“Great events make me quiet and calm; it is only trifles that irritate my nerves.”
It is seemingly hard to not freak out just a little about the Eurozone’s economic, financial, and political woes, often labeled The Eurozone Crisis, especially if you have money at work in the capital markets. In the interconnected global world we live in with a 24/7 news cycle, crises boost air, print, and electronic media revenues, and it’s this news flow that also influences investor behaviors. Interestingly enough, the crises throughout Europe have lasted for months and years, far from the limited, “turning point” definition of the word, with the loudest headlines of fear coming from the region’s smallest economies.
While this state of developments come as no surprise to even a casual observer, below we’ll reinforce numerous points that suggest there’s no need to freak out about the future bailout needs from such smaller countries as Cyprus, Portugal, and Slovenia (as they’ll be easily covered), and while larger countries like Italy, Spain, and France (in particular) show material systemic risks, we ultimately see the ECB providing a full backstop to keep the Union of uneven economies together at all costs.
A Broken System with Political Resolve
To refresh, we believe the Eurozone is in no better of a structural state today than it was in May 2010 when Greece received its first bailout, with little exception. Yes, the European Commission has crafted a banking system 101, but it’s far from encompassing or focused enough to materially erode the sovereign-banking feedback loop on its own.
What continues to lie at the heart of the mismatch is that these uneven economies are joined by one monetary policy, therein preventing any one nation from independently debasing its currency to spur competition, or help inflate its way out of debt, which is further compounded by the ECB 2% inflation target mandate. And even hypothetically if (say way down the line) one monetary policy equitably governed the Eurozone states, you’d still need a fiscal union (say from Brussels or Frankfurt) to oversee the budgets of the member countries to ensure (witnessed magnificently through this crisis) that countries don’t overstep their fiscal boundaries.
But here too you run into problems:
- Countries don’t want to give up their fiscal sovereignty to a higher order
- There will remain structural imbalances trying to mandate deficit quotas, especially for example with countries that historically run trade deficits and have limited economic breadth to diversify
Yet, despite the structural juxtapositions described above, and while it’s not empirical, one cannot rule out the resolve of the ECB and Eurocrats to keep the Union together. It’s a belief grounded in their desire for job security, and supported by a belief in trade benefits, freedom of borders, as a force against superpowers like the USA and China, and a post WWII desire for a peaceful collective.
It’s Not All So Bad And the Germans Are All-In
At every weak fiscal point in the Eurozone, Troika (the European Commission, ECB, and IMF) has answered the call to throw good money at bad and sweep the fears under the rug. Here we expect more of the same since it’s our intention that Eurocrats greatest fear remains a tumble weed effect in which the exit of one country can dissolve the entire union.
From a market perspective, despite a protracted slow growth outlook, it has not paid to sell Eurozone capital markets since Draghi issued his famous OMT put to bail out any nation that requests it in SEPT 2012. We expect the Eurozone will remain grounded on Draghi’s word and below are a number of factors that support the view that now is also no time to freak out about this continuing crisis:
- German Checkbooks – it’s clear the Eurozone playing field is tilted in Germany’s favor via a weaker EUR and easy access to trading partners. Writing bailout checks is a much more profitable exercise than returning to the D-mark.
- ECB Leverage –the Bank has taken down its balance sheet -14% since SEPT 2012 due in part to the repayment of the LTROs, so it has room to lever it up.
- ECB Rate Cut – Draghi has been tight lipped but continues to signal a weak economic outlook. ECB executive board member Joerg Asmussen said this week that he sees more downside risks to a recovery in the Eurozone in the second half of the year, which may be an early indication of a 2H rate cut.
- Still Liquid Credit Markets –Despite political concerns across the region, sovereign yields on the 10YR for Germany, France, and the Netherlands are low at 1.30%, 1.85%, and 1.73%, respectively. As a promising sign, this Wednesday Italy sold €8B of 1YR bills at a yield of 0.92%, down significantly from the 1.28% it paid at the last auction in March. It also sold €3B of three-month bills at 0.24%.
- Cyprus was a One-off Mistake – the deposit levy scheme in Cyprus was a misstep by the Eurocrats, which even Draghi admitted. It will be caged as a one-off and a similar scenario will not be carried out again.
- Italy’s Saving Grace, its Deficit – despite a high debt, which this week was revised upward to 130.4% of GDP in 2013 vs 126.1%, and that we’re no closer to a coalition government today than we were when elections ended on February 25 (and we suspect new elections will have to be called), the country’s deficit should remain below -3% this year which may be one important saving grace in shielding against expedient rises in sovereign yields as politicians wrestle with budget promises.
