10 May 2022

Weekly global economic update

What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.

Ira Kalish

Ira Kalish

United States

US monetary policy is now completely reversed

Everyone expected that the Federal Reserve would raise its benchmark interest rate by 50-basis points last week. It did. And yet equity prices soared following the Fed’s unsurprising announcement. Why? Perhaps it was Wall Street offering a sigh of relief. There must have been some apprehension that the Fed would surprise everyone and raise the rate only 25-basis points. The market would likely have plunged if this had happened. There were some analysts who predicted a 75-basis point increase. That might have shaken investors as it would have indicated the Fed is more worried about inflation than it has let on. Instead, last week’s action was the Goldilocks action: not too much, not too little, just right.  Moreover, Fed Chairman Powell said that “if higher rates are required, we won’t hesitate to deliver them.” In addition, he said that “there is a broad sense on the committee that additional 50-basis point increases should be on the table at the next couple of meetings.” 

The Fed’s action and Powell’s words signaled that the Fed is not only concerned about inflation. Rather, the Fed believes the economy is strong enough to whether a significant boost to borrowing costs—at least for now. That, in turn, likely means a good environment for corporate profitability. Powell offered a favorable assessment about the state of the US economy. 

Meanwhile, bond yields initially fell as investors absorbed information suggesting that inflation will be brought under control. The yield on the 10-year bond fell less than the yield on the two-year bond, thereby slightly steepening the yield curve. This signals a lessened perception of recession risk. Still, many past episodes of monetary tightening did, in fact, presage recession. US Treasury Secretary Yellen, Powell’s predecessor as Fed Chair, said that the Fed will need to be “skillful and also lucky” to avoid a recession.

Prior to last week’s announcement, bond yields had increased sharply ever since the Fed indicated that it intends to reduce the size of its asset portfolio. Interestingly, despite a rise in bond yields, there has lately been a reduction in the breakeven rate, which is an indicator of bond investor expectations of inflation. Thus, yields have risen because of an expectation of an increase in the available supply of government bonds. At the same time, it appears that investors are increasingly shying away from more risky assets such as distressed debt.  The value of junk bonds trading in the United States that are below 70 cents to the dollar has doubled this year. This is likely a direct result of Fed action. 

The Fed’s action came following a 40-basis point increase in the Indian central bank’s benchmark interest rate. That action, the first such increase in four years, was likely intended to fight inflation as well as avert substantial capital outflows that would lead to severe currency depreciation. India had been a lonely holdout among emerging economies in not raising interest rates in recent months.  

US labor market and productivity trends

  • The latest employment report from the US government offers some conflicting information. On the one hand, the establishment report found strong job growth, more so than analysts anticipated and more than the ADP survey predicted. Markets greeted this news as affirming their view of a strong economy bedeviled by inflation. This justifies the Fed’s choice of a rapid tightening of monetary policy. On the other hand, the separate survey of households found a sharp decline in participation and the size of the labor force as well as a decline in employment. That left the unemployment unchanged at 3.6 percent, a fact that was also well received by investors. 

Let’s look at the details: there are two reports published by the government; one based on a survey of establishments, the other based on a survey of households. The establishment survey found that 428,000 jobs were created in April, a robust number.  This was the 12th consecutive month of job gains in excess of 400,000. Moreover, unlike early in the pandemic recovery, job growth was not simply skewed toward leisure and hospitality. Rather, it was broad based across a range of industries. Moreover, the strength of job growth might seem surprising given that the economy is at full employment and that participation did not rise in April. 

Among the interesting aspects of the report was a very modest 2,000 increase in construction employment. This likely reflected a shortage of construction workers, partly due to a paucity of immigration. This shortage has contributed to higher home prices as builders are unable to attract sufficient workers. On the other hand, manufacturing employment was up a strong 55,000. In addition, there was strong growth of transportation and warehousing (up 52,000), finance (up 35,000), professional and business services (up 41,000), education and health services (up 59,000), and leisure and hospitality (up 78,000). 

