Relevant and even prescient commentary on news, politics and the economy.

Durable goods orders: more evidence of near-term weakness in the US economy

They keep calling it a ‘soft patch’ in my business; but when’s the data going to show otherwise? This soft patch is persistent, and durable goods orders confirm it into Q2 2011.

Note: The ‘all manufacturing’ orders Y/Y growth rate are available through March only in Datastream for the chart above; the nondefense capital goods ex aircraft orders are current through Aptil.
READ MORE AFTER THE JUMP!From the Census April preliminary release on durable goods orders and shipments:

New orders for manufactured durable goods in April decreased $7.1 billion or 3.6 percent to $189.9 billion, the U.S. Census Bureau announced today. This decrease, down two of the last three months, followed a 4.4 percent March increase. Excluding transportation, new orders decreased 1.5 percent. Excluding defense, new orders decreased 3.6 percent.


We know that the auto industrial production print was influenced by the supply chain disruptions stemming from the Japanese earthquake. This probably affected the durable goods orders and shipments as well. Furthermore, the big monthly drop was driven (partially) by a large 30% decline in nondefense aircraft and parts orders over the month.

But the gist of the report, in my view, was disappointing. Total durable goods shipments fell 1% over the month, while new orders plummeted 3.6%. This is a very volatile series, and the March growth in new orders was revised upward to 4.4% over the month from 2.5%; but the average growth rate in ‘core orders’ is showing holes.

Core durable goods orders, ‘nondefense capital goods excluding aircraft’ – a leading indicator of domestic investment spending on equipment and software – fell 2.6% over the month. Volatile, yes; but the real core goods orders turned negative, -0.33% on a 3-month average growth basis, furthering a downward trend that’s been in place since January 2011. The April figure was down 0.2% on a real basis compared to the January-March 2011 average – not a good start to Q2 2011.(The real series is constructed using the CPI durable goods deflator.)

The contributions to Q1 2011 fixed investment spending demonstrate that the entirety of fixed investment growth came from equipment and software, 0.8% quarterly contribution. (On data, you can view the contributions data in Table 2 of the release here or download the data for the entire report here.)

So when will this ‘soft patch’ end? Neil Soss today tells me that 2H 2011 will be quite the kicker, as the temporary supply chain disruptions to industrial activity wear off. We’ll see. It’s going to take quite a bit of growth in 2H 2011 to get the US back on track to the consensus 2011 growth forecast of 2.7% (according to Consensus Economics May report).

Rebecca Wilder

"Survey says"…. German growth has probably peaked

This week further evidence has emerged of Germany’s slowing growth trajectory. At 4.9% annual growth (calendar-adjusted) and a tightening bias from the ECB, this was, of course, to be expected.

READ MORE AFTER THE JUMP!
Yesterday the Manufacturing May ‘Flash’ PMI by Markit Research highlighted, in my view, that sentiment is unlikely to remain at these absurdly elevated levels indefinitely, as the index dropped to 58.2 from 62 in April. Notably, the index remained above 60 for five consecutive months.

Today the Ifo Institute released its business survey for May, revealing that industry and trade remained stable in May. This index hovers at record highs compared to a post-unification time series.

Overall, while the two sentiment indicators diverged this month (the PMI waning, while the Ifo holding firm), the story remains that Germany is slowing down. Furthermore, the Ifo survey portends a deceleration in industrial production growth (IP), perhaps over the next quarter.

Exhibit 1 The ratio of the components of Ifo – expectations and current conditions – suggest a sharp reversal in the industrial production growth trend.

The chart correlates annual industrial production growth with the % differential between the expectations and current conditions components of the Ifo index at a 6-month lead. I don’t expect IP growth to turn negative, but a slowdown is certainly due.

Exhibit 2 Take the Ifo sentiment with a grain of salt!

Ifo really is more of a coincident indicator of economic growth than anything else. For example, the Ifo composite has a 77% correlation coefficient with annual real GDP growth. Previous to the current recovery/expansion, the Ifo index hit a peak of 108.7 in March 2008 only to see growth decelerate sharply the next quarter, 2.7% Y/Y to 1.6% Y/Y. My point is, while it’s a decent indicator of economic strength during expansions, it’s a terrible predictor of turning points.

