Tuesday 29 May 2012

What We Are Thinking (WWAT?)


The curious flirtation with statistical normality which we noticed in last week's Shocks & Surprises is echoed in the pattern of Google searches, as regards growth vs recession, and inflation vs deflation.

This is particularly noticeable in the change of search patterns for 'inflation' relative to 'deflation'. As the chart below shows, the re-eruption of the Eurozone crisis in early and mid-May got people thinking more actively about deflation than inflation, with the peak of the change coming in the ten days to May 13th. If that change in search patterns was driven by fears of deflation -as seems likely – then the chart also suggests the worry was short-lived. We are currently back to a pattern which is, perhaps, 'normal'.  

There is a similar recovery in search patterns of 'growth & recovery' compared with 'recession & depression.' The tilt towards 'recession & depression' interest captured by the pattern of Google searches started at the beginning of April, and climaxes at the beginning of May. Quite dramatically during the last 10 days, that pattern has changed again, until once again, we are back with a pattern of interest which looks 'normal'.

But there is something worth pointing out: if the world's sudden surge in interest in deflation and depression was short-lived, its impact on US bond markets has not been. As we have previously pointed out, US bond markets have previously seemed very alive to shifts in global sentiment (if that's the beast we're tracking with these Google search analytics). Not this time: so far US bond markets do not believe in a recovered 'normality'.  Not so far. . . . 

  

Sunday 27 May 2012

Shocks & Surprises, Week Ending May 26th


The guiding principal of Shocks & Surprises is that it identifies that data which falls one standard deviation above or below the range of consensus expectations, or in the absence of a surveyed consensus, more than a standard deviation outside identifiable current trends.

One of the upshots of this is that if these Shocks & Surprises are distributed normally, we should expect roughly 16% of the data to Shock and 16% to Surprise, and the remaining 68% to conform to consensus or trend. That would represent a state of affairs we might call 'normality'. Over the last six weeks, we been a long way from normality: typically between 45% and on occasion 60% of the data coming across our screens has been either Shocking or Surprising. Statistically we have been living in distinctly non-normal times. I am sure you have noticed.

What is less obvious is that, news headlines notwithstanding, the last couple of weeks may be edging back to normality, in the sense that the economic data is beginning to conform once more to statistical normality. This is not wholly or solely a matter of the financial industry's stable of economists reconciling their short-term forecasts to the new reality; it also includes a reassertion of historic seasonal patterns, albeit perhaps at slightly lower levels than previously expected. Thus, two weeks ago, the proportion of Shocks & Surprises fell to 43.1%, and this last week it sank to 35.2% of the 70 pieces of data I tracked - which is within roughly three percentage points of statistical 'normality'.

More, the only part of the world which is still delivering a statistically abnormal proportion of Shocks & Surprises is, of course, Europe. In the US certainly, but also within Asia as a whole, we are no longer in abnormal territory.

So we must start with Europe, where this last week brought the advance readings of manufacturing PMIs for May. Dire reading they made, with Germany, France and the rest of the Eurozone showing the worst readings for around three years, and with new orders shrinking fast owing to faltering domestic demand more than falling export interest. In the UK, the CBI Trends Total Orders survey gave the same message, as it retreated to levels last seen in December, although export orders eased only marginally. Germany's Ifo Institute also published their monthly survey of Germany business sentiment, with readings for overall Business Climate, Current Conditions and Expectations all falling below the level of expectations – although even now German business expectations are running higher than the long-term average for the series. There's no such mitigation for Italian Consumer Confidence, which for the second successive month explored previously untouched depths of gloom: a reflection on the outlook for the national economy rather than current individual economic and financial experience.

Even in Europe, however, positive surprises remain. The Eurozone's construction output for March surprised, jumping 12.4% mom as the zone recovered (Germany particularly) from February's construction-halting freeze. In addition, there were two sharply positive surprises from the UK, when March output of services rose 0.5% mom, and April's budget cash surplus was roughly four times bigger than the previous year (and expectations). The regular run of UK data for 1Q becomes increasingly difficult to reconcile with the 0.3% qoq GDP contraction recorded in the national accounts.

The US gave us two surprises this week. The first was a 1.8% mom rise in the Federal Housing Finance Agency house price index: to put this into context, it was the highest monthly jump for at least the last 10 years, with prices jumping all across the US. There's no other real estate data reporting this sort of a jump, so for the time being it remains an unexplained anomaly, raising the suspicion that there's something surprising about the way the data has been produced, rather than it telling us something genuinely surprising about improving conditions in the US real estate market. The second surprise looks far more convincing: the final version of the Uni of Michigan Consumer Confidence survey for May contained a very sharp upward revision in the 'economic outlook' reading, which took the total index to its highest level since October 2007.

Set against that, orders for capital goods, excluding defence and aircraft, contracted 1.9% mom in April, extending a run that's really souring fast: January orders fell 3.1% mom, in February they rose 2.9%; in March they fell 2.2% and now in April they are down 1.9%.

Asia brought no positive surprises at all during the week, but few shocks either. The HSBC Manufacturing PMI for China made headlines as it retreated to 48.7 in May from 49.3 in April, but although this was towards the bottom end of current trends, it did not break them. Rather, the Shocks came elsewhere: Japan's 7.9% yoy rise in exports in April disappointed (exports to China fell 12.4% mom); Taiwan's April export orders shocked by falling 3.5% yoy (mainly thanks to a 8.2% mom fall in orders from US and 7.1% mom fall in orders from China and HK); and Singapore's industrial production also disappointed by falling 3.5% mom and 0.3% yoy in April.  

