Austria PMI rebounds; Europe picks up

 Austria is in a sense an entrepôt economy.  It's at the centre of trade in Eastern Europe, bordering Germany, Italy, Czechia, Switzerland and Slovakia, and close to Poland, and its economy closely parallels the pan-Europe economy.  The rebound in the PMI over the last few months is much more obvious in Austria than in Europe, which suggests to me that Europe is at last moving towards economic recovery.

What will happen with Trump throwing a spanner into the works with his sharp tariff increases is hard to tell.  But a jump in tariffs on imports from Europe into the USA will slow growth, and the response of governments and the ECB will be to roll out stimulatory measures to offset that.

World interest cycle has clearly peaked

Despite some contra movements (for example, Brazil is raising its Central Bank rate), world interest rates have broadly peaked.   The ECB has just cut the discount rate for the Euro Area (the countries which have the Euro as their currency), which has been followed by other European countries.  The Fed Funds rate (the US's equivalent of the discount rate or bank rate) will prob'ly not be cut again in the near term because of the inflationary impact of Trump's tariff and immigration policies.  However, other countries will prob'ly cut their interest rates even faster to reduce the impact on growth of Trump's trade wars.

In the chart shows the GDP-weighted average discount rate for 83% of the world.  The other shows the unweighted median interest rate, including many additional countries in the analysis (e.g, Angola, Kenya, Ukraine, Argentina, and others.) 

Europe's recession deepens

 The chart below shows the extreme-adjusted PMIs for manufacturing and services, and their unweighted average.  Being diffusion indices, when PMIs are below 50%, they show that the majority of components/respondents are falling.  Hence, it's called the 50% recession line.  All three time series are now below 50%, and falling.

The ECB (European Central Bank) is staggeringly inept.

Big 4 PMI flat in December

The extreme-adjusted GDP-weighted average of the provisional ("flash") PMI for the "big 4" (US, Euro zone, UK & Japan) for December was down slightly on November's number.   In the chart below it is compared to OECD GDP, and not world GDP, because the big 4 PMI calculation does not include Russia, China, India and Brazil, for which "flash" estimates are not released.  The estimates were released unusually early because of the Christmas holidays.

The chart suggests that the QoQ (quarter-on-quarter) percentage change for OECD GDP will remain low for Q3 and Q4 of this year. (Q3 and Q4 data have not yet been released)

GDP in the US is picking up, despite the Fed's increase in the fed funds rate over the last year, because of Federal deficit spending in response to the "IRA".   In Europe, interest rates have also gone up dramatically, but there has been no big jump in deficit spending by governments, so growth has been much weaker.  Moreover, while the Fed has signalled that it will cut rates in 2024, the ECB (European Central Bank) and the BoE (Bank of England) have strongly hinted that they will not.  An interesting divergence.

Austria's PMI heading for GFC lows

 Austria's PMI for June continues to slide deeper into recession territory.  (The June PMI for Europe in the chart is provisional ("flash") and may be revised.) 

In the chart below, I have extreme-adjusted the original data.  This reduces the downward spike of the Covid crash at the beginning of 2020.  Strictly speaking, both Europe's and Austria's PMIs fell to deeper lows during the crash than where they are now, but that downturn lasted for just 2 months.  The GFC downturn lasted for nearly a year.  So my extreme-adjustment program reduces the Covid crash decline, but not the GFC and not the current decline.  Both series are now well below the 50% "recession line".

It is important to remember that it is Europe driving Austria's economy, not the other way round.  Austria's weakness is because Europe is slipping into a deeper recession.

The ECB (European Central Bank) will probably raise rates again.  It is clear to me that they have raised rates by more than enough, but it may not be clear to them.  The economy takes time to respond to changing interest rates, and its response to the rate increases which have already occurred is not yet over.

As in US data, we have seen a little uptick earlier this year as services grew because of pent-up demand after Covid.  But that uptick has faded.   Recession is deepening.

Europe core inflation still rising

 Although headline inflation in Europe is falling, because fuel prices are declining. Core inflation continues to rise.   The ECB will only stop raising rates when core inflation has fallen back towards 2% or if the economy falls into recession---and by that I do not mean a mild slowdown.  Despite the fact that the economy's response to rising rates lags, the ECB will be concerned about inflation becoming entrenched.   The risk that the ECB raises rates too much remains.

Source: Trading Economics

German inflation stubbornly high

 Inflation in Germany (Europe's largest economy) just isn't going down.  The ECB will prolly raise rates again, even though there is a risk that previous rate rises have already primed the economy for a recession.

Source: Trading Economics

Euro zone core inflation rises to new high

 The Euro zone (countries using the Euro currency) inflation rate rose to new highs in February.  The core inflation rate excludes price movements in energy, food, alcohol and tobacco.

