Download March 15 2013

WEEKLY ECONOMIC AND MONETARY REPORT
15 March 2013
Almost without anyone noticing, there have been shifts in the global economic
environment that one can justly describe as ‘tectonic’. The yen, for instance, has now
fallen 16% against the US dollar since the beginning of the year – and 28% since its
post-War high in October 2012. As for the dollar, it is up 5% on a trade-weighted basis
so far this year, while sterling is down 6%. These are major moves, and it is easy to
argue that we are already seeing competitive devaluation. But it is not just currencies
that are causing concern. The ‘great rotation’ out of bonds and into equities is also a
concern. It may be ‘normal’ – but it could also be a bubble. After all, the Nikkei-225 is
now up 19% for the year-to-date, while the DJIA is up 11% and the S&P 500 is up
almost 10%. Perhaps more dangerous, this week has seen several stories in the press
about retail investors pouring their money into the high-yield, junk bond market, through
mutual funds, ETFs or directly, as part of a global “search for yield”.
None of this is conclusive, but there is a strong sense that shifts in capital within and
between markets is increasing global volatility.
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INTERNATIONAL ORGANISATIONS
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THE IMF: At the beginning of this week, a new scandal broke that could do
serious damage to the Fund’s French MD, Christine Lagarde. It could even bring her
down – though, at the moment, that seems unlikely.
The problems stems from her time as Finance Minister in 2008, when she approved a
controversial deal that gave €285 million of public funds to the flamboyant financier,
Bernard Tapie, in settlement of a claim he had brought against Credit Lyonnais. At that
time, Tapie – who was a personal friend and financial backer of President Sarkozy – had
already been convicted of bribery, and was in desperate financial trouble following an
abortive bid to buy Adidas. The money from the public purse got him out of a financial
hole – and there has always been speculation that it was essentially a payoff by Sarkozy
for Tapie’s earlier help to him. A judge is (finally) investigating – and Lagarde’s approval
of the payment is a crucial part of the case.
More positively, one hundred US academics and policymakers (led by Tim Adams, the
new head of the IIF) published an open letter this week, calling for Congress to ratify
proposals to double the Fund’s quota, to shift quotas in favour of emerging markets, and
to reduce the number of European Executive Directors. The US has an effective veto
on IMF reform, and has been dragging its feet; Adams’s involvement is welcome.
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UNDP: Earlier this week, UNDP published its 2013 Human Development Report
– which focuses this year on the ‘rise of the South’. The main point the report makes is
the rapid growth of the middle class in middle-income countries. In 2009, it says, the
global middle class numbered around 1.85 billion – of which 29% were in the AsiaPacific region, 18% were in North America and 36% were in Europe. By 2020, it
forecasts that the global middle class will total 3.43 billion – 51% in Asia-Pacific, less
than 10% in North America and 21% in Europe.
The other noteworthy feature of the HDR is its Human Development index, which ranks
186 countries on a wide range of economic, social and environmental considerations:
2013 HDR – Human Development Indicators (selected ranking)
1
2
3
4
5
7
9
10
Norway
Australia
US
Netherlands
Germany
Sweden
Switzerland
Japan
12
13
16
18
20
25
26
29
Korea
Hong Kong
Israel
Singapore
France
Italy
UK
Greece
36 Qatar
41 UAE
55 Russia
57 Saudi Arabia
61 Mexico
84 Oman
90 Turkey
101 China
2
110
121
130
136
146
153
160
186
Palestine
South Africa
Morocco
India
Pakistan
Nigeria
Yemen
Niger
II
RECENT ECONOMIC AND MARKET DEVELOPMENTS
At the macro level, the OECD’s composite leading indicators were flat in January, while
the average unemployment rate in the 37 member states rose from 8.0% to 8.1%. What
is particularly worrying is the continuing rise in youth unemployment: in the eurozone, for
instance, the unemployment rate for 15-24 year-olds rose from 16.5% to 16.7%.
