Saturday, July 30, 2011

Real retail sales in Europe: will German consumers save the day? Maybe, perhaps

Retail sales in Germany and Spain were reported last week for the month of June. On a working-day and not-seasonally adjusted basis, real retail sales fell 7.0% on the year in Spain. In contrast, working-day and seasonally adjusted real retail sales surged over the month in Germany, 6.3%, and posted a 2.6% annual gain.

But the Spanish data is better than the non-seasonal numbers would suggest. In fact, accounting for seasonal factors as in the manner done by the Federal Statistical Office of Germany, Spanish real retail sales posted a monthly gain, 1.2% in June. Don't get too giddy on me - the Spanish data looks awful in a small panel (time series and cross section).

(click to enlarge)

The chart above illustrates the seasonally adjusted level of real retail sales for Germany, Spain, Italy, and the US. Since last year, Spain and Italy have seen a precipitous decline in real retail sales. This decline is especially coincident with the outset of fiscal austerity, as I highlighted in a post last month.

The only positive on this chart - US real retail sales have stalled and that in Italy and Spain are on a relentless trend of contraction - is Germany. Although there was a outstized gain in June, the 3-month/3-month annualized pace of growth is still negative, -1.5%. However, since auto sales are not included in this measure of retail sales, the surge is not just a Japan story. The point is, that it's possible there's consumer spending anew. If German consumers can push on their domestic economy and eventually seeping out to the Periphery via increased import demand, then there's hope for Europe after all. However, it's still way to early to tell if June will form a trend.

I have my doubts, though, as I'll highlight in a sequential post.

Rebecca Wilder

Wednesday, July 27, 2011

Credit growth in the euro area - seriously, where is it?

Today the ECB released details on monetary aggregates for the euro area. According to the statement on the asset side of the consolidated balance sheet of the euro area monetary financial institutions (MFIs):
the annual growth rate of total credit granted to euro area residents decreased to 2.6% in June 2011, from 3.1% in the previous month. The annual growth rate of credit extended to general government decreased to 4.6% in June, from 5.7% in May, while the annual growth rate of credit extended to the private sector decreased to 2.2% in June, from 2.5% in the previous month
Weak credit growth is entirely consistent with the deteriorating pace of the macroeconomy (see Edward Hugh's post here). How does 2.2% annual credit growth compare to history? Meager. Spanning 2005 to June 2011, loans to euro area households grew at an average 5.5% annual pace, while that to non-financial businesses marked an average rate of 6.8%. According to this indicator, the ECB need not be 'vigilant' at all.

Perhaps it's one country, like Germany? One country that will eventually challenge the stability of prices and the financial system. (Nope, not through loans to the private sector.)

To investigate the dynamics of lending across the euro area, I illustrate the stock of private sector credit for the euro area 12 ex Luxembourg in the series of charts below (the data is available here). Each chart plots the level of loans to households and non-profit institutions (HH) alongside the level of loans to non-financial corporations (NFC). HH loans are generally made to households for consumption or for house purchase. NFC loans can be made for any number of reasons, but typically for investment spending.

Of note, the Periphery economies are generally deleveraging, but to varying degrees. Ireland is clearly experiencing the biggest credit crunch among the PIIGS (Portugal, Ireland, Italy, Greece, and Spain). Also, note that any media report alluding to a German spending and investment boom is just wrong. Credit growth to HH and NFC is literally non-existent. France and the Netherlands are problematic - strong macroprudential regulation is likely needed in these countries while real rates remain low (or negative).

Enjoy viewing the charts - I did. (Click to enlarge)

Rebecca Wilder

Sunday, July 24, 2011

Economists are terrible forecasters - why trust them anyway?

The herd that is 'consensus' clings to this hope that GDP will bounce back smartly in Q3 and Q4, where all the while some pretty miserable data and financial conditions are staring us in the face. On May 26 I worried about the 'soft patch'. On July 24, the data doesn't look too much better.