Friday 25 May 2012

There Are Also Reindeer


"Fantastic grow the evening gowns;
Agents of the Fisc pursue
Absconding tax-defaulters through
The sewers of provincial towns."
Raise a cheer for St Louis Fed President James Bullard who sat down with Reuters earlier this week and told them: 'I'm one that thinks that Greece could exit, and it could be handled in an appropriate way without causing too much damage, either in Europe or in the US.'

I've previously tracked how foreign banks in New York and London, including European banks, have restructured their offshore balance sheets to an extremely conservative stance. To those outside the Eurozone's political cluster it seems obvious that recovery from Southern Europe's Depression won't begin before they are set free from the hobbles of a wrongly-pegged faux gold standard. It also seems certain that the 'bad equilibria' between public and private sectors of the economy in Southern Europe are intensifying dramatically right now (see this story, for example), and that if post-Euro these countries get a chance to migrate to a 'good equilibrium' then their recoveries could be surprisingly dramatic.

Mostly, Bullard's comments remind us this is no longer just a financial or economic crisis (though it is that, right enough), but fundamentally a crisis of European politicians' unwillingness to confront  their own failure. Instead, like damned souls, they shuffle endlessly into windowless rooms (18 times in the last two years) in the hope, presumably, that the world will be different in the morning.

But perhaps we need not join them. As the Euro's denoument draws nearer, a curious thing is happening: CDS markets are beginning very gently to consider whether Bullard might be right. The correlations between movements in CDS rates in Europe and elsewhere cannot but be high, but the 30-day correlations have peaked for both Asia and Europe, and are now falling. For the US, in particular, the correlation is now below the average since August 2011 (which I measure as the start of the true end-game for the Euro).

For the crisis of the Eurozone is not the only thing happening in the world. Or, as Auden ended the poem:
“Altogether elsewhere, vast
Herds of reindeer move across
Miles and miles of golden moss,
Silently and very fast."

Wednesday 23 May 2012

US Savers Turned the Screw in 1Q


  • US Cyclical Factors including ROC and Real Labour Productivity Remain Sharply Positive
  • But Deleveraging Accelerated Again in 1Q, Pushing Up Private Sector Savings Surplus , and and Pushing Down Loan / Deposit Ratios
  • Renewed deleveraging is anomalous, and is not reflected in asset prices or straightforward risk measurements
  • Renewed deleveraging is anomalous at a time of exceptionally bad bond-market value
  • So the Growth Risk for the Rest of the Year Remains on the Upside

We now have quarterly GDP numbers for the world's major economies, so it's time to start tracking movements in the fundamental ratios which structure the world's business cycles, starting with the US.

Our view based on these ratios for 4Q11 were (in this piece)as follows: “. . . by our estimate returns on capital are around their highest since 2000 and are still rising, which will continue to foster investment spending; labour productivity continues to grow (adjusted for changes in capital stock), which will underpin the slowly- accelerating addition of jobs; and, most importantly, we believe that the net develeraging of the economy which started in 2008 is now complete. We do not expect significant re-leveraging to take place this year, but the mere fact that deleveraging is no longer the key dynamic will shift the economy out of its modest 2.4% annualized growth trend which it has sustained since the end of the recession in 2009 and towards a 3%+ rate.”

How much of that is still right? The good news is that returns on both capital and labour continue to rise, at an accelerating pace – the best underlying news for a sustained business cycle upswing.

ROC is still climbing, and this continues to fire major capital investment spending: in nominal terms, total fixed capital investment jumped at an annualized pace of 20.8% during 1Q. In real terms, private capital spending rose only a miserable 1.4% annualized - but there seems to be an unaccounted seasonal factor at work depressing the 1Q investment numbers, since this was the best 1Q reading since 2006. Overall, nominal capital stock is probably growing around 1.2% a year – still less than half the c4% yoy nominal GDP growth, so we should expect ROCs to continue to rise along with asset turns.

Real output per worker, adjusted for capital stock per worker, also accelerated mildly to 3% during 1Q, an inflection from from 2.8% in 4Q10 which should be enough to sustain improvements in the labour market. 
As far as margins are concerned, the US international terms of trade have held steady since they bottomed out in December 2011: since then export prices have risen 2%, whilst import prices have risen just 1%.

All of this suggests the US cycle should be in buoyant good health. But it doesn't seem to be: the 2.2% annualized GDP growth recorded in 1Q was lower than I expected, and a retreat from the 3% of 4Q11. And there's probably more on the way, since the GDP data disappointed even before the 'soft patch' began to show up in the data for April and May's economy.

I have previously explained the origins of that 'soft patch' in the industrial sector, using changes in momentum of output, domestic demand, inventory and export demand. I think that analysis is both correct and useful . . . . but also incomplete.

For the big disappointment of 1Q is that deleveraging had not stopped, as I expected. Rather, it re-started and re-intensified – and it is that which so far is the decisive factor in the US recovery. One can capture this by two counts. First, the private sector savings surplus jumped to 8% of GDP in 1Q from 5.2% in 4Q11. There are strong seasonal factors at work, but nevertheless, that jump was sufficient to push up the 12m ratio to 4.7% of GDP, from 3.8% during calendar 2011. This is the only quarter since 2009 that the PSSS has risen significantly. 
Second, the same story is written in the banking system's balance sheet: during 4Q11 banks' loan to deposit ratio stood at 81.8%, and was rising gently, having seemingly bottomed out in 3Q11. But by early May 2011, the ratio had fallen again, to 80.8%, with deposits rising US$153bn since the beginning of the year, compared to a rise of only US$70bn for loans. 
Awaiting Eurogeddon, it may seem obvious that caution must reassert itself. But, of course, the timing doesn't fit. More, reawakened caution was not obviously reflected – and frankly, still is not obviously reflected – in US financial asset prices. During 1Q, most measurements of risk were in retreat: 5y bank CDS rates declined to average 201bps in 1Q12 from 252bps in 4Q11, whilst the capital risk premium on 10yr Treasuries (spread between 10yrs and 10yr TIPs) widened modestly in a way which usually signals improving risk tolerance.