The establishment report also found that although average hourly wages were up 5.5% in April from a year earlier, not much changed in the past seven months. In addition, hourly earnings were up only 0.3% from the previous month, the second lowest rate of increase in the past year. In other words, wages do not appear to be accelerating, although they are growing at a robust pace. Yet that pace remains below the rate of inflation, meaning that real (inflation-adjusted) wages are declining, rendering less purchasing power for consumers. The wage behavior is surprising given the evident tightness of the job market and the shortage of workers.

The separate survey of households, which includes data on self-employment, was a bit of a shocker, although one-month changes can often be statistical noise. The survey found a decline in participation and employment in April. It also found that the unemployment rate remained steady at 3.6%. 

Investors saw this report as likely reinforcing the intention of the Federal Reserve to tighten monetary policy, but not offering a reason to tighten more dramatically. Bond yields increased while equity prices fell slightly after release of the report.

  • One of the interesting stories in the pandemic era has been the acceleration in productivity growth, where productivity is defined as output per hour worked. This increase was, in part, driven by the switch toward remote interaction, thereby requiring more use of information technology. The big IT investment helped to boost worker productivity. The good thing about productivity gains is that they can offset wage gains, thereby suppressing inflationary pressure. 

Yet we learned this week that, in the United States, productivity declined sharply in the first quarter of 2022. Non-farm business productivity fell 7.5% from the fourth quarter of 2021 to the first quarter of 2022, the biggest single decline since 1947.  Productivity was down 0.6% from a year earlier. This followed a very robust 4.5% increase in productivity in 2021 versus 2020. 

What happened in the first quarter? Deconstructing the report, we learned that hours worked were up 5.5% while output was down 2.4%.  Yet the decline in output, as we learned from the first quarter GDP report, was largely due to a sudden decline in inventories and sudden weakness in exports. If these items are excluded, then final domestic demand grew. In other words, the productivity number is, to some extent, distorted by one-off factors. Productivity might have declined, but not nearly by that much.  

The government also reported a stunning increase in unit labor costs (ULC). ULC is a measure of the labor cost of producing an addition unit of output. ULC is calculated by dividing labor costs by productivity. If labor costs rise and productivity declines, then ULC rises. In the first quarter, hourly compensation was up 3.2% from the previous quarter and up 6.5% from a year earlier. The result is that unit labor costs were up 11.6% from the previous quarter and up 7.2% from a year earlier. Normally, this would be cause for concern. A sharp rise in ULC augurs higher inflation. Yet given the distorting impact of a sharp decline in inventories, these numbers should be taken with a grain of salt. Not surprisingly, much of the press coverage has been relatively hysterical, suggesting that the surge in ULC means bad news on the inflation front. Interestingly, productivity in the manufacturing sector was up modestly in the first quarter while unit labor costs increased modestly.

Purchasing managers’ indices and the global economy

  • The global manufacturing industry suffered a deceleration in activity in April, according to the latest purchasing managers’ indices (PMIs) from IHS Markit. In fact, growth of activity in the global industry hit the lowest level since August 2020, largely due to a sizable lockdown-related slowdown in China.

PMIs are forward-looking indicators meant to signal the direction of activity in the manufacturing industry. They are composed of sub-indices such as output, new orders, export orders, employment, pricing, inventories, pipelines, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth—and vice versa. 

The global PMI fell from 52.9 in March to 52.2 in April, the lowest since August 2020.  The deceleration was driven by an absolute decline in output and a deceleration in new orders and employment. In addition, the global sub-indices for input and output prices indicated an acceleration of inflation in April, likely the result of disruption from the war in Ukraine as well as lockdowns in China. Of the 20 countries analyzed, the highest PMIs were in the Netherlands, United States, Australia, Austria, and Canada. The lowest PMIs were in China, Mexico, Myanmar, Taiwan, and Brazil. Only China and Mexico had PMIs below 50 indicating declining activity. 

