Download WEEKLY ECONOMIC AND MONETARY REPORT 20 January 2012

WEEKLY ECONOMIC AND MONETARY REPORT
20 January 2012
Ahead of next week’s Davos meeting of the World Economic Forum, the heads of 11
international organisations (including the IMF, World Bank, WTO, OECD and Financial
Stability Board) have issued an unprecedented warning that “over-aggressive” deficit
reduction and the general emphasis on fiscal austerity could have dangerous economic
and social consequences. In their opinion, the top global priority should be job creation
– and their recommendation is (not altogether surprisingly) increased spending on
infrastructure and on ‘green’ energy.
I
WORLD BANK
Out of the blue, a series of news stories have appeared this week about the succession
to Bob Zoellick as President of the World Bank.
Zoellick’s five-year term expires in July. Although there is no reason to believe he would
not accept a second term, it is said that the White House is compiling a list of potential
successors. Top of the list is (bizarrely) Larry Summers, 57, currently a professor at
Harvard, who is busily promoting his own candidacy. The other name that is being
floated is much more significant – Hillary Clinton, who has said she doesn’t want to
serve in a second Obama Administration.
Rather surprisingly, there is (so far) no pressure for the US to drop its traditional
insistence that the Bank’s President should be an American.
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EUROZONE CRISIS
Last week ended with a bang: late on Friday night, S&P finally announced its longanticipated downgrades of eurozone sovereigns. There was no real surprise – but a lot
of synthetic outrage. Essentially:
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France and Austria were downgraded one notch, from AAA to AA+;
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Italy, Spain, Portugal and Cyprus were each downgraded two notches (to
BBB+, A, BB and BB+ respectively); and
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Slovenia, Malta and Slovakia were downgraded one notch (to A+, A and A
respectively).
Germany, The Netherlands, Finland and Luxembourg kept their triple-A ratings, and
Greece (CC), Ireland (BBB+), Estonia (AA-) and Belgium (AA) were also unchanged.
So far, these changes (which have not yet been followed by Moody’s or Fitch) have had
little impact on the markets. Indeed, both France and Spain managed successful
auctions this week (for €8 billion and €6.6 billion, respectively) at interest rates
significantly lower than in December. The only country that did suffer was Portugal,
whose debt is now in junk territory. That said, the EFSF (which depends on the
guarantee of its member states) was also downgraded – which, effectively, reduces the
amount of money it can lend. (That makes it even more important to accelerate the
conversion of the EFSF into the European Stability Mechanism – which, unlike the
EFSF, will be a permanent institution with its own paid-in capital.)
The other big story of the week has been the continuing saga of the Greek debt
negotiations.
Although there is (apparently) confidence that a deal with the banks can still be worked
out in time for the January 23 ECOFIN meeting, it is important to reiterate that any relief
for Greece is likely to be short-lived. Even if private creditors accept a 50% ‘haircut’ on
100% of the privately held debt, and even if they agree to an interest rate on the new 30year bonds of just 4%, Greece will still have to run a primary budget surplus amounting
to 3.2% of GDP in perpetuity just to keep its debt burden stable. It won’t happen. Plus:
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the banks are agitating for a coupon that will rise from just under 4% to over
6%; and
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since the restructuring is said to be ‘voluntary’, hedge funds and so-called
vulture funds (who hold around €50 billion of the €200 billion or so of Greek
debt in private hands) will almost certainly refuse to go along.
But the key is that the deal (as it is emerging) is really no solution for Greece. FM
Venizelos admitted yesterday that the Greek economy contracted over 6% last year,
after a fall of 4.8% in 2010. As it stands, GDP will drop at least 5% again this year – or
maybe more if the ‘troika’ gets its way. In addition, Greek banks almost certainly need
at least €40 billion in additional capital (not the €25 billion previously estimated), as a
result of massive deposit withdrawals. IMF and ECB officials arrived in Athens again
this week to hear the government’s explanation for why it has only cut one thousand
public sector jobs (it had planned to cut 30,000 by now), and why it is so far behind with
privatisation and tax reform. The simple answer is that it faces an election in April – and
the only beneficiaries of further austerity are likely to be the extreme left and right.
In our opinion, although a ‘voluntary’ rescheduling may well be agreed this weekend, it
will be followed pretty quickly by a ‘coercive’ (or hard) rescheduling in which the
government imposes much tougher terms on holders of the 93% or so of its debt that is
governed by Greek law (the rest is written under Swiss or UK law, and may be harder to
reschedule). It will also need to get relief on debt held by the ECB (which has so far
refused even to contemplate a rescheduling).
