Even as Eurozone inflation continues to frighten, the stage is being set for a recovery

Outlook:

The US data today includes the usual weekly jobless claims and pending home sales, with tomorrow bringing in the big guns, the employment cost index and advance Q4 GDP. Tomorrow is also big because of flash eurozone CPI, forecast at minus 0.5% y/y. One forecast reported by Market News is Pantheon’s minus 0.3%, the low end of the forecast range. We take heart from better-than-expected M3 and bank lending eking out a tiny gain. Even as inflation continues to frighten, the stage is possibly being set for a recovery, however tentative and feeble.

The conflict over Greece’s third bailout may be worsening, although we don’t know what’s going on behind the scenes and we are dependent on screaming headlines and the propensity of newspaper writers to sell a few papers by playing the crisis card. One point sometimes overlooked is that the existing bailouts were never more than the troika buying time, and demands in return for the bailout were never realistic. Case in point: if you want to wipe out tax avoidance and related corruption, you don’t raise taxes. You lower them. And you don’t price state assets for sale at the depth of a recession. We don’t know how Greece was pricing assets for sale, but the probability is high that they were fire-sale prices. Freezing the state asset sales may be the correct business decision and not ideologically-driven, for all we know.

Opponents of giving the Greek deadbeats and moochers more money to squander are contaminating the discussion more than demands from the Greek side. Tsipras has a list of priorities that seems entirely fact-based and reasonable. It’s the European side that is being rude and recalcitrant. This is why we expect the IMF to step in, and if it does not, or fails to change the dialogue, the situation could indeed become dire. But it’s early days and no one can tell what is positioning and what is real.

In Germany, for example, the hard line is from EconMin Gabriel, who said “If Greece wants to deviate from some of these measures, it must bear the cost itself rather than exporting this to other European countries via a debt cut or other such ideas. It is clear that we must aim to keep Greece in the eurozone. But it is also clear that we need to be fair to our own population and other euro states,” he added, pointing out that foreign taxpayers were contributing €278bn to support Greece.”

We don’t know where Gabriel gets that number. Technically, the bailout amount is €240 billion—a drop in the bucket. And it’s a loan, not a gift. What is Gabriel referring to, and who are his constituents? Presumably German voters. For their part, the Greeks are being sane and reasonable. Varoufakis said “There won’t be a duel between us and the EU . . . There won’t be any threats.” The new government will not start spending big-time. Tsipras said new talks with the troika have the aim of reaching a “a viable, fair, mutually beneficial solution so that the country exits the vicious circle of excessive debt and recession.” He wants a “productive” meeting tomorrow with Eurogroup chief Dijsselbloem, who is also the Dutch Finance Minister.

That means, maybe, that what happens in Greece comes down to one Dutch economist. Dijsselbloem is a no-drama guy (who has the experience of winding down one bank) and while he represents the no-handout crowd, he is also an economist who might come to see that “viability” is a critical criterion. Getting the troika to admit that the first deal was badly designed and was never going to work might be a good first step. Well, a girl can dream. One thing we know, or think we know—5-year Greek yields at 18.48% are not sustainable.

As for the US, we should be wary of putting too much stock in good data—or bad data, either. The Fed is expecting inflation to get lower before it gets higher, and growth is better than it was, which should favor job growth. But the expectation of a hike in June or at least before year-end is hardly a commitment. Remember, just yesterday we had an economist naming Q1 next year. This is why, presumably, the fixed income market is not impressed. A year ago, we expected yields to top 3% by now. But various things have happened to prevent that straight-line forecast, including the drop in competing paper, most-ly in the eurozone. Yield itself is not as important for currencies as the differential, and even that doesn’t rule the way it used to.

Gary Shilling’s forecast of the 10-year note yield falling to 1%--yes, 1%--is really very frightening. It’s an emperor-has-no-clothes moment. Can we get there? You bet. Flight to safety from geopolitical turmoil and defaults (e.g. Venezuela, Russia) and even from equities can push yields lower. It’s not clear the dollar necessarily follows, but we do need to be worried. When everyone forecasts a prolonged dollar rally, as we have now, is precisely when we need to start looking at what can go wrong. So don’t bet the ranch.