Old Maid Continues as Europe's Great Men go to China

by Claus Vistesen

cross posted from Alpha Sources


Not too long ago as I was finding my self in my creative corner as I quoted the Stereophonics song Pass the Buck as a metaphor for what was going on at the moment in global financial markets. At the time I was also scouring my mind and, as it were, the internet for a the name of shedding card game where it set piece is to relinquish yourself from all the cards and then to avoid remaining with the 'old maid.' You see, it appears that the old maid is a fitting metaphor for what at the moment seems to be a global game being played about not ending up being stuck with the Dollar. Yet, as practitioners of the dismal science no doubt will be at pains to point out we need both pairs of those scissors. As such and while everybody can agree, at least based on economic logic alone, that the Dollar must fall which indeed is has been it is a little bit more tricky when it comes to the flip side. In this way, we need to understand that when you sell USD (or USD denominated assets) you buy something else which in this case could be foreign denominated assets or domestic assets where the latter would signify that you own currency appreciates. Of course this is all things equal and all and especially the general growth in the monetary supply must be taking into account but still I think it is fair to say the fall in demand for USD denominated assets has to be matched by a corresponding increase in demand for assets denominated in other currencies from other regions of the world. This would then bring us back to those scissors of Marshall's since where is indeed the supply and where is the yield?
Ultimately, I have a strong belief that economic fundamentals will solve such global games of old maid and I even have a pretty good reason as to what kind of fundamentals to look out for. However so far, the game is played and apart from the USD starring it could also seem as if a derivative of the old maid would be who in fact must step up to take the role for the USD as the structure of Bretton Woods II is ground down. Here of course, it will soon (i.e. after my exams) be time to re-visit old arguments but for now I will merely note that I always saw the current structure as very strong and fragile at the same time. It was/is very strong quite simply because de-coupling/re-balancing in the traditional sense where Europe and Japan ascends to take over the throne of the US would be virtually impossible. The fragile nature then comes in as an immediate consequence of this since if Europe and Japan cannot step up to the task who can and indeed will? As I say, fundamentals will tend to drive this and no-doubt the process of global re-coupling whereby the likes of India, Brazil, and Turkey takes over the clout of the US will materialize itself but a lot of glasses might end being shattered in the process. Ok, enough about that for now. Also, it clearly seems that my view of the fundamentals has not quite sunk in just yet epitomized by the very sharp decline of the USD against the Euro and the Yen. Of course this is only natural as an interim but the current process of shift in capital flows is beginning to bite. As such and turning back to my headline above the game continues as Europe sends an envoy to China in order to persuade Chinese authorities to do something about the Yuan/remninbi ...
Europe's finance chiefs arrived in Beijing today with the warning that China must let its currency strengthen against the euro or risk sparking a trade war. European Central Bank President Jean-Claude Trichet, Luxembourg Prime Minister Jean-Claude Juncker and European Union Monetary Affairs Commissioner Joaquin Almunia will argue that an undervalued yuan is ``triggering protectionist tendencies,'' according to a briefing document obtained by Bloomberg News.
The yuan rose to its strongest since a peg to the dollar was scrapped in July 2005 as Juncker told reporters in Beijing that the exchange rate will be the main topic of the two-day talks. European policy makers are pressing for the yuan to gain more versus the euro to curb a trade deficit with the world's fastest-growing major economy that's swelling by $20 million an hour.
Of course, the strong Euro relative to the Yuan is not exactly news straight in off the wire but in the light of the USD's recent slide it has clearly began to pinch. Especially the following kind of 're-balancing' is something which the Eurozone won't be able to muster for long ...
While the yuan has risen 5.7 percent against the dollar this year, it has dropped by about the same margin versus the euro. That leaves the Chinese currency undervalued in the eyes of European policy makers who blame it for inflating their trade deficit with China by $20 million an hour and helping to push the euro to an all-time high against the dollar.
On the other hand you can ask yourself what good all this will make. Quite obviously, and in light of Paulson's formidable strides, it may take many a trip from Frankfurt and Brussels to make China budge if at all. Meanwhile, the process continues as Brad Setser demonstrates in his recent post. Go see for the graphical version but the picture is pretty clear in words alone ...
I didn't’t use the term “sudden stop” in my post on the September TIC data release lightly. The attached graph -- which comes straight from the TIC data -- shows an extremely sharp fall in net purchases of US long-term financial assets over the last three months.
As a counterpart to this Setser cites a recent analysis from Danske Bank's Teis Knuthsen which shows that inflows with respect to the FDI and portfolio accounts into the Eurozone continue to increase on a rolling month basis. Also in annual terms the net inflow of portfolio investments reached an all time high. This is clearly the text book case for re-balancing/de-coupling in the traditional sense but do remember as an aside that the Eurozone is still running an overall external surplus on the trade balance which suggest an overall process of re-funnelling. In this respect, please do not miss the following seemingly trivial but very important data point as reported by Eurostat.
EU27 trade with most of its major partners grew, with the exception of exports to the USA (-2% in January-August 2007 compared with January-August 2006), and imports from Norway (-9%) and Russia (-5%). The largest increases were for exports to Russia (+29%), India (+22%), Brazil (+17%) and China (+15%), and for imports from China (+22%), Brazil and India (both +17%) and Turkey (+14%).
Now, this would be tantamount to re-coupling. More generally and while nobody can deny the facts as they are presented the very nature of the current shift is likely to present notable and difficult issues in the interim not least for the Eurozone and certain key members as well as of course those most strained economies in Eastern Europe. Ok, I will sign off for now. Of notable things that I missed out on in terms of commentary include Federal Reserve Vice Chairman Donald Kohn's statement today which has largely been interpreted that the Fed is going to cut once more this year. As always, I remain rather contrarian and believe it to be a holding operation but given the sharp rally in equities today I seem to be pretty alone on this position. Moreover, the tradeoff in the Eurozone facing the ECB is becoming crystal clear if it ever was anything else as inflation seems certain to pick up.
As a more general note I am entering exam periods now which means that I may be a bit more erratic than usual but I will try to keep up. Tomorrow (Thursday) is applied econometrics; wish me luck.