Despite that, as noted, equity markets around the world have soared. Last week, for
instance, all the major US indices were up – the DJIA by 2.18%, the S&P500 by 2.1%
and the Nasdaq by 2.4%. In Europe, the FTSE-100 was up 1.65%, the CAC-40 was up
3.8% and the Xetra Dax was up 3.6%. In Asia, ‘Abenomics’ is continuing to drive the
Japanese market, with the Nikkei-225 up 5.9%. No change this week: through mid-day
Friday, the DJ is up another 1.0%, the S&P is up 0.8% and Nasdaq is up 0.5%. In
Europe, rises are more modest, but, in Japan, the Nikkei is up another 2.3%. Japan has
become (as the FT put it) a “global outlier” but most markets are pointing in the same
direction.
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THE US: Washington is finally starting to get serious about the budget – though
a deal is probably still some weeks away. What we now have is two very different
proposals – one from House Republicans (presented by Paul Ryan) and one by Senate
Democrats (presented by Patty Murray). The former aims at balancing the budget in 10
years with US $4.6 trillion in spending cuts and no tax rises. Only military spending is
spared. The latter raises almost US $1 trillion in new taxes, but makes only (relatively)
small spending cuts – though these do include defence. The White House will look at
each, weigh the political pros and cons, and issue its own version before month-end; it is
not likely to win over many Republicans.
Meanwhile, it is now becoming the conventional wisdom that the US economy is back
on track. This week, for instance, it was reported:
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that retail sales rose 1.1% in February (more than twice what was expected) –
though ex-gasoline and building materials, the rise was only 0.4%;
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that industrial production was up 0.7%, after having been flat in January,
thereby driving capacity utilisation up from 79.2% to 79.6%; and
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that first-time jobless claims fell 10,000 in the latest week, with continuing
claims also down.
In addition, the NFIB’s small business optimism index rose in February, and the trade
deficit for the fourth quarter fell slightly, from US $112.4 billion to US $110.4 billion. All
of that is positive – as, generally, was so-called TIC data. Net purchases of long-term
government securities fell from US $64 billion in December to US $26 billion – but that is
still strong. In addition, there are signs that household ‘deleveraging’ is close to
complete. Consumer debt actually started to rise again in the fourth quarter.
That said, not all the indicators this week have been so bullish. In particular:
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the Empire State (NY) business sentiment index fell in March, from 10.0 to
9.2; and
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the final reading for the Michigan sentiment index dropped from 77.6 to 71.8.
And producer price inflation is still stuck well below the Fed’s target 2%, despite a 7.2%
rise in gasoline prices last month. Nevertheless, there certainly seems to be new
confidence that the worst is over.
B
EUROPE: Not so in Europe – where just about the only good news is that the
eurozone crisis hasn’t flared up again.
That said, it hasn’t gone away – and, as shown below, spreads over German bunds
have increased slightly over the last week for all the ‘peripheral’ eurozone members –
though they are still well down on last month’s levels:
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Eurozone: Sovereign 10-year spreads over German bunds (basis points)
February 28
March 7
March 14
Belgium
91
77
79
France
72
57
62
Greece
952
900
921
Ireland
233
217
222
Italy
331
312
317
Portugal
491
440
445
Spain
368
331
338
Again, the two countries that are giving most concern are Greece and Cyprus.
In Greece, talks with the ‘troika’ broke down this week over the reluctance of the
government to fire public sector workers who have been placed in the so-called ‘labour
reserve’. As a result, release of the next €2.8 billion in bailout aid has been stalled.
Plus, the head of the country’s controversial privatisation programme quit over the
weekend, following the usual campaign of character assassination and allegations of
corruption – almost certainly politically-inspired.
As for Cyprus, there have been reports that eurozone Finance Ministers will announce a
€17 billion deal this evening that will recapitalise the banks and bail out the sovereign.
That amounts to 50% of Cypriot GDP. The only issue is the terms that the government
has agreed to – particularly on bank regulation and money laundering, though there
have also been reports that Germany is insisting on an increase in the corporate tax rate
(currently 10%) and introduction of a financial transaction tax. There is also the issue of:
Who pays? In particular, whether senior bondholders and uninsured depositors should
somehow be ‘bailed in’. That may be the only way to stop Cyprus’s debt ratio breaking
an utterly unsustainable 145% of GDP, but it is so controversial that it seems very
unlikely that FMs will tackle it at this stage.
