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By HaleStewart October 10, 2014 1:37 pm
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International Week in Review: Eurodoom Edition

     Let’s begin by looking at a general overview of each major developed country with a non-manipulated currency.

  • The EU region is perilously close to a recession, if it has not already begun.  Unemployment is high, growth is weak and a potential deflationary spiral is either developing or in its early stages.
  • After coming out of the New Year’s gates in strong fashion, the UK is slowing down.  Some of this deceleration is a natural slowdown from a period of fast expansion, but a not insignificant percentage is directly attributable to the EU situation.
  • The US is doing well; recent data show the economy continues to grind out 2%-2.5% annual GDP growth rates.
  • Canada continues to print numbers indicating solid annualized growth rates of between 2.1% and 3%.
  • The effect of “Abenomics” may be waning, leading to slower overall growth and a potential return of the deflationary issue
  • Australia continues to grow, but is potentially experiencing problems as the economy tries to transition from one based on natural resource exports to a more evenly based growth.

     European news was uniformly negative this week, as the region’s largest economy (Germany) issued several statistics implying the country may be heading into a shallow recession.  Factory orders decreased 5.7% M/M while industrial production contracted 4%.  Exports – clearly hit by sanctions related to the Ukraine situation – dropped 5.8% M/M.  Continent wide retailing showed continued contraction with a retail PMI reading of 44.8.  And ECB head Mario Draghi offered a very pessimistic analysis of the region’s economy in a speech delivered on Wednesday:

There are some parallels here for Europe: we are also engaged in reform and recovery. But in fact we face the opposite concern to that expressed by Keynes. Without reform, there can be no recovery.


Second, I am uncertain there will be very good times ahead if we do not reform now. This is because the problems we face in Europe are not just cyclical, but structural. Potential growth is too low to lift our economies out of high unemployment. It is also too low to allow us to overcome quickly the debt burden left over from this crisis and the period that preceded it. Thus, while stabilisation policies that raise output towards potential are necessary, they are not enough. We need to urgently raise that potential. And that means reform.

This speech contained the most negative assessment of the region given by Draghi since he assume leadership of the ECB and it stands in stark contrast to his “whatever it takes” public pronouncement issued several years later that jawbowned EU equity markets higher for the last few years.  Wednesday’s comments were a tacit admission that the EU structure as it currently stands is in desperate need of meaningful and systemic change.

     I provided a general analysis of the UK economy earlier this week, noting that while torrid pace of expansion that occurred earlier this year had slowed down, the economy was still expanding at a positive rate.  Several economic data points released after publication corroborate that analysis.  The BOE kept rates at .5% as well as maintaining their asset purchase program at the 375 billion pound level.  And exports decreased slightly, falling .7 billion pounds.  The best overview of the UK’s economy was provided by the Conference Board’s leading and coincident indicator numbers:

The Conference Board LEI for the U.K. increased for the eighth consecutive month in August. The index has been revised upward between March and August, after second quarter data for productivity and total gross operating surplus of corporations became available. Between February and August of this year, the leading economic index increased 2.6 percent (about a 5.2 percent annual rate), down from 3.8 percent (about a 7.7 percent annual rate) in the previous six months. The strengths among the leading indicators remain more widespread than the weaknesses, with six out of seven components advancing in the last six months.

The Conference Board CEI for the U.K., a measure of current economic activity, increased for the third consecutive month in August. In the six-month period ending in August, the coincident economic index increased 1.2 percent (about a 2.5 percent annual rate), slightly slower than its 1.3 percent increase (about a 2.7 percent annual rate) during the prior six months. The strengths among the coincident indicators have been more widespread than the weaknesses, with three of the four components increasing over the past six months. Meanwhile, real GDP increased 3.9 percent (annual rate) in the second quarter, up from 2.7 percent (annual rate) in the first quarter.   

While the pace of increase in both the leading and coincident indicators has slowed, it is still positive, with a large number of respective constituent components of providing momentum. 

     Canada continues to grow.  The Ivey PMI index increased to 58.6:

The employment component of the index has increased for the last three months and now stands in positive territory.  Although building permits dropped sharply, this was after several months of strong increases, placing the data series back closer to its median growth rate.  The best news, however, was the .2% drop in the unemployment rate, sending it to 6.8%.  This data series has been stuck around the 7% level for about a year, making this move lower that much more important. 

     The biggest piece of US economic news was released on Wednesday when the US Federal Reserve issued the minutes from their September meeting.  The post-release market rally indicated the market interpreted the comments as dovish.  But while the general tenor of the commentary was positive (the committee continued to describe US growth as “moderate” in numerous places) several underlying risks are clearly evident, starting with the labor market.  While the declining unemployment rates indicates improvement, there is a large amount of underutilization as evidenced by weak wage growth, the large number of people temporarily employed for economic reasons and declining employment/population ratio.  Meeting participants are also worried about the potential negative impact of international events.  And while housing is healthier, a big potential problem exists due to the educational debt burden of millennials:

Households with relatively low credit scores continued to have difficulty obtaining mortgage loans. It was noted that this difficulty could be a factor restraining the demand for housing, particularly among younger households who have high levels of student loan debt or weak job prospects. A few participants pointed out the relative strength in construction of and demand for multifamily units, which possibly was due to a shift in demand among younger homebuyers away from single-family homes.   

The overall tone of central bankers concerns was very cautious regarding the outlook.

     The BOJ issued their leading and coincident indicators, both of which dropped 1.4%.   The bank also released their monthly report, which contained the following graph of the indicators:

Both the leading and coincident numbers have been dropping since approximately the first of the year, indicating the current slowdown was telegraphed a bit before the spring tax hike that led to the sharp 2Q GDP contraction.  The BOJ also released the minutes of their early September meeting which highlighted additional areas of weakness.  While public spending and business investment were bright spots, consumer spending on durables (appliances and autos) was weak.  And the anticipated post sales tax consumer spending rebound was slower than expected.  Overall, the minutes indicated the economy probably has more questions than answers at this point.

     The Australian Statistics Bureau corrected the previous month’s employment report in the latest labor market commentary where they reported the unemployment rate increased .1% to 6.1% on a seasonally adjusted basis.  And finally, on Monday, the RBA kept interest rates at 2.5%, reporting the following regarding the Australian macro-economic environment:

In Australia, most data are consistent with moderate growth in the economy. Resources sector investment spending is starting to decline significantly, while some other areas of private demand are seeing expansion, at varying rates. Public spending is scheduled to be subdued. Overall, the Bank still expects growth to be a little below trend for the next several quarters.

The downward revision to the previously reported unemployment spike (which was 6.4% before the revision) bought the RBA some much needed time.  But the Australian economy still has the large problem of over-investment in resources and under-investment in non-resource business:

Declining demand will result from the decreased resource investment.  But there is no compensating increase from non-resource spending to make up for the increased slack, leading to an overall lower pace of economic growth.

     This week marked the return of the risk off trade, leading to dropping equity prices and rising bond prices.  There are a number of reasons for this development, but the uncertain international economic situation is a big factor, as noted by Josh Brown over at the Reformed Broker:

5. The rest of the world is not only not improving, it’s becoming a disaster. Europe is looking at a continent-wide triple-dip recession. An absolute absurdity, and yet here it is. Japan is going nowhere, China’s slow-mo unwind continues apace and the commodity collapse / dollar rally is killing off any hope of strength around the rest of the emerging world.

The uncertainly factor is clearly rising, with the obvious ramifications of heightened volatility.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer





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