This week we get the Q2 GDP report from the Bureau of Economic Analysis, of which the mean growth forecast from 69 polled economists by Bloomberg is 1.8% Q/Q SAAR (Bloomberg terminal, no link). That may change as we near Friday (unlikely by much), but those same economists (on Bloomberg) are forecasting a 3.2% rebound in Q3.

Alas, after the huge forecast miss in the first half of the year, I no longer put much stock in what economists expect by way of GDP growth just one quarter ahead (some yes, but broadly no).

See, economists are generally terrible forecasters.

The chart illustrates the one-step-ahead quarterly GDP forecast of the Philadelphia Fed's Survey of Professional Forecasters (SFP) alongside the ex-post GDP growth rate (GNP prior to 1992 for continuity with the SFP data). You can download the GDP data here or here, and the historical SFP data here. As an example, 2011 q1 represents the SFP mean real GDP growth forecast (% Q/Q, SAAR) from the fourth quarter of 2010, 2.5%, and the actual q1 GDP growth rate, 1.9%.

They do okay looking broadly at the business cycle; but the SFP point-to-point forecast error is huge. In sum, the average forecast error is 0.3% on a Q/Q basis spanning the years 1968 to 2011. That means economists miss the next quarter forecast by an average of 0.3%. And they're really terrible recession forecasters: the average error is -2.1%. Spanning the historical expansion periods - of which we are in right now - the SFP miss was 0.8% on average.

On May 13 the SFP predicted a Q2 growth rate of 3.2% SAAR, where 1.8% is the Q2 forecast for Friday.

Economists completely underestimated the following factors in the first half of 2011:

(1) the adverse effects of rising oil prices in the first third of 2011,
(2) the supply disruption from the Japanese earthquakes, and
(3) the underlying weakness in the economy.

Remember David Altig's July 8 post on the implication of sub 2% GDP growth? Mark Thoma expanded on the commentary as well. Mark Thoma also points us to a Macroeconomic Advisers piece that forecasts a 'brief growth recession' if the US economy gets downgraded. S&P puts the probability of downgrade at 50%.

I don't trust economic forecasts. I'll take the under on Q3 and Q4, especially given the way the budget talks are going and recent high-frequency data is looking.

Rebecca Wilder

Friday, July 22, 2011

The latest Eurozone response: one step closer to the crisis point

Here on News N Economics, I’ve generally not commented on the politics of the sovereign debt crisis in Europe. Regular readers are well aware of my skeptical outlook on the growth prospects for countries forced into fiscal austerity amid piles of private-sector leverage, a slowing global recovery, and a central bank with a tightening bias. However, Tyler Cowen points us to various reactions (H/T RJS) – I’ll break my silence here and likewise comment on the latest Eurozone policy response.

The latest response to the Euro area banking, economic, and now fiscal crisis was heavy on promises and light on details and substance. Specifically, it outlines 16 different measures on 4 pages of text. The optimists – you know, the ‘glass half full types’ – see the ‘increased flexibility’ of the EFSF fund, or point 8. of the announcement, as a boon to the single-currency union. I see it as one step closer to the point where Eurozone policy makers will ultimately decide whether they're willing to institute a policy to keep the 17-country 'zone' together or let it fail.

Point 8. gives the European Financial Stability Fund (EFSF) the ability to do the following with ‘appropriate conditionality’: act on the basis of a precautionary programme; finance recapitalization of the banks for countries not in the EFSF programme; and purchase bonds on the secondary market (what the ECB was doing under its Security Markets Programme).

This is all fine and dandy; but these measures will do nothing to stem the contagion. Basically, the size of the EFSF is effectively too small to really make a difference, 323 billion euros remaining (note too that the 'full' EFSF lending capacity, 440 billion euros, has only been agreed upon, not yet ratified by all the governments at this time). If Ireland or Portugal were to need new assistance - this is not unlikely, in my view, given recent data coming out of Europe (H/T Credit Writedowns) - the remaining funds would quickly dissipate. Forget about Italy - it's too big. According to Bloomberg (not shown) 418 billion euros worth of Italian sovereign debt will mature through 2012.

