It is up to governments to curtail the sovereign crisis and the global slowdown; central banks have done their part
It is hard to find any clue about risk-on or risk-off markets' expectations, judging by this week’s financial market performance. On one hand, equity indexes have slightly increased this week, and risk premia in Spain and Portugal have decreased somewhat. In fact, Portugal managed to exchange EUR3.67bn in securities due in September 2013 for a note maturing in October 2015, while the demand for this week’s Spanish bond auction was reasonable good. However, on the other hand, flows toward safe-haven assets, mainly to US Treasuries and the German bunds, have continued. This lack of definition of financial markets may respond to pending uncertainties about both the European crisis resolution mechanism and global growth expectations
- Despite decisive steps taken by European institutions to ease sovereign debt crisis, the true is that the eurozone continues to muddle through, introducing uncertainties about the crisis resolution mechanism. The Troika's decision on an extended aid package for Greece is still pending. On the other hand, there is no consensus on the timing of implementation of the Single Supervision Mechanism, which is a precondition to allow the ESM to recapitalize banks directly. Besides, there are different interpretations about the ESM direct bank recapitalization (an agreement taken in the June Summit). In fact, several ministers suggested that the ESM cannot take direct responsibility on legacy assets. In our opinion, maintaining the political consensus and take further steps to further integrate remains key to solve the European debt crisis, while in the meantime the ECB provides assurance (a "fully effective backstop) to stabilize markets and thus, give time to governments. The ECB's OMT programme is not exempt from risk of implementation given the conditionality attached to the programme. According with the latest ECB statement, the ECB will interpret conditionality in line with the Troika: "OMTs would not take place while a given programme is under review and would resume after the review period once programme compliance has been assured". Yet, the effect of the OMT on the long end of the yield curve is unknown, as the ECB intervention will be focused on the shorter part of the yield curve (up to three years). In the short-term, the ECB is ready to undertake OMTs (and maintain) but governments have to previously ask for a rescue under an appropriate EFSF/ESM programme i.e., "[...] the decision is with governments".
However, European woes are not the only factor weighing on investor appetite. The global slowdown is also a concern
- Despite a bunch of positive data coming out in the US this week, growth risks remain tilted to the downside as the recent improvement is not seen as self-sustainable. Furthermore, the fiscal cliff posts a risk on the US growth, which is not going to be dispelled before the US elections and uncertainty could continue until early 2013. Regarding the employment figures, the ADP private sector payrolls increased by 162.000 in September, which topped expectations, and printed a good feeling for this afternoon's job creation figure. Additionally, the manufacturing ISM index surprisingly increased above 50 to 51.5 in September, while the non-manufacturing ISM index also posted a strong reading in September.
- In the Eurozone, the downturn in the PMI indexes eased somewhat though weakness remains. The German PMI rose to a six-month high but its level continues indicating a contraction in manufacturing activity. Furthermore, retail sales in the eurozone increase a modest 0.1% in August. Besides, producer prices in the Eurozone remained suffering the impact of the increase in energy prices. The only positive is that given this weakness in eurozone domestic demand, underlying price pressures are likely to remain moderate and the transitory increase in inflation should "not give rise to second-round effects".
- Disappointing Asian economic data confirms the ongoing slowdown in the region. In China, the official PMI for September, slightly rose to 49.8% below our and consensus expectations. The improvement was disappointing as the manufacturing index remained below 50. Meanwhile, the Korean exports showed a contraction for a third straight month in September, while the country reported inflation ticked up to 2.0% y/y in September on supply disruptions from a typhoon last month.
To bolster growth expectations and to regain confidence, a more forceful set of fiscal and monetary policies should not be ruled out in China, while in the US and Europe is now up to governments, as central banks have done their job already
- Following the economic weakness registered in the main Asian economies, we expect supportive policy actions in the region. In China, once the forthcoming leadership transition is formally settled at the National People's Congress, scheduled to begin on November 8. In Korea recent data will place further pressure on the Bank of Korea to deliver a rate cut at their next policy meeting on October 11.
- In the case of Europe, this week the ECB held policy steady and gave no hints on what it would do if economic conditions worsen further. Also it insisted that it is ready to undertake OMTs but is up to governments: "The ECB is there to make an environment that is conducive to reforms, but the decision is with governments", Draghi said.
