A summer lull?

July 20, 2012

It seems foolish to hope for a summer lull given recent history but in euro zone debt crisis terms at least, the next week looks quieter unless the markets turn savage again.

That’s not to say things are getting better – Spain’s 10-year borrowing costs are still above the seven percent level which it cannot survive indefinitely — it’s just that things aren’t getting much worse at the moment. Certainly with the Spanish bank bailout signed off as far as it can be, there’s nothing on the policy front to shake things up for a while although the debt-laden region of Valencia’s call for help with its debt hardly inspires confidence that Madrid can get things back on track.

What there is next week is a welter of evidence coming up on the health, or lack of it, of the world economy.
Flash PMIs for the euro zone, France and Germany are swiftly followed by Germany’s Ifo sentiment survey and second quarter GDP figures from Britain. The Q2 U.S. growth figure also comes out on Wednesday as well as the Chinese PMI on Tuesday. The euro zone’s slide into recession is likely to be confirmed and of course Britain is already there and unlikely to clamber out despite government and central bank protestations that the country’s travails are all to do with the euro area.

The market landscape is perplexing at a first glance. Not just Germany, but France, the Netherlands and Finland are selling debt with negative yields – which denotes a high level of fear and loathing about the euro zone and wider world’s prospects – yet stocks have been buoyant. The index of leading European shares is up more than 3 percent from a July 12 low, largely due to hopes the Federal Reserve will turn on the printing presses again and because of some upbeat U.S. company earnings figures.

So you have gloomy economic news being offset by the fact that, in the markets’ eyes, it increases the chances of more central bank stimulus. That will have to come from the Fed, Bank of England and maybe China. The European Central Bank may cut interest rates further but it seems very reluctant to create more money or buy government bonds unless the euro zone crisis needle hits critical again, although if we do get a summer onslaught from the markets, it remains pretty much the only game in town, given the euro zone’s ESM rescue fund won’t be operational before September .

Whether more QE is a good idea in the long-term is a very open question. There is a profound paradox at work. Ultra-low borrowing costs should help boost consumption but are a disaster for savers and pension funds, so people will have to save even more and spend less to try and avoid an old age in poverty. Ergo, the net effect could be a further drag on consumption and therefore economic recovery. There’s the rub — further central bank action to ward off a global slump will drive the borrowing costs of “safe havens” yet lower, compounding the problem.

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