The size needs to be bigger, yes, but this clinging to conditionality of fiscal austerity is the true weak link. “Strict”, “appropriate”, or “adequate” conditionality is a prerequisite for accessing the EFSF in any form. Conditionality for an autonomous sovereign government without autonomous monetary policy means fiscal austerity. And fiscal austerity for Europe means growth risk. And growth risk is now morphing into sovereign risk via weak domestic demand and rising fiscal deficits. There’s practically no way out except under fiscal union - or some version of it - and this must entail (literally) unconditional transfers.

It’s not a currency crisis, it’s a bond market crisis.

One can point to market reaction as testament that yesterday’s announcement was a successful response. Since July 18th (the day that bond investors started the long-standing tradition of “buying the rumor”) 10-yr yields across the Euro area fell precipitously: 171 bps in Portugal, 54 bps in Italy, 55 bps in Spain, 219 bps in Ireland, and a quick 353 bps in Greece. The biggest moves were in Ireland, Portugal, and Greece, where the curves shifted to reflect the lower borrowing costs and longer loan maturities. Furthermore, the euro gained 1.8% against the US dollar (+2.24% through yesterday).

It’s all about levels. Despite the quick drop in yields, today’s spread of 10-yr Periphery bonds over a like German bund reflects a substantial mismatch of risk: 815 bps for Portugal (that’s Portugal must pay 8.15% effective interest on a 10-yr bond above Germany’s 2.8% 10-yr borrowing cost), 262 bps for Italy, 296 bps in Spain, 907 bps in Ireland, and a completely unmanageable 1,187 bps for Greece. Note, Greece, Ireland, and Portugal do not pay these rates, since they are blanketed for now under an EFSF program or bilateral loans. Ironically, despite the clear crisis in bond markets, the euro is up 12.6% against the dollar in the last year.

A friend pointed me to a CNBC interview with Warren Buffett from July 7: This is what he said when asked about the Euro area: “When you have 17 countries that all have the same currency, and the yields on their bonds are dramatically different, the situation is not solved.

He’s right. If the US States are any comparison, let’s see what a ‘divergence’ in pricing and risk should mean for a single-currency union. A AAA 10-yr Maryland municipal bond trades at 2.68%, while the worst (in pricing) of the States, Illinois, which is rated at A1/A+, trades at 3.98%. That’s a 130 bps risk premium for a 4 notch rating differential. Forget the ‘worst’ in Europe, Greece, because it’s about to go into default. Or even the next or next or next worst in European bond pricing (in order, these would be Ireland, Portugal, Spain, and Italy). But Belgium, an Aa1/AA+ country is trading at 145 bps over the AAA Germany and just one notch lower in rating, Aa2/AA+. Something’s wrong here; bond markets are still in crisis mode.

This policy response is not a boon to the Eurozone, it’s just a step closer to the crisis point - the point where policy will determine whether the euro dies or survives.

Rebecca Wilder

Wednesday, July 20, 2011

Scary chart of the day: Ireland's bank run

I knew that the Irish deposit base was shrinking - I just didn't realize the severity of the situation. In sum, €21.4 bn in household and non-financial business deposits have been drawn down since their respective peaks.

Irish businesses in aggregate have been in a silent bank run since 2007, households since 2010. So how big is €21.4 bn? Roughly 14% of Irish GDP.

Rebecca Wilder

Tuesday, July 19, 2011

It's wrong to compare Italy to Japan

Reader Dilip pointed me to Paul Krugman's article over the weekend, Italy Versus Japan. In it, Krugman (via commenters) asks why Italian debt is trading at 5.7% on the 10yr, while that in Japan is trading at 1.1% (as of July 19, 2011).

The answer's pretty simple: just 7% of Japan's public debt is held outside its borders. Furthermore, near all of it is denominated in yen, a fiat currency that is funded by the Japanese government itself. On the other hand, Italy has quite a large share of external public debt, 43% of total public sector debt, and the sovereign has conceded monetary policy to the currency union. Simply put: Italy's constrained, Japan is not - and interest rates reflect this.

On a similar note, I often hear that 'Italy is very similar to Japan' in my business. The point is that while the government debt is high, the private sector balance is elevated, so that accounting requires the government to run large deficits and accumulate debt. This is true of both economies; but Japan's private sector surplus is multiple factors of that in Italy.

