The disaster in Europe versus data in the US (plus China and Argentina)
Despite the title, this is not a mono-themed post but more of a highlight of recent news and data and their importance in interpreting the direction of the economy and potential effect on markets. I do want to concentrate on European and US data but I also have some data points from elsewhere. Let’s start with Europe.
Europe needs a boost.
An article in the FT by Richard Portes of London Business School caught my eye. Portes write:
“Economic commentators conventionally define a recession as two consecutive quarters of declining output. That narrow definition belies economic reality, however. Under the chairmanship of economist Philippe Weil, the business cycle dating committee at the Centre for Economic Policy Research identifies economic cycles by looking at a wide range of indicators. It has twice warned that the meagre signs of a rebound in the eurozone since early 2013 were not enough to declare the end of the double-dip recession that started in the third quarter of 2011. It signalled concern that the economy could again go into reverse, or that sluggish growth could become the new, dismal normal of the eurozone. “
Portes is saying that Europe is still in a protracted recession using the US-style dating committee pattern and his conclusion is that “the acute, pressing problem is aggregate demand” and that Europe’s focus on structural reform is misguided. I don’t have an answer here except to say that Europe’s institutional structure practically guarantees stagnation. I don’t see any robust rebounds coming no matter what kind of policy leeway fiscal or monetary authorities get.
On that note, I see Portugal as the next in line behind Greece for default because it is not a big country and its debt to GDP numbers are huge, on par with Italy. The Portuguese paper Jornal de Notícias had an article recently noting that Portugal’s government debt is now 134%, up from 132.4% in Q1 (article in Portuguese).
At the same time, Spanish newspaper El Pais noted yesterday that Portuguese one-year paper was auctioned off at a record low yield of 0.216%. That’s down from 0.453% just a month ago and the auction was 1.79 times oversubscribed. El Pais’ title appropriately was “After the BES rescue, Portugal finances itself at the lowest cost in history” (article in Spanish).
So how does a country, with a government debt level now over twice the Maastricht 60% level that is increasing, and on the heels of a shock large bank bailout finance itself at record low yield levels? I’m not sure what the answer is, but a lot of it has to do with reaching for yield, the Portuguese Bank – Portuguese sovereign nexus and the implicit ECB backstop. I would suggest that at least one of these factors will break, forcing yields up.
US data are good.
Meanwhile, in the US we had two good macro data points that came out today. First, in the week ending 16 August, seasonally-adjusted initial jobless claims were 298,000, putting the 4-week moving average at 300,750. Those are great numbers. At the same time, the US manufacturing PMI came in at 58.0, which was the highest in 4 years, and well above 55.7 consensus. The key consideration here is that the number was also higher than all 24 economists’ forecasts in the Reuters poll.
This is a huge upside surprise that tells you production/inventories are going to add to GDP in Q3 in a very meaningful way to make the Q3 GDP number a good one despite weak retail sales data.
And, yes, the retail data have been weak. I mentioned the earnings downgrades yesterday. Sears reported yesterday as well. And they showed yet another loss, the ninth straight quarter. I think they have business-specific problems. But core retail sales in July were up only 0.1% and auto sales were weak falling 0.2% after falling 0.3% in June. Clearly, the auto sector is not robust at the moment. And this is concerning given the subprime factor.
I saw a French article today on US auto subprime in L’Express (article in French). There are two things to note here other than the fact that even the French are picking up on the fact that US auto subprime has a look and feel like pre-crisis US mortgage subprime. First, S&P has become unnerved by credit conditions and the quality of American car company guarantees. They see an inflection point having occurred. Second, the article notes that loan losses are now increasing, with S&P noting that average LTV for auto loans is now over 115%. The bottom line then is that demand has weakened and credit quality is weakening as well. We should expect loan losses to mount, especially in the face of huge used car inventory that is putting downward pressure on prices. All of the data is consistent with a credit cycle that is on the way down toward a trough in the auto sector this is why I said we should watch the auto space for further confirmation of weakness in retail..
The final data points I want to concentrate on here come from Argentina. Three things are notable.
- The Argentine debt swap proposal met a tepid market response. The Wall Street Journal reported that “several owners of restructured bonds said they would be unlikely to accept a swap.” The paper also said that even “participating in the swap could be seen as a violation of U.S. law” Argentine debt and the currency were down on the news, with some people saying a deal can’t get done until after next years presidential elections in October 2015. That’s very bad news for Argentina.
- Weather in the US has been favorable for agricultural production and commodities prices have declined as a result. Soybean production is at record levels. According to Argentine newspaper La Nacion, the US Department of Agriculture sees a record 103.85 million tons of soybeans being poduced and this will put downward pressure on the prices of the crop, a major source of export and foreign currency revenue for Argentina. At the same time La Nacion is also saying that the area under production for corn will fall 10.4% in Argentina. And that means lower export volumes and less foreign currency for reserves.
- The Argentine government is also banning the export of meat for 15 days in order to halt the rise in food prices, which are skyrocketing. Import quotas and export bans are seriously ineffective public policy. And the fact that Argentina has resorted to an export ban when those exports earn foreign currency tells you that the inflation situation in Argentina is out of control.
Overall, these data points point to serious economic weakness in Argentina where I believe the situation continues to deteriorate.
China. On Monday I reported on the across the board weakness in Chinese housing as prices fell in 64 of 70 cities surveyed. This is happening despite the stimulus now coming online. Today, we saw data out of China that showed the preliminary Purchasing Managers ‘ Index from HSBC and Markit Economics at 50.3 in August. First, 50 is the demarcation between expansion and contraction, meaning this data showed Chinese manufacturing barely expanding. Second, the numbers trailed every single one of 22 estimates in a Bloomberg News survey of economists where the median forecast was for 51.5. In July, the PMI was 51.7 and that was already a three-month low. So these numbers are awful. It is not clear whether the stimulus has been strong enough to counteract weakness in housing. More stimulus may need to come online to prevent a further fall in GDP growth.