Sound bites: Eurozone economic sentiment drops to 90 in March from 91.1 in February

The drop in the Eurozone economic sentiment index in March compounds a very negative message for recovery prospects ahead. The debt crisis is not going away and the turmoil in Cyprus is putting a heavier deadweight on economic confidence. The evidence is piling up from an array of leading indicators that the Eurozone is sinking deeper into the recession swell. There is little chance of escape from recession this year and the odds seem to be rising that some of the better performing economies like Germany will eventually succumb to recession again. Germany is not out of the woods by any stretch of the imagination. The drop in output in the fourth quarter underlines that Germany is already half way there and there is no guarantee that the economy will sidestep it given the recent downturn in economic confidence and leading indicators.

ECB policymakers have a major dilemma. Self-enforced fiscal austerity is ripping the heart out of any recovery hopes. The ECB are doing a limited amount of counter-cyclical stimulus, but they need to do more. The German/Bundesbank model of tough policy medicine is blocking recovery. The Eurozone have a choice. Either follow the German model and face euro extinction, or else follow the  easier path being mooted by France to ditch austerity in favour of pro-growth stimulus. This is down to survival tactics now. Eurozone governments need to abandon their fiscal austerity targets and the ECB needs to cut rates again and open up the monetary sluice-gates for unsterilized quantitative easing. Without this, the Eurozone will be blighted by recession for years and the euro will find itself at growing risk of spreading contagion. Short term, the euro will be heading back down to a re-test of USD1.25. Beyond that parity looms in the long term.

Euro: running out of road (and life-expectancy)

Forget kicking the can down the road. The euro is fast running out of road. The crisis in Cyprus marks a new milestone in the euro’s demise. The problems are getting bigger for the Eurozone and the ability of policymakers to patch the euro’s fractures back together again are looking increasingly in doubt. The Eurozone almost went to the brink over the Cyprus crisis and  yet the economy there only accounts for a tiny 0.2% of Eurozone output. A minnow almost toppled the euro majors. In the lead-in to the crisis the euro cascaded nine big figures from the USD1.37 February  peak. The subsequent  rally from the USD1.2845 low last week has been pretty flaccid to say the least. It is beginning to dawn on the markets that the euro might now be fatally holed beneath the water-line. Try telling the Russian depositors who have lost their trousers in the Bank of Cyprus and Cyprus Popular Bank debaggings that the euro is a credible store of  wealth. There will be many global central bank reserve managers who will be scratching their heads today about the viability of the euro as a premiership reserve currency. The euro should now be seen for what it is - an ultra  low return-high risk currency. There will be many savers with deposits in excess of 100,000 euros in the troubled Eurozone periphery who will now be looking for much safer havens for their wealth. Given the enormity of what has just happened this weekend, the subsequent rally in risk assets has been pretty limp-wristed too. In the post-Lehman Brave New World, there is a growing  cynicism that we are anywhere near redemption from the contagion. The words ‘lost ‘ and ‘decade’ spring to mind.

You have to pity the nation. Cyprus was a sacrificial lamb on the altar of German politics. Chancellor Merkel could ill-afford to show any further mercy or philanthropy with German federal elections breathing down her neck later this year. If there is a ‘rotten heart of Europe’ now, it is less the on-going peripheral contagion threat than the danger that voters in the Eurozone core have just had enough. The Eurozone is starting to show more symptoms of spinning apart. These centrifugal forces are not only coming  from voters in the troubled periphery who have had enough of enforced austerity, but also emanating from voters in the core who wish to put a stop to endless bail-outs at their expense. Team Eurozone is no longer a dream – it’s a nightmare. It is interesting to see that the latest Sentix survey of investor confidence shows a record 41% in March expecting a Eurozone country to quit the euro in the next year, up sharply from 19.25% in February. The forces of instability for euro break-up are rising and no surprise considering the poor way that policy makers handled the crisis over Cyprus. The risks are probably even that a euro break-up will not only come from the bottom, but also the top. Ireland, Greece, Portugal and Cyprus are already feeling the heat in the kitchen. But it is not just the endemic risks facing Italy and Spain too, toiling under the excessive burden of austerity policies and uncertain politics. France is looking like it is coming close to ditching austerity in favour of pro-growth policies. Germany is looking increasingly like a country that has had enough. New View Economics expect that the euro will cease to exist in its current shape over  the next five years and will be very lucky to survive the next two years.

Set against this backdrop, the risk asset rally has a hard task ahead. There are two conflicting forces. The post-July 2012 rally has been super-fuelled by the Big-Easy super-flood of central bank liquidity, bolstered by Draghi’s commitment to do whatever it takes to ensure the euro’s survival. The euro is the linch-pin now. Worries about euro-contagion have had a huge viral effect on risk asset sentiment in the last few years. As contagion breaks out again – which it will do – the markets will be hamstrung every time a debt crisis comes back onto the radar screen again. Unfortunately, investors have little alternative to stock markets as a higher yield play, while zero interest rates and low bond yields persist in the mainstream markets. It underlines the message that stock market performance looks set to experience a bumpy ride for the rest of 2013. As far as the euro is concerned, the substantive trend will be lower. The ECB will be forced into further tranches of liquidity injections to help restore calm into the troubled Euro-system. Much more ECB money must be poured into the Eurozone economy to ensure there is some semblance of life left in what is increasingly becoming a zombie economy outside of Germany. Given the German economic advisers’ down grade to 2013 GDP growth to 0.3% from the former 0.8% forecast, at least there is some dawning recognition now of the future dangers, unless a switch change of tack is adopted soon. The future for the euro will be bounded now by unfettered quantitative easing and the cachet of limited life-expectancy. A return to parity seems inevitable in the next 1-2 years.

