SCOREBOARD: Tempered Europe

Notionally there should be little to disturb abating European concerns this week, though you never can forecast what politicians will say.

Friday’s session was pretty good and it looks like the same themes that have been guiding markets for the last week or two were in operation again, there was no disturbance. This we know to be an abatement of European concerns and, across the pond, it doesn’t look like the US is ‘stalling’.

To give you a bit of a taste as to how it’s all played out for the week, Spanish and Italian bond yields were lower again – the Spanish 10-year down about 7 bps to 6.44 per cent (-45 bps for the week), while the Italian 10-year was little changed for the session (down 12 bps for the week). Impressive in a week where the US 10-year yield rose almost 20 bps to 1.82 per cent.

Moreover, in the equities space, stocks were up modestly with the S&P500 up 0.2 per cent and 0.9 per cent for the week (and within reach of a four year high), while the Dax rose 1.5 per cent for the week. I won’t go through all of the price action but suffice to say that investors appears to be cautiously optimistic. Crude was about $4 higher for the week ($96.01) and even good ol’ Dr copper managed to finish the week higher – if only just 0.8 per cent.

So far so good, but we’ve learnt that it doesn’t take much to change things and in that regard there are quite a few question marks over the subdued VIX action. It’s at a five-year low, which probably doesn’t reflect the true state of things, but there you go.

That’s not to say that I think the magnitude of worry is valid. I’ve been consistent in highlighting for some years now that the extent or the magnitude of fear is completely out of whack with the probability of any of those fear-events occurring (stall speed US growth and eurozone implosion and the like). It’s just that so much is arbitrary. Global economic data by and large remains pretty good despite the repeated claims made by doomsayers who have been perpetually wrong. Growth is at and expected to remain at trend, notwithstanding the downturn in the eurozone, which is turning out to be modest in any case. Similarly growth in the US is only just below capacity, which compares very favourably to past recoveries and while some sentiment indicators have slumped, the hard data remains quite robust. It’s only the political antics in Europe which shake things – and that can change on a whim.

Notionally there doesn’t look like there will be much to change this mood over the week. Although you can never forecast what European politicians will say. In that regard we have the Greek PM meeting with the eurogroup president and the German Chancellor this week so watch out for that. So far they are all singing the same tune. No Grexit, and Europe will do whatever it takes. I believe them and as I highlighted some years ago, Europe isn’t and never was about being an optimal currency area. It’s about political union – about peace.

As I motioned in 2009 or maybe 2010, Europe has spent more on war than any bailout you could possibly muster. The sums are vast and the costs associated with ensuring the union – and the peace – pale in significance. Again, and apart from some banks who want the forex revenues that a European break-up would bring and some die hard euro sceptics in Britain, I don’t really know anyone who sensibly thinks it’s a good idea.

Any way my broader point was that there is a very good chance it will remain quiet this week, especially as there isn’t much in the way of hard-hitting tier one data out.

For the US for instance, we see existing home sales data on Wednesday night and then the FOMC minutes Thursday morning. Other than that (and in addition to the usual weekly indicators like jobless claims etc) we get new home loans Thursday night and durable goods Friday night.

For Europe we get the breakdown of German GDP on Thursday and then the European PMI’s (for August) on the dame day. Some other data points worth watching are the UK GDP revisions on Friday and the ‘flash‘ Chinese manufacturing PMI Thursday. The latter data point actually isn’t very useful but for some reason gets media attention.

Domestically of course there are a few things, mainly some of the big ASX companies that are reporting – BHP Billiton, Woolowrths – but not much in the way of data. Most of the economic interest will come from the RBA’s minutes on Tuesday and then the RBA governor’s appearance before the House of Reps Economics Committee.

Now in terms of the RBA's minutes and the governor’s testimony I don’t think there is much more to learn. On the policy front have come full circle. In truth, the last nine to 12 months have been disgraceful in terms of the very low quality of economic debate.

Much of the public discussion was focussed on economic weakness despite the balance of credible evidence showing this wasn’t the case. I was pretty much alone in highlighting to readers why this was false and it’s only just recently that the broader economic discussion has been realigned to the facts. For the RBA then this probably a period of recalibration. We know the Bank has revised up the growth and inflation outlook, as they should, and they have signalled they are on hold. Interest rates should be, in my view, 75 bps to 100 bps higher now and no case can be made that this stance would harm the economy with rates so low and with growth at its fastest in four to five years.

I can’t forecast rate hikes though. It’s impossible with the board being so erratic. I mean with growth so strong and the unemployment rate so low they clearly should not have cut rates, but they chose to think that domestic demand was weak. It was a mistake but one they won’t rectify. That fact doesn’t leave me with confidence. They can read the economic signals clearly and that makes it virtually impossible to forecast how they will act. If inflation picks up, and it could do so rapidly, will they dismiss it as temporary? I suspect so, if only because of the political and industry pressure to do so.

Not much else otherwise, so have a great week…

Adam Carr is a leading market economist. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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