Overview of global economy 11/2024
U.S.: soft landing is still the most likely scenario
While the US economy keeps growing, analysts are increasingly focusing on the leading indicators of recession of the US economy in order to understand whether the US is heading towards a soft landing or a real recession. We think that the first scenario (soft landing) is still the most likely outcome. Even though the US recession indicators that we are tracking are highlighting the risk of economic slowdown, it almost seems that the worst has already been over for the US economy and the economic cycle has actually started to improve again.
In regard to the nowcasting and forecasting of the US economic cycle, we are tracking the following indicators: (1) employment in US super cyclical sectors; (2) US Sahm rule; (3) difference between actual US unemployment and 36 months moving average of the US unemployment.
Employment in the US super cyclical sectors (residential construction, manufacturing, temporary help, trucking) continue to decline, however, the pace of decline has been steady. What is more, in the most sensitive sectors, such as trucking and temporary help, YoY employment dynamics have been improving.
US Sahm rule numbers are also indicating that, for now, the US economy has reached its peak slowdown and the situation has improved a bit. The Sahm recession indicator signals the start of a US recession when the three-month moving average of the US unemployment rate rises by 0.50 percentage points or more relative to the minimum of the three-month average of the US unemployment from the previous 12 months. Sahm rule has been flashing red during the last 3 months, however in September the figure stood at exactly 0.5% points, i.e. was barely in a recession.
Lastly, the latest data on US labor market indicates that actual level of US unemployment rate has risen above its 36 month moving average, which normally also indicates the beginning of a US recession. However, as in the case of US cyclical employment and the Sahm rule, data for September was encouraging and signaled that peak of US economic slowdown has passed.
However, it is worth noting that all 3 US recession leading indicators remain at dangerous levels, therefore we will continue to monitor them closely.
China: waiting for bazooka stimulus
Economic cycle of the Chinese economy has been weak for some time – which is reflected by the sharp decline in the hang Seng index. However, it seems that the start of a rate-cutting cycle in the US has triggered Chinese authorities to start gradually stimulating the economy. Recently, a number of stimulus measures have been announced during several press conferences of Chinese authorities. The current amount of stimulus is far very small: for example, the measures aimed at stimulus of consumption account for less than 1% of Chinese GDP. However, recent chatter in financial community indicates that this is not the end and much bigger stimulus measures are on the way. The new stimulus measures might be unveiled at the Chinese NPC event (National People Congress) which will be held on Nov 4-8, therefore the larger stimulus package may be announced straight after the US presidential election. This will be the key for the Chinese financial markets as smaller stimulus package will result in a sharp decline in Chinese equities, which have been enjoying a positive ride as of recently on actual announcements and anticipation of further economic stimulus. Large stimulus package, on the other hand, will result in a major boost for the Chinese equity markets.
Euro area: more ECB cuts to come
In regard to the euro area economy, we have positive and negative news. The positive news is that we have seen a significant slowdown in the inflation rate: in September annual inflation in the euro area reached 1.8% and was below the 2% rate that European Central bank (ECB) has been targeting. Core inflation (total minus energy and food) and services inflation remains above 2%, but leading indicators that we are tracking indicate that core inflation will slowdown significantly in the near future. This, together with weak economic cycle in the euro area, will allow ECB to continue with its rate-cutting cycle, with markets expecting ECB to cut rates 5 more times from December 2024 until June 2025. Expectations of further ECB cuts are also well anchored in the latest 3 and 6 month Euribor forecasts among market participants. Latest forecasts from Chatham Financial indicate that 3 month Euribor, that is currently at 3%, will decline to 1.9% by June 2025 and will be lower than 1.9% in December 2025.
The bad news, however, is that lower inflation in the euro area in part comes with very weak economic activity, i.e. weak economic cycle in the euro area is contributing to the current slowdown in euro area inflation. Germany – which is one of the main export partners for the Baltic economies – remains the weakest link in the euro area, with German economy de facto entering recession. This is well reflected in the latest data of the EU Commission economic sentiment index – a good leading indicator of the euro area (EA) economic activity. Situation in German industry – the heart of German economy – remains especially dire, with German industrial sentiment (the level of optimism of German manufacturing companies) currently stands at the levels last seen in June 2020.
However, it is worth noting that while German economy remains in the contractionary territory, leading indicators such as German manufacturing companies’ assessment of new orders and German truck toll mileage index might be indicating that German economic weakness has reached its peak and the economy is bottoming out. Therefore, we might have already reached the peak pessimism in terms of euro area economic activity, however overall economic activity remains muted and may well deteriorate further.
Baltic region: economic activity to pick up in 2025, Estonia to exit recession
In regard to the Baltic economies, the trend is generally positive, however economic cycle in the 3 Baltic economies are also somewhat different.
In Lithuania, economic activity keeps expanding, driven by resilient manufacturing sector, recovering domestic demand and stabilization in transport sector. The dynamic in manufacturing sector have surprised on a positive side as, despite deep recession in German industry, Lithuanian manufacturing sector keeps expending at a higher rate. We think that Lithuanian industrial sector has managed to exploit the structural shifts in European manufacturing sector very well. Large German industrial companies, due to lack of orders, are pushing expensive suppliers in Europe to cut prices and are shifting part of manufacturing operations to Eastern Europe, where labor costs are more competitive. We think that there is a reasonable chance that we are observing this trend in Lithuanian industry.
Another positive new for Lithuanian economy is the strength of domestic demand, which is driven by high level of optimism among Lithuanian consumers – in summer, the opinion of Lithuanian households on their financial perspectives was as high as in summer 2007, i.e. just before the global financial crisis. In autumn the optimism of consumers also remained very high. What is more, we are also observing first signs of rebound on real estate activity – both in terms of new mortgage loans and in terms of new real estate purchase contracts.
In Latvia, manufacturing sector remains resilient, and we also observe sharp improvement in consumer sentiment. In September, overall optimism of Latvian consumers reached the highest level since December 2021, driven by improving consumer’s opinion on finances and growing willingness to spend money on major goods. We have also seen a reasonable pick up in economic activity in the services sector, while retail sector optimism has also improved, which is logical given the sharp improvement in Latvian consumer sentiment.
In Estonia, the economic activity remains much weaker than in other Baltic states, with economic activity being restricted by highest private sector debt in the Baltic region and high dependence on foreign trade with Scandinavia where economy has been restricted by high rates. The positive news is that we observe a visible improvement in the Estonian manufacturing sentiment, which may be driven by (1) more contract manufacturing orders from Central Europe as discussed above) and (2) expectations of a pickup in the Scandinavian economies as Europe as central banks have started to cut rates. However, consumer optimism level remains very low retail sentiment still standing at the level last seen during June 2020 – a clear indication that consumer spending remains muted.
In terms of forecasts, we maintain an opinion that economic activity in all 3 Baltic states will pick up in 2025 due to decline in rates, stronger economic activity in the EU as well as stronger domestic demand and investments. We expect the GDP of Latvia to grow by 2.7% in 2025, while Estonian and Lithuanian economies should grow by 2.8%. We also forecast that in each Baltic economy growth in wages will continue to outpace inflation, therefore contributing to stronger domestic demand. Domestic demand and investments will also be boosted by further cuts in ECB rates as each Baltic country is sensitive to the ECB rate cycle due to high share of variable rates in total loan structure.
