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"Deflation In Europe Is Just Beginning"... And How To Trade It
From Francesco Filia, CEO and CIO of Fasanara Capital, excerpts from September 1 Investment Outlook letter
Deflation in Europe is Just Beginning
Differently than Russia/West crisis, the problem of deflation in Europe is far more structural of an issue, likely to hold the stage for the foreseeable future.
As often stated, we believe Europe looks like Japan in the early 90’s. Similarly to Japan, Europe has few unmistakable connotations at interplay:
- High level of indebtedness, drawing resources away from productive investments into sterile debt service.
- Overvalued currency, especially to peripheral European countries (30% overvalued against D-Mark, 40%+ overvalued against the rest of the world). Peripheral Europe is experiencing a currency crisis as if they borrowed in foreign hard currency.
- Secular trend of falling working population mixed with falling productivity rates.
The data released in the past few weeks provided evidence of European growth having grounded to a halt for most countries, including Germany. Italy dipped in triple-dip technical recession, while France slowed down concerningly and even Germany contracted in Q2. All the while, inflation averaged 0.3% for the Euro Area as a whole, well below the ECB target and on a clear downtrend.
In Japan in the early 90’s, it took four years for disinflation to become deflation, under the push of a strong Yen and with the help of an inactive Central Bank dismissing such risk until late.
Likewise in Europe, the EUR is far too strong when measured against GDP growth prospects and productivity trends. A misleading current account surplus of 200bn only managed to make it stronger (overshadowing imbalances across countries in Europe), together with a shrinking balance sheet of the ECB for almost Eur 1 trn on deleverage flows and LTROs repayments.
In crafting crisis resolution management, European policymakers blamed the lack of reforms for the low levels of productivity, whereas Europe was suffering from a structural lack of demand. A much more dominant problem. Given that, the ECB balance sheet was allowed to shrink for almost two years now, the EUR was allowed to strengthen against most currencies around the world (which were actively engaging in the opposite effort, one of bold currency debasement, ranging from the US, to the UK, to Japan.. including even Switzerland and Norway), and austerity was imposed to shrink fiscal deficits. The candidly stated goal was to drive Internal Devaluation across peripheral European countries, so as to close the competitiveness gap to northern Europe: output contractions, wage declines, fall in prices. Almost the opposite of what should have happened if the problem was diagnosed as one of deficient demand. Tightening fiscal and monetary policies took place in Europe for two consecutive years, all the while as most other large economies were engaging in the polar opposite.
Nomen omen. Internal Devaluation in Southern Europe is itself an intentional form of deflation. It should have been confined there where it mattered to level off imbalances across nations in Europe. Instead, the laboratory experiment failed as it metastasized around.
Globally, other structural forces were inductive of deflation, from robotics and technological advances shedding jobs and depressing input prices (the Amazon effect), to low energy prices (on shale gas revolutionary discoveries and the end of the Commodity super-cycle), to weaker than potential growth, slack in the labor market, weaker dollar on ZIRP policies, Yen devaluation exporting deflation, China slowing down, etc.
The result is that Germany’s GDP itself is in tatters, even before considering the damage to be from trade wars with Russia. Deflation took hold and derailed the improvement in the soft data and surveys projected earlier on.
The problem with deflation is that minuscule levels of GDP growth are unable to drive unemployment lower and unable to prevent debt ratios from grinding higher and posing a larger threat down the line. Mathematically, as primary budget balances are lower than the difference between real GDP growth and real interest rates on public debt, the debt/GDP ratio is set to rise, from already alarming levels.
Italy, is the main vulnerability here, as a debt/GDP ratio might reach 140% by the end of this year, thanks to disinflation and GDP contraction, and despite austerity and a 2% primary surplus on GDP. By the same token, thanks to zero inflation rates, real rates are too high in Italy, standing at over 200bps above France and 250bps above Germany.