Sound bites: German IFO index tolls a negative bell for recovery

It looks like the bells are starting to toll in Germany that the Eurozone crisis is about to hit recovery prospects again. The drop in the bellwether German IFO business sentiment index shows a new reality that Germany cannot shrug off mounting political and economic problems in the Eurozone for too much longer. The biggest risk right now is that euro contagion is once again un-caged and ready to rip through the heart of economic  confidence. The crisis in Cyprus is coming to a head and ready to pounce on recent optimism that the Eurozone and Germany could get back onto a more even keel. That has just been wishful thinking. The political situation is so looking so tenuous that it is bound to hit German confidence very hard in the next few months.

The March IFO index dropped to 106.7 from 107.4 in February, reversing four months of sharp gains. Future expectations marked the worst fall, dropping back to 103.6 in March from 104.6 in the previous month. What was interesting was that IFO pointed out that 85% of the survey responses were taking after news broke over Cyprus, intimating that most of the worst effects were already factored in. To the contrary, perhaps German industry has its head in the sand and ignoring the impending contagion risks. The crisis looks set to escalate with likely collateral damage expected to affect business prospects all across the Eurozone. Germany will not be spared.

Germany might have been showing some recent signs of economic spring, but it will all tend to implode if contagion pressures begin to surface in a bigger way. Even recent domestic lead indicators have shown warning signs that all is not right in the German recovery right now. The recent fall in industrial orders, especially in foreign order books, all underline that there are fractures under the German recovery. There is a risk now that Germany may already be in recession again after the dip in output in the fourth quarter. There will be a dawning reality that Germany is in this together with the rest of the Eurozone and that its economic fortunes are inextricably linked up with the rest of its Eurozone partners – rich and poor. It is a reminder that Germany can ill-afford to turn its back on countries like Cyprus. The Eurozone has to rise or else fall together. This is another reminder to the ECB that they need to keep monetary policy on a very easy setting for a long time.

 GERMANY                  MARCH 13     FEB 13      MARCH 12
 BUSINESS CLIMATE           106.7       107.4         109.8

 BUSINESS CONDITIONS        109.9       110.2         117.4

 BUSINESS EXPECTATIONS      103.6       104.6         102.7

Forex bites: a ticking time-bomb under the euro

There is a palpable sound of ticking coming from under the euro. The crisis in Cyprus is a time-bomb waiting to explode. Over the next few days the fall-out could be really severe. Markets are waiting for the crisis to be disarmed and hoping for a credible resolution. That looks heavily in doubt. The credible option has gone away with the government ruling out a levy on depositors to help pay towards the implied 16 billion bailout cost. If the government cannot work out a bail-out for the banks by the end of the week, the odds are that the ECB will pull the plug on its support operations, Cyprus will be in default and will quickly exit out of the euro. It is a result that nobody wants, not least Cyprus. The fact that the Austrian Chancellor Werner Faymann and ECB chief negotiator on Cyprus, Joerg Asmussen are openly talking about it underlines the systemic risk.

Risk assets and the euro have managed some semblance of short squeeze on the notion that a compromise can be slipped in at the last minute. But the cupboard is bare there right now. Either Cyprus compromises and concocts a new deal with the EU, or alternatively Russia coughs up some new cash, or else the country defaults. If nothing is in place by the time the banks re-open in the next few days it will only be a matter of hours before the banks’ balance sheets go into cardiac arrest. The only way that the ECB can continue their lines of support is that the banks are recapitalised and the only way for that to happen is for the Cyprus government to accept bail-out conditions in their entirety from the EU, IMF and ECB. Right now, the political will is not there to achieve this.

What seems to have happened is that the political tables have turned. It is not a question of the Germans blinking at some stage. They are throwing down the gauntlet that things must change. Germany has key elections looming in the autumn and voter tolerance for never-ending bail-out charity money has not only worn thin, but also worn right through. That is why the liability has been thrown back on depositors. It is not that Cyprus is a special case due to its offshore banking status. Germany is throwing back moral hazard and responsibility to its local source. Collective Eurozone responsibility is being railed in and domestic economies are being made to pay. Whether or not it is the burden of severe austerity or the new precedent of depositor scalping, it is not a situation that can last forever. The sudden rise of political populists like Beppe Grillo in Italy underline the risks that public opinion will say ‘no more’. When that happens the system will pop.

In the next few days these pressures will resurface again for the euro. The currency is on a collision course now with its own bad history. It is all down to confidence and that is fast diminishing. In the past the euro has generally sprung back from disaster. More recently since the financial crisis began, the euro’s rally has been predicated on the reserve recycling of debased US dollars into euros, especially by central banks of trade surplus Asian economies. If the euro’s very existence starts to come into question, then this currency reflex reaction is not going to work in future. And if central banks start to dispose of their glacial holdings of euro reserves, based on euro survival fears, the meltdown effect could be traumatic in the coming weeks. Cyprus might mark a small drip in the meltdown process, but the repechage effect into Spain and Italy will turn into a deluge of investor money away from the euro. The euro is not off the hook here and a concerted break down towards USD1.25 should be on the cards very soon. Longer term, the old adage of dead as a parity still comes into play.

