Tuesday, 6 December 2011

Euro area gets new budget plan as well as downgrade warning

The euro area took another step towards resolving the debt problem. Reuters reports:

The leaders of France and Germany agreed a master plan involving treaty change on Monday to impose budget discipline across the euro zone...

President Nicolas Sarkozy and Chancellor Angela Merkel said their proposal included automatic penalties for governments that fail to keep their deficits under control, and an early launch of a permanent bailout fund for euro states in distress.

They said they wanted treaty change to be agreed in March and ratified after France wraps up presidential and legislative elections in June. "We need to go fast," Sarkozy said.

They need to go fast indeed after yet another credit rating warning.

Standard & Poor's said it had told 15 of the 17 euro zone countries, including Germany, France and four others with the top AAA credit rating, that it might downgrade them en masse within 90 days, depending on the outcome of a crucial EU summit on Friday.

The timing of the reports is ironical; a move towards fiscal union for the euro nations, and then a move to downgrade them all together.

Meanwhile, data on Monday showed that the eurozone economy is already shrinking. Markit's composite PMI for the euro area rose to 47.0 in November from 46.5 in October but remained below the 50 mark that indicates contraction despite the services index rising to 47.5 from 46.4.

Eurozone retail sales did rebound by 0.4 percent in October after having fallen 0.6 percent in September.

In the UK, the services sector has performed better. The Markit/CIPS services PMI rose to 52.1 in November from 51.3 in October.

However, the British Retail Consortium reported that retail sales grew just 0.7 percent in November over the previous year, down from 1.5 percent in October. Like-for-like sales fell 1.6 percent.

In the US, the services sector showed slower growth in November. The Institute for Supply Management’s non-manufacturing index fell to 52.0 in November from 52.9 in October.

And notwithstanding the resilience in the ISM's manufacturing index reported last week, factory orders declined 0.4 percent in October after having fallen 0.1 percent in the previous month.

Indeed, John Hussman thinks that the US economy is still headed for recession. From his latest article:

As of last week, a simple average of 20 of these binary recession indicators continued to show a preponderance of signals still in place - a condition that has never been observed except alongside a U.S. recession...

In short, recent U.S. economic reports have improved modestly from the clearly negative momentum that we saw in late-summer. Unfortunately, the underlying recessionary pressures we observe are largely unchanged. When we take the present set of economic evidence in its entirety, we see very little evidence of a meaningful reduction in recession risks. Indeed, the evidence from the rest of the world, both developed and developing, reinforces the expectation that the global economy is approaching a fresh contraction.

Hussman also has some words regarding the resolution of the eurozone debt crisis through a German or ECB bailout.

Europe doesn't face a liquidity problem. It faces a solvency problem. What investors really want isn't just for someone to buy distressed European debt, but for someone to buy that debt and willingly take a loss on it so the money doesn't ever actually have to be repaid. That isn't going to happen easily. Short of major fiscal improvements in Europe (which appear increasingly hopeless in the face of an oncoming recession) any solution will have to explicitly or implicitly impose losses on someone. In my view, the best "someone" is the investors who willingly made the loans in expectation of earning a spread, and who knowingly took a risk.

The worldwide hope among these investors is that the "someone" taking the hit will instead be the German people, but Germany remains resolutely against printing permanent new euros in order to effectively redeem the debt of Italy and other countries. Despite hopes that the ECB will suddenly shift its policy on this, I continue to expect that any ECB purchases of distressed European debt will follow an agreement on European fiscal union, and that even if initiated, will be on a smaller scale than investors seem to hope. Without airtight fiscal credibility among distressed Euro-area countries, whatever debt purchases the ECB makes will be almost impossible to reverse.

No comments:

Post a comment