German investors confidence at the highest in 42 months

Despite uncertainties related to the US government shutdown and the discussions in Congress to rise the debt ceiling, German investors confidence rose to the highest since April ’10 in October. Zew economic sentiment index rose in October from 49.6 to 52.8, better than market expectations (51.0).

The figure is a positive sign for the IFO business confidence index due on Friday October 25th and it is in line with a 1.5%/2% annualized growth of GDP in Q4. The only negative pieces of news came from the current conditions index, declined from 30.6 to 29.7.

 

 

Further signs of a weak recovery in the Euro zone

Final PMI services indices released today in the Euro zone confirmed that economic activity could pick up in H2 ’13, even if at moderate pace.

 

Euro zone PMI services index rose from 49.8 in July to 50.7 in August, lower than flash estimate at 51.0. Composite index rose from 50.5 to 51.5, lower than flash estimate at 51.7.

 

According to our calculations, the past relationship between the PMI composite and the overall economy indicates, the August PMI corresponds to a 0.5% y/y GDP growth in Q4 ’13.

 

National services indices signaled that services index expanded in Germany (at 52.8 in August) but continued to contract in France (48.9 in August – 12 month high) and Italy (48.8).

 

 

 

August PMI manufacturing indices: recovery in the Euro zone and in China. Emerging Asia ex-China slowing down

PMI manufacturing indices for August released today strengthened the view that Euro zone economy could extend the rebound started in Q2 – when GDP rose by 0.3% q/q – in H2 ’13. Euro zone PMI manufacturing index rose from 50.3 to 51.4, above an estimate of 51.3 published on Aug. 22. A reading above 50 indicates growth.
Euro zone figure is in line with a slight recovery in Q3 and Q4. Economic activity could improve in the quarters ahead but the risk of a return to recession in case of negative shocks are still very high, in our view.
Indices were above 50 in all major Euro zone countries, with the exception of France:

1)      German PMI rose from 50.7 to 51.8 (flash estimate 52.0). The revision in Germany does not seem meaningful. The trend remains positive   and industrial production is expected to continue growing in the months ahead despite market expectations for a correction of orders and output in July (data are due during the week);

2)      French PMI remained unchanged at 49.7. French data could increase concern on the recovery there. However, INSEE index for August rose more than expected, giving an opposite message compared to the PMI index. French outlook is still worrisome as competiveness is low and public finance continue to deteriorate;

3)      Italian PMI rose from 50.4 to 51.3 – the 27 month high of the index;

 

PMI indices also rose in Netherlands - from 50.8 to 53.5 – and in Spain – from 49.8 to 51.1. In Europe, UK PMI manufacturing index climbed from 54.8 to 57.2.
Positive news also came from China, where PMI manufacturing index was at 51.0 against market expectations at 50.6.
However, the picture in the emerging Asia ex-China was less positive, with indices below 50 - signalling contraction for the sector - in South Korea, India, and Indonesia.

Euro zone CPI calls for an ECB rate cut

Flash August Euro CPI decelerated from 1.6% y/y to 1.3% y/y, lower than market expectations at 1.4% y/y. Looking at the details of the release, most of the fall can be attributed to the energy component which decelerated from 1.6% y/y to -0.4% y/y while the remaining components remained broadly stable. Core CPI remained unchanged at 1.1% y/y.

With energy slowdown likely to be temporary, CPI could rebound to 1.5% y/y by year-end.

However, inflationary pressures are likely to remain subdued in the months ahead as indicated by latest ECB monetary aggregates figures. Money supply M1 growth rate fell from 7.5% to 7.1% and M3 2.4% to 2.2% y/y. The following data suggest that CPI should remain weak in the next few months.

 

 

Low inflationary pressures should push the ECB to further ease monetary policy as soon as next week. Indeed ECB is missing both the target of CPI below but close to 2% and on M3 growth rate of 4.5%.

However we do not expect the ECB to ease monetary policy unless Euro zone economy falls back in recession.

Italian confidence indices improve in August. Will the positive trend continue?

Both business and consumer confidence indices improved in August, suggesting that economic outlook is slightly improving also in Italy.

