Wednesday, July 28, 2010

Do The Latest European Bank Lending Numbers Reveal A Major Headache Looming For The ECB?

According to Ralph Atkins, writing in the Financial Times:

"Eurozone mortgage borrowing grew last month at the fastest pace in almost two years in a sign that bank lending across the 16-country region may be flickering back to life. Lending for house purchases rose at an annual rate of 3.4 per cent in June – the fastest since September 2008, according to European Central Bank data published on Tuesday. The acceleration pointed to a revival in consumer confidence and an increased willingness by banks to fuel the economic recovery with loans to the private sector."

So is this really the good news it seems to be? Well the answer is (as usual) yes and no. The problem is that behind the positive aggregate data lie the individual national details (you know, the place where the devil is usually to be found), and when we dig down to this level, then we find the position is much more complicated than it seems. Nor should this surprise us, since if a one size fits all interest rate policy didn't work in the pre 2008 world (just look what happened to Spain and Ireland for heavens sake), is there any good reason to assume that it will in a post 2010 one?

To take the two extreme cases, France and Spain, in France mortgage lending was up by an annual 5.3% in June (considerably above the aggregate average of 3.4%), and not only this, lending has in fact been accelerating since it hit a trough in October last year (see chart below).

In Spain, on the other hand, mortgage lending continued to languish, rising by only an annual 0.9%.

Indeed, lending to households generally was up in France, by an interannual 4.4%.

while in Spain total lending to households was only up by 0.5% over June 2009.

This is not a question of there simply being a credit crunch operative in Spain (which there is), but a different relative levels of indebtedness, since total household debt in Spain is 902 billion euros (or around 90% of GDP), while in France it is just a fraction under 1,000 billion euros (or just a tad over 50% of GDP). So French households have the capacity to leverage themselves more, while Spanish households are dangerously overleveraged, and herein lies the danger for the ECB, with its single interest rate policy limitation. Not raising rates risks fuelling a sizeable consumer credit and construction boom in France, while in Spain raising them (given that in Spain around 90% of mortgages are with variable rates) means flooding the Spanish banking system with non performing loans.

In fact the situation in the construction industry is quite different between the two countries, In Spain construction seems (for the time being) to be in near terminal decline.

while in France construction activity may not have revived, but then it never fell as dramatically as it did in Spain.

Nor did industrial output fall as far or as fast, as it did in Spain.

Retail sales reveal a rather similar picture.

As do the respective sevices PMIs.

Jack Kennedy, economist at Markit and author of the France Services PMI, said:

“Growth momentum in France remained marked during June, rounding off a strong Q2. A solid gain in service sector employment – the sharpest since April 2008 – is encouraging for the labour market and, by extension, consumer spending. Overall, the upturn appears to still have considerable traction despite signs of a recent cooling of growth in the manufacturing sector.”

Commenting on the Spanish Services PMI survey data, Andrew Harker, economist at Markit and author of the report said:

“Latest Spanish service sector PMI data provide some worrying signs regarding the path of the sector. Foremost among these is the first drop in new business since February. Also of note is the marked weakening of sentiment seen in the previous two months amid worries surrounding austerity measures in Spain and the effects these will have on the fragile economy.”

So the divergence between these two economies couldn't be clearer at this point. While house prices continue to fall in Spain.

In France there is already evidence of an uptick.

Of course, this is still early days yet. But lets just remember how Spain got into the mess it is currently in.

During the key years of the construction bubble negative interest rates were applied to a booming Spanish economy. So what is happening now in France?

As can be seen (blue patch at the end), since December last year the French inflation rate has been above the Eurozone 16 one, something that has almost never been the case since the Euro came into existence. And since almost the same date French interannual inflation has been above the ECB policy rate of 1%. That is to say, negative interest rates are being applied to the French economy. Possibly there was no harm in that while that economy was in the midst of the deepest recession in a decade, but now the French economy is showing clear signs of recovery.

But if we come to look at the French goods trade balance (a sure early warning indicator of problems to come) we can see that the trade deficit is widening again, which basically means that French industry is once more losing competitiveness, and the economy becoming structurally distorted, just as happened to the Spanish economy in its day.

