macro economic analysis

1. MACRO
COMMENTARY
Stalos Capital
For independent investors
2011, n°36
July 15
This week….
Moody’s put the US triple A ranking on review
EQ3 as the last resort weapon to save the US
economy
Greece and Ireland sovereign debt cut again by
rating agency
Chinese GDP in Q2 beat the estimates to 9.5%
but inflation increases to 6.4%
Indian inflation accelerates to 9.44%
BOJ left interest rates unchanged to 0.10%
Macroeconomic analysis
 United States
 Euro Area
 Other countries

2. United States The Federal Reserve may keep interest The minutes from the FOMC meeting on
rates at record lows for the longest period 22nd June reveal that, despite the evident
since World War II. The 3 percentage point slowdown in GDP growth, there is little ap-
gap between yields for three-month and 10- petite among Fed officials for a third round
year Treasuries indicates the economy may of quantitative easing (QE3), at least not in
grow 1.1% in the 12 months ending June the short term. It is not really surprising
2012, according to a study by the Fed Bank considering the US situation. Even if some
of Cleveland. That’s less than half the cen- members like the ideas, they cannot afford
tral bank’s current forecast. The last time it. According to the minutes only some par-
the Fed maintained such prolonged mone- ticipants thought it would be appropriate to
tary support for the economy was from provide additional stimulus in the medium
1937 to 1947. From 1941 to 1951 the cen- term if the unemployment rate remained
tral bank also bought Treasuries as America elevated, and even then not unless inflation
grappled with the need to fund World War had fallen back. Fed Chairman Ben Bernan-
II, convert the U.S. back to a peacetime ke's written semi-annual testimony repeats
economy, and pay for the Marshall Plan to the main message . QE3 would be a possibil-
rebuild Western Europe. Slower expansion ity, but only if deflationary risks re-emerge.
means the Fed is unlikely to tighten credit In other words, it is a possibility next year if
until June 2012, the longest static period inflation drops back, but not in the short
since the government forced the central term.
bank to buy Treasuries during the 1940s.
Import price index dropped minus 0.5%
Any spending cuts agreed by President
(less than the consensus –0.6%) in June for
Barack Obama and Congress before the
the first time in a year as oil and food ex-
Aug. 2 deadline to raise the $14.3 trillion
penses retreated. Prices excluding petrole-
debt limit may restrain the economy.
um fell 0.2%, the first decline since July
The economy’s inability to produce jobs 2010. Compared with a year earlier, import
may be the biggest obstacle for the Fed be- prices rose 13.9%, the biggest 12-month
fore it can remove the support it has provid- advance since August 2008. The cost of im-
ed with purchases of $2.3 trillion in assets ported petroleum fell 1.6% m/m. Even with
and the reduction of its overnight lending the decrease, the cost was still up 50% from
rate to near zero. The U.S. has added 1.7 a year earlier. Imported food was 1.9%
million jobs since the start of 2010, after cheaper last month, the largest decline
losing 8.7 million in 2008 and 2009. The since February 2009. Companies are, none-
unemployment rate stands at 9.2% against theless, feeling the effects of more expen-
4.4 % in 2007. sive goods. Input cost inflation and air
freight expenses will reduce gross margins
The Fed completed its $600 billion of pur-
by at least 300 basis points for the first
chases of Treasury debt on June 30, though
quarter of fiscal year 2012, according to
it could continue to reinvest about $300
Donald Blair, chief financial officer of the
billion of proceeds from maturing mortgage
Nike.
-related assets and government securities
into U.S. government debt in order not to
contract the supply of money.