The Liquidity Crunch Deepens

This news from reuters doesn't sound too promising, not at all it doesn't!

Money markets tightened further on Wednesday with the cost of borrowing euros in the wholesale interbank market hitting fresh 6-1/2 year highs as banks paid a higher premium for cash covering the New Year period.

Cash is getting less available and more expensive in the market since the credit crunch started in August as banks hoard cash as a contingency against credit-related losses. This general shortage is being exacerbated by liquidity concerns over the seasonally thin Christmas and New Year period.

London interbank offered rates (Libor) -- the benchmark lending rates between banks -- for two-month euros rose to 4.73875 percent at their daily fixing, the highest since May 2001. In early August rates were below 4.2 percent.

Libor rates for two-month dollars rose to a one-month high of 5.08563 percent, while sterling rates for the same period rose to a two-month high of 6.63875 percent.

"The level of confidence remains quite low. Banks are still reluctant to lend because of counterparty risk and balance sheet constraints on their own side," said Nathalie Fillet, senior fixed income strategist at BNP Paribas.

"Until recently, banks have been funding on an overnight basis but have now started to secure funding to cover the year-end. Hence, central banks have no choice but to continue to support and flood the market with liquidity."

And to all this can be added the announcement yesterday from the ECB that they are about to inject a further €30bn ($44.3bn) in one-week funds into the banking sector.

For what it's worth here's the most recent 3 month euro libor chart we have available (the BBA only updates the data with a one week time lag).




Also today we have news that China's CSI 300 Index has followed Japan's Topix into bear market territory, I have a much fuller reflection on what is happening to Japan in the Asian context up on Global Economy Matters.