We’re not at a turning point now – Ifo plus PMI demonstrate that the German economy continues to expand, albeit at a slower pace.

The real question is, what does this mean for the rest of Europe, specifically the Periphery? It’s not totally clear, but certainly with Germany contributing more than 50% to the quarterly growth rate in Q1, downside risks are emerging. Prieur du Plessis argues that this is related to the global slowdown in manufacturing.

Rebecca Wilder

Greece is in a pickle

There is growing discord between the ECB and national politicians over a ‘soft restructuring’ of Greek debt. The ECB doesn’t want it, while national policy makers grapple over it.

And just in case you were wondering what a soft restructuring actually is, Joseph Cotterill at FT Alphaville explains.

Beyond the gobbledygook restructuring talk is a simple story of incentives and the outlook for the Greek economy in the face of default. Over at Roubini Global Economics, Edward Hugh investigates the issue:

Put another way, if the most valid argument against going back to the Drachma always was that this would imply default, now that default is coming, why not allow Greece to devalue?

The problem is that Greece’s manufacturing sector is NOT competitive, nor will it be under even the most severe fiscal austerity measures…not to mention that the fiscal austerity measures make their problems worse by deepening the domestic recession. Barring permanent fiscal transfers, they need a currency devaluation in order to gain any sort of competitiveness back.
READ MORE AFTER THE JUMP!

According to the Surveillance of Intra-Euro-Area Competitiveness and Imbalances (.pdf here), Greece faces the following:

In view of Greece’s weakened competitiveness in the euro area and its persistent current account deficit, adjustment in the context of the euro area would be facilitated by relative price and cost adjustments and a shift of resources from the nontradable to the tradable sector.

This is difficult to do without devaluation. An it’s not going to improve with a lower stock of debt (through restructuring)!

According to Eurostat, the 4-quarter MA (Angry Bear blog calculations) of Greece’s export base as a share of GDP has improved by just 0.6% of GDP from its low, while Ireland’s export base as a share of GDP has improved a large 22% of GDP.


Greece is getting most of the impetus to net exports via a sharp drop in import demand. A squeeze in import demand can technically grow GDP, but only so far.


Again – how’s the economy to grow after default? Greece needs a devaluation to shift resources from the nontradable to the tradable sector. (from the EU report)

Rebecca Wilder

Euro area inflation: gaining momentum below the hood

Today Eurostat released April 2011 inflation for the Euro area. Prices are increasing at a 2.8% annual pace, up from 2.7% in March and very much above the ECB’s comfort zone of around but slightly below 2%.

Today’s report is the second release and includes the cross section of price gains below the headline number. The first ‘flash’ estimate does not specify the breakdown.

Inflation’s hitting all sectors, goods (primarily) and services alike, via inputs to production.

READ MORE AFTER THE JUMP!April core prices rose 1.6% over the year. The goods-price inflation is flowing into the the service-sector as well – headline service-sector inflation is 2.0% in April, up from its low of 1.2% one year ago. There may be some seasonal distortions here associated with the Easter holiday, but the upward momentum has been established.

Price gains at the country level are broad based.

2% annual inflation is increasingly ubiquitous for key countries, Periphery and Core core alike. Below is the diffusion of 2% annual price gains, where an index value above 50 indicates that the majority of component prices are rising at a 2% rate. The legend indicates the longer-term average diffusion of price gains.

Germany is still seeing the majority of annual price gains below 2% – the current index is 43 – but the breadth of 2% inflation is increasing beyond its longer-term average of 34.8. In Spain and Italy, current inflation diffusion indices are likewise increasing, where Spanish price gains are broad, 55.6 in April.

And it’s not just VAT taxes.

The chart below illustrates the tax-adjusted inflation rate across the Eurozone (ex Ireland, unfortunately, whose data is unavailable, Austria, Estonia and Cyprus). This series is lagged one month.

The tax-adjusted inflation rate assumes that all tax hikes are passed fully through to final goods prices. It gives a proxy for the inflation effect of fiscal austerity (hike in VAT, for example).