1) manufacturing confidence index rose from 91.8 to 92.9 - the highest since November '11. Despite remaing at value in line with a contraction of industrial output in the next 2/3 months, it signalled that industrial sector could find a bottom soon;

 

2) Consumer confidence index rose from 97.4 to 98.9. It is a sign that consumer spending could improve in H2 '13 even if at modest pace due to high unemployment rate.

The two data strengthened the view that - absent other negative shocks - Italian economy could stabilize in Q3 and return to growth in Q4

How close is the end of US Government bond yields rally?

The trend of the last weeks

US 10 year Government bond yields jumped from 2% on May 22^nd – when Fed President Mr. Bernanke suggested that the Fed might cut back on bond purchases some time in “the next few meetings” and the minutes of April 30^th/May 1^st monetary policy meeting indicated that “a number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting – to 2.61% on Monday 24^th. From the lowest level touched on May 2^nd at 1.63% yields increased by 98bp.

The upward trend of 10 year yields further strengthened following the Bernanke’s press conference on June 19th, when he confirmed that that the central bank could reduce its purchases this year and halt them around mid-2014. The acceleration of the yields increase fuelled concerns that rising government bond yields could have a negative impact on equity markets. However, S&P500 was so far resilient, falling by a mere 3.4% from the historical high at 1655 set on May 22. On Wednesday 26th 10 year yields corrected to 2.52% as final Q1 GDP data disappointed investors: indeed it was revised down from 2.4% to 1.8% annualized, mainly due to weaker consumer spending growth.

Fed’s reaction

The strong increase of Government bond yields alarmed Fed’s members. For example, Minneapolis Fed President Narayana Kocherlakota said in an interview with CNBC on Wednesday 26th that the bond-market reaction to last week's Federal Reserve decision was "outsized". He also highlighted that the Fed needs to defend its 2% inflation target both from above and below.

Limited upside potential

Our base scenario is that from current level government bond yields have limited upside potential. In our view, 10 year government yields will hardly exceed the 2.75% target for year-end set by Deutsche Bank chief economist Joseph LaVorgna in a recent note. Indeed we believe that the economic outlook does not support a further increase of government yields.

First, because US economy lacks a strong engine of growth in the next few quarters:

1)     Consumer spending is likely to continue expanding at moderate pace (1.5/2.0% annualized) as jobs creation remain weak;

2)     Government spending contribute to economic growth will soften for the spending cut become effective since March 1^st; 

3)     Investments are likely to be negatively impacted by the tightening of fiscal policy;

4)     Exports will suffer due to weakening of economic activity in emerging market and recession in the Euro zone.

Second, because inflationary pressures are well contained and are not expected to pick up in the foreseeable future.

The case for being bullish

In our view, the potential for a decline of Government bond yields in the months ahead is higher than the potential for a further increase. In particular should economic activity being weaker than Fed projections for a 2.4/2.5% GDP growth in 2013 and 3.2/3.3% in 2014.

A similar view is shared by Jeffrey Gundlach, head of DoubleLine Capital LP. He said on Tuesday 25^th that “the selloff in the bond market is likely to end in the next few weeks and that now is the time to consider buying riskier debt”. Gundlach characterized the selloff in the bond market as a "liquidation cycle" that will end within weeks, once the benchmark 10-year Treasury hits a high of 2.75%.

USA: CPI and housing market sligthly weaker than expected

May headline consumer price inflation rose by 0.1%, below expectations of a 0.2% increase, and up 1.4% from the prior year. Core CPI, excluding food and energy, rose by 0.2% in line with expectations, and up 1.7% from past year.
These numbers confirmed that inflationary pressures are non-existent now, strenghtening the view that the Fed could continue in its asset purchase programme at current pace.

 

Housing market data came out slightly worse than market expectations. Housing starts set at 914K, below expectations of 950K, and permits at 974K (exp. 975K).

Germany: Zew index better than expected in June

June Zew economic sentiment index rose from 36.4 to 38.5 beating market consensus at 38.2. It is a sign that German economy could improve at year-end.
With regards to the perspectives of German economy, the focus is now on business confidence indices: PMI manufacturing index due on Thurday 20th and IFO business confidence index due on Monday 24th. The indices should remain almost unchanged compared to the previous month (at 49.9 and 105.7 respectively), in line with a moderate growth rate for the industrial sector in Q3.