German GFK Consumer Confidence Index December 2007 Down

German consumer confidence fell to the its lowest level in almost two years according to GfK AG's index for December, which is based on a survey of about 2,000 people. The index fell to 4.3 from a revised 4.8 in November, the market- research company said in Nuremberg today. That's the lowest reading since January 2006.



According to GFK:

An upswing in the consumer climate is unlikely, even towards the end of the year. While income expectations rose, economic expectations and the propensity to buy fell. Following the revised 4.8 points in November, the consumer climate forecast for December is 4.3 points.

Well-known economic risk factors, such as the strong euro, turbulences on the international financial markets and high food and energy prices continue to impact on the generally good German economy. A "sense of impending inflation” is currently influencing German consumers and the positive factors which are currently evident, such as the sustained improvement on the job market and rising incomes seem unable to prevent the evaporation of optimism where propensity to buy and economic expectations are concerned. Conversely, income expectations have stabilized at a slightly higher rate in November.

In fact, the rise in income expectations is pretty marginal - from minus 0.7 to zero - and the sub indexes are in non too spectacular shape generally.



What we can say is that the income expectations are now pretty flat, that the expectation about the economic outlook has been steadily deteriorating since June, while the propensity to consume took a nose-dive after December 2006 (isn't that strange, just after the 3% VAT hike that everyone said wouldn't matter) and hasn't budged, except slightly downwards. What this seems to indicate is that German consumers are now preparing for a hard winter (a hard and more elderly one) and, like their Italian counterparts, are busy thinking about saving. Maybe this helps put yesterday's IFO reading in a bit more perspective. I think the IFO was more about current conditions (and how they have mildly surprised on the upside) than about anticipated future ones.

Italian Business Confidence November 2007

Well hot on the heels of the small rise in the German IFO business confidence index we find that in contrast the ISAE Italian business confidence index declined in November to the lowest in almost two years as the euro's gains have been acting as a curb on exports. The Isae Institute's business confidence index fell to 92.2 from a revised 92.8 in October, the Rome-based research center reported today. That is the lowest reading since December 2005.




Again, I would draw attention to Claus Vistesen's eurozone Q3 GDP conclusions:

Although the slowdown seems set to be Eurozone and indeed also EU25 wide I will be watching Italy, Greece, and Portugal in particular since these three countries are those most likely to feel the pinch longest and hardest.

German IFO Business Confidence November 2007

Well this certainly is a moment with possible interpretations to suit all tastes. The German IFO just came in with a monthly upward rebound. True the bounce was marginal, up to 140.2 from last months 139.9, but still, up is up. So what do you make of that? Well, if we actually look at the chart we can see the numbers are in fact still well down on the autumn 2006 and spring 2007 readings, which more or less fits in with the general picture we are getting.



Interestingly if we turn to an examination of the sub-components in the index we find that the assessment of current conditions rose to 110.4 from 109.6 in October, while the indicator of expectations slipped to 98.3 from 98.6. German manufacturing is undoubtedly getting a good push from the favourable climate for exports (despite the rapidly rising euro), and especially in Eastern Europe where many of the currencies are directly or indirectly pegged to the euro. This impression is confirmed if we look at the readings for trade and industry, which rose from 7 to 7.6, and for manufacturing, which rose from 17.8 to 19.3 and compare these with construction, which fell to minus 21.3 from minus 20.6 and retail, which fell from minus 6.8 to minus 9.2.

As Claus Vistesen said in his revue of Q3 Eurozone GDP performance:

On the face of it the Q3 GDP release from the Eurozone seems to point to a rebound but we should not be fooled. I know that I tend to be a bit of a party pooper sometimes when it comes to the Eurozone but this time around you need to consider I think that the collective mass of almost all respectable analysts and economic commentators seem to agree with my general forecast. As such, all of us Eurozone watchers had pretty much agreed that Q3 all things equal would show a rebound relative to Q2 but given the monthly real economic data and confidence readings which have been rolling in it would also prove to be short-lived.

