You know, it is all a tad unfair.
Yesterday was a bad day in the US, and markets in Europe suffered.
The last few weeks have seen a string of bad news coming out of Europe over fears of sovereign debt default, and the dollar rises.
In other words, when the news from the US is bad, Europe suffers; when the news from Europe is bad, the US gains.
But now the latest media reports suggest a new chunk of unfairness, and it is enough to make you want to throw your dummy out of the pram.
But to begin, let’s tell the story of yesterday’s bad news coming out of the US.
The big bit of bad news concerns US consumer confidence. According to data from the Conference Board, US consumer confidence fell back sharply in February, dropping to a ten-month low. Last month things were looking promising, or at least promising in an it’s stopped snowing but it is still cold, sort of way. January had seen the index leap to 56.5, its highest level since the fall of Lehman, and more than double the index’s recent nadir set during the bad old days of last year’s winter. On the other hand, back in the glory days of 2007, the index was still more than double the January level. But alas, in February it fell all the way to 46. Now some have seen a ray of hope in the figures. The alternative measure of consumer confidence, produced by the University of Michigan and published a few weeks ago, didn’t fall so sharply. Some analysts are putting this down to bad weather. They say that the time of the month reflected by the Conference Board data saw particularly bad snow. This reasoning is a bit odd. Do you feel less confident about your finances when the weather is bad?
The fact remains, however, despite the surge in US growth in the final quarter of last year, US consumers are very unhappy bunnies. It is a tad worrying, because it suggests the US recovery is largely down to the turn in the inventory cycle. In other words, the recent improvement in the US is solely down to temporary factors.
Meanwhile, some media saw a ray of hope shining out from the US housing market, with the Case-Shiller 20-city index seeing only very modest falls in December. But alas, Capital Economics reckons recent signs of an improvement in US house prices were down to a temporary tax credit, which will be removed in April.
So, what do you get when you put anaemic consumer confidence and a poor prognosis for US house prices together? Answer, you get an economy that is dependent on other countries buying its wares.
This is of course the precise opposite of what Europe needs. Europe, especially the likes of Germany, requires a resurgent US consumer.
Hence the fact that bad news out of America meant a weaker euro.
And while the data put the dampeners on markets, two bits of data, this time coming out of Europe, made things damper than ever.
In Germany, the IFO index tracking the business climate saw its first dip in over a year. What with the German ZEW index falling recently too, markets are beginning to feel this sense of dread every time data comes out of Germany. So there will be a lot of dread today, because today is the day when the second guesstimate for German GDP in Q4 will be published. The first guess said GDP was zero.
Now pause for a moment. Write some numbers on a piece of paper, ranging from, say, minus 0.5 per cent to plus 0.5 per cent, put a blindfold on and get a pin. Now lower the pin onto the paper. What is the nearest number? Congratulations, you have just discovered a far more reliable method of economic forecasting than the one employed by economists.
As for France, the problem is le Cliff. French consumer spending on manufactured goods fell a somewhat worrisome 2.7 per cent, or to put it anther way, the index tracking this fell off the French equivalent of Beachy Head.
Mind you, France remains one of Europe’s star performers.
But now we get to the unfair bit.
If credit default swaps are any guide, markets have decided that Europe’s problems are not Uncle Sam’s problems. Apparently, over the last couple of weeks, the cost of protecting US companies from default has fallen by over 7 per cent, while in the eurozone it is down a mere 2.1 per cent. Bloomberg quoted Mikhail Foux, a New York-based credit strategist at Citigroup Inc, who said that recent efforts in the EU to constrain Greek debt “did lessen the risk of contagion on this side of the ocean. On the other side of the ocean, there’s still a lot of problems.” In other words, by talking the talk that the EU won’t let Greece’s problems drag down the rest of Europe, markets concluded that the US was safe, but Europe was still vulnerable.
And finally, before we leave the story of the US and Europe, there’s another crisis in the making. As you know, the rate of interest in the US is low, very low. So what do markets do? Why, they borrow in the US and lend abroad. It is called the carry trade. You may recall during the days of the credit boom, Japan stood centre stage in a carry trade, and its unwinding may have been a contributory factor to the credit crunch. But the recent rises in the dollar are making investors think twice. What has really got markets spooked, however, is that this week the Fed upped the discount rate, that is the rate at which it lends to banks. According to the FT, the dollar carry trade is worth $1.5 trillion, much bigger than the Japanese trade of a few years ago. The big fear now is that the unwinding of this carry trade could create massive problems for credit markets across the world.
However, don’t rush for the UK equivalent of Beachy Head, which is, err, Beachy Head. Take some comfort; the pink ’un was pretty sceptical about the strength of the dollar carry trade.
It said: “Analysts say there is little evidence outside the short-term speculative data that investors have built significant long positions in the dollar.”
And finally, there is another point. The Fed went to some lengths to say its decision to up its discount rate did not in any way imply it was going to up the Fed Fund rate, which is the one we normally talk about, and which underpins the carry trade.
© Investment & Business News 2013