NEW$ & VIEW$ (7 JANUARY 2014)

Weaker Than Expected ISM Services

Monday’s ISM Services report for December came in weaker than expected.  While economists were expecting the headline reading to come in at a level of 54.5, the actual reading was a bit weaker at 53.0.  Taking both the ISM Manufacturing and Non Manufacturing reports and accounting for their size in the overall economy, the combined reading for December fell to 53.5.

Sad smile Slumping new orders and backlog! First contraction in new orders since July 2009.

U.S. Rents Rise as Market Tightens

Nationwide, landlords raised rents by an average of 0.8% to $1,083 a month in the quarter, according to a report to be released Tuesday by Reis Inc., a real-estate research firm. While that is below the previous quarter’s 1% increase, it is above the 0.6% gain seen in 2012’s final quarter. Rents climbed 3.2% for all of 2013.

The vacancy rate, meantime, fell to 4.1% in the fourth quarter from 4.6% in the year-earlier quarter, remaining well below the 8% peak at the end of 2009. (…)

Nearly 42,000 units were completed in the fourth quarter, the most since the fourth quarter of 2003, and about 127,000 for all of 2013, according to Reis. (…)

In 2014, completions should total more than 160,000 apartments, roughly one-third more than the long-term historical average, according to Reis. That could cause the national vacancy rate to rise slightly for the first time since 2009.

CoStar Group, another real-estate research firm, predicts new-apartment supply will peak this year at 220,000, but an additional 350,000 units will hit the nation’s 54 largest markets in 2015 and 2016 combined. (…)

Euro-Zone Inflation Rate Slips

The European Union’s statistics agency Tuesday said a preliminary reading showed consumer prices in the 17 countries that then shared the euro rose by just 0.8% over the 12 months to December, a decline in the annual rate of inflation from 0.9% in November.

After stripping out prices for food and energy, which tend to be more volatile, prices rose by just 0.7% in the 12 months to December—the lowest rate of “core” inflation since records began in January 2001. That suggests that weak domestic demand is becoming an increasingly significant source of disinflationary pressure, adding to the impact from falling world energy prices and the end of a period of administered price rises as governments sought to repair their finances by increasing revenue from sales taxes and charging more for services such as health care. (…)

Separate figures from Eurostat suggested consumer prices are unlikely to rise sharply in coming months. The agency said the price of goods leaving factory gates in November fell for the second straight month, although by just 0.1%.

Slump in Trading Threatens Profit Engine

The trading boom that helped reshape global investment banks over the past decade is sputtering, raising fears that one of Wall Street’s biggest profit engines is in peril.

(…) Executives have warned that lackluster markets could lead to year-over-year declines in fixed-income, commodities and currency trading revenue when banks begin reporting fourth-quarter results next week. That would mark the fourth consecutive drop and the 11th in the past 16 quarters.

Few corners of banks’ trading operations have escaped the slump. A 10-year commodities rally has fizzled, while foreign-exchange trading volume has fallen sharply from its 2008 peak. Since the financial crisis, investors have eschewed exotic fixed-income securities in favor of low-risk government bonds, which are less profitable for banks, and overall trading volumes have dipped.

A rash of new regulations, meanwhile, have prompted Wall Street firms to exit from once-lucrative businesses such as energy trading and storing and transporting physical commodities.

The slump has gone on so long that some observers are beginning to question whether it is part of an ordinary down cycle or a more permanent shift. (…)

FRENCH PMIS DISAPPOINT ONCE MORE

The French Manufacturing PMI fell for the third consecutive month in December to 47.0. It has been stuck below the neutral 50 level for almost two years. On this measure, the French manufacturing sector is the weakest in the Eurozone by some margin. Even the Greek manufacturing PMI improved slightly last month, from 49.2 to 49.6. Official surveys of the French economy paint a somewhat brighter picture. According to a survey by the French statistical agency, Insee, business manager’s perceptions of the overall business climate improved by 2 points to 100 in December, in line with the historic average.

France continues to suffer from declining competitiveness, both in absolute terms and relative to its Eurozone competitors. According to IMF estimates of the real effective exchange rate, the competitiveness of the French manufacturing sector has deteriorated by 12% against Germany since the debt crisis hit in 2010. Over the same period, it has fallen much further against those countries that have experienced deflation. For example, French competitiveness has declined by 28% against Ireland, and by 23% against Greece. Our central view is that France will continue to disappoint through 2014, with growth around zero – the Consensus is looking for something closer to 1%. Risks to our central view are to the downside.

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GOOD READ

Great dollar rally of 2014 as Fukuyama’s History returns in tooth and claw China and Japan are on a quasi-war footing, one misjudgement away from a chain of events that would shatter all economic assumptions (By Ambrose Evans-Pritchard  Tks Fred!)

We enter the year of the all-conquering US dollar. As the global security system unravels – with echoes of 1914 – the premium on the world’s safe-haven currency must rise.

The effect is doubly powerful since the US economy is simultaneously coming back to life. America has shaken off the most drastic fiscal tightening since the Korean War, thanks to quantitative easing. Growth is near “escape velocity” – at least for now – at a time when half of Europe is still trapped in semi-slump and China is trying to cool the world’s most dangerous credit boom.

