PMIs (Purchasing Managers' Index) are coming off their highs, economic surprise indices are flat or negative and consensus forecast estimates are no longer being revised up in the way they were late last year.
Does this mean that the cyclical economic recovery is slowing?
Although you can never rule that out let’s put this into context.
Firstly, economic surprise indices tell us about the relationship between outturns and expectations; they don’t tell us about the underlying growth rate. Over the last year surprises have been positive because the economic cycle has strengthened at a faster rate than expected. Now that economic surprises are flat (or negative in the Eurozone) it tells us that expectations have finally caught up with reality.
Secondly, it’s important to understand what PMIs represent. Put simply, a number above 50 means a greater percentage of purchasing managers reported an improvement relative to last month; in contrast, a number below 50 indicates a greater share of purchasing managers reporting a deterioration. As such, when PMIs fall from elevated levels, but remain comfortably above 50, it tells us that growth is still accelerating - it’s just the incremental change is marginally weaker.
That’s not to downplay the decline in PMIs more generally – the GDP growth rate is the change in the value of all goods and services produced in any given country. As such, the incremental change is important. In that sense, marginally lower PMIs do offer some tentative evidence that the strength of the economic cycle may’ve peaked. But one also has to consider what it doesn’t tell you. It of course doesn’t imply that growth is contracting – for that the PMI would need to be below 50 – and it doesn’t take into account the strength of the reference point.
So we glean from the latest batch of economic surprises that expectations have caught up with reality. Moreover, in some regions decelerating PMIs do offer some tentative evidence that the pace of this cyclical upswing has peaked. At the same time, however, it’s important to acknowledge 1) where we’re coming from (i.e. strength of the cycle), and 2) the fact that growth in the majority of regions is still above potential (which means a closing of the output gap).
