William De Vijlder

Group Chief Economist BNP Paribas

Economic cycle

How are growth, inflation and employment trends evolving in a given country or region? William De Vijlder examines the cyclical fluctuations of an economy in crisis, expansion, recession and recovery phases as part of a cyclical analysis.

Economy

Central banks, markets and the economy: three times wrongfooted

In the US, financial conditions have eased in recent months and weighed on the effectiveness of the Fed’s policy tightening. Jerome Powell recently gave the impression of not being too concerned, so markets rallied, and financial conditions eased further despite the hawkish message from the FOMC. In the Eurozone, another rate hike by the ECB and the commitment to raise rates again in March caused a huge drop in bond yields because markets expect we’re getting closer to the terminal rate. It reflects a concern of not being invested in the right asset class when the guidance of central banks will change: based on past experience, one would expect that bond and equity markets would rally when central banks signal that the tightening cycle is (almost) over. However, as we have seen with the surprisingly strong US labour market report, such positioning comes with the risk of being wrongfooted by the data. What follows is huge volatility.  

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United States of America

US: GDP growth, good on the surface but with negative undercurrents

On an annualised basis, US GDP increased 2.9% in the fourth quarter compared to the third. This healthy increase implies only a mild quarterly slowdown. The result was also better than the consensus expectation. However, a detailed analysis shows causes for concern. About half of the increase in GDP reflects inventory rebuilding, although this comes after a negative contribution in the previous two quarters. Personal consumption expenditures have also contributed approximately half of the GDP increase, but investments in structures had a negligible impact and residential investments continue to act as a drag, suffering from high mortgage rates. Moreover, in the final quarter of 2022, GDP only grew 1.0% versus the same quarter of 2021. Despite the apparent resilience in the fourth quarter, the undercurrents are clearly negative, and they should be reinforced by the delayed effects of past rate hikes and the upcoming policy rate increases. Were it not for the strength of the labour market, the talk about recession risk would be even more intense.

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US: job creation and the unemployment rate

The state of the labour market occupies a central role in the analysis of the business cycle. Historically, the percentage of months over the past 12 months with nonfarm payrolls below the 200K threshold increases in the run-up to a recession. Today, this indicator stands at 0 percent. Although there have been many false signals, a significant increase in this percentage calls for vigilance, necessitating closer monitoring of other data as well to assess the risk of recession.  An alternative approach consists of making the link between monthly payrolls and the unemployment rate. However, given the latest data on job creations, a swift increase in the unemployment rate sufficient to trigger a recession signal seems unlikely. This means that the slowdown of wage growth and, more broadly, the decline of core inflation, might take more time than expected, forcing the Federal Reserve to keep policy rates high for longer. This is not exactly what is being priced by financial markets.

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Dollar US

US: leading indicators, the labour market and the recession narrative

Despite the ongoing good pace of job creation and slower wage increases, which through its impact on inflation could influence future Fed policy, there is enough ambiguity in the recent data to fuel the debate on whether the US will end up in recession or not. The survey of professional forecasters points towards heightened recession risk and so do the inversion of the yield curve and the downtrend of the Conference Board’s index of leading economic indicators. If this index were to decline further, one would expect, based on the past relationship, a significant weakening in the monthly payroll numbers whereby the narrative that a recession is around the corner would gather force.

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BCE

Eurozone: starting the year on an upbeat note

The drop in gas prices, the decline in headline inflation and the improvement of survey data in December have created a feeling that for the Eurozone 2023 might be better than expected hitherto. The survey data bode well for the growth momentum at the turn of the year, which could create a favourable carry-over effect for GDP this year and some hope that lower inflation will mean fewer ECB rate hikes. However, caution is warranted. Inflation remains far too high and core inflation has moved higher in December. Moreover, survey data provide little or no information on the pace of growth beyond the first quarter of this year.

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William De Vijlder

Economic outlook 2023: three “certainties”, many uncertainties

Economic developments in 2023 will to a large degree be the result of the inflation shock of 2022 and the policy reaction of central banks that followed. Three developments look highly likely: disinflation -in terms of headline inflation- should gather momentum, central bank policy rates should reach their cyclical peak and activity should suffer from the rise in interest rates that started last year, implying that the euro area and the US should spend part of the year in recession. The list of uncertainties is long -the evolution of energy prices and the extent and pace of disinflation are key ones- but there are also several factors of resilience, implying that, all in all, the recession should be shallow.

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Brouillard

2023: a year of transition, to what?  

2022 was a year of profound transformation, of shifting geopolitical and economic paradigms. Looking ahead, 2023 should see a change of direction in key economic variables. Headline inflation should decline significantly, central bank rates should reach their cyclical peak and the US and the euro area should spend part of the year in recession. 2023 can be considered as a year of transition, paving the way for more disinflation, gradual rate cuts and a soft recovery in 2024.   

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Bend

Three ‘certainties’, many uncertainties

From an economic perspective, 2022 will go down in history as the year in which elevated inflation made a surprising comeback forcing major central banks to start an aggressive tightening cycle. It is highly likely that in twelve months’ time we will look back at 2023 as a recession year, a year of disinflation, and a year in which official interest rates reached their terminal rate and stayed there. As usual, the list of ‘known unknowns’ is long. Energy prices might increase again after their recent decline, disinflation might be slower than expected, policy rates might peak at a higher level than currently priced by markets, and the recession might be deeper and longer than anticipated. However, we should also pay attention to factors of resilience: companies hoarding labour, thereby limiting the rise in unemployment, the support from fiscal policy in many European countries, the need to invest in the context of the energy transition.

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Transition énergétique

Will the energy transition cause an increase in interest rates?

