There is more than just loan delinquencies, unemployment rates, and PMIs that are on the rise in Europe. As we have long-feared, the relative austerity combined with high unemployment has historically always been a boiling pot for increased social unrest and it would appear this is very much the case among the most troubled peripheral nations in Europe. As Bloomberg's Niraj Shah points out, burglaries in Greece (up a stunning 63%) and Spain (53.5%) have soared since the crisis began in 2007. This compares with a European-Union-wide average increase of 7% (which is notable in and of itself) as Cyprus and Portugal also see ~20% increases in theft. With unemployment rates showing no signs of slowing, we suspect this trend will only get worse as the divide between the haves and have-nothings increases.
The week ahead will be relatively quiet with few major data releases. The main focus will be on the Flash PMIs in the Eurozone and China as well as the FOMC minutes and Jackson Hole. In the US the relatively new Preliminary PMI has been found useful by our US team in forecasting the ISM. Existing and new home sales are additional data points of interest in the US. The key focus this week will be on central bank action. Minutes from the FOMC and the RBA will be followed by rate decisions in Thailand and Turkey. Finally, on Thursday starts the annual Jackson Hole conference with lots of Fed speakers, including Yellen next weekend. Chairman Bernanke, whose term ends in January, will not attend.
It's all about rates this largely newsless morning, which have continued their march wider all night, and moments ago rose to 2.873% - a fresh 2 year wide and meaning that neither Gross, nor the bond market, is nowhere near tweeted out. As DB confirms, US treasuries are front and center of mind at the moment.... the 10yr UST yield is up another 4bp at a fresh two year high of 2.87% in Tokyo trading, adding to last week’s 20bp selloff. As it currently stands, 10yr yields are up by more than 120bp from the YTD lows in early May and more than 80bp higher since Bernanke’s now infamous JEC testimony. We should also note that the recent US rates selloff has been accompanied by a rapid steepening in the rate curve. Indeed, the 2s/10s curve is at a 2 year high of 250bp and the 2s/30s and 2s/5s are also at close to their highest level in two years.
Draghi is a clever man in charge of a pretend central bank (for it’s only equipped to fight inflation, not a banking-turned-sovereign-debt-and-unemployment crisis). He must guess that bond investors will soon figure out that a stateless central bank defending a stateless currency is so hamstrung politically that it carries far less firepower than, say, the Federal Reserve has over the US economy and US dollar. If his outright-monetary-transactions bluff collapses, he may well have other tricks ready to suppress yields on struggling sovereign debt and save the euro (without which there is no need for the ECB). If Draghi is out of surprises, he can be thanked for buying time for politicians to come up with durable solutions to the eurozone’s woes. Oh, that’s another flaw with Draghi’s scheme; it removed the pressure for politicians to act. So they haven’t.
Peripheral bond spreads have rallied for 10 of the last 11 days. At a mere 269bps, Spanish bond spreads are the lowest in 2 years; Italian spreads (at 240bps) are the lowest since July 2011, and even Portugues bond spreads compressed 15bps today to near 2-month-lows. Since mid-July, it is clear that hot-money flows are charging into peripheral European bonds and not into US equities. European stocks (mostnotably the worst economically) have also risen (Greece +21%, Spain/Italy/Portugal +11.5%) but most recently it is the bonds that have seen the major flows.
In the world these days the markets often believe the rhetoric. This would be political rhetoric, corporate rhetoric or the prayers and hopes of the talking heads. This is especially true in the equity markets. Critical advice in this environment is, "forget what they tell you; just look at the numbers." So what is the Fed doing? As of July 31, 2013 they have parked $1,157 billion in foreign banks as compared with $1,112 billion in U.S. banks. To us this is a telling sign. The European banks are in trouble and the Fed is propping them up. One of the consequences of tapering, when it comes, may well be less available cash for this task and then the cracks in the European banks may well blow into gaping holes... "There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time."
Next month promises to be more volatile than this month. Consensus views are unlikely to be challenged by the data in the week ahead.