The most notable PMI report came from China. There, the manufacturing PMI fell from 48.1 in March to 46.0 in April, a level indicating a rapid decline in activity and the lowest PMI since the start of the pandemic. The sub-index for output fell at the steepest pace since February 2020 when China was largely locked down. It fell from 49.5 in March to 44.4 in April. There was also a sharp decline in new orders, dropping from 48.8 in March to 42.6 in April. Export orders fell to the lowest level since June 2020. In addition, the time it takes for inputs to be delivered to manufacturers increased sharply, indicating renewed supply chain trouble. Some companies reported the cancellation of orders due to difficulty in producing and transporting products. Despite this, there was an increase in backlogs. 

All these difficulties were entirely due to the imposition of severe restrictions on activity meant to quell transmission of the virus, including the severe lockdown in Shanghai, China’s financial hub. Although survey respondents indicated optimism over the long-term, they also expressed concern about how long current restrictions would last. This remains unknown.

The troubles in China, as well as the war in Ukraine, led to a sharp decline in the manufacturing PMI for neighboring Taiwan. There, the PMI fell from 54.1 in March to 51.7 in April, a level indicating modest growth in activity. The sub-indices for output and employment indicated a decline. The sub-index for new orders showed no direction while the sub-index for export orders declined sharply. Only the sub-indices for delivery times and inventories improved. The health of Taiwan’s manufacturing sector is a good indicator for the global technology industry. The decline in Taiwan’s PMI shows how the lockdowns in China are affecting this key industry.

The lockdowns in China also affected Japanese manufacturing, but not as much. Japan’s manufacturing PMI fell from 54.1 in March to 53.5 in April. This indicates a healthy rate of growth. Output was mostly unchanged as were new domestic orders. However, export orders dropped sharply, mainly due to the situation in China. That, and the war in Ukraine, added to supply chain disruption. The survey found a sharp decline in business confidence among Japanese manufacturers.

Growth of manufacturing activity remains strong in the United States and Europe, although there was a sizable deceleration in Europe in April. In the eurozone, the manufacturing PMI fell from 56.5 in March to 55.5 in April, a 15-month low but still a number indicating strong growth. The decline in the eurozone was largely due to supply chain disruption which led to soaring input prices and shortages. This was especially true in Germany which saw a very sharp decline in its PMI to a 20-month low.  German automakers have been disrupted by lack of access to components made in Ukraine. France, Italy, and Spain faced less difficulty. Although the overall PMI for the eurozone remained healthy, the sub-index for output showed no increase in production.

Finally, the US manufacturing sector performed well in April. The manufacturing PMI increased from 58.8 in March to 59.2 in April, the highest level in seven months and one indicating rapid growth in activity. Evidently, the United States has not been as badly affected by events in Ukraine and China as other parts of the world. In April, there was strong growth of output, new orders, export orders, employment, and business confidence. Markit commented that “demand from consumers and businesses is proving encouragingly robust despite severe inflationary pressures, which intensified further during April.” Markit concluded that growth of economic activity in the second quarter is likely to be good, even as inflation gets worse. 

  • The latest purchasing managers’ indices (PMIs) for services in major countries demonstrates that the pattern of growth in this industry is hugely influenced by how governments react to the pandemic. Economic restrictions prevent people from going to restaurants and theaters, while easing of restrictions has the opposite effect. In China, the services PMI fell to the second lowest level on record in April, indicating a collapse in activity largely due to the various lockdowns that are currently in place. In the eurozone, however, the continued removal of government restrictions led to an acceleration in services activity in April, with the eurozone services PMI at 57.7, an eight-month high and a level reflecting rapid growth in activity.  In the United States, growth of services remained strong but declined somewhat, hitting 55.6 in April, following a rapid surge in March. In India, services activity grew very rapidly following further removal of restrictions. The April PMI was 57.9. 

