Takeaway: European markets are trading on policies, not fundamentals. We caution that there’s risk in simply riding Draghi’s coattails.
Positions in Europe: Long German Bonds (BUNL); Short EUR/USD (FXE)
Asset Class Performance:
- Equities: The STOXX Europe 600 closed up +1.3% week-over-week vs +2.3% last week. Top performers: Cyprus +17.8%; Russia (RTSI) +7.4%; Greece +7.1%; Ukraine +7.0%; Hungary +4.8%; Finland +4.7%; Austria +4.3%; Sweden +4.1%; Poland +3.7%. Bottom performers: Denmark -1.6%; Slovakia -1.5%; Estonia -0.7%. [Other: France +1.8%; UK +2.1%; Germany +2.7%].
- FX: The EUR/USD is up +2.37% week-over-week. W/W Divergences: RUB/EUR +1.50%; HUF/EUR +1.14%; PLN/EUR +0.81%; CZK/EUR +0.79%; DKK/EUR -0.06%; CHF/EUR -0.48%; GBP/EUR -0.98%; NOK/EUR -1.67%; SEK/EUR -1.78%; TRY/EUR -2.15%.
- Sovereign CDS: Sovereign CDS followed yields with all main countries we track down on the week. On a week-over-week basis Portugal fell the most, down -72bps to 464bps, followed by Italy -148bps to 315bps, Portugal -133bps to 536bps, Ireland -97bps to 343bps, and France -25bps to 115bps.
- Fixed Income: The 10YR yield for sovereigns fell dramatically across the board for peripheral countries, while the core gained on the week, for a second straight week. Greece saw the largest decline, -83bps to 20.79%, followed by Portugal’s -16bps move to 8.09%; Italy fell -15bps to 4.97% and Spain dropped -11bps to 5.64%. Germany was up +8bps to 1.70% and France gained +2bps to 2.26%.
Central Bankers Make Waves
The last two weeks of market trading have been dominated by the policy moves of Draghi and Bernanke. Period. Draghi’s “unlimited” bond purchasing program, named Outright Monetary Transactions (OMTs), and Bernanke’s further monetizing of MBS and push of the zero interest rate bound out to 2015 have stoked most global markets and the EUR (see price moves above), irrespective of the underlying fundamentals.
Specific to Europe, Germany’s Constitutional Court decision on Wednesday to uphold the ruling on the ESM and fiscal union added a further boost to capital markets, however we remain very cautious on the underlying weakness of these regional economies, and firm in our belief that a transition, if it is possible at all, to a united Europe (or at least Eurozone) under a monetary and fiscal union, is a long, challenging road.
A few broader challenges that stand in the way of a fiscal union are:
- The unevenness of economies.
- The strong cultural differences (namely language) that prevent frictionless labor moment.
- The inability of states to willingly give up their fiscal sovereignty to Brussels or Frankfurt. Example: this week Spanish PM Rajoy, in response to talk about his country taking bailout monies said: “I will look at the conditions. I would not like, and I could not accept, being told which were the concrete policies where we had to cut.”
This week there was much talk about the formation of a European banking union. The European Commission (EC) delivered its proposal on a “single supervisory mechanism” of all banks in the Eurozone supervised by the ECB. Importantly, Germany is reluctant to cede control of its banking sector and wants the new regulator to concentrate only on the region's biggest banks, perhaps an estimated 20-25 banks.
While Germany's private-sector banks, including Deutsche Bank, have embraced the commission's proposal, the country's public-sector banks oppose it, saying their lower-risk business models should allow them to avoid the new layer of pan-European supervision. Certainly creating an FDIC of the Eurozone is an important step in the path to a fiscal union, however we see challenges arising from striping existing national supervisors to a new ECB supervisory board.
Taken together, we are fully aware of the powers of Central Bankers to drive markets. That said, the fundamental data keeps us grounded in our opinion that despite best efforts from Eurocrats to craft rescue programs, we think the structural flaws inherent in creating a Eurozone will continue to present challenges that should negatively impact markets; we expect the biggest challenge to be a protracted period of slow growth that misses expectations as Europe works through the debt trap it has amassed over the last ten years. Finally, in the near term, the impact of high commodity prices as well as sticky to rising inflation (broadly), will add further negative economic pressures.