Meanwhile, Bundesbank President Weidmann has continued to make it clear this week
that he does not think the euro crisis is over. Indeed, in his view, “new risks (are)
constantly being acquired” – notably in the form of bonds issued by Southern eurozone
sovereigns. As a result, he said, the Bundesbank is steadily building up its own
reserves.
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Turning to the EU more generally, the European Parliament exercised its newly-granted
powers this week, and rejected the budget deal that Finance Ministers had worked out
so carefully last month. However, the EP is not pushing its luck too far; all it is really
asking for is that there should be more flexibility to move funds around from one
‘envelope’ to another (while respecting the overall budget cap) and that unspent funds
should be carried over from one year to the next. There is room for compromise here –
particularly following yesterday’s EU Leaders’ Summit, which appears to have loosened
fiscal restraints somewhat by drawing a clearer distinction between ‘structural’ and
‘cyclical’ deficits. That will give some comfort to French President Hollande, who
admitted this week that France’s budget deficit this year will be at least 3.7% of GDP –
not the 3% he had promised.
It will, however, not please Germany – which announced its 2014 budget on
Wednesday. This is a fierce document, which makes little or no concession to
communautaire sentiments. Essentially, despite the fact that the German economy
contracted in the fourth quarter, it cuts spending by €5 billion, and aims for a budget
balance by 2015. Keynesian critics (like the FT’s Martin Wolf) argue that, in order to
hold the eurozone together, Germany needs to be running a multi-year fiscal deficit
amounting to at least 2-3% of GDP.
In the meantime, it was reported that eurozone industrial production fell more sharply
than expected in January, and that overall employment dropped 0.3% in the fourth
quarter (and by 0.8% year-on-year). What is particularly disturbing is that, for the year
as a whole, employment in Greece dropped 6.5%, while that in Spain fell 4.5%.
Joblessness is, clearly, the eurozone’s biggest issue.
That said, there are also problems at the national level.
In Italy, for instance, there is still no government – though Parliament reconvened today
to face an economy that contracted 0.9% in the fourth quarter (or by 2.8% for the whole
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of 2012). Given that kind of economic picture, the appetite for austerity is limited. Same
in France, where it was reported this week that industrial output fell 1.2% month-onmonth in January, with automobile production off 13.5%. Same in Spain, where retail
sales dropped 10.2% last year.
But not, of course, in Germany – which continues virtually untouched by the problems of
Southern Europe. There, the big issue this week has been publication of the SPD’s
platform for the September elections. Chancellor-candidate Steinbrück – who appears
to have very little chance of winning – has decided to try to outflank Merkel on the left by
pushing for sharp increases in income and capital gains taxes, a new minimum wage
and tough new quotas for women in executive positions.
As for the UK, attention is now firmly focussed on next week’s 2013/14 budget
statement – which could well be the last that Chancellor Osborne makes.
The general feeling is that the Coalition government cannot change tack unless Osborne
is fired. That means the broad outline of the current austerity programme will continue.
However, there is bound to be a lot of tinkering around the edges. This may include:
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a more relaxed remit for the Bank of England on inflation;
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some relief from business rates (a sort of property tax) for SMEs; and
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expansion of the Treasury’s (subsidized) ‘Funding for Lending’ programme.
None of this is likely to stop the growing clamour for Osborne to quit – and (though we
are sympathetic to his dilemma) he is not getting much help from the UK economy. This
week, for instance, it was reported that industrial output fell 1.2% in January (and by
2.9% year-on-year), with manufacturing output off 1.5%. In addition, the index of
industrial production is now at its lowest level since May 1992, and the National Institute
has estimated that GDP probably fell 0.1% in December-January – prompting fears of a
‘triple dip’ recession. Given sterling’s fall and the likelihood of rising import prices, there
is also renewed talk of ‘stagflation’.
