AA+ for United States
Global Economics Weekly Brief
AAA Lost in the USA, Violence in the UK
and let's not forget Italy and Spain...
A is for AAA status – lost in the US; B is for Italian and Spanish bond purchases by the European Central Bank; and C is for Crikey, how much?! As investors look at low equity values and the huge price of gold. An accumulation of bad economic news sent markets into turmoil last week as worries about the effect of sovereign debt on the global recovery boiled over. Equity markets fell sharply across the world as investors got nervous and sought out safe havens. And if that wasn’t enough for one week, Standard and Poor’s shocked everyone by downgrading the US from its AAA rating. On top of that, fears for the Eurozone forced the European Central Bank to buy Spanish and Italian bonds to try to calm the markets. These developments will take time to digest so things are going to remain very jumpy in the weeks to come. Do Governments and bankers know what they are doing?
Standard and Poor’s downgraded the US from its AAA rating. The US top notch risk rating was a casualty of the messy political negotiations to raise the US debt ceiling. The risk that the US will actually default is still tiny, especially compared with other countries, so perversely US government bond yields fell even after the announcement. But the unprecedented move to downgrade casts another shadow on the US recovery and, as a result, on the pace of the global recovery. More issues to come over the next few months to impact on the global economy.
UK and Eurozone interest rates stay put and ECB bond purchases begin rapidly. There was little doubt that UK and Eurozone interest rates would stay where they were this month. Weaker economic performance along with threats from turmoil in Europe and the US, even before the latest events, made it inevitable that the Monetary Policy Committee and the European Central Bank would keep rates steady. But increasing worries about sovereign debt in Italy and Spain put more pressure on the ECB to act. It announced its bond purchase operations would restart now. This happened perhaps a bit more quickly than ECB President Trichet expected as the Bank intervened to buy Spanish and Italian bonds. But it has helped to reduce borrowing costs for Spain and Italy and gives policymakers a bit more time to sort out the structure for future support. How long can the purchasing of bonds continue?
Manufacturing activity slowed across the globe. Surveys of manufacturing across the world are softening. An index number below 50 indicates contraction, and in the UK, the Purchasing Manager’s Index (PMI) fell from 51.4 in June to 49.1 - the first contraction in the UK since September 2009. The Eurozone PMI fell from 52 in June to 50.4 in July, while in the US the ISM survey collapsed from 55.3 in June to a sickly 50.9. Even China saw hardly any growth. A collapse in orders was the reason for the slowdown everywhere, except China where stronger domestic demand helped soften the blow.
Eurozone unemployment is steady in spite of the slowdown (look closely over the next few months when unemployment will rise). Unemployment in the Eurozone held steady at 9.9% for the fourth consecutive month in June, but this differs vastly across the region. Things are fine in Austria and the Netherlands where rates fell to about 4%, but not so good in Spain, where unemployment rose to 21% and will continue to rise now more rapidly. The usual worries are likely to put off new hires until there are stronger signs of recovery. There are few signs of this in the retail sector. Like the UK, Eurozone retailers’ sales have been volatile from month to month. But the end result is that sales are 0.5% lower than in June 2010. Like unemployment it’s mixed. Sales were up 3.1%y/y in France, but down by a whopping 7.6% y/y in Spain. Look very closely over the next months when there will be more unemployment especially in Spain and Italy.
Sovereign Debt Crisis Warning Issued By European Commission President. Jose Manuel Barroso, president of the European Commission, has hit the panic button. As the Eurozone debt crisis worsened, he remained among the most optimistic of EU officials, repeating his faith in the ability of the myriad of rescue packages to prevent further contagion from affecting larger European economies. But no longer.
Barroso has issued a clear warning to the policymakers in Europe that has a strong note of dire panic. He no longer pretends that the debt-financed rescue stratagems cobbled together by the inept politicians of the European Community are safeguarding larger economies such as Spain and Italy being exposed to the rapidly metastasizing debt crisis. He admits with brutal frankness that the markets “remain to be convinced that we are taking appropriate steps to resolve the crisis.”
The panicky communication from the European Commission president has sparked a wave of frantic selling among stock markets across the globe, while leading gold to ascend to ever higher prices. Is the handwriting on the wall? It is becoming ever more obvious, even to the formerly sanguine politicians, that the global economic crisis never ended, and that its current phase, the sovereign debt crisis, is getting more dangerous, while the inept policymakers run out of options.
Jittery investors are seeking out safe havens. Uncertainty is not only affecting job prospects, but also investors’ choices, and safety seems to be the name of the game. Gold reached a new high at $1,700/ounce as the traditional favourite mopped up proceeds from equity sales. But Japan and Switzerland also saw capital inflows which threaten their competitiveness. Both took action. The Japanese intervened in the markets and announced an expansion of their asset-purchase program. The Swiss cut rates to almost zero and injected liquidity. With conditions still so uncertain, it’s not clear that this will be enough though.
The US continues to struggle but labour market news is better (mostly part-time jobs). Surveys are giving clear signs that confidence in general has slipped significantly in the US. But better news on the US labour market may help. Payrolls rose by 117k in July and June's terrible number was revised up by 28K as well. These increases, together with a fall in participation, were enough to bring the unemployment rate down by 0.1% to 9.1%. It remains to be seen whether this will be enough to reassure businesses of the economy's future prospects, especially after the downgrade. But jittery markets make a swift bounce back unlikely.
