Europe drives world econ higher

 We now have all the PMI and ISM data for October.   

The GDP-weighted averages for the Big 8 manufacturing and services PMIs are shown below.  The Big 8 are:  the USA, the UK, the Euro zone, Japan, China, Brazil, Russia, India.  Together, they make up roughly 70% of world GDP.  

Services rebounded sharply in October, pushing up the average of the services and manufacturing PMIs (the green line in the chart)   Most of that rebound was in Europe (from 51.3 to 53.0) and in the UK (from 50.8 to 52.3).  Russia also rebounded, from 47 to 51.7.

While the recovery in manufacturing has been sluggish, services have been surprisingly strong.

Historically, the main drivers of the business cycle have been manufacturing and construction, with services following, because of the inventory (stocks) cycle.   So far, the recovery in manufacturing has been weak, but services have held up, which is interesting.   This suggests that Trump's trade war is affecting manufacturing, but since tariffs haven't been set on traded services, it is not affecting services.  The problem is: how long can this disconnect continue?  If manufacturing goes back into recession, services will surely in the end follow.

Business confidence in the Big 8 is picking up too, also driven mostly by surging business confidence in Europe.

My view of the world recovery and the negative effects of the Trump tariffs has so far been too pessimistic.  Perhaps, like Brexit, it will take a couple of years for the negative effects outside the USA to become apparent---they are much clearer within the US.  Yes, manufacturing is soggy, as the trade war has (some) effect.  But services are responding in the normal way to the fall in global interest rates over the last year.

So far, though the recovery has not been steep, it is clear that the world economy is picking up.  How sustainable that is, isn't clear.

[As usual, the data come from a variety of sources, including S&P Global, the ISM, and the OECD, among others.  They are my calculations for extreme-adjustment and the GDP-weighted indices]

Australian economy continues to slow

 The S&P Global/Judo Bank composite PMI for Australia ("flash" data just released for October) continues to weaken after the "revenge spending" blip (which propped up services) continues to fizzle.  Since this is a diffusion index, anything below 50% indicates declining economic activity.

The other "PMI" survey, by the AIG (Australian Industry Group), confirms this deepening recession.

Big 4 PMI slumps in August

 The preliminary ("flash") average PMI for the Big 4 economies (the US, UK, Euro zone & Japan, together representing 48% of the world economy) fell again in August.  This is the GDP-weighted average PMI for services and manufacturing, and each time series is extreme-adjusted before the average is calculated.

It's clear that the mini rebound or "blip" caused by "revenge spending" driving up services PMIs is over.  

The longer term negative forces (50-year record declines in real money supply; the largest and fastest rise in central bank discount rates in 40 years; and the consequent credit crunch) are driving the world economy down.  The service sector rebound held those forces back for a few months.  That's stopped.

Share markets were pleased that the "flash" PMIs were weak, because that meant that Central Banks might be less likely to raise rates.  But maybe it's time they started worrying about the risk of a recession, potentially a deep one, even with the big deficit spending from Biden's Inflation Reduction Act.

Services still supporting Big 8

Even though services have started to slow, they are still much stronger than manufacturing.  The gap between the two has never been this wide, in all my nearly 50 years as an economist and fund manager.

Will services continue to slide?  My prediction is that, despite "revenge buying" after the Covid lockdowns, expenditure on restaurants, holidays, hotels, air travel and shows will in fact continue to fall.   But, as ever, I might be wrong.

All the same, it looks to me as if the rebound "blip" or "spike" in the world economy in the first few months of this year is fading, and that the green line, representing the whole economy PMI for the world's largest economies, will fall below the 50% recession line in the next couple of months.

[The big 8 is made up of: the USA, the UK, Euro Zone, China, Japan, India, Brazil, Russia.  Each time series is individually extreme-adjusted before the global averages are calculated, using PPP GDP weights.]

Big 8 PMI falls again

 Though not by a lot

We'll have to wait for a couple of days for the services PMIs, to see how the whole economy is going.  At the moment, it's "revenge spending" on services, specifically on restaurants, air flights, tourism, holidays, and shows which is holding up economies.  And I have no idea how sustainable that is.

Euro area M1 falling fastest in 50 years

 I talked before how the US's M1 is falling faster than it's done since the Great Depression in nominal terms, and the fastest since WW2 in real terms. 

I was alarmed to see that the Euro Area's M1 is now falling faster than at any time in the last 53 years.   And that's in nominal terms, i.e., before adjusting for inflation.

What does it look like in real terms?  And compared with GDP?

The chart is below.

Note:

1.  The downward spike in GDP with covid, and the upward spike caused by the year-on-year calculation because of it;
2. that there is a lag between the changes in real M1 and the changes in the economy;
3. that real money supply (adjusted for inflation) is falling faster than before previous deep recessions (1974; 1980-83; 2007-2008).

