Europe will be going into a second year of recession

Outlook:

Today’s data includes personal income and spending, with Bloomberg reporting that income probably rose a measly 0.2% and spending stagnant at zero growth (after a fairly nice 0.8% in Sept). 

The US economy is on the mend and would have done better in Q3 were it not for the drought and in Q4 were it not for Hurricane Sandy. The Fed has committed to “whatever it takes,” if in less brash language, meaning continuation of accommodation. These two factors are dollar-negatives, the first because a good US economy makes the world safe for risk and the second because lower rates for longer (actually, negative real rates for longer) are inherently dollar-negative.

 Meanwhile, Europe will be going into a second year of recession, with rising unemployment and falling inflation, made more difficult and confusing by the divergence between conditions in the core vs. the periphery. On the larger stage, the US is diverging from Europe. As noted before, divergence is a bad thing. It can hide impending Shocks because we get used to data slowly spreading apart until suddenly the gulf is huge. Example—French banks come periodically under attack as undercapitalized and the French economy as uncompetitive and sluggish. France is a true core country. The reputational aspect of bad conditions in France is far worse than in Spain. We could wake up some morning to a French banking sector crisis that puts Paris on the ECB’s and ESM’s doorsteps with cup in hand, and will imagine we didn’t see it coming. 

So again we have the endless problem of short-term sentiment vs. long-term economic analysis. As traders, we have to focus on short-term sentiment and right now that is risk-favorable and euro-positive. Longer run, the potential for a European crisis of one sort or another is rising by the minute and even if a major crisis is avoided, if we fall over the fear cliff, the dollar is the beneficiary. This accounts for euro forecasts being so confusing— it’s either 1.3500 or 1.2500. Well, we will probably get both.

• The eurozone is officially in recession, with Q3 GDP down 0.1% after -0.2% in Q2. The IMF predicts a 80% probability of eurozone recession in 2013. The European Commission say 2012 growth will be 0.4% and cut its eurozone growth forecast to 0.1% in 2013 from 1% in May. German growth was cut in half to 0.8% from 1.7%. France will contract by 1.4%. The OECD forecasts 2014 as a second full year of recession.

• S&P cut Spain's rating two notches to triple-B-minus, one step over junk; Moody’s cut France’s rating by one notch to Aa1, leaving Finland as the only eurozone country with a Triple A rating. The Economist Magazine names France the ‘time-bomb at the heart of Europe” on labor market rigidity and loss of competitiveness. 

• The EU banking supervisor will be established by year-end but may not have the authority to recapitalize the Spanish banks for another 6-12 months.

• Greece still needs Bailout Two, now settled (11/27/12) but yet to be disbursed and disbursement dependent on each member government agreeing and a debt buyback.