“Some day, following the example of the United States of America, there will be a United States of Europe.”
Well, if Washington is right, “some day” is still a long ways off.
In fact, over the intermediate to longer term we expect the culture clash that is the Eurozone to continue transpiring – from the top (Brussels and the ECB) right on down to the bottom (individual member states).
Our macro playbook continues pointing to a Euro with potential downside from here (it’s down around -9% since May and is broken across TREND and TAIL durations in our quantitative models). Despite ECB President Mario’s Draghi’s pledge “to do whatever it takes” (and lever up the balance sheet by €1 Trillion) to support growth and inflation, we’re not buying the promise of Draghi’s Drugs producing sustainable economic growth.
Why? Because we expect some member states to be very slow in passing the necessary fiscal and labor market reforms to improve their competitiveness.
Back to the Global Macro Grind…
And so the culture clash took another turn this week when the French government announced that austerity is dead and that it would not meet its original deficit reduction target. This shot across the bow stands to reignite tension with the fiscally conservative member states (Germany in particular) and may influence the policy stance of other members (like Italy) that have A) long questioned the merit of austerity, B) have yet to deliver on a full package of reforms, and C) like France, are looking to push out their own deficit timetable.
Specifically, France in its 2015 budget stipulated that it would adapt a pace of deficit reduction parallel to the economic situation of the country. Therefore, instead of meeting the original target of 3% deficit by 2015, the country would push out that target by an additional two years.
And so for the first time in history, the European Commission may exercise its power to reject France’s budget and ask for a new one. A resolution could come at the end of the month.
In follow-up remarks, French Finance Minister Michel Sapin has said that the EU must shift its policy to avert the threat of prolonged low growth and low inflation (along with boosting investment), if Europe was to prevent being stuck in Japanese-style stagnation.
Here’s the rub playing out from Top to Bottom:
- The European Commission (EC) and ECB: (pointing the finger at a select group of member states): “You guys need to reform (more).”
- The Member States Being Accused: (pointing the finger back) “We just issued loads of “austerity” to minimize the public sector, reduce our borrowing costs and improve our credit rating, yet in doing so we’ve choked off growth, are saddled with record high unemployment rates, and have zero ability to manipulate policy to make ourselves more competitive than our European peers. We’re done with this course of action, so be your expectations for deficit and debt consolidation!”
- The EC and ECB: “But if you don’t reform at the state level, there’s no chance our newest programs (ABS & covered bond buying programs and TLTROs) will have any chance of success!”
The problem is that countries like France haven’t done enough. For proof of the shortfall, France’s government spending still stands at a monster 55% of GDP. And as an anecdote, the Magic Kingdom a la France (Disneyland Paris) reported this week that it needs a bailout to the tune of $1.25 Billion. The company cited French labor laws and planning regulations making it difficult to replicate the success of the other Disney enterprises, and called-out in particular the high cost of employing French workers.
Similar structural shortfalls could be identified in Italy, which just this Wednesday happened to host an EU Summit in Milan to discuss job creation.
And so as the “rub” between the Top and Bottom plays out, Eurozone growth stands to suffer as there’s no clear action plan on how to fix it. This week the IMF (a classic lagging indicator) revised down its global GDP forecast and specifically took the Eurozone GDP outlook to 0.8% in 2014 (vs a prior estimate of 1.1% July) and 1.3% in 2015 (vs prior 1.5%).
A quick look at key Eurozone data metrics over the last two weeks shows a similar trend downward:
- Eurozone PMI Services fell to 52.4 SEPT (exp. 52.8)
- Eurozone PMI Manufacturing fell to 50.3 SEPT (exp. 50.5)
- Eurozone PMI Retail Sales 44.8 SEPT vs 45.8 AUG
- Eurozone Sentix Investor Confidence -13.7 OCT (exp. -11) and -9.8 SEPT
- Eurozone Business Climate 0.07 SEPT (exp. 0.10) vs 0.16 AUG
- Eurozone Economic Confidence 99.9 SEPT (inline) vs 100.6 AUG
- Eurozone Industrial Confidence -5.5 SEPT (exp. -5.8) vs -5.3 AUG
- Eurozone Consumer Confidence -11.4 SEPT vs -10 AUG
- Eurozone Unemployment Rate UNCH at 11.5% AUG
- Eurozone CPI fell 10bps to 0.3% Y/Y in SEPT
Our bottom-up, qualitative analysis (e.g. our Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates). We discussed this point in depth on our Q4 2014 Macro Themes Call on 10/2 (email if you’d like access) in our theme #EuropeSlowing (one of three).
Our key conclusions include:
- We do not believe Draghi will be able to turn the tide of deflation (see chart below) and growth through his policy tools alone. German Finance Minister Wolfgang Schaeuble has repeatedly said the ECB has “run out of tools” and that “cheap money can’t force growth”
- We expect the recent package of “supportive” measures (ABS and covered bond purchasing program and TLTRO) to come up short of expectations. Recall as an initial read-through that demand was light for the first round of TLTRO at €83 Billion vs estimates of €150-300 Billion
- Should Sovereign QE become a reality, expect push back from member states (think uproar over OMT and hearings from the German Constitutional Court)
- We believe it’s still largely unlikely that a sovereign QE program can support sustained economic growth (witness years of shortcoming on this front from the Japanese).
