“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 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:
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:
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
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Best of luck out there,
Associate: Macro Team
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:
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:
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:
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:
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:
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
Please see full report: http://docs.hedgeye.com/HE_3Q14_Lodging_Transactions_10.9.14.pdf
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