Business cycles, financial stress and a mixed picture in China

Clocking out another downswing in the EU

The following chart is a “clock” tracking the European Union’s progress through the business cycle, divided into four quadrants: contraction, upswing, expansion, and downswing. The arrows track the overall economy as well as five subsectors.

The data starts in January 2020, and the arrows quickly head downward to contraction as the pandemic gathers pace. Since then, the economic climate indicators have traveled in a full circle around the clock, including upswing and expansion during the economic recovery in late 2020 and 2021. 

As central banks hike rates aggressively, we are already in the downswing and contraction phase again.

Financial stress is more European than American this time

Measures of stress in the financial system are showing that the turmoil of 2022 is playing out quite differently than the global financial crisis of 2008 or the Covid-19 pandemic.

The following chart plots the US stress index from the Federal Reserve Bank of St. Louis against a similar measure that the European Central Bank calculates for the euro region. The weekly data points go back to 1999.

We’ve highlighted the GFC and pandemic periods to show how financial stress was elevated on both sides of the Atlantic during those episodes. During the worst of Covid-19, financial conditions were tighter in Europe than they were in the US. The ECB was also able to keep stress much lower than it did during the European debt crisis a decade earlier.

This time is different. The eurozone is experiencing a broad-based increase in financial stress. But even as the Fed hikes rates rapidly to bring down inflation, financial conditions still seem to be quite loose for the US economy -- at least according to the St. Louis Fed’s metric. This might be fodder for Fed hawks who see room to keep tightening.

Chinese travel slows as we await GDP

China unexpectedly delayed the release of its gross domestic product figures, a move that is unlikely to reassure markets concerned about the nation’s sharp economic slowdown and the consequences of its zero-Covid strategy. A new release date has yet to be scheduled. 

While we await the GDP figure, we can contemplate alternative data sets that may give an idea of how lockdowns are affecting economic activity.

The following charts track plummeting road and public-transit mobility data related to the city of Zhengzhou, the capital of Henan province. The metropolis is a manufacturing hub for the iPhone, and made the news recently after one of its most populated districts was locked down to tame a coronavirus flare-up.

The first chart uses a “willingness index” (measuring searches and inputs into navigation tools) for travel from China’s two biggest cities to Zhengzhou. The second tracks passenger volumes on the city’s subway.

A prominent Chinese official has a favourite alternative dataset

A Communist Party congress effectively removed Li Keqiang from senior leadership in China over the weekend. Li, previously the nation's no. 2 official, is viewed as a proponent of market-oriented reforms.

His prominence inspired the Economist magazine to create the Li Keqiang index. This measure uses high-frequency data – private-sector loans, energy consumption, and rail freight traffic -- to construct an alternative picture.

Li is said to prefer this data to GDP to truly assess the Chinese economy. (Recent research suggests that China is among a group of countries that have been overstating GDP growth by quite some margin.)

That said -- as one can see in the following chart -- both GDP and the Li Keqiang index tend to move in the same general direction.

China business finance is surprisingly strong

There is an outlier to the gloomy picture generally painted by Chinese economic data. Non-governmental business loans are rebounding, helped by the central bank’s August interest-rate reduction. This could be a turning point; when we examined Chinese credit conditions in May, borrowing was not getting any easier.

The following chart tracks month-by-month medium- and long-term private enterprise financing figures for recent years. 

The dark line, for 2022, shows the strongest September reading in recent history. The year as a whole may be on track to outperform 2021, which ended with a whimper. 

UK bankruptcies on the rise

As we recently discussed, the UK economy is struggling for a variety of reasons, from the energy price shock to higher interest rates and increased trade friction post-Brexit.

Business failures are another measure of the economic pain. As our chart shows, bankruptcies are at the highest level in more than a decade, almost twice as high as a year earlier. (The lull in 2020 is notable, when the government was shielding business from the impact of the pandemic.)

With the UK forecast to be in a recession by early next year, a further increase in bankruptcies may be likely. That may well exacerbate the negative feedback loop in the economy – adding to the challenge for whoever succeeds Liz Truss as Prime Minister.

The total return wipeout for government bonds

For bonds, the only way was up for a decade. As interest rates headed on their long-term downward trend, the total return on long-run government bonds (15 years and above) for Germany and the UK approached 100 percent between 2010 and 2020. Some investors may have been lulled into a false sense of security.

As interest rates surge globally, bond prices have fallen tremendously, and investors are sitting on enormous (if unrealised) losses. Over the course of 2022, as our chart shows, the entire total return since about 2012 has been wiped out for long-term gilts and bunds.

 It turns out that fixed income investments are riskier than what was widely assumed.

The following chart can only be accessed with a subscription to ICE BofA Merrill Lynch data.

Approval rating wavers slightly for Putin

The following chart tracks Russians’ opinion of Vladimir Putin, as assessed by the Levada Center, a Moscow-based polling and research organisation. 

According to Levada, the Russian leader’s approval ratings surged after this year’s invasion of Ukraine, as they did when Putin moved to seize Crimea in 2014. Recently, Putin’s approval rating has slipped, though it remains above 75 percent.

Watching small business to predict cooling US inflation

US small businesses are becoming less likely to raise their prices. 

That’s according to the National Federation of Independent Business (NFIB), which tracks smaller firms’ intentions for the next three months, as our chart shows. About 30 percent of businesses surveyed plan a price increase over that time; while that’s still a high number, the proportion was recently above 50 percent.

This data set has a very high correlation (almost 80 percent) with actual inflation dynamics; the consumer price index tends to lag the NFIB moves by about five months. 

We’ve adjusted the timing on the chart accordingly to show just how close the correlation is. Given this correlation, we can anticipate a normalization in CPI data after the soaring inflation of 2022. The Fed’s tightening cycle may already be having its desired effect.