As long as core inflation is still rising, it is hard for Central Banks (in this case, the ECB) to avoid raising interest rates, even if they are aware that previous rate increases have not yet had an effect on the economy or inflation.  Which risks a deep recession.

Euro zone core inflation rate.  Source:  Trading Economics

Inflation in Europe isn't falling

 [From Trading Economics]

[The] annual inflation rate in France rose for a second straight month to 6.2% in February of 2023 from 6% in January, above market forecasts of 6.1%, preliminary estimates showed. Cost increased faster for food (14.5% vs 13.3% in January), services (2.9% vs 2.6%) and manufactured products (4.6% vs 4.5%). On the other hand, inflation slowed for energy (14% vs 16.3%). On a monthly basis, the CPI went up by 0.9%, following a 0.4% increase in January. Meanwhile, the harmonised CPI was up 1% on the month and surged 7.2% on the year.  [France inflation]

The annual consumer price inflation rate in Spain accelerated to 6.1 percent in February of 2023 from 5.9 percent in the previous month, a preliminary estimate showed. The reading came in well above market expectations of 5.7 percent as electricity prices rose again after a fall in January and food prices were higher than a year earlier. On the other hand, prices of fuels and lubricants decreased following the rise in January. The annual core inflation, which excludes volatile items such as unprocessed food and energy, accelerated to 7.7 percent in February, a new high since the end of 1986. [Spain inflation]

[The] annual inflation rate in Germany was confirmed at 8.7% in January of 2023, higher than a downwardly revised 8.1% in December, and pushed by a rise in energy prices after the government's one-off subsidy for energy bills expired in the end of 2022. Cost of energy increased 23.1% and household energy prices 36.5%, namely natural gas (51.7%) and district heating (26%). Prices of firewood, wood pellets and other solid fuels were up 49.6%, and prices of heating oil 30.6%. Electricity cost increased 25.7% despite the electricity price freeze and the abolishment of the EEG surcharge. Cost for motor fuels went up 7%. Meanwhile, food cost surged 20.2%, led by dairy products and eggs (35.8%) edible fats and oils (33.8%) and bread and cereals (22.7%). Compared to the previous month, the CPI surged 1%, reversing a decrease in December.  [Germany inflation]

The moral of the story is that the ECB will keep on raising rates.  It's been cautious so far, because it expected a deep recession to be caused by a severe physical shortage of gas.  Thanks to quick action to secure new supplies (LNG), and very mild weather (thank you, global warming), that hasn't happened.  The European natural gas price has plunged from its post-invasion highs.   And the sustained high rates of inflation have occurred despite falling oil and gas prices.  Two of the world's largest economic zones, the USA and Europe, will keep on tightening.  The third, China, is stimulating its economy.  I expect, on balance, a tightening recession.  We'll see!

Europe also at 40 year inflation highs

Earlier, I did a blog post showing that US inflation is at 40-year highs.  This isn't just a US problem.  European inflation is also at 40-year highs.  And the ECB (European Central Bank) is likely to respond much as the Fed will, by raising interest rates sharply.  World growth is likely to slow fast.  It takes a year or longer for interest rates to affect economic growth, and even longer for them to reduce inflation.  Which means that the real impact of rising interest rates on economies won't be felt until next year.  However, the impact on share and bond markets, and indeed on most asset classes, is likely to be much more immediate.

Central banks might choose not to raise interest rates to the sorts of highs seen last time we had such high inflation (the Fedfunds rate briefly touched 19% in 1981!), because they may regard this rise in inflation as temporary.  But ― and this is vital  ― they will not stop raising rates just because the stock market falls. 

To slow inflation, the real interest rate will have to be positive, i.e., the nominal rate will have to be higher than inflation.  That means nominal discount rates would have to exceed 8%.  CBs might argue that if the rise in inflation is temporary, they can quickly reverse the interest rate increases.  But even a six month rise in rates to 8% will push economies into recession.  And stocks into bear markets.

US dips into recession

We now have both the ISM and the PMI surveys for August.  As usual, I have extreme adjusted both and added them together.  That's the green line in the chart below.  This average is now lower than it's been at any time since the GFC (Global Financial Crisis) in 2009.