So as Ralph Atkins says, "The pick-up in mortgage lending could offer some cheer after months of gloomy eurozone bank lending data and fears about the stability of the region’s banking system" - but it could also add to the worries too. As far as I can see there are only two ways around this problem, either start increasing rates at the ECB, or press for a substantial internal devaluation to restore economic growth in Spain, but both of these routes pose serious issues for the stability of the Spanish banking system, since in the former case the burden of mortgage interest payments becomes excessive (and quickly - simply raising the refi rate from 1% to 2.5% would represent an almost 100% increase in mortgage service costs given the close attachment between Spanish mortgages and 1 year Euribor). One thing is for sure though, some sort of solution or other needs to be found, and soon.

Sunday, July 25, 2010

Under Stress

After a long and rather tense wait, the initial response to the publication of the European bank stress tests was always going to be something of an anti-climax. Indeed the results should hardly have comes as a surprise to anyone It is hardly breaking news to learn that a number of Spanish cajas will find themselves badly undercapitalised if the economic recovery – as surely might be expected – fails to materialise as planned. For the rest, the outcome is really a victory for politically correct: thinking. The situation, we learn, is slightly more serious than previously acknowleged, but we are a long way from seeing the imminent collapse of the European financial system. How could we be, when we have the friendly face of the ECB, always there ready to offer a helping hand.

Wednesday, July 14, 2010

Oh It's All Gone Quiet Over In The Eurozone!

Or has it? According to Anchalee Worrachate in Bloomberg:

"A report from the Bank of Spain showed Spanish lenders borrowed a record 126.3 billion euros ($161 billion) from the ECB in June as investors shunned the nation’s banks. Spain’s banks increased borrowing 48 percent from 85.6 billion euros in May. That compares with a drop of 4 percent to 496.6 billion euros that the ECB provided lenders in the whole euro area. Spanish banks haven’t sold any bonds publicly in the past two months on concern the nation won’t be able to cut its deficit without hurting the economy."

Pretty hard to argue now the Spanish bank borrowing from the ECB is simply in line with the country's share of total GDP I would have thought. Also, after having trended upwards ever so slightly for a couple of months, Spain's industrial output actually fell back again in May (by 0.3%) while output in Germany roared ahead by 2.9%. Obviously not everyone is getting the same benefit from the weaker euro, could competitiveness have anything to do with it, I wonder?

Quoted in the Financial Times earlier today Klaus Regling, chief executive of the European Financial Stability Facility said the fund would be "ready to act whenever the politicians tell us to act.” I guess the situation of Spain's banks would be one of the things he must have had in mind.

Using a footballing analogy, you get to see a lot in the press about how this club is chasing this player, while that one is chasing another one, until the moment of the actually negotiations comes. Somehow, at that point the sporting press goes strangely silent.

Of course, when those much talked of stress test finally come out, we'll all be able to see for ourselves that Spain's banks - apart from a few ropey old Cajas that no one in their right mind would be interested in anyway - are in absolutely sterling and tip top condition (and not like their shabby German counterparts at all). Won't we José (Viñals)?

Or are those reponsible for the Spanish banking system finally going to face up to their responsibilities, amble out of that closet they have been tightly locked away inside for the last three years, and follow the advice of Jacques Cailloux, chief European economist at RBS, by seizing opportunity provided by this months "getting it all out in the open" fest to start restoring investor confidence by really getting down to straightening out the mess?


The number of people employed continues to fall, unabated, as measured by contributers to the social security system. On a seasonally adjusted basis the number hit 17.66 million in June, down from the January 2008 peak of 19.42 million.

Seasonally adjusted unemployment in Spain - as reported to Eurostat - was at 19.9% in May, up slightly from the previous month, and with no real sign of reducing.

House prices continue to fall slowly according to the TINSA index.

and in June were down 16.5% from the December 2007 peak.

The goods trade deficit deteriorated again in April.

As did the current account deficit, which has now widened again considerably from the lows reached in the autumn of 2009.

The manufacturing sector showed very slight growth in June, as both output and new order growth fell back.

As Markit's Andrew Harker said in his report:

“Latest PMI data highlight the continued uncertainty surrounding the Spanish economy. Output growth slowed for the second month running and firms still do not have the required workloads or confidence to prevent job losses. With the VAT rise kicking in and further austerity measures to follow, there appears to be a real risk of the private sector falling back into recession.”

While services activity actually contracted for the first time in four months.

Again, I will leave Andrew Harker to sum the situation up:

“Latest Spanish service sector PMI data provide some worrying signs regarding the path of the sector. Foremost among these is the first drop in new business since February. Also of note is the marked weakening of sentiment seen in the previous two months amid worries surrounding austerity measures in Spain and the effects these will have on the fragile economy.”