More, US Treasuries became ever more expensive relative to the fair value you would expect in an economy growing 2.2%, CPI inflation of 2.82% and a Fed Funds target of 25bps. Historically, as the chart below shows, when Treasuries represent such astoundingly bad value, one expects Private Sector Savings Surpluses to start to dwindle. But rather, the opposite happened.
In conclusion, we really do not know what has provoked re-invigorated deleveraging in the US during 1Q12 - for the time being it remains anomalous. Unless or until a workable explanation is found, we should expect precisely that it will be an anomaly, which is likely to be corrected in the coming quarters. If so, the upside risks to US growth during the rest of 2012 continue to look greater than the downside risks.  





Tuesday 22 May 2012

What We Are Thinking (WWAT?)


This week's WWAT? is the simplest yet, comparing Google's normalized data for financial searches of 'China' with those containing 'Eurozone'. It will come as no surprise that the grip on the world's imagination which China seemed to exercise during March and April was lost pretty quickly in May as the Eurozone's crisis reasserted itself.

A similar search, comparing 'China real estate' with 'Eurozone crisis' provided a little more detail: the world has been far more interested in what Google has to say about Chinese real estate than about the Eurozone crisis until. . . . the last 10 days, actually.

Why have I chosen this chart? Partly because it allows me to run another chart, which I submit as my Spurious Chart of the Week, in which I notice the remarkable correlation between the absolute performance of the CSI 300, and the relative lookup frequencies of China and the Eurozone (both averaged over 10 days). I think you'll agree, the correlation is spooky.

Sunday 20 May 2012

Shocks & Surprises, Week Ending May 19th


For the first time in five weeks, positive surprises on growth outstripped negative shocks in the 58 separate piece of economic data released this week, with both the US and Europe being the surprise-providers. More, as the chart shows, the proportion of negative shocks reached their lowest level for give weeks. This does not necessarily mean the data is getting stronger, but it does suggest that the consensus is catching up with the data.

 There is a third aspect: there was very little data this week from China and NE Asia, and that which did arrive all conformed to consensus or current trends. In China, for example, the MNI Business Sentiment Survey flash pulled back slightly, the 70 cities residential price index declined slightly, but on closer inspection showed signs of stabilization, and FDI fell 0.7% yoy, which was within the range of expectations. There was no signal here that commanded a change in view or policy.

US: May Blossoms?
As usual, the US produced the biggest concentration of positive surprises. The most important was Empire State Manufacturing survey: this is the first read we have for May, and it showed a sharp rebound from April's weakness as shipments and working hours jumped, whilst new orders and payrolls also gained. But running it a close second was a surprise rise in the NAHB Housing Market Index, which produced the strongest reading for five years, and which was led by a large increase in buyers' traffic in the Northeast.

On the face of it, March's 1.1% mom rise in industrial output ought to have been the biggest surprise of the week, given that this was the strongest reading since December 2010. However, the surprise was mainly confined to a 4.5% mom jump in utilities output, which in turn reflected a 17% mom jump in natural gas : by contrast manufacturing rose by 0.6% - respectable but no reason to reassess consensus.

Although the Empire State Manufacturing survey gave a very strong steer for May's conditions, it was contradicted later in the week by a shockingly poor Philadelphia Fed manufacturing survey, which delivered the weakest verdict since September 11, as new orders and unfilled orders both actually contracted.

Europe: Eurostat Says 'No Recession'
The Eurozone sprang the least-likely surprise of the quarter, when the European Commission's Eurostat announced that the Eurozone had escaped recession during the first quarter. It's challenging to think that although the Eurozone may be the epicentre of a epoch-defining financial catastrophe, its statisticians can know that it is sailing through it without contracting.

Germany's 1Q GDP grew a surprise 0.5% qoq, with growth in net exports and domestic consumption offsetting a fall in investment spending, and this in turn was sufficient to allow the Eurozone as a whole to report no overall contraction qoq in 1Q – although France was flat, Spain contracted 0.3% and Italy contracted 0.8%.

The avoidance of recession is miraculous on two counts. First, the Eurozone hasn't shown a Manufacturing PMI of 50 or better since July 2011, and has produced a Services PMI reading of better than 50 only once in the last nine months. And, of course, the 50 reading is meant to be the fulcrum between expansion and contraction. And second, there is the broader data-run: during the last six weeks, I have tracked 139 major pieces of economic data from the Eurozone and its major economies, of which 70 conformed to consensus or trend, 43 arrived more than a standard deviation below consensus or trend, and 26 (including this GDP result) were a standard deviation or better than consensus or trend.

If Eurostat's preliminary calculations must be expected eventually to be revised towards the land of plausibility, the week did bring some less-unlikely positive surprises: Italian industrial orders rose 3.5% mom, Eurozone trade balance doubled expectations for March (as imports shocked by falling 0.4% yoy). French non-farm payrolls rose 0.1% qoq, and UK unemployment fell to 8.2%. But there were also shocks: UK unemployment is falling, but wage growth slowed very sharply, to just 0.6% yoy in the 3m to March, with private wages rising 0.3% and public sector wages up 1.3%. Eurozone industrial production fell 0.3% mom and 2.2% yoy in March, despite rises of 1.3% in German and 0.5% in Italy.