I think this is it. Steady as she goes, but the nose of the ship is now pointing downwards.

Some Further Snippets on the Q3 Figures from the Eurozone

by Claus Vistesen

cross posted from Alpha Sources

This is really just a small pointer relative to what I have already said in my two recent comprehensive notes on the Q3 GDP numbers as well as outlook from and on the Eurozone. In this way, Spain published a more detailed break-down of the Q3 GDP numbers today. Quite as expected and as I noted it is in particular the construction sector which is beginning to trend down as well as Spanish consumers are winding down what has otherwise been a very steady propensity to spend. From Bloomberg ...

Consumption growth in Spain dropped to its slowest pace in four years in the third quarter as higher borrowing costs cooled property price gains and hiring eased. Household spending grew 2.9 percent from a year earlier, after a 3.3 percent increase the second quarter, the National Statistics Institute in Madrid said in a statement today. The economy grew 0.7 percent in the third quarter from the prior three months, when it expanded 0.9 percent. That matched the initial estimate published Nov. 13. Unemployment rose in the third quarter and hiring slowed as homebuilders cut back on new projects. Growth is set to slow across the rest of the euro region next year as the euro's rise to a record against the dollar curbs exports.

``It really is the beginning of the end of the Spanish boom,'' said Dominic Bryant, an economist at BNP Paribas in London. ``Spanish housing investment will fall by about 20 percent over the next few years, meaning the economy will grow well below trend, which is about 3 percent, next year.''

Meanwhile, news and analysis has also been trickling in on Italy as Edward summarizes in a recent note over at Bonobo Land. The first thing of note is of course that consumer confidence actually rose this month but contrary to what you might expect the high figure recorded springs from the fact that consumers are looking forward to save more. This of course does suggest that relative to actual spending we should not get our hopes up; as Edward notes ...
One surprising detail in this months report is, however, that consumers are saying that they are more likely to save their money than spend it in the near future (as Pillonca imagined they would), possibly becuase they are anticipating that a significant economic slowdown is now close in Italy.

And if you don't know who Pillonca is I can understand since Edward is referring back to his mentioning of a recent analysis posted by Morgan Stanley on the Italian economy (authored by Vladimir Pillonca). In essence, Pillonca is tuning in to, as me and Edward, the fact that Italy might very well see a hefty slowdown as we move forward. The main thrust is this and I cannot but agree;

The Italian – and global – growth outlook seems to be darkening every day, despite the expected bounce-back of growth in the third quarter. We forecast Italian growth to slow sharply next year, to just 1.2%Y, from 1.8%Y this year, and we don’t anticipate a recovery to gather traction until the second half of next year. Risks are skewed to the downside. The possibility of a growth recession next year – defined as two or more quarters of negative quarter-on-quarter growth – is not a remote one.

Italy Q3 2007 GDP and November 2007 Consumer Confidence

Well, we had a positive surprise on the upside from Italy for a change in Q3, since Italian economic growth accelerated, powered it seems by consumer spending on services and manufactured goods, according to the report recently released by ISTAT (we really have to wait till early December to get a clearer picture).

Gross domestic product rose 0.4 percent from the second quarter, when it grew 0.1 percent, and expanded 1.9 percent when compared with Q3 2006.






Where we go from here is really anyone's guess, but there must be strong downside risks. Claus Vistesen has quite a comprehensive summary of the Q3 eurozone situation here. Summing up the Italian performance Claus says the following:

Finally, before summing up we have of course Italy where Bloomberg told us that the Italian economy managed to expand in Q3. But alas what does that matter when the number we have is 0.4% q-o-q which follows, as can be observed above, a o.3% and 0.1% reading q-o-q in Q1 and Q2 respectively. Even those amongst my readers with next to none inclination towards math exercises should have no trouble calculating that the average q-o-q growth rate now stands at a measly 0.27% q-o-q. If we annualize the current figures (i.e. assume 0.4% in Q4) Italy is looking at a annualised growth rate of 1.2% (the official forecast is for 1.9% y-o-y which is well below its peers). However, do take note that these annualised figures rest on a status quo situation which quite frankly seems highly unlikely at this point. In this way, the evolution we are now seeing in Italy is not at all surprising for me and confirms the general perception that when economic fundamentals turn against the Eurozone Italy is one of the first economies to suffer.

Morgan Stanley's Vladimir Pillonca is hardly optimistic either:

The Italian – and global – growth outlook seems to be darkening every day, despite the expected bounce-back of growth in the third quarter. We forecast Italian growth to slow sharply next year, to just 1.2%Y, from 1.8%Y this year, and we don’t anticipate a recovery to gather traction until the second half of next year. Risks are skewed to the downside. The possibility of a growth recession next year – defined as two or more quarters of negative quarter-on-quarter growth – is not a remote one.

as he says:

Consumer spending looks set for a slowdown after an unsustainably strong first half of the year. After all, wages are barely rising once we account for inflation, and both tax pressure and interest rates have risen in the recent past. Forward-looking consumers are likely to react to a more uncertain future, by allowing their savings to rise and their consumption growth to fall.

Is he clairvoyant or something, I ask myself , since this is exactly what the most recent ISAE survey is showing consumer expectations to be (for a rise in savings that is) at this point (and Pillonca's piece was written before this data release).

In fact Italian consumer confidence surprisingly rose to a six-month high in November. The Rome-based Isae Institute's index, which is based on a poll of 2,000 households, rose to 107.6, the highest level since May, from 107.3 last month. However if we look at the chart we will see that the index has hardly budged since September, and that we are still in comparatively low territory.




One surprising detail in this months report is, however, that consumers are saying that they are more likely to save their money than spend it in the near future (as Pillonca imagined they would), possibly becuase they are anticipating that a significant economic slowdown is now close in Italy.

Of particular note is the fact that a sub-index measuring household confidence in the ability to save rose to 143 from 132, while another measuring the ability to put money away in the future rose to minus 76 from minus 86. On the other hand, consumers grew ever more negative about future growth, with this component of the index falling to minus 35 from minus 29 in October.

I will try and find the time to do a more in-depth analysis of Italian GDP when the full results are published in early December.

Q3 Eurozone GDP - More than Meets the Eye?

By Claus Vistesen Copenhagen

As I noted just a few days ago over at Alpha.Sources in a small review and preview this week would see the release of the Eurozone Q3 numbers and now, as it were, they are out. In general, I focused more, in my last note, on the forward looking outlook of the Eurozone economy than the actual numbers for Q3 as they were certain to show a rebound on the back of a weak Q2 reading. And as we shall see below they sure did. In essence we need to consider, as always, that quarterly national account readings are always a bit backward looking as they are released when we are deep into the next quarter. Especially in this case and this seems evident as all forecasters and analysts seem to agree that this Q3 reading is a bit of a fluke relative to its ability to tell/describe the immediate economic outlook. However, this also means that what is in the book is indeed in the book and on the back of this strong reading an aggregate growth rate of 2% in the Eurozone seems well within reach. Let us do the visual inspection first which extends the graphs I showed in the last post (linked above);


As we can see the Eurozone Q3 GDP came out, quite respectably above my forecast of 0.5%, at an impressing o.7%. This already amounts to 1.9% and although we are talking about preliminary estimates it is difficult to see how the Eurozone can go under 2.0% in 2007 although of course this is still well below those 'goldilocks' forecasts we saw in the beginning of 2007. My own forecast however of 1.7% which admittedly was also on the downside clearly seems in need for an upward revision of some degree. So far, the growth rate in 2007 has averaged 0.63% per quarter for the entire Eurozone which is not too shappy at all. Having said that, a closer inspection at y-o-y growth rates also reveal that momentum in the Eurozone seems set to level off considerably as growth remained largely stable y-o-y. Yet and even when looking at q-o-q figures, we must really also be looking forward and on the back of this very strong reading I am expecting a pretty miserable Q4 reading to say the least. However, as I have stressed many times the Eurozone is not one big economy and as such the country specific break down seems to offer some important indications as to where we are moving and why this reading needs to be taken with a pinch of salt relative to the general trend.

