Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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German IFO: This is not what you would like to believe
Christopher Dembik
Head of Macroeconomic Research
Summary: Following the improvement of the ZEW poll of financial market experts last week and the Sentix index early this month, all the IFO indicators have increased in June on the back of fewer restrictions on economic activity. Both investors and business leaders have the same judgement regarding the economic situation in Germany, which doesn't happen as often as you might think.
The IFO business climate index is out at 86.2 in June vs 85.0 expected and prior 79.5. The assessment of the current situation has also improved at 81.3 vs 84.0 expected and prior 78.9. Looking at business expectations, we also notice a strong increase to 91.4 vs 87.0 expected and prior 80.1. The rebound in all the three main indicators was largely anticipated by market participants due to the lifting of lockdown measures in Germany, which explains the rather muted market reaction to the release. Though social distancing remains in place and that isolated clusters are emerging here and there, notably in Lower Saxony and in the town of Rheda-Wiedenbrueck where more than 1,500 workers have been infected, the health crisis seems contained and well-handled by the authorities which tends to have a positive effect on businesses’ assessment of the current situation and of expectations. It is also likely that the rapid policy response to the economic crisis, via a €130 billion stimulus package, played a key role in the current improvement.
In the below chart, we have plotted the business situation and the business expectation indices since 2005 to create the IFO clock. It is composed of four quadrants: upturn (on the top left), boom (on the top right), downturn (on the bottom right) and recession (on the bottom left). We observe a major and expected improvement compared with last month, but it remains deeply in recession territory, at a level worse than in 2010. In other words, this is no time for celebration, there is still a long way to go before confidence is back.
On a final note, we want to give a gentle reminder on how to interpret data in this challenging period of time. Over the past few weeks, we have seen that many investors and even economists have misinterpreted post-lockdown indicators. It is of prime importance to remember that the improvement in recent statistics, such as the PMIs released yesterday, does not reflect any V-shaped recovery, but rather a deterioration at a slower rate in most cases. We could have talked about V-shaped recovery if the latest PMI were out close to 100, which was not the case. At best, it was slightly above the threshold of 50 – as was the case for France – which doesn’t scream booming yet.
The same problem of interpretation arises with customary diffusion surveys, like the ZEW or the German IFO that has been released today. Typical diffusion surveys only gives us a direction and a strength. Those questioned are merely asked to compare with how the current situation and expectations are relative the past month. Given the massive impact of the lockdown on the economy, it is not surprising that the assessment of the current situation and of expectations is improving, but this is mostly because it cannot really be worse – all the indicators are increasing from an utter stand-still. It is clear that we are only at the beginning of a very long process of normalisation for business and consumer confidence and that it will take at least another quarter to assess the shape of the recovery. We need to very be careful and avoid jumping to conclusions each time a new statistic is released.
The same problem of interpretation arises with customary diffusion surveys, like the ZEW or the German IFO that has been released today. Typical diffusion surveys only gives us a direction and a strength. Those questioned are merely asked to compare with how the current situation and expectations are relative the past month. Given the massive impact of the lockdown on the economy, it is not surprising that the assessment of the current situation and of expectations is improving, but this is mostly because it cannot really be worse – all the indicators are increasing from an utter stand-still. It is clear that we are only at the beginning of a very long process of normalisation for business and consumer confidence and that it will take at least another quarter to assess the shape of the recovery. We need to very be careful and avoid jumping to conclusions each time a new statistic is released.
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