IMF Warning runs Counter to Data Releases

Economic news was mixed through the week, with the positives in Europe and the US overshadowed by a damning forecast from the IMF.

Firstly to Europe, where the EU was awarded the Nobel Peace Prize for its work to contain the Eurozone debt crisis. Further positive news came when industrial activity numbers showed a second consecutive month of growth. Though output was 2.9% below the level seen at the same time last year, countries where the economy has been weakening markedly saw a bounce, with August output expanding by 1.5% over July in France and Spain, 1.7% in Italy, and a whopping 6.8% in Portugal. However, Germany’s industrial output fell by 0.4%.

On the debt front, Greece failed to agree terms with its creditors and Standard & Poors downgraded Spanish government debt to one notch above junk grade. The market expects the move will force Spain to request a bailout, which in turn will trigger buying of its bonds by the ECB, under the new unlimited bond buying program. Because of this, Spanish 10-year bonds actually saw support and the yield eased back slightly. In the United States, consumer confidence rose to the highest level since 2007, home sales improved again, and foreclosure filing numbers in California collapsed to a near 6 year low.

Perhaps the best news of all came with the release of the jobless claims numbers, which showed a fall of 30,000 to 365,000 for the week ending October 6.

Meanwhile, flying in the face of all this positive news, the IMF cut its global growth forecasts for this year and next, and warned of a greater downside risk. Its forecast for 2012 is now 3.3%, and for 2013 just 3.6%. It stressed that it sees ‘an alarmingly high’ risk of a far worse slowdown, and a near 20% chance of sub 2% growth this year and next. Within these figures is a dark forecast for the Eurozone: a contraction of 0.4% this year and a bounce of only 0.2% next. It also sees growth in the US throughout the period of no more than a shade above 2%.

Over the week, the Dow Jones Industrial Index fell by 2.1% to close at 13,328.85, and the S&P drooped by 2.2% to 1428.59. The Nasdaq 100 was worst hit, falling 3.2% to 2720.14, as Apple and Facebook moved lower. In the UK, the FTSE 100 Index dropped 1.3% to stand at 5793.32.

Trading View

With demonstrations against austerity measures forced by the EU in countries such as Greece and Spain in recent weeks, some of which have turned violent, and calls for autonomy from national governments and the EU itself, it seems an inopportune moment for the EU to receive the Nobel Peace Prize. But, then, I’ve felt for a while now that the Nobel Peace Prize is a waste of time.

I have to question the growth in industrial production seen in the weakest of the Eurozone countries. Is this the beginning of a sustainable rally, or a blip in the downward lurch? We mustn’t forget that most of the austerity measures already announced don’t kick in until next year, and then the following 12 months. A ‘dead cat bounce’ is a phrase that springs to mind, particularly with Europe’s largest economy now seeing industrial contraction.

As for Standard & Poors’ downgrade of Spanish Government debt: the market reaction says all it needs to. The market expects Spain to request a bailout, and this will pave the way for buying of its debt by the ECB. Traders are positioning themselves ahead of this, buying bonds now to offload to the mug punter who comes in at the wrong level later. This mug punter, however, is the muggest of the lot: it has already said that this is exactly what it will do. Banks buy the bonds now, with money that they mostly received from the ECB and the EU to bail them out, then they wait for the Spanish bailout and the buying of bonds by the ECB to begin. They then sell the bonds to the ECB, banking a healthy profit. The ECB then gives the banks a better than average interest rate on the cash they deposit with it as part of the ‘bond sterilization program’ that goes hand in hand with its bond buying program.

Net effect? No extra cash is pumped into the economy to help it grow, the Spanish tax payer will be landed with a debt bill stretching beyond the horizon of time, Spain’s government will be forced to accede to further and deeper control by central Europe, but at least the banks will be making a bigger profit.

As for Greece’s situation: we’ve been here before. The country is a basket case, and Mother Europe will take it home from its latest shopping spree. It can’t do otherwise.

The big worry looking forward must be the way the market is beginning to accept high levels of debt as the norm. This sentiment may be good for investors in the short term, but the fall will be harder and faster when it comes.