Although the uptick in inflation is warranted at this stage in the recovery, especially in the core, the momentum in prices can no longer be attributed to taxes only – it’s broader than that. Greece, for example, saw its inflation rate peak around 5.6% in September 2010 when its tax-adjusted inflation rate (inflation excluding VAT) was just 1.1%. Now, however, the headline and tax-adjusted inflation rates are converging, 4.5% vs 1.7% in March. Much of the tax-adjusted inflation can be attributed to food and energy; nevertheless, the base effects of the VAT hikes are wearing off.

Tricky times for Euro area policy makers when the Core AND the Periphery are showing such broad price gains. Meanwhile, the Periphery are contributing little by way of growth.

Rebecca Wilder

The Euro area is ‘miserable’

For all of our economic problems here in the US, a simple measure of ‘misery’ illustrates that US households are less miserable in March 2011 than those in the Euro area.

The chart below illustrates the simple ‘misery index’, which is the unemployment rate plus inflation. The blue line is a 45-degree line; those countries below it have seen their misery index fall on a y/y basis. Not one Euro area economy misery index fell since this time last year – French and German misery indices are unchanged despite improving employment. In contrast, the US misery index improved over the year with labor market conditions.

The problem is, that European fiscal austerity is clinching aggregate demand, raising inflation (via higher taxes) and producing unemployment. Consumers and firms alike are feeling this in Europe.

In the US, fiscal policy has been accommodative enough to allow for private sector deleveraging while keeping the economy on an upward trajectory. However, food and energy price inflation in April stabilized the misery index compared to last year (not shown) – i.e., it’s no longer improving. Unless the labor market shows marked improvement in coming months, US misery will turn “Euro” as inflation batters consumers amid elevated unemployment. Please see Marshall Auerback’s piece at the New Deal 2.0 regarding QE2 – QE2: The Slogan Masquerading as a Serious Policy.

Rebecca Wilder

Euro area GDP report: unbalanced

Today Eurostat released their estimate of Euro area growth for the first quarter of 2011. The economy grew smartly, or 0.8% on the quarter on a seasonally- and working day- adjusted basis. On the face of it, Euro area growth, which is 3.3% on an annualized basis, dwarfs the 1.8% seen in the US economy. Really, though, it’s joint German and French growth that tower US Q1 GDP growth.

Eurostat doesn’t explicitly highlight how inordinately unbalanced is growth across the region in their report . Germany and France alone accounted for roughly 72% 78% of the quarterly growth of Euro area GDP.

(As I highlight below, the Euro area quarterly growth rate in the chart is slightly different to that in the Eurostat report since some euro area members are missing. The cross-sectional contribution should be roughly unchanged during the revisions, though.)

Update: This chart has been re-posted with only slight modifications from the original. It does not change the article’s premise in any way. H/T to Philippe Waechter in comments below.


READ MORE AFTER THE JUMP!

If final demand was growing so quickly in Germany, I would say that the Euro area is adjusting more healthily than I had expected. Spenders become savers and vice versa, and capital flows adjust current account balances (and trade) accordingly. Germany spends more at home and abroad, while the Periphery less so. This does seem to be occurring according to the Federal Statistical Agency:

In a quarter-on-quarter comparison (adjusted for price, seasonal and calendar variations), a positive contribution was made mainly by the domestic economy. Both capital formation in machinery and equipment and in construction and final consumption expenditure increased in part markedly. The growth of exports and imports continued, too. However, the balance of exports and imports had a smaller share in the strong GDP growth than domestic uses.

Euro area average growth is likely slow down a bit, as the global economy moves toward a tightening bias and fiscal austerity clenches demand further. However, the outlook for the Euro area as a whole does look increasingly reliant on the trajectory of German and French economic conditions. This is a risk, especially since Germany is an export-driven economy.

As a comparison, 2005 saw growth as broadly more balanced, where Germany and France contributed a smaller 50% to total Euro area growth.


The Q1 2011 growth trajectory (top chart) is entirely consistent with ECB targeted at the core countries.

Rebecca Wilder

What? Greece has to raise capital in 2012 and meet a 7.5% deficit target this year?

