Three Surprises From Last Week

The world's economic data continues to break positively: on a strictly numerical basis, last week was the most positively ‘surprising’  since mid-July, and leaves the 6wk tally 0.32 SDs above ‘normal’ – also the most positive score since late-July, and a positive background for financial assets.

Meanwhile, here are three surprises from last week which are worth bearing in mind: 

1. US Confidence indicators are surging, primarily reflecting an expectation that things will get better, rather than that they have got better. It's important to the extent that it curbs the rising private sector savings surplus. 

2. China's Financing.  Loan growth disappointed in September, but this disguised a reliquefying of corporate cashflows which is being achieved through other forms of finance than bank loans. 

3. Eurozone Industrial Production. Notice that the surprise rise in August production was the work mainly of those Southern European countries suffering to achieve internal devaluations. Might it possibly be working?  

 1. US Confidence  The central shock of the US economy this year has been the resurgence of its private sector savings surplus (rose to 5.3% of GDP in the 12m to June, up from 3.9% in 2011), which in turn has leached strength from domestic demand and growth. One can identify various reasons for this renewed outbreak of financial caution at different times throughout the year – none of which seem grounded in the fundamentals of the US cycle itself. 

But two surveys of October consumer confidence suggest this might be passing: both the University of Michigan’s consumer confidence survey, and the IBD/TIPP Economic Optimism survey both recorded really sharp improvements in economic expectations. The Uni of Michigan survey is particularly dramatic: the subindex for ‘economic expectations’ jumped to its highest level since 2007. More, as the chart shows, it is now within 0.2SDs of the 2001-2007 average reading. On the face of it, confidence in the future has very nearly returned to pre-financial crisis levels!  

If the survey is truly representative, and if its findings are sustained, this renewed confidence can be expected to result in surprising levels of domestic demand growth during 4Q, including an acceleration in the recovery of housing markets. Whilst equity markets would be delighted, there will be a price to be paid in the bond markets.

2. China Financing  At the heart of China’s surprisingly robust September monetary aggregates (M1 up 7.3% yoy, M2 up 14.8%)lies a large-scale but quiet reliquification of China’s industrial companies.  Analysts have been fixated on fluctuations in new bank lending, on the basis that it would be here that any general policy-loosening would show up – as it did in late 2008-early 2009. 

But even up to September, there has been no such loosening – September’s Rmb623bn in new lending was below the range of expectations. Instead, the loosening is being done outside normal bank lending totals, using large issuance of bankers acceptances, fx loans, trust loans. As a result, total ‘aggregate financing’ jumped to Rmb 1.65tr in September 2012, compared with just Rmb 428bn in Sept 2011. 

The rise in BAs – Rmb 216.3bn were newly issued in September - is particularly important because they are a direct response to potentially cascading cashflow problems in the corporate sector. But at the same time, there is only limited opportunity for these funds to inflate politically-sensitive property markets. For the banks,  these alternative financing instruments can side-step official ceilings on direct lending, and on loan-deposit ratios. Indeed, despite the surge in aggregate financing in September, banks could report a net increase of Rmb 1.65tr in deposits during the month  - exactly the same number as new aggregate financing – which led to a fall in the loan-deposit ratio.  

The bottom line is that as China sequences its way to financial liberalisation, Goodhart’s Law will apply in spades: we (and China’s policymakers) will inevitably end up tracking the wrong thing. Like bank lending, for example. 

3. Southern Europe Industrial Production Regardless of how its financial/political diplomacy plays out, the Eurozone will not survive – and will not deserve to survive  – if it condemns Southern European economies to an impossible competitive disadvantage to its Germany competitor. The ‘internal devaluations’ being forced upon Southern Europe can be justified only by the belief that eventually the pain will be justified by a competitive gain that will allow its industries to flourish. 

August’s industrial production data gave some hint of what that would look like: the Eurozone’s output rose 0.6% mom, but mainly because of Southern European countries’ growth (Italy 1.7% mom, Spain 12.3%) whilst Germany contracted 0.4% mom. Is this the start of something? 

Probably not: as the chart shows, since 2008, Southern Europe’s industrial output has contracted by around 20%, whilst Germany’s has risen around 12%. The divergence has been particularly stark since the second half of 2009. August’s reversal in growth patterns breaks that trend by 1.2 SDs, but so far it remains just a ‘blip.’