Whilst China and NE Asia sprang no shocks or surprises this week, two readings from Japan's machinery industry – both shocking - need noticing: machinery orders for March fell 2.8% mom and 1.1% yoy, whilst machine tool orders for April rose only 0.5% yoy. Both numbers were worse by more than a standard deviation than consensus or trend, with foreign orders generally weaker than domestic orders: NE Asia's investment cycle is stuttering.  

Friday 18 May 2012

North & South: There's More to Greece Than Meets the Eye


The crucial fact and role of Southern Europe's Shadow Economies

What's the perimeter of the possible for Greece after its exit from the Euro?
I keep coming back to two assumptions:
  • Where necessary, money will be improvised (it always is);
  • The real Greek economy is likely to be significantly bigger, and significantly healthier, than is currently measured.

Both these mean that the V-shape crisis that would accompany Greece's exit from the Euro is likely to look more extreme on paper than it is on the ground. Quite conceivably, if the right fiscal policies are followed, the recovery could, on paper at least, be extremely dramatic.

The key point is that Greece's economic statistics capture comparatively little of Greek economic activity. The Greeks, we are repeatedly told, are tax dodgers. This is true, but raises really interesting questions: how much tax is dodged? why is it dodged? and what is likely to improve matters?

Surprisingly, we have very good answers to these questions, which can be found in a World Bank research paper called 'Shadow Economies All Over the World', published in July 2010, and which can be downloaded here. I strongly recommend it: it's key reading for the immediate post-Euro future.
 
The paper works out a methodology for estimating the size of shadow economies: ie 'those [otherwise legal] economic activities and the income derived from them that circumvent or otherwise avoid government regulation, taxation or observation.' By its nature, you can't count the shadow economy directly, but the World Bank makes estimates of its size by looking at deviations from various monetary and other ratios which are commonly observed and observable. It reckoned that by 2006, Greek's shadow economy was equivalent to 30.8% of GDP – this was the second-highest proportion in the 25 OECD countries the World Bank looked at (the survey covers 145 countries in all).

If 30.8% of Greece's economy is escaping official detection, its economic and fiscal plight might seem less dramatic than it usually appears. The ECB records that in 2011 Greece's public debt/GDP stood at 165.3%. If 30.8% of the economy is lost in translation, as it were, then the public debt/real GDP ratio is actually more like 126%.

Good news? Unfortunately not, because under current conditions, and certainly under current fiscal plans instituted by the troika of the IMF, ECB and EU, that shadow economy is going to grow, not shrink, relative to the official economy. That, at least, is what the World Bank found: “. . . the driving forces of the shadow economy include an increased burden of taxation, labor market regulations, the quality of public goods and services, and the state of the “official” economy.”

So the troika's austerity plans are likely to be counterproductive not just for the usual Keynesian reasons, but, just also because they'll mean that an even greater proportion of economic activity will opt-out of visibility to statisticians, economists and most importantly, the taxman. Raising taxes simply won't do it.

Actually, the misunderstanding is even more profound than that, and so far we have understated the malignity of current policies – and not just fiscal policies, but the entire gambit of EU regulation. Back to the World Bank: “Wealthier countries . . . find themselves in the 'good equilibrium' of relatively low tax and regulatory burden, sizeable revenue mobilization, good rule of law and corruption control, and a [relatively] small unofficial economy. By contrast, a number of countries in Latin American and the former Soviet Union exhibit characteristics consistent with a 'bad equilibrium': tax and regulatory discretion and burden on the firm is high, the rule of law is weak, and there is a high incidence of bribery and thus a relatively high share of activities in the unofficial economy'. In addition 'the provision and especially the quality of public sector services is also a crucial causal variable for people's decision to work or not to work in the shadow economy'.

So the question for the EU is whether the troika's austerity policies which raise taxes and degrade public services in Greece will entrench the state into a 'bad equilibrium' relative to the rest of the Greek economy. Of course it will!

But this points to a more radical conclusion: austerity policies which should work in countries which start from a 'good equilibrium' – such as Germany and most of Northern Europe – should not be expected to work in countries which start from a 'bad equilibrium' - such as Greece and . . . who else? And at the extreme, they might even be expected to push an economy from a 'good equilibrium' into a 'bad equilibrium'.

If you start from a 'good equilibrium' there is a likelihood that fiscal austerity, though painful, might work. If you start from a 'bad equilibrium' it simply can't, because it intensifies precisely those factors which put the country in a 'bad equilibrium' in the first place.

Or, to put it more bluntly: if you raise taxes in Northern Europe, people grumble but pay up. Try that in Greece, and see how far it will get you. They don't play, they defect.

We can be fairly sure that the relationship between the Greek state and the Greek economy has always been in a bad equilibrium, but what about the rest of Southern Europe? Is the Northern European misunderstanding of the possible in Greece likely to extend to the rest of Southern Europe. The short answer is 'yes' – unfortunately Greece is not (or perhaps was not) a particularly striking outlier in Southern Europe. The chart below shows the track record: by 2006 Northern Europe (UK, Netherlands, Germany, France) had shadow economies equivalent to 15.2% of GDP (unweighted average), whilst those in Southern Europe (Italy, Spain, Portugal and Greece) were equivalent to 27% of GDP. More, they were pretty tightly bunched, with a standard deviation of 1.8 percentage points for Northern Europe, and 3.5 percentage points for Southern Europe.
The conclusion which forces itself upon us from this data is that there is every chance that responses to fiscal austerity which would work in 'good equilibrium' Northern Europe should be expected to fail in 'bad equilibrium' Southern Europe. We should expect not 'rebalancing' but 'defection'.