Sound bites: BOE on amber alert for more easing

The BOE remains on amber alert ready for green to go on more easing. With Governor King in the vanguard for more quantitative easing, it is less of question of if but when the BOE opens up the sluice gates to more monetary stimulus. The outlook for UK recovery is in a mess thanks to the Chancellor’s stranglehold on growth prospects due to deepening fiscal austerity. There may be a rump of MPC opposition to new QE due to inflation concerns, but worries about a slip into triple trip recession should be concentrating minds now that the BOE will need to do more to bolster recovery prospects. Consumer confidence remains dangerously weak thanks to job loss fears and low wage inflation. Businesses are holding back on new investment. And the Chancellor’s cupboard will be bare in the Budget. It leaves it to the BOE as the only swing producer of extra recovery stimulus ahead. The BOE should have announced new QE measures by mid-year. Sterling may get a temporary fillip from the BOE sitting on its hands right now, but the stage is set for more QE and more pressure on the pound ahead. The pound still looks set to retrace back towards USD1.35-1.40 territory in the next 3-6 months.

Highlights

BANK OF ENGLAND MPC VOTED 6-3 TO KEEP QE TOTAL AT 375 BLN STG IN MARCH; KING, FISHER AND MILES VOTED FOR 400 BLN STG

 BOE MPC VOTED 9-0 TO KEEP INTEREST RATES AT 0.5 PCT (REUTERS POLL 9-0)

BOE - RECENT DATA HAS NOT ALTERED ECONOMIC OUTLOOK MATERIALLY, BUT INFLATION OUTLOOK A LITTLE HIGHER

BOE - PROBABLE GROWTH WILL PICK UP OVER 2013, INFLATION LIKELY TO EXCEED 2 PCT FOR MUCH OF NEXT 3 YEARS

BOE - RIGHT TO ACCOMMODATE FIRST-ROUND IMPACT OF WEAKER STERLING ON CPI IF WEAKNESS REFLECTS REAL FACTORS

BOE - STERLING WEAKNESS DUE TO ANY PERCEPTION OF EXCESSIVELY LOOSE POLICY OR WEAKER ANTI-INFLATION COMMITMENT WOULD BE DIFFERENT

BOE - SOME MPC MEMBERS ARGUED FURTHER QE COULD LEAD TO UNWARRANTED DEPRECIATION OF STERLING

BOE - INFLATION EXPECTATIONS CONTAINED BUT MPC WILL CONTINUE TO WATCH THEM CLOSELY

Euro: close to the edge

The euro is getting close to the edge again. Cyprus is not the root cause, but the effect of the crisis that has been building in the Eurozone for years. Irrational exuberance in the banking sector, really bad budgetary control and a deepening divide between the economic Haves and the Have-Not underlines little hope of this having a happy ending. Cyprus should not be underestimated. Cyprus could well be the trigger for a much deeper debacle in the peripheral markets if the Eurozone fails to stop the contagion from spreading. Make no bones about it. The Eurozone authorities have seriously goofed on the bail-in proposals. The Eurozone ‘bright ideas’ department may have come up with a Baldric style ‘cunning plan’ over the bank levy proposals, but it is not going to impress anyone at ground level. The people of Cyprus  are going to have to pay the penalty for the misdemeanours of the over-blown banking sector and years of bad budget fundamentals. And they are now starting to kick back hard. There is about as much hope of getting the two-tier bank levy through in its initial form as hell freezing over. The Cyprus parliament’s new draft bill might have a better chance of passage. This suggests a zero tax levy on deposits up to 20,000 euros, 6.75% on deposits between 20,000-100,000 euros and 9.9% for deposits over 100,000 euros. In the bigger picture it  is simply re-arranging deckchairs on the Titanic. If this is rejected in parliament or resisted by public opinion, Cyprus would be forced into default and driven out of the Eurozone. The euro would be left stigmatised.

If the Cyprus government can swing the latest proposals past the electorate then fine. It simply kicks the contagion can a little further down the road again. But it will not go away. The euro looks a doomed ship. It may not be a sudden submersion, but the odds are that the euro is so fatally holed below the waterline that any hope of challenging the US dollar’s reserve currency status are wrecked forever. The problem with the bank levy proposal is that the Eurozone authorities have opened a new Pandora’s Box of uncertainty. It sets a precedent for potential bank runs if depositors get even half a whiff of a future bail-out. Depositors and institutional investors will vote with their feet and look for safer havens to bank their cash. That means the front end of the German yield curve, the Swiss franc currency and gold will continue to be the market’s on-going friends. Ironically, even the much debased US dollar will start to show its lustre again, much as it did in the second half of the 1990s when Greenspan’s irrational exuberance regime attracted massive capital inflows into the ill-fated US dot.com boom, pushing the dollar higher in the process. With the US authorities opening up the stimulus floodgates in such grand style again, the US dollar should regain its growth spurs, especially relative to the recession-bound and contagion-ground euro.

There may be some short term relief rally from a Cyprus compromise in the next few days, but the fundamental odds have clearly shifted against the euro in the long term. With the US economy continuing to show signs of better economic spring, at some stage, the markets will begin to factor in the prospect of the Fed applying a future touch on the policy brakes. With the ECB looking set to cut rates again, in conjunction with more proxy QE in the form of extra LTROs, the euro will come unstuck. This will be compounded by further escalation in the Euro-crisis. Italy and Spain are all waiting in the wings. Meanwhile popular opinion is turning against enforced austerity. If the peripheral nations start to take a leaf out of the French counter-cyclical book, then the euro will be flushed out. The trend looks set for a test of USD1.25 in the next 1-3 months and a shift below USD1.20 is the fate awaiting the euro in the next six months. It is going to get a lot worse for the euro before there is any chance of redemption, if at all. It should be more of a fight for its very survival in the next couple of years. And who could rule out a Pythonesque ‘dead as a parity’ play for the euro ahead? It’s been there before and it deserves to go there again.