France - The French 2013 budget is to be introduced on September 28th. French Finance Minister Pierre Moscovici said that it needs to find €30-€35B in additional revenue from spending cuts. It plans to seek as much as €20B from new taxes (including the 75% on annual income over €1M, which President Hollande said this weekend could be dropped after around two years in place) and €10B from spending cuts to meet its pledge of reducing the budget to 3% of GDP next from a projected 4.5% in 2012. He also said that the government expects GDP to be 0.8% in 2013, down from its earlier forecast of 1.2%.
Portugal - Troika agreed to ease Portugal’s deficit goal from 4.5% to 5% of GDP this year.
Italy - Prime Minister Monti hinting that he would be open to remaining in his position after elections next year.
Eurozone Banks - JPM sees another 15% upside in the group.
Netherlands - The Liberal Party of caretaker Prime Minister Mark Rutte was headed to victory in the Dutch parliamentary vote. The Liberals took 41 of the 150 seats (up from the 31 in the last vote in 2010); the Labor Party of Diederik Samsom won 40 seats (up from 30); D66 rose to 12 from 10; the Christian Democrats lost eight seats to 13; and Geert Wilders’ anti-immigrant Freedom Party lost 11 seats to 13. It appears likely Rutte, with the strongest international profile, will remain premier.
Spain - Cinco Dias, citing unidentified sources at the Budget Ministry, reported in its Wednesday Internet edition that the Spanish government is planning to increase the tax rate on short-term capital gains to as much as 52% in 2013. The paper pointed out that the highest tax rate on short-term capital gains currently stands at 27%. It added that move is intended to boost tax revenues and dampen market speculation and volatility.
Our immediate term TRADE range for the cross is $1.27 to $1.30. In the second chart below we look at CFTC data for net contracts of Euro non-commercial positions. Interestingly, since a high in short position in the Euro on 6/5/12 (-213.060 contracts), investors have been less bearish (and covering). Week over week, contracts are 10% less bearish, -95,080 as of the most recently reported data on 9/11 versus -105,433 as of 9/4.
Eurozone Sentix Investor Confidence -23.2 SEPT vs -30.3 AUG
Eurozone Industrial Production -2.3% JUL Y/Y vs -2.1% JUN
Eurozone CPI 2.6% AUG Y/Y vs 2.6% JUL [0.4% AUG M/M vs -0.5% JUL]
Germany CPI Final 2.2% AUG Y/Y (UNCH)
Germany Wholesale Price Index 3.1% AUG Y/Y vs 2.0% JUL [1.1% AUG M/M vs 0.3% JUL]
UK ILO Unemployment Rate 8.1% JUL vs 8.0% JUN
UK Jobless Claims Change -15.0K AUG vs -13.6K JUL
France CPI 2.4% AUG Y/Y vs 2.2% JUL
France Q2 total payrolls -0.1% Q/Q (exp. -0.1%) vs -0.1% in Q1
Bank of France Business Sentiment 93 AUG vs 90 JUL
France Industrial Production -3.1% JUL Y/Y (exp. -3.7%) vs -2.5% JUN
France Manufacturing Production -2.8% JUL Y/Y (exp. -4.2%) vs -2.9% JUN
Italy Q2 GDP Final -0.8% Q/Q (exp. -0.7%) vs -0.7% initial [-2.6% Y/Y (exp. -2.55) vs -2.5% initial]
Italy Industrial Production -7.3% JUL Y/Y vs -7.9% JUN
Italy CPI Final 3.3% AUG Y/Y (initial 3.5%) vs 3.6% JUL
Spain CPI Final 2.7% AUG Y/Y (UNCH)