Zero inflation is like death penalty to debt-laden countries. It has been estimated that Italy would need a primary surplus of ~8% if it wanted to stabilize its debt/GDP at zero inflation, which means just stopping it from moving even higher. Spain would need a primary surplus of 2%+, instead of current negative 1.44%. Which means more austerity and more contractionary policies, to cause more internal devaluation than it is currently the case, more declines in unit labor costs, more salary cuts, more unemployment, less consumer spending, less corporate investments. In Italy, for example, average salary would have to be cut by an additional 30%/40% before closing the competitive gap to Germany. This does not account for the fact that inflation in Germany is itself on the verge of becoming negative, making the necessary adjustment even more painful than that.
The good side of the story is that we believe that the ECB and fiscal authority will be forced into further action from here, in an attempt to avoid a fully-fledged debt crisis and a long period of Japan-style depression.
Germany is the key determinant of European policymaking, all too obviously, and we believe they might be about to give in to request for expansionary policies, both fiscal and monetary.
Few reasons for it:
- The German economy itself is contracting, hardly a satisfactory result after many years of implementation of their policy recipe.
- German inflation itself is borderline negative. Europe-wide inflation expectations have dis-anchored from 2% desired line, falling off 20bps in August alone (both 10y and 5y5y forward inflation swap curve). Any concern about price stability and Weimar-style inflation risk should have been put to rest by now.
- German concerns with moral hazard on the side of weaker European member states should have abated by now, as most political parties have embraced structural reforms as essential, and married their political agendas to it. Government in France, Greece and Spain have already spent their political capital embracing the German agenda, being now certain to lose in future elections, while the Italian government is close to do the same, having credibly committed itself to reforms. Germany faces the best mainstream political parties in Europe they can aspire to; any future coalition is most certain to be less receptive of German’s diktat than these ones. The calendar of national elections across Europe next year and beyond should serve as a countdown. Thus, we believe Germany should be prepared now for a relaxation of austerity policies and spreading the adjustment process of fiscal consolidation over a longer time horizon, while opening up to real monetary stimulus.
- Confrontation with Russia, while it may ease over time, surely highlights the urgent need for a common defense policy / energy policy across Europe, helping the case for integration in Europe in the short-term, softening German resistance to more expansionary policies.
In summary, we believe the ECB will be allowed to engage in non-conventional monetary policies, their version of QE, pushing equity and bonds higher in Europe, compressing spreads and yields further, within the next 6/12 months.
Whether it is going to be enough to avert a currency/debt crisis in Europe in the long run is a different matter. We think that there is a genuine case to be made for seeing dissolution of the currency union down the line, in an attempt to save the European Union. Early days to visualize that, though. What matters to the financial markets is the next twelve months - the foreseeable future - and we believe the next twelve months to be highly supporting of financial assets in Europe, both bonds and equity.
Incidentally, we have for European assets and the ECB the same feeling we have for Japan and the BoJ. Abenomics has a high chance of failure, in the long term. Nevertheless, on the road to perdition, chances are that efforts will be stepped up and more bullets shot in an attempt to avert the end game. As stakes are raised, financial assets will be supported and melt-up in bubble territory, doing so at the expenses of a more turbulent end-game in the years ahead.
* * *
Implications of Deflation + ECB’s Activism: Yields & Spreads to Compress to Minuscule Levels, Equity Melt-Up First
As discussed in our previous Outlook, ECB policies and deflationary forces are two weapons firing in the same direction. From here, odds are high for European rates to move lower, credit spreads to narrow, risk premia to implode, interest rate curves to go flatter. That is financial repression at its best, with the added help of deflationary forces, putting any sort of risk premia and rate differentials under attack.
Without the ECB policy move, such process was less obvious. In the absence of an active ECB, such deflationary forces could have failed to drive rates lower and spreads narrower, as credit and risk spreads could have widened massively on fears of a replay of the sovereign and liquidity crisis of late-2011, mid 2012. Credit spreads could have widened out well in excess of base rates moving lower. An active ECB, moving decisively and unanimously (including Weidmann), helps generate the expectation of mutuality across Europe, rendering deflationary expectations even across European countries.