From which I conclude:

1. That Europe (which is already in recession) is going to go into at least as deep a recession as the GFC (2007-2008), and; 
2. that it will be impossible for the world to avoid a deep recession, since the US makes up ±25% of the world economy and Europe ±20%.  In fact, one reason for China's weakness (±15-20% of the world's economy) is the slowdown in her exports.

Of course, I could be wrong.  Or, which is almost as bad, too early.  All that's keeping the US economy afloat is "revenge spending" on things like holidays, air travel, restaurants, hotels and entertainment, all things which Covid severely limited.  The gap between the services and the manufacturing sector has never been bigger.  Like Wile E. Coyote, if people look down, they'll fall.  But when?

The spike in M1 in 2005 looks suspiciously like a one-off definitional change.
I'll do some research to find out if that's so.
But it doesn't change any of my conclusions---it'll just improve the fit of the two curves.

Services are all that's holding up the economy

 I've talked before about the post Covid Crash catch-up, as demand for services has boomed since the beginning of the year.   The chart below shows the manufacturing PMI vs the services PMI for the Big 8, and you can see the record gap.

Services normally follow manufacturing, and services normally have a smaller cyclical swing than manufacturing, creating a larger gap at recession lows.   But the gap that's developed now is unprecedented.  

With services holding up the economy, it has become less responsive to rises in interest rates.  Yes, manufacturing is in recession and getting deeper, but the overall economy is OK.  Will Central Banks have to raise rates further to bring inflation back under control?  There has to be a serious possibility that that will happen.  The PMI sub-indices and commentary show falling inflation in manufacturing, but not in services.   

This unprecedented overall whole-economy lack of response to tightening means, I think, that CBs will raise rates too high (in my opinion, they already have) and then, services will snap back to manufacturing.  At which point overall GDP will plunge.

Very interesting situation.  This is the first time in my nearly 50 year career in economics and funds management that this has happened.  Covid continues to screw up economic relationships.

At any rate, I'll be watching the trajectory of services PMIs very closely.

The Covid Crash payback

A common pattern is emerging over the last couple of months, in Europe, the USA, Australia, and other places too.  Manufacturing PMIs are plunging, after a brief levelling off.  But service PMIs are rising sharply.  Here is the commentary from the UK news release from S&P Global:

The latest survey indicated a robust and accelerated increase in service sector output (index at 54.9), with growth the highest for one year. In contrast, manufacturing production (index at 48.5) decreased for the second month running and at the fastest pace since January. 

The contrasting trends for business performance in April largely reflected divergent demand patterns. New order growth hit a 13-month high in the service economy amid rising spending on travel, leisure and entertainment. Meanwhile, manufacturers attributed a renewed fall in new work to customer destocking, elevated energy costs and subdued demand for big ticket consumer goods. Similarly, export sales increased at a solid pace across the service sector, but manufacturers experienced a decline for the fifteenth consecutive month. 

I think the difference is due to a recovery from the Covid pandemic.  Manufacturing, directly impacted by rising rates, is struggling.  But people have been starved of travel and holidays and shows (travel, leisure and entertainment) by lockdowns.  And it's taken time for their plans to enjoy themselves to be realised.  So now they're flying away on holiday, staying at hotels and resorts, and going to see music and plays and bands once again, after a prolonged drought.

As this chart for the US shows, mostly the services and manufacturing sides of the economy move in sync, but manufacturing  (the blue line) tends to lead services (the orange one):

It is not often that services lead the business cycle---except with the Covid pandemic, because it was lockdowns (not monetary policy) which crushed services.  

In the chart below, note how the gap between manufacturing and services expands during recessions, with manufacturing falling faster than services.   Except, that is, during the Covid crash, when services fell much faster than manufacturing (the spike at the beginning of 2020).   The gap the other way between manufacturing and services now is "payback" for the gaps when services were below industry, evident since the beginning of the Covid crisis.

Click on chart to see a clearer image.
Chart shows gap between manuf and services PMIs
Shading shows US recessions

Having explained this anomaly to my satisfaction, and I hope yours, the obvious question is:  when will this end?  Is the post-Covid recovery in services over yet?  

It won't be until unemployment starts rising.  The problem is that, if overall GDP remains robust, because services are strong, and price increases in services remain high, Central Banks will go on tightening.  And because of the lags involved, they risk tightening too much.   By the time they realise their mistake, it will be too late.   But at that point, unemployment will be rising fast, and services will have followed their manufacturing brethren into recession.  

How many months away is that?  I don't know.  Any ideas?  Comment below.