Something different for today: world trade. Recently, South Korea and Taiwan released July 2012 trade statistics, where annual export growth was seen contracting at a 8.8% and 11.6% rate, respectively. The annual pace of export growth in Taiwan contracted for the fifth consecutive month, where that in South Korea turned negative following a 1.1% annual rate in June 2012.
On balance, exports in key Asian markets, such as South Korea, Taiwan, and China, are seen as leading indicators for world demand due to their intermediate nature of production in the supply chain. And the signal there is not good for global demand.
The correlation between the 3-month percentage annual rate of change of world trade and the global PMI have a 77% correlation dating back to 1998. Although the world trade statistics are current as of May 2012, the June and July global PMI, 49.1 and 48.4, respectively, do confirm the weakness seen in the Asian country export data and portend deterioration in this measure of world trade.
A simple bivariate regression of the 3-month growth trend in world trade on the global PMI implies a 3-month annualized contraction of 0.66% in July. This is far from the pace of contraction in 2009 – according to this statistic, World trade declined at its fastest 3-month trend rate in January 2009 of 50.5%. Furthermore, there’s no precipitous downtrend in the PMI that would suggest a sharp contraction in world trade.
I can only conclude that it’s too early to call stabilization in World trade, rather the opposite. However, the pace of contraction could be quite mild if policy makers ease globally.
Today Eurostat released its June estimate of real retail sales for the Euro area. On a month/month basis, real retail sales increased at a rate of 0.1%. However, on a trended basis, the 3-month/3-month average growth rate was down 0.7% in the three months ending in June. Given that the 3-month trended pace of contraction quickened compared to Q1, real consumption is likely to detract from Q2 GDP growth (spending components released on August 23).
On a Y/Y growth basis, there’s a 96% correlation between real retail sales and real private consumption by households and non-profit institutions. Using a simple linear regression, the annual growth rate of consumption should stabilize somewhat in Q2 compared to Q1. \
Across the region, real retail sales in Ireland, Estonia, and Germany are the only reported countries to see growth through Q2.
Note: the chart below illustrates the 3-Month/3-Month growth rate through June 2012 (Q2/Q1).
On balance, Q2 domestic consumption spending in the Euro area is expected to be buoyed by Germany through June. The problem is, German retail sales growth have just a 38% correlation with real consumption growth, so the bump in retail sales won’t necessarily feed through to consumption at the aggregate level. Euro area real consumption is still contracting. The question then becomes: will the pace of consumption contraction increase or decrease in coming quarters? We’ll have to watch leading indicators such as retail and consumer confidence, both of which deteriorated in July.
Mario Draghi cautioned on the ‘hampered’ transmission channel of monetary policy in his now famous London speech last week:
To the extent that the size of these sovereign premia hampers the functioning of the monetary policy transmission channel, they come within our mandate.
I referred to the clogging of rates policy back in April via evidence from mortgage lending rates.
I address Draghi’s point that the ECB 1% refi rate will support economic activity through the lens of the mortgage market. Specifically, I find that the interest rate channel is clogged in the economies that are in most desperate need of lower rates: Spain, Portugal, and Italy.
Here I show that on a relative basis, while the household lending rate is quietly trending down for key periphery markets, the real problem lies in the non-financial corporate rates transmission channel. Specifically, rates in Portugal, Italy, and Spain have seriously diverged from both the trend in the refi rate (ECB policy rate) and those of other countries in the Euro area.
The trend in key periphery household mortgage rates is consistent with the ECB rate cuts: down Note: All ECB refi rate data is through June 2012, so the latest rate cut to 75 bps is not included in the charts.
The magnitude still favors the core – the drop in German mortgage rates is 91 basis points since the max mortgage rate of the Euro area as a whole in August 2011 – but the trend is down for all countries.
In stark contrast to the trend in household mortgages relative to the ECB refi rate, non-financial corporate lending rates in Portugal, Spain, and Italy diverged from the other country trends.
If the ECB means business on improving the monetary transmission channel, they’ll need to attack the price of corporate loans in the Periphery markets.
Data Note: All non-financial corporate AAR lending rates is the annualized agreed rate on new business loans with a maturity of greater than 5 years and amount between €0.25 bn and €1 bn. Irish data is not available in Ireland and the Greek data is too sporadic.
Of note, the service industries in both Germany and Belgium may offer a “ray of hope” (the Ifo Institute puts it.), as these large economic sectors are perhaps stabilizing in the surveys.
Furthermore, consumer confidence in the Netherlands and Italy remain depressed. Notably, the July prints increased 8 and 1.1 points, respectively, over the month – is this the start of a trend, or rather a dead-cat bounce? If I were a betting girl, I’d go with the latter, given the weakness in labor markets and election cycles coming up (September in the Netherlands and TBA in Italy).
In Germany, the Ifo survey has deteriorated swiftly in recent months. This now brings this survey more in line with other business surveys, such as the German PMI, which had shown a more pronounced economic decline.