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3. The 0.4% decline in the producer-price in- outstanding bonds and notes even though
dex followed a 0.2% gain in May. The core the risk remains low. It is unthinkable that
measure, which excludes volatile food and Democrats and Republican do not find an
energy costs, increased 0.3%, more than agreement about the debt. But this will not
projected. The rise in commodities prices changes the issue of the American debts.
this year, which prompted some U.S. com- Taking in considerations different agencies
panies to pass them along to customers, is the total US debt amount is around 130% of
starting to ease for the moment. Fuel costs GDP. The triple A ratings of financial institu-
dropped 2.8%, the most since July 2009. tions directly linked to the U.S. government,
Residential electric prices fell by a record 2% including Fannie Mae, Freddie Mac, the Fed-
in June. eral Home Loan Banks, and the Federal
Farm Credit Banks, were also put on review
Consumer price index inflation peaked at
for cuts.. Moody’s also placed 7,000 munici-
3.6% in June, but core inflation edged up to
pal (equivalent of $130 billion) ratings on
1.6% last month, from 1.5%, and will contin-
review for possible downgrade.
ue to climb over the next few months. Over-
all consumer prices fell by 0.2% m/m in The 0.1% m/m increase in retail sales in
June, thanks mainly to a 6.8% m/m decline June was a bit better than expected. But the
in gasoline prices. In contrast, excluding key point is that the level of sales has been
food and energy, core prices increased by pretty much unchanged for the last three
0.3% m/m. At 1.6%, the annual core rate is months and annualised real consumption
still below the Fed's target of about 2%, but growth in the second quarter as a whole
the three-month annualised rate shot up to was probably around 0.6%, down from 2.2%
a worrying 2.9%. June's increase was re- in the first. As the number of manufactures'
markably similar to May, in that it was driv- auto sales fell, that suggests either used car
en principally by a surge in clothing prices, sales shot up, vehicle prices rose sharply or
hotel room rates and vehicle prices. The there was a collapse in business purchases.
1.2% m/m jump in clothing prices is a reac- Sales were also boosted by a 1.3% m/m gain
tion to the massive spike in cotton prices in sales of building materials, as the clean
over the past year. More recently, however, up after the severe tornadoes and floods in
cotton prices have plummeted by 30% over April and May continued. These gains were
the past month alone, so we should see offset by a 1.3% m/m decline in gasoline
clothing prices eventually come back down station sales. Sales excluding auto, building
a bit, although not until 2012. This latest materials and gas up by only 0.1% m/m. This
strong rise in core prices will make Ben is the best measure of underlying sales
Bernanke and his Fed colleagues even more growth and suggests that households are
reluctant to countenance and new quantita- hardly increasing their spending at all. In-
tive easing in the second half of this year. deed, spending on discretionary goods such
as furniture and electronics in June fell for
The U.S rated triple A since 1917, was put
the third month in a row. Clearly the recent
on review by Moody’s for the first time
stalling in employment growth has forced
since 1995 on concern the debt threshold
households to be a bit more careful with
will not be raised in time to prevent a
their cash. With no light coming, the situa-
missed payment of interest or principal on
tion looks like blacker than ever.
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4. The trade deficit widened in May to the the supply disruptions following the Japa-
highest level in almost three years to $50.2 nese earthquake in late March are still hav-
billion (+15%), reflecting a surge in crude oil ing a restraining effect. In addition, the 0.4%
imports. After eliminating the influence of m/m gain in May was revised down to a
prices, which renders the figures used to 0.1% increase. Motor vehicle output de-
calculate GDP, the trade deficit rose to clined by a further 2.0% m/m last month.
$47.8 billion from $43.9 billion. The second- Nevertheless, even outside the vehicle sec-
quarter average so far remains lower than tor, output only increased by a lacklustre
$50.4 billion average in the first three 0.2% and barely increased over the second
months of the year, indicating trade will quarter as a whole. The knock-on impact
probably contribute to growth for the April from Japan undoubtedly explains some of
through June period. Trade helped damp this lethargy, but there also seems to have
the first quarter’s economic slowdown, con- been a more general slowdown in the
tributing 0.14% point to GDP. Imports rose growth rate that might not be fully reversed
2.6% to $225.1 billion, second only to the in the third quarter. Looking at the product
record $231.6 billion reached in July 2008. A breakdown, business equipment production
barrel of crude oil cost an average $108.70 fell by 0.7% m/m, which is a discouraging
in May, the Commerce Department said, sign as far as business investment in ma-
the most since August 2008. The petroleum chinery and equipment is concerned. Over-
gap for the month was the biggest since all, add this report to the disappointing em-
October 2008. Excluding petroleum, the ployment figures released a week ago and
trade gap rose to $19.8 billion from $17.5 it's pretty clear that the economy had not
billion in April. Exports decreased 0.5% to started to pull out of its soft patch in June.