The ISM commentary is bleak:

Comments from the panel reflect a notable decrease in business confidence. August saw the end of the PMI® expansion that spanned 35 months, with steady expansion softening over the last four months. Demand contracted, with the New Orders Index contracting, the Customers' Inventories Index recovering slightly from prior months and the Backlog of Orders Index contracting for the fourth straight month. The New Export Orders Index contracted strongly and experienced the biggest loss among the subindexes. Consumption (measured by the Production and Employment Indexes) contracted at higher levels, contributing the strongest negative numbers (a combined 5.6-percentage point decrease) to the PMI®, driven by a lack of demand. Inputs — expressed as supplier deliveries, inventories and imports — were again lower in August, due to inventory tightening for the third straight month and continued slower supplier deliveries. This resulted in a combined 1.5-percentage point decline in the Supplier Deliveries and Inventories indexes. Imports and new export orders contracted to new lows.

Respondents expressed slightly more concern about U.S.-China trade turbulence, but trade remains the most significant issue, indicated by the strong contraction in new export orders. Respondents continued to note supply chain adjustments as a result of moving manufacturing from China. Overall, sentiment this month declined and reached its lowest level in 2019.

As I've said before, my US longer-leading index (18 months to two years' lead) suggests a turn sometime in 2020, and that timing is more or less consistent with my shorter leading index (9 months to one year).  That's a good six months away, and it ignores any stupid actions from Trump.

And I am concerned that there are few tools to reverse this slide.  Yes, the Fed can cut rates.  But they are already very low.  And QE (Quantitative Easing, i.e., buying long dated bonds to drive down the yield)?  They are already at 75 year lows.  Fiscal stimulus?  We've had our fiscal sugar hit.  And though Republicans voted for a tax cut for the rich and for companies, somehow I doubt they'll vote for any more fiscal stimulus.  The deficit is already substantial.  A tax cut at the economic peak is always stupid.  So it proved this time too.

And remember, in a world where trade flows between countries are significant, weakness in one can be transmitted around the world, especially if politics doesn't provide a circuit breaker.  Look how the U economy turned down in 2012 in response to the Euro crisis.  And right now politics is actually reducing confidence, worsening trade, affecting demand and investment.  We have cretins in charge in the US, the UK, Brazil, and Oz.  And in Europe, the German passion for budget surpluses is constraining Europe's ability to spend its way out of its recession, while the ECB already has a interest rate of zero.

Europe continues to slow

I mentioned the close correlation between Austria's economy and the economy of the whole of Europe before.  The latest PMI survey data for September show another fall for Austria after the "flash" (preliminary) estimate for Europe also fell.  Though both surveys are still above 50%, i.e., are still growing, the gap between them and 50% has narrowed, showing the growth is lower.

In 2012, when the European economy experienced a "double-dip" recession as a result of the debt crisis, these indices fell below zero.  The ECB (European Central Bank) and the European government don't seem to  be managing this very well, frankly.  Growth for the last 6 years has for the most part been sluggish.  If the current cycle is to end soon, that is not good news.

Spain bank audit paves way for bailout

The Age article here.

We're coming to the end of the GFC-related disasters (though note how the article points out that the current Spanish crisis has been made more severe by previous austerity; maybe the same will happen again).  No convincing signs yet that Europe has bottomed.  The usual suspects among the brokers have been wheeling out the champagne ("the worst is over") at a very modest rise in the European PMI.  I hae me doots.

Meanwhile the Spanish 10 year  bond yield has drifted up a tad (Chart from Bloomberg)  Personally, I would be extremely careful not to short Spanish or Italian bonds.  You'd be on a hiding to nothing -- if yields rise any more, a rescue will be announced and the ECB will then be empowered to buy unlimited quantities of bonds.  In other words:  if things improve by themselves, bond yields will fall, and if they don't, the ECB will open its purse, and bond yields will fall.

Testing times

Last week, the President of the European Central Bank Mario Draghi ushered in some reforms which will make it much less likely that solvent eurozone countries (as opposed to Greece which is insolvent) will be driven to default.  This week the German Constitutional Court rules on whether the European Stability Mechanism is consistent with Germany's constitution.

Personally, I don't think it's as important as the ECB's agreeing to buy the bonds issued by threatened eurozone members. Although the ECB will only buy the bonds if the country is part of a rescue process approved by the EEC, the European Stability Mechanism is not essential to bailouts.  It does help formalise the process.  But rescues can be cobbled together without it. What the ECB's bond buying initiative does is much more powerful.  In essence it says that if markets drive yields on government bonds to levels which potentially cause a default and therefore a bailout, it will buy the bonds in whatever quantity is necessary to drive their yields down.  In other words, it caps bond yields.  Which means default for a solvent eurozone country becomes very unlikely.   It also means that the banks in those countries can be saved, because they can borrow from the ECB at zero percent and buy their government's bonds at, say 6% and know that the capital loss downside is limited.  And the margin they make can be used to plug the black hole of property losses.  Clever.  The ECB is finally getting a grip of the problem.

See how Spanish bond yields have plumetted since the announcement?

[Chart courtesy of Bloomberg]