If we look at Germany first the headline number of 0.7% was perhaps the most surprising number for me. However and especially with respect to Germany there seems indeed to be more than meets the eye. As such and even though I would like to stress that the actual breakdown is not ready yet, the following stands out from the German statistical office destasis.de.

In a seasonally adjusted quarter-on-quarter comparison, GDP growth in the third quarter of 2007 was based on domestic factors: Capital formation in machinery and equipment and in construction was up on the second quarter. Economic growth was also supported by a moderate increase in final consumption expenditure of households and NPISHs. Contrary to the second quarter, the balance of exports and imports did not contribute to growth, which is mainly due to a marked increase in imports.

Now, let us begin with the ever recurrent trend in Germany namely the point about how final consumption expenditures contributed with a 'moderate' increase in GDP. Clearly, the actual figure is yet to be revealed but such narratives are basically 'econ-speak' for virtually flat. So, no surprise here. What was more surprising was the point about how net exports did not contribute to growth at all. Given the longstanding German track record of being dependant on exports for growth it really begs the question of where those 0.7% came from. Well, if you have studied macroeconomics 101 you will have spotted that only one thing which remains is corporate capex/investment (and of course government consumption but that is held equal). This is important because it links in with what we can expect as we move forward and specifically how we can expect corporate capital formation to wane considerably in the quarters to come. I have already noted Sebastian Dullien's analysis (see link to my review and preview post above) in which he paints a bleak picture of investment in Germany going forward. If you want to dig deeper into this Edward also has an entry up today in which he analyses the recent sharp drop in German ZEW business confidence. His analysis supports, with facts and analysis, my own prediction that corporate capex in Germany and in indeed in the entire Eurozone is heading for a sharp slowdown. So, that was Germany then.

In France, growth also rebounded strongly to 0.7% and actually if we look at the charts above we can see that the French economy has actually been accelerating in the past 4 quarters on a q-o-q basis. The break up reveals that adjustment in inventories were flat, domestic demand and investment remained the main driver of growth which confirms the traditional picture of French consumers as being more ready to spend than their Italian and German counterparts. Surprisingly and after having slashed GDP by 0.3% in Q2 exports actually contributed 0.1% after exports saw a minor boom in Q3. Now, this of course broad a slight smile to my face as my thoughts peered off to Sarkozy's numerous tête-à-têtes with ECB officials over the strong Euro. For the really data miners the INSEE release reveals that in particular intermediate goods and cars were strong export commodities. However, before Trichet picks up the phone to wheel in Sarkozy just yet I do think that also France will see a slowdown in the quarters to come. Yet, contrary to Germany where corporate investment as a key growth ingredient seems to be trending firmly down France also has a much more dynamic domestic consumption which may act as a shield.

In Spain, as can also be observed by the graph above growth continued to decline and is now in line with Germany and France at 0.7%. Clearly, this should not be seen as a sign of convergence since the 0.7% recorded by France and Germany seems to be a bit too high relative to the general trend. As such, the Eurozone has been accustomed to a Spanish economy which has grown well above the Eurozone average and in this way we can say that the Spanish economy in many ways have driven the aggregate growth rate on the margin. However, and in light of the Spanish slowdown in Q3 we also need to understand that the current market turmoil and subsequent correction which is sharply related to construction and housing is likely to hit Spain particularly hard. This, as it were is also the case of Ireland which at this point has not published numbers for q3; to the best of my knowledge that is.