Over the last couple of months, a string of events made policy makers and investors alike say, what? Greece must raise capital next year and meet a 7.5% deficit target this year? Yes, they do, unless circumstances change. It’s near impossible to bet successfully on what Euro area policy makers are going to do, so let’s just review the facts here.

Greece missed its 2010 budget deficit target by near 1%, 9.6% of GDP projected (see .pdf page 45) vs. 10.5% actual (see Eurostat release, .pdf). The 2011 target is 7.5% of GDP.

Greece needs to raise roughly 30 bn euro in the private market next year – see .pdf page 50 here, where the IMF projects that Greece will finance 40.3bn in 2012, up from the 11 bn required in 2011. Furthermore, they’ll need to issue debt with longer maturity than the 3-month bills they’ve been marketing this year. At 1200 basis points over German bunds on a 10yr note, Greece cannot ‘afford’ this and is very unlikely to be tapping markets for term loans anytime next year.

Greece’s privatisation plan – selling state-owned assets – is probably too aggressive, amounting to roughly 4% of GDP per year through 2015 (10 bn euro average per year, see .pdf of presentation here, as a percentage of average GDP spanning 2010-2012).

But here’s something that is really important, and another reason why I do not believe that Greece would voluntarily default until at least next year: they’re expected to run a primary surplus in 2012. I take note that one can challenge the IMF’s forecast, but it’s the best information that I have at this time.

The chart illustrates the IMF’s 2011 and 2012 primary balance forecast across the Euro area (16) from the April 2011 World Economic Outlook. Those countries above the zero axis are expected to run 2012 primary surpluses – Greece, Germany, and Italy.

The primary balance is general government net lending (borrowing) excluding net interest expense. Better put: if the government runs a primary surplus, tax revenues are sufficient to pay all the government’s bills except the interest payments on the outstanding debt. Restructuring when an economy is in primary surplus makes much more sense.

If Greece runs a primary surplus in 2012, it will have a strategic ‘default card’ to play. This year it doesn’t, or Greece still needs the EFSF/EU/IMF to finance its spending. Next year, Greece can say “hey, we don’t need your money anymore.”

What to expect

Barring an immediate secession, I anticipate that Greece’s ‘circumstances’ will change in one of two ways over the near term: (1) Greece terms out its loans – a very soft restructuring – in the amount of 30 bn euro (or roughly thereabouts), or (2) the EFSF raises another 30 bn – that’s what it’s for.

On default, there’s a body of literature that attempts to quantify the costs of sovereign default – see the Economist article for a short literature review. Broadly speaking, the true economic impact could be ‘short-lived’ but is difficult to measure (see specifically this IMF paper).

It all comes down to this: I’m Greece, and I’ve put through structural reform that gets me a primary surplus next year – why subject the economy to further depressionary austerity measures rather than haircut my creditors and start from scratch? It’s been done before (see Table 2 of this paper). Or, I’m Germany (or France), do I want to write a check to Greece? Or recapitalize my banks outright.

Rebecca Wilder

The re-balancing of trade within the Euro area: some improvement but not enough

I thought that the whole point of fiscal austerity was to turn the balance of trade and capital flow within the Euro area: debtors becoming savers and capital flows out of the Periphery and into to the core. We’re seeing the outset of such a shift; but it’s probably too slow in the making.

The chart below illustrates the trade balance (exports minus imports) within the Euro area (17) for key austerity – Ireland, Greece, Spain, and Italy – and core – Germany, France, and the Netherlands – countries. The data span the last six months and are normalized by the European Commission’s 2010 GDP estimate for each country (listed on the Eurostat website).

(Let me be clear here: the trade balances illustrated below include only trade flows within the Euro area.)

It should be noted that this is an incomplete picture, since there are 17 Euro area countries. However, the following point is worth noting: the balance of trade is arduously improving in Spain and Greece at the cost of just a small share of surplus in the core. To me, policy makers are grasping at straws when they stick to the ‘exports will grow the Periphery out of their debt problems’ story.