And finally, we have the inflation data, were I have put the CPI up against the German one. Worryingly, after falling sharply at one point in 2009, Spain's inflation is now once more back over Germany's.

Which means the the Spanish economy is once more losing competitiveness against the German economy, the exact opposite of what you want to see. And in July VAT went up two percent. Many argue this move is totally benign, but it will be interesting to see how Spain's retail sales move over the months to come, and how the inflation differential with Germany is affected. Didn't anyone tell them there are no free lunches in economics? And how cutting back on government fiscal spending - necessary as it is, since more government deficit is only going to get the country more into debt, not to mention the impact on investors - is going to help sort all this lot out, well I'm afraid that's a complete mystery to me.

Monday, July 12, 2010

Is There Global Economic Slowdown In The Works?

According to Ralph Atkins writing in the Financial Times last week, "the pace of Germany’s recovery is helping dispel fears of a “double dip” recession across the continent as a result of the crisis over public finances in southern European countries". Coincidentally, however, on the very same day, Alan Beattie writing from Washington informed us that the IMF feel "the risk of a slowdown in the global economic recovery has risen sharply". This left me asking myself which is it: is the global recovery a question of up up and away, or are we at the start of a renewed slowdown (whether or not you wish to term this a "double-dip")? So I thought I would take a look through some of the most recent data (both hard and soft) to see if I could make any sense of the situation.

Well one place we could look for some sort of indication would be in the latest batch of PMI survey results. David Hensley, Director of Global Economics Coordination at JPMorgan, put it like this: "Signs are that growth of global GDP may have reached an near term peak in Q2 2010. June PMI data indicate that growth of business activity and new orders are starting to wane. Some cooling in the manufacturing boom was expected as the inventory cycle matures. What is more concerning is that the service sector also may be losing momentum."

Most importantly it is, as we shall see, new order growth that is waning, and that does look rather ominous, with even Ralph Atkins admitting that Germany is no exception here, since German industrial orders fell by a seasonally-adjusted 0.5 per cent in May compared with April according to the latest data from the economy ministry. Nor should this surprise us, since given that the German economy is export dependent, economic growth in Germany is a dependent variable (and not a leading indicator), since the German economy expands in the wake of expansion elsewhere, and falls back as the wave loses power.

And if you don't get this, just take a look at the evolution in German retail sales (below): a country with this lack of dynamism in domestic sales is never going to lead the global growth charge.

Manufacturing In The Van

In fact it is obvious that something somewhere is slowing, since the rate of growth of the entire global manufacturing sector fell back again in June, for the second month running, with the reading recording the weakest performance so far this year, although since it is still showing 55 it is clear that growth in the sector remains solid and indeed it is still above the longer run series average. So the worry here is not about what is actually happening now, but about what gets to happen next, about the future, and we might expect to happen in the second half of the year.

In fact manufacturing production rose for the thirteenth consecutive month in June and the Global Manufacturing Output Index averaged 59.1 across the whole second quarter, making for the strongest performance since Q2 2004. But current output is just one of the components of the PMI, and if we look at some of the other components the future however seems decidedly less optimistic, and especially in the new orders indicator where growth (and especially in new export orders) fall back sharply to hit the lowest level in six-months, with the rates of increase slowing in the majority of the national manufacturing sectors covered by the survey.

Thus the phenomenon seems far more general than local, and national PMI New Orders indices fell in the US (eight-month low), the Eurozone (weakest expansion in the year-to-date), Asia (one-year low) and the UK (seven-month low), although in each case the indicator continued to register expansion.

When we come to national performance, it is perhaps the Chinese reading which has generated most comment. At 50.4, down from 52.7 in the previous month, the headline China Manufacturing PMI showed only a marginal improvement in Chinese manufacturing sector operating conditions over May. What's more, it was the third month that the reading has fallen (see chart below).

In fact seasonally adjusted manufacturing output actually fell in China during June (as I said, the PMI is a composite, and output is but one of the components), bringing to an end a fourteen-month stretch of continuous expansion. Although it was only marginal, the contraction contrasts strikingly with the near-record growth levels registered at the start of the year. And for the first time in fifteen months, the level of new business taken by Chinese manufacturing firms fell in June. The rate of decline in new work was only fractional, but marked a distinct turnaround from strong growth seen throughout Q1 2010. Those respondents that reported a drop in new orders widely commented that this reflected softer market demand. New orders placed by foreign clients also fell in June, with the pace of decline the fastest since March 2009. Survey respondents widely mentioned that reduced new export business reflected lacklustre global demand, and really you would think that this was something Chinese manufacturers would know about.

