LAST WEEK

1. Revived EU Sovereign Debt/Banking Crisis Concerns

1. Data Showing Combined US and China Growth Slowdown Threaten To Drag Global Recovery

• US: FOMC Stimulus Decision, Weekly New Unemployment Claims Report, Retails Sales Data Show Stagnant US Recovery

• China: Shows Slowing Imports, Industrial Production

COMING WEEK

1. Monday ECB Announces Amounts Given To Irish Banks Last Week

1. Tuesday Irish Bond Auction

1. Bank of Japan Intervention Threats May Bring Yen Pullback

1. Key Economic Calendar Events

——

LAST WEEK

The big theme: The potential for market rallies remains limited and the long term downtrend remains in effect as long as the EU sovereign debt/banking crisis remains unresolved.

Revived Sovereign Debt/Banking Crisis Concerns

Going into the week, it looked like the FOMC statement would be the big event of the week, and it indeed was significant. Markets dipped Monday after the FOMC’s downgrade of the US economic outlook and mostly symbolic new stimulus.

However, the big plunge came Wednesday, after Ireland was forced to inject more capital into its banks (all of which had passed the EU’s loose stress tests), further bloating Ireland’s debt, and rumors circulated that the ECB was buying Irish bonds to keep it’s yields (and those of other weak EZ members) from soaring in the panic that was likely to follow.

As we had warned after the EU bank stress tests, NOTHING has fundamentally changed for the better in the EU. Markets have calmed largely because the weaker nations were able to find buyers for their bonds, though we have questioned whether this was genuine private demand or mere central bank buying in order to paint a soothing picture in the hope that private buyers could be lured in. That indeed may have been the case with Ireland.

All it takes is some kind of unexpected setback to the EU’s stability to send markets plunging. Likely catalysts include:

• a bad sovereign bond auction
• an unexpected new need for capital injection (aka bailout) of a major bank
• a sudden spiking sovereign or bank bond yields
• some other evidence that a major bank or any EZ member faces a liquidity crisis
• seriously contracting growth that threatens to push an EZ member closer to default

We got plenty of these last week. In addition to the above Irish troubles, highlights included:

• Spiking Irish Government Bond Yields: On Thursday, Ireland sold €1 billion in six- and eight-month treasury bills, paying 2.458% on the six-month note, a whopping 79% increase from the 1.367% yield it paid just three weeks ago on the same maturity. The yield on the 10-year bond rose to 5.367%, 2.94 percentage points higher than the relative German bund and up almost half a percentage point – a nearly 10% increase- from one week ago.

• Soaring Irish Bank Debt Insurance Rates (CDSs):The banks receiving the aid all saw their borrowing rates spike

Via the Wall Street Journal 01aug15

• Uncertainty On Irish Bank Bond Guarantees: Fueling the rate increase is the coming expiration in late September of Irish government guarantees on bank debts. If the guarantee is not renewed, or extended under less generous terms, some Irish banks, especially the troubled Anglo Irish Bank, are likely to have trouble refinancing their debts.

• Slovakia Refuses To Pay EU Rescue Dues: The Slovak parliament rejected participating in the Greek EU aid package. Its contribution was not significant, and no punitive measures have been announced. However, the move highlights the unenforceable and fragile nature of EZ unity.

• Southern EU Banks Depend More On the ECB: Per data released Thursday by central banks, banks in southern Europe have increased their reliance on the European Central Bank as a source of funds. Greek banks increased their borrowings in July by about 2.5% from June, Portuguese banks by about 21% and Italian banks by12%.

• Weak Italian Bond Auction: Friday’s Italian bond auction attracted bids worth only 1.27 times the amount offered with a yield of 4.36%.

• Deteriorating Spanish Regional Debt: Reports that Spanish regional government borrowing costs derailing Spain’s drive to clean up its budget and drive down its credit costs. These regional governments control around twice as much spending as the state, employ more than half of all public workers. While yields on Spanish Government bonds have come down, many regional bodies cannot sell bonds at all, or only at unsustainably high rates. While legally Spain cannot bail out its regional governments, many expect it to do so if need arose. That would worsen Spain’s deficit and force markets to consider the likelihood of other regional government bailouts and deepening Spanish deficits.

• Weak economic data from the peripheral countries: Greece Q2 GDP fell -1.5% from the prior -0.8%, Spanish Q2 GDP at +0.2% q/q missed expectations of a +0.3% gain, raising concerns that Spain can meet growth targets needed to reduce debt as a percentage of GDP. Hungary too reported stagnant GDP, and remains highly dependent on its exports to the core economies.

• Divergent Performance Raises Doubts About EZ’s Durability: Divergent performance between core and peripheral EZ economies raise doubts about whether the monetary union can survive in its current form, given the difficulties confronting it in forging a one-size-fits-all monetary policy that some members may ultimately find too ill-fitting. Solid 2Q GDP in Germany and France contrasted with weaker Greek and Spanish 2Q GDP readings, and served to remind markets that slower growth exacerbates budget deficits and increases debt service burdens, leading to a self-feeding cycle of slower growth and growing national debt. That’s significant, because Southern EZ consumer spending nearly matches that of Germany. Thus trouble in these economies threatens to cancel out the net benefit of German growth for the EU.

Data Showing Combined US and China Growth Slowdown Threaten To Drag Global Recovery

Meanwhile, export markets for the EU’s core economies showed signs of shrinking.