The Ifo Business Climate survey contains a wealth of information, but is generally dissected into assessment of the current business situation and expectations of the future business environment. The current environment survey, 111.6 in July, fell over the month but remains above the longer term average, 102. In contrast, expectations as regards the future business environment are falling swiftly. The Euro area crisis is impacting the business decision process.
Finally, as demonstrated in the Ifo Business Climate survey that highlighted its ‘significant deterioration’, the manufacturing base is leading the way down. In France and Germany, Markit Manufacturing PMIs hit the low 40s, 43.6 and 43.3, respectively in July. This implies a quickening of the pace of contraction across the French and German manufacturing bases with not much hope of near-term relief, neither from domestic nor foreign demand. The Dutch Statistical Agency, CBS, today reported further decline of Dutch manufacturing opinions in July, as manufacturers anticipate layoffs.
My only question becomes how much weakness is needed in the core (Germany) to get a(nother) significant response from the ECB?
Euro Area Imbalances Are a Symptom of the Broader Global Imbalances
Every year I travel to Germany to visit my in-laws, which is where I am now. Given the extra time on my hands, I’ve now mulled over a June 2012 NY Times opinion piece by Gunnar Beck. Beck displays an interesting medley of data in support of his view that Germany cannot afford to backstop the European Monetary Union (the single currency union referred to as the Euro area, or EA). Germany itself has been the loser, not the winner, of the single currency union. His comments are loosely based on the research of the Ifo Institute’s Hans-Werner Sinn.
Based on the ideas of Beck and Sinn, I start a short series on the benefits of membership in the EA, ex-post and ex-ante. The conclusion from this initial post: Some call the EA a microcosm of the world imbalances, i.e., Germany is to China as Spain is to the US. I disagree. I’d argue that the EA imbalances are a function of, rather than a mirror of, the broader global imbalances.
Let’s start by looking at the simple net trade statistics as rents derived by membership in the EA since 1999. I further Beck’s analysis on intra-EA trade (trade among the EA countries) for the original 1999 EA 11 economies. The 11 economies to meet the convergence criteria by 1999 were: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland.
By definition, the trade balance is the difference between total exports and total imports, both of which are affected by relative prices and membership in the EA.
The chart below illustrates the change in the annual intra-EA trade balance as a share of GDP during the period 1999 to 2011. Spanning the years 1999-2011, intra-EA gains from the fixed exchange rate regime within the EA have been lopsided toward Spain, Portugal, and the Netherlands.
(Note: for consistency, I use the EA 17 economies as the ‘trading partner’ for the period in the chart below. Furthermore, notice that the axis points in both charts are equal for ease of comparison.)
Being a port economy, the Dutch trade ties to the EA are strong, and gains from EA trading partners have been robust, +11% of GDP spanning the years 1999-2011. Portugal and Spain have likewise benefited, however, their intra-EA net trade gains occurred exclusively since 2008. Of interest, Finland fares the worst, having seen a 5.1% (of GDP) decline in its net trade with EA partners. And Ireland, for all its praise (please see current account stats on Ireland here ), saw its intra-EA net trade decline by 5% of GDP while in the EA – admittedly, there’s been a 4.2% of GDP gain in net trade with the EA since 2008.
Who are the winners of intra-EA trade spanning the entirety of the Euro Area? As demonstrated above, not many countries. The gains from trade came primarily from net exports from developed economies outside the EA (while I do not include a country breakdown, the large net importers are the developed economies – see the IMF WEO database).
The chart above illustrates the change in the annual total trade balance (extra- plus intra-) of the EA 11 as a share of GDP spanning the period 1999 to 2011. Here, the gains from trade are a bit less lopsided and the ‘usual suspects’ are evident. Germany was the third best performing economy by this measure, where net trade increased an average of 2.8% of GDP over the period. The Netherlands benefited the most of the EA 11; but the improvement was based exclusively on intra-EA trade. Portugal experienced gains from net trade from the rest of the world and the EA, where the total trade balance improved by 3.2% of GDP (again, exclusively in the post 2008 period).
Of note, France performed poorly on both counts: intra- and total net trade, -3.2% and -4.9% of GDP, respectively. In contrast, Germany performed relatively well. Being the largest economies in the EA, and given that the absolute value of the total trade balances (either deficit or surplus) exceed that of their respective intra-EA balances, I hypothesize that the global imbalances exacerbated, even caused, the EA imbalances.
Thus, EA imbalances are not a microcosm of the broader global imbalances, rather a symptom of global trade policy.
Confidence Indicators Deteriorated Significantly This Week
This week national confidence surveys rolled in with just one story: the economic infection in Europe is spreading. Business confidence indicators in France and Germany declined 1.1% and 1.6%, respectively, in the month of June. In Italy consumer confidence hit another record low since 1996 of 85.3 after falling 1.4% in June.
The National Bank of Belgium and Statistics Netherlands released their balance measures of consumer confidence. Both balances fell 2 points over the month of June. Notably, consumer confidence in the Netherlands is depressed, hitting a record low since 1986 at -40 in June.
These are highly credible indices with robust correlations with hard data like real retail sales and production. Given the precipitous decline in confidence, it’s hard to imagine how European economic sentiment will turn around without truly innovative policy action.