$174.9 billion, also the second-highest on
The sharp fall in the University of Michigan
record and depressed by a drop in foreign
measure of consumer confidence, to 63.8 in
demand for industrial supplies like fuel oil
July from 71.5 in June, casts doubt over our
and cotton. Purchases of American-made
hope of a rebound in consumption growth
capital equipment was the strongest ever.
in the third quarter. On this measure, confi-
Goods shipped into the U.S. may receive a
dence is now back at the level last seen in
temporary boost in coming months as Japa-
January 2009 when the US was still in reces-
nese suppliers recover from disruptions
sion.
caused by the natural disaster in March.
Imports from Japan dropped by $500 mil-
lion. The trade gap with China, on the other
hand, climbed to $25 billion from $21.6 bil-
lion in April.
The Empire State manufacturing index im-
proved modestly to -3.8 in July, from -7.8,
suggesting that things are getting a little
better in the factory sector. However, the
figure remain negative. Manufacturing out-
put was unchanged in June suggesting that
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5. Euro area Ireland joined Portugal and Greece as the recovery in the wider euro-zone economy
third euro-area nation to have its credit may soon grind to a near halt.
rating reduced to below investment grade.
Moody’s Investors Service cut Ireland to Ba1
from Baa3, citing the probability that Ireland
will need additional official financing and for
investors to share in losses before it can
return to the private market to borrow. The
downgrade underlines the need for some-
thing more radical in terms of a European
solution as the creation of the euro bond
market. We really need European leaders
taking responsibilities to come up with a
solution rather than pushing it into the fu-
ture. Indeed, Irish government criticized the
Moody’s downgrade, argued that Ireland
has met the targets so far under its bailout
program. It is true in term of cut but unfor-
tunately we are far away from 2.5% annual
growth forecasted to put Ireland out the
problem. At the best this year, Ireland will
grow by 1%, likely at zero. Ireland’s debt will
rise to 118% of GDP in 2012 from 25% at the
end of 2007.
Greece’s credit rating was cut three levels
to Fitch Ratings’ lowest grade for any coun-
try in the world to CCC, as the absence of
credible program by the International Mon-
etary Fund and the European Union dark
the outlook.
Euro-zone industrial production data con-
firm that growth in the economy as a whole
slowed pretty sharply in the second quarter.
The 0.1% monthly increase was weaker than
the consensus forecast of a 0.4% gain and
particularly disappointing after earlier data
revealed sharp increases in Germany and
France (1.2% and 2.0% respectively). Indus-
try remains very weak in the periphery. Giv-
en this and the fact that tight fiscal policy
will keep domestic spending subdued, the
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6. Other countries China: trade surplus widened more than climbed 3%, the biggest gain since at least
forecast to $22.3 billion in June, the highest 2005.
level in seven months, as imports grew at
GDP rose 9.5% (above the consensus 9.3%)
the slowest pace since 2009. The surplus
in Q2 from a year earlier, after a 9.7% gain
adds to the cash flooding the economy and
in the previous three months. Industrial
complicates Premier Wen Jiabao’s efforts to
output advanced 15.1% in June, the most
cool the fastest inflation in three years. Poli-
since May 2010. Demand is holding up in
cy makers are seeking to rein in price gains
the fastest-growing major economy even
that are stoking social discontent without
after the central bank boosted lending rates
choking off growth that’s already showing
five times since mid-October and lifted bank
signs of slowing. Exports climbed 17.9%, the
reserve requirements to a record. The In-
least since December after excluding sea-
ternational Monetary Fund forecasts that
sonal distortions from the Chinese New Year
China’s economy will expand 9.6% this year.