Sound bites: German ZEW overshadowed by Eurozone debt crisis in March

Germany’s economic sentiment looks like it is peaking, with the ZEW index only edging up to 48.5 in March after the sharp rise to 48.2 in February. It looks like the Eurozone debt crisis is taking its toll again. German business confidence cannot shrug off the deepening Eurozone crisis much longer. The Eurozone is mired in recession, governments keep tightening the fiscal screw, and contagion risks are starting to spread again – this time from Cyprus. The peripheral economies are sinking fast and starting to pull core countries like Germany and France into the downdraught. The German economy might be showing more relative buoyancy right now, but with so much demand governed by economic fortunes elsewhere in the Eurozone, the longer term prospects do not look encouraging. ZEW is a sentiment gauge and as a result tends to be very fickle, sensitive to negative influences inside and outside of the German economy. These are not looking good. Domestic economic indicators are slowing. The latest German industrial orders data were ominous with foreign demand dropping sharply, largely thanks to recession in the Eurozone periphery and slowdown in the core countries. If the latest spell of contagion risks escalate from drama into crisis, then Germany’s ZEW and IFO business confidence surveys will be heading south again, foreshadowing Germany’s return to its fourth recession since the start of the new millennium. The bottom line for the ECB is that it must keep the monetary floodgates wide open and rates need to go down again. The ECB cannot afford for its only bright hope for recovery to fall back into recession shadows again. This is another nail in the euro’s coffin set against the background Cyprus risks.

Highlights

• ZEW INSTITUTE MARCH GERMAN ECONOMIC SENTIMENT INDEX 48.5 VS 48.2 IN FEB (POLL 48.0)
• MARCH GERMAN CURRENT CONDITIONS INDEX 13.6 PTS VS 5.2 PTS IN FEB (POLL 6.0)
• ZEW - POLITICAL SITUATION IN ITALY, CYPRUS RESCUE PACKAGE INCREASED RISK OF EURO ZONE DEBT CRISIS WORSENING
• ZEW - EURO ZONE DEBT CRISIS REMAINS BIGGEST RISK

Euro: the Mummy Returns

The euro Mummy returns. It’s no Boris Karloff incarnation, but it could be the market’s worst nightmare. The creature is back, lurching about, bandage clad and scaring the living daylights out of risk perceptions again. It is a horrible vision. The body has been embalmed as well as possible by the ECB and bandaged up to prevent any further decay, but it’s not going to stop the horror show from unfolding further. The spectre of euro-risk contagion is back to haunt us. The proposed Cyprus rescue may be small fry relative to the bail-outs in Greece, Ireland and Portugal but this time it adds a new dimension of risk. The proposal for a bail-in involving depositors might seem an appropriate political concession to Germany, aiming to recoup nearly two thirds of the expected 10 billion euro rescue. But it is not a smart move from the perspective of heightening the risk of future bank runs. While depositor funds might have been ring-fenced in this instance, the risk of precedent setting could take a terrible toll in future Eurozone country bailouts and bail-ins.  Depositors have been warned and will be ready to run in future. While the ECB is insisting that Cyprus is a special case, since the scale of the banking sector outweighs GDP there by a factor of 8, it nevertheless opens up a fear of being repeated in other situations. If the risk of an EU bail-out gets a grip in Spain, it could trigger a massive run on the Spanish banks that could spell a new wave of financial risk, not just for the banking sector there, but for the Eurozone at large.

While Draghi’s commitment last year to ‘do whatever it takes’ to solve the Eurozone crisis  helped seal much of the contagion crisis in the last eight months, the Cyprus ‘solution’ has clearly opened up old wounds again. With the vote in the Cyprus parliament postponed until tomorrow, the short term outlook remains very unclear for markets especially since the vote will be a close run event. The Cyprus parliament could easily reject the deal, given the high degree of domestic political opposition. It would be dynamite for markets, as the country would go into immediate default opening up risk crevasses everywhere across the Eurozone. This would sound a definite death-knell for the recent 4-month rally in stocks, intensifying spread widening pressure in beleaguered high yield Eurozone bond markets in the process. The euro would return to square one of deep uncertainty about the Eurozone breaking apart and the currency disappearing out of existence again. The usual safe haven plays of running into the safety of the front end of the German curve and bailing into Swiss francs would continue to dominate sentiment.

All hope is not lost for the moment. The Cyprus parliament could accept their lot and vote the bail-in measures through, or attempt to restructure the deal, watering down the severity of the hair-cut for poorer depositors. It should also be remembered that Cyprus is not a lost cause as the country has the advantage of sitting on significant oil and gas reserves that might be worth up to 300 billion euros, a  huge bonanza for a country worth an estimated 15bn euros. The intrinsic problems of the Eurozone would still remain firmly entrenched though.  Italy remains a powder keg of contagion risk for markets while the political situation remains deeply gridlocked and Beppe Grillo refuses to play ball with the main political parties. Spain remains subsumed by deep-rooted banking and recession risk. The Eurozone remains in the grip of deep recession forces, unemployment is high and spreading political dissent is continuing to rise. There is no chance of breaking free of the crisis while fiscal austerity continues to hit the Eurozone economy hard. The only way forwards is via the soft route of a u-turn in fiscal policy, combined with an ECB adding to recovery hopes by massive pro-cyclical monetary stimulus. Either way, the euro is destined to go weaker. It either suffers the shock of a deepening Eurozone contagion crisis, or else follows the same monetary debasement route that has happened in the US, Japan and the UK, which has holed the dollar, yen and the pound below the waterline. A break down towards the USD1.25 level should be on the cards in the next 1-3 months and further out a re-test of USD1.20 remains a high possibility over the next 3-6 months. The risk-rally remains postponed for the time being.