From our June Outlook: ‘’Pushing lower a 10year German bund yield of 1.35% might be difficult (although Japan shows the downside is still wide), but forcing lower a 2.75% yield on a BTP is easier, as it offers twice the yield of a Bund, for the same Central Bank. So it is easier to push down a 6% yield on a Greek govie (and its CDS at 450bps over), on the presumption of mutuality and ECB backstop. For the time being, until further notice’. Fixed income-wise, we expect yields to plummet, spreads to narrow further: Italian BTPs at 2%, and at 100bps spread over Bunds, 60bps over French OATs; 10year Greek yield at 5% and below, soon enough’’.
The impact on equity we expect is one of melt-up, at least in a first phase, pushing them into bubble levels, not supported by fundamentals but rather by the mix of lower yields, zero inflation rates, modest economic growth. Against this backdrop, we believe that the activism of the ECB can lead into 20%/30% upside for equities in Southern Europe, especially in the financial industry. Our favorite markets are Italy and Greece, which we think have the potential of being best performers in the next 12 months, although with heavy (realized) volatility along the way.
* * *
European Deflation Trades
Disinflation is just about to turn into outright Deflation in Europe. The ECB is active but most likely already late in the game, behind the curve, and unable to prevent deflation from kicking in. There are important consequences for rates and spreads in Europe, together with the level of the EUR itself:
- Rates to reach new lows, especially in the far end of the interest rate curve, especially in Germany. Bunds 10yr yields moving flat to JGBs, Bunds’ 30yr yields below JGBs
- Spreads to compress, both between peripheral debt and core European debt, and across the curve. Italian 10yr BTPs at 2% yield by year end, and at below 100bps spread over Bunds, below 60bps over French OATs; Greek 10yr GGBs at below 5%
- Risk premia to implode, interest rate curves to flatten. Curve spreads to tighten, volatility spreads to compress, cross-spreads to narrow.
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I thought it was to short gold and silver every morning as Kevin Henry does.
Deflation? .... So food and fuel will be getting cheaper?
Not sure what planet these dudes have been on over the past 30 years.
Europe.
That's not a planet you idiot. Europe is a country!
do i need to put the /s?
Europe is a continent... Germany, France, Italy ect... are countries. Just having fun.
/s
Not holding my breath on the ECB doing a real outright QE purchase.
1. It's illegal under the treaty
2. The Germans will not cave on this
Agree stackers/
Germany is a fucking puppet for other interests. If they weren't, they would be able to get their gold back overnight.
So Sarah Palin already discovered that Africa is a continent not a country.....?
PS. So also the CB mantra that "Deflation is BAAAAAAD" is now universally believed. Especially now that incomes are declining and Banks are paying no interest on deposits, a bit of deflation might be welcomed by the vast majority of society???
Believe you got your talking points all mixed up...SloJo Biden called Africa a nation when addressing the summit of African leaders in DC 2 last month, not Sarah Palin.
https://www.youtube.com/watch?v=2U7S3Aq51II&feature=player_embedded#t=11
Um, no..........both it would seem
http://www.youtube.com/watch?v=Mc0YPh7v-54
Although they do also both share unimpressive intellects
What a moron. Germany is contracting? Because the GDP reading of GDP for O2 14 was down 0,2 percent q/q, but just saisonal adapted? And the reason for that is just that Q1 14 was a really good quarter, so what you see here is a mere statistical effect? Hard to believe the Tylers give idiots like that space to publish their nonsense here.
Germany isn't contracting, but the macro has been weak over the last 4-6 weeks. Look at the 10 year Bund.
Germany 10Y 0.950 0.958 0.971 0.927 -0.008 -0.84% 16:58:32
That's what infuriates me about the yield curve/spread with the PIIGS.
How about a subcontinent.
As all the worlds central banks race to print, there will be deflation in certain currencies as they compete for their last breath. These are the times when certain people become super wealthy while others lose everything. All fiat untimately ends with zero value.
You're from the US right?
That was my first thought too. I'd like to see a shadow stats type measurement of their inflation. I bet it's a good deal higher than zero. And what a clownshow we live in. As if it's bad that people's money and savings increase in value over time. And this is supposed to be a good thing because now there will be another carry trade like Japan when they start creating money out of this air. Until there is sound money I the world again, we will continue on this path of stupidity.
When these guys say "deflation" they are talking about a contraction of the credit outstanding and the velocity of money. This is death to a fractional reserve banking system that requires ever expanding credit levels to stay afloat. Has nothing to do with "falling prices" which are sometimes, but not always a "symptom" of deflation.
