Marcuard's Market update by GaveKal Dragonomics
Europe’s political leaders may be talking about fresh sanctions on Moscow, but the continent’s remaining economic optimists are fast capitulating in the face of Russian aggression in eastern Ukraine. Both the European Commission’s eurozone economic confidence survey and the INSEE French business confidence survey, released late last week, deteriorated in August, with the EC survey slumping to its gloomiest reading this year. This decline in sentiment reverses a divergence between softening ‘hard data’ and survey results that until recently were relatively upbeat. However, instead of the hard data grinding higher as the optimists had hoped, the surveys have slumped lower. It is now obvious that the eurozone has got itself into a veritable economic funk. Behind this funk is a confluence of forces including:
• The weakness of the yen over the past 18 months. A weak euro-yen exchange rate long helped keep the wind in the sails of Europe’s exports to emerging markets. However, as the yen weakened the eurozone’s exports to emerging markets began to struggle. Take Germany as an example: while exports to China continue to make new highs (at EUR 19bn a quarter), quarterly exports to other BRIICS markets have dropped from EUR 18bn to 15bn.
• The impact of Russian sanctions. Even before Moscow adopted an openly confrontational stance over Ukraine, Russian growth had decelerated from 5% year-on-year in 2012 to just 0.7% in the first quarter of this year. This is alarming, especially as the oil price remains relatively elevated, and emphasises how hopes that Russia’s WTO accession would prove a new locomotive for eurozone growth need to be revised. To be sure, sanctions will hurt Russia a lot more than Europe. Last year, Russian businesses enjoyed some $194bn of foreign direct investment inflows, 75% of which came from the EU. This will now slow to a trickle (as will transfers of productivity-enhancing management expertise and technologies). Meanwhile, on the EU side of the equation, the 29% appreciation of the euro against the ruble since March 2013 had already contributed to a 20% fall in exports to Russia even before the first round of sanctions was announced at the end of July. As a result nearly 0.1% was shaved off nominal GDP growth over the last year, an amount that is bound to rise as sanctions kick in.
Of course, the good news is that the euro is now falling, which should help exports. Plus, exports to Russia only account for 2.7% of the eurozone’s total (down from 3.4% a year ago). However, with most European countries either already in recession (Italy) or flirting with one (Germany and France) even a small blow could be enough to injure animal spirits in an already depressed eurozone.
This brings us to one of the more significant stories of the last few days: the news that the ECB has hired Blackrock to devise a programme of asset-backed securities purchases. After months in which the ECB insisted it was ‘monitoring the data and ready to act’, this news can only be seen as a disappointment. After all the data has been terrible for months, but it turns out that ‘ready to act’ actually meant ‘ready to hire an advisor who will then help us devise a plan so we can transform words into actions’. Why wasn’t Blackrock hired three, or even six, months ago? And how come the 2,000 or so staff members who toil in Frankfurt, along with the thousands more at the Banque de France, the Bundesbank, the Bank of Italy, etc., can’t manage to put together an ABS purchase plan by themselves?
At this stage, it is obvious that most European countries (not least Italy and France) need tax cuts financed in part by a more expansionary monetary policy. However, after six months in power Italian prime minister Matteo Renzi is more focused on political reform than fiscal change, while in France the recent government reshuffle seems to highlight that the EUR 40bn in corporate tax cuts announced six months ago is likely to be as good as it gets for the next budget (though the arrival of the ‘supply-sider’ Emmanuel Macron as economy minister is an encouraging sign that more labor market reforms may yet happen). Meanwhile, the ECB is still ‘studying its options’, rather than taking action. Putting it all together, we have to conclude that the path of least resistance is for Europe to continue deteriorating and that no major policy initiatives will be taken over the next couple of months. This will reinforce the growing investor perception that Europe should be a source of, rather than a destination for, capital.
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