Today: All focused on ECB. Time to short U.S. bonds?
MBA Mortgage Applications:
- Composite Index: +0.2% vs. +2.8% last week.
- Purchase Index: -2% vs. -0.4% last week.
EMU PPI Is Still Declining
The EMU PPI fell in July and its 1.1% year-over-year drop is the largest since April. Capital goods prices are eking out gains over all horizons (in the table), but the increases are marginal. Consumer goods prices over all horizons are a tick either side of flat. Intermediate goods prices are falling over 12 months and six months but are rising at a 1.2% annual rate over three months.
Headline PPI trends show declines on all horizons with the 3-month pace barely lower at -0.1% saar. Producer prices look to be weak everywhere and on all horizons – but perhaps not weakening further.
Draghi Sees Turbulence Ahead
(…) Yet perhaps Mr. Draghi’s U-turn should not have come as such a surprise. Over the summer, he appears to have become increasingly disillusioned with the institutional setup of the eurozone, which he clearly thinks isn’t adequate to meet the economic challenges it faces.
In July, he made a hard-hitting speech calling for Brussels to be given new powers to oversee structural reforms in member states. That was an implicit acknowledgment that he fears political institutions in some countries may be simply too weak to overcome vested interests. This latest call for governments to coordinate their fiscal policies to boost aggregate eurozone demand fits a similar pattern.
(…) In the absence of a true political union, the long-term cohesion of the currency union depends largely on its members self-insuring against shocks by reducing their debt and boosting competitiveness—creating what Bundesbank President Jens Weidmann has dubbed a “stability union.”
Is Mr. Draghi losing faith in the eurozone’s ability to sustain a stability union? He has good reason. Look at what has happened since he took the markets by surprise with his 2012 “whatever it takes” speech.
Back then, newly-elected French President François Hollande had just announced that he intended to honor ill-judged manifesto pledges to raise taxes and lower pension ages that had been demanded by his party’s left-wing. The result was to crush confidence, snuff out the recovery and drive up unemployment to a record high of 10.3% in July.
By January this year, Mr. Hollande recognized his mistake and embraced reform. But it took him until last week to complete the U-turn, with the purging of anti-reform left-wing ministers from the cabinet. Meanwhile, two years have been wasted.
It is the same in Italy. In July 2012, Prime Minister Mario Monti had just agreed a deal with parliament on watered down labor reform after six bruising months of negotiation. The experience exhausted his political capital. Although his government limped on for another nine months, he attempted no further major reforms. His successor, Enrico Letta, spent nine fruitless months seeking a deal on electoral reform while the economy stagnated, before being replaced this year by Matteo Renzi who also spent his first five months pursuing political reform.
Mr. Renzi has just announced an economic reform package. But the cost of Italy’s two lost years has been immense.
The result is that the eurozone is barely in better shape to absorb a major shock than two years ago—just as it faces potentially major shocks from geopolitical tensions along its Eastern and Southern borders. Debt-to-GDP ratios are higher than two years ago, eurozone unemployment is flat, compared with last year, and there is a risk of outright deflation. The lack of growth in Germany, France and Italy, its three biggest economies, is placing a cap on euro-area growth that no amount of reform-led growth in countries such as Spain, Ireland and Portugal can overcome.
The message of Mr. Draghi’s Jackson Hole speech is that he thinks the eurozone’s growth challenge is now so serious that it needs to act more like a political union in both fiscal and monetary policy as well as in the oversight of structural reforms to spread risks and absorb shocks.
That risks setting him on a potential collision course with Berlin—already alarmed at Mr. Draghi’s self-proclaimed willingness to embark on a large-scale government bond-buying program, which German officials warn will inevitably be challenged in the constitutional court. Officials fear that Mr. Draghi’s call for greater coordination of national fiscal policies was a not-so-coded call for Germany to abandon its own debt reduction strategy and embark on a fiscal stimulus program, something Berlin is sure to resist.