These considerations also show why EU policymakers are foolish to point to Ireland as a relevant success story for fiscal austerity: from a good/bad equilibrium standpoint, Ireland is very definitely 'North European' with a shadow economy estimated at 17.1% in 2006.

In this piece, I've considered only the predictable short-term failure of Northern European austerity measures on Southern Europe in the context of the Euro crisis. But the implications are far wider for the structure of the European Union single market itself, and for the impact of European-wide structures of regulation across a large number of fields. For the same mechanisms of compliance/defection which mean that tax-raising policies will have predictably different economic impact in Northern and Southern European economies, mean deliver different outcomes over a range of regulatory measures. World Bank again: “Our results further show that the driving forces of the shadow economy include an increased burden of taxation, labor market regulations, the quality of public goods and services, and the state of the “official” economy.” And “reducing the tax burden is the best policy measure to reduce the shadow economy, followed by a lessening of fiscal and business regulation.”

What this is telling is that EU 'harmonisation' measures are, de facto, not likely to foster 'harmonisation', but rather widen already-measurable structural divisions between Northern and Southern Europe.


Wednesday 16 May 2012

Waiting For The End in New York and London


Say what you like about the Euro, but you can't call its agony a surprise. When Greece finally exits the Eurozone, it will be probably the most lengthily-anticipated financial catastrophe in history. The world's financial systems have had literally years to prepare, and I suspect we're about to find out whether they've spent the time well.

Let's look first at New York, where we've previously tracked the dramatic change in behaviour of foreign banks' operations over the last 18 months. As of end-April foreign banks operating in New York had raised the amount that those operations are funded by their home head offices to a net US$262 billion. In a crisis, this has advantages and disadvantages. The advantage is that the sudden closure of New York money markets to European banks won't immediately cause a liquidity crisis for their US operations, since they are, on a net basis, no longer funding from them. The disadvantage is that if Greek's exit from the Eurozone triggers a massive express unwinding of European foreign capital flows, then we should expect that that US$262bn will exit New York quickly.   
A capital outflow of that kind will inevitably cause funding strains, and we can expect those to be accompanied and intensified by outflows of deposits from non-US banks. But foreign banks in New York have spent the last 18 months structuring their local balance sheets to give themselves the best chance of surviving just such a collapse in confidence. First, deposits as a proportion of total liabilities have fallen from just under 80% at the end of 2010 to around 46% now, and during that time total deposits have fallen by 17.2%, or US$182.5bn. Secondly, during the same period, banks have added US$404.3bn to their holdings of cash, more than doubling the total. As a result, at the end of April, these banks held enough cash to pay out 84.4% of all deposits. My bet is that proportion is even higher now. Clearly, this is a pretty good defensive crouch.
In New York, we can only track the mass of foreign banks: but the Bank of England provides data specifically on the operations of European banks in London. These report that even though total Euro deposits have fallen by Eu39.bn in the year to end-March, these deposits still make up 92% of Euro-denominated liabilities, and 31.8% of their total London-based liabilities – a proportion which actually has crept higher as the crisis has evolved. The proportion of these Euro-denominated deposits which are covered by Euro cash, near-cash or time deposits at the end of March 2012 had risen to 72%, only mildly higher than the 68.6% a year earlier.

In other words, European banks in London are running a net short Euro-position, which first appeared in June 2011, and by March 2012 was equivalent to £23.6 billion. London banks are not, therefore immediately in a position to fund any emergency call from their head offices for Euros.  


On the other hand, their London operations are running long positions in other currencies, amounting to £13.6bn in Sterling and £10.0bn in other foreign currencies.

Conclusion: If Greece exits the Euro, in its wake we can that capital will exit European institutions all over the world, whilst pooling in the Eurozone principally in German banks. Foreign banks in New York can be expected to be an immediate source of rapid liquidity, and probably do have the capital structure to manage this role effectively even during a severe loss of confidence. European banks in London, however, cannot be expected to emerge as an immediate source of Euro-funding, since they now structurally short Euro. However, we can expect the net long positions in other currencies to be unwound rapidly as the Euro-shorts are covered.

The irony is this: European banks' operations in both New York and London are positioned extremely conservatively, so that cash can be rushed 'back home' in an emergency. Result? When the balloon goes up, expect interbank rates to spike in New York and London, and the Euro to have a short-run period of strength as short-covering kicks in. If capital controls are imposed, or threatened, that spike could hurt.





Tuesday 15 May 2012

What We Are Thinking (WWAT?)


There's no doubt at all: during the last two weeks, the world is back on deflation-watch.

To recap, what this chart tracks is Google's normalized score for the frequency with which financial searches worldwide looked up 'inflation', minus the score for 'deflation', and smoothing to a 10-day average. In its way, it is the biggest rolling survey of global preoccupations there has ever been. A month ago, the relative interest in 'inflation' was at its peak for the year; now far more people are looking up 'deflation' than 'inflation'.

I think there are three comments worth making;

First, the swing towards concern about deflation is far more pronounced than the swing from thinking about 'growth & recovery' rather than 'recession and depression' which we tracked last week (and which, most surprisingly, is making a slight recovery towards growth this week.)

Second, this is not, alas, an early indicator – the US bond markets anticipated the change in What We Are Thinking by almost exactly a month.

Third, no intensification of deflationary forces is yet showing up in the world's inflation data.