Let’s focus on China. The services PMI for China fell from 42.0 in March to 36.2 in April, the second lowest on record and a level indicating a catastrophic decline in activity. This was entirely due to lockdowns that limited mobility and production. The sub-indices indicate a decline on both the demand and supply side of the services industry. There was a decline in output and a severe decline in new orders. Travel restrictions meant a paucity of export orders. Employment fell modestly and backlogs of work increased as the pandemic had a negative impact on supply chain efficiency. Input prices were up but output prices fell. The latter meant that service enterprises, facing limited demand, were compelled to cut prices in order to attract sales. Interestingly, the sub-index for business sentiment was positive, meaning that businesses were optimistic that the current crisis will ultimately pass. Meanwhile, the weakness of both the services and manufacturing PMIs (the latter was 46.0 in April) bode poorly for GDP growth in the second quarter.  

Russia and the European Union wrestle over energy

  • As the war in Ukraine continues with no end in sight, European leaders are looking for ways to further tighten sanctions on the Russian economy. The financial sanctions have been impactful, driving up Russian inflation, reducing expected Russia GDP, and creating shortages of consumer products for Russian consumers. Yet the sanctions have not stopped Russia from waging war. Moreover, there are reports that President Putin has given up hope of reaching a peace settlement with Ukraine. Now, his goal is said to be a complete takeover of Ukraine, regardless of how long it takes. Putin’s ability to wage war will depend, in part, on his ability to generate revenues from energy. And that is where the European Union is looking to make a difference. 

It is reported that EU leaders are considering new measures aimed at Russia’s energy sector. Although there is not sufficient support within the European Union to simply ban imports of Russian oil and gas, there are other ideas on the table. This includes placing a cap on the price that the European Union would be willing to pay for Russian oil. Russia would likely accept the European Union’s price, thereby allowing for a sizable decline in foreign currency revenues. That, in turn, could put further downward pressure on the value of the ruble.

Another reported idea involves imposing a steep tariff on Russian oil but not on oil imported from other countries. This would also likely force Russia to lower the price it charges Europe, but it would mean a higher price paid by European consumers. However, the revenue from the tariff could be used for fiscal support to offset these higher prices. 

These measures can be considered preferable to a ban or partial ban on Russian oil, which would have the effect of significantly raising the price Europeans pay for imported oil without any offsetting revenue. The main goal, of course, is to deny revenue to Russia while, at the same time, not doing ruinous damage to the EU economy. As such, it is a political balancing act. Note that the actions under consideration are about oil and not natural gas. The dependence on Russian gas is too great and alternative sources are not necessarily readily available.    

  • Meanwhile, observers have wondered what Russia’s next move will be. The sanctions imposed by the West have damaged the Russian economy. Meanwhile, the European Union is engaged in discussions about potential next steps in its effort to undermine Russia’s economy. They are looking at new measures meant to reduce Russia’s revenue from the sale of oil and gas. Thus, it is not entirely surprising that, very recently, state-owned Gazprom (Russia’s largest supplier of natural gas) announced that it is suspending supplies of natural gas to Poland and Bulgaria. Immediately, European gas prices increased by roughly 20% on a single day while the euro fell sharply against the US dollar, hitting a five-year low. 

Gazprom’s action came after Russia had demanded that European countries pay for their gas in rubles. Most have refused to do so, saying that this would violate existing contracts. The suspension of supplies to Poland and Bulgaria was due to their refusal to pay in rubles, according to a statement from Gazprom. Yet many observers see it as an effort to divide the European Union and to put pressure on it not to implement further sanctions. EU Commission president Ursula von der Leyen said that it is a form of blackmail and that Russia is no longer a reliable partner. Recall that, for the last two decades, Putin often spoke about how Russia was a reliable partner. 

Poland’s prime minister said: “Russia has moved the borders of gas imperialism a step further. This is a direct attack on Poland. But we have been preparing for this moment for years. From the autumn, Poland will not need Russian gas at all. We will cope with this blackmail, with this gun to our head, in such a way that Poles will not feel it.”

There were reports that Germany will attempt to provide gas to Poland and Bulgaria. Germany’s economy minister said that the Gazprom action will accelerate the European effort to diversify sources of gas. He said that “the EU’s goal is to become independent of Russian energy imports as quickly as possible.” 