The sectoral balances in Japan and Italy

The Japanese private sector financial balance (the current account as a % of GDP less public sector net lending as a % of GDP) is seriously elevated, 11.7% of GDP in 2010 (mostly the business sector). Given that Japan runs current account surpluses, the level of deficit spending is somewhat less, 8.1% of GDP in 2010.

In stark contrast, Italy runs current account deficits, -3.3% of GDP in 2010, and the private sector financial balance is only slightly positive, +1.3% of GDP. This implies smaller but manageable public sector deficits on the order of 4.6% of 2010 GDP.

However, given that Italy does not have monetary sovereignty, the credit has become more 'risky' with rising current account deficits. Because for a given level of private sector saving, a higher current account deficit will by definition pressure government debt via increased public deficit spending. This dynamic will ultimately hinder the Italian sovereign's ability to refinance - we're seeing this now.

So while Italy does have a positive private sectoral balance, the economy's sectoral balance does not represent that in Japan. It's wrong to compare Italy to Japan.

Rebecca Wilder

Wednesday, July 13, 2011

What do Spain and Vietnam have in common?

What do Spain and Vietnam have in common?

Roughly a 25% chance of defaulting over the next 5 years. That's what the credit default swap market is telling us.

Vietnam's long-term rating is B1 by Moody's, BB- by S&P, and B+ by Fitch (not that these ratings really 'mean' anything). Spain's current rating is high investment grade - Aa2, AA, and AA+ by Moody's, S&P, and Fitch, respectively. Italy's is in good company as well, the low BBB camp (Croatia and Hungary, for example). Italy is currently rated mid- to low- A by all three rating agencies.

My model (not shown) rates Italy BBB and Spain BBB+ based on economic and structural fundamentals on a cross-section of 76 emerging and developed countries.

The chart above illustrates the shift in CDS pricing from 2 years ago (X-axis) to today (Y-axis). The red line is the 45-degree line. All sovereigns above the red line saw a point-to-point increase in CDS spreads spanning the last two years. There are a lot of European economies populating the upper-left area of the chart.

Is Europe going to end up with a few investment grade credits alongside a host of below-investment grade credits? Greece is roughly CCC by all three major rating agencies. At this time, Portugal and Ireland are below investment grade by Moody's only, Ba2 and Ba1, respectively. We'll see.

Finally, a bird's-eye view of CDS-land.


Rebecca Wilder

Monday, July 11, 2011

The US unemployment rate: European levels without the European safety net

This post is crossposted with Angry Bear blog, where it first appeared.

Jobs growth is a lagging indicator of economic activity, so the June report confirms that the US economy has been in a deep rut (Marshall Auerback calls it a 'fully-fledged New York City style pot hole'). Yes, the US economy is growing; but sub-2% really 'feels' like stagnation, if not recession for many. As always, Spencer provides a fantastic summary of the employment report here on AB: 'bad news', he says.

I call it abysmal, both relative to history and on a cross section. The chart below illustrates the unemployment rates across the G7 spanning 1995 to 2011.

Across the G7 economies, the level of the US unemployment rate is second only to France. This is true on a harmonized basis as well.The speed at which the US unemployment rate reached European levels was abrupt. Only the UK has seen such a swift deterioration in labor market conditions.

The chart above illustrates the same time series as in the first unemployment chart, but the rates are indexed to 2005 for comparability. France's high level of unemployment is structural. In contrast, the US level of unemployment is NOT, not even close.

The chart above illustrates the components of the OECD's indicators of employment protection. Also, see a short note by the Dallas Fed highlighting the differences between the French and US labor markets (and the 1994 OECD jobs study).

The French labor market is quite rigid, which leads to a structurally elevated unemployment rate and expansive unemployment compensation (see this follow up to the OECD 1994 jobs strategy report). The US Labor markets is much more fluid, which is why the unemployment rate has surged relative to comparable economies in Europe (see second chart).

European levels of unemployment without the European safety net.

