multi-asset
Is China’s reopening lifting the global economic cycle?
The current macro situation is puzzling. The three main economic regions are exhibiting three very different trajectories: the US is decelerating, China is recovering and the Eurozone is showing remarkable resilience.
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Need to know
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Who is leading the way?
Each of the big three economic regions now express roughly equal weightings in global GDP: China currently accounts for 19% of global GDP, the US 15% and the Eurozone 12%. Combined, they produce about half of global output.
The situation investors are currently faced with is the following: these three influential zones face different prospects, but only one of them offers an indication of the future. Investors need to decide if the world economy is recovering (without having experienced a recession), deteriorating, or heading for a soft landing. The answer to that question is now even trickier as each of these zones influences the other two, meaning we first need to understand what the influence is and how it is being exerted.
This edition of Simply put focuses on the situation in China. Economic data there have been improving over the past couple of months and that improvement is likely to have clouded Eurozone macro numbers, but also the US’s. We think it’s time to run a couple of econometric regressions to deconstruct these influences.
High-frequency economics
The starting point of our analysis is shown in figure 1. It charts the daily evolution of our growth nowcasting indicator for each of the three zones. The US growth deceleration that started in June 2022 has led the indicator to move from 70% (signalling growth above potential) to 25% (where growth is far below potential). To resolve any doubts about whether the US is actually slowing down, look at how goods consumption and investment have been contracting in the GDP reports of the past three quarters.
China’s situation is very different. China deployed far less fiscal stimulus during the pandemic. Its growth trajectory was lower and has improved with the country’s re-opening. This has led our Chinese growth nowcaster to reach 50% (indicating that growth is at potential), which is not too bad given the circumstances.
Finally, the Eurozone is demonstrating resilience, having been largely flat since summer 2022. With the three major economies signalling different fates – all of which are common stages in the business cycle – only one of them is pointing to what’s coming up next, in our view.
Figure 1: Daily evolution of our US, China and Eurozone growth nowcasters
Source : Bloomberg, LOIM at June 2023.
China’s bigger role
Our growth indicator for the US stopped deteriorating in May (figure 1). This outcome is puzzling: the banking crisis in March was supposed to have accelerated the slowdown, helping the Federal Reserve to transmit its hawkish monetary policy to its economy. However, within our indicator, half of the 75 different time series analysed show signs of stabilisation. A data point does not make a trend, but this evolution is puzzling enough to make it worthy of an investigation.
It may be that instead of the US gaining in strength, the country is now enjoying the indirect stimulus of China’s reopening. This cannot be measured without some econometric analysis, and figure 2 shows the estimated impact over 12 months of a one-point increase in China’s PMI on two of the leading macro indicators: first, the US ISM, and second, the European Commission’s confidence indicator for industrial ecosystems (based on impulse response functions). The chart clearly illustrates two key elements:
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The region profiting most from a surge in Chinese industrial activity is the Eurozone
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Since the end of the pandemic, both the US and the Eurozone’s sensitivity to China has increased – and that has led their respective reactions to double
To put it simply, this indicates that China’s influence on the US and the Eurozone economies has doubled since 2020. This means that idiosyncratic situations in each zone are probably obscured by the global impact of the China’s recovery.
FIG 2. Indirect stimulation arising from China’s reopening
Source : Bloomberg, LOIM at June 2023.
Net of reopening, the slowdown goes on
If these estimates are accurate, then we can try to use them to eliminate the influence of China and see what would be happening in the US without this reopening. Why does it matter? Because the reopening of the Chinese economy is a temporary, albeit positive, shock. The moment it passes, each indicator should return to its original trend. What would this reversion look like?
Figure 3 shows the result of that calculation. Our estimate of the US manufacturing ISM net of Chinese economic influence indicates that it should be below 45 instead of 46.9 as of May and, more importantly, should have remained on its downward trend.
This message is important if you think that the reopening of China is a temporary, supportive factor for the global economy. The recent stimulus measures could prolong it, but in our view the key message remains: the downtrend in the US has stopped for now and is largely explained by China’s recovery. The same applies to the Eurozone, so let’s remain careful as the dawn of Q3 approaches.
Figure 3. US manufacturing ISM excluding the impact of China’s PMI
Source: Bloomberg, LOIM at June 2023.
| Simply put, the stabilisation of the US economy is probably rooted in the reopening of China. Should this factor prove temporary, US key leading indicators would likely go into decline again. |
Macro/nowcasting corner
The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises and global monetary policy surprises designed to track the recent progression of macroeconomic factors driving the markets.
Our nowcasting indicators currently show:
- Our growth indicator held steady over the week: it points to a low growth environment
- Global inflation should continue to decline, with our inflation indicator remaining low again this week. The US inflation report provided a further signal
- Our monetary policy signal has crossed the threshold that separates a neutral stance from a dovish stance, as the US indicator declined over the week. This is mainly the reflection of investment-related data such as the capacity utilisation rate. Could the age of tightening could be behind us?
World growth nowcaster: long-term (left) and recent evolution (right)
World inflation nowcaster: long-term (left) and recent evolution (right)
World monetary policy nowcaster: long-term (left) and recent evolution (right)
Reading note: LOIM's nowcasting indicators gather economic indicators in a point-in-time fashion to measure the probability of a given macroeconomic risk - growth, inflation and monetary policy surprises. The Nowcaster ranges from 0% (low growth, low inflation and dovish monetary policy) to 100% (high growth, high inflation and hawkish monetary policy).
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