Most inflation data is arriving roughly in line with consensus (so far this week French CPI, Korean trade prices, German WPI, and Japanese Domestic Corporate Goods Prices; last week China's CPI and PPI, US PPI, German and Spanish & Taiwanese CPI). If anything, over the last month the news has been of inflationary pressures slightly greater than anticipated: India's WPI, Britain's PPI, Japan's Corporate Services PI, Singapore's PPI, and the US ISM Manufacturing survey of prices paid were all slightly higher than expectations. Only French PPI, Korean CPI and PPI, and Taiwanese WPI hinted at a current disinflationary shock.  

Monday 14 May 2012

Shocks & Surprises, Week Ending May 12th


Things rarely turn out as expected. This was going to be the year when the giant emerging economies, led by China, would throw a tow-rope to a near-stalling US economy. Instead, the data tells us that even sustained recovery in the US is struggling to provide China with enough external stimulus to allow it to overcome its own cyclical and structural problems.
That, at any rate, was the message this last week, when:
·         Shocks were concentrated in China and Europe, and to a much lesser extent NE Asia
·         Surprises were concentrated in the US and to a much lesser extent in Japan

China Sneezes
The week's shocks were dominated by China's data for April: seven out of the 11 pieces of official data released by China this week undershot economists' consensus, or current trends, by a full standard deviation or more. The worst news is still monetary: where M1 growth slowed to just 3.1% yoy, and actually contracted by 300bn yuan during April. Deposits also contracted by 600bn yuan during the month, even though the banks gave out 680bn yuan in new loans. What this tells us is that the cashflow cramps afflicting China's economy are intensifying, with China's banks running to a net negative cashflow (deposits in minus loans out) of 1.14tr yuan last month.

In response, PBOC has announced reserve ratios will be cut by a further 50bps starting May 18th. But this easing now looks to be behind the curve, freeing up only 420-430bn yuan in lendable funds. So far PBOC has not released the broader 'aggregate financing' measure for April, so we cannot be sure there isn't further action being taken behind the scenes to relieve the pressure on corporate cashflows.

The cashflow grind is behind China's other major shocks: imports grew an anaemic 0.3% yoy; exports did little better, falling 1.5% mom (though growing 4.9% yoy) even in the face of unexceptionable growth in Western demand (see below). This underlines our observation that the crucial structural fact about China's economy since the financial crisis has been its failure in export markets, not its success. Growth of industrial production slowed to 9.3% yoy, the weakest since May 09, mainly reflecting slumping output of electricity and rolled steel. Retail sales slowed to 14.1% yoy from 15.2% in March. Although this was shockingly weaker than economists' estimates, it merely extended the sequential weakness seen in March.

The Neighbours Catch Cold
China's slowdown is also taking its toll on its nearest NE Asian neighbours. The most obvious sign of this was Hong Kong's GDP, which slowed unexpectedly to just 0.4% yoy in 1Q – a slowdown that was not anticipated, and owed everything to a trade contraction (exports of goods fell 5.7% yoy, imports fell 2.7% yoy). And Taiwan's export performance is also shockingly slowed by China: April exports fell 3% mom and 6.4% YoY, with exports to Hong Kong and China down 5.6% mom, whilst exports to the US fell only 0.7%, and to Japan rose 4.1%.

Japan Still Surprises
Part of what ails China's export and industry yoy comparisons is the fact that this year, no combination of earthquake/tsunami/electricity shortage has knocked Japan out of the ring. This is still not being represented in economists' views on Japan (and certainly not the stockmarket), and for the fourth week out of five, Japan's data produced more positive surprises than negative shocks. The highlight was the unexpectedly strong reading of the Economy Watcher's Outlook survey, which rose to levels previously seen only in mid-2007, on the back of particularly strong readings for prospects for employment, services, retail and the non-manufacturing sector.

US: Trade, Jobs, Federal Budget
The US had its strongest set of readings for a month, strong enough to offset the series of modest negative shocks of the previous three weeks. Three sets of surprises in particular are worth noting: the best JOLTs job openings data since July 2008; the strength of March trade data (exports up 2.9% mom, imports up 5.2% mom); and a US$59.1bn April Federal budget surplus that very nearly doubled consensus expectations, resting on a 10.1% yoy jump in receipts. The strength of exports is particularly important, since we have previously identified the role that exports need to play in regulating the mismatch between industrial supply and domestic demand which underlies and regulates the US's current 'soft patch.

The strength of the US's exports is partly testament to German demand – US exports of goods to the EU jumped 13.8% mom in March. Germany, after all, accounts for nearly 52% of total Eurozone import demand.

Europe: Germany and the Rest
Although Europe's data is still regularly shocking in its weakness, Germany remains resilient. Its industrial sector in particular refuses to buckle, with output surprising by rising 2.8% mom and 1.6% yoy in March, whilst factory orders rose 2.2% mom. Encouragingly, this strength is still resting on the capital goods sector, where orders were up 4.2% mom and output was up 2% mom. And it's still overseas orders which are driving the numbers: that 4.2% rise in capital goods orders came despite a fall of 1.3% in domestic orders and a 2.9% mom fall in orders from the Eurozone! Similarly, Germany's exports showed surprising strength, rising 0.7% yoy overall, with a 3.6% yoy fall in exports to the Eurozone being offset by a 6.1% yoy rise in exports outside Europe.

For the rest of Europe, though, there is no such comfort: last week saw the Sentix Investor Confidence survey slump to its weakest reading since June 09 – investors expect a severe recession from which even Germany will not escape altogether unscathed. The oscillations in UK data continue, with the week bringing shocks in like-for-like retail sales (down 3.3% yoy) and Nationwide Consumer Confidence, which dived because of a very sharp deterioration in 'economic expectations' rather than any downturn in 'current conditions'. In Spain, however, the plight of current conditions was signalled by a 7.5% yoy fall in industrial output in March – the sharpest contraction since October 2009. 