More comments like this.
Correct, and precisely why they should all be summarily executed. They have intentionally and maliciously confused/disquised/manipulated capital, money, collateral etc. and those of us who require energy and commodities to actually deliver something of real fucking value are fucking done.
Want to eat? You better have PMs some diesel fuel or a strong back motherfucker.
Me, I'm stocking whiskey. Lots of whiskey.
We can legally distill up to 20 gallons and have plenty of corn and sorghum. you'd be surprised how far "20 gallons" goes these days.
Bunga bunga in a deflationary shrinkage environment will be painful. Their economists must be getting dismal charts. Deflation is like economic anti-viagra.
Buy the US$ thru UUP? Thanks.
<-- pool party at my house
The reason the can is always kicked down the road is because the consequences of doing so are always less than not kicking.........until they are not. It really is that simple.
Well it's our culture. It's like raising spoiled children because you wanted to be loved and didn't want the trouble of being a parent, it was easier to be a friend. It's that simple really, then one day you don't understand why they hate you and want to hang you. Karma, justice, the wheel of life? Who knows? (I know but won't say)
Re: "our culture"
It's Europe, Japan, China, and (well) who ISN'T doing it?
Most people take the easy path out, especially when they might get blamed for doing otherwise.
It's a Western phenomenon. Not everyone in the world drank the same koolaid. They hate us for our freedom really means the East hates us for being degenerates. It's that simple. Really.
Obama is thinking: "Man if I can just putt my way through the next couple of years....."
What are the Europeans, Japanese, and Chinese - who are doing the same thing - thinking?
The Chinese have a plan, the Japanese don't have a choice but they have homogeny, Europe is just a kept woman. So much for being smart and savvy.
Well, everybody has a plan. But, if it comes down the our degenerate smart-n-savvy people vs their degenerate smart-n-savvy people, I'd like you to know, I still win the smart-n-savvy argument (altho, I have to admit, degenerate smart-n-savvy people is pretty descriptive too).
"everybody has a plan, right up until that first punch is landed" - Mike Tyson.
Harbanger, if Europe is a kept woman, it is nevertheless a working girl. Which, together with the other working girl, China, sends full containers to your shores, which then come back... empty. So much for being smart and savvy
btw, you put the Niall Ferguson picture on it's head. he says America is the wife, and China is her (new) husband (which makes Europe the previous husband)
here: "The United States and China are involved in a marriage like my wife's and mine. The wife ... spends what the husband saves and earns. A very healthy equilibrium. It will remain that way."
Ok, wait a sec... The "east" - which is Japan and China - are doing the same "degenerate" thing we are.
Or are you only talking about the Muslim "east"?
And, yes, I would agree that the Muslims - who are about as male, Old Testament, kick-ass daddy as a religion can possibly get - would hate our fornicating-harlots for the same reason any male, Old Testament, kick-ass daddy religion would (but there's is much more intensity there as they actually still believe in a real God who smites things).
Absolutely, the Easterners are also degenerates, in their own way of course!
Yup. Dude, try it, what-a-ya-got-ta-lose?
The dog ate my homework.
Soooo, yet another central bank will be joining in with the competitive devaluations? I know the fed can't afford to let the dollar appreciate too much against the euro. A couple more negative GDP prints, which seems inevitable, even with the bullshit stats they use, and it looks like the fed will be 'forced' into moar QE.
Cog it's human nature to take the path of least resistance...
Ex; running a printer to make more fake fiatskis is a lot easier than getting off ones' ass and actually doing something productive.
Albert J. Nock called it "Epstean's Law", and considered it one of three fundamental principles necessary for analyzing social phenomena.
So, the cost of living is Europe is going down?
Time to move.
/s
Don't forget to bring your dry powder sitting on the sidelines. It'll get even dryer in deflation.
with all this dry powder lying around, I certainly hope no one trys to light up...
The longer you're here the smarter you get....
LOL.
Let me guess ... they'll commence the Euro printing jubilee ?
Well, when in Rome...
"Zero inflation is like death penalty to debt-laden countries." -
The Japanese disagree...