It also potentially puts him at odds with officials in Brussels, alarmed at his use of the politically-charged “F-word”—adopting the same language used by the French and Italian governments for greater “flexibility” in interpreting the fiscal rules. Officials in Brussels and Berlin are resigned to a face-saving deal with France and possibly Italy over their deficit limits, potentially using the Ukraine crisis as an excuse. But they are pushing hard for big reform and spending commitments in return.
Mr. Draghi will have a chance to clarify his position at his monthly news conference this week. But he has set the stage for a politically turbulent few months. If another major shocks materializes, the eurozone will have to bind further together or risk being blown apart.
Draghi’s new deal
ECB president’s call for a financial compact
(…) The ECB’s governing council, he said, “will use all the available instruments needed to ensure price stability in the near-term”.
Yet his pledge came with a caveat. Conditions had become so bad that, while the ECB could act, it could not do it all alone. Mr Draghi signalled the ECB was reluctant to reach for its most powerful tool – mass government bond buying, or quantitative easing – without the co-operation of European governments. (…)
For the first time, the ECB president proposed what amounts to a fiscal and monetary compact with the currency area’s lawmakers. The only way to defeat the region’s low inflation and double-digit unemployment was, he said, “a policy mix that combines monetary, fiscal and structural measures at the union level and at the national level”. (…)
The message: Paris and Rome must reform their economies, removing barriers to the creation of businesses and jobs. Countries with the flexibility to spend more while staying within EU deficit rules should do so, creating what Mr Draghi described as “a more growth-friendly overall fiscal stance for the euro area”.
Though the ECB president did not name names, that suggestion was widely interpreted as a call for Germany, the eurozone’s dominant economic power, to raid its fiscal coffers. (…)
President François Hollande’s embattled government seized on the speech. “It is the position held by the president for the past two years,” insisted prime minister Manuel Valls in a speech on Sunday aimed at rallying the rebellious ruling Socialist party behind Mr Hollande.
Only now is the government gearing up to rein in its vast public spending bill, via €50bn savings over the next three years, and to take steps to loosen rigidities in the economy. (France said yesterday it will miss targets to trim public spending.)
In Italy, now suffering from its third recession since the crisis began, Matteo Renzi, the country’s 39-year-old prime minister, took office in February vowing to bring new flexibility to the EU’s rules. But while Mr Draghi’s shift in tone on fiscal policy brings him closer to Mr Renzi’s position, the ECB president is thought to favour less flexibility than the Italian prime minister.
Mr Renzi has taken a swipe at Mr Draghi’s criticisms and calls for more centralised control of reform efforts, with the prime minister pugnacious in his defence of Italy’s sovereignty. “I agree . . . when he says that Italy needs to make reforms, but how we are going to do them I will decide,” he told the Financial Times last month.
Mr Renzi has responded to Italy’s economic malaise with what he has called his “1,000-day” reform programme, which includes pledges of structural reforms to be undertaken over three years.
If the ECB president is to pull off his strategy to mend the eurozone economy, it is crucial that he wins the support of German chancellor Angela Merkel. “In Germany what matters is that he has Merkel’s support. If Draghi is keeping her onside, then he’ll be fine,” says Lorcan Roche Kelly, of Agenda Research. (…)
But Ms Merkel’s willingness to raid the fiscal coffers is unclear. Though she left the door open to channelling the budget surplus into investment programmes, she has indicated this could happen only if the economy were strong enough. (…)
Some analysts view the apparent trade-off between quantitative easing and more reform from France and Italy – and more spending from Germany – as a ploy to buy more time.
“Draghi’s remarks shouldn’t be taken at face value. His call for fiscal easing deflects pressure on the ECB to launch QE, safe in the knowledge that Germany would block any such move,” says Philippe Legrain, an economist and former adviser to then European Commission president José Manuel Barroso. “By arguing that the effectiveness of QE depends on a more stimulative fiscal policy and bolder structural reforms, he was in effect raising new hurdles to it.” (…)
SENTIMENT WATCH
Confidence is building that the US economy is not too weak or too strong; that inflation is restrained; that the Fed will not lurch toward tightening, particularly with geopolitical risks building; that ECB could ease further; and that the next US recession is years away. (ISI)
Meanwhile, Citibank’s economic surprise index surged last week while bond yields dropped further.