Finally, before summing up we have of course Italy where Bloomberg told us that the Italian economy managed to expand in Q3. But alas what does that matter when the number we have is 0.4% q-o-q which follows, as can be observed above, a o.3% and 0.1% reading q-o-q in Q1 and Q2 respectively. Even those amongst my readers with next to none inclination towards math exercises should have no trouble calculating that the average q-o-q growth rate now stands at a measly 0.27% q-o-q. If we annualize the current figures (i.e. assume 0.4% in Q4) Italy is looking at a annualised growth rate of 1.2% (the official forecast is for 1.9% y-o-y which is well below its peers). However, do take note that these annualised figures rest on a status quo situation which quite frankly seems highly unlikely at this point. In this way, the evolution we are now seeing in Italy is not at all surprising for me and confirms the general perception that when economic fundamentals turn against the Eurozone Italy is one of the first economies to suffer. This seems to be a role Italy has the ill-earned pleasure to share with Greece and Portugal where the latter for example saw its growth rate q-o-q stall to 0.0%; Greece's q-o-q growth rate has not yet been released.

In Summary

On the face of it the Q3 GDP release from the Eurozone seems to point to a rebound but we should not be fooled. I know that I tend to be a bit of a party pooper sometimes when it comes to the Eurozone but this time around you need to consider I think that the collective mass of almost all respectable analysts and economic commentators seem to agree with my general forecast. As such, all of us Eurozone watchers had pretty much agreed that Q3 all things equal would show a rebound relative to Q2 but given the monthly real economic data and confidence readings which have been rolling in it would also prove to be short-lived. In this way I maintain my main focus on the following three things as I outlined them in my entry posted Monday this week ...

• Although the slowdown seems set to be Eurozone and indeed also EU25 wide I will be watching Italy, Greece, and Portugal in particular since these three countries are those most likely to feel the pinch longest and hardest. Clearly, I am also watching with some anxiety Germany where the recent signs that net exports and thus external demand seem to be waning suggest that growth is going to be rather meager as we move forward.

• Secondly, I am watching the EUR/USD which is still trading at very high levels at 1.46. At the moment it seems as if the much traded currency pair is taking a breather but as we move closer to the next decision at the Fed as well of course at the ECB volatility seems set to return much to the pleasure of FX punters and participants in funny money investment games :). More seriously of course, the value of the Euro at these levels and to the extent that it remains here will have consequences as we move forward.
  

• Thirdly and perhaps most importantly at this point I am watching Eastern Europe and particularly the Baltics with much anxiety. Of course, there are issues in themselves with these economies which I have treated extensively at this space. Only yesterday we learned that inflation in the Baltics continues to hasten upwards while economic growth and confidence indicators seem to be seriously wobbling. This is looking more and more like a hard landing and a subsequent/potential threat against the pegs to the Euro, especially as an extension of the fact that the EUR/USD is now at a very high level. In short, I cannot stress enough that Eastern Europe now needs ardent watching and essentially investors and most importantly policy makers need to prepare for events where prudence, responsibility, and overview must be exercised in order not to allow some of these economies to fall into what, for some countries, can only be described as an abyss.

Finally, as regards to the most general market implications of the Q3 GDP reading I still see the ECB on hold as well as I don't see the EUR/USD trading persistently over 1.47 where of course this latter claim is the equivalent of wearing a blindfold while throwing an anvil up in the air and hoping that it will not hit you on its way down.

Germany's ZEW Business Sentiment Index November 2007

Well perhaps this news is hardly surprising, but German investor confidence - as measured by the ZEW Center for European Economic Research in Mannheim - dropped to its lowest level in almost 15 years this week.




The Economic Sentiment index - which attempts to measure investor and analyst expectations - fell to minus 32.5, the lowest reading registered since February 1993. This was down from a 'mere' minus 18.1 in October. Looking at the chart, of course, it is plain that we have almost been here before, in November last year, but an unexpected upswing in the demand for German exports globally (and especially in the East of Europe) and a weaker than expected negative reaction from German consumers to the 3% VAT increase introduced in January, meant that the bleakest expectations of that moment were not realized. However now the 3% extra cost of purchasing is still with us, and the export upswing is much weaker than it was, and in addition the financial turmoil of last August is having a much stronger than expected impact on construction activity in Germany.