/s
Inflation - prices rising faster than wages.
Deflation - wages falling faster than prices.
Pick your poison.
well done. < and leveraged asset pricing ? ..oh, the humanity ! >
bullshit, there is no price discovery. Ergo, you can't "price" shit. Try again.
(hint;, the currency dies and everything is "repriced")
You got part #2 reversed... Deflation, is prices falling faster than wages.
That's why central bank policies run on the premise of 2-3% annual inflation... In order for fractional reserve, credit based economies to function, there needs to be forward cost push.
If you know that TV will be more expensive in (6) months you'll hypothetically buy it today. Unfortunately the middle class has been gutted, so those rules no longer apply.
Inflation is by definition an increase in currency supply, whereas deflation means an increase in purchuasing power.
The article is pure BS btw. There is no way you can have deflation with money printing running as it has been running over the yrs. What the author means by deflation is simply deflation in prices in some sectors -- you know, bussiness cicles - after the boom always goes the bust. It's the nature of central banking and fiat money.
// '; filtry.appendChild(div); }); })(); // ]]>// '; filtry.appendChild(div); }); })(); // ]]>// '; filtry.appendChild(div); }); })(); // ]]>// '; filtry.appendChild(div); }); })();]]>Credit markets contracting faster. Credit markets = trillions. Money printing = billions. Equals deflation.
well, ignoring debt and debt servicing, yes. That ain't contracting, not by a long shot.
Your definition of inflation is the old classic definition which doesn't quite work these days.
The more up to date definition is:
Inflation is an increase in the currency supply and/or credit.
Deflation is a decrease in the currency supply and/or credit.
In the fractional banking system currency is created when someone borrows currency; as the debt is paid off then currency is reduced.
So, now the Baby-Boomers are retiring are they creating more debt, or are they paying off debt while readying for retirement?
There's a major contributing factor in the deflation we're seeing around the world.
you can give whatever definitions you want but that does not change the essence of the discussion and it is about that prices of most goods are falling in EU
Allowing crypto-currency to be used to pay off debts, using it alongside a national currency and the subsequent piling into it since the market is undersaturated would create inflation in things like bitcoin now wouldn't it.....
QE in EU = weaker EURO
Weaker EURO = Stronger USD
Stonger USD = US GDP Negative (recession) = FED prints.
QE in EU + QE in US = KeepStackin my bitchez!
If everybody would just convert to the DowBuck they wouldn't have any problems. The DowBuck can buy allot of bread and gas right now.
"European growth having grounded to a halt for most countries, including Germany"
It's even worse than that, because this time, they calculated their GDP taking the criminal activities profits (prostitution, drug dealing, black market, etc) into account. As these figures are by essence impossible to evaluate with any precision, they used their imagination and probably inflated those 'profits' at will...
Go figure what a train wreck it really is.
Europe is about to hit a new personal all-time low in CBs contest to the bottom.
"Internal Devaluation in Southern Europe is itself an intentional form of deflation. It should have been confined there where it mattered to level off imbalances across nations in Europe. Instead, the laboratory experiment failed as it metastasized around."
Really? It could have been contained? Not likely...
This is a global event of contraction. There is no exit. The theater's doors are locked and the smoldering fire is starting to gain traction...
Try Biflation on for size
As Europe slides and as the Euro slides, the USD should climb sharply
http://bullandbearmash.com/chart/dollar-montly-breaks-close-85-move-usd-90/
Down vote all you want, but the USD is on it's way to 85 in the near term, and 90 by mid next year.
And you thought a joke economy with markets at all time highs was odd.
We're the best of the Wurst! We're number -1, we're number -1!!!
I think major currencies will fall in the following order, first the yen in Japan, then the Euro, Followed by the Pound in the UK. Cross border flows will force money into the biggest game the US dollar that will then roll over and cause a reset.
The games central bankers are playing in supporting their and other currencies has reached a dangerous level, we may be in the "red zone". Currencies are important chips in the commerce of government and the business of running a country. History has shown that in the past both leaders and governments have fallen with the demise of their coin.
