June 23rd, 2014 7:00 am | by John Jansen |

Via Brown Brothers Harriman:

  • The disappointing euro area flash PMI cut short the single currency’s attempt to establish a foothold back above $1.36.  The pullback has not been deep, with the euro holding above the pre-weekend low seen near $1.3565.  Both France and Germany disappointed expectations, but the French report was particularly miserable as its flash manufacturing PMI fell to 47.8 from 49.6 (consensus was 49.5) and the services fell to 48.2 from 49.1 (consensus was 49.4).  This puts the composite at 48.0, the lowest since February and the third consecutive monthly decline.  
  • In a perverse way, it may serve the interests of the beleaguered French government.  It is going into the heads of state summit at the end of the week looking for greater fiscal leeway to pursue some pro-growth measures.  According to reports, France may seek to exclude some budget items (such as investment in energy, the digital economy and defense) from the deficit calculation for EU purposes.  
  • The German data was not nearly as disappointing and it remains in higher levels.  The manufacturing PMI ticked up to 52.4 from 52.3 (consensus was 52.5).  Disappointment was greater in the service sector with a 54.8 reading, down from 56.0 (consensus was 55.8).  This produced a composite of 54.2 compared with 55.6 in May.  
  • For the euro area as a whole, the composite reading of 52.8 in June after 53.5 in May, is still seen consistent with 0.3%-0.4% quarter-over-quarter Q2 GDP.  However, there is no momentum. The one bright spot was a small tick up in the price component.
  • In Q3, the Federal Reserve continues to taper at its measured pace.  The ECB will monitor the implementation of its new initiative as it prepares for both the targeted LTROs (TLTROs) starting in September, and for the possibility (eventuality?) of purchasing asset-backed securities.  The BOJ will continue to purchase about $70 bln of assets each month and will closely watch the impact of the recent retail sales tax increase.
  • The BOE’s forward guidance has turned more hawkish, and there is increased speculation of a rate hike toward the end of the year.  Sweden’s Riksbank is expected to cut rates next month while Norway’s Norges Bank has opened the door to a rate cut as well.  Within the dollar-bloc, New Zealand is in the middle of a rate hike cycle.  The Reserve Bank of Australia is on hold with a record low cash rate, but another rate cut cannot be ruled out.  The Canadian monetary stance is neutral, especially underscored by the uptick in both retail sales and inflation reported at the end of last week.
  • Emerging market economies are too diverse to make generalizations about the monetary stance.  China has selectively cut required reserve ratios.  More targeted moves seem likely even as economic growth stabilizes.  The HSBC flash manufacturing PMI, to be released on Monday in Beijing, is expected to tick up to 49.7 from 49.4, which would be the highest of the year.  The index ended Q1 at 48.0.
  • Two emerging market countries are expected to cut rates this week.  Turkey is likely to cut the one-week repo rate by 50 bp to 9.0%.  Given its elevated inflation (9.6-9.7%% headline and core), the risk is that rate cuts are seen as politically motivated and a negative for the lira.  For the fourth consecutive month, Hungary is expected to cut its base rate by 10 bp to 2.3%.  Lastly, the Bloomberg consensus is for no change in the Israeli base rate now at 75 bp, though a handful of analysts look for a dovish surprise.  The US dollar does look to be carving out a base around ILS2.44.  
  • The firmer than expected HSBC flash China PMI (50.8 vs. 49.7 consensus) should help EM sentiment this week.  This fits in with our view that the mainland economy has stabilized, albeit at slower growth rates.
  • Japan:  Japanese consumers are expected to have returned to the shops in May after staying home in April as the sales tax hike took effect.  Retail sales are expected to have risen by around 2.8%, and the y/y contraction in overall household spending is expected to ease to around -2.1% from -4.6%.  Although there has not been much data, and the early signs are ambiguous, there does seem to be some confidence (bravado?) on the part of policy makers that the economic recovery will quickly resume.
  • Separately, Japan also reports May national CPI figures.  The core rate, which excludes fresh food, and is officially preferred (targeted) measure, is expected to increase to 3.4% from 3.2% in April, due to higher energy prices.  This core rate, excluding the sales tax impact, is expected to be stable around 1.4%.  The BOJ’s target is 2%.
  • Toward the end of the week, the government is likely to announce more initiatives under the third arrow of Abenomics, structural reforms.  A key component will be a corporate tax cut.  The tax schedule (as opposed to the effective tax rate) is 36% in Japan, the second highest, behind the US, among OCED countries.  Given the large savings accumulated already in the Japanese corporate sector, we are not convinced that a corporate tax cut will boost investment or growth in Japan.  Moreover, it is likely to announce a plan to cut the corporate tax without detailing how it will be funded on a permanent basis, which is needed if the government is going to stick to its fiscal goals.
  • More promising are reports that suggest the Abe government is considering cutting tax benefits that discourages spouses from working.  However, simply reducing the benefit may increase family hardships unless accompanied by other social changes, like better and more accessible childcare services.
  • UK:  The increase in house prices is regarded as the potential source of the greatest financial risk facing the UK.  When it delivers its Financial Stability Report, the FPC (Financial Policy Committee of the Bank of England) is expected to recommend macro-prudential measures to slow the housing market down.
