Morning Note: USA is MIA this week

Posted on September 4, 2012 by Linda Nazareth

It is about Europe this week – yes again – or then again maybe it won’t be. Here’s where we are: the situation as regards Greece is not getting any better, and there is a realistic chance that, everybody’s efforts (and money) notwithstanding, they are going to exit from the Eurozone. So yes, it is a tricky time for European markets, which is to say global ones too.

Click here to download: Morning Note, September 4th, 2012

[quote float=”right”]The Big Picture:

Worrying About Europe, Worry About China, No Worries in Australia (sort of)
On tap today: U.S. ISM Index, Quebec Election
Mr. Bernanke to the Rescue – Why Exactly?
Bank of Canada Preview

[/quote]
So Far This Morning:

Nevertheless, everyone is pretty cheerful this morning and the euro is trading at about a two month high vs. the U.S. dollar (around $1.2611 as of 5:30 ET). That’s because ECB Head Mario Draghi yesterday said that he would be okay with the idea of buying three year bonds from countries like Italy and Spain. The idea would be to create demand, push down the yields on the bonds, and keeping a crisis at bay (subject to a bunch of conditions, obviously). Mr. Draghi’s comments prompted a rally in Europe yesterday, although markets have come down this morning.

All will be revealed on Thursday, when the ECB makes their scheduled rate announcement. An interest rate cut (the ECB rate is now at 0.75 percent, so there is room for it) is not out of the question, but more likely we will just get some details on the bond buying plan. Markets are getting so hopeful about the

whole thing that unless Mr. Draghi really has something exciting to say there may be some disappointment. Today’s Purchasing Managers’ Index readings from Europe are may prompt Mr. Draghi to action. Markit’s final PMI reading for August is 45 – solidly below the ‘50’ that is generally accepted to signal that Europe’s manufacturing sector is expanding.

China’s Purchasing Managers Index was out yesterday and at 49.2 it too showed a contraction in manufacturing. That is raising hopes that China is going to doing something to stimulate the economy, but it might not happen immediately. The last batch of data on China has definitely shown a deterioration (to put it nicely) and China has responded by cuts to the bank reserve ratio, the last one happening two months ago. Thing is, the excesses in the property market in China (and around the world for that matter) are still fresh in everyone’s minds, so rapidly declining rates may actually do more harm than good – or at least that seems to be the thinking in Beijing.

And finally some cheerful news: the Reserve Bank of Australia has decided to leave its benchmark rate on hold, citing decent domestic economic growth in th face of the negative vibes coming from China (okay they did not put it exactly like that, but that’s what they meant) . Australia’s economy looked pretty shaky earlier this year, and the RBA responded by chopping 75 basis points off the benchmark rate, taking it to 3.75 percent. Still another cut may be in store, maybe even next month, given that lower commodity prices might slow the economy a bit much.

Coming Up Today: United States

All of the sweetness and light coming from Europe is nice, but if today’s U.S. data disappoints, the markets are going to react, probably (although not necessarily) badly.

U.S. ISM Index of Manufacturing
Released by Institute for Supply Management, 10:00 ET Market expectation: 50.0 for August (following 49.8 in July)

The ISM Index has been a top-tier market indicator for a long time – and it is even more important right now. That’s because in July it dipped just a nudge below the all-important 50 mark, to 49.8. Anything below 50 signal ‘recession’ in manufacturing.

This time around the market are looking for a ‘50’ dead on for the ISM. The indicators from regional surveys – from New York, Philadelphia and Chicago – have all shown contraction though, so the national figure could disappoint. If the number does come in above 50 could signal a small relief rally (or maybe a large one). Below 50 who knows – maybe a sell-off, or maybe not since it may bring the Fed one step closer to yet another round of bond purchases.

U.S. Construction Spending To be released at 10:00 ET

Market expectation: +0.4% for June (May was -0.3%)

The other number coming out today is U.S. construction spending. This one never really captures the imagination of the markets – with a three month lag, it really is just not timely enough. Still it adds to the overall picture on economic health and may well be an offset to a disappointing ISM reading.