holiday, to a record $162 billion. Imports
Fixed-asset investment, excluding rural
jumped 19.3% to $139.7 billion, the customs
households, rose 25.6% in the first half from
bureau said, the weakest expansion since
a year earlier. Retail sales expanded 17.7%
gains resumed in November 2009 after a
last month from a year before, exceeding
year-long decline. China, the world’s biggest
also he consensus. The global economy is
consumer of energy, iron ore and soybeans,
increasingly dependent on China’s demand
has seen its import bill surge over the past
as the U.S. labour market deteriorates, and
year as commodity costs climbed. Higher
investors have been concerned that tighten-
global prices are increasing inflationary
ing measures will choke off growth. Signs of
pressure in China, and led to a 14.7% in-
a slowdown have spanned weakness in im-
crease in the overall price of imported com-
ports, a manufacturing index falling in June
modities in the first half. Exports to the Eu-
to the lowest level since February 2009, and
ropean Union and U.S., the two biggest
carmaker General Motors Co. (GM) saying
trading partners, rose 16.9% in the first half,
that sales may be at the low end of a fore-
compared with overall export growth of
cast. At the same time, lending exceeded
24%.
forecasts last month and growth in M2, the
Inflation accelerated to the fastest pace in broadest measure of money supply, re-
three years to 6.4%, highlighting the chal- bounded. So, even if figures from Q2 are
lenge for policy makers of sustaining growth positive, Chinese economy will continue to
while taming prices. The government slow in the coming months. If the world
curbed lending by boosting lenders’ reserve needs a strong Chinese economy, China
requirements to a record and raised interest does not need a strong growth but cooling
rates five times since September. Inflation inflation, more particularly food inflation.
was mainly driven by a 14% gain in food
UK: house-price gauge showed little im-
costs and also pushed up by an unfavoura-
provement in June as a subdued economic
ble base for comparison a year earlier, an
outlook hampered demand for property,
effect that will diminish in the second half.
according to the Royal Institution of Char-
Producer prices rose 7.1% in June from a
tered Surveyors . The number of real-estate
year earlier. Non-food consumer prices
agents and surveyors saying prices fell
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7. exceeded those seeing gains by 27%, com- India: inflation accelerated to 9.44% in
pared with 28% points in May. In separate June, adding pressure on the central bank to
reports, PricewaterhouseCoopers predicted extend its longest stretch of interest-rate
that the average U.K. home price is unlikely increases in a decade. The benchmark
to return to a 2007 peak until about 2020. wholesale-price index rose 9.06% in May
from a year earlier, according to the com-
Unexpectedly, consumer price index
merce ministry. Food-price inflation quick-
dropped in the headline rate from 4.5% to
ened to a three-week high of 8.31% in the
4.2% reflected the unwinding of temporary
week ended July 2. The Reserve Bank of
factors which have exacerbated the upward
India may raise rates this month even after
trend over the last month or two. It gives
Mumbai was hit this week by the biggest
some breath to BOE. But the fall in the core
terrorist attack since November 2008. The
rate from 3.3% to 2.8% might be the first
Reserve Bank has raised borrowing costs 10
real sign that the weakness of households’
times since the start of 2010. Inflation accel-
spending power is starting to bear down on
erated in June because of an increase in
underlying price pressures in the high
diesel costs and higher prices of minerals
street. That does not mean that inflation
and manufactured products. Curbing infla-
has now peaked, due to the impact of com-
tion is the top agenda for India’s policy mak-
modity prices, particularly food, inflation is
ers as price gains erode spending power in a
likely to continue rising in the coming quar-
nation where the World Bank estimates
ter.
more than three-quarters of the people live
May’s dreadful trade figures , showing a rise on less than $2 a day.
in the trade deficit from 7.6 billion pounds
South Korea: Bank of Korea kept interest
to 8.5 billion, look like another blow to
rates at 3.25% unchanged after an increase
hopes of a strong boost to growth from net
in June as policy makers monitor the threat
trade.
posed by Europe’s sovereign debt crisis.
