Macro economic analysis provided by Stalos Capital

1. MACRO
COMMENTARY
Stalos Capital
For independent investors
2011, n°33
June 24
This week….
 As expected FED hold interest rate at 0.25%
 Despite the confidence vote to the govern-
ment, Greek default remains inevitable
 The ZEW fell sharply confirming the deceler-
ation of the German economy
 Brazil: unemployment fell to a record low
6.4%
 US economy grew 1.9% in Q1
Macroeconomic analysis
 United States
 Euro Area
 Other countries

2. United States Most of the 3.8% m/m fall in existing home The FED seems completely lost. They were
sales in May, to a six-month low of 4.8m expecting a miracle and it did not happen.
from 5.0m in April, was probably due to the With a rising inflation fuelled by commodity
unusually severe weather. Nevertheless, the prices, after having printed money as it
data are still overestimating the level of never did before and cut interest rates close
sales by up to 20% and a chronic lack of de- to zero, the FED has no more bullets to fire.
mand will mean there probably won't be a Declining home prices, high unemployment
housing recovery to talk about until 2014, at and weaknesses in the financial system may
the best. restrain the recovery in the longer term.
The 2.1% m/m decline in new home sales The economy grew at a 1.9% pace in Q1.
shows that homebuilders are still struggling The revised rise in GDP matches the median
to sell new builds at a time when housing forecast of economists surveyed by Bloom-
demand remains in the doldrums and there berg News and follows a 3.1% gain in the
is fierce competition from foreclosed prior quarter. The figures also showed a
homes. At 319,000 in May, down from higher inflation than the one previously cal-
326,000 in April, the number of new home culated. The jump in commodity prices and
sales is still 14% above February's record the shortage of auto parts stemming from
low. However they are 77% below the 2005 the disaster in Japan earlier this year that
peak and only a third of the 900,000 that we have also restrained growth this quarter are
would expect in a healthy market. showing signs of improvement.
As expected, the statement issued after the The first-quarter revision reflected a smaller
end of the two-day FOMC meeting offers trade deficit and a bigger increase in inven-
no hint that the recent signs of a renewed tories than previously reported. Nothing
economic slowdown might tempt the here is going to change the big picture.
Fed to launch another round of large-
Orders for durable goods climbed more
scale asset purchases. At the same time, the
than forecast in May to 1.9% after slumping
Fed pledged to continue reinvesting the
the prior month. By minus 2.7%.
principal payments from its maturing securi-
ties holdings and to hold its key interest rate
at near-zero for an extended period. The
upshot is that the Fed will leave policy un-
changed for some time. The statement
acknowledges that the economic recovery is
shaping up to be slower than the FOMC had
anticipated and that recent labour market
indicators have been weaker than anticipat-
ed. Nevertheless, Fed officials need to bal-
ance that slowdown against the incoming
news of a pick up in core inflation. Given
that the annual rate of core inflation
climbed to 1.5% in May and the three-
month annualised rate jumped to 2.5%.
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3. Euro area A year after European officials bailed out age a prerequisite for a new aid program to
Greece, banks haven’t raised sufficient capi- avert the euro-area’s first default. Greek
tal to withstand the contagion that may government and European leaders are not
follow a default. going to solve any issues, just winning some
time.
European banks have raised 59 billion euros
since stress tests last July, according to Mor- The direct hit from Greece is manageable
gan Stanley. While European lenders re- because investors have had time to prepare.
duced their risk tied to Greece by 30% to As I mentioned before, a Greek default is
$136.3 billion last year by not renewing inevitable. How this default will be organ-
loans, writing down the value of debt and ised is crucial to avoid a big crisis. The conta-
shifting it off their books, they still have al- gion to other countries is the big risk.
most $2 trillion linked to Portugal, Ireland,
So far, the market did not properly price this
Spain and Italy, according to the Bank for
risk estimating that a country weighing less
International Settlements.
than 3% of the Euro GDP will not massively
French lenders had the highest overall for- damage the euro-zone. I strongly disagree .
eign claims on Greek borrowers of $56.7
Indeed, the International Monetary Fund
billion, including $15 billion in public debt,
warned that Europe’s debt crisis has the
at the end of 2010. The banks had $589.8
potential to crush the otherwise positive
billion of loans tied to Ireland, Italy, Portugal
economic outlook for the region unless poli-
and Spain. German lenders were the biggest
cy makers step up efforts to resolve it.
foreign owners of Greek government debt
with $22.7 billion in holdings last year and The fund said policy makers should scale up
had the second-most overall claims. Their Europe’s rescue fund and extend its poten-
claims on Ireland, Italy, Portugal and Spain tial uses to secondary market purposes and
amounted to $498.8 billion. The two coun- term funding guarantees. That echoes pro-
tries hold more than 60% of all foreign posals from the European Central Bank
claims on Greece. which wants the rescue fund to purchase
government bonds in the secondary market.
