Fear of recession: What the early warning systems of the economy are good

Many indicators suggest that an economic downturn may soon occur. But how meaningful are the data of the experts at all?



The bad news is piling up. German industrial production shrank by 1.9 percent in November, for the third time in a row. According to Carsten Brzeski, Germany's chief economist at Bank ING, the new data has "clearly increased the risk of a technical recession".

Experts talk about a "technical recession" when the economy shrinks for two quarters in a row. In the third quarter of 2018, the German economy was already down by 0.2 percent, in the fourth could again be a minus - but this was "without significant impact on the labor market," as in the previous, hardly noticed recession in the winter of 2012/2013.

Nevertheless, the concern is there - not so much in view of the past half year, but on what is yet to come. Signals of the downturn send Germany as well as the largest economies USA and China. "We need to prepare for the likelihood of a recession," said US economist Larry Summers of the Financial Times.

Everything just scare? In such a situation, early warning systems are particularly important. Here are the main indicators - and what they tell us.

Ifo business climate

According to own data "the most important leading indicator for the development of the German economy" is the business climate index of the Munich economic research institute Ifo. Every month, 9000 companies from the construction, industry, commerce and services sectors are surveyed to assess their current business situation and their outlook for the next six months.

Significance: Moods can change quickly even on executive floors. In addition, the surveyed companies do not represent the entire economy - the inclusion of the services sector in the index in April 2018 fixes this shortage somewhat, but also makes the overall index less sensitive to the economy.

If you want to know early, you only look at the expectation component in the particularly cyclical manufacturing industry - and then, according to an analysis by the Leibniz Information Center for the Economy, you can look about three months into the future. When things got serious before the last recession in 2008, at least the direction was correct, if not the extent of the crisis.

The current signals: Since the end of 2017, business expectations have declined almost continuously, to an index value of 97.3 in December (the value 100 marks the level of the year 2015) - and thus as low as four years ago. You probably did not hear the big crisis of 2015?

The "economic light" supplied by the Ifo Institute is red, but switches more often. The "business cycle clock", which is also included in the package, still stands on "boom", but shortly before "downturn" - and through this quadrant, the pointer moves usually fast, either in the recession, or right back to the boom. You can interpret the Ifo index as threatening, but you do not have to.

ZEW Financial Market Test

The ZEW financial market test has one major advantage: it has an eye-catching look even eight months ahead. Like the Ifo, the Mannheim Institute also uses an expert survey and creates balances of positive and negative answers. In this case, around 300 analysts from banks, insurance companies and industrial groups are surveyed about their economic forecasts.

Significance: The opinion of most of the 300 experts should be publicly known in real time. And the combined mood of the financial markets can also be captured more directly - with a look at the stock market prices. These in turn have only a loose connection to the economic development and fluctuate wildly up and down - so it is difficult to filter out meaningful signals.

The current signals: According to ZEW, economic expectations have "markedly deteriorated" in 2018. December was slightly up but still negative at minus 17.5 points (17 per cent of respondents expected a better economy, 34.5 per cent a worse one) - a mood "just before a recession" , This can not be said of the stock market. The Dax with 18 percent price drop last year only dissolved the profits made in the 2017 boom, not more.

New orders in mechanical engineering

Those who do not want to rely on moods need hard data. Naturally, these are only delayed, especially in the official statistics. At least relatively early are the orders received from the mechanical engineering companies published by the industry association VDMA.

Significance: Industrial machines are classic capital goods that typically provide early signals for the business cycle. There is little demand for them if companies fear overcapacities and therefore cut back investments. Only then does production shrink in the normal course of events, jobs are reduced and finally consumption also suffers. Those who read the VDMA data may know beforehand.

However, monthly data is often distorted by special factors and fluctuates wildly, but smoothing over several months nullifies the benefit of early warning. The data should therefore not be read by itself to derive an overall picture.

The current signals: The November data released by the VDMA on Wednesday show that orders received by mechanical engineers from abroad grew by two percent, while domestic sales shrank by three percent - both still noticeably above the level of sales in 2015. The trend curve continues to point up, but becomes flatter. "It seems to be increasingly difficult for companies to top the already high levels of the previous year," says VDMA chief economist Ralph Wiechers. That sounds like an expiring boom, not a crisis.

PMI

Incoming orders and some other early signals such as inventories are summarized in the PMI, split into industry, services, construction and, for many different countries, published by the global information services provider IHS Markit. Again, experts are interviewed, around 400 for German industry.

Significance: The purchasing managers are closer to the events than company bosses or even analysts - and they express themselves on facts, only as additional information and expectations. Therefore, the index predicts the actual development quite reliably, if only with a few months lead.

The current signals: The index for the German industry in December published in January was with 51,5 points on the lowest level in 33 months (a year ago there had been a record high) - but above the 50-point threshold, the a growing divorce from a shrinking economy. The export orders sub-index fell as sharply as it had in six years.

IHS Markit economist Phil Smith speaks of an "inevitable course correction after the approaching overheating in 2017", which is now surprisingly strong "pushing the industry further towards stagnation".

Yield curve

Hard facts can also be seen in the financial markets, which have a direct impact on the economy - for example, lending, but with a very considerable delay. At the Bundesbank, on the other hand, there are interest rates on bonds with different maturities. If short-term debt is higher-rated than long-term, it is called an inversion of the yield curve - a very early recession signal.

Significance: Here too, the driving force is the mood of investors - which, however, has consequences for the real economy through the cost of credit. If the yield curve is inverse, investors fear for their money in one or two years more than in ten years (a period of time no one knows about and therefore usually carries higher risk).

That rarely happens. And when it does, there is usually a recession - but sometimes delayed by several years, on average by ten months. A very reliable signal is not the yield curve, according to a new analysis by the Federal Reserve Bank of St. Louis.

The current signals: while in the US, the curve for some maturities already tilted in November, the German data are still completely normal: While one-year Federal securities on Thursday dropped negative interest rates of -0.63 percent, ten-year interest at 0.23 percent. Investors may moan about the persistently low level of returns, but from an economic perspective, everything is in the green.

GfK consumer climate

The majority of German gross domestic product is used for private consumer spending - most of the growth is currently coming. Because of its great weight, consumer behavior is also interesting for the future economy.

As part of a Europe-wide survey commissioned by the EU Commission, the market research firm GfK determines its monthly consumer climate index with around 2,000 interviews. Consumers judge their assessment of the economy, the expectation of their personal income development and their mood for larger purchases.

Significance : Consumption is significantly more stable than investment - and usually a lagging indicator. Only when jobs are canceled or short-time working and salaries are frozen, consumers feel it. But then we are already in the midst of the recession. However, in the current situation, many economists are hoping that a healthy labor market and rising incomes will continue to drive growth, even if exports and investment temporarily collapse.

The current signals: In December, the GfK consumer climate fell slightly to 10.7 points - still close to the historic high. Respondents expect continued rising incomes, but also begin to grasp the bad news from the economy. "The propensity to consume remains very good," reports GfK, predicting 1.5 percent growth for this year. The right recession would then have to be postponed at least to 2020.

REF: http://www.spiegel.de/wirtschaft/unternehmen/konjunktur-was-die-fruehwarnsysteme-der-wirtschaft-taugen-a-1247531.html