* The Netherlands’ intra-Euro area trade surplus increased near 2 pps to 22.6%.
* Italy’s intra-Euro area trade deficit hovered at just under -1% of GDP.
* Spain’s trade deficit improved somewhat, falling roughly 50 basis points to -0.5% of GDP – probably nothing to write home about, given that the economy’s facing a 20%+ unemployment rate.
* The Greek trade deficit improved 90 bps to -5.3% of GDP.
* Ireland remains as open as ever.
* The German surplus dropped 15 bps to 1.3% of GDP.

It is true, that the re-balancing will take time. Some will argue that it’s extra-euro area trade that will provide the impetus for growth in some of these countries (Spain, Ireland, Greece, the usual suspects). However, while exports to the extra-Euro area market have played an important role in some growth trajectories – Spain, for example – intra-Euro area trade is critical. Below I list the average share of total export income derived from within the Euro area:

Average share of exports (source: Eurostat and Angry Bear calcs)
40.9% 38.8% 41.5% 55.7% 48.6% 43.8% 62.0%
Germany Ireland Greece Spain France Italy Netherlands

How much more austerity and ‘competitiveness’ will it take to turn the tide here? Probably more than some are willing to give. A nominal devaluation is needed. Without that, it’s ultimately ‘bailout’ or ‘default’, or both.

A side note: it would have really helped if the ECB allowed prices in Germany, for example, to overshoot the 2% Euro area inflation target.

Rebecca Wilder

Greece will not be ‘allowed’ to default until policy shores up the Irish bond market

Just look at Tracy Alloway’s imagery at FT Alphaville, and you’ll know what’s expected: an imminent Greek default. I still argue no, although European policy tactics are quite enigmatic and their next move is really anyone’s guess. Alas, here’s mine.

Assuming that Greece does not secede from the Euro area, I give you three reasons why Greece will not be allowed to default soon (at least the next 12 months, given current market conditions). I say ‘allowed’ because true to the IMF legacy, EU/Euro area officials very likely see restructuring as a ‘gift’ for good fiscal behavior.

(1) Moral hazard is an important issue in Europe, and Greece has only begun its austerity program. We’ll need confirmation that they are not on track in order to assess the timing of default, in my view.

Ironically, the EU/IMF/Euro area are sticking to the ‘exports will grow the Greek economy’ story. I say ironically because Greece was exporting a larger share of GDP before the recession, average 22.6% spanning 2005-2007, than it is now, 19.8% in 2010 (average Q1-Q3).

(2) The banking system’s not ready. Unless the Germans want to instantly recapitalize the Landesbanks this year, I’d argue that the Euro banking system remains overly exposed to mark-to-market accounting (i.e. holding the assets at fair value not wishful thinking) for all of the crappy debt that it holds on balance.

In fact, the German banks purchased 11bn 1.1bn euro in Greek sovereign bonds in January. That’s the most current data available; but I bet they’re simply moving debt out of the Greek banks and corporates and into the sovereign as the probability of default rises (see chart below).

(3) This one’s critical: policy makers must shore up Ireland and Portugal in order to avoid a quick contagion across the European banking system. They haven’t done that yet. In fact, the Finnish election results exposed the tenuous negotiation process overall.

See, the Greek yield curve is inverted – so are the Portuguese and Irish yield curves, albeit to a much lesser degree. The point is, that Portugal and Ireland are very close to the Greek brink.
(read more after the jump!)

Inversion matters. Currently a Greek 10yr bond yields 14.5% with a euro price of 59, while a 2-yr bond yields 21.4% with a euro price of 73. Bond investors are going for the cheapest bond not the highest yield (at the end of the yield curve) as a bet on a binary situation: haircut or no haircut. When a curve is inverted, it’s all about price not yield.

Portugal and Ireland are already inverted and close to the Greek brink. If Greece were to restructure without a full-fledged backstop from the Euro area governments, the Portuguese and Irish curves would swiftly turn over. And if European policy makers could stop the contagion there, then that would be a true feat….

Spain, the economic ‘line in the sand’, would be next. We saw last week how markets view the Spanish sovereign, still risky. Bond yields on the Spanish 10yr broke out of a 4-month trading band, hitting 5.55% on April 18 (latest number is 5.47%).