This article at Voxeu reminded me that exchange rate pegs might come back in vogue. Voxeu has an article on the “trilemma” of ’emerging’ economies:
Do sterilised interventions allow countries a way around the fundamental trilemma of international finance by providing them with a means of systematically affecting exchange rates independent of their monetary policies? Japan, Switzerland, and China provide some lessons… … The fundamental trilemma of international finance maintains that a country cannot simultaneously peg an exchange rate, maintain an independent monetary policy, and permit free cross-border financial flows (Feenstra and Taylor 2008). At best, only two of the three are feasible.
Lifted from a note, Rebecca Wilder writes in an informal e-mail:
I found it rather difficult to read. But this idea of trilemma is not broadly applicable to developed markets except Switzerland – they did address that. I don’t know, the one thing that I do notice, is that the trade ‘imbalances’ are not really moving back into ‘balance’ neither in Europe nor globally. Thus, something’s gotta give at some point; I suspect that it’ll be exchange rate pegs.
Eurostat released its volume-adjusted estimate of construction for April (release here, .pdf). Over the month, Euro area construction declined 2.75% following a large 11.41% monthly increase in March. Across the countries that make monthly data available (8 countries total), Slovenia and Portugal saw the largest decline in April construction activity, -9.3% and -6.7%, respectively, while France was the only country to see an increase in construction, +2.3%. The trend is clearly down, as 3-month over 3-month Euro area construction declined 4.8% through April.
Germany is getting a bit bubbly as regards domestic construction. This shouldn’t be surprising, given that longer dated bunds (even the 10yr) are negative on a real ex-post basis, i.e., using historical measures of inflation.
Note: I re-scaled the volume-adjusted indices to 2001=100 to fully capture the bubble in countries like Spain – the bubble illustration wouldn’t be quite as obvious with Eurostat’s index to 2005. Furthermore, the chart illustrates the monthly construction, while some countries, like Greece or Ireland, for example, list construction solely on a quarterly basis. Eurostat simply estimates construction in these countries to produce the Euro area aggregate on a monthly basis.
Going forward, this construction data does give real-time evidence that the German economy is moving marginally toward domestic-led growth….or we’re seeing the outset of a bubble in German construction
Euro area consumer prices increased at a 2.4% annual pace in May, down 0.2 ppt from the 2.6% pace in April. Core inflation fell to 1.8% in May from 1.9% in April. Headline and core inflation peaked in the fourth quarter of 2011, and disinflation is underway.
Euro area price inflation is burning out but at a very slow pace.
The 0.6 ppt differential between headline and core inflation is explained by energy and unprocessed food prices. In May, the energy component in HICP (harmonized index of consumer prices) fell 1.4% over the month and posted a 7.3% pace compared to May 2011. Energy prices peaked in April 2012, but base effects will prop up headline inflation through early 2013 even if energy prices go unchanged over the near term. That means headline inflation could be sticky for some time above 2%. But core inflation is not.
President Draghi often speaks of the upward pressure on inflation stemming from tax hikes across the various fiscal austerity programs. Stripping out the tax effects (this data is provided by Eurostat), the theoretical inflation rates in Portugal and Italy are 1.8ppt and 0.8ppt, respectively, below the headline rate. The downward pressure on inflation may quicken through next year, as the effects of VAT and various tax hikes wear off across the region…barring a miraculously robust economic recovery, of course.
(Note: In the chart below, the black line represents 0% difference between headline inflation and tax-adjusted inflation. For orange triangles above the black line, headline inflation is above tax-adjusted inflation, i.e., taxes are boosting aggregate prices.)
Inflation takes time to build, so this disinflationary trend is unlikely to change anytime soon without significant policy accommodation.
Euro Area ‘Hard Data’ Catching Up with the ‘Soft Data’ – Industrial Production
Euro area industrial production (ex construction) declined 0.8% in the month of April. Across the major sectors, the largest decline occurred in capital goods; however, the trend in consumer and intermediate goods is worse than that of capital goods.
The regional divergence is clear, as the two-month trend in industrial production – I use the two month trend since this series is quite volatile month-to-month – is strongest in Luxembourg, Slovakia, Slovenia, and Ireland, and weakest in the Netherlands, Spain, Estonia, and Greece. (much more below the fold)
Another way to look at the divergence is to plot German production against the rest of Europe. It’s evident that Germany, with its large 35% weight in this index, is propping up the average. German industrial production is 10% above 2005 levels, while the Euro area ex Germany’s industrial production is 8% below levels in 2005. That’s an 18 ppt divergence.
Finally, a comparison to the US is illustrative. The US industrial sector is outperforming that in Europe, as production continues its positive trend with relatively easy fiscal and monetary policy accommodating the private sector’s desire to save. The US production base is 2% above that in 2005, while that in the euro area (including Germany) is 2% below.
In all, the euro area April industrial production release points to further divergence in growth prospects and a very weak start to the second quarter of 2012. The ‘hard data’ seems to be catching up with the weak ‘soft data’, like the PMIs (see Edward Hugh’s summary on the Euro area PMI).