- From an investment position, we are recommending shorting French (EWQ) and Italian (EWI) equities and the EUR/USD (FXE).
The former President of France Jacques Chirac once said: “The construction of Europe is an art. It is the art of the possible”. Indeed, if the Eurozone is to become a functioning United States of Europe, it’s just in the initial sketch stage.
Our immediate-term Global Macro Risk Ranges are now:
WTI Oil 84.02-89.82
Takeaway: The Hedgeye Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and noteworthy quantitative signals.
CLICK HERE to view the document. In today’s edition, we highlight:
- What TACRM's 25% Optimal Asset Allocation to Cash implies for your portfolio
- The strength in short-term Treasuries – which was led by strength in zero coupon bonds for nearly three weeks – confirming a shift to marginally dovish policy out of the Federal Reserve
Best of luck out there,
Associate: Macro Team
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Takeaway: Our models indicate the ECB is under the most pressure to act dovishly, followed by the Fed and then the BoJ, which should remain dormant.
To Borrow a Football Analogy…
If you’ve ever watched an NFL football game, you’ve likely heard the quarterback bark out something on the order of, “Mike’s 52! Mike’s 52!” or something along those lines pre-snap. This is because he’s communicating to his teammates who the play-side “zero” defender is, which is the defender from which the entire blocking scheme is anchored upon. Specifically, each offensive lineman, tight end, fullback, etc. is responsible to work either separately or in combination with his teammate(s) to block a specific “number(s)”.
For example, the center is responsible for blocking the “Mike”, or zero, defender; the play-side guard has the “Mike”, or zero, defender plus one; the play-side tackle has the “Mike”, or zero, defender plus two; and so on and so forth. These blocking relationships are simply inverted on the back side of the play.
To the passive observer, it would appear that the “fat guys” up front are merely responsible for colliding with the defenders lined up directly across from them. While this is generally true at lower levels of football (i.e. Pop Warner), the need to quantify defenders and communicate exact blocking assignments increases dramatically as one progresses up the ranks.
For example, our pro-style offense at Yale had 50 base plays and no less than 10 different formations to run them out of. Without adding a single wrinkle to any play (something that effectively increases our universe of potential plays to infinity) we had 500 unique plays to memorize, which is a number that favors a quantitative – rather than qualitative – approach to setting blocking assignments.
That is no different than macroeconomic analysis. Specifically, the need for market participants to quantify their conjectures stems from two core issues:
- Either implicitly or explicitly, every market participant has a macro view, but not everyone actually does or pays attention to macro research.
- For those that are doing the work, the use of varying analytical methodologies can lead to disparate views. Thus, recording deltas, inflections, etc. in a purely quantitative manner tends to lead to more reliable conclusions.
Our macro team obviously has a proclivity for quantitative analysis. This is mostly because our collection of four former hockey players, a former competitive body builder and a former football player is simply not smart enough to get by on “feel” and “storytelling” alone. Numbers simplify things for us.
Quantifying the Currency War
One topic that has become increasingly front and center on the minds of investors is the reemergence of the “Currency War” among G3 central banks. In light of the growing importance of this topic, we thought we’d add some good ol’ fashioned Hedgeye Macro quant to the discussion. The conclusions of our analysis are threefold:
- Our models indicate the ECB should continue to enact dovish policy and/or guidance, at the margins, and is currently under the most pressure to do so.
- Our models indicate the Fed should continue to enact dovish policy and/or guidance, at the margins, though it is facing less pressure than the ECB to do so at the current juncture.
- Our models indicate the BoJ should continue to remain neutral, at the margins, and is facing fairly subdued pressure to enact marginally dovish policy at the current juncture.
In chart #1 above, a low reading implies the need to ease, while a high reading implies the need to tighten. In chart #2 above, a high score implies a commensurately high amount of pressure to ease (i.e. engage in the “Currency War”), while a low score implies a commensurately low amount of pressure to ease.