Forex bites: the ECB is for easing

There is nothing stopping the ECB from cutting rates and easing monetary policy again soon – apart from a twist of Bundesbank recidivism and a short term show of political neutrality. With recession storm clouds gathering on the near horizon, Bundesbank resistance should give way soon . A little more discrete distance from the Italian elections should leave the ECB free to shift policy into an easier gear from as early as next month. With the German recovery now starting to show signs of fatigue, the Eurozone has lost its best champion for stronger growth ahead. The 3% January drop in German export orders was not a one-off as some suggested, but a signal that Eurozone economic conditions look set to become much more sour in the months ahead. By the time the first quarter Eurozone GDP numbers are published next month, the economy will have sunk even deeper into recession, after 5 successive quarterly output drops to date. The ECB monetary dials are pointing to extremely weak  barometric pressure persisting for a long while ahead.

Certainly, the ECB discussed a rate cut at today’s meeting and Draghi confessed that policy is set to stay accommodative. It has to. The ECB forecasts expect greater downside risks to growth than before. Eurozone inflation is below target and set to go lower in the coming year. Credit conditions remain tight for consumers and the corporate sector. Monetary policy also needs to over-compensate for extremely restrictive fiscal settings in the Eurozone. Rising unemployment remains a key concern even for the ECB. The ECB can huff and puff about improving the transmission effect of monetary expansion getting through to beleaguered SMEs, but it is a side show. In reality, the banks’ payback of LTRO money (about 40%) is nothing to do with easing contagion jitters, but more to do with the banks wanting to slim down their balance sheets. If new credit growth is going to be the life-blood of the Eurozone recovery, the ECB still have to work out the best way to ensure the monetary transfusion is going to work. Maybe the ECB needs to disintermediate the banking sector as the delivery vehicle and apply direct mouth-to-mouth quantitative easing as the Fed, BOJ and BOE have done. The consequences can only be positive.

Lower rates, cheaper money and increased liquidity and credit will help all concerned. Lower borrowing costs will boost consumer and business confidence. Cheaper capital costs will boost confidence in the markets, lifting wealth effects in the process. Lower rates will help steepen the Eurozone yield curve. This will boost the banking sector’s natural franchise – borrowing short, lending long – improving profitability in the process. Easier ECB monetary policy will also help weaken the euro, boosting Eurozone export competitiveness at a stroke. If the ECB can see the vision, they should have the tools to get the Eurozone back into a virtuous circle of recovery. Perhaps they have a much better chance under Draghi’s pragmatism that they ever had under Trichet’s pro-Bundesbank conformism. And it is better if the moves are pro-active and pre-emptive rather than the same old reactive stable-door slamming. The Italian contagion stallion has not bolted yet, and better to beat it to the first fence while the current political gridlock holds in Rome.

The dollar should be the model for the euro as the ECB eventually relents. If the global Big Easy reflation coming through from the US, Japan, the Eurozone and UK starts to bubble up, the odds are that it will be the dollar that assumes the crown as the King-pin growth currency, as the euro abdicates its risk-on reign. If the currency markets start to chase the dollar on growth differentials, as happened around the turn of the millennium, the euro could see a sustained break below USD1.30, down towards the USD1.25-1.27 range. It will be capital flows on the hunt for better returns, deserting Europe for North American shores, that will be the swing producer fuelling dollar recovery ahead.

Sound bites: BOE policy bias tilted towards more easing

The Bank of England is holding fire for now but the policy bias is heavily tilted towards more easing. The BOE are clearly in the driving seat  and steering expectations towards additional monetary measures. BOE governor King is acting as the stalking horse for extra QE and more gilt purchases should be on the way very soon. The BOE  are worried about negative trends they can see in the economy that need pre-emptive attention pretty soon. They are not going to drag their feet for too long at the expense of delaying the recovery even further into the future. The government’s austerity cuts are hitting the economy hard. Consumers are on the ropes, reeling from the very sharp squeeze on real incomes. Business confidence remains at a low ebb, hampering new investment intentions. Export prospects are being held back by Eurozone recession and the global slowdown. And credit conditions remains tight thanks to a defensive UK banking sector. The BOE have no alternative than to open up the sluice-gates and unleash a new flood of liquidity into the economy to help foster recovery prospects. The odds are that the QE bucket is going to be a lot larger than the market anticipates, with the lock-gate left open for more to come when Carney takes over from King. Britain is back in its third recession in five years and the economy is in trouble. The pound might enjoy some short term relief in the absence of extra QE this month, but the prospect of more easing to come will continue to drag sterling lower. A sustained break below USD1.50 is on the cards soon and the longer term target should see a return to USD1.35 in the coming months.

Highlights 

• BANK OF ENGLAND SAYS LEAVES QE ASSET PURCHASE TOTAL UNCHANGED AT 375 BLN STG (REUTERS POLL 375 BLN STG)
• BANK OF ENGLAND SAYS HOLDS BANK RATE AT 0.5 PCT (REUTERS POLL 0.5 PCT)
• BOE MAKES NO STATEMENT AFTER MONETARY POLICY DECISION

Sound bites: German economic spring withering on the vine

Germany’s economic spring is withering again. As clear as night follows day, the downdraught from Eurozone recession and slower global activity is taking a deepening toll on the German economy. Domestic orders demand remains lacklustre while export orders are critically collapsing now. With two-thirds of German exports destined for the EU, the endemic slowdown there continues to pose a very depressive effect on German factory order books. Even though German economic confidence surveys such as IFO, ZEW and PMI have been painting a much brighter picture of German recovery prospects, it is simply a mirage. There is a growing gulf between economic hope and economic reality. Germany can lead from the front in terms of economic performance, but will always be held back by the recession tail-enders, especially Italy, Spain, Greece and Portugal where economic austerity is really taking a heavy toll on demand. The slowdown in France is also casting a big shadow over its German neighbour.

