Shocks & Surprises, Week Ending June 2nd

So much for 'normality'! This week delivered enough shocks to torpedoed the notion that the underlying strength of the US economy would prevail in the second half of the year after enduring a short-term 'soft patch' enabling industry to adjust to an anomalous uptick in savings surpluses during the first quarter (detailed here and here).

Data from both Europe and the US force a change in that complacent view. First, early in the week, the Eurozone's monetary aggregates confirmed that the money-go-round initiated by the ECB's LTRO operations (detailed here), had run out of steam. M3 growth slowed to 2.5% in April from 3.2% in March , and although credit to governments expanded 7.7% in April, credit to the private sector was flat yoy.

The Eurozone's financial institutions have no capital to buy or create risk assets, so credit to the private sector has dried up even as holdings of government securities rise. More, the deterioration in economic and industrial sentiment tracked by the EU's indicators confirms what we'd already been told by the ECB's quarterly banking conditions surveys – there's no appetite for new debt anyway. Service sector sentiment readings in May hit the lowest since October 09; general economic sentiment was the worst since Dec 09, and industrial sentiment the worst since Feb 2010.

And the Eurozone's corporate sector isn't generating much cashflow anyway: corporate deposits fell 0.8% yoy in April, and deposits by non-monetary financial institutions (mainly insurance and pension companies) fell 1% yoy.

It is hoped that Southern Europe can generate positive cashflows despite carrying a severely mispriced currency, and despite quite serious fiscal tightening. It would be nice to think there was even the faintest sign that Europe's policymakers understood how one can disaggregate the sources of profits. If so, they would know that of the three principal motors of profits generation:

1. exports minus imports;
2. government spending minus taxes; and
3. consumption spending minus wages);

the determination to stay in the Euro scuppers I) and fiscal austerity measures scupper ii). The de facto collapse of Southern Europe's banking systems mean that the private sector must necessarily generate positive cashflow, so the entire burden falls on iii – somehow cutting wages even faster than consumption.

This can't be done. So whilst current policies, institutions, preconceptions and political personnel cling on in the Eurozone, the Southern half of the Continent is condemned to a genuine Depression, the political consequences of which are unknowable. History will not be kind to this generation of policymakers.   

The three major shocks came in areas central to the health of the domestic economy:

1. Labour Markets, where the rise in May's non-farm payrolls came in at 69k only, against a consensus expectation of 150k with a 1 SD range of 129 to 173k. This poor news was accompanied by an unexpectedly trimming of the average workweek from 34.5 hours to 34.4 hours, and a rise in weekly initial unemployment claims back to mid-April levels.
2. Real Estate markets, where pending home sales fell 5.5% mom in April, led by falls in the West and South. This weakness found an echo in the labour market data, which showed construction sector employment fell by 13k mom.
3. Consumer confidence, which retreated unexpectedly to the lowest levels since January, with sharp downgrades on both the current and likely future economic situation.

Meanwhile, China's policymakers appear still to be underestimating the extent to which cashflows are cramped – perhaps not fully understanding that when a decade or more of excessive investment has left you with a capital stock growing at around 18%, when industrial production growth slows to 9.3% (as it did in April), with exports growing only 4.9% (as they did in April) asset turns must necessarily be collapsing, taking profits and cashflows with them. This last week brought shocks from China's official manufacturing PMI and HSBC's revision of its manufacturing PMI. The message of the two isn't absolutely identical (the official version has manufacturing stagnating, whilst HSBC's has it contracting), but the message is clear: output is slowing, but new orders are contracting faster, leading to a building up of inventories of finished goods and a contraction of order backlogs. Chinese companies are therefore slowing purchases of inputs, and (probably) firing staff, whilst deflationary forces intensify.