Disappointment in Core, but Some Positive News in Periphery
The shockingly weak euro zone flash PMI, especially the sub-50 reading for German manufacturing, is the main focus today. New orders have been weak and the Bloomberg consensus does expect the euro zone economy to contract not only in Q1 but in Q2 and Q3 as well. Many participants seem to have confused the dramatic equity market rally in Q1 and reduced tail risks with economic strength.
There is also a bit of a double-whammy for Germany. It had diversified its exports away from the periphery in Europe toward Asia, especially China just as fears of a harder landing–more pronounced slowdown, have been "confirmed" by the drop in the HSBC flash manufacturing PMI.
As the core of Europe is the flash point today, there have been some encouraging developments on the periphery that should not be overlooked.
First, Greece’s Jan-Feb budget deficit (excluding social security and local government figures) fell 53% year-over year to 495 mln euros. This compares with a target of 879 mln and 1.05 bln in the Jan-Feb 2011 period. Greece also reported that the January current account deficit of 1.5 bln euros is more than a 40% reduction from January ’11 2.75 bln deficit. Somewhat better tax collection and higher taxes, coupled with the dramatic compression of local demand is having the impact that Greece’s creditors desire.
Second, Portugal also reported a sharp reduction in its current account deficit. The January shortfall of 808 mln euros represents roughly a 35% reduction from a year ago. Exports are improving and there was a drop in the volume of fuel imports. It also appears there were few Portuguese tourists going abroad–perhaps reflecting domestic recession.
Third, Ireland has a 3.1 bln euro promissory note coming due at the end of the month. It appears an agreement is in the works to allow it to be replaced by a 25 year government bond.
The second tier of the periphery, namely Spain and Italy are not faring as well. There is talk that Spain may be downgraded, but we suspect this reflects the flurry of high profile reports lately warning about the outlook for Spain rather than something from the rating agencies per se. In Italy Monti is pushing ahead with labor market reforms, though the largest Italian trade union is resisting.
The yield on Italy’s 10-year bond (generic) has risen every day this week and is now trading about 40 bp higher than on March 9th when the yield bottomed. The yield now is above 5% for the first time since March 3. Recall that because of the sovereign bond holdings by Italian banks, the decline in sovereign yields not only lower the debt servicing costs for the government but also strengthened the banks’ balance sheets. The process could go into reverse.
The same dynamic is evident in Spain. Spain’s 10-year yield has risen by about 65 bp this month. Today is the ninth consecutive session that has seen the Spanish 10-year yield rise. It is flirting with the 5.5% level for the first time since mid-February.
I still see problems in the periphery, the core has the same problems but will suffer later from them. Ireland is back in recession and the debt burden will eventually kill the irish household and there will be large numbers of bankruptcies eventually there.
UK banks are still weak and could still collapse. Debts here are causing problems and austerity is not helping. The problem is that traders are looking for any positive sign that the crisis is over and it is a long way from being resolved and that is why mainstream economists are fools.
Of course therre are problems in the periphery. Yes Ireland is in a recession, as is Portugal, Italy, Greece, Belgium, Holland and Slovenia. By citing positive developments–smaller c/a deficits, for example, and acknowledging the repression of domestic demand, I was trying to give the impression that the crisis was over by any stretch.
Perhaps the desire to criticize “mainstream economist are fools” prevents a careful reading of the analysis presented. Not to recognize the facts–smaller Greek current account and budget deficit and improvement in Portugal’s external imbalance and the Irish move on the prommissory note is not to try to truly understand the situation–what is changing and what is staying the same.
of course that should read “not” trying to give the impression that the crisis is over by any stretch.
My comments are aimed at neoclassical and monetarist economists who are still clueless. I was not criticising you. Globally I am bullish but then the world economy has only ever had recessions during global oil (1973/74, 1989) or financial crises (2008). China will possibly have a hard landing but it has the scope and funds to restructure. That is positive.
Though each major country still has problems, some of which have yet to impact, such as a coming property crash in Australia, Canada and Netherlands, which will impact these nations severely. Policy mismanagement such as demand repression is only going to extend the problem and make it reality when it could have been contained by freezing government expenditure and normalising interest rates to clear out the mal-investment in real estate and banks lending. Then and only then can a secure pattern of growth for the economy be built. Until the downsides are eliminated only the brave and foolhardy will invest. Companies realise that to invest there needs to be demand, and until mill stone debts are eliminated will there be sufficient demand to justify new investment. Though with the large over capacity right now, that does not seem likely.