The `Big Crisis` in the Eurozone – What it means for the UK
Last week politicians in Washington concluded an agreement to raise the US debt ceiling to $14.3trn (£8.8trn) to prevent the `world’s largest economy` from defaulting on its debt repayments. This weekend the Eurozone, the `world’s second largest economy`, faced a similar situation; with fears that the crisis that had seen the bailout of smaller peripheral states such as Ireland, Portugal and Greece, risked spreading to the larger economies of Italy and Spain and in the future others!
The fear of the slowdown of two of the world’s largest economies saw a dramatic sell off of shares across the world, as investors sought to limit the damage, wiping £3.5trn off stock markets worldwide.
What prompted concern in Europe were suggestions that current yields for both Italy and Spain are not substantial enough to fund their current rate of borrowing, suggesting that both nations may soon request a bail out from the European Central Bank or risk defaulting. Present talks continue with Spain and Italy this week to `iron` out an agreement for both countries.
I do not believe we are at the stage where Italy and Spain will default on their loan repayments (but wait and see the out-come of talks this week) also, there is the potential that this will push both countries and other Eurozone economies back into recession. Germany, the richest country in the Eurozone, has the lowest levels of debt; is growing ever more reluctant to continue to write cheques for member countries that lack the fiscal discipline and political will to implement tough austerity measures. Added to this is the weakness of the Berlusconi Government that risks collapsing this month, if the ‘fast paced’ austerity measures that will soon be voted on, fail to go in its favour.
European leaders such as Germany’s Angela Merkel and President Sarkozy of France have interrupted their holidays to discuss the crisis. David Cameron, himself still on holiday, has telephoned the Governor of the Bank of England and Chancellor Merkel. Ollie Rehn, EU Commission for Economic and Monetary Affairs as well as Jose Barroso, the President of the European Commission, both have called for an increase in the European Financial Stability Facility EFSF at the same time appealing for calm. This mixture of a need for calm and lack of urgency from the Eurozone leaders and influencers is doing nothing to allay investors’ fears. This week will see another stampede on the stock markets globally!
The UK although not in the Euro is still at high risk, with the threat of contagion to its banking system. The knock on effects could be huge, as when investors lose confidence in a nation’s ability to repay its debt; this in turn has implications on those nation’s banks. Given the interconnected nature of banking, the exposure of the UK banks is very high.
Investor confidence in the UK is relatively high given the circumstances, but that is due to UK banks’ lending more and UK companies exporting more (at present). But, if UK banks cannot access finance, then they cannot lend to business, if business cannot access finance, then the very fragile UK economy could slow down further. This also slows job creation and leading to even slower growth. This, together with the lack of public sector spending, further dampens economic activity; that could lead to a fall in investor confidence in the UK. Watch this space!
The potential of a fall in the value of the Euro and Dollar against the pound would see the cost of UK exports rise at a time when costs of living in Eurozone and US are rising, and job creation has stagnated. This fall in revenue for the UK economy could leave the Government no choice but to increase corporation tax, further damaging the recovery.
The Bank of England will publish its growth forecasts on the 10 August 2011, and it is predicted they will be lower than the 1.75% forecast, with the CBI suggesting growth figures could be around 1.3% ( I believe they are less than 1%). This is due to the UK’s largest trade partners the US and EU engulfed by trouble. UK trade with Europe is 40%, therefore we need Europe to be strong otherwise we will be back in recession (depression).
These low UK growth forecasts are only further confirmed by news from America that the short lived boost in confidence over 117,000 new jobs being created in the last quarter, has been offset by fears that austerity measures agreed would slow down growth. On Friday, Standards & Poor’s, the credit rating agency downgraded America’s premium AAA+ credit rating to AA+, citing that political initiative on debt reduction did not go far enough, suggesting that tax rises were needed along with adjustments to Medicare. Something both the Republicans and Democrats resisted.
The S&P report was direct at laying the source of investor unease at the nation’s politicians saying; "the political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed."
With two the UKs biggest trading blocs’ grinding to a halt the need for a political solution is critical. The markets have demonstrated that investors have lost confidence in the ability of our politicians to stay ahead of the markets. The political inability to compromise and protracted dealings are damaging, whether it was the negotiations over the US debt ceiling or the inadequate fudging to Eurozone debt that we have seen in Greece and now witnessing.
Investors have seen that both EU and American politicians fudging the problem; throwing good money after bad is not the solution. The announcement that the ECB would buy Italian Government bonds was slow in coming, only highlighting the indecision in that organisation and suggestions that Germany is no longer willing to continue to bankroll such economic ineptitude of other members. If this is the case we could see a breakup of the Eurozone, with those countries that haven’t played by the rules expelled, and made to tough it out on their own. In the States the only comment from the Obama administration is over the debt ceiling and comments that it will ‘push back’ on the S&P rating.
The UK Government has announced it is monitoring the threat of contagion from US and EU banks, in an attempt to maintain investor confidence, allowing banks to continue lending to businesses. But now is the time for a strong Europe, not a divided one.
In terms of a silver bullet there is none. But what is needed is a clear consensus and plan across the whole of the Eurozone and US is needed. The calling of a G7 meeting to discuss the crisis is a positive, but politicians need to get back to their desks and postpone their holidays otherwise investors will continue to bulk. Yes, that means you Mr Cameron.
The causes of the credit crisis in a short, engaging video: click on the link below;
The Crisis of Credit Visualized:
The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.
More to come.
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AAA Ratings in the USA and UK Violence