3 Numbers To Watch: German PPI, EU Roundtable, Spanish Housing

A quiet day in terms of data: the German producer price index is the day’s main data release, but should not present any market-moving surprises. The G20 summit of finance ministers and central bank governors begins today and while a generic statement is to expected, all the major central banks have already announced their policies, so no market impact should be expected. Japan’s upper house elections on Sunday can push participants to close positions ahead of the weekend. Next week sees the release of the July flash PMI indices for Europe and US and the German IFO indices, so quiet summer trading today is probable.

Because of the less important data releases of the day, I will focus on two Spain-related events: Spain’s attempts to increase the size of the European Stability Mechanism (ESM) and the ongoing housing crisis.

German June Produce Price Index (06:00 GMT): The consensus forecast expects an increase of 0.6 percent in June after May’s modest rise of 0.2 percent. The rate of change of the producer price index has been trending down for the past couple of years and in April and May has flirted with the zero level. This is a reflection of low growth, low demand and the fact that most economies in the world are running way below their potential output. Unless consumer demand in Germany increases there is only limited room for prices to increase: in practice labour shortages leading to wage increases would have to be seen in Germany first.

Future of Europe Roundtable: European foreign ministers will meet in a high-level roundtable meeting on the future of Europe, organized by Germany, and Spain has announced earlier that it will push for a removal of the size cap of the European Stability Mechanism (ESM). While several other countries have also supported an increase, Germany has opposed such ideas. The German Supreme Court has previously stated that Germany’s participation in the ESM is constitutionally legal as long as it is limited in size. The court’s decision on the European Central Bank’s (ECB) Outright Monetary Transactions-programme is expected soon, and the German elections are very close. With this background, an adamant “no” from Germany is expected.

Spain’s Housing Bust: Earlier this week it emerged that Spanish banks’ bad loans as a share of total credit rose to 11.2 percent in May from 10.9 percent in April. Thomson Reuters’s graphic clearly shows the correlation between the non-performing loans and unemployment. The International Monetary Fund recently said that it expects the non-performing loans (NPL) to increase further, even if the economy stabilises, as the NPLs tend to lag behind other economic indicators. There might be other considerations here as well: perhaps some banks try their best to keep loans officially performing by, for example, providing interest-free periods for select customers. Perhaps some banks are simply hiding the NPLs deeper in their books.

The European Central Bank (ECB) is preparing a comprehensive review of the European banks’ balance sheets before the stress tests scheduled for March 2014. It is probable that any underreported non-performing loans would become visible during the review. This would lead to loss recognition and needs to raise the capital base. After the German elections are over, some sort of solution will have to be found – and soon. Robert Kahn recently wrote about rumours that there would be a European leaders' meeting in December where the “move towards more Europe” would be discussed. Steen Jakobsen has for a long time suggested that a “meeting of the cardinals” is coming. Something that was an outrageous prediction only 18 months ago might soon become reality. An anonymous macro economist suggested privately and off the record to me that the current low bond yields in the crisis countries are pricing in a strong transfer union with a relatively high probability, perhaps over 50 percent. What if something unexpected should happen, in Portugal, Greece or elsewhere, and the “Full Union”-implied probability were to fall to, say, 10 percent?