German Chancellor Angela Merkel retreated
last week from a confrontation with the Besides, the IMF launched a serious warning
European Central Bank that threatened to about the Spanish economy. According to
shove Greece into the euro zone’s first sov- the fund, some of the underlying problems
ereign default, softening demands that of the Spanish economy, especially weak
bondholders be forced to shoulder a big productivity growth and the dysfunctional
part of a rescue. Europeans are asking more labour market, remain to be fully addressed.
efforts to the Greek government which has The government has pledged to cut the
to cope with intense social pressures. budget deficit to 6% of GDP this year and
3% in 2013 from 9.2% last year, with
Prime Minister George Papandreou’s gov-
measures including public- sector wage cuts
ernment will try next week to rally support
and a pension freeze. Meeting the medium-
for a package of austerity measures worth
term targets will likely require additional
78 billion euros to go to parliament. Europe-
measures.
an Union leaders made passage of the pack-
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4. The global recovery has been driven by a very low level, despite a sharp drop in con-
massive policy stimulus that cannot simply struction activity. This perhaps provides
be repeated anytime soon, and growth is tentative signs that the booming external
already faltering under the weight of high sector is beginning to prompt firms to in-
commodity prices. But the big picture is crease their production capacity. Nonethe-
worse than that, a Greek default would crys- less, the recent bout of soft global data sug-
tallise and deepen the worries about the gests that export growth is likely to slow
dire state of recent public finances in many over the coming quarters. Ireland’s heavy
countries. exposure to the US and UK means that it
will suffer more than most from the euro’s
A Greek default would inevitably increase
strength and also from any accidents hap-
the pressure on other weaker members of
pening in these two countries heavily ex-
the monetary union, notably Portugal, Ire-
posed to an economic contraction.
land and perhaps Spain and Italy. Ironically,
the contagion risk might be even greater in Household spending fell by 1.9% in Q1, the
the event of an otherwise “orderly” default. sharpest quarterly fall since Q1 2009. With
real household incomes likely to continue to
Indeed, Moody’s Investors Service said it
decline and the on-going fiscal and mone-
may cut its Aa2 rating on Italy, whose 2010
tary squeezes set to make matters worse,
amounted to 119% of GDP, Europe’s second
the situation is not going to improve.
highest after Greece.
According the very optimistic four year plan,
The Greek problem will drive European Un-
it is likely that the Government may eventu-
ion to the creation of the Euro bond area or
ally come under pressure to implement
has the potential to destroy the Euro. I think
more austerity measures and seek a second
the market completely underestimates the
bail-out package.
impact and the risk of such crisis.
The Euro-zone PMI for June provides fur-
Irish GDP expanded by 1.3% on Q1, com-
ther signs that GDP growth in Q2 slowed
pared to a 1.4% quarterly contraction in Q4
pretty sharply. The headline composite in-
(revised from 1.6%). The Irish economy has
dex fell for the third time in four months,
now stagnated for around the past year.
from 55.8 to a below consensus 53.6. The
Note though that GNP, a measure of the
decline was down to falls in both the manu-
level of output produced by Irish residents,
facturing and services sub-indices. The drop
fell by 4.3% on the quarter, almost entirely
in the manufacturing one might reflect dis-
reversing the gains recorded over the previ-
ruptions to global supply chains caused by
ous year.
the Japanese earthquake, suggesting that it
The expenditure breakdown shows that might rebound over the coming months.
remain sharp divergences remain between But the decline in the service and the com-
the health of the domestic and external posite employment indices suggest that the
sectors. Exports rose by a healthy 3.8% on fiscal and monetary squeezes are taking
the quarter, perhaps a sign that Ireland is their toll on the domestic economy.
benefitting from recent falls in wages and
costs. Investment also rose, albeit from a
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5. The sharper than expected fall in the head-
line German ZEW index brought further
signs the German economic recovery has
passed its peak. The economic expectations
index fell for a fourth consecutive month,
from +3.1 to -9.0, its lowest level since
January 2009 (consensus -2.0). Accordingly,
the majority of investors now expect Ger-
man economic conditions to worsen over
the next six months. The current economic
conditions remains close to its record high,
it fell for the first time since May 2009. All
this combined with the recent falls in other
timely indicators of activity would appear to
support the view that the robust German
recovery is rapidly losing steam.