And it isn't only manufacturing which is showing the strain, growth in the services sector (which remained fairly strong at 55.6) also weakened to what was a 15 month low. And although new business received by service providers continued to rise in June, the rate of growth lost further ground on the strong expansion seen at the start of second quarter. Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC had little doubt what the culprit was: “The slowdown in services activities reflects the effect of property market tightening measures. This, combined with the moderating manufacturing production, implies the economy is cooling off sequentially", he said.

Of course, none of this means China is spinning off towards recession, or anything like it. But it does mean the Chinese economy is unlikely now to become the source of global demand many expected, a fact which is reflected in the large goods trade surplus recorded in June (see below). Really the argument about the property boom doesn't need to be so much about whether China has had a bubble or not. The key point is that the earlier dynamic in the property sector wasn't sustainable, and the domestic market in China will note the consequences. As will those who have been benefiting from the imports surge into China (see Brazil below).

Brazil's Economy Slowing Sharply

Less commented on is the perhaps more surprising fact that growth also seems to be slowing in Brazil, as should be evident from looking at the Composite PMI reading. (The Composite is a synthesis of the separate services and manufacturing ones). This fell back to 51.6 in June, from 52.5 in May, and reflected a weakening of activity in both sectors. While expansion in the services sector was only marginal (50.9) manufacturing continued to show modest expansion with the reading (52.7) up slightly from May’s eight-month low of 52.4. Again we aren't necessarily talking about recession threat here, but we are also hardly seeing the kind of momentum we would need to see in terms of Brazil making a notable contribution to sustaining global demand.

India's Economy Heating Up?

In India, by way of contrast, growth continues to be impressive, and the International Monetary Fund just revised their 2010 economic growth forecast for the country to 9.4 percent from April's 8.8 percent estimate. And India's manufacturing industry continues to roar ahead, following the twenty-seven month peak of 59.0 seen in May, the seasonally adjusted PMI maintained the strong expansionary tone in June, despite slipping back slightly to 57.3. This was the fifteenth successive month of continuous expansion. Services put in an even stronger performance, and the headline Business Activity Index for the service sector hit a two-year high of 64.0. As a result the India Composite Output Index - at 62.8 - suggested the sharpest rise in activity for almost two years.Indeed, if you look at the chart below, it tells its own story.

India's problem is not then growth. India's problem has a different name: inflation. Just to show us that nothing in this world is ever completely perfect wholesale prices in India are now climbing at double digit rates. Indeed Central bank Governor Duvvuri Subbarao recently increased benchmark interest rates for the third time this year after they rose by an annual 10.16 percent in May.

Food price inflation is an even more serious problem, and the cost of feeding yourself went up by 12.63 percent in the week ended June 26, following a 12.92 percent increase the previous week (year on year figures in both cases). So India is likely to slow somewhat too, or at least a brake will be applied, and this is somewhat unfortunate, since India runs a trade deficit, which means that at this critical time it is a net provider of demand to the global economy.

There are, of course, other net providers of demand to the global economy, like the US.

Or Spain.

Or the UK.

But the problem is that these economies are all heavily indebted, and consumers need to deleverage, not take on more debt. So they need trade surpluses, not deficits. Running these unsustainable deficits was how we got here in the first place.

Exporting Their Way Into Trouble?

Then there are the current account and trade surplus economies, like Japan and Germany. Japan's Sevices Activity Index fell from 47.5 to a four-month low of 47.1 in June, suggesting a continuing contraction in the Japanese service sector. Nonetheless the Manufacturing PMI continued to show robust growth, even if it did fall back slightly /for the first time in five months), from 54.7 to 53.9. The New Export Orders index also fell slightly (by 0.6 points), but again remained at a high level at 56.9.

As a result of the stronger decline in services the headline Composite Output Index fell to 49.8, below the neutral level of 50.0 for the first time in four months.

While the fall-off in new export orders in the June PMI is hardly alarming, the drop in May core machinery orders (i.e., private-sector orders excluding shipbuilding and electric power company orders) that was reported by the Industry Ministry is slightly more preoccupying, since they slid by 9.1% from April, well under consensus expectations for a 3.2% drop. (All percentage comparisons are MoM unless otherwise specified.) These results are also consistent with the previously announced 10.2% drop in capital goods exports for the month. While it would be premature to make any rapid judgment (May was in fact the first month in which machinery orders and capital goods shipments both fell back) they do suggest we may be seeing a faster than anticipated peaking in machinery and equipment investment worldwide.

