Thoughts on Europe and the global synchronised slowdown
I am in semi-vacation mode. It’s been about a week since I last posted any real macro analysis or daily links and more than two weeks since the last weekly review. A lot has happened since then. I will be talking about Europe and some of these issues at 12:40 today on BNN. So tune in.
European Austerity Union: Most eyes are focused on Europe where the German-led fiscal austerity union is not proceeding smoothly. I continue to be sanguine there in that I expect a late but robust policy response which will mean support for euro government bonds and the broader stock market over the short-term. Over the medium-term, despite easy money from the ECB, there are problems and I anticipate these to come to a head for the situation in Greece and for euro zone economic growth. In the medium-term, through 2012, I don’t expect euro zone failure. I do expect a worsening crisis as poor growth takes a toll. Over the longer-term, however, I am less sanguine. The euro cannot work as envisioned by the Germans. It will see at least Greece leave.
The things that I think are actually most relevant over the short to medium term on markets are outside Europe. Here are three events that should be on your radar screen as market watchers:
Chinese housing bubble pops: Global Macro Monitor has run a few pieces on this of late. Now, in April I warned that overheating and an aggressive policy response could eventually lead to a hard landing (ie. 5% growth, down from over 10%). We’re not there yet.
But Nomura expects China to run a trade deficit in Q1 2012 as external demand dives for China’s export machine. Moreover, Bloomberg has reported that China’s largest provincial borrowers are ‘deferring payment’ on loans just 2 months after regulators said some local companies would be allowed to do so. Andy Lees of UBS wrote this morning that:
Hunan Provincial Expressway Construction, Guangdong Provincial Communications, Gansu Provincial Highway Aviation and Sichuan Railway Investment owe a total of more than CNY200bn to banks and plan to defer CNY34.4bn in interest payments according to their bond prospectuses. Fitch says of the Gansu disclosure that "This prospectus is telling us that banks can expect to only receive roughly half of what would have been expected in interest payments". Professor Patrick Chovanec says that if bank capital is being tied up simply rolling over existing non-performing debt, this will crowd out new loan growth. "This is a problem that’s going to start to bite next year".
This sounds like shades of Dubai World if you asked me.
China watchers like Shaun Rein and Michael Pettis both argue a soft landing is very doable. Rein recently mentioned "pent up demand and lack of debt among homeowners" as a real economy reason why. That doesn’t mean growth will remain high nor is it bullish for stocks as Rein is bearish on China’s stocks but bullish on the real economy.
I think Paul Krugman has a must-read piece out on this topic – and it’s not bullish. Bottom line, China is the story to watch for 2012.
Australia housing bubble popping: Moody’s has downgraded Australian mortgage insurers because of ‘tail’ risk in the Australian housing market. In the piece I posted last night, they wrote:
The revised outlooks follow the publication on December 12, 2011 of a report outlining Moody’s negative outlook for the Australian lenders’ mortgage insurance industry (LMI) and reflect the rating agency’s concerns regarding the companies’ exposure to tail-end outcomes in the Australian housing market.
"Although the financial metrics of rated LMIs suggest these firms are well-positioned for the comparatively stable conditions we expect for the Australian housing market in the near term, we believe there are meaningful uncertainties about tail-end scenarios over the mid-term which place downward pressure on the LMIs’ credit profiles", says Ilya Serov, Moody’s lead analyst for the Australian mortgage insurance sector.
While Moody’s views the probability of a severe housing crisis to be low, a greater degree of caution with regard to the future performance of Australian mortgage portfolios is warranted.
These so-called tail scenarios are very tied to China. A booming Chinese housing, infrastructure and property construction market is great for Australian commodity exports. A bust in those markets is bearish for commodities and therefore bearish for Australia and its over-valued housing market. I would actually watch the policy response to the burst bubble and declining export growth in China to gauge the directionality of this incipient Australian housing selloff.
Indian growth slowdown: Christopher Wood, a well-regarded market analysts at CLSA and an India bull. recently cut his guidance for growth in India to 6% from 7%. In conjunction with this downgraded growth expectation, CLSA cut Indian equities to ‘neutral’ from ‘overweight’. And Wood has said the Indian Sensex stock market index could go down even further, even after having traded down into bear market territory. The Reserve Bank of India is now cutting rates. So India’s currency, the Rupee, is at record lows versus the US dollar as well. That’s market bearish for foreign investors.
We are in a second synchronised global growth slowdown. Moreover, the policy response must be more muted this go round as the public sector is more indebted and has less policy space than in 2008 or 2009. Expect policy inaction followed by fits of volatility due to inaction, followed by vigorous policy responses to keep the muddle through from collapsing into Depression. Overall, all of the risk is to the downside, not just in the euro zone but globally.
Like you I do see a global slowdown coming. Unless there is another credit crunch, which is highly likely, I do not see a global recession until then. There are many factors which will exacerbate the next crisis. A china slowdown will significantly impact Australia, and it’s housing bubble. Canada also has a housing bubble which needs deflating, but is off most peoples radar right now.
Reporting from down here in Australia, I think the Australian “policy response” to an economic slowdown/housing market decline will be bad. All sides of government down here have the austerity bug – the current government has been working hard to bring the budget back into surplus, while the main opposition have been mocking them for not doing it faster. The reason is of course obvious – we have virtually no public debt…but we’ve learned from the Europe situation that if we run up a little debt, we will very quickly become Greece! Scary views from people who have no idea how the economy really works. In summary, expect an economic slowdown to be met with panic over a rising deficit and calls for UK-style austerity…
The fact that there is virtually no national debt is not necessarily a virtue. Ireland had a surplus and little government debt before the crash. Though it made the mistake of taking all the banks debts onto the national balance sheet and that is what destroyed the Irish balance sheet. Australia’s banks are also very heavily dependant on foreign money especially chinese funds. If that were to change then the big Australian banks would all be in trouble. If the government then guaranteed them then you would very rapidly see an increase in the deficit. If the government refused to bail out the banks then that would be a start. If you actually had an austerity package to take the heat out of the bubble that is fine but the Australian housing bubble is rather large to do safely. Counter cyclical policy is best started at the beginning of the bubble not at the end of a bubble.
What do people think of the fact that Australia’s yield curve has been inverted since June?
How do you mention Shaun Rein and Michael Pettis in the same sentence? Michael Pettis is a Finance professor at Peking University; Shaun Rein is a self-promoting mouthpiece for the Chinese Government.