The IFO business climate unexpectedly in-
creased to 114.5 from 114.2 the previous
month. Both gauges current conditions and
expectations fell.
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6. Other countries UK: average prices in London jumped 1.8% est rates on hold is a bit of a relief, given
from May to 438,622 pounds due to de- that he had sounded a bit hawkish in his
mand from overseas buyers for luxury prop- testimony to the Treasury Committee. So
erties. Nationally, values increased 0.6%, now just Spencer Dale and Martin Weale
according to Rightmove,. are left voting for a hike. The Committee
noted that the current weakness of demand
While Britain’s property market is struggling
growth was likely to persist for longer than
to build momentum as banks limit lending
previously thought and judged that the
and budget cuts undermine confidence, the
downside risks to the medium-term infla-
exception is London where foreign buyers
tion outlook had increased over the months.
are seeking homes in areas such as Kensing-
ton and Chelsea. Rightmove said a lack of Brazil: unemployment rate fell to 6.4%
mortgages and a seasonal slowdown means from 7.5%, the lowest ever for the month
national values will probably fall about 7% in of May as companies in Latin America’s big-
the second half after an 8.1% gain in the gest economy hire workers to meet growing
first six months. domestic demand.
In a separate report today, Markit Econom- This gives the central bank a reason to raise
ics said Britons’ expectations of house prices interest rates again in July. Record low un-
over the next year turned positive this employment coupled with a substantial in-
month for the first time since September. crease in wages are an important risk for
Markit said Britons’ finances deteriorated at inflation and a driver of economic growth.
the fastest pace since March 2009 this Average real wages rose 4% from a year
month. A gauge of household finances fell ago.
to 35.1 from 36 in May.
Policy makers have increased the bench-
Public finances revealed few signs of im- mark interest rate four times this year to
provement in the UK’s fiscal position. The 12.25% slashed spending by $31.9 billion
monthly PSNB figure of 17.4 billion pounds and increased taxes on consumer credit as
was a bit below last month. But in the first they seek to bring inflation back to their
two months of the fiscal year together, bor- 4.5% target next year.
rowing has totalled 27.4 billion compared to
Commodity: the continued deceleration in
last year’s 25.9 billion. At this pace, borrow-
China’s economy signalled by the PMI for
ing will overshoot the forecasts by almost
June threaten the commodity trend, indus-
30 billion. The figures provide a clear warn-
trial metal in particular. The prices of indus-
ing that the weakness of the economy could
trial metals in particular are strongly corre-
derail the Government’s deficit reduction
lated with the performance of China’s man-
plans and will add fuel to the debate over
ufacturing sector. This makes sense, of
whether it should scale back the size and
course, given that China now accounts for
speed of the fiscal tightening.
around 40% of total global demand for in-
The minutes of June MPC meeting suggest dustrial metals. China’s demand for metals
that a near-term rate rise is still very unlike- already appears to have dropped sharply
ly. The fact that new member Ben Broad- this year. The volume of copper imports,
bent voted with the majority to leave inter- for example, fell by 36% y/y in May.
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7. Short term prices could drop due to a global
slowdown and the end of easing quantita-
tive policies. However, medium term, the
needs from the emergent economy will con-
tinue to support demand for such commodi-
ties.
China: HSBC and Markit reported a sharp
fall in their flash estimate of June’s PMI to
50.1 from 51.6 in May. This estimate is
based on 85% - 90% of survey responses.
The average difference between flash and
final estimate over the last 12 months has
been 0.4 (either up or down). In other
words, even if subsequently revised, June’s
data are likely to signal a further and sizea-
ble slowing of activity.
The biggest falls were in the output and new
order components, both of which now
stand close to 50. New export orders
dropped to their lowest since March 2009,
consistent with other evidence of weaker
global demand and suggesting that the re-
cent slowdown in China’s export growth
could be prolonged. Manufacturers also
signalled that employment is declining
again.
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