December 20, 2019

News in Charts: Economic sentiment points towards subdued growth but no recession

by Fathom Consulting.

Fathom’s monthly Economic Sentiment Indicators (ESIs) are designed to measure underlying economic sentiment. They use a technique known as principal component analysis to distil the information from numerous consumer and business surveys into a single composite indicator. The ESIs have been trained on quarterly GDP growth in their respective countries, and by construction have the same mean and variance as those series. They provide monthly updated estimates of underlying sentiment that display less short-term volatility than quarterly GDP growth.

Our US ESI has troughed, supporting evidence from the Fathom Leading Indicator (FLI) that the world’s largest economy will avoid recession next year. The November US ESI was 2.9%, up from a cycle low of 2.4% in September but still well below the 2019 high of 4.6%, recorded in May. The Federal Reserve’s mid-cycle adjustment has helped to boost confidence, which has been further supported by a reduction in trade-related uncertainty. Nonetheless, the US economy is entering a lower gear: we expect GDP growth to be 1% (annualised) in the fourth quarter, and expand by just 1.5% in 2020.

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Similarly, Fathom’s euro area ESI has also fallen substantially since the start of 2018, driven by a fall in manufacturing sentiment. That said the ESI has stabilised in November at 0.3%. Although we expect activity to remain subdued over the coming few quarters, our modal forecast does not anticipate a further deterioration in euro area growth.

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However, the latest reading from our Economic Sentiment Indicator (ESI) for Italy challenges this view with the indicator dropping to -0.4% in November, the weakest reading since the end of the euro area crisis. The fall was broad-based with declines in roughly two-thirds of the indicator’s subcomponents, with both consumer and business sentiment affected.

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However, Italian sentiment tends to be quite volatile, often exhibiting more mini-cycles and sending more false signals than in other countries. We therefore stick to our current view that Italy is likely to avoid another recession, though growth is likely to remain weak at just 0.2% next year.

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Trade uncertainty has acted as a substantial headwind for growth in the euro area. With monetary policy almost out of ammo, there are now growing calls for fiscal stimulus. European governments have undertaken a substantial and sustained fiscal adjustment in recent years, with only a few member states still posting large deficits, and many running sizeable surpluses. As a result, investor concerns over debt sustainability appear to be fading, with Fathom’s proprietary probability of default indicators close to all-time lows. In line with evidence from academic studies, our Global Economic and Strategic Allocation Model (GESAM) suggests that fiscal multipliers are larger at the effective lower bound, lending increased support to these calls. Within reason we would support additional stimulus.


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