructed measure shows a quite severe slowdown in productivity recently. It tracks OECD productivity figures quite closely as well. 

Bitcoin and wine are anomalies in our eight year asset class scorecard

The following chart displays the annual performance of different asset classes from 2015 to 2022. 

Several things stand out. First, Bitcoin returns have been “binary” over the last few years. For every calendar year in this time frame, it was either the best or worst asset class. The S&P 500 performs quite well most years, whereas emerging market equities and commodities, including gold and oil, are much more volatile.

Wine is another interesting case as it’s one of the few remaining assets measured in GBP. Returns in sterling terms have been decent, but in USD, your cellar would have lost money due to the greenback’s surge.

UK stands out as a weak market in commercial property scenarios

Real estate will be a key sector to watch in 2023 as interest rates rise. And in the office market, the long-term impact of the pandemic-driven shift to work from home is unknown.

The following chart compares commercial real estate values in different countries in 2021 with forecasts for 2023, courtesy of our newly extended partnership with Oxford Economics. 

In any scenario, from a strong economic rebound to severe disruptions stemming from a renewed coronavirus outbreak to geopolitical conflict, the UK stands out as a weak market for commercial property.

US CPI inflation would be lower using market rental prices

Lagging indicators in economic data can lead to policy mistakes. With this in mind, it’s interesting that real-time residential rents differ from shelter costs used in the US consumer price index (CPI).

The following chart displays US core CPI, which uses the cost of shelter index calculated by the US Bureau of Labor Statistics (BLS), and a hypothetical alternative that uses market-based rents.

Core CPI would have been significantly higher last year using market-based rents, easily exceeding 10% throughout 2021. Now, however, the situation has completely reversed. 

Consequently, the hypothetical core CPI would be close to the Fed’s 2% target. The actual core CPI series is still above 5%. 

If you use the BLS numbers, the Fed should stay hawkish. But market rents are suggesting that tighter policy has already had a significant impact on at least one segment of the economy.

Recession risk is creeping higher with US industrial production in focus

The following chart tracks US industrial production against a backdrop of recession risk – based on a model estimated by the New York Fed using the yield curve, which historically has been a good indicator of future economic downturns. Darker shaded areas mean higher risk. 

As one can see, we are currently edging toward higher recession risk; the US yield curve has been inverted for quite some time. The Energy Information Administration is forecasting a decline for industrial production by the start of next year. 

There is a broad consensus that even if a recession is avoided in 2023, the US economy will slow significantly as a result of tighter monetary policy. 

Stocks tend to follow a trend before and after inflation peaks

As one of our previous charts showed, high-inflation environments can hamper stock-market performance. Tighter monetary policy brought in to tame that inflation can have a knock-on effect on equities, as can looser policy once inflation eases.

The following chart displays the S&P 500’s performance 250 days before and after inflation touched a peak. 

The market’s median performance is extremely strong after inflation peaks. But there are severe outliers – especially 1957 and 2008  – when equities suffered substantially. 

Applying the Taylor Rule to Germany

The European Central Bank must set policy for the whole eurozone, but it has been arguably too loose for the continent’s largest economy. 

John Taylor gave his name to an equation used as a rough guideline for the Federal Reserve’s response to inflation.

Typical formulations of his rule include the concept of a “natural” rate of interest. In the chart below, applying the Taylor Rule to Germany, we used two assumptions: In the first, we assume the natural rate r* = 2, and in the second we assume that r*=0.

Even the more dovish version would have called for tighter policy for Germany than what was actually in place from 2014 to 2020. This looseness likely contributed to the real estate boom the country experienced, even pre-pandemic, after decades of stagnating prices. 

With inflation at a record high and the economy arguably running near its potential, the Taylor rule prescribes an interest rate of more than 5% for the German economy right now. The ECB’s policy rate is only 2%.

China Covid cases and retail sales

Unsurprisingly, Covid-19 outbreaks result in tough business conditions for retailers.

The following chart tracks retail trade figures and coronavirus cases in China. There is quite a tight correlation between the two due to China’s zero-Covid strategy, which has seen entire metropolitan areas locked down. 

Cases are now rising rapidly as we move into winter, and we could have a repeat of the retail downturn we saw during the start of the summer.

European producer price inflation is mostly easing

Inflation – as measured by the price companies pay for their inputs – is easing in Europe. And this should pass through into consumer prices going forward. But the continent isn’t a monolith.

The following chart focuses on producer price index (PPI) readings across Europe, measuring how much they have fallen from their 2022 peak in percentage terms. This year was notable for soaring energy prices and global supply chain disruptions. 

About half of Europe is seeing significant drawdowns, including Germany and Italy. France is the biggest economy to have experienced little relief by this metric.