  • Among the range of recommendations that have been a source of speculation are curtailing the Help-to-Buy program and tightening requirements regarding loan-to-value and loan-to-income metrics.  Given the institutional and foreign participation in the UK property market the impact of such macro-prudential steps will impact the middle class domestic demand more than other market segments.
  • Euro zone:  With the flash PMI for June out of the way, investors will now focus on the preliminary inflation reports from Spain and Germany at the end of the week.  The Bloomberg consensus expects Spain’s y/y reading to ease to 0.1% from 0.2%.  Consensus also has the German harmonized measure to rise 0.2% m/m for a 0.7% y/y gain.  In May, it fell 0.3% m/m and rose 0.6% y/y.  The risks seem to be on the downside.  Although no policy changes should be expected in the coming months until the impact of the negative deposit rate and TLTROs are understood, a worsening of the disinflation can only strengthen ideas that the ECB will have to resort to an asset purchase program.
  • EU Summit:  The heads of state meet on Thursday and Friday.  There are two issues, economics and politics.  Fiscal and structural reform plans will be reviewed.  Here, France, Spain and Italy, in what appears to be more a concert of interests rather than a coordinated position (which is why it is difficult to conceptualize this as a bloc), are pressing in different ways for a more liberal interpretation of the fiscal mandates.  Germany may be able to make some concessions on the condition that the Stability and Growth Pact is itself not amended.
  • The high drama may be seen in the political agenda.  The immediate issue is the European Commission President.  The operative treaty requires the heads of state to take into account the parliamentary election results in naming the new president.  The two main blocs in the European Parliament must choose a lead candidate to represent them.  The center-right (EPP) won a plurality, but not a majority of votes.  About one in four votes were cast for parties that are anti-EU.  Juncker, who was the EPP’s candidate due to his extensive experience in European politics, was identified with the status quo.  Moreover, even though Juncker was a head of state for many years, he is seen as a federalist who seeks greater authority for the European Union.
  • Juncker may not be very well liked, but the UK’s prerogative and obstructionism is less well liked.  As more decisions are decided on a qualified majority basis rather than unanimity, the value of the UK’s veto is eroded. In the past, it has effectively vetoed EC presidential candidates.  UK Prime Minister Cameron’s public objections may be a part of a principled position (against federalism), but seems poor politics and exposure the UK’s isolation.  If Cameron had been more adept at negotiating and trading horses, as the case may be, he might have been able to have greater influence.
  • Recall that Cameron took the Tories out of the EPP coalition, in which Merkel’s CDU is a key participant, and recently formed an alliance with the AfP (Germany’s anti-EU party). There are three state elections in Germany in Q3 and the AfP, which did not meet the threshold for participation in the national parliament, will likely win some seats in these state elections.  The AfP campaigns to the right of Merkel and may take votes from the CDU.
  • Cameron faces his own challenge in the form of the UKIP, which did well in the recent local and EU Parliament elections.  Cameron has promised a referendum on the EU if he is reelected next year.  There is a not very subtle threat:  If there are not concessions forthcoming for the UK, it will withdraw from the EU, for which is accounts for a third of the budget, and this includes the EC President.
  • Yet, a recent YouGov poll (conducted for The Sun) found that by a 44-36 margin, British people wanted to remain in the EU.  This was the widest margin since the survey began in September 2010.  This dovetails with other reports that suggested that many who voted for the UKIP also want the UK to remain in the EU.  Ironically, the kind of federalism Cameron eschews in Europe, he wants Scotland to accept within the UK.
  • US:  The first quarter was more dismal than anyone anticipated.  The recently reported decline in health care spending means that GDP is likely to be revised to something on the magnitude of -2.0% (annualized).  The rebound in Q2 is just as impressive and this is where the real focus is now, especially given that economists, including at the IMF and Federal Reserve have already adjusted their 2014 forecasts to reflect the horrible Q1 results.
  • The housing market remains a disappointment, but weakness in capital expenditures in Q1 appears to have been erased in Q2.  That said, the headline durable goods orders will likely be restrained by fewer aircraft orders, the underlying details should bolster confidence of a capex rebound.
  • The US also reports personal income and consumption data for May.  Income growth has been strikingly stable. The 6, 12, and 24-month average is 0.3%.  There has been a slight increase recently and a 0.4% increase in May will keep the 3-month average at 0.4%.
  • Consumption should rebound smartly from that fluke 0.1% decline in April (which followed a 1.0% gain in March). Household consumption has been trending slightly higher.  The 24-month average is 0.3%.  Over the past 6 and 12 months, it has average 0.4% and over the past 3-months 0.5%.  What is remarkable is that this consumption has occurred with little increase in revolving debt (credit cards).
  • With the personal consumption data, the Fed’s preferred inflation measure (the core PCE deflator) will also be reported.   It is expected to have risen to 1.5% in May from 1.4% in April.  Recall that last week, the government reported that core CPI rose from 1.8% to 2.0% in May.  The discrepancy between the two will be widely discussed in the coming days.  Suffice to say that for our purposes, we note that the PCE measure covers a wider range of goods and services.  The weighting of its components comes from businesses while household surveys shape the CPI weightings.
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