Macro Weekly – Patience tested

by: Han de Jong

Big Picture - 29 September 2014 - Patience tested.pdf ()

We have held the view that weakness in the eurozone economy over the summer was going to prove temporary. We stick to that view, but last week’s crop of data remained mixed. ECB President Mario Draghi, meanwhile keeps talking. His words have, in the past, been very effective and powerful, but one has to wonder if he can deliver on implicit promises if markets were to call his bluff.

Bad Ifo

The Ifo index of German business confidence has a long history and is, arguably, the most authoritative business confidence gauge in Europe. It dropped for a fifth consecutive months in September and is now only fractionally above its long-term average. The closely-watched expectations component of the survey took a large tumble and is now actually below its long-term average. The eurozone PMI also weakened further in September according to the preliminary reading. But the decline was small: from 52.5 to August to 52.3 in September.

Having said that, there are a couple of bright spots as well. Business confidence in the German services sector improved in September. So did Belgian business confidence and some elements of the French business confidence survey.

Perhaps most important was the ECB’s money and credit data for August. The total amount of outstanding loans to the household sector continues to grow while the decline in the amount of loans to the non-financial corporate sector continues to abate. We must bear in mind that the credit cycle, when looked at this way, is a lagging indicator. When the total amount of outstanding credit drops, it does not mean banks are not extending credit. It means that repayments on previous loans are larger than new loans. That is a normal phenomenon after a recession. We consider the money and credit data consistent with the ECB’s most recent bank lending survey, which showed banks are now easing lending criteria, although only marginally, and that demand for loans is picking up across the board.

Mario Draghi has built a formidable reputation for his verbal interventions. Last week he spoke again and underlined that the ECB would step up its actions further, that is, beyond what the ECB is already committed to, should economic circumstances deteriorate. A couple of remarks are in order here. First, we think that it will not be necessary as we believe economic growth will pick up modestly and inflation is close to a trough. Second, most market participants have made some simple calculations in order to work out what the ECB might do. It goes like this. Mr Draghi recently said that the ECB wants to increase its balance sheet total towards a level early in 2012. A simple sum teaches us that Draghi is talking about an extension of the ECB’s balance sheet of some EUR 700 bn to 1,000 bn. But it is not clear what assets they could buy. The TLTRO will make up a big part, but not more than EUR 400 bn, and possibly less. The ECB has long signalled it intends to start an ABS purchasing programme, but that market is simply not big enough for huge purchases. Then there is agency debt and perhaps a few other sorts of paper. The bottom line of all these calculations is that it is hard to se how the ECB can reach anywhere near EUR 1,000 bn without buying government bonds. Unfortunately, there is a big taboo attached to that.

Out view is that huge further purchases of debt instruments by the ECB will not be necessary. If we are wrong, we think that Draghi will find a way to get around the problem of the taboo attached to buying government bonds. But it might be a messy process.

World trade and Asia: a little better

The Dutch CPB released its estimate for world trade in July last week. The volume of trade increased by 1.4% mom after a 0.3% rise in June. These numbers suggest that world trade growth is accelerating from a very sluggish pace earlier. This picture is consistent with some Asian data released last week. The HSBC index for business confidence in Chinese manufacturing improved a little in September. Hong Kong exports for August were also encouraging: +6.4% yoy. Korean department store sales were up 10.5% yoy in August. Taiwan’s industrial production was up 7.0% yoy in August and export orders 5.2%. Singapore’s industrial production was up 4.2% yoy in August. US data did not provide a lot of news. Housing data was mixed. Jobless claims were just below 300,000 in the most recent week, suggesting continued improvement in the labour market. The volatile durable orders showed a big drop in August, after an even larger increase in July. If on strips out volatile transportation orders, the picture is that durable orders are rising a an unspectacular, but decent clip. The suggestion is that business investment is picking up a little. This was also borne out by the revision of the US Q2 GDP data. GDP growth itself was revised up from 4.2 to 4.6% (following a weather-induced drop of 2.1% in Q1). Half of that revision came from investment having been stronger than originally thought. Net exports were also slightly better.