The chart illustrates the maximum number of months that a worker can claim unemployment insurance for the year 2007. In normal times, French workers can collect benefits for up to 23 months by law, where the US worker collects for just 6 months. The tax and benefit policies data are updated infrequently, and listed on the OECD's website (excel file link).

Seriously, shouldn't Congress be focused on the depressed state of the US labor market, rather than a 'scaled back' version of deficit cutting? Addressing one will clearly impact the other - it goes both ways. Unfortunately, the government's pushing in the wrong direction (cutting deficits brings further unemployment rather reducing unemployment drops the deficits).

Rebecca Wilder

Thursday, July 7, 2011

Why you shouldn't get too excited about the 1.2% increase in German industrial production: ECB + global slowdown

Yesterday, I illustrated (and rather convincingly, in my view) that German factory orders are more of a harbinger of bad economic things to come rather than a strong report to get 'excited' about. Well, today I illustrate why you shouldn't get too excited about the 1.2% rise in working-day and seasonally adjusted German industrial activity in the month of May, as reported by the German Federal Statistical Agency.

Case 1: Industrial activity is set to slow, as illustrated by recent PMI trends.

The chart above illustrates the cyclical component of Industrial Production, filtered using the HP Filter (see reference at end of post), and the previous month's PMI survey. The correlation is 64%, so there's a clear signal from the PMI that stabilization of the cyclical IP is afoot. Better put: the trajectory of cyclical industrial activity is going to plateau.

So while IP remains robust, German industrial activity is unlikely to push Euro area GDP growth up and up for much longer.

So where's the German 'growth' machine going to come from? It must come from domestic demand, of course.

Case 2: Germany remains too reliant on exports and government spending to finance growth.

The table above illustrates spending components of German GDP since the previous cyclical peak. The German economy, as measured by GDP, was just 0.1% above its recent cyclical peak in Q1 2011. Domestic demand recovered somewhat, with consumption and government spending having surpassed the 2008 peak by 1.2% and 7.4%, respectively. Spending on machinery and equipment remains 5.4% below its previous peak. It's the government and trade that's driving domestic demand on a cumulative basis.

Here's the reason NOT to get excited about the industrial report: the ECB is trying to clamp down on domestic price pressures via higher interest rates. But Germany is an export machine, so the slowdown in global economic growth (see my post yesterday for one reasonably robust indicator) will do the ECB's job for them without rate hikes. The ECB's doubling down on policy in Germany when the Periphery are attempting to scrape themselves out of a fiscal austerity hole by way of exports to Germany.

Rebecca Wilder

BTW: Kurt Annen (German, ironically) provides a free HP Filter add-in for Excel. I coded this some time ago into Gauss, but did not want to spend time on it in Excel (VBA is a terrible language). Thanks Kurt.

Wednesday, July 6, 2011

Why you shouldn't get too excited about the 1.8% increase in German factory orders

German factory orders increased rather sharply in May, 1.8% in volumes and on a seasonally adjusted basis. The impetus to industrial orders growth on the month was primarily German factories buying capital goods, +2.4%.

Factory orders do lead economic activity, so German domestic demand is likely still plugging away. But that's as good as it gets - the report also reveals further evidence of a global economic slowdown.

While domestic orders surged 11.3% in May, orders from abroad (EMU countries plus extra-EMU countries) fell 5.8%. The three-month moving average of the index for German factory orders from abroad is now falling at the margin.

Of the new factory orders coming from outside Germany's borders, extra Euro-area orders fell a sharp -6.1% over the month (demand from the UK, the US, and presumably Asia). Factory orders from other Euro-area countries fell 5.4% in May.

The three month moving averages are stable to down for orders stemming from all sources except for within Germany. The implication is that Germany, which drove 50% of GDP growth in Q1 but holds just a 30% share, will further drive Euro-area economic activity into Q2 via robust investment spending. However, this report is consistent with a crystal clear slowdown in global demand.

This is not good for the outlook for Spain nor Italy. Note, too, that Italy's PMI is now in sub-50, i.e., contracting, territory across both the service and manufacturing industries.

Rebecca Wilder