More on Ireland

I assure you, that it’s too early to deem the Irish sovereign as impervious to the Irish banking system’s fake asset base. The banking system is living on emergency liquidity assistance (ELA) and the ECB’s marginal refinancing operations (currently Irish banks can borrow as much as they want on a short-term basis from the ECB at the current rate, 1.25%).

By my calculations, the Central Bank of Ireland (via the ELA) and the ECB are subsidizing – I say subsidizing because market funding costs are proxied by the sovereign borrowing costs of 10% – 16% of the Irish banking system’s balance sheet. As such, profit margins are thin, and mortgage rates are running low at 3-4%. (see CBI website for plenty of data.) These funding costs are not sustainable – not to mention the Irish stress tests assume that they remain fixed at Q4 2010 levels (see exhibit 2 in Appendix C of the stress test documentation). Nonperforming loans will rise.

I leave you with this illustration of possible non-performing loans when mortgage rates rise on the following:

(A) ECB rate hikes – mortgages are tied to 12-month euribor and most Irish mortgages are variable.
(B) the dissipation of record-low bank borrowing costs (this also is another post, but the ECB has yet to release its medium-term funding program for Ireland).

Note: if/when they do default, Kash at the Street Light blog provides an overview of some technical considerations.

Rebecca Wilder

ECB policy is tightening – has been for some time

Update: Nouriel Roubini front pages this post on Euromonitor here.

The ECB dove in and hiked its policy rate by 25 basis points to 1.25%. I had the pleasure of listening to Wolfgang Munchau on Thursday, and he reiterated what I reluctantly understood: the ECB’s strict inflation target is ridiculously simple for such a complex region; but more importantly, the Governing Council is just itching to tighten.

Eurointelligence blog highlights the various interpretations of the ECB’s shift in policy: Thomas Mayer at Deutsche Bank suggests that the ECB’s normalization is appropriate, while David Beckworth and others (links at Beckworth’s site) are more sympathetic to the impact on the Periphery. They highlight that relative price fluctuations could facilitate the much-needed redistribution of capital flows (i.e., the current account); and furthermore, that ECB policy is even too tight for the core (a google translation of Kantoos Economics). Yours truly has written extensively about this – among others, here’s one, another, and another. Who’s right? Ultimately time will tell.

But I do suspect that we haven’t seen the end of this crisis. The ECB is squeezing out liquidity when more liquidity is needed. Furthermore, the core remains subject to export shocks via external demand; and there’s building evidence that global growth will slow (see this excellent post on global PMIs by Edward Hugh).

It’s ironic, too. While the ECB is currently being heralded or chastised for raising rates, monetary and financial conditions in Europe have been tight for some time, both on a relative and stand-alone basis!
(read more after the jump!)

First, the ECB’s bond purchase programs, the Securities Market Programme and the Covered Bond Purchase program, amount to just 1.4% of 2010 Eurozone GDP. In stark contrast, the size of the Fed’s program broke 16% (and is rising) and the Bank of England’s purchase program remains firm at around 13% of GDP.


The asset purchase programs are emergence liquidity programs and are not normal monetary policy tools. But while the Fed and the BoE do not sterilize their flows, the ECB does. And my interpretation of ECB rhetoric and policy as of late is that they want out of the secondary-bond purchase business. For example, they’ve slowed their SMP purchases markedly in 2011 (see the ad-hoc announcements here).

Second, Eurozone financial conditions have been tightening since August 2010, while those in the US and England loosened up. Goldman Sachs constructs a financial conditions index, which is comprised of real interest rates (long and short), real exchange rates, and equity market capitalization. I love this index (subscription required), as it represents a broad measure of monetary policy pass-through.

Even though the ECB just started its rate-hiking cycle, they’ve been effectively tightening for some time.

I would say that Eurozone (as a whole) growth prospects are seriously challenged at this time, especially by comparing monetary policy to that in England and the US. We’ll see if the ECB’s able to push its target rate back to 2.5-3% through 2012 – I suspect that may be just a pipe dream, as tight liquidity and a slowing global economy drag economic growth.

The ECB’s actions imply to me that they still do not understand the following: Europe faces a banking crisis not a fiscal crisis!

Rebecca Wilder