As US equity markets slide notably from overnight highs on the back of JPY carry unwinds, the USD weakness is the EUR's gain and the EURUSD pair pushing up towards 2 month highs near 1.3400. As the pool of global liquidity sloshes away (briefly) from Japan and the US, the dash-for-trash of what is working drives it into the highest-beta European assets. Banks and insurers rallied on the day across Europe. The best 4 equity markets across the EU were Greece (+2.5%), Portugal, Italy, and Spain with UK unch (as investors remain undecided on Carney's new deal) and all this amid a disappointing German data print. Spanish and Italian bond spreads compressed (of course) and notably US Treasuries are outperforming Bunds by around 4bps on the day.
The “smart” money is fleeing the market en masse (institutions, wealthy private investors, etc.).
August is traditionally Europe’s holiday month, with many government officials taking several weeks off. In the process, important initiatives are put on hold until the “great return” at the beginning of September. This year, there is another reason why Europe has pressed the pause button for August. With a looming election in Germany, few wish to undermine Chancellor Angela Merkel’s likely victory. Some of the recent economic news has seemed to justify this approach. Yet no one should be fooled. This summer’s sense of normality is neither natural nor necessarily tenable in the long term. It is the result of temporary and – if Europe is not attentive – potentially reversible factors. If officials do not return quickly to addressing economic challenges in a more comprehensive manner, the current calm may give way to renewed turmoil. In essence, Europe (and the West more generally) owes its recent tranquility to a series of experimental measures by central banks; consequently, the resulting surface calm masks still-worrisome economic and financial fundamentals.
A discussion of this week's key events and data within the context of the investment climate characterized by shifting Fed tapering expectations, evidence still pointing to a soft landing of the Chinese economy, a cyclical recovery in Europe and renewed capital outflows from Japan, while foreign investors slow their purchases of Japanese equities.
Today’s bizarre confluence of negative real interest rates, money printing, eurozone sovereign default, aberrant asset prices, high unemployment, political polarization, growing distrust… none of it was supposed to happen. It is the unintended consequence of past crisis-fighting campaigns, like a troupe of comedy firemen leaving behind them a bigger fire than the one they came to extinguish. What will be the unintended consequences of today’s firefighting? We shudder to think.
At a time when Spain is back in the limelight on account of its ever-sprouting corruption scandals, the government is trying to switch public attention to the prospect of impending economic recovery. Last Thursday, when the National Statistics Institute (INE) reported a 0.90 percent drop in the active population unemployment rate (down to 26.26 percent from the previous quarter’s 27.16 percent), Economy Minister Luis de Guindos assured: “Despite all the difficulties, today I am convinced that the worst is over and that the Spanish economy will leave behind the negative growth rates.” Mariano Rajoy’s government may, as its predecessor did, announce “around the corner” recovery to keep the population’s hope alive and dodge uncomfortable matters such as corruption scandals, but in reality the country’s trend is quite worrying.
While the market's eyes were fixed on the near record slide in Japanese Industrial Production (even as its ears glazed over the latest commentary rerun from Aso) which did however lead to a 1.53% jump in the PenNikkeiStock market on hope of more stimulus to get floundering Abenomics back on track, the most important news from the overnight session is that the PBOC's love affair with its own tapering may have come and gone after the central bank came, looked at the surge in 7 day market repo rates, and unwilling to risk another mid-June episode where SHIBOR exploded to the mid-25% range, for the first first time since February injected RMB17 billion through a 7-day reverse repo. The PBOC also announced it would cut the RRR in the earthquake-hit Lushan area. And with that the illusion of a firm and resolute PBOC is shattered, however it did result in a tiny 0.7% bounce in the SHCOMP.
European financial stocks had their best week of the year - jumping an impressive 6.2% on the week and over 10% in the last two - as once again 'Europe is fixed' (except credit markets don't seem as enthused). At the same time as this exuberance is taking place, Germany's DAX and Switzerland's SMI saw almost their worst weeks of the year (down 1% and 1.7% respectively). The week was very oddly dispersed with Spain, Portugal, and Greece (up 5%, 4%, and 3%) having an incredible rip while the broad-based Bloomberg Europe 500 (Europe's S&P) dropping 0.25%. Bond markets were just as enthused with Portugal, Spain, and Italy continuing their un-Taper rallies (spreads down 49bps, 20bps, and 15bps respectively). All of this as the EUR strengthened, composite PMI peeked over the 50 mark, French unemployment hit a record high and Italian bad loans surged to a new record. Schrodinger has moved from China to Europe it would seem...