Meeting the European Union’s climate-related and digital ambitions will require a huge additional annual investment effort. In the near term, against a background of slowing growth and the prospect of a recession in 2023, this represents a potential source of resilience. In the medium term, this demand impulse may underpin or even increase inflation, in addition to other factors that could lead to greenflation. This would influence the level of official interest rates as well as long-term interest rates. The latter could also be under upward pressure due to the huge additional financing needs compared to the normal financing flows. The financing mix -banks versus capital markets- plays a key role in this respect.

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Emploi

Labour hoarding: a source of resilience during a recession

Companies in the US and the euro area continue to struggle to fill vacancies. This will probably make them reluctant to lay off staff when economic conditions worsen, fearing that during the next upturn they would rapidly face new hiring difficulties. By limiting the increase in unemployment, such labour hoarding would be a source of resilience. However, this would be reflected in a decline in labour productivity, which would weigh on profits and could push companies to increase selling prices, thereby slowing the pace of disinflation.

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Prévisions économiques

US: the sobering record of real GDP forecasts during recessions

Economic forecasting in the run-up to and during recessions is particularly challenging. An analysis of the Federal Reserve of Philadelphia’s survey of professional forecasters shows that, since 1968, forecast errors during recessions are significantly higher than during non-recession periods. Moreover, forecast errors during recessions are predominantly positive, so forecasts tend to be too optimistic, even if they concern the next quarter. At the current juncture, there is broad consensus, if not unanimity, that downside risks to growth dominate due to the multiple headwinds and uncertainties. The historical forecast record is another reason to be mindful of these risks.   

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Emploi

Eurozone: the surprising resilience of the labour market, will it last?

Since the start of this year, the European Commission’s industry sentiment survey has seen a significant decline, yet companies continue to report that labour remains a key factor limiting production. This is probably due to order books that remain at record high levels in terms of duration of assured production. Through their impact on the growth of employment and wages, labour market bottlenecks should provide some resilience to consumer spending when the economy is turning down. This support will probably not last however. Hiring intentions of companies have started to  decline, which should ease the bottlenecks through a slowdown of employment growth.

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Household wealth

Gone with the wind: the erosion of real household wealth

Household wealth -the difference between assets (property, financial) and financial liabilities- matters because in the longer run, it should allow to finance expenditures post retirement. During the pandemic, we have seen in the euro area a big jump in the savings rate as well as an above-trend increase in property prices whereas financial assets suffered from negative valuation effects. The European Commission estimates that, on balance, between the onset of the pandemic and the end of 2021, households accumulated around EUR 2.7 trillion of new wealth in excess of the normal trend. This was considered as a factor of resilience for household spending. Households could save less than normal in case of a weaker economic environment because they had saved more than normal during the pandemic. However, according to the European Commission, by mid-2022 elevated inflation had already eroded the real value of additional wealth by almost 50%, implying a much thinner cushion to absorb shocks.

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United States of America

US: disinflation has started

The US consumer price data for October have reinforced the view that disinflation -the narrowing of the gap between observed inflation and the central bank’s inflation target- has started. That conclusion seems clear as far as headline inflation is concerned -it has peaked in June- but we need confirmation that the decline in core inflation from the September peak is not a one-off. Core goods inflation has been moving down but core services inflation  remains stubbornly high on the back of transportation services and shelter. What matters now for the economy and financial markets is the speed of disinflation because this will influence Fed policy, the level of the terminal rate and how long the federal funds rate will stay there. All this influences the perceived downside risks to growth.

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Eurozone: the disinflation of 2023, between hope and uncertainty

The latest ECB survey of professional forecasters (SPF) shows a downward revision of the growth outlook and an upward adjustment of the inflation forecast. For next year, the real question is not about the direction of inflation but about the speed and extent of its decline. Slower than expected progress could convince the ECB of the need for more rate hikes than currently priced by markets, implying a bigger output cost of bringing down inflation. Disinflation could indeed take longer than expected. Over the past two years, a variety of factors have led to an exceptionally elevated but also broad-based inflation. Not all shocks have occurred simultaneously and it often takes time for them to work their way through the system, from the producer to the wholesaler to the retailer. This creates an inertia in the inflation dynamics.

 

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Crise économique

Global: growth at risk

When growth is slowing, risks tend to be tilted to the downside because households and companies adopt a more cautious attitude in their spending and investment decisions. At the present juncture, it is also difficult to see what could create an upside surprise. To the contrary, according to the IMF, there are several downside risks: the cost of energy, the problems in Chinese real estate, persistent disruptions in the labour market. Financial conditions could deteriorate. Already today they create a discomforting environment, with the risk of a non-linear impact on growth. It illustrates the challenge of central banks with growth-at-risk being at the low end of historical ranges and inflation at the other extreme.

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Public debt

Eurozone: rising interest rates and public debt sustainability

Due to the recent significant increase in interest rates, Eurozone countries now have a borrowing cost on newly issued debt that, for an equivalent maturity, is higher than that of the existing debt. From a debt sustainability perspective, this necessitates a smaller primary deficit or a larger surplus, depending on whether the average interest cost is, respectively, lower or higher than the long-term nominal GDP growth rate. However, this effect will only be fully operational when the entire debt has been refinanced at the higher interest rate. Given the long average maturity of existing debt, the annual adjustment effort is small for the time being but it will grow over time. However, debt sustainability is about more than keeping the debt ratio stable under certain circumstances. It is also about the resilience to interest rate and growth shocks. The higher the debt ratio, the more important it is to do more than simply trying to stabilize it.

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The struggle to find good news about the economy

Usually, during a period of sluggish growth and rising official rates, bad news about business activity and demand is often welcomed by the stock market, as it often causes central banks to take a more cautious approach during their monetary-tightening cycle.

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