If people lose faith in the system it could just come crashing down around our ears. At a time when billions of dollars can be traded in just the blink of an eye imagine how fast things could go to hell. More on this subject in the article below.
http://brucewilds.blogspot.com/2013/01/currencies-games-in-danger-zone.h...
I've been saying that here for years. No currency crisis for the US buck until after Japan and most of Europe "go Greece".
As they all spin down, the US will get the scared money. But the US is in big trouble when those other countries correct and become safe investments again.
It is actually more like the mid 90's but what's a few years between frenemies
Listen to what they have to say...
then do the exact opposite.
Watch Murkle's curve spread tightening.
She probably has some video of that on the cloud...
Too bad nations don't have militaries any more. Banksters are never going to jump at this rate. Another visit to NYC and another set of photos and not a single jumping bankster. I'll be back over the year maybe I'll get lucky next time.
as long as the bread can be delivered, yes, sme as it ever was...
So how do we trade it? Oh, I forgot we must buy staks!
It's "stawks"...and yes, this is one way to trade deflation in Europe. It is interesting to note how many US companies are now buying up European ones. "That moves the top and bottom line"(in theory.)
There is a question of timing. If the euro is about to massively devalue...
Then again lending for said activities might dry up as well.
"How is one to know when an irrational exuberance has taken hold of investors?"
Indeed....how is one to know? Only through collapse perhaps?
One man's collapse is another's realized return. Same as it ever was.
And it was just yesterday that we were worried the European companies were going gobble up American ones.
But then the stock market went for a ride on printed money.
Problem solved.
The boyz (and well hung girlz) won't be giving up their precious dollar any time soon.
It appears the central banks of the world have made the crux of their existence a balancing act. You can almost imagine these bankers standing atop a fence. On one side lays a field of inflation and on the other a deep pit of deflation.
A new round of easing by central banks to combat a slowdown in growth may again be in the cards but do not be surprised if this time it is less successful. The magic of this policy is losing its luster. More below on why this is not working.
http://brucewilds.blogspot.com/2013/11/central-banks-try-to-balance-on-f...
We are plaqying on a world wide field and what happens in other countries results in cross border money flows. I contend the primary reason that inflation has not raised its ugly head or become a major economic issue is because world over we are pouring a large percentage of wealth into intangible products or goods. If faith drops in these intangible "promises" and money suddenly flows into tangible goods seeking a safe haven inflation will soar. Like many of those who study the economy I worry about the massive debt being accumulated by governments and the rate that central banks have expanded the money supply.
The timetable on which economic events unfold is often quite uneven and this supports the possibility of an inflation scenario. A key issue being one of timing. If the price of gas jumps to $8 a gallon overnight do you buy gas and not make your car payment or stop driving the twenty miles to work? Answer, it could be months before your car is repossessed so you buy gas.
It is important to remember that debts can go unpaid and promises be left unfilled. If this happens where does it leave us? Chaos and major disruption would result from such a scenario. As we have seen from the economic crisis of 2008 and following many other unsettling developments legal actions can continue to drag on for years. More in the article below.
http://brucewilds.blogspot.com/2014/04/inflation-seed-of-economic-chaos....
Detroit could be the straw. Opening arguments started today.
"Bond insurer's attorney tells judge 75 cents on dollar is fair settlement of Detroit debt"
Read the blog. Nice.
"If the price of gas jumps to $8 a gallon overnight do you buy gas and not make your car payment or stop driving the twenty miles to work?"
you stop driving and relocate to a place near your work so that you can walk there or at least drive a bycicle
this has happened already in asia and eastern europe, the west is going to follow the suit because it makes economic sense
“sterile debt service”
C’mon now, one man’s ‘sterile’ outflow is transferred to another man’s ‘fertile’ inflow.
So, the ECB will allow Italy and Spain to fail so that it can gain control over their valuable assets and hold the countries and their people hostage?!?
diabolical...
all that means the only solution is debt restructuring or outright helicopter money drop which ECB has no mandate to do
Markets do not move in melt up to met down phases anymaore. (An aged trading paradigm).
If you have the testicles, you do carry trades shorting Euro and German bunds where the liquidities are. Illiquid spaces are easier for the ECB to fix you.
haha...........