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That said, there is some good news. For instance, the Federation of Small Business’s
confidence index rose in the first quarter from -5.6 to +6.3, and BDO’s business
optimism index jumped 1.7 points to 90.6 last month. More importantly, the number of
homes sold in the November-February period hit a 2½ year high, and mortgage lending
hit a five-year high in January. Still, the general sense is that the UK economy is in
deep trouble – and even the (notionally independent) Office of Budget Responsibility
appears to be pushing for a change in policy.
C
JAPAN: One reason for the popularity of ‘Plan B’ in the UK is the apparent
success of ‘Abenomics’ in Japan – at least so far. We have noted the astonishing rise in
the stock market, coupled with the weakness of the yen. Both are likely to continue with
confirmation of the new team at the BoJ. There is even talk that new Governor Kuroda
may convene an emergency meeting of the BoJ’s Policy Board to announce new
measures.
That said, the PM suffered his first economic setback this week, when it was reported
that core machinery orders were down a massive 13.1% month-on-moth in January –
the first drop in four months. In general, the economic mood in Japan is much more
positive, but Abe cannot count on ‘animal spirits’ alone to get the economy going.
D
CHINA: Same in China – where there were reports at the beginning of this week,
suggesting that growth was slowing down and that inflation was picking up. The latter
may well be true. Indeed, government figures put consumer prices up 3.2% in February,
compared with 2.0% in January. However, it was also reported:
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that industrial production was up 9.9% year-on-year in January-February;
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that retail sales were up 12.3%; and (perhaps a more objective indicator)
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that steel production was up 9.8% last month, to a new record.
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That doesn’t sound too bad. The market also took comfort from the announcement that
PBoC Governor Zhou Xiaochuan had agreed to stay on for another term, beyond the
usual retirement age of 65. Investors are looking for continuity, given recent political
changes, and this was reassuring.
E
RUSSIA: Less reassuring was Putin’s decision to replace the outgoing Governor
of the Russian central bank, Sergei Ignatiev, with his chief economic adviser, Elvira
Nabiullina, 49. She is a former Economics Minister, who was largely responsible for
Russia’s admission to the WTO. And she is known to be “pro-market” – which is a good
thing. However, she is entirely a creature of Putin, and no one seriously expects her to
be as independent as Ignatiev. She will take over in June.
F
KENYA: So far, so good… Despite fears of ethnic violence if there was not a
clear winner in last week’s Presidential election, it appears that non-Kikuyu voters may
accept the legitimacy of Uhuru Kenyatta’s narrow victory (he avoided a run-off by
winning 50.07% of the vote). However, nothing should be taken for granted. Both
Kenyatta and his main opponent, Raila Odinga, have militias who could take to the
streets at any time. And, as noted before, Kenyatta is already under indictment by the
ICC for inciting ethnic violence after the last election.
III
FOREIGN EXCHANGE MARKET DEVELOPMENTS
As noted, the yen and sterling have been under strong selling pressure this year, while
the US dollar has risen 5% on a trade weighted basis. Indeed, last week, there was talk
of a new “bull run” – with the dollar up 1% on a trade-weighted basis, 0.8% against the
yen and 0.6% against sterling. The consensus was that the dollar is headed higher as
the US economy “crawls out of the mud”, and that (despite a modest recovery) the yen
would continue to fall. As for sterling, the market was also negative – at least until
Thursday, when BofE Governor King sounded the alarm. Conceding that the Bank had
been happy to see the pound sell off to a more realistic level, he said “I think we are
probably there” – and sterling promptly bounced.
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This week, however, there has been a correction for the dollar – though it may well be
nothing more than that. For the week as a whole, that means:
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the dollar is down 0.6% against the euro, falling from US $1.298/€ to
US $1.306 (having hit US $1.292 on Wednesday after release of poor
eurozone industrial data);
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the dollar is down 1.5% against sterling, falling from US $1.493/GBP to
US $1.515 (though it had strengthened to US $1.489 on Tuesday); and
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the dollar is down – albeit just 0.1% - against the yen, falling from Y96.2/US $
to Y96.09.