Finally, Gazprom warned that, if gas flowing in pipelines through Poland is diverted, then the volume of gas in the pipeline will be cut commensurately. It is likely that today’s action will cause an intensification of efforts to obtain alternative sources of gas. Several European countries, including Poland and Germany, are investing in the ability to receive liquid natural gas from other countries such as the United States. In the long term, this trend will likely damage Russia’s ability to generate revenue from the sale of gas. 

The ECB navigates stagflation

  • The word stagflation is being used by some to describe the Eurozone economy. That word implies weakening growth combined with accelerating inflation, something experienced in the 1970s. In the first quarter of 2022, real GDP in the Eurozone was up only 0.2% from the previous quarter (although it was up a robust 5% from a year earlier, reflecting the base effect of a weak first quarter in 2021). 

Inflation in the Eurozone continued to accelerate in April. Prices were up 7.5% from a year earlier and up 0.6% from the previous month. When volatile food and energy prices are excluded, core prices were up 3.5% from a year earlier and up 1.1% from the previous month. The latter figure reflected the fact that, in Europe, energy prices actually fell from March to April. 

This data points to the reason why the European Central Bank (ECB) is reluctant to dramatically shift gears and start raising interest rates. First, growth is already receding and is threatened by the possibility of restrictions on energy imports from Russia. Second, although inflation is historically high, it is mostly due to what has happened with oil and gas prices. When these are excluded, core inflation remains far below the more onerous level seen in the United States. As such, underlying inflation is less of a threat and receding growth is more of a threat than in the United States.   

Despite rapidly accelerating inflation in the Eurozone, and despite a sharp decline in the value of the euro (which could be inflationary), the ECB has been reluctant to shift gears and tighten monetary policy, even while the US Federal Reserve does so. The argument is made that Europe is far more vulnerable to recessionary pressures than the United States, that most of the European inflation is related to increases in energy prices, and that a tightening of monetary policy might not have much impact on inflation but might increase the likelihood of recession. Indeed, core inflation (inflation excluding the impact of food and energy) remains quite low in the Eurozone. 

Despite the ECB argument, private investors are becoming skeptical. In fact, investors are now pricing in an interest rate increase as early as July. Currently, the ECB’s benchmark interest rate is –0.5%. Investors now expect the rate to move into positive territory later this year and above 1% sometime next year. Christine Lagarde, ECB president, has said that any action on interest rates is unlikely this year. 

Are investors correct and is Lagarde likely to change direction? The answer is more nuanced. Many economists know that monetary policy is most effective when it is least expected. That is, if the ECB raises rates sooner than investors expect, it will change their behavior more radically. If, however, investors get ahead of the central bank, then ECB action will simply demonstrate that investors had it right all along. Still, Lagarde has made a fairly strong argument for forbearance. She recently said that “If I raise interest rates today, it is not going to bring the price of energy down.” 

Deceptive US GDP data

  • With many people increasingly expressing concern about the risk of recession in the United States, pessimists likely felt validated by the news that US real GDP fell in the first quarter. After increasing at an annualized rate of 6.9% in the fourth quarter of 2021, real GDP fell at an annualized rate of 1.4%, the first decline since the second quarter of 2020. Yet the reality is that the decline in first quarter GDP was entirely due to a sudden decline in inventories as well as a sudden decline in exports. Absent these factors, underlying demand was stronger than in the previous quarter. Regarding inventories, there was a massive accumulation of inventories in the fourth quarter. Consequently, businesses ran down inventories in the first quarter as they satisfied robust demand. Inventory investment is a key and volatile component of GDP. Thus, when inventories rise sharply in one quarter, thereby boosting GDP growth, they tend to fall in the next quarter, thereby suppressing GDP growth. The important thing is to look at underlying demand, which remains strong.

Let’s look at the details. First, consumer spending growth accelerated in the first quarter, rising at a rate or 2.7% after rising 2.5% in the previous quarter. This included a significant acceleration in spending on durable goods and services. Yet spending on nondurable goods declined, principally due to a drop in spending on gasoline and food—both driven by much higher prices of energy and food. The surge in durable goods was principally due to much more robust spending on motor vehicles. 