- Finally the FOMC minutes of the September 12-13th meeting revealed a majority agreement with the announcement of the QE3 and the extension of the interest policy guidance. Most members agreed that the risk related to this policy were manageable. In our view, now that the FOMC has maximized its policy accommodation for the time being, we do not expect much to come out of the October session. Furthermore, Bernanke and his colleagues made it very clear that without some sort of compromise in Congress, monetary policy will be unable to prevent the economy from sliding into recession in 2013.
Next week: investors will keep interest on the Eurogroup/Ecofin meeting on 8-9th of October. Additionally, EU Parliament panel will debate banking union proposals. Besides, in the coming week EU officials (Van Rompuy, Barroso and Monti) will be very active. Regarding the world economy, the IMF and World Bank meeting will take on October 12th; and early in the week the IMF will release both the world economic outlook and the global financial stability reports.
Calendar: Indicators
Germany: Trade balance, s.a. (August, October 8th)
Forecast: €15.5bn Consensus: €15.6bn Previous: €16.1bn
We expect the trade balance to have narrowed in August for the second month in a row, as exports have likely declined while imports are set to increase further. This is in line with the slowdown in global growth, especially in some emerging countries, while robust domestic demand should have supported imports. Therefore, we see the net exports contribution to fade further in the third quarter, as it was observed in Q2.
Eurozone: Industrial production (August, October 12nd)
Forecast: -0.2% m/m Consensus: -0.3% m/m Previous: 0.5% m/m
Industrial output is expected to have declined slightly in August, offsetting partly the rebound observed in July. As a result, industrial production could have remained virtually flat over Q2, in contrast with the gloomier outlook painted by soft data. Both the EC and PMI surveys point to a significant contraction in industrial activity in Q3, driven not only by a weaker domestic demand but also by a broader softening of global economic growth. Nonetheless, these surveys were not conclusive, as the former showed a continuing downward trend in industrial activity, while the latter showed some stabilization in the pace of deterioration. Given the high correlation between industrial output and the economic cycle, all these figures are in line with our projection of a GDP fall in Q3 for the second quarter in a row.
US: International Trade Balance (August, August 11th)
Forecast: -$43.0B Consensus: -$44.4B Previous: -$42.0B
The US trade deficit is expected to grow slightly in August for the second straight month given continued slowing in the global economy. Figures for July exports show a 1.0% decline from June, and various manufacturing indicators for new export orders tell the same story, still in decline. Export prices in August increased which may inflate the value of total exports even though we expect a monthly decline in volume. While the decline in the balance may be cushioned by weaker import growth, we expect that rising import prices will offset gains from the export side.
US: Consumer Sentiment (October, August 12th)
Forecast: 77.9 Consensus: 77.5 Previous: 78.3
As food prices and rising price per barrel loom, University of Michigan’s Consumer Sentiment Index stands to worsen as consumers’ uncertainties grow about their income and expenses. The Midwest drought has moved food prices higher, and consumers fear paying more not only for their grains and meats, but for their fuel as well. Oil prices in September were higher than levels seen earlier in the summer but remain lower than the significant price gains in the beginning of the year. Both scenarios translate to higher gas prices at the pump and then a higher bill once consumers reach the grocery store. With the Fed announcing QE3 and the unemployment rate still high at roughly 8.2%, the government’s attempt to bolster sentiment and increase employment won’t be realized just yet and the aforementioned commodity price increases won’t make it any easier.
Singapore: Third quarter GDP (October 11-18)
Forecast: 0.1%, q/q, s.a. Consensus: Previous: -0.7 q/q, s.a.
The third quarter GDP release will be closely watched, in tandem with the Monetary Authority of Singapore’s (MAS) next semi-annual meeting in mid-October. Singapore’s growth momentum has slowed sharply since Q4 2011 as weak exports have been having knock-on effects to domestic demand. There is risk of a technical recession, following a -0.7% q/q, s.a. GDP contraction in the second quarter on both weak external and domestic demand. We expect the MAS to ease monetary policy at their upcoming meeting, through a re-centering of the exchange rate band at a more depreciated level and/or a flattening of the appreciation slope (the MAS uses the exchange rate as its principal monetary policy instrument). At its last meeting in April the MAS tightened policy to contain inflation by increasing the appreciation slope (to 2% per year based on our estimates). An easing of the monetary stance, however, is not without risks given that inflation is still somewhat high (3.9% y/y in August).