The ECB can cut rates again in the near term, but something more structural is now needed to help all the Eurozone. Much greater monetary stimulus is warranted from the ECB and Eurozone leaders need to endorse a quick sea-change in fiscal policy to a much more expansive line.

Highlights

GERMAN JAN INDUSTRIAL ORDERS -1.9 PCT M/M (DOMESTIC -0.6 PCT M/M, FOREIGN -3.0 PCT M/M)

GERMAN JAN INDUSTRIAL ORDERS COMPARES WITH REUTERS CONSENSUS FOR +0.5 PCT M/M

Ahead of the ECB: what now for QE?

The ECB have a pretty full plate of monetary considerations tomorrow. The Eurozone is tilting back into recession, the third in the space of 5 years. Enforced austerity cuts have hammered consumers and put businesses on the ropes. Monetary conditions are tightening. And the spectre of euro contagion jitters is raising its ugly head again. The simplest thing would be to cut rates. The odds are that it will not happen this week. It would smack of the ECB hitting the political panic button in the wake of the Italian election disaster. If the ECB holds its fire this week, markets should not have too long to wait. Without a doubt, the ECB will cut rates down to 0.5% in the next few months. The economy is a disaster zone and needs much more policy sticky tape. A fresh wave of ECB monetary injection should be one the way soon too. Will this be the real thing this time? Are we now heading for unreconstructed quantitative easing? If so, what will be the trigger?

The ECB have already been doing QE in all but name for the last few years, force-feeding liquidity through to the Eurozone by hook and by crook. Last year’s EUR1Tn LTRO programmes pump-primed a huge amount of extra liquidity into the euro banking system. This was QE by proxy, granting cheap cash hand-outs to Eurozone banks, who funnelled it into distressed high-yield euro government bonds. In other words, the ECB sub-contracted its open market bond buying operations over to the banks. While this helped stave off a deeper financial crisis last year, contagion tail risks still remain acute, especially in the wake of the recent Italian elections.

The ECB’s liquidity injection sorely missed its target for economic reflation by a wide margin. The Eurozone economy remains in deep trouble. Recession is on the cards for the third time in less than five years. Germany also risks getting sucked under again in the downdraught. The contraction in Eurozone bank credit tells a very sorry tale of missed opportunity. The money the ECB ploughed into the banking sector has failed to reach the parts of the Eurozone economy that are crying out for help. Loans to consumers and businesses are shrinking, because the banks are slimming down their balance sheets. Much of the liquidity creation has ended up in the banks for their own precautionary purposes - what Keynes described as a classical liquidity trap. What the Eurozone needs is unrelenting QE and in massive size – just like the Fed, the BOJ and the BOE have pumped into their economies as part of the Big Easy monetary reflation.

The only way for monetary reflation to be more effective is for the ECB to make policy unequivocally clear. A new wave of LTROs needs to start up again, with ultra cheap, ultra long and ultra size liquidity gushing back into the banking system. In other words, flood the economy back to health. The ECB also need to do their own dirty work too and buy bonds for their own account – buy assets and stash them on their own balance sheet. In other words, the ECB should begin QE in earnest. Bundesbank hawks may gripe about inflation risks, but that is the last of their worries right now. The very survival of the Eurozone is the key right now.

The ECB needs to adopt the same kind of clear-speak as the Fed so the markets fully understand the message and intent. Despite Draghi’s improved communication skills, the markets still feel unclear about the ECB’s real purpose. Right now, monetary conditions are tightening again in the Eurozone. The banks are repaying LTRO proceeds and this flow needs to be reversed. The ECB should pressure the banks to on-lend it too. Despite some recent easing, the euro still remains relatively strong, while other nations seem happy to play currency war games. The ECB needs to be a much more unequivocal about the benefits to growth from a more competitive and weaker euro. If the BOE can do it, then why not the ECB?

What might trigger real, unashamed QE? The very survival of the euro area itself could be the catharsis. A groundswell of grass-roots rejection of the old political order, with deepening antipathy to austerity is already taking root in Italy. If Grillo-politics and Grillonomics get a hold in other troubled Eurozone economies, the whole EMU experiment is in trouble. If political rejection of the EMU status quo begins to snowball, the Eurozone risks breaking up. Germany and France will need to take a much more pro-active line in saving the Eurozone’s hide. Eurozone leaders will need to stop any other economy following Greece’s descent into near depression. Spain has already been submerged under six successive quarters of recession. With the Spanish jobless rate at 25% and youth unemployment at 50%, Spain is ripe for growing political dissent. A copy-cat anti-austerity protest movement in Spain would wreak havoc with future EMU expectations.

The ECB can deal with minnows like Greece, Portugal, Ireland and Cyprus, but it cannot contend with the bond behemoths of Italy and Spain going pear-shaped together. If they start to teeter, it would be the bellwether for aggressive QE coming to the rescue. By that time, it will probably be too late and it will be game over for the Eurozone and the euro. Once QE is let out of the gate in big size, the euro will be heading back down to parity again. The market is already starting to get a sniff of sea-change at the ECB. The tide has turned on the euro and a sustained break below USD1.30 should get established as Draghi opens the door for more easing ahead.