Nonresidential fixed investment also accelerated, rising at a very robust rate of 9.2% in the first quarter versus 2.9% in the previous quarter. Investment in structures, which fell sharply in the fourth quarter, stabilized in the first quarter. Meanwhile, investment in equipment accelerated sharply in the first quarter while investment in intellectual property continued to grow at a robust pace. Residential investment continued to grow at a modest pace. 

Finally, exports of goods and services, having grown at a rate of 22.4% in the fourth quarter of 2021, fell at a rate of 5.9% in the first quarter. If the impact of inventories and trade are excluded, we arrive at final sales to domestic purchasers. This is a measure of domestic demand and is a good reflection of the strength of the domestic economy. In the fourth quarter of 2021, this measure increased at a rate of 1.7%. In the first quarter it accelerated to 2.6%. In other words, underlying demand in the US economy improved. And this is despite the fact that real disposable personal income has declined in six of the last seven quarters, largely due to a reduction in government stimulus.  

Does this mean we should not worry about recession? Hardly. It simply means that the first quarter data offered no evidence that recession is imminent. Other data points to continued economic strength. The unemployment rate is the lowest in nearly 50 years. Plus, the number of initial claims for unemployment insurance last week was close to the lowest in 50 years. Still, there are substantial risks to the economy going forward. These include elevated commodity prices (which undermine consumer spending power), high inflation, tightening of monetary policy, contraction of fiscal policy as government stimulus fades away, and the negative impact that an uncertain political environment has on business investment decisions. The biggest risk comes from a tighter monetary policy that is currently under way. However, it is worth noting that, in recent history, recessions tended to begin about three years after monetary tightening commenced. 

Is a shift in US trade policy imminent?

  • If you asked almost any economist to find a quick way to reduce inflation, they would likely suggest cutting tariffs. That would reduce the prices of imported goods, create more competition for domestically produced goods, and thereby suppress inflationary pressures. Yet in the United States, that is not a popular sentiment, nor has it even been discussed—until now. US Treasury secretary vetted the idea, saying that cutting tariffs is “worth considering.” In addition, Deputy National Security Advisor Daleep Singh said that the existing tariffs on China “serve no strategic purpose,” especially those on consumer goods. It thus appears that the Biden Administration is attempting to start a conversation, perhaps to test the treacherous political waters.

Meanwhile, the administration’s lead trade negotiator, Katherine Tai, was relatively quiet on the topic, not answering a question at a recent press conference. In addition, in Congressional testimony recently, she said that to cut tariffs unilaterally would imply a loss of leverage with US trading partners. She said, “No negotiator walks away from leverage, right?” 

Also, it is reported that the administration debated a plan proposed by the National Security Council to cut tariffs on consumer goods. However, the administration has, instead, adhered to Tai’s plan to focus on negotiating a follow-up to the so-called Phase One trade agreement between the United States and China that was negotiated by the Trump Administration. That agreement called on China to significantly boost imports of key products in exchange for US forbearance on new tariffs. The agreement was signed just as the pandemic began. Consequently, it has been impossible for China to meet the targets in the agreement. This fact gives the United States leverage with China.

In any event, Yellen’s comments have created a stir in Washington on the part of lobbyists and members of Congress. Perhaps that was the intention. The administration has already boosted the availability of exemptions for existing tariffs, effectively reducing the rate at which duties are imposed. Perhaps the administration will cut some tariffs before Congress has a chance to influence the process. If tariffs on consumer goods are cut, it would take time before the disinflationary effect is felt.

Cover image by: Sylvia Chang

Deloitte Global Economist Network

The Deloitte Global Economist Network is a diverse group of economists that produce relevant, interesting and thought-provoking content for external and internal audiences. The Network’s industry and economics expertise allows us to bring sophisticated analysis to complex industry-based questions. Publications range from in-depth reports and thought leadership examining critical issues to executive briefs aimed at keeping Deloitte’s top management and partners abreast of topical issues.

Ira Kalish

Ira Kalish

Chief Global Economist, Deloitte Touche Tohmatsu


to receive more business insights, analysis, and perspectives from Deloitte Insights