- Slovenia is a Peanut – certainly the risk signals are “on” with 5YR Slovenia CDS making a new YTD high of 369bps (vs a high of 511bps last summer) and 8YR sovereign yields at 6.36% (off a high of 7%), but the country’s economy at €35B (or 0.3% of the Eurozone) is only slightly larger than Cyprus, and nowhere near as levered to banking. If needed, a potential bailout package will likely be less than the figure Cyprus may get. (Interestingly enough, Austria is the country with the most leverage to Slovenia according to Bank for International Settlements data.)
Risks Will Always Remain
IMF Head Lagarde said this week that a three speed global economy has emerged with the Eurozone being the weakest link with lots of distance to travel. It’s clear that the Eurozone unemployment rate is ugly at an all-time high of 12% (with youth unemployment reaching 50% in many peripherals), that labor reforms on the country level are a huge uphill battle, that country resources and cultures will influence economic competitiveness, and that austerity’s bite is a significant tax on economies, but a necessary one in light of outsized fiscal positions.
These are not light issues, and the political scandals – from the French budget minister lying about a secret untaxed foreign bank account to Spanish PM Rajoy being accused of taking construction kick-backs, or even the head-scratcher that the most corrupt of them all in former Italian PM Berlusconi has a chance of forming a coalition government – compound these economic ails. That said, this “crisis” is being managed by the European Commission, which wants to extend debt and deficit reduction targets for most countries and lengthen bailout loan maturities (likely for Portugal and Ireland) so as to lessen the economic and political stresses.
Taken together we think there’s plenty of evidence to support a continued Eurozone capital markets rally and tactically trade the short side on time and price around catalysts; we believe that no country will be leaving the union due to the fear of contagion; and that there is plenty of powder tools to use should they be needed: the OMT, a rate cut, and possibly even the issuance of Eurobonds (which George Soros continues to be a big proponent of). We’d also say that while we don’t think the EUR is going away, or going to parity, we do think it carries some additional downside risk against our call for a strengthening US Dollar.
Stay calm and look to the hills for support.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, USD/EUR, UST10yr Yield, VIX and the SP500 are now $1, $101.72-106.71, $3.29-3.46, $82.22-83.28, 97.45-100.98, $1.28-1.31, 1.71-1.87%, 11.78-14.51, and 1, respectively.
Congratulations to the Yale Men’s Ice Hockey team on their big win last night and advancing to the NCAA Finals. Go Bulldogs!!
The Macau Metro Monitor, April 12, 2013
SINGAPORE ECONOMY CONTRACTS IN FIRST QUARTER Channel News Asia
Based on advance estimates from the Ministry of Trade and Industry, the Singapore economy contracted by 0.6% YoY in 1Q 2013 or -1.4% QoQ. The numbers undershot market expectations of 1% growth. Despite the contraction in Q1 GDP, the Monetary Authority of Singapore (MAS) says the economy should grow at a modest pace this year, as external demand recovers.
GOVT TO DEMAND CASINOS TO IMPROVE AIR QUALITY: TAM Macau Business
Secretary Tam said that the government is “determined” to demand casinos to meet the required air quality standards inside their smoking areas; otherwise, they will be penalized. He added the government and the operators would improve the implementation of the smoking areas “step by step”.
CASINO REVENUE TO GROW IN "MID-TEENS" IN 2013: TRACY Macau Business
Sands China CEO, Edward Tracy, forecasts Macau’s casino gross gaming revenue to grow in the “mid-teens” this year. He said casino revenue would be positively impacted by the availability of more hotel rooms and because of the opening of the Gongbei station, the last stop of the high-speed railway link connecting Zhuhai to Guangzhou, in late December. He also said that the Parisian project, to be built by Sands China near the Four Seasons in Cotai, is to be completed by late 2015 or early 2016.
VISITOR GROWTH TO BE FLAT IN 2013: MGTO Macau Business
The Macau Government Tourist Office expects the 2013 visitor number to total 28 million, roughly the same as last year, bureau head Maria Helena de Senna Fernandes says. Fernandes adds that the number of tourist arrivals in the first quarter grew at low-single digit rates YoY. She also said that the H7N9 flu is not expected to have a severe impact on Macau tourism.
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Takeaway: China is planning new environmental regulations. We will discuss the changes and their market impact with Dr Melanie Hart on April 18 at 1PM
Expert Call: China’s New Environmental Policies
Setting Long-term Course Now: China’s new government is planning to implement stricter environmental policies in coming months. The disclosure of more information on air quality in China, as well as greater understanding regarding its impact on health, has generated substantial political pressure for change. While cleaning-up air quality in cities like Beijing is a long-term process, the new government is setting the course now amid widespread discontent.
