This note was originally published at 8am on September 19, 2014 for Hedgeye subscribers.
“Every human has four endowments - self awareness, conscience, independent will, and creative imagination. These give us the ultimate human freedom... The power to choose, to respond, to change.”
As of early this morning the vote is in: the Scots squashed independence and with it the 307 year old union with England remains intact… at least for now. The vote was 55% NO to 45% YES.
And did Pound Sterling ever bounce on the outcome, rising as high as $1.65, and currently is settling in at $1.64! We were positioned long the GBP/USD (via the etf FXB) ahead of the event (we added it on 9/8 to our Real-Time Alerts) with a succinct thesis:
A NO vote leads to a relief rally (see the chart below) and a YES vote leads currency traders to assess the United Kingdom’s fiscal health without Scotland as much improved, which leads to a long term tail wind for the Pound.
In effect, a win-win situation. And we didn’t even have to use our crystal ball!
Back to the Global Macro Grind…
In some sense the Scottish independence vote felt like another Greece moment during the thralls of the Eurozone crisis. There were many ways to interpret what was the “best” outcome.: Greece in or out of the union? And what prevailed was politicians fear mongering on the consequences of a breakup and impressing how the whole is stronger than the sum of its parts – and so Eurocrats quelled the Greek urge for self-determination outside of the Eurozone.
It appears that in Scotland, like Greece, the more rational perception of economic wellbeing (along with the fear of myriad uncertainties associated with independence) won over the emotion of nationalism.
But is economic wellbeing in Scotland, like Europe, a myth?
Our macro team has been making a call for growth slowing in Europe these last months (we’ve recommended shorting Eurozone equities (EZU), France (EWQ), and the EUR/USD (FXE) throughout the quarter), as Eurozone GDP rolled over in Q2 and everything from confidence figures to industrial production and retail sales fell across most European countries over the last 3-6 months.
In recent weeks, and in classic lagging fashion, we’ve seen confirmation of this descent in the form of numerous European central banks, countries, and economic organizations revising down their economic expectations for the year:
- The ECB revised down its 2014 Eurozone GDP projections to 0.9% vs 1.0% in June
- The Swiss National Bank cut its 2014 GDP projection to 1.5% vs 2% previously forecast
- Italy’s 2014 GDP projection was cut to 0.4% by the OECD vs the government forecast of 0.8%
- France’s Finance Minister cut 2014 GDP projection to 0.4% vs 1.7% initially forecast
- Sweden’s Riksbank cut 2014 GDP projection to 1.7% vs 2.2% forecast in July
Additionally, when we evaluate “health” at the country level based on unemployment rates, it appears that the crisis in Europe has hardly passed. The Eurozone unemployment rate is elevated at a sticky 11.5%, almost double the U.S. at 6.1%. Moreover, when you look at unemployment for people under the age of 25 the numbers are staggering:
- Spain 53.8%
- Greece 51.5%
- Italy 42.9%
- Ireland 25.1%
- France 22.5%
Now while it’s plenty easy to push back on these figures and say we’ve mostly cherry-picked the weakest countries (well, France is the 2nd largest economy of the Eurozone), or that there’s no merit in the way unemployment rates are calculated (possibly fair, but the European figures here all come from Eurostat), the point we’re making is that there will be generational TAILs from what some have call this “lost” generation of youth that cannot or will not find a job/establish a career and will rely even more heavily on state support throughout their lives.
As the ugly equation of declining growth + high unemployment + low and deflating inflation comes home to roost, the ECB’s newest response is to lever up its balance sheet (ECB President Mario Draghi has indicated the willingness to increase it by €1Trillion) and extend QE as the “elixir” to inflect weak and declining fundamentals across the region.
As Keith mentioned in yesterday’s Early Look:
“When it comes to central planning limits, there are none (yet). And that’s making your job as a Risk Manager all the more challenging. No matter what you think the Fed, ECB, and BOJ should do, you have to operate within the paradox of what they will do.”
Our view on the impact of ECB policy and the direction of Eurozone fundamentals remains decidedly bearish; here’s a look at how we’ve sized up the latest actions since the ECB’s last meeting on Sept 4th:
- While QE has proven to put a floor in equities in the past, QE is far from the elixir to inflect weak and declining fundamentals across the region. Witness Japan’s failed efforts with QE!
- While on the margin Draghi’s credit easing programs should help to encourage lending and therefore growth to the real economy, the failure of past LTROs to improve lending conditions are fresh in memory. This time the TLTROs may in fact not be different. Interestingly, the first TLTRO tranche yesterday saw take-up by the banks of only €82.6B, well below consensus estimates of €150B
- We reiterate that inflation (via currency debasement) is not growth, even if Draghi showers us with QE
- From here our proprietary GIP model (growth, inflation and policy) for assessing economies suggests the Eurozone economy will land in the ugly quads #3 and #4 in 2H, representing growth slowing as inflation decelerates/accelerates (see the chart of the day below)
Don’t forget that a full 45% wanted Scottish independence. Certainly some significant percentage of this group’s thinking also anchored on the hope that a vote for independence would benefit their personal stead. But interestingly it appears that this camp was not favored by a youth presence (today’s vote included age 16 and above). In fact, a poll by TubeMogel ahead of the vote asked 16-18 year olds their preference and 57% selected NO.
And this actually makes some sense: the life of this group has been so influenced by the global recession and impacts from the Eurozone crisis on slower growth and joblessness (if not for them directly, then their parents and others around them) that their highest priority for this vote was limiting future economic uncertainty.
While Scotland is not Catalonia and France is not Greece, there remain many cracks across Europe, economic and cultural alike. We suspect these cracks are here to stay and that even the mighty Draghi QE wand can’t fix them.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.36-2.63%
Have a great weekend!