So far we haven’t said much about global demand, without which there would be no production.

That doesn’t mean we don’t think about the demand side of things. On the contrary, over the longer run global (goods) demand and production must by definition grow at roughly the same rate. So – though the data is harder to come by – we also track a global proxy for private sector demand – which consists of real retail sales and business investment in about 45 economies.

The chart below shows how global IP over and under shoots our demand proxy through time:

The ABC of forecasting global IP – as opposed to tracking it via the PMIs – contains three elements:

How fast is demand growing?

How big is the current gap between demand and production?

And how big is the cumulative gap between production and demand – or in other words how much have inventories been built up or run down?

Typically, it’s the second factor which powers steep recoveries from recession or panic: once production has fallen (way) below sales, and demand stabilizes, the desired rate of de-stocking usually begins to slow, which means production usually begins to grow. And it’s the size of the gap which drives the speed of the subsequent recovery as much as the growth rate of demand.

We call this the rebound phase.

Equally, once the gap between demand and production is (largely) closed, production growth will cool off again, until it is growing somewhere around the rate of demand growth, or perhaps a bit higher if businesses are confident enough to rebuild inventories depleted during the downturn.

If at this stage, demand goes into a nosedive – so will production. If it grows steadily, or even accelerates, so will production.

The classic pattern is for global IP momentum to peak 6-12 months into the recovery, decelerate for several months and then – most often – pick up moderately again as restocking begins. At which point of course, the PMI new orders numbers generally stop declining and turn a bit higher, though its rare for them to get back to their early cycle peaks.

This is what we tend to call the expansion phase, and is the transition we think the global economy should now be making.

As we shall see later, its usually somewhere around this point in the process that employment, income and output growth in the service sector (much the bigger share of GDP in the developed world) begins to pick up, and the recovery starts to broaden and feel more sustainable.

Among several encouraging indicators that this has been happening is the recent trend in discretionary services spending by US consumers, which has re-accelerated in recent months, more or less in line with the recent revival in discretionary goods purchases (real retail sales). Black Friday shopping trends seem to confirm this pattern, and so do the most recent employment indicators, which include lower weekly claims and a sharp fall in the duration of unemployment, often a leading indicator for consumer confidence more generally.

So will the PMIs confirm that global growth is – finally – making that crucial transition from rebound to expansion?

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Jonathan Wilmot, chief global strategist at Credit Suisse Investment Bank, is blogging at FT Alphaville for the day.

Please read this Credit Suisse small print.

This entry was posted by Guest writer on Tuesday, November 30th, 2010 at 19:30 and is filed under Capital markets, People. Tagged with credit suisse, Jonathan wilmot, PMIs. Edit this entry.