Largely immune from the economic and financial tribulations which beset most of Europe and parts of Asia during the first half of this year, it now turns out that America is in trouble as well. Yesterday’s manufacturing ISM for June was a warning sign that all is not well across the pond. Particularly worrying was the collapse in new orders, which plummeted from 60.1 in May to a 3yr low of 47.8 last month, and new export orders, now below 48 for the first time in more than three years. The backlog of orders fell once again, inventories are low, production fell sharply, and the overall index was under 50 which in the past usually presages a recession. Obviously, the trials and tribulations of Europe and Asia/China have resulted in increased hesitation on the part of US manufacturers. This ISM outcome implies more QE from the Fed, spells trouble for President Obama and will divert some safe-haven demand away from the dollar.
A slippery euro slope. In many respects it was no surprise to see the single currency slip back below 1.26 yesterday. Firstly, the Finns and the Dutch scuppered much of Friday’s summitry feel-good by declaring that they were opposed to bond-buying by the rescue funds. As we suggest below, the bond-buying proposal is unlikely to be the panacea for resolving Europe’s sovereign debt crisis. Secondly, the report from the French National Audit Court was a reminder of the significant fiscal pressures being faced by Europe generally and France specifically (see below). Thirdly, the euroland unemployment and PMI data was poor, even though it was expected. Finally, the Lie-bor scandal involving more than USD 500 trln of derivatives continues to weigh like an anchor over financial markets, especially in London.
Bond-buying. While last week’s EU Summit statement was clear on some matters, it was vague on others. The ability (or otherwise) of the European Stability Mechanism (ESM) to buy bonds of sovereign nations in the secondary market has long been an issue of discussion. The impression given at the summit was that leaders were moving towards an agreement on this, but both the Netherlands and Finland yesterday come out and stated that they are opposed to the secondary buying of bonds. The situation with respect to bond-buying needs to be clarified however because currently we are experiencing something of a hiatus. The ECB’s bond-buying program effectively has been shelved, with no purchases of any significance undertaken since February of this year. This is despite the fact that yields in Spain (for example) have risen some 100-150bp higher since this time with no reaction from the ECB, which maintains that the program remains active still. But, whilst at one point the ECB’s intervention was seen as a positive, the issue of seniority has now taken over with private sector investors increasingly fearful of being crowded out by the ever growing pool of official debt-holders (ECB, IMF and EU). So, whilst it was agreed that the debt incurred for recapitalising Spanish banks would rank at the same level as existing government debt (even when transferred to the ESM), this would not be the case for secondary market-purchases by the ESM. Of course, tying up the resources of the ESM in bond purchases naturally leaves less firepower available for other capital injections should they be needed and the resources of the ESM are already looking depleted in relation to both Spain and Italy. In its current form, secondary market ESM purchases are likely to be a weak weapon against the wider solvency risks.
The limits of sterling as a safe haven. There was a decidedly muted reaction from sterling to the rebound in the manufacturing PMI data for June. The fall in the May number was one of the largest monthly declines seen on record, only surpassed by that seen in the depths of the global liquidity crunch back in November 2008. The rebound to 48.6 means that nearly two thirds of the precipitous May decline was reversed in the June data. The underlying components suggested export demand remained in negative territory for the third consecutive month although by a smaller margin than the prior two months. The muted reaction of the currency reflects the fact that the market has already discounted further quantitative easing from the Bank of England at this week’s meeting. It’s also the case that, with the ECB likely to offer some concessions on policy this week, we are still in a QE arms race of which the currency winners and losers are becoming less defined as central banks gain even more monetary weaponry. For its part, EUR/GBP wants to break below the 0.8000 level, and has tried to do so on three occasions over the past couple of months, but it’s proving to be a tough sell and the longer-term charts tend to show why this is the case, with the same level proving to be strong resistance for the pair back in the first half of 2008. Given the weaker economy and prospect of further QE, there’s a case for saying that the safety/diversification premium afforded to sterling by the euro’s troubles has a limit against which GBP is pushing.
French fiscal pickle. The single currency was not helped by a report from the National Audit Court yesterday, which claimed that the French government needed to make an extra EUR 6-10 bn of budget savings in order to achieve their fiscal deficit target of 4.4% of GDP for this year. The president of the Court claimed that the major issue has been over-optimistic revenue assumptions, with weaker growth resulting in more subdued corporate tax receipts and VAT proceeds.