Turning to Germany, the recent export performance is certainly impressive. As is the fact that 30 billion euros out of the total of 77 billion exported in May went outside the EU.

The rebound in German industrial activity is also impressive, so it is perhaps not hard to understand why Ralph Atkins felt able to be so positive.

And even though the manufacturing PMI has fallen back slightly from the earlier very high levels, at 58.4 it is still showing very strong growth. But even in Germany the storm clouds may be gathering. As I have noted, German growth is ALL about exports, since domestic demand is more of a drag than a stimulus, but even in this case the June PMI data showed that new order growth slowed for the third month running and was at its weakest level since December 2009. New export order growth also eased markedly and was the slowest for five months. Now, you might say, that should not surprise us since they were growing very rapidly, but you can't take these movements in isolation: we are talking about exports here, so it is important to think about what is happening in the other economies.

Water, Water Everywhere

Lastly I would just mention the state of play with the Baltic Dry Index, since this has now registered 31 days of continuous decline, making for what Bloomberg describes as its longest losing streak since the 34 session run to Aug. 15, 2001. Of course, not everyone likes this index, since it measures shipping freight charges, and as Capital Economic's Julian Jessop points out, there are many factors (like shipping supply) that can affect it, and not just end demand. But as Bloomberg would doubtless be quick to point out, the drop does correlate with the movement of commodity prices in China. The price of hot-rolled steel, for example, has fallen 17 percent since it hit its 2010 high of 4,698 yuan on April 15. So while movements in the index should not be taken as strong evidence for anything, they should hardly be ignored as additional background information.

Something similar could be said about the work being done by the Economic Cycle Research Institute (ECRI) and their U.S. Long Leading Index. This has been pointing to growing economic weakness for months now, and it fell again this week with the growth component slipping to -8.3% from -7.6% at the end of June. Of course, there are plenty of other people out there who would disagree with them, but ECRIs record does seem to have been pretty good during the current crisis.

At the end of the day, it would seem to me, it all depends whether you are one of what Wolfgang Munchau terms the "optimists" or one of the "pessimists".

The pessimists believe that a strong global recovery is unlikely given the persistence of financial stress, and the deleveraging of the private and public sectors across the industrialised world.

The optimists divide into two groups. There are those who have difficulties counting to zero, who cannot add up the global private, public, and foreign balances, which must equal zero by definition.

And then there are the rational optimists, whose expectations of resurgence in private sector demand must surely rest on the assumption of a return to even greater global imbalances than before the crisis, to which the eurozone will this time contribute actively. But this is surely not a sustainable position.

The pessimists would argue that global demand growth will not be sufficiently strong to support a self-sustained recovery in the eurozone. Even the rational optimists, who believe that this is possible, would probably conclude that these imbalances are not sustainable, and may trigger another financial crisis down the road. And if that is what you expect, you are not really an optimist.

What we know is that some of our societies are deeply over-leveraged, and that de-leveraging them means running trade surpluses, not deficits (see the indebtedness chart for the US economy below).

What we also know is that it is deeply unrealistic to imagine that a burst of new consumer credit will restore growth to economies with such deep structural distortions, and the data seem to be confirming that this rebirth in new credit growth just isn't going to happen (at least not in the short term). According to the most recent ECB data, while the annual rate of Eurozone credit growth for general government stood at 9.8% in May, growth of credit extended to the private sector was at a meager 0.1%. The annual rate of change of loans to companies was -2.1% in May (yes minus, it fell) while the annual rate of change of consumer credit stood at -0.4%. So if it wasn't for the respective governments, I don't think it is too hard to see that domestic demand would be in contraction mode.

And the situation is broadly similar in the US, where the Federal Reserve announced last week that consumer borrowing in the dropped by $9.1 billion in May, following a revised $14.9 billion slump in April. In fact there have only been two months since the end of 2008 when borrowing has increased. So, when Jean-Claude Trichet says that all the global gloom over the Eurozone's prospects is being overdone, since the data they are looking at over on Kaiserstrasse is “not confirming this pessimism”, and adds that a double dip into recession “is not at all what we are observing” someone might just like to ask him which data it is he is looking at. Maybe we won't see a complete double dip, but a serious slowdown in growth does seem to be in the works, and contractions will be once more registered in more of Europe's economies than M Trichet seems to be currently contemplating.