To arrive at the aforementioned conclusions, we built a quantitative model that transforms 10 relevant economic indicators into a standardized format that allows for cross-country comparative analysis:
- 5Y-5Y Forward Breakeven Rate (latest reading as a percentile of the trailing 6M sample): a higher reading indicates rising inflation expectations among market participants and vice versa
- Benchmark Equity Market (latest reading as a percentile of the trailing 6M sample): a higher reading implies rising stock prices and/or valuations and vice versa
- Bloomberg Consensus 2014 CPI Forecast (latest reading as a percentile of the trailing 12M sample): a higher reading indicates rising inflation expectations within the academic economist community and vice versa
- Bloomberg Consensus 2014 GDP Forecast (latest reading as a percentile of the trailing 12M sample): a higher reading indicates rising growth expectations within the academic economist community and vice versa
- Core CPI YoY (latest reading as a percentile of the trailing 10Y sample): a higher reading indicates elevated structural inflationary pressures and vice versa
- Econ Surprise Index (latest reading as a percentile of the trailing 12M sample): a higher reading indicates an improving economic outlook and vice versa
- REER (latest reading as a percentile of the trailing 10Y sample): a higher reading indicates a perceived loss of structural competitiveness and vice versa; to maintain directional consistency, we invert this number to highlight the fact that policymakers are more likely to react in a dovish manner to a perceived loss of competitiveness
- Sovereign 10Y-2Y bps Spread (latest reading as a percentile of the trailing 6M sample): a higher reading indicates an improving growth outlook among market participants and vice versa
- Spot FX Rate vs. Basket of Peer Currencies (latest reading as a percentile of the trailing 6M sample): a higher reading indicates a perceived loss of cyclical competitiveness and vice versa; to maintain directional consistency, we invert this number to highlight the fact that policymakers are more likely to react in a dovish manner to a perceived loss of competitiveness
- Unemployment Rate (latest reading as a percentile of the trailing 10Y sample): a higher reading indicates a high degree of slack in the labor market and vice versa; to maintain directional consistency, we invert this number to highlight the fact that policymakers are more likely to react in a dovish manner to a cyclically or structurally depressed labor market
Converting each of these indicators into a percentile reading versus its respective trend allows us to consistently quantify the most likely path for a given central bank’s monetary policy (chart #1 above), and exactly how much “pressure” they are under to enact such policies relative to peer central banks at the current juncture (chart #2 above).
Central Bank Catalyst Calendar Through Year-End
As we re-learned amid yesterday’s melt-up and today’s melt-down, central banking catalysts matter big time as it relates to risk managing your gross and net exposures. The following is a chronological list of the most noteworthy central bank events through year-end:
- October 11th at 12:00pm EDT: Mario Draghi holds a press conference in Washington D.C.
- October 15th at 2:00pm EDT: Mario Draghi speaking in Frankfurt
- October 17th at 8:30am EDT: Janet Yellen speaking in Boston on the [rampant] inequality she helped perpetuate via the Fed’s Policies To Inflate
- October 29th at 2:00pm EDT: FOMC Rate Decision
- October 31th overnight: BoJ Rate Decision
- November 4th at 9:30pm EDT: Haruhiko Kuroda speaking in Tokyo
- November 5th at 6:50pm EDT: BoJ releases the minutes of its October 6th-7th meeting
- November 6th at 7:45am EDT: ECB Rate Decision
- November 6th at 8:30am EDT: Mario Draghi holds a press conference regarding the ECB rate decision
- November 19th overnight: BoJ Rate Decision
- November 19th at 2:00pm EDT: Fed releases the minutes from its October 28th-29th FOMC meeting
- November 24th at 6:50pm EDT: BoJ releases the minutes of its October 31st meeting
- December 4th at 7:45am EDT: ECB Rate Decision
- December 4th at 8:30am EDT: Mario Draghi holds a press conference regarding the ECB rate decision
- December 17th at 2:00pm EDT: FOMC Rate Decision
- December 19h overnight: BoJ Rate Decision
- December 24th at 6:50pm EDT: BoJ releases the minutes of its November 18th-19th meeting
By Jove, these people keep us busy…
Investment Conclusion: Get Defensive Amid a Slowdown in Global Growth
All told, we continue to think global growth is slowing, as highlighted by our individual GIP outlooks for the four largest and most economically relevant economies in the world – i.e. the U.S., the Eurozone, Japan and China:
Please review the following research notes to the extent you’d like to dig deeper into any specific region’s GIP fundamentals:
- THE MARKET THINKS WE’RE IN #QUAD4… DO YOU? (10/7)
- HOUSING: CORELOGIC HPI DATA - DECELERATION INTACT (10/7)
- REPLAY: 4Q14 MACRO INVESTMENT THEMES CALL (10/2)
In conjunction with our negative outlook, we continue to prefer defensive exposures from both an asset allocation perspective and from a equity style factor perspective:
On that cheery note, have a fantastic evening! Email us with any follow-up questions.
Associate: Macro Team
- Q3 2014 worldwide reported hotel transactions (Luxury & UUP segments) volume was close to $2.9 billion, lower than the $5.3 billion reported during Q3 2013 but slightly higher than Q2 2014's $2.7 billion
- The total number of UUP/LUXURY hotel transactions increased in Q3 to 30 versus 25 in Q3 2013; however, six transactions did not disclose a deal price.
- Luxury average price per key was higher YoY in the US and internationally.
- The environment bodes well for H, HLT and HOT and their continued transitions to asset light strategies.
Please see full report: http://docs.hedgeye.com/HE_3Q14_Lodging_Transactions_10.9.14.pdf
Hedgeye's Macro Team, led by CEO Keith McCullough recently hosted its quarterly Macro Themes conference call in which it detailed the THREE MOST IMPORTANT MACRO TRENDS it has identified for 4Q14 and the associated investment implications. At the top of the list is #Quad4. Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deceleration in inflation here in Q4. The confluence of these two events is likely to perpetuate a rise in volatility across asset classes as broad-based expectations for a robust economic recovery and tighter monetary policy are met with bearish data that is counter to the consensus narrative.
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