Thursday 10 May 2012

Reasons to be Mostly Cheerful


  • NE Asia's Exports Remain Robust
  • G3 Imports Have Not Collapsed
  • China's Exports are Flagging for Structural, not Cyclical, Reasons
  • Global Domestic Demand Retains Momentum
  • NE Asian Demand is as Big a Drag as European Demand
Back in December, when Europe's finest were last bewailing that their jerry-built Euro project could plunge the world into a 1930s-style Great Depression, world trade data showed that "so far not only is the slowdown nothing like what happened at the end of 2008, but it's less dramatic even than the slowdown which accompanied the near-recession of 2000-2001.''

And it's still true: the world trade environment remains in decent health despite the disaster being engineered in Southern Europe. In the three months to February, imports by G3 nations rose 7.4% YoY, and in the three months to March, NE Asia's exports rose by 4.4%. In 6m momentum terms, G3 imports are losing sequential momentum negligibly, whilst NE Asia's is slightly positive. 

Over the last couple of days, we've had trade data which pushes the argument further.  March trade data from the US came in remarkably strongly today, with imports up 5.2% mom and exports up 2.9% mom. We've had surprisingly strong March trade data from Germany, too, showing exports up 0.9% mom, and imports up 1.2% mom (and let's not forget – Germany's imports comprise nearly 52% of the Eurozone total). But we've also had  shockingly bad April numbers from China: exports up just 4.9% yoy and imports virtually static (up 0.3% yoy).

Here are five things the data is telling us. 

First, NE Asia's exports remain robust – there's still no repeat of 2001, let along 2009, showing up in either YoY or momentum terms.  
Second, the reason why NE Asian exports remain relatively buoyant is that G3 imports have slowed only mildly. This has been achieved because a surprisingly mild slowdown in European and Japanese demand has been countered by a robust demand from the US.
Third, China's export-problem continues. I have argued for some time (in detail, here) that since 2009 China's extraordinary top-line export numbers disguise a deeper failure – one in which ever-more expensive investment efforts have yielded ever-decreasing gains in market share. We should expect that trend to become more obvious this year, simply because this year Japan's export-sector isn't crippled by  supply-side disruptions. In fact, so far this year, Japan is no longer losing market share of NE Asia exports at all.
Fourth, right now the slowdown in NE Asia is as big a problem for world trade as the Eurozone's problems.

Well, you aren't going to read it in the newspapers but it's there in at least three sets of data. First, the details of China's 1.5% mom fall in exports during April, which show that  exports to the EU rose 0.2% mom, and exports to the US fall a relatively mild 1.7%. What killed China's numbers in April were exports to Asia: to Japan they fell 5.9% mom, to Korea 6% mom, to Taiwan 5.9%!

Second, if our horrified attention is fixed on Southern Europe it is difficult to hold in mind the fact that Germany accounts for around 52% of total Eurozone imports. Greece is spectacular, but so too, in the opposite way, is Germany's importing track record so far this year: up 2.4% mom sa in January, up 3.6% in February, up 1.2% in March.

Third, I directly track changes in momentum in domestic demand in the US, in NE Asia and in Europe (taking Germany, France and UK as the major economies). When taken as a GDP-weighted aggregate, it tells the same story as our trade data – the world economy is not falling off a cliff. I shall go into more detail about this next week.
When you strip out the momentum changes in the various regions, the geographic pattern is surprising: the US is once again leading the world economy, the major economies of Europe have just about reversed the loss of momentum seen during the second half of last year, and NE Asia's economies are not doing much more than marking time.







Tuesday 8 May 2012

What We Are Thinking (WWAT?)


  • The changing shape of Google searches are a gigantic rolling global survey of interest and opinion probably unrivalled even by financial markets. There's never been anything like it in human history, and its relationship to that other great 24hr global survey of opinion – financial markets – has yet to be explored. So let's get to work.

Google publishes data daily on the the frequency of a particular search-word being used for financial searches. The data is normalized and re-normalized relentlessly, with words assigned a score according to frequency of search, from zero to 100. This repeated normalization means one should not use the numbers directly as a series. But if one is interested less in the exact score, but much more in the difference between contrasting sets of lookup searches, the problems are not so great.

For example, in this first WWAT? I'm recording the scores for 'Growth' and 'Recovery', and subtracting from them the scores for 'Recession' and 'Depression.' The point is to reveal changes in our relative interest between the two as revealed by global financial search patterns. Here's how it looks since February, smoothing to a 10-day average.

Broadly, one can divide the year so far into two phases:
  • The first, up to late March, when searches for 'growth' and 'recovery' were dominant.
  • The second, since late March, when that salience collapsed, with interest in 'recession' and 'depression' peaking in early April, and again at end-April.
The first downturn in the balance of interest came as the first wave of disappointing/shocking US regional surveys began to appear. The second wave appears to have been coincident with an not just with the acceptance of a US soft patch, but also the shocking discovery that the price of the Eurozone's fiscal pact is Southern European Depression.  

In the very short term, early May is seeing some stabilization of the flows of interest which involves a recovery in interest in 'growth' and 'recovery' relative to 'recession' and 'depression'.

The temptation to 'interpret' these results is hard to resist. But it would be surprising if there were no correlation between what the financial world is musing about as it consults Google, and the direction of key markets. For example, how this series compares to the movement in US bond markets. We do not yet have sufficient data to be certain, but it looks as if the two may indeed be related – as one might instinctively expect.

