A Look At Europe, The U.S. And China

A swathe of dismal economic news cast a long shadow across Europe yesterday, beating the single currency down by nearly 1%. The manufacturing PMIs in the periphery for April were uniformly dreadful, with Spain down to 43.6 and Italy to 43.8 (from 47.9 in March). For the latter, the new-order balance saw the biggest monthly decline in three years; from 45.7 to 39.2, suggesting there’s not a whole lot on the horizon that will turn around the fortunes of the manufacturing sector anytime soon.

There was also a modest downward revision to provisional PMI readings for both France and Germany, by 0.4 and 0.1 respectively, to 46.9 and 46.2. As if that wasn’t bad enough, the unemployment rate in Italy jumped to a 12-year high of 9.8% in March (9.4% was expected), Germany recorded its largest monthly increase in unemployment (19k) in nearly two years, while the unemployment rate for the euro-area rose to a 15-yr high. Today’s ECB meeting is therefore extremely timely. At the very least, with recession deepening in a number of eurozone economies -- and in spite of any real guidance from ECB President Mario Draghi, today -- one can only hope the central bank is at least pondering its next move.

With the US recovery looking more assured these days, it is no wonder that the single currency took yesterday’s smorgasbord of shocking news rather badly. It was also worth noting the response of peripheral bond markets to this darker economic landscape -- bond yields rose markedly in both Italy and Spain -- while the spread to Bunds at the long end widened by around 15bp. Both the dollar and the yen gained on this renewed burst of risk avoidance, while the Aussie dipped back to 1.03.

Payrolls Palpitations
For understandable reasons, the US recovery is getting the benefit of the doubt these days, although Friday's monthly payrolls report will be closely scrutinised to get a reading on the economy's temperature. In terms of tomorrow’s outcome, anecdotals are mixed. Initial jobless claims have risen over the past few weeks and private payrolls fell back last month, according to the ADP Employer Services report. In contrast, the employment component of the ISM survey registered a nine-month high in April.

The consensus expectation is of a rise of more than 160K. Prior to the disappointing March outcome, payrolls averaged around 200K for the previous six months, aided by favourable weather, which contributed to outsized gains in both construction and retail employment. It could very well be that average payrolls’ growth through the current quarter may dip back below 150K now that weather-related conditions have run their course.
 
The Bar For More Fed QE Just Gets Higher
In sharp contrast to Europe's worsening situation, recent signals out of the U.S. have generally been encouraging. Buoyed by strengthening demand for autos and decent growth in export orders, the American manufacturing sector is remarkably robust.Consumer are spending (albeit cautiously), the economy has recorded positive growth in each quarter since mid 2009 and monthly-payroll growth has averaged nearly 150K over the past two years.

It may not be exciting growth, but it certainly looks much steadier relative to other advanced economies. As a result, Fed policy makers are understandably shifting their perspective away from the need for additional QE. Over the past week, no less than four Fed Presidents have suggested that more asset purchases may be unnecessary. San Francisco Fed President John Williams, for instance, claimed that the threshold for further action would require either a stalling of the decline in the unemployment rate or a reduction in the inflation rate to ”significantly below” the Fed’s 2% target.

Leary Of Inflation
Most hawkish is Richmond Fed President, Jeffrey Lacker, who believes that further QE at this point risks igniting inflation. Indeed, he's advocating an increase in the funds rate, should unemployment fall to near 7% (currently 8.2%).

These individual policy perspectives are very much consistent with the message contained in the most recent FOMC Minutes. The Fed Chairman declared after the April 24-25 FOMC meeting that additional stimulus would be unlikely, unless the growth outlook deteriorated markedly. Equity investors are sufficiently reassured, judging by the Dow’s ascent to a 4½-year high yesterday. Fingers will be crossed in the hope that Friday’s payrolls outcome does not shake the tree of expectations too vigorously.

Chinese Home Prices Continue To Fall
Chinese policy-makers will, no doubt, be conscious of housing prices, which continue to decline. According to SouFun Holdings, the largest real-estate website in the country, residential-property prices fell another 0.3% last month, the eighth consecutive MoM decline. Of the 100 major cities tracked, 71 recorded a fall in prices last month. In response, Beijing has allowed lenders to offer discounted interest rates on mortgages to first-time buyers. At the same time, policy officials are determined to maintain some of the other restrictions on the property market in an attempt to thwart excessive speculation. Developers have been targeted, and they are being forced to reduce prices aggressively as unsold inventory increases.

China thankfully still has a huge matrix of policy choices available to deal with the situation. The biggest risk, however, is hubris. Policy officials may well believe that they can turn the growth tap back on at will. However, it is already apparent that the growth multiplier is falling in China. In other words, policy needs to work much harder in order to achieve a certain growth outcome.