Business confidence improves in Germany and France. Consumer confidence down in Italy

May business confidence indices released today in Germany and France came out better than expected, signaling that the two major Euro zone economies could improve in the next 2/3 months.

In Germany, IFO business confidence index jumped from 104.4 to 105.7 against economists’ expectations for a data almost unchanged at 104.5. The sub-index measuring current business jumped to 110.0 points in May from 107.2 points in April. And the outlook sub-index was unchanged at 101.6 points. The data is in line with an acceleration of industrial production in the next 2/3 months.

 

In France, INSEE business confidence index jumped from 88 to 92, better than market expectations at 90. The figure is in line with an improvement of industrial sector outlook despite remaining below long term average and at a value in line with 0.6% y/y contraction of French industrial production in the next 2/3 months.

Italian consumer confidence index fell from 86.3 to 85.9. The index is now close to the historical low at 84.7 recorded in January due to high unemployment rate. In this scenario, consumer spending could continue contracting in the months ahead.

Is it time to invest in the Italian equity market?

The economic data released over the last week confirmed that the Italian economy is in a dire recession:

1)      The Q2’s GDP contracted by 0.7% q/q – slightly better than market expectations at -0.8% q/q. It was the fourth consecutive quarterly decline: -0.8% q/q in Q1 ’12, -0.7% q/q in Q4 ’11 and -0.2% q/q in Q3 ’11. The year over year change fell from -1.4% in Q1 ’12 to -2.5% in Q2 ’12.

2)      In June, the Italian industrialproduction fell by 1.4% m/m, 1.7% q/q and 8.2% y/y.

The leading indicators released over the last few weeks signaled that a recovery of the Italian economy is not imminent:

1)      The Istat business confidence index was at 87.1 in July – only slightly above the 3 year low at 86.5 posted in May. The index signaled that the industrial production may contract by 10% y/y in Q3;

2)      The Istat consumer confidence index signaled that the consumer spending will continue to remain weak in H2 ’12 for the negative outlook of the labor market. According to the latest Eurostat’s data, the Italian unemployment rate rose to a multiyear high of 10.8% in June. 

However, despite the negative economic scenario, the Italian equity market strongly rebounded over the last few weeks: from the year-low at 12295 posted on July 25^th, the FTSEMIB jumped by almost 20%.

The main reason behind the rebound of the equity markets were the expectations that the ECB may intervene in the secondary market to lower the government bond yields in Spain and Italy. Indeed, the equity market rally started after the ECBpresident Mario Draghi said on July 26th at the Global Investment Conference in London  that the ECB “will do whatever it takes to preserve the euro” and continued after the ECB announced at the end of the last week monetary policy meeting that it will start buying the Spanish and Italian government bonds on the secondary markets if the two countries will ask for the intervention of the EFSF/ESM.

Following the ECB announcement, the Italian government bond yields declined: the 2 year yield fell from 5% to 3.08% and the 10 year yields fell from 6.6% to 5.9%.

A steep decline of the government bond yields in Italy will have a strong impact on the Italian economy as:

1)      It will lower the interest expenses on the huge public debt (close to 120% of GDP);

2)      It will improve the outlook for the banking sector, which is highly exposed on the Government bonds;

3)      It will lower the cost of financing for the non-financial corporations.

For this reason, a further decline of the long-term Government Bond yield – i.e. a decline of 10 year BTP yield below 5.5% - is crucial for buying the Italian equity market in a medium term perspective. Since 1994 a simple trading strategy of buying the Italian equity markets (we used the Comit index as a benchmark) at the end of the month when the 10 year BTP yield was below the previous year yield and exiting from the market in the opposite case gained a 121% performance versus the -5% of a buy and hold strategy.

Another positive sign should be a rebounded of the business confidence index. In the past, a bottom of the business confidence index anticipated not only an improvement of the economic activity but also the start of an upward trend of the equity market. The next Istat business confidence index will be released on August 30^th.

U.K. Q2 GDP: The Sterling Is Not A Safe Haven

In the UK, Q2 GDP data came out worse than expected, with a 0.7% q/q contraction. The consensus expectations were for a 0.2% q/q decline. Compared to the same period 1 year ago, the GDP contracted by 0.8%. The ONS indicated that (continue on seekingalpha)...