Or consider also this chart, which compares the series with changes in movements of the dollar, expressed as movements in the dollar vs the Special Drawing Right basket (again, both are averaged over 10 days). Once again, it is too early to be conclusive, but the two series do seem to share changes in direction.

There's not enough here yet to draw absolute conclusions – but there's more than enough to suggest they are worth keeping an eye on.

My intention is to develop a series of these WWAT? series to track the relative frequency of various contrasting ideas, with the results to be published each Tuesday. My early ideas include: 'Inflation' vs 'Deflation'; 'Oil' vs 'Shale Gas'; 'Fiscal Pact' vs 'Growth Pact'. But please feel free to suggest possible pairings.  



Saturday 5 May 2012

Shocks and Surprises, Week Ending May 5th


Of the 68 data-releases monitored this week:
·         32 conformed to within one standard deviation above or below the consensus or current trends,
·         15 provided positive growth surprises, and
·         21 fell shockingly below that standard.

By dint of sheer regularity, Europe shocked most regularly, but in proportionate terms, the heaviest shockers were NE Asia (ex China and Japan) followed by the US. For positive surprises, China provided easily the largest proportion of surprises, albeit on a sparse sample. So the major shocks and surprises this week were:
·         The degree to which still-intensifying weakness in Europe is now finding a mirror in data in NE Asia and to a lesser extent the US
·         The surprise recovery of growth momentum in China

Other features of the week were
·         The extension, but not intensification of the US soft patch
·         The shocking implosion of Italian manufacturing, services and labour data

China: Surprising Recovery of Growth Momentum
China’s three positive surprises were the HSBC Services PMI for April, the CEMAC/Goldman Coincident Indicators Index for March, and Hong Kong's retail sales for March. The HSBC Services PMI rose to 54.1, the strongest reading since October, and good enough to break a nine-month trend. New orders grew the strongest for 10 months, payrolls the strongest since November. But – and this is worrying – input price inflation also jumped to the worst since August 2010, whilst output prices were unchanged. The CEMAC/Goldman Coincident Indicators index had little detail, but its modest improvement was sufficient to break the recent deteriorating trend. Both these indicators, however, are consistent with our previous observations about the easing of China’s cramped cashflows. As for Hong Kong's retail sales (up 17.3% YoY by value, 13.4% by volume), the surprises came from strong demand for the sort of portable luxury items most associated with the mainland tourist trade: jewellery and watches rose 19%, clothing/footwear rose 15.7%, and department store sales rose 14.5%.

NE Asia: Echoing the Soft Patch
Meanwhile, the US’s soft patch is turning up in the data from the nimble/niche economies of NE Asia. South Korean industrial production rose only 0.3% yoy in March, whilst exports fell 4.7% yoy in April. Dig down, and the problem was a sudden weakening in exports to the US (up 7.2% yoy in April vs 27.7%% in March), as well as to Japan (down 11.3% yoy) and Asean (up 4% yoy). Taiwan's Manufacturing PMI showed the weakest pace of growth since January. Orders continued to rise – but predominantly from domestic buyers – whilst margins continue to deteriorate. Finally, Singapore's PMI shocked by a relapsing back into a contraction for the first time in three months, as employment and backlogs of orders both fell.

US Soft Patch, Extended but Not Intensifying
Data from the US confirmed and modestly extended the manufacturing soft patch into labour markets and the service sector, but didn’t intensify it. The ADP Employment data early in the week gave early notice that Friday's non-farm payroll data was likely to be shocking, and in due course it was: a rise of just 115k was the worse reading since October, and to add insult to injury, previous months' gains were also revised down sharply. The bad news was amplified by shocks to average earnings (flat mom), whilst the cheer engendered by the unemployment ratio unexpectedly falling to 8.1% was dissipated by the fact it was mainly generated by a fall in the labour participation ratio. In addition to the labour market data, there was a clutch of shocks from regional surveys: the ISM New York survey, the Chicago PMI, and the Dallas Fed Manufacturing Activity all disappointed, with the Chicago PMI falling to the weakest reading since November 09.

Nonetheless, almost all surveys show that growth is continuing, albeit at a slightly reduced pace. And positive surprises are also continuing: the ISM Manufacturing survey for April was the strongest since last June, and even the weekly unemployment counts managed to surprise on the upside.

Europe: Continent of Falling Swords
Europe would kill for a 'soft patch' like that. But it's at the start of a recession which in Southern Europe is fast curdling into depression.  In Italy the reality is souring even faster than expectations. Its Manufacturing PMI came in at 43.8, the worst reading since October, and jobs were cut at the sharpest pace since January 2010. The Services PMI showed just 42.3, the sharpest contraction since mid-2009, with jobs being shed at the most rapid pace since July 09. In view of the message from the PMIs, the shocking jump in  unemployment to 9.8% in March - the worst reading in 12 years – should be no surprise. Certainly the news will be even worse in April.

There was also a shock from France, where the previous week's very soft Services PMI preliminary reading of 46.4 was cut in the final release to 45.2. New orders and work backlogs were both falling at the steepest pace since April 09. This collapse has not yet produced job cuts – but they surely cannot be long in coming.

Even in Europe, however, there were a couple of positive surprises. Eurozone retail sales fell only 0.2% yoy, which was better than expected, mainly because German retail sales rose 0.9% mom and 2.3% yoy, both pleasantly surprising. 

Outside the Eurozone, UK PMI readings continue to outpace both its European partners and the recent GDP data: this week the UK's Construction PMI read 55.8; its Services PMI read 53.3 and its Manufacturing PMI read 50.5.