US: FOMC Stimulus Decision, Weekly New Unemployment Claims Report, Retails Sales Data Show Stagnant US Recovery

Fed policymakers decided to keep constant the Fed’s holdings of securities at their current level (at $2.05 trillion) by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities (2-year to 10-year bonds). The Fed’s downgrade combined with disappointing economic indicators released during the week were what worried investors the most

On Friday, US CPI rose +0.3% m/m in July (consensus: +0.2%) after contracting -0.1% in the prior month. However, core reading eased to +0.1% during the month from +0.2% in June. The set of data indicates deflationary fears remained. Fear of deflation is the likely driver behind the Fed’s latest stimulus move.

Retail sales just missed forecast with a 0.4% (vs. 0.5%), however the details were worse than the headline figure, which was inflated gas station sales (+ 2.3%) and autos sales (+1.6%). Most of the other discretionary spending numbers contracted.

For example, consumers cut back spending on clothing, food, beverages and electronics.  Sales excluding auto purchases and gas station receipts fell 0.1 %. 

With a weak labor market, retailers have had to lure in shoppers with deep discounts and promotions.  The need to discount to move inventory explains why consumer price growth has been extremely muted.

China: Slowing Imports, Industrial Production, Money Supply, And Lending

In China, deceleration in import growth and a soft set of July economic data weighed down the market further. Export growth slowed to +38.1% y/y in July from +43.9% y/y in the prior month while import growth decelerated to +22.7% y/y from +34.1% y/yin June.

A separate report showed that China’s industrial production expanded +13.4% y/y in July, down from +13.7% growth a month ago. This is the 5th monthly slowdown for IP and the further weakness is expected in coming months given soft readings in PMI.

Money growth and lending also slowed while fixed asset investment eased to +22.3% y/y in July from +24.9% in June. Disappointment from these areas upstaged headline CPI reading which soared +3.3% y/y in July from +2.9% y/y in June.

US is the world’s largest economy while China has been the growth engine in recent years. Simultaneous slowing in both threatens the fragile world recovery, especially in the volatile EZ, which depends on its export economies to carry the weaker members.

COMING WEEK

Monday ECB Announces Amounts Given To Irish Banks Last Week

There have been as yet unconfirmed reports that the ECB bought Irish government bonds this past week in an attempt to sooth nervous markets anxious about Irish banks. On Monday, the ECB will announce the amount of bonds it bought this week.

Tuesday Irish Bond Auction

Given that concerns about Irish debt were arguably the prime (though far from exclusive) cause of the market plunge Wednesday, the Irish bond auction to be held on Tuesday could be a critical event for fueling or halting the current slide.  The Irish central bank may intervene and buy bonds to fill in for any weakness in demand. That would avoid a failed auction, though markets would not be fooled and would likely go lower, with the EUR likely to drop further.

Monday Japan Q2 GDP: Bank of Japan Intervention Threats May Bring Yen Pullback

Already the strongest performer of 2010, the JPY hit multi-year highs against the USD at 84.70 in the flight to safety panic mid-week, before pulling back on Japanese intervention threats. Up to now few have taken these seriously given the low chance of sustained results and US opposition. However the harm to Japanese export profits and stocks is becoming too much for Japan to ignore. If it can get some selling going and get the USDJPY above 86.50 that might start a rally in the pair.  Watch Monday morning’s Q2 GDP. If weak enough it could provide the spark for selling the JPY.

Key Economic Calendar Events

The coming week is potentially a classic slow summer week. Many traders are on vacation, and the calendar is comprised of mostly second tier data. In the US, there’s the Empire State and Philadelphia Fed manufacturing surveys, the Treasury International Capital flow report, Housing Starts, Building Permits, Producer Prices, Industrial Production and Leading Indicators. None of these reports are important enough to really change the current picture. Apart from some U.K. data, no major economic reports are expected from other G20 nations. The real risk is of more exogenous aftershocks from the EU following last week’s events. Potentially the biggest event is Tuesday’s Irish bond sale. Given the stakes, concerned parties are likely to ensure all goes smoothly. The question is whether markets will be convinced.

We’ll know by watching PIIGS bond and CDS rates, as well as EU interbank lending.

Here’s a summary of the key calendar events.

US

Monday: August Empire Manufacturing Survey and June TIC.

Tuesday: July PPI, July Housing Starts, Building Permits, Industrial Production, and Capacity Utilization. Thursday: Initial Jobless Claims, August Philly Fed, and July Leading Indicators.

Euro-zone

Monday: July EZ CPI

Tuesday:  August ZEW Survey of Economic Sentiment. Potentially most important, considering the recent 17 month highs in credit default swaps on Irish sovereign debt, the €1.5 bln Irish government bond auction. As noted above markets will be watching carefully for signs of deterioration or improvement in demand for lower quality sovereign EU debt.

Wednesday: June Euro-zone Construction Output for June, German Producer Prices

UK

Tuesday: July CPI, Retail Sales, RPI

Wednesday: Bank of England Minutes and

Thursday: July Retail Sales

Japan

Monday: Q2 GDP and June Tertiary Industry Index

Thursday: June All Industry Activity Index

Friday:  July Machine Tool Orders. Also, recent yen strength combined with aggressive rhetoric from Japanese central bankers increases the risk of BOJ intervention

Switzerland

Thursday: Trade Balance, ZEW Economic Expectations

Canada

Tuesday: June Manufacturing Sales

Thursday: July Leading Indicators, June Wholesale Sales

Friday: July CPI on Friday

Australia

Monday: RBA’s August Minutes

Tuesday: June Westpac Leading Index and August DEWR Skilled Vacancies

New Zealand

Wednesday: Q2 Producer Prices-Outputs, Inputs

Thursday: July Credit Card Spending on Thursday

China

Monday: Conference Board of China June Leading Economic Index

Disclosure: No Positions

Cliff Wachtel

Cliff Wachtel, Chief Analyst, AVAFX