Sound bites: -0.6% Q4 Eurozone GDP dip presages triple trip recession

There is so much food for thought for the ECB in the latest Eurozone GDP drop. It presages a further escalation in the Eurozone crisis and must concentrate the ECB’s minds for another early cut in interest rates and more monetary stimulus coming down the slipway in the coming months. The ECB needs to move fast to stop the current downturn turning into a deeper economic rout. As it stands, double dip recession in the last five years risks slipping into a triple trip recession.

We are already half way there judging by the fourth quarter drop in output. Prospects for the first quarter look grim. Recent economic data and confidence surveys reveal a picture of continuing gloom. There is no chance of an early return to positive growth and the likelihood stands that the Eurozone will flat-line at best, or slip deeper into recession for the whole of 2013 in the worst case. The political backdrop looks grim. EU fiscal austerity looks set to extend for years. The markets are not out of the grip of Eurozone contagion tail risks. Consumer demand is being squeezed hard. Businesses are not in the mood to invest. And the global slowdown is putting a brake on Eurozone export prospects.

Pressure is mounting on the ECB to pull more stimulus out of the bag very soon. The odds of a rate cut are slender this week, but we will probably hear more from Draghi about the possibility of further liquidity measures coming on stream in the future. The ECB will need to join the Fed, the BOJ and the BOE on the Big Easy route to monetary expansion and economic reflation. It is all about co-ordinated teamwork now. The ECB should not delay too long on rate cuts and a quarter point ease should come on line in the next couple of months. In the coming months a move closer to zero interest rate policy should not be ruled out. The Eurozone crisis is snowballing and requires exceptional policy response. The Bundesbank will need to bite their lips.

Highlights 

• Economy shrinks 0.6 percent in Q4, quarter-on-quarter
• Economy contracts 0.9 percent year-on-year

Sound bites: Eurozone retail sales bounce 1.2% mom in January - no reason to celebrate

Eurozone retail sales still remain on a contractionary footing despite January’s 1.2% monthly bounce. The underlying retail sales trend remains decidedly lower, with no chance of near term recovery. If the ECB wanted to see a very clear barometer of the recession storm encircling the Eurozone, it is the collapse in consumer confidence in the last few years. Deepening fiscal austerity is taking a very deep bite out of consumer demand. There is a very sharp squeeze on real incomes from higher taxes and rising energy costs, exacerbated by unemployment at a record level in the euro area. The only way to turn this around is going to come through greater policy stimulus and stronger growth. This is not going to come via fiscal means as pressure remains on Eurozone governments to clear up their budgetary mess.

The finger continues to point at more easing from the ECB. This week may be too soon for the ECB to cut rates as it might be seen as hitting the panic button after the Italian elections. It does not want to be accused of moving for political considerations. But as sure as night follows day, the ECB will have to cut rates again soon and feed more quantitative easing into the beleaguered Eurozone economy to stop the recession turning into a complete rout. The directional bias for the euro will remain lower as the message sinks in that the ECB will be going exactly the same way as the Fed, BOE and BOJ in the coming months – and they will need to do QE in much bigger size than they have delivered so far.

Highlights

Euro Zone Jan Retail Sales 1.2 Pct M/M - (Reuters Poll Forecast 0.2 Pct)

Euro Zone Jan Retail Sales -1.3 Pct Y/Y - (Reuters Poll Forecast -2.9 Pct)

Euro Zone Dec Retail Sales Confirmed At -0.8 Pct M/M, -3.0 Pct Y/Y (Pvs -3.4 Pct)

 

Sound bites: UK services grow at fastest pace for 5 months

Maybe a small glimmer of hope showing through for the UK services sector amidst deepening gloom for the UK economy. Britain’s service sector showed a little more bounce in February, with the services PMI index expanding at its fastest pace in five months. The non-manufacturing PMI edged up to 51.8 from 51.5 in January. Taking into consideration the sharp dip in the manufacturing economy last month underlines that the UK economy is still in trouble. It is far too tenuous to suggest, taking the two PMI components together, that there was some uplift in activity in the first quarter. The upward movement in the UK services index in February is far too insignificant to offset the strong forces of recession taking a grip in the UK. Rising unemployment worries, the squeeze on real incomes, falling consumer confidence, deepening fiscal austerity and the weak global economic backdrop underline the deep-set problems for the UK ahead. The first quarter GDP numbers will be in negative territory and should confirm the UK economy is back in its third recession in the space of five years.The onus remains heavily on the Bank of England to deliver more quantitative easing ahead, with the first opportunity for the next tranche to come through at this week's Monetary Policy Committee

Highlights

                                             FEB   JAN          DEC   F'CAST
Services headline index       51.8   51.5         48.9     51.0
Business expectations         67.6   67.2         64.0  

Sound bites: Eurozone in dire duress

The Eurozone services sector remains in dire duress. Germany remains the one exception of positive economic activity, but everywhere else is sliding deeper into a sink hole of negative growth. The Eurozone remains subsumed by aggressive recession forces that look likely to extend all through 2013. It is going to take a much bigger policy spade to dig the Eurozone out of this mess. The ECB will be bound to consider more monetary stimulus measures at this week’s policy meeting. An interest rate cut is probably ruled out  this week. It would smack of a panic more too close to the Italian political crisis. Considering another rate cut soon will definitely be on the discussion agenda though. The ECB need to consider throwing the kitchen-sink of monetary expansion at this deepening economic crisis. Rising unemployment, falling new orders and economic confidence in deepening distress bear all the hallmarks of some Eurozone economies being irreparably damaged for years. Greece, Portugal, Ireland, Spain and Italy all fall into this camp in the next few years.