The labour market figures continue to give With inflation exceeding its 2%-4% target
a bit of a mixed picture about the strength limit every month this year, the central bank
of the jobs recovery. On the one hand, the will probably boost borrowing costs twice
widest ILO measure of unemployment fell more in 2011, according to the median fore-
by 26,000 in the three months to May, driv- cast of economists in a Bloomberg News
en by a decent rise in employment. But the survey. Consumer prices rose 4.4% in June
50,000 increase in employment was none- from a year earlier. Core prices, which ex-
theless a bit weaker than the increases seen clude energy and food, advanced 3.7% last
in the last few months. And the 22,500 rise month, the fastest gain in two years. With a
in the claimant count measure of unemploy- pending increase in electricity rates and
ment in June was the biggest increase since relatively low prices a year earlier to com-
March 2010. Besides, average earnings pare with, inflation, prices will likely stay
growth remains very low. The headline rate high above 4% at least until Q4. Inflation is
picked up from 2% to 2.3% in May. So, real becoming a political issue with parliamen-
pay is still falling by over 2% a year. tary election scheduled for nest spring while
presidential election coming up next year.
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8. South Korea’s economy expanded 1.3% in shrank 1.2% in Q1, the biggest contraction
the three months through March from the in two decades, as floods and a cyclone dis-
previous quarter. rupted farming and mineral shipments from
Queensland, the nation’s biggest coking coal
Japan: Governor Masaaki Shirakawa left
-producing state. A net loss of 5,400 jobs
the benchmark lending rate between zero
from April to June was the weakest quarter
and 0.1%. The central bank said in a state-
for Australia’s labour market since the first
ment. They also kept unchanged a $125
three months of 2001, when a U.S. reces-
billion) fund to buy assets such as corporate
sion began. Retail sales unexpectedly fell
bonds and exchange-traded funds. The BOJ
0.6% in May, the steepest drop since Octo-
cut its growth forecast for the year ending
ber.
March 2012 to 0.4% from an April estimate
of 0.6%. It kept its predictions for a 2.9% Singapore: economy shrank for the first
expansion in the following year and inflation time in three quarters to minus 7.8% annu-
of 0.7% for both fiscal 2011 and fiscal 2012. alised as manufacturing slumped, adding to
Manufacturers see business prospects im- evidence the slowdowns in Europe and the
proving later this year and plan to spend U.S. are curbing growth in Asia. The Singa-
more on plant and equipment while also pore dollar, the best performing Asian cur-
stepping up hiring of workers, the central rency after the South Korean won in the
bank’s Tankan survey showed. Conditions past year, weakened from a record. The
for service providers have also been improv- government forecasts an expansion of 5% to
ing. Retail sales fell at the slowest pace in 7% this year after a record 14.5% pace in
May since the disaster and wages rose for 2010. The central bank, which tightened
the first time since the temblor. Japan’s gov- monetary policy for the third time in a year
ernment yesterday pledged to keep all nu- in April, guides the local dollar against a
clear reactors halted by the accident idle basket of currencies within an undisclosed
until it completes safety tests. Almost two- band. Consumer prices rose 4.5% in May
thirds of the nation’s 54 reactors have been compared with a 5.5% gain in January, an
shut by the earthquake or taken offline be- easing that may encourage policy makers to
cause of regular checks. Prime Minister hold off on allowing faster currency gains in
Naoto Kan has proposed a 2 trillion yen se- the October review. The city state, home to
cond extra budget for rebuilding after the the world’s second-busiest container port,
quake. The disaster has left more than has remained vulnerable to fluctuations in
22,000 people dead or missing, and the gov- overseas demand for manufactured goods
ernment estimates it caused 16.9 trillion even as the government boosts financial
yen in damage. services and tourism to reduce its reliance
on exports. Manufacturing fell 5.5% from a
Australia: consumer confidence fell by the
year earlier in the three months ended June
most since Lehman Brothers collapsed in
30, after gaining 16.4% in previous period.
2008 as concern intensified about the Euro-
Services industry grew 3.3% last quarter
pean debt crisis. The sentiment index
from a year earlier, after climbing a revised
plunged 8.3% to 92.8 from a month earlier,
7.6%in the previous three months. The con-
the biggest decline since October 2008 and
struction industry grew 1.6%, compared
the lowest level since May 2009. Economy
with a 2.4% increase in the first quarter.
8 - Stalos Capital 2011