JP Morgan: Time To Short 10-Year Treasuries
Going forward, we turn bearish on Treasuries, for a number of reasons. First, growth fundamentals have improved and economic data have outperformed relative to consensus expectations: our Economic Data Surprise Index (EDSI) has risen substantially from its lows at the beginning of this month and now stands at its highest level since May. Second, valuations are supportive of duration shorts, as intermediate Treasury yields sit near their lowest levels of 2014. Third, there is a well-defined cyclical pattern to Treasury yields in the weeks around payrolls….. 10-year yields tend to rise by 6.2bp, on average, in the week leading up to payrolls. Moreover, this cyclical pattern has been consistent, occurring in 5 of the last 6 months. Fourth, FOMC cyclicals are supportive of higher rates over the near term. As we have argued in the past, Treasury yields have a pronounced tendency to rise in the weeks leading up to FOMC meetings which are accompanied by a Summary of Economic Projections (SEP) and a press conference.
Nothing on EU yields! From ISI:
The spread between US and German bond yields is in record territory (2.34% versus 0.89%). The last two times the spread peaked, which were in 1999 and 2006, US bond yields declined roughly -30bp on average over the following three months. So US mtg rates, which declined -22bp last week to 4.06%, could move back below the 4.00% tipping point.
U.S. Manufacturing Rolls on Aged Wheels Even as economic indicators rise, domestic capital spending has remained anemic by historical standards and the nation’s capital equipment base is getting long in the tooth.
The average age of industrial equipment in the U.S. has risen above 10 years, the highest since 1938, economists at Morgan Stanley MS +0.70% said in a recent report.
The growth of all types of capital spending by U.S. firms grew just 3% last year, far below the long-term average of more than 8%, Morgan Stanley says. The firm sees only modest improvement ahead: 3.8% growth this year and 5.3% in 2015. (…)
The Association for Manufacturing Technology reported that U.S. orders for machine tools and other equipment used to shape metals and other raw materials into products in the first half were down 2.7% from a year earlier. Pat McGibbon, a vice president at the association, cites uncertainty over interest rates, the economy and taxes.
One big unknown is whether Congress will restore so-called bonus depreciation, which allows companies to write off new equipment faster, cutting their tax bills and making capital spending more tempting. (…)
Despite the negatives, Daniel Meckstroth, chief economist at the Manufacturers Alliance for Productivity and Innovation, a research organization, expects an upswing in capital spending. For one thing, he says, old equipment can be nursed only so long before it has to be replaced: “We’ve postponed investment for so long that it almost has to occur.” For another, many of the CEOs making acquisitions will find that they need to make capital investments that previous owners deferred.
Banks’ Fee Bonanza Dries Up Banks are making less of their money from customer-account fees than at any time in the past seven decades as strict government rules and changing consumer behavior squeeze a major source of revenue.
After peaking in 2009, the annual account fees collected at U.S. commercial banks have declined markedly, even as the volume of bank deposits has swelled, according to the Federal Deposit Insurance Corp. The fees have dropped nearly 21% to $32.5 billion last year from $41.1 billion in 2009. The total fees had climbed every year since 1942, when the FDIC started collecting the data.
As a result, such fees are making up a smaller share of profits. As a percentage of total noninterest income, deposit-account fees dropped to 14.1% in 2013, the lowest level since 1942, according to the FDIC data. From 2000 through 2009, those fees accounted for an average of 17% of such income. (…)
Bank of America has said it can earn more by persuading customers to maintain more of their finances at the bank and its units, and that it is cheaper to have fewer overdrafters because about two-thirds of its call-center contacts are from customers with questions about fees and balances. Fewer calls means the bank can reduce call-center costs, said Thong M. Nguyen, a retail-banking executive at Bank of America. (…)
Home Depot Probing Possible Breach of Credit-Card Data Home Depot is working with banks and law-enforcement agencies to investigate a potential breach of customer credit- or debit-card data.
GEOPOLITICS
“There will be consequences”…