As a result growth in Europe's biggest economy is undoubtedly slowing, and quite fast, and, naturally, this is the conclusion that the ZEW institute itself draws. Among other factors mentioned is that the euro has risen 8 percent against the dollar in the past three months alone, and reached a record high of $1.4752 only last week, eroding on it way up the competitiveness of German exports, whilst at the same time making products from the US companies which compete with Germany in third country markets cheaper. At the same time, higher energy bills and tighter lending conditions have sapped companies' and consumers' spending power.

One other key data point which serves to back up the ZEW finding is the fact that growth in Germany's key manufacturing sector is now slowing notably. Morgan Stanley's Eric Chaney, in noting the decline which was also registered in the IFO index last month, took the opportunity to draw attention to the rather dramatic way in which German manufacturing seems to be slowing.

The devil is often in the details, as the saying goes. This might be true for the euro area economy: while the widely scrutinized headline Ifo index posted only a modest slip in October, one key detail of its manufacturing section sent a much gloomier message: production fell from a cliff in Germany, the powerhouse of the recovery so far.

More evidence for this situation was to be found in the RBS/NTC Eurozone Manufacturing PMI (Purchasing Managers' Index), which came in at 51.5 in October, in line with the preliminary “flash” reading. While the reading indicates (as does any over 50) that output is still expanding, the fall from 53.2 in September was the largest decline to be registered in almost three years and the reading showed the weakest monthly expansion since August 2005. This weakening in the PMI was led by Germany, where the index showed the largest points fall in the eleven-year history of the survey. The PMIs also fell in Spain and Italy, while the reading was unchanged on a month earlier in France.

This easing-up in the rate of growth is the steepest recorded since November 2004, largely reflecting the sharpest slowdown in production growth seen in Germany for five years. Although Germany still continued to record the fastest growth of output in the eurozone big-four, the rate of increase was the weakest for over two years. Output growth also slowed to the weakest for at least two years in all the other big-four countries, slowing to near stagnation in both France and Spain, with France recording the weakest rate of expansion of the big-four.

Output rose for investment, intermediate and consumer goods, with the former continuing to show the strongest rate of increase. However, investment goods production slowed to the weakest since November 2005, reflecting a particularly sharp easing in Germany.

Growth of new orders was only very modest and was the lowest for two-and-a-half years. New orders in fact fell in Germany for the first time since August 2005, dropping at the fastest rate since November 2004. A marginal decline was also recorded in Spain (the first drop since June 2005). New orders rose in both Italy and France, but in both cases the increases were only very modest.

New export orders rose only modestly, showing the weakest increase during the current 29-month period of expansion. Sharply slower growth in Germany and Italy brought their export growth into line with the modest pace seen in France. Meanwhile, new export orders fell (though only very marginally) for the second month running in Spain.

Backlogs of work fell for the first time since June 2005, dropping in Germany, Spain and Italy. Stocks of finished goods meanwhile rose slightly for the first time since March 2005, caused by sluggish sales. Rising stocks and falling backlogs, of course, point to weak future production, and this is really the overall meassage which we are getting from the data at this point.

German Industrial Output September 2007

German industrial output continued increased in September, although the pace of increase is definitely slowing.

Production rose a seasonally adjusted 0.3 percent from August, when it advanced 1.9 percent, according to data released by the Economy and Technology Ministry in Berlin yesterday. From a year earlier, output rose 6 percent when adjusted for the number of working days.

Growth in emerging markets such as Russia and Eastern Europe is helping offset the impact of the euro's appreciation on exports, encouraging companies to expand. Still, record oil prices may curb economic growth as they erode spending power among Germany's customers, and stagnant internal demand may also take a toll. In one indication of this new factory orders dropped 2.5 percent in September from August, according to the Economy Ministry in an earlier release.