Europe on the up – Concerns over Ukraine

by: Han de Jong

While US data continues to be affected by the weather, making it hard to gauge exactly how the economy is developing, European data is generally continuing its upward trend and the European Commission has raised its growth forecasts. Several peripheral economies are showing promising signs. Growth is returning and that background will make it so much easier to deal with debt problems. Europe is not out of the woods yet, and won’t be for a long time, but the outlook is positive. Japan is heading into its April tax hike with relatively strong momentum. Fingers crossed. 


I do not have any special knowledge or talent to predict what is going to happen in Ukraine. Clearly, the situation escalated over the weekend with Russian troops on the ground. There are several scenarios to be considered. In the worst ones, risk aversion will hit financial markets. In the best ones, markets for risky assets will only be temporarily affected. We will produce a more focussed commentary shortly. For now, I am assuming that some sort of negotiated settlement will be achieved. Volatility and risk aversion may come in play during this process, but in such a scenario neither the global economy, nor markets for risky assets will experience a fundamental change of direction.

Eurozone confidence strengthens further

Key confidence indices for the eurozone improved in February. The European Commission’s index of Economic Sentiment inched up from 101.0 in January to 101.2 in February, as confidence strengthened in the industrial sector as well as in services, while consumer confidence stabilised.

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A country like Portugal generally does not make headlines, particularly not positive ones. But its economy is developing favourably. The improved competitiveness and the reform measures taken are resulting in a noticeable improvement in economic conditions. The country has erased its persistent external deficit and industrial production was 7.2% higher than a year earlier in December. Portuguese consumer and business sentiment rose sharply in the course of 2013, a trend that is continuing so far this year. Obviously, significant challenges remain. The budget deficit still needs to be reduced further and the country’s debt level of over 120% GDP remains a big concern. Ireland is in a comparable position. It has stronger growth than Portugal and the 3.3% rise in employment in 2013 is particularly impressive. The volume of Irish retail sales was up 8.9% yoy in January. This is a volatile series and the relatively warm weather may have helped, but this is a strong number. Moody’s raised Spain’s credit rating one notch, adding a positive outlook, after having raised the outlook from negative to stable as recently as early December. So that is quite an improvement.

The German Ifo index of business confidence increased in February, although the ‘expectations component’ fell back a little. The German labour market is also continuing its improvement and consumer confidence rose to its highest level since 2007. The breakdown of Germany’s Q4 GDP numbers showed strength in business investment, construction and exports.

The continued positive trend in European data is a pleasant surprise as US data has weakened significantly recently, largely as a result of the cold and the snowstorms. Various official organisations have already raised their growth forecasts for the region. Last week, the European Commission pushed up its forecasts. Having said that, nobody is expecting miracles and economic growth for the region as a whole is expected to amount to 1.2% this year and 1.8% next. We are marginally more optimistic.

Escape velocity in Japan?

Japan’s sales-tax hike is approaching. In April, the tax will be raised from 5% to 8%, with a further increase likely later. It is no surprise that people have brought forward purchases. The question is to what extent this is the case and how badly the economy will dip after the hike? The plan always was to generate growth high enough to avoid a new recession after the tax hike. We will have to wait and see whether the plan will work, but it is clear that momentum has built in Japan in recent months. Industrial production rose strongly in January, pushing the yoy rate to 10.6%. Household spending is obviously strengthening and the labour market is improving. Inflation is also rising. The Tokyo measure of inflation showed an acceleration to 1.1% yoy in February. Inflation was only higher for brief periods in 2009 and 1997 and we have to go back to 1992 to find inflation consistently above February’s level. For now, we have to give Japan the benefit of the doubt. The international backdrop may improve enough between now and April for the economy not to sink back into recession.

US data still affected by the weather

Many US data releases are still affected by the weather, but last week also produced some positive signs. Durable goods orders fell 1.0% mom in January, but the elements with the strongest link to business investment were up. Q4’s GDP growth was revised lower from 3.2% qoq annualised to 2.4%, but the composition was more compelling. Business inventories had contributed much less to growth, business investment more. The regional business confidence surveys are still showing a difficult to interpret pattern. Milwaukee’s ISM fell below 50, but the PMI of nearby Chicago stayed strong and moved higher. Business confidence indices from Kansas, Richmond and Dallas were all considerably weaker.

Chinese currency weakens

The Chinese yuan continued its downward trend against the USD. It has now slipped in two consecutive weeks. While officials deny that the central bank has anything to do with it, market behaviour suggests they have had a hand in it. Their intentions are unclear. We believe the policymakers wanted to make market participants feel that the currency is not a one-way-bet. But it is also possible that economic weakness is leading to a preference for a weaker currency. For now, we stick to the first interpretation and think the weakness will be temporary.

Brazil posted better than expected Q4 GDP numbers. Having said that, growth amounted to only 1.9% yoy and growth prospects remain modest. The central bank in Brazil raised its Selic rate for the eighth consecutive time, but chose to hike by only 25 bp this time.