Very volatile data today in the USA

Economic data released today were very volatile: 1) Initial jobless claims fell from 388k to 353k vs market consensus. The data was very volatile in the last weeks due to plant shutdown and difficulties in seasonal adusting the data. However, the data is a positive indication for the labour market in July. Jobs creation in July may slightly below 100k. 2) durable goods orders rose by 1.6% m/m vs expectations at 0.3% m/m. The ex-transportation data fell by 1% m/m. The data is in line with the contination of a moderate of growth for the manufacturing sector in Q3.

Euro zone: M3 data rose but loans declined

The data for June released today by the ECB signalled that the Money supply growth accelerated slightly but loans to the private sector decreased. the M3 rate of growth rose from 3.1% y/y (revised from 2.9% y/y) to 3.2% y/y. The annual total credit growth to the private sector fell from -0.2% to -0.4%. Loans to household remained unchanged at +0.3% (for home purchases +0.8%, consumer credit -1.9%). Loans to financial corporations fell from 0.0% to -0.6% y/y. The latest data signals that the situation of the credit market is still dire and increases the possibilities that the ECB may further ease monetary policy over the next week.

Italian consumer confidence rebounded in July

The Italian consumer confidence index unexpectedly rebounded from 85.4 in June - the historical low of the index - to 86.5 in July. The improvement was led by the view on the Italian economic outlook and a better view on the labour market. Despite the rebound in July the index remains on historically low level, signalling that consumer spending may continue contracting in Q3.

S&P 500: Is It Too Risky Investing Now?

Despite the debt crisis in the eurozone, the signs of weakening of the economic growth in the USA and in China, the S&P 500 remains only 4% below the highest close since '08 posted on April 2nd at 1419. Over the last week, the index managed to gain 0.4%, with the decline on Friday (-1%) only limiting the performance. continue on seekingalpha

PMI indices: Euro zone outlook continues deteriorating

In our article "No Sign Of Relief In The Eurozone" we highlighted that the major business confidence indices due for release over this week should confirm that the Euro zone economic has been deteriorating fast.
The PMI indices for the Euro zone just released had mixed results despite confirning that an recovery is not coming anytime soon. Indeed, while the PMI manufacturing index unexpectedly fell from 45.1 to 44.1 vs market consensus at 45.2, the PMI services rose from 47.1 to 47.6 vs expectations for an unchanged reading. The PMI composite index remained unchanged at 46.4, a level in line with a 0.5% q/q contraction of the Euro zone GDP in Q3.

 

Moody's cut the German outlook to negative. Rating unchanged at AAA

Moody's decided to cut yesterday the outlook for Germany, Luxembourg and the Netherlands to negative but confirmed the AAA rating. The rating agency explained in a statement that: "The level of uncertainty about the outlook for the area and the potential impact of plausible scenarios on member states, are no longer consistent with stable outlooks".

The German Finance Ministry said the risks in the euro zone are “not new” and that Germany remains “in a very sound economic and financial situation.” In counterpoint to Moody’s, it cited the verdict of financial markets that have rewarded Germany with record low borrowing costs on government bonds.

The Moody's announcement may have a limited impact on the financial markets. After S&P stripped France and the U.S. of AAA grades, interest rates paid by the countries to finance their deficits dropped rather than rose

Some links on the topic:

Germany's AAA rating under threat after Moody's cuts outlook

Germany Pushes Back After Moody’s Lowers Rating Outlook

Euro zone consumer confidence index at the lowest since 2009

The European Commission consumer confidence index for the Euro zone fell in July from -19.8 to -21.6, the lowest since 2009. A rebound of the consumer confidence is unlikely until the outlook of the labour market does not improve. The data is line with a further contraction of the Euro zone GDP in Q3 and anticipates the continuation of the downward trend of the PMI indices due for release tomorrow.

No Sign Of Relief In The Eurozone

Over the next week, the most important event in the eurozone will be the release of the business confidence indices for July in the eurozone (PMI indices) and in Germany (IFO index).

We do not expect any improvement (continue on seekingalpha)

Is The EUR/USD Heading Toward 1?

Last week's ECB decision to cut the Refi Rate and the deposit by 25bp - respectively to 0.75% and 0% - was not enough to push up the European equity markets as the CB did not give any indication on a further easing of monetary policy in the months ahead. (continue on seekinalpha)...