Reshaped Industrial Infrastructure: China is by far the largest consumer of commodities like coal and iron ore, in addition to being the largest player in polluting industries, like steel and rare earth metals. Dramatic growth in Chinese fixed asset investment and manufacturing has reshaped global industrial infrastructure in the past decade, impacting firms like CAT, VALE, UNP, Siemens and Komatsu.
Benefits and Costs: New policies could drive investment in pollution control technologies, potentially providing opportunities for well positioned competitors, like Siemens or BWC. Plants are expected to be moved away from population centers, which may provide opportunities for factory automation firms amid higher labor costs and tighter regulations. There may also be negative impacts, such as limitations on urban automobile permits and potential reduced coal demand. In addition, increased costs associated with steel production could impact iron ore sales to China.
No Easy Task: While the changes are likely to be implemented slowly so as not to shock markets, the government will need to show steady and independently verified progress. Balancing economic growth with definite environmental progress may prove more challenging than some expect given the severity of pollution and the nature of Chinese economic output.
- New environmental policy initiatives
- Natural gas price deregulation and potential for ‘fracking’
- Potential restructuring of Chinese electrical grid
- Nature and timing of new emissions policies
- Enforcement and implementation challenges
- Discussion of key figures involved
- Industrial consolidation and relocation
Key Tickers: JOY, CAT, VALE, CLF, BHP, RIO, SIE, GE, BWC, GM, ROK
Melanie Hart Bio
Melanie Hart is a Senior Policy Analyst for Chinese Energy and Climate Policy at American Progress. She focuses on China’s science and technology development policies for energy innovation as well as its domestic energy efficiency program, environmental regulatory regime, and domestic and international responses to global climate change.
Before joining American Progress, Melanie was a project consultant for the Aspen Institute. She also worked on Qualcomm’s Asia Pacific business development team, where she provided technology market and regulatory analysis to guide Qualcomm operations in Greater China. She has worked on Chinese domestic and foreign policy issues for The Scowcroft Group and the University of California Institute on Global Conflict and Cooperation, and as a Chinese-English translator for Caijing Magazine in Beijing.
Melanie has a Ph.D. in political science from the University of California, San Diego. Her doctoral work focused on China’s environmental regulatory regime and local-level policy enforcement challenges. She studied Chinese at China Foreign Affairs University in Beijing and has a B.A. in international studies from Texas A&M University.
Last week's initial jobless claims numbers were tepid due in some part to the holiday season (Easter, Passover, etc.). But what a difference a week can make; today's report showed that claims fell by 42,000 week-over-week. The lower the number, the better.
"The time shifting of Easter has historically been a notable challenge for the seasonality department at the Department of Labor," Hedgeye Financials Sector Head Josh Steiner noted. "Looking at the latest two weeks of data, we saw claims spike by 28k two weeks ago and then drop by 39k last week (these are both comparisons vs. the unrevised prior number). On the margin, claims were better by 11k over two weeks."
On a non-seasonally adjusted (NSA) basis, the data is clearly improving. This week, we saw a decline of -9.3% on a year-over-year basis, beating the consensus expectation and bringing relief to those who had become worried after last week's slew of abysmal labor market data. Overall, the labor market is steadily improving and the charts we've included below show the change that's occurred over time.
Takeaway: In contrast to last week's soft payroll report, on both an SA and NSA basis, labor conditions improved sharply in the latest week.
Easter Bunny Distortions
The time shifting of Easter has historically been a notable challenge for the seasonality department at the Dept. of Labor. Looking at the latest two weeks of data, we saw claims spike by 28k two weeks ago and then drop by 39k last week (these are both comparisons vs. the unrevised prior number). On the margin, claims were better by 11k over two weeks.
Market cheering aside, the trend in SA rolling claims is fulfilling its destiny. A look at the first chart below shows this plainly. SA claims are beginning their steadily rising path that they'll follow through August of this year. In the last three years this has been a major factor contributing to the sector's turn in the Feb-April timeframe.
On an NSA basis the data improved. Last week we lamented that the rate of YoY improvement slowed to almost zero. This week, it jumped to -9.3%, one of the strongest prints we've seen in the last six months. Ostensibly, the two should be averaged, producing a blended YoY improvement of around 4-5%, which happens to be precisely what the rolling NSA YoY trend did (-4.5%).
Overall, labor market conditions are holding up well, despite last week's scary headlines. We continue to expect the SA data to deteriorate on the margin over the coming months, but the true, underlying trend is strong.
Prior to revision, initial jobless claims fell 39k to 346k from 385k WoW, as the prior week's number was revised up by 3k to 388k. The headline (unrevised) number shows claims were lower by 42k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 3k WoW to 358k. The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -4.5% lower YoY, which is a sequential improvement versus the previous week's YoY change of -3.5%
Joshua Steiner, CFA
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