As the Fed turns off the spigot of dollar liquidity, it will starve the world’s dysfunctional economy of $1 trillion a year of stimulus. This will occur through the quantity of money effect, hitting in a series of hammer blows, regardless of whether interest rates remain at zero. The Fed denies that this is “tightening”, and I have an ocean-front property to sell you in Sichuan.

It is hard to imagine a strategic and economic setting more conducive to a blistering dollar rally, a process that will pick up speed as yields on 10-year US Treasuries break through 3pc. (…)

In case you had forgotten, China has imposed an Air Defence Indentification Zone (ADIC) covering the Japanese-controlled Senkaku islands. The purpose of this escalation in the East China Sea is to test US willingness to back its military alliance with Japan, just as Kaiser Wilhelm provoked seemingly petty disputes with France to test Britain’s response before the First World War.

The ploy has been successful. The US has wobbled, wisely or not depending on your point of view. While American airlines comply, Japanese airlines fly through defiantly under orders from Japan’s leader Shinzo Abe. Mr Abe has upped the ante by visiting Tokyo’s Yasukuni Shrine – the burial place of war-time leader Tojo – in a gesture aimed at Beijing.

Asia’s two great powers are on a quasi-war footing already, one misjudgement away from a chain of events that would shatter all economic assumptions. It would leave America facing an invidious choice: either back Japan, or stand aloof and let the security structure of East Asia disintegrate. (…)

The US is stepping back from the Middle East, leaving the region to be engulfed by a Sunni-Shia conflict that resembles Europe’s Thirty Years War, when Lutherans and Catholics battled for supremacy. Sunni allies are being dropped, Shia Iran courted. Even Turkey risks succumbing, replicating Syria’s sectarian fault lines. (…)

In Europe, the EU Project has by now lost so much caste that Ukraine’s leaders dare to tear up an association accord, opting instead for a quick $15bn from Vladimir Putin’s Russia. (…)

So with that caveat let me try to make sense of global economic forces. Bearish as usual, I doubt that we are safely out of the woods, let alone on the start of a fresh boom. How can it be if the global savings rate is still rising, expected to hit a fresh record of 25.5pc this year? There is still a chronic lack of consumption.

As the Fed tightens under a hawkish Janet Yellen, a big chunk of the $4 trillion of foreign capital that has flowed into emerging markets since 2009 will come out again. It is fickle money, late to the party. (…)

Euroland will be hit on two fronts by Fed action. Bond yields will ratchet up, shackled to US Treasuries. Emerging market woes will ricochet into the eurozone. The benefits of US recovery will not leak out as generously as in past cycles. Dario Perkins from Lombard Street Research says the US is now more competitive than at any time since the Second World War. America is poised to meet its own consumption, its industries rebounding on cheap energy. Europe will have to generate its own stimulus this time. Don’t laugh. (…)

Credit to firms is still contracting at a rate of 3.7pc, or 5.2pc in Italy, 5.9pc in Portugal and 13.5pc in Spain. This is not deleveraging. The effects have been displaced onto public debt, made worse by near deflation across the South.

Italy’s debt has risen from 119pc to 133pc of GDP in three years despite a primary surplus, near the danger line for a country with no sovereign currency. For all the talk of reform – Orwellian EMU-speak for austerity – Italy is digging itself deeper into one hole even as it claws itself out of another, its industries relentlessly hollowed out. Much the same goes for Portugal and, increasingly, France. (…)

There is just enough growth on offer this year – the ECB says 1pc – to sustain the illusion of recovery. Those in control think they have licked the crisis, citing Club Med current account surpluses. Victims know this feat is mostly the result of crushing internal demand. They know too that job wastage is eroding skills (hysteresis) and blighting their future. Yet they dare not draw their swords.

It will take politics – not markets – to break this bad equilibrium, the moment when democracies cease to tolerate youth unemployment of 58pc in Greece, 57.4pc in Spain, 41.2pc in Italy and 36.5pc in Portugal.

Unemployment in the eurozone (yellow), US (red) and Japan (light blue)

The European elections in May will be an inflexion point. A eurosceptic landslide by Marine Le Pen’s Front National, Holland’s Freedom Party, Italy’s Cinque Stelle and Britain’s UKIP, among others, will puncture the sense of historic inevitability that drives the EU Project. (…)

Over all else hangs the fate of China. The sino-bubble is galactic. Credit has grown from $9 trillion to $24 trillion since late 2008, as if adding the US and Japanese banking systems combined. The pace of loan growth – 100pc of GDP over five years – is unprecedented in any major economy, eclipsing the great boom-bust dramas of the past century.

The central bank is struggling to deflate this gently, with two spasms of credit stress in the past six months. I doubt it will prove any more adept than the Bank of Japan in 1990, or the Fed in 1928, and again in 2007. This will be a bumpy descent.

China may try to cushion any hard-landing by driving down the yuan. The more that Mr Abe forces down the Japenese yen, the more likely that China will counter with its own devaluation to protect the margins of it manufacturing industry. We may be on the brink of another East Asian currency war, a replay of 1998 but this time on a much bigger scale and with China playing a full part.

If so, this will transmit an a further deflationary shock through the global system, catching the West sleeping with its defences against deflation already run down. The US may be strong enough to cope. For Europe it would be fatal. The denominator effect would push Club Med into a debt compound spiral. Let us give it a 30pc probability. Happy new year.

 

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