Democratic Convention starts in Charlotte, North Carolina

The other thing to watch today (and this week) is the democratic convention which kicks off in Charlotte, North Carolina. The Republicans seem to be going with a theme of ‘are you better off than you were four years ago?’ (sadly no, would be the answer from a lot of Americans). The Democrats are going to have to counter with ‘How bad would things have been if we hadn’t shown up four years ago?’, which may be a harder argument to make. Let’s see if the polls change one way or another by week’s end.

Coming Up Today: Canada

Quebec Election

There is no economic data coming out of Canada today, but it is election day in Quebec. As of this morning it is still anyone’s game to win, but there is a reasonable chance that Pauline Marois’s Parti Quebecois (the sovereignist party) could end up forming a minority, or even a majority government. In the old days, that would have prompted much hand- wringing and bond selling over the prospect of a quick referendum on independence, but that is really not the case this time.

Even if Ms. Marois does form a majority, it is very unlikely that there is going to be a ton of drama in the markets, although we could certainly see a short-term dip in the Canadian dollar or a bit of reaction in the bond market.

Bernanke to the Rescue – Why Exactly?

As I watched the reaction to Ben Bernanke’s speech at Jackson Hole last week, I got uncomfortable memories of the days of the ‘Greenspan Put’. That was the time, way back a decade or a decade or two ago, when former Fed Chairman Alan Greenspan could reliably be expected to step in, cut rates, and make sure that the markets kept going up. Current Fed Chairman Ben Bernanke is not trying to save the markets however (and Mr. Greenspan really was not either): he is trying to stop the U.S. economy from stagnating or worse yet, falling into another recession. Mr. Bernanke cannot rely on rate cuts however (what with the benchmark Fed Funds rate already at zero and all) so his weapon of choice is bond purchases.

Mr. Bernanke sounded pretty downbeat about the U.S. economy at Jackson Hole, basically admitting he was disappointed in the frustratingly slow pace of the U.S. recovery (‘the daunting economic challenges that confront our nation’) and in particular about the fact that the unemployment rate in the U.S. remains above 8 percent. (the stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entail, but also because persistently high unemployment will wreck structural damage on our economy that would last for years’). Translation: yes, okay, we’ll buy some more bonds.

Like some of the Fed’s members, I am not entirely sure that another round of quantitative easing is going to do that much, so it does seem that the Fed is capitulating to what the markets want. If you look back at the transcripts from the minutes of the past several Federal Open Market Committee meetings, you can see a bit of everything – members who think there is already too much stimulus out there, members who think the Fed cannot fix anything with policy, members who think the Fed needs to do more, and quickly.

The next Federal Open Market Committee announcement will be in a couple of weeks, on September 13th. Best bet now seems to be the Fed goes with some kind of ‘don’t pin us down’ bond purchasing plan where they buy bonds until they do not feel like they need to anymore. There is also a bit of a buzz over a possible cut to the 0.25 percent rate that the Fed pays on money that banks deposit with them. If the Fed moves that into the negative range (that is, forces banks to pay them if they want to deposit the money) then you would have an incentive for the banks to just lend out the money instead. Either or both measures could be announced at the meeting.

Getting back to Mr. Bernanke, thought, I can hear genuine distress over the labor situation – in this speech, and in previous ones. Let’s remember that this guy is a scholar on the Great Depression and his nightmares probably center around a return to double- digit unemployment. The markets may think he is giving them a break, but his actions – this month or in

months to come – are really going to be more about the unemployment rate.

Waiting for the Bank of Canada

Finally, it is Bank of Canada week – tomorrow Canada’s central bank will make a call on whether it will adjust the benchmark interest rate, which currently sits at 1 percent. Actually there is no suspense at all over the whole thing – no one expects the Bank of change the rate- but the language on the statement will be crucial for the direction of the Canadian dollar. Rates may be on hold for now, but there seems to be no consensus as to where they will be in a year or so. More on that tomorrow.

Linda Nazareth
linda@relentlesseconomics.com