Two other points are worth mentioning:
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The IMF has formally asked member states to cough up a further US $500
billion to augment its existing available resources (currently put at US $400
billion). Of this, the EU-27 is supposed to contribute €200 billion – which
almost certainly means a fight with the UK, which does not want to contribute
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any more to a eurozone bail-out. This is supposed to be discussed by G20
Deputies in Mexico, next Thursday-Friday.
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The ECB is expected to offer European banks another €400 billion or so in
super-cheap three-year funding within the next couple of weeks. It now
seems clear that last month’s Long-term Refinancing Operation (LTRO) was
the main factor in stabilizing the market. According to data released this
week, Italian banks were the main borrowers: notably Unicredit (€12.5 billion),
Intesa (€12 billion) and Monte dei Paschi (€10 billion). Spanish banks also
borrowed heavily, and even the UK’s RBS borrowed €5 billion through its
Dutch subsidiary.
III
RECENT ECONOMIC AND MARKET DEVELOPMENTS
As part of its preparations for Davos, the World Bank has just issued updated global
economic forecasts, which show a significant downward revision from mid-2011.
The global economy is now expected to grow just 2.5% this year and 3.1% in 2013,
down from earlier projections of 3.6% growth in each year. As for the eurozone, the
Bank has cut its 2012 forecast from +1.8% to -0.3%; other advanced economies are
expected to grow 2.1%. What worries the Bank is that, in its view, the rich countries
now have very little monetary or fiscal ammunition left, while poorer countries face an
increasingly difficult trading environment and a shortage of capital.
A
THE US: Politically, the race to win the Republican Presidential nomination may
well resolve itself over the weekend, as a result of the South Carolina primary. Despite
a number of serious handicaps (in particular, the controversy over the enormous sums
of money he made in private equity, his failure to release his tax returns and the peculiar
beliefs of his Mormon religion), Mitt Romney remains the front-runner. If he defeats his
most plausible challenger, Newt Gingrich, this weekend, he will be very hard to beat –
though one or two of his challengers may stick it out until the Florida primary on January
31 (where the Jewish vote is usually said to be key).
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The conventional wisdom is that, if he is the nominee, Romney will run Obama close in
November – but that he will lose. What seems certain is that Obama will focus on
Romney’s wealth, on the (alleged) damage that private equity has done to the US
economy, and on Romney’s links with Wall St. It will be a ‘rich vs the middle class’
election.
Economically, the recovery that seemed to be underway in the fourth quarter, seems to
be back on track after a difficult few weeks. In particular, it was reported this week:
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that previously-owned home sales rose 5% in December, to the highest level
since last January;
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that industrial production rebounded in December, increasing 0.4% after a fall
of 0.3% in November, with manufacturing output up 0.9%;
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that the NAHB homebuilders’ confidence index rose in January from 21 to 25
(admittedly, still low);
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that the Empire State (NY) business activity index came in at 13.5 in January,
better than expected and up from 8.2 in December;
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that the Philadelphia Fed’s activity index for January rose from 6.8 to 7.3
(which was described as ‘good, but not that good’); and, perhaps most
striking,
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that first-time jobless claims in the latest week fell 50,000, to a 3 1/2 year low
of 352,000.
Although housing starts actually fell 4.3% in December (while new building permits were
flat), the consensus is that the recovery is picking up again and that the pace of job
creation is also picking up. Given that TIC data shows net foreign purchases of longterm government paper bounced from US $8.3 billion to US $59.8 billion in November,
there seems to be no external constraint on US policy.
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Under these circumstances, the conventional wisdom is that US equities are starting to
look like a strong buy. Indeed, in what has been a short trading week (Monday was a
holiday), stocks have risen strongly. Through Thursday, for instance, the DJIA was up
1.6%, the S&P500 was up 2.0% and the Nasdaq Composite was up 2.8%. On the other
hand, interest rates have risen. The yield on the benchmark 10-year Treasury, for
instance, has risen from 1.85% to 1.98%, while the yield on the long bond has risen from
2.90% to 3.04%.
B
EUROPE: In addition to the Greek crisis, next week’s ECOFIN meeting is
expected to debate the latest draft of the new eurozone treaty which is supposed to
tighten fiscal rules on eurozone members. As a result of criticisms by the ECB, this is
expected to be tougher than the preliminary version. In particular, it refers to a
centralised ‘correction mechanism’ which will ‘automatically’ impose penalties for
‘significant’ deviations from the 0.5% limit for budget deficits. In addition, the ECJ will
have the power to fine rule-breakers.
That said, it is worth emphasising that (whatever it might claim) the ECB itself is not
above politics. Indeed, a row has just broken out between The Netherlands and Spain
over the latter’s insistence (backed by France) that it has the right to nominate one of its
own to replace Jose Manuel Gonzalez-Paramo when his 8-year term as a ECB board
member expires.