Highlights

Markit Eurozone Feb Final Services PMI 47.9 (47.3 Flash, 48.6 Jan)

German Feb Final Services PMI Index 54.7 (Flash 54.1, Jan Final 55.7)

French Final February Services PMI Rises To 43.7 (Flash 42.7, Jan Final 43.6), 2nd-Lowest Since March '09

Italy Feb Services PMI Falls To 43.6 (Jan 43.9, Forecast 43.6)

Spain Feb Services PMI Falls To 44.7 From 47.0 In Jan, First Monthly Drop Since September

Irish Feb Services PMI Drops To 53.6 From 56.8 In Jan, Lowest Since August 2012 Markit estimates euro zone GDP will shrink 0.2% in Q1

Forex bites: sterling in the firing line

Another weak UK PMI reading  and another grizzly election result for the British government highlight the pound’s mounting plight. Strong odds of another dip back into recession and rising political uncertainty underline the spreading risks ahead for sterling. It is not helped any by an audible back door whispering campaign from the Bank of England, primarily to help provide a boost UK exports via a more competitive pound. The chips are stacking up against sterling

A likely drop in first quarter UK output should confirm in a few weeks time that the third recession in five years has already begun. Hints from last month’s monetary policy committee, suggest the BOE could opt for more quantitative easing from as early as next week. Given King’s ringing endorsement for new QE, it is only a matter of time before fresh stimulus begins to flow again. And better sooner rather than later. Debt deflation and deepening fiscal austerity are dealing fatal blows to economic confidence. The BOE remains the last line of defence and need to pull a bigger weapon from their armoury. While market expectations are looking for an extra £25bn QE injection, a punchier £50bn may be more appropriate now.

Rising political uncertainty is also making its mark. The Eastleigh by-election result rang some worrying bells for PM Cameron’s Conservative Party. Rising grass-roots support for the euro sceptic UK Independence  Party will be an ominous spur pushing the Conservative Party into a more populist anti-EU slant. That is not good news for the pound in the long run. Question marks about the UK’s long run EU commitment are bound to unsettle overseas firms’ commitment to their own UK operations. A marginalised UK in Europe might pose a serious risk of an exodus of foreign direct investment out of the UK’s shores. Given the deep deficit on UK’s trade account, a threatened outflow of foreign capital would deal the pound a mortal blow.

With the pound poised on a key break below USD1.50 at the moment, the odds are mounting for a bigger break down in sterling sentiment in the weeks ahead. The weak economy, over-easy monetary policy and an uncertain political backdrop could lead the currency back down towards sub-USD1.40 territory quite quickly. The pound will stay down on its luck, with very little looming to pull it back up. Another euro crisis will make little difference for the pound as a safe haven play as it will probably suffer in tandem just by geo-political association.

Sound bites: a shock drop in the UK manufacturing PMI

The shock drop in the UK manufacturing PMI is another ominous sign for the UK economy. It tolls the bell for another shift back into recession. Double dip is now turning into triple trip recession. Consumer demand is heavily under water, corporate confidence is holed beneath the waterline and the squeeze on public spending is sinking the economy even further. It is up to the Bank of England to provide another lifebelt by way of further quantitative easing. UK monetary policy must stay easy and over-accommodative for a long way into the future. The pound will continue to bear the burden. That’s the good news in this data. The weaker pound will continue to provide more export led stimulus into the economy ahead.

KEY FIGURES FROM MARKIT/CIPS PMI SURVEY
(Previously announced data in brackets)

                                             FEB    JAN           DEC   F'CAST
Manufacturing headline index  47.9   50.5 (50.8)  50.7    51.0
New orders index                    46.6   49.7            51.1  

- First fall in overall activity since November - New orders index lowest since July - Employment index lowest since October 2009

Eurozone remains in the grip of recession

The tale of two economies continues to haunt the Eurozone. Manufacturing activity is just managing to keep a positive hold in Germany, but still falling into negative territory elsewhere. There are no signs of the Eurozone emerging from the grip of recession anytime soon. Germany is just about the only bright hope with PMI manufacturing activity rising to 50.3, just keeping a toe-hold in positive growth. But elsewhere the picture remains grim. Spain manufacturing perceptions recovered a little but still remain subsumed in a contractionary vein.  The French manufacturing economy remains stuck in a deep rut. Italy manufacturing sentiment is sinking again. At least there were some brighter signs in the Greek economy with the fall in new orders slowing and manufacturing confidence picking up a little from deeply weak levels. With the overall Eurozone manufacturing PMI stuck at 47.9 in February, the outlook remains bleak for any hope of near term economic recovery.

The picture remains very clear on the policy front. With so much potential demand being sucked out by Eurozone-wide fiscal austerity, it’s up to the ECB to keep policy on very easy settings for  long while. The odds are the ECB will have to cut rates again as soon as the next policy meeting. The bias remains firmly pointed towards more easing, more monetary stimulus and the need for a lower euro. It’s a question of all hands to the monetary pumps now.

Highlights

GERMAN FEB FINAL MANUFACTURING PMI 50.3, HIGHEST SINCE JAN 2012 (FLASH 50.1 JAN FINAL 49.8)

FRENCH FEB FINAL MANUFACTURING PMI RISES TO 43.9 (FLASH 43.6, JAN FINAL 42.9)

ITALY FEB MANUFACTURING PMI FALLS MORE THAN EXPECTED, TO 45.8, LOWEST IN 3 MONTHS (JAN 47.8, F'CAST 47.5)

SPAIN FEBRUARY MANUFACTURING PMI RISES TO 46.8, HIGHEST SINCE JUNE 2011, FROM 46.1 IN JANUARY