Shocks and Surprises, Week Ending April 27th

• Eurozone data is unambiguous that recession is lengthened, broadened and intensified in April. The ECB already has leveraged its balance sheet, but banks are still tightening lending conditions, so very little time has been bought very expensively.
• US data confirming a rapid U-turn in capital spending plans as industrial sector enters a soft patch. This looks like a tweaking of schedules to accommodate slightly weaker-than-expected demand, not a fundamental cyclical turning-point.
• China and Japan delivered negligible shocks or surprises, with both economies showing modestly strengthening trends.
• Taiwan leading and coincident indicators break up out of a year's miserable trend. Hong Kong's trade data disappoints – but is it covert capital flows disappearing?

Sometimes, the numbers tell their own story. Of the 84 pieces of data which I've logged this week, exactly half arrived within a standard deviation of the consensus forecast, or within a standard deviation of current trends. For the rest, it was a week of unusually gathering economic misery: there were 30 negative shocks, of which 18 came from Europe, compared with only 12 positive surprises, of which five came from the US.

Eurozone - Recession Intensifies and Broadens. What Now?

So we should start with Europe. This was the week in which it not only because clear that the Eurozone is not escaping recession, but worse – that the recession is most likely intensifying in 2Q, contrary to consensus expectation. The news to this effect came so thick and fast throughout the week that one can hardly mention it all. On Monday we had the April PMI readings which showed the manufacturing, services and composite PMIs all falling shockingly below expectations, with manufacturing in particular at a 34 month low. Worse, there were shocks in the core of the core: the German manufacturing PMI was the worst for 33 months, and whilst the French services PMIs was the weakest since October 2011. Later in the week a series of confidence surveys measuring general economic sentiment, as well as specific industrial and service sector confidence confirmed the deterioration in the environment. But by this time, the 'shock' factor was purely statistical, the insouciant belief displayed by the consensus that things weren't getting any worse looking extremely vulnerable even before the data was released. Nor was that the end of the shocks: French consumer spending fell 2% YoY, whilst the number of French jobseekers jumped 6.7% YoY; German consumer confidence fell back to December 2011 levels; Italian business confidence levels slumped to the worst reading in the series' history; and the UK service sector activity fell 0.4% MoM. None of these results were anticipated in the range of economists' expectations.

The complacent expectation that intensifying fiscal austerity softened only by the ECB's cheap three-year bank funding program could lead to anything else but deepening recession in the short term is difficult to explain. It was a belief, however, which was expressed in some detail in the economic consensus. It is difficult to explain this professional complacency.

That the consensus is failing means a new set of questions will now be raised. The most urgent of these is what more the ECB should and can do to ease monetary policy. The long term refinancing operations of the last few months have lifted the central banks' total assets/capital leverage ratio from around 25x in mid-2011, to around 35x now. But that extra money appears simply to have encouraged the banks to hold yet greater quantities of government paper (of deteriorating credit quality) whilst at the same time cutting lending to the private sector. This was confirmed by an ECB survey this week which showed that banks continued to tighten lending standards to the private sector yet more during 1Q12. So far the ECB has not even really managed to buy time in exchange for leveraging its balance sheet. So where does it go from here?

Outside the Eurozone, the UK's 1Q GDP preliminary results also suggested a recession, with the economy contracting 0.2% QoQ. Markets discounted, or rather dismissed the news within hours, noting that the key 3% YoY contraction in construction contradicted a series of surveys which had pointed to unusual strength in the sector.

US - Evasive Action

In the US, the shocks and surprises were evenly matched for a good reason: this was the week which saw the clearest evidence of US industry pulling a U-turn to avoid getting side-swiped by the Eurozone's car-crash. The message could hardly have been made clearer than in the monthly report on durable goods. First there was a positive surprise, that shipments of capital goods (non-defence, ex-air) had jumped 2.6% MoM – well above expectations – driven by a 6.5% MoM jump in shipments of machinery, and a 2.1% rise in shipments of electrical equipment. Yet the same report brought shock that total orders for durable goods fell an alarming 4.2% MoM. Although this fall was exaggerated by a near-halving of orders for civil aircraft, the remaining fall of 0.8% MoM in orders for capital goods (non-defence, ex-air) was also outside the range of expectations. The combination of unexpectedly heavy shipments of capital goods, accompanied by an unexpected fall in orders tells its own story of an abrupt scaling back in near-term capex plans. My view is that this reaction has arrived early and the US's 'soft patch' should this year be seen as precautionary and preventative rather than anything seriously cyclical.

The other feature of the US week was surprising strength regained by the property market, with positive surprises on pending home sales (up 4.1%), new home sales (surprising strength in March, plus upward revisions for previous months), and a rise of 0.3% MoM in the house price index for February.

Japan. China and NE Asia  - Loads of Data, Few Surprises

Although this was the big week of the month for Japanese data, with no fewer than 10 major data releases on Friday alone, there were no surprises at all, and only two negative shocks: industrial production rose only 1% MoM (vs central expectation of 2.3%), and housing starts also disappointed. Every other data-stream fell within consensus, or in line with current trends. There was nothing here that need force a rethink of the expectation that Japan's economy has started an unlikely upward curve.

By contrast with Japan, there was very little data from China this week, and none which delivered shocks or surprises. The HSBC Manufacturing PMI flash reading showed a modest but broadly-based improvement on the month, whilst remaining below the expansion/contraction line of 50. The Conference Board Leading index rose 0.8%, without breaking the current upward trend, with the easing of loan conditions providing a significant part of the impetus.

Elsewhere in Asia, there was one shock and one surprise which may be important. The surprise came from Taiwan, where for the first time for a year, the Composite Index of Coincident Indicators gave a positive reading, despite still-negative reports from exports and wholesale/retail sales. This improvement clearly broke trend. So too did the set of Leading Indicators, partly on the back of an improvement in the SEMI book-to-bill ratio to 1.13 in March from 1.01 in February. The ratio of Leading Indicators to Coincident Indicators is still rising, so this is a constellation both unexpected and extremely positive.

The shock came from Hong Kong's March trade, where exports shockingly fell 6.8% YoY, mainly thanks to an 8.1% YoY fall in exports to China, whilst imports fell 4.7% YoY, mainly reflecting a 4.5% YoY fall in imports from the US. It is not easy to interpret these numbers as faithful indicators of the state of China's economy. Historically, HK-China import and exports numbers have been inflated or deflated by widescale under-invoicing or over-invoicing, reflecting traders desire to move capital into and out of a China which was subject to more or less effective capital controls. As those capital controls loosen, we must assume that this practice will dwindle. It may take some time for the data to settle down.