Economically, there is little doubt that both the eurozone and EU-27 are slowing down
sharply – and that the N-S division (between Germany and the eurozone periphery) is
becoming more marked. One indicator of that is new car sales. For the EU as a whole,
they fell 1.4% in 2011 – the fourth straight decline. But, while French registrations fell
2.1%, Italian registrations fell 11% and UK registrations fell 4.4%, German new car
registrations actually rose 8.8% last year.
In addition, it was reported this week that Germany’s ZEW economic sentiment index
recovered strongly in January – improving from -53.8 to -21.6, with the current
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conditions index rising from +26.8 to +28.4. That said, it was also reported that German
GDP actually fell 0.4% in the fourth quarter, and Bundesbank President Weidmann
predicted that it would grow just 0.1% in the first quarter of 2012.
Still, that is better than France where the state of the economy (particularly employment)
is key to the April/May Presidential election. Sarkozy was clearly hit by the loss of
France’s triple-A rating – though he had prepared the ground well. Perhaps more
worrying for him is the growing anti-euro (and anti-EU) sentiment, epitomized by support
for the right-wing candidate, Marine le Pen. She is now polling around 21.5% – not far
behind the Socialists’ Francois Hollande (27%) and Sarko (23.5%).
As for the UK, evidence is growing that the retail sector is doing better than expected.
Retail sales, for instance, were up 0.6% in December (after a fall of 0.5% in November)
– though that was largely due to fierce discounting. That said:
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the UK unemployment rate jumped unexpectedly from 8.1% to a 17-year high
of 8.4% in the September-November quarter, with 2.68 million now out of
work’ and
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the Federation of Small Business confidence index slumped from -9.5 to -24.5
last month, which suggests that the retail surge may be short-lived.
On the other hand, the UK’s inflation rate eased unexpectedly in December from 4.8%
to 4.2%. Although that is still twice the BofE’s target rate, it takes some of the pressure
off monetary policy.
C
JAPAN: PM Noda gave his cabinet a modest reshuffle last week – replacing his
Defence and Consumer Affairs Ministers, and bringing in Katsuya Okada, the former
President of the DPJ, as Deputy PM for tax and administration – an utterly thankless job,
given that the public still opposes Noda’s plan to resolve Japan’s fiscal problems by
doubling the sales tax from 5%. In the meantime, the ‘flash’ PMI for December was
moderately encouraging. The economy may be finally responding to the massive
amounts of liquidity that the BoJ has been pumping in.
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Equally significant, Noda signalled a policy shift this week when he urged Japanese
companies to emulate their Chinese peers by using the strong yen to fund investments
abroad – including long-term supply contracts. It will be interesting to see whether
industry responds.
D
CHINA: The good/bad news this week was that China’s GDP growth rate
dropped to 8.9% in the fourth quarter of 2011 – pushing growth for the full year down to
9.2%. This is hardly grounds for concern – and it was indeed slightly higher than
expected. But it was the lowest growth rate in ten quarters.
The expectation is that Chinese growth will continue to ease. The preliminary reading of
the HSBC PMI for January came in at 48.8, up fractionally from December’s 48.7 – but
still below 50. That has actually boosted equities. The Shanghai Composite, for
instance, has just closed up 3.3% for the week – largely because the PBoC is now
expected to relax monetary policy.
IV
FOREIGN EXCHANGE MARKET DEVELOPMENTS
Last week, the dollar was up against the euro (by 0.3%, to US $1.267/€) and sterling,
but down slightly against the yen. This week, it is down against the euro, sterling and
Swiss franc, and broadly flat against the yen:
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US $/euro: The euro closed last week at US $1.267/€, and has strengthened
fairly steadily all week. It broke US $1.29 for the first time in two weeks
yesterday, hitting an intra-day high of US $1.295 when the market decided
that apparent progress in the Greek debt negotiations meant ‘risk on’. The fact
that little real progress seems to have been made means the euro has fallen
back, but, at US $1.2922, it is still up 2.0% week-on-week.
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US$/sterling: The pound closed last week at US $1.529/GBP. Again, it has
strengthened fairly steadily, and is currently trading at US $1.5523 – up 1.5%
for the week.
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Yen/US $: The dollar closed last week at Y77.0/US $. It fell to Y76.7 on
Monday – prompting a warning by the BoJ that it might intervene. (In fact, the
BoJ’s real concern is the Y/euro rate; since mid-2011, the yen has risen 15%
against the euro, hitting Y97.2/€ on Monday.) Since then, the dollar has
firmed a bit. It is currently trading at Y77.15/US $ - essentially unchanged on
the week.
