Weekly Forecasts 22/2025

Leading indicators and possible global upturn

Forecasts:

1. Impulse-response analysis of OECD’s leading indicators.

2. Forecasts for leading indicators of China, Major-4 Europe, and the U.S. imply improving global economic momentum.

This week marks something of a milestone for us, I hope. The forecasts we produce in this report for OECD’s leading indicators start to behave in a manner they should. I am hopeful that we are now on a path leading us to produce reliable forecasts on the leading indicators and thus on the turning points of the world economy.

We start by analyzing the time-varying relationship between leading indicators of China, four major European countries, and the U.S. and discover that, while the U.S. and China were both leading the business cycle between them before 2008, after the Great Financial Crisis, China has been the sole leader. Our forecasts indicate that the world economy would enter a short recovery led by China before a slump and possible recession. This outcome is something we have speculated on since mid-January. Now we have something more concrete to back this up, statistically at least. This raises the need to reassess our recession call, which currently expects the global recession to start in Q3. We do this next week, while I will start speculation on it already today in my newsletter, which all subscribers of the GnS Economics Newsletter will naturally receive.

Tuomas

Impulse-response analysis

Sometimes the structure of the time-series of a variable or a relationship between some variables can change in a fundamental way over time. In statistics, such an event is called a structural break, and it implies a change in the underlying dynamics of a single time-series or a set of time-series. It has, for example, been our argument for quite some time that China took the leading role in the world economy in 2009. This “structural break” is also visible in the leading indicators.

Leading indicators of the OECD for China, Major-4 Europe (France, Germany, Italy, and the U.K.), and the U.S. from May 1992 until April 2025. Source: GnS Economics, OECD.

Before the Great Financial Crisis (2007-2009), the U.S. looked to lead at least the Major-4 European countries. Every time the U.S. leading indicator rose (fell), the leading indicator of Major-4 Europe followed with a lag of a few months. Since maybe 2003, but definitely after 2008, the leading indicator of China looks to take the leading position. It seems to pull Major-4 Europa and the U.S. indicators from both the GFC and Corona-lockdown slumps (with a lag). Furthermore, whenever the Chinese leading indicators sink or rise, the Major-4 Europe and the U.S. indicators seem to follow. We uncovered some of this dynamic in Weekly Forecasts 18/2025. Let’s now continue from there.

We devote most of this month’s Black Swan Outlook to explaining the estimation of cointegration relationships, with the OECD leading indicators as an example. While we enter into some ‘backward logic’ here, with the results presented before theory and analysis, we want to concentrate just on the results here (also to save space). We used the Vector Error Correction (VECM) model to estimate a model incorporating the leading indicators of China, Major-4 Europe, and the U.S. over two different time periods: from May 1992 (the earliest data available) to April 2008 (before the deepening of the GFC), and from March 2009 (when global recovery starts) to April 2025. Here are the (orthogonal) impulse-response functions for the former time period.¹

Orthogonal impulse-response functions of leading indicators for China, Major-4 Europe (France, Germany, Italy, and the U.K.), and the U.S. with bootstrapped 95% confidence intervals using data between May 1992 and April 2008. Impulse variable: USA. Source: GnS Economics, OECD

Orthogonal impulse-response functions of leading indicators for China, Major-4 Europe (France, Germany, Italy, and the U.K.), and the U.S. with bootstrapped 95% confidence intervals using data between May 1992 and April 2008. Impulse variable: China. Source: GnS Economics, OECD

Orthogonal impulse-response functions of leading indicators for China, Major-4 Europe (France, Germany, Italy, and the U.K.), and the U.S. with bootstrapped 95% confidence intervals using data between May 1992 and April 2008. Impulse variable: Major-4 Europe. Source: GnS Economics, OECD

According to the impulse-responses, between May 1992 and April 2008, both the U.S. and China led the “global” business cycle between China, Europe, and the U.S. The impulse-responses indicate that a (unit) shock to the leading indicators of China and the U.S. has a statistically nonnegligible (lagged) effect on both of their indicators and the leading indicator of the Major-4 Europe. A shock to Major-4 Europe has a negligible effect on China and a smallish nonnegligible positive effect on the U.S. indicator at smaller lags, followed by a smallish nonnegligible negative effect on the longer lags. Note that the bootstrapped confidence intervals behave a bit strangely,² with the impulse-response function with impulse from Major-4 Europe to the U.S. This raises questions about their reliability. Let’s now switch to 2009–2025 data.