Spain House Transactions -2.5% JUL Y/Y vs -11.4% JUN
Spain House Prices -14.4% Y/Y in Q2 vs -12.6% in Q1
Portugal CPI 3.2% AUG Y/Y vs 2.8% JUL
Switzerland Producer & Import Prices -0.1% AUG Y/Y vs -1.8% JUL
Austria CPI 2.2% AUG Y/Y vs 2.1% JUL
Netherland Retail Sales -4.0% JUL Y/Y vs 1.0% JUN
Denmark CPI 2.6% AUG Y/Y vs 2.1% JUL
Norway CPI 0.5% AUG Y/Y vs 0.2% JUL
Finland CPI 2.7% AUG Y/Y vs 2.9% JUL
Sweden Q2 GDP Final 1.3% Y/Y (initial 2.3%) vs 1.3% in Q1
Sweden Unemployment Rate SA 7.8% AUG vs 7.5% JUL
Sweden CPI 0.7% AUG Y/Y vs 0.7% JUL
Sweden PES Unemployment Rate 4.8% AUG vs 4.6% JUL
Sweden Industrial Production -0.4% JUL Y/Y vs 1.2% JUN
Ireland CPI 2.6% AUG Y/Y vs 2.0% JUL
Ireland New Vehicle Licenses 5341 AUG vs 7944 JUL
Greece CPI 1.2% AUG Y/Y vs 0.9% JUL
Greece Unemployment Rate 23.6% in Q2 vs 22.6% in Q1
Poland CPI 3.8% AUG Y/Y (exp. 3.8%) vs 4.0% JUL
Czech Republic CPI 3.3% AUG Y/Y vs 3.1% JUL
Czech Republic Unemployment Rate 8.3% AUG vs 8.3% JUL
Estonia Exports 12% JUL Y/Y vs 8% JUN
Estonia Imports 14% JUL Y/Y vs 14% JUN
Hungary CPI 6.0% AUG Y/Y vs 5.8% JUL
Romania CPI 3.9% AUG Y/Y vs 3.0% JUL
Romania Industrial Output 1.9% JUL Y/Y vs 1.4% JUN
Slovakia CPI 3.7% AUG Y/Y vs 3.7% JUL
Turkey Q2 GDP 1.8% Q/Q vs -0.1% in Q1 [2.9% Y/Y vs 3.3% in Q1]
Turkey Industrial Production 3.4% JUL Y/Y vs 3.1% JUN
Interest Rate Decisions:
(9/13) Switzerland SNB 3M Libor Target Rate UNCH at 0.00%
(9/13) Latvia Refinancing Rate CUT 25bps to 2.50%
The European Week Ahead
Sunday: Sep. UK Rightmove House Prices
Monday: Jul. Eurozone Current Account, Trade Balance; 2Q Eurozone Labour Costs; Jul. Italy Trade Balance
Tuesday: Sep. Eurozone ZEW Survey Economic Sentiment; Aug. Eurozone New Car Registrations; Sep. Germany ZEW Survey Current Situation and Economic Sentiment; Jul. UK ONS House Price; Aug. UK CPI, Retail Price; Jul. Greece Current Account
Wednesday: Jul. Eurozone Construction Output; BoE Minutes
Thursday: Sep. Eurozone Consumer Confidence – Advance, PMI Composite, Manufacturing and Services; Sep. Germany PMI Manufacturing and Services - Advance; Aug. Germany Producer Prices; Sep. UK CBI Trends Total Orders, CBI Trends Selling Prices; Aug. UK Retail Sales; Sep. France PMI Manufacturing and Services – Preliminary; Jul. Italy Industrial Orders and Sales
Friday: Aug. UK Public Sector Net Borrowing, Public Sector Finances; 2Q France Wages – Final; Jul. Spain Mortgages-Capital Loaned, Mortgages on Houses, Trade Balances
Takeaway: The Fed pulling the trigger on QE3 is bullish for gasoline and, historically, prices north of $4 per gallon have led to equity sell-offs.
This note was originally published September 13, 2012 at 14:35 in Macro
It seems 99% of Wall Street was correct as QE3 was extended. Usually fading consensus is a great strategy, although perhaps not as it relates to the Fed, at least yet. But for starters, let’s look at the Fed’s statement from earlier today, the key points are as follows:
“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.”
That’s actually not a key point, although it does emphasize, as we will touch on shortly, the mandate that the Fed has struggled to fulfill.
