Opinion

James Saft

Europe, U.S. show similar profiles: James Saft

May 15, 2014

May 15 (Reuters) – Very poor European growth figures add a
hint of concern about a cyclical downturn to enliven the ongoing
worries about a structural malaise.

What is particularly striking is the way in which the euro
zone and the U.S., though operating in vastly different
conditions, are both exhibiting some common traits: very poor
economic growth, very low inflation and a bond market which is
predicting more of the same.

The news from Europe on Thursday was disappointing, with
euro area GDP advancing only 0.2 percent in the first quarter.
Most of that paltry growth seems to have come from a buildup in
inventories rather than an expansion in actual final demand.

And while Germany did surprisingly well, growing by 0.8
percent in the quarter, the data elsewhere was far less good.
Growth in France was at a standstill, while in Italy it
contracted by 0.1 percent and the Netherlands’ shrank by 1.4
percent. Inflation in April was at 0.7 percent with large
swaths of the euro zone in or near outright deflation.

No surprise then that what has been a source of calm – the
fact that borrowing markets are ticking over nicely for euro
area sovereigns – is now looking like a warning sign. German
10-year yields were as low as 1.37 percent on Thursday, while
even Italy can now borrow for 10 years at just over 3 percent.
Euro zone bonds are telling you that yes, as the European
Central Bank essentially promises, you will get your money back,
but don’t hope for too much economic growth or inflation to go
along with it.

All of this puts pressure squarely on the ECB, which at last
seems ready to move, almost certainly at its June meeting. Look
for a cut in all official rates, something which would take the
deposit rate into negative territory. Here’s hoping too the ECB
gets over its institutional and procedural hurdles and manages
to actually create something to channel credit to smaller
businesses.

That could, according to reports, take the form of a
tit-for-tat injection of liquidity, with the payback from banks
taking part being an increase in lending to smaller firms, or a
more straightforward QE-style program of buying up securitized
small and medium-sized entity loans.

All of this isn’t so much too little too late, as same
stuff, different year. Or, if you prefer, same stuff, different
continent.

COMPARE AND CONTRAST

Compare, for example, the U.S. to the euro zone. Couldn’t be
more different, I hear you say. After all the U.S. enjoys cheap
energy, no real fear of Russia there. And the dollar is cheap
enough to not only make euro zone exporters jealous but to force
the ECB’s hand. Also, the U.S. enjoys cheap market interest
rates in a financial market-driven system.

U.S. firms use public markets far more for financing than
their euro zone counterparts, who still rely on banks. As said
banks in the euro zone are in difficulties this causes, well,
issues. Not to mention the U.S.’s other signal advantage – it is
a country, not a currency union.

So with all of these advantages, you’d expect the U.S. to be
hitting it out of the park, comparatively speaking.

Well U.S. first-quarter growth was just 0.1 percent, with
all of the increase attributable to an increase in healthcare
spending. Take out healthcare and we’d be looking at a
contraction of 1 percent in the first three months.

As for inflation, though there has been a bit of movement in
producer prices, benchmark consumer price inflation is still
below target, with core CPI 1.8 percent in the year to April.

U.S. 10-year yields touched 2.44 percent and have fallen by
half a percentage point so far this year. That’s striking given
the higher-than-expected inflation reading released on Thursday.

Clearly in both the U.S. and euro zone there is some reason
to hope the rest of the year will be stronger than the first six
months. And yes, you can say that GDP reports are backward
looking and so might be somewhat discounted as old news.

The bond market, however, is forward looking. And what the
bond market is telling you on both sides of the Atlantic is that
there is very little expectation for growth or inflation.

That’s particularly remarkable given the role central banks
are playing. On the one hand Treasuries are rallying despite the
Fed buying up fewer of them. Euro zone inflation and growth
expectations seem to take very little comfort from the idea of a
more active ECB.

Watch bonds, they just might be telling you something. They
usually do.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •