Risk assets fell sharply in the month of September, with equities generally down by between 5 and 10 per cent, and commodities falling by even more than that. The best performing asset in the month was the US dollar effective rate, a clear symptom of the widespread flight to safety. The worst performers were equities in the BRICs, and cyclical commodities like copper. (See charts on asset performance here.)
What had appeared to be mainly a problem for European markets in August has therefore broadened considerably in the past few weeks. The financial markets have started to price in a global recession. They will be very sensitive to the next move in the economic data. So far, it is hard to tell whether a renewed recession has been triggered, or whether the developed world has “only” become stuck in a period of prolonged stagnation. Either outcome would be bad enough for labour markets, and risk assets – but there would still be a large difference between them, which is why the question matters a lot.
One of the complications in assessing global economic data at present is that there has been a wide gap in recent months between the “hard” economic data, and the “soft” data from business and consumer surveys. At least until August, the former have been much more encouraging than the latter, and the eventual outcome will depend on how the gap is closed between the two sources of data.
This applies both to the industrial sector and to the retail sector. In the graphs below, the hard data are shown with the blue lines (with the quarterly averages marked by the red bars); and the global survey data are shown by the green dotted lines. The first graph shows the recent behaviour of the consumer sector:
The global consumer has been sluggish for much of 2011, having been hit by the rise in commodity prices in the early part of the year. This became apparent with the marked slowdown in consumption in Q2, which coincided with the large drop in consumer confidence as real incomes were squeezed. However, as commodity prices have stabilised in Q3, real consumption seems to have rebounded to the growth rates seen in earlier quarters, which would normally be taken as a healthy sign.
But this has been accompanied by a very large drop in consumer confidence, especially in August when households in the US and the eurozone took an extraordinarily pessimistic view of the competence of policy-makers as the various debt crises intensified. Although confidence may have stabilised in September, and has not yet collapsed as it did in 2008, the current level of confidence seems to be pointing to negative growth in global retail spending as we enter Q4.
What about the industrial sector? It is much the same story, as the following graph shows:
The decline in industrial production seen in Q2 was largely driven by the Japanese earthquake, which had a huge effect on global car production, and this has been mostly reversed in Q3. However, as in the case of the consumer sector, the “soft” evidence from business surveys has continued to decline into September, with much of this coming in Europe. (We do not yet have the US ISM survey, which is due on Monday.) Unless business survey readings improve markedly soon, they are signalling that manufacturing output in Q4 may contract at an annual rate of about 2.5 per cent.
The sentiment indicators are therefore signalling that recession risks are elevated as we enter Q4, with the eurozone currently looking in greater danger than the US or Asia, though the latter two areas are clearly also in trouble. The main hope is that the drop in the sentiment indicators has been affected by the plethora of bad economic news in the headlines in the recent past, and that consumers and businesses will realise that their underlying economic prospects have not, in reality, weakened as much as these headlines indicate. If so, the sentiment indicators may be giving a false alarm.
It would, however, be very optimistic to assume that this will necessarily be the case. There have been signs that the hard consumer data have been slowing as Q3 has progressed in both the US and Europe, and there are definitely increased concerns from manufacturers that inventories are rising more rapidly than desired. The risks that a renewed recession will take hold are far too high for comfort. And the alternative possibility – that the developed economies will remain stuck in an anaemic, jobless recovery – should be wholly unacceptable to policy makers in any event.
Two central banks are meeting this week – the ECB and the Bank of England. And Fed Chairman Bernanke is testifying to Congress on the state of the US economy on Tuesday. Action is needed.