Recession In Europe Still Base Case Despite Soft-Data Hype

Authored by Simon White, Bloomberg macro strategist,

The level of optimism that Europe may avoid a recession is not justified by hard data, with stocks facing an end to their outperformance.

Hopes have been rising that Europe could avoid a recession. PMI data across the region has bounced, consumer confidence has risen, and measures of economic sentiment have rebounded strongly.

 

But sentiment and survey-based data are subject to the vagaries of whim and herd mentality, and recoveries can evaporate as quickly as they appear. It is for this reason such data is referred to as “soft”.

Hard data, on the other hand, such as industrial production and retail sales, is based on actions rather than opinion, and is thus less subject to caprice than soft data.

Outside of the still-resilient jobs market, there are several hard-data points that are still very negative in the euro-area. Most notable is the collapse in real M1 growth to series lows.

 

Real M1’s drop is consistent with what we saw prior to the last two European recessions.

There is an “it’s different this time” counter-argument, that higher rates means that businesses and households are terming out their overnight deposits more, artificially depleting M1.

But this is nothing new. Higher forms of money, e.g. M2, tend to be counter-cyclical, as people are likely to move money into more “current” accounts when they perceive a good reason to use it (i.e. economic confidence encourages them to spend or invest it). And the opposite applies when they are not confident in the economy.

The chart below shows that M2 ex-M1 often lags, not leads, economic activity, and in periods is counter-cyclical not pro-cyclical.

 

Already the marginally positive euro-area real GDP print for 4Q22 is looking vulnerable to being revised into negative territory, with Ireland considerably revising lower its 4Q22 GDP to 0.2% from 3.5%.

European stocks have been on a tear, fueled by soft-data optimism, but that looks to be on the verge of changing, with US stocks set to reclaim their leadership.