The US dollar has also fallen 1.4% against the Australian dollar, and by 0.8% against
the Canadian dollar – which ended a five week slide. All of that aside, the consensus in
the market is that this is just a hiccup, and that the relative strength of the US economy
will pull the dollar higher.
As for gold, it fell 1.3% last week, to close at US $1,578.90/oz. This week, the dollar
sell-off probably explains its modest strength. It is currently trading around US $1,591 –
up 0.8%.
IV
OIL
At the beginning of this week, front month Brent was trading at US $110.85/barrel –
close to its low for the year, as North Sea production recovered from several field
closures. In contrast, April WTI was up quite sharply, at US $91.95 – narrowing the
premium in favour of Brent to just US $18.90. (It had been as high as US $28.08 in
October 2011.)
Over the course of the week, Brent has eased to US $110.05, while the price of WTI has
increased to US $93.59 – narrowing the Brent premium still further, to US $16.46.
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There are a number of factors for this, most obviously the continuing rise in North Sea
output, which is now expected to increase another 8% over the next month. That has
already forced the Brent market into backwardation (ie prompt prices are higher than
forward prices), while WTI is in contango.
That said, US crude inventories were up another 2.62 million barrels in the latest week,
and as distribution problems in the MidWest work themselves out, the price of WTI –
which everyone accepts is increasingly irrelevant as a marker crude – seems likely to
drift further.
V
BANKING
Several developments are worth noting:
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Tyrie Commission: Over the weekend, the UK’s Parliamentary Committee on
Banking Standards (chaired by Andrew Tyrie) released its long-awaited
report, looking into the situation of UK banks after the financial crisis and the
LIBOR scandal. Its conclusions were tougher than expected. In particular, it
recommended that banks should raise still more capital – or shrink their loan
books still further. There should also be a regular review of bank regulation at
least every five years, and leverage ratios should be tightened sharply. The
Commission also urged a tougher interpretation of the Vickers Commission’s
proposals for ‘ring-fencing’ UK retail banks. Most analysis of Tyrie’s
recommendations has so far focused on the tougher leverage requirements –
which would sharply curtail bank lending.
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Basel Committee: While the UK is toughening regulation, Basel may be
rethinking its approach. On Tuesday, the Committee’s chairman, Stefan
Ingves, reported that he had set up a Task Force to evaluate the many
criticisms that have been made about Basel 3 – particularly with regard to its
complexity, the risk weightings and the possibility that it could be ‘gamed’.
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Senate Permanent Committee on Investigations: Yesterday (which was the
fifth anniversary of the collapse of Bear Stearns), the Senate Committee
issued a 300-page report criticising JP Morgan’s management over the socalled ‘London Whale’ affair – which cost the bank US $6.2 billion. The report
claims quite specifically that several senior executives deliberately misled
investors and regulators by claiming that the massive positions were hedges,
rather than speculation. While most of those identified have already left the
bank, its chairman, Jamie Dimon, is in an uncomfortable position. According
to the Committee Chairman, Carl Levin, the report is also ammunition for
those who want an even tougher ‘Volcker rule’.
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ECB: It was reported this week that the ECB is looking to recruit 800 banking
supervisors over the next year, as it builds up its resources ahead of
becoming the main financial supervisor for the eurozone.
In addition, it was reported today that Richard Fisher – President of the Dallas Fed – is
to address a meeting of the Conservative Political Action Committee this weekend, and
that he will urge Republicans to support the break up of big US banks. This may well be
a hopeless cause, but Fisher (who is one of the brightest regional Fed Presidents)
argues that conservative Republicans should oppose concentrations of economic
power, and that the only way to end ‘TBTF’ is to break big banks into smaller legal
pieces.
VI
NEXT WEEK
President Obama is off to Israel, for what has been described as a ‘maintenance trip’.
Back home, the FOMC meets. As far as US economic data is concerned, the most
significant are:
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housing starts and permits for February;
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the NAHB index for March;
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existing home sales for February; and
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the Philadelphia Fed index for March.
Elsewhere, ‘flash’ PMIs are due in both Europe and China. The UK also announces its
budget on Wednesday; a big question is whether it will change the BofE’s mandate.
Regards,
Economic Evaluation (London)
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