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SF/US $: At the close last Friday, the dollar was trading at SF 0.955/US$ –
while the SF was trading at SF1.21/€. Since then, the dollar has eased to
SF0.934, while the euro has eased to SF1.207. It appears as though the
markets are willing to test the SNB’s commitment (under Thomas Jordan) to
defend the limits set by former Chairman Hildebrand.
As for gold, it rose US $28.40 last week, to close at US $1,650.40 /oz. This week, it has
traded in a fairly narrow range, despite the continuing threats over Iran. It is currently at
US $1,657.60 – up just 0.4%.
Looking forward, the dollar can be expected to strengthen sharply if the talks on
restructuring Greek debt do not reach a conclusion by Monday. It will also by helped by
the widening gap between the economic performance of the US and that of the
eurozone.
V
OIL
Last week, oil prices were surprisingly weak – given the Iranian situation and the threat
of strikes in Nigeria. Week-on-week, the price of front-month WTI actually fell US
$2.86/barrel to close at US $98.70, while February Brent fell US $2.62 to close at US
$110.44 – narrowing the Brent premium to US $11.74.
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This week, PM Jonathan essentially halved the proposed gasoline price rises in Nigeria,
therefore removing the immediate threat of strike action. (The retail price of gasoline
was cut from N141/litre to N97 – still well up on the previous price of N65, or US $0.40.)
That should have relieved potential pressure in the Brent market. In addition:
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natural gas prices in the US hit a 10-year low, with Henry Hub selling at US
$2.322/mBTU (down 22% year-on-year);
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the IEA estimated that total oil demand was down 300,000 b/d year-on-year in
the fourth quarter, and predicted that the global demand increase this year
would be just 1.1 million b/d (down from an earlier projection of 1.3 million);
and
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the US DofE reported that US gasoline consumption fell 2.2% last week, to
the lowest level since September 2001.
Given the uncertainties over the Greek debt negotiations, it is, therefore, no great
surprise that oil prices are down. In mid-day trade on Friday, front-month WTI was
selling at US $98.52/barrel (off 18 cents for the week) while March Brent (the new front
month contract) was at US $109.67 (down 77 cents).
That said, it is worth emphasising two things:
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US crude oil inventories, which fell 3.44 million barrels in the latest week; and
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Iran.
The Iranian situation remains extremely volatile, with US naval ships patrolling the Strait
of Hormuz and Iran ‘warning’ Saudi Arabia (and other producers) not to try to
compensate for the loss of Iranian production if the US and EU press ahead with an
embargo. On that score, the EU is now suggesting that it will implement a full embargo
as of July 1, in line with the US.
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VI
BANKING
Today is the deadline for the 31 big European banks to submit to the EBA their plans for
raising the €115 billion in extra capital that the regulators deemed they need. So far, the
only one of the big banks to have tried to raise the money is Unicredit – which launched
a rights issue last month to raise the €8 billion that the EBA says it needs. Although it
had only limited success, Abu Dhabi’s Aabar Investments is reported to have now
bought 6.5% of the bank, which may solve its problem.
The two banks that are expected to have the most difficulty raising capital are
Germany’s Commerzbank (which needs to raise €5.3 billion) and Italy’s Monte dei
Paschi (US $3.3 billion) – though Spain’s Bankia is also looking for merger partners as a
solution.
Meanwhile, in the US, the FDIC has proposed that all banks with more than US $10
billion in assets (of which there are 23) should be subject to a new regime in which they
will submit to regular, annual stress tests, based on three hypotheses, using September
30 data.
VII
NEXT WEEK
It will be a very busy week.
In the US, the South Carolina primary takes place this weekend, and Obama makes his
State of the Union speech on Tuesday. A resolution to the US housing crisis will
apparently feature prominently. The FOMC also meets on Wednesday.
Among the key US economic releases that are due, the markets will focus on:
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the advance estimate of fourth quarter GDP growth;
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durable gods orders for December;
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leading economic indicators for December; and
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new home sales for December.
In Europe, attention will be focussed on Monday’s ECOFIN meeting. Ministers will also
discuss the Iranian oil embargo. Economic releases that are due include:
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the ‘flash’ PMIs for eurozone members;
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eurozone money supply growth;
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eurozone consumer confidence; and
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UK GDP growth.
As noted. the World Economic Forum begins its Davos meeting on January 24. There is
also an important Presidential election in Finland, where anti-euro forces have recently
picked up support.
Chinese markets are closed all week for the Lunar New Year.
Regards,
Economic Evaluation (London) Ltd
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