First on QE, the Fed effectively, as Keith would say, extended QE to infinity and beyond with this statement:
“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”
On a basic level, this will start with increasing purchases of longer-term securities by about $85 billion each month through the end of the year, included in this will be $40 billion of mortgage paper. As it relates to interest rates, the Fed indicated that a zero to 0.25% federal fund rate is likely to be warranted at least through mid-2015.
In the chart below, we show the aggregate growth of the Federal Reserve balance sheet. The first chart shows the massive growth in the Fed balance sheet since 2008 with close to $3 trillion dollars being printed over the course of that period. As a ratio of nominal GDP (just shy of 20%), this is a meaningful quantity as the following chart highlights. Unfortunately, we have not seen a corresponding increase in economic activity.
The broader issue with extending QE is that it has been largely ineffective at fulfilling the Fed’s dual mandate. Ironically, or not, the key economic data out this morning before the Fed’s statement enforced this. On price stability, August’s producer price index came in at +1.7%, versus last month’s +0.3%. This is near a three year high in terms of MoM acceleration. Jobless claims also came in higher than expected at +382K versus +370K consensus, and +367K in the prior month.
While the employment data is only marginally bearish, the PPI data point is far more critical. At +1.7% MoM growth in producer prices, this is the largest increase in PPI since June of 2009. Our key issue with QE / money printing is that it is bearish for the dollar, which conversely inflates key commodities that are priced in dollars. As Keith noted in the Early Look today, the CRB index currently has a -0.94 correlation to the dollar over the past month.
Obviously, the most relevant commodity to the U.S. consumer is crude oil and the derivative price of gasoline. Given that there are 254 million registered vehicles in the U.S., the relevance of gasoline costs to consumer spending and growth should not surprise anyone. That question, as always, though, is when does increasing commodity inflation start to matter?
In the chart below, we show that prices at/north of $4 per gallon at that the pump have had a definitively negative impact on growth and the stock market over the last few years. Gasoline exceeded $4 per gallon in mid-2008, mid-2011, early 2012, and now. In each instance there was a corresponding sell off in equities. Perhaps this time is different, though we have our doubts.
Daryl G. Jones
Director of Research
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Takeaway: There is a lot of risk in assuming a rebound in casual dining comps any time soon $DRI, $ BLMN, $DIN, $EAT,
The Bureau of Labor Statistics released CPI data for the month of August this morning. The spread between CPI for Food at Home versus Food Away from Home continues to grow. Inflation in the restaurant check is far-outstripping inflation in the grocery aisle.
We have long been calling out this trend; the advantage that restaurants enjoyed over grocers in 2011, in terms of lower price increases year-over-year, continues to fade. Grocers were forced to raise prices in line with inflation to protect margins during 2011; we believe that restaurants benefitted from that. Last year, restaurants’ strong top-line trends helped the industry mitigate the impact of inflation on margins but, it seems, this year pricing power is much-diminished. Even McDonald’s is running price at roughly 3% in the United States.
Using a “Restaurant Value Spread”, which is the basis point spread between CPI for Food at Home and CPI for Food Away From Home, we believe we have a good indicator of the traffic cycle for many casual dining brands. This is not a complicated theory; when inflation at the grocery store is far in excess of inflation at the restaurant, people are more likely to skip the grocery store and eat at a restaurant. We will be publishing on this in more detail over the weekend/early next week but our initial take is that the collapsing Restaurants Value Spread is bearish for casual dining traffic and comps (Knapp). The relationship is quite strong.
Looking at the first chart in this note, above, it seems that the value spread has more room to decline. Darden’s Red Lobster, in particular, could be facing a difficult environment if the current Restaurant Value Spread cycle has similar amplitude to the last. In addition, consensus estimates (quarterly so not shown here) from Consensus Metrix suggest that the Street is anticipating a quick rebound for Red Lobster comps. We do not think that is going to happen; the Restaurant Value Spread is likely to decelerate for another 6-9 months.
Please reach out if you want to discuss this in greater detail or in the context of other names within the restaurant space.
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