Some Reflections on a Quiet Day

The capital markets are subdued. European markets have been thinned by the Assumption Day holiday.  The US dollar is a bit softer against most of the major currencies, except the Japanese yen.  Equity and bond markets are mostly firmer as well.  

The news stream has been light.  Investors are still digesting the poor euro zone GDP figures.  The contraction of the German economy was the shocker, but the continued stagnation of the French economy and the contraction of the Italian economy also weighs on sentiment.  

The US economy contracted in Q1.  That was a fluke. Growth rebounded in Q2, though recent data has made investors question how strong of momentum the economy really enjoys at the start of Q3.  The Japanese economy contracted in Q2, pressured by the retail sales tax.  Policy makers may have been surprised by the magnitude of the contraction, but expect the economy to rebound.  The German economic contraction in Q2 is also a bit of a fluke.  Growth is expected to return here in Q3.  

However, the French and Italian economies are a different story.  France has not strung together two consecutive quarters of growth since Q4 11/Q1 12.    Italy has recorded positive growth in one quarter since mid-2011.  Some observers are trying to count dips as if that is the meaningful issue here.  It is not.  The key is whether growth is on a sustainable path.  It is not.  

There are no agreed upon definitions of recession.  The word itself was made up to distinguish between the end of business cycles and the Great Depression.  The US itself does not define a recession as two consecutive quarters of negative growth.      While some pundits talk about a triple dip recession in Italy, for example, it does not really help further our understanding.  Neither it not France arguably had a sufficient expansion from which it could dip from.  

It is also remarkable that some of the same observers who questioned the merits of QE in the US and elsewhere now insist that it is the only thing that will lift the euro zone economy.  It is not so obvious.  With the German bund yield flirting with 1%, and peripheral yields near record lows, high interest rates do not appear to be the major obstacle to growth.   While Nero is said to have fiddled while Rome burned, Renzi is expending political capital on reforming the Senate, while structural economic reforms are awaited.  

Some observers want to blame the currency union itself for Europe's economic problems, but even before EMU, some countries, like Italy and Portugal struggled with stagnation.  France was already unable to keep up with Germany's economic prowess.  EMU may have helped give particular shape to the crisis, but the challenges pre-date it.  

Today is the anniversary of Nixon's decision to severe the final link between the dollar and gold in 1971. This marked the end of Bretton Woods.  Hopes of a new Bretton Woods are misplaced.  Bretton Woods required, as hegemonic stability theory suggests, one country to have sufficient power and will to establish and enforce "rules of engagement".  The asymmetries of power at the end of WWII allowed for this.  Such conditions do not exist now, even if we are not a G-Zero world as some political scientists suggest.  

It is also instructive to recall that the demand for such quantities of gold that posed a quandary for US policy makers, did not arise from the rivals, like the Soviet Union, but from US allies, like France, Germany and Great Britain.  It was the rebuilding of Europe, and their desire to hold more gold rather than Treasuries (were they really called paper gold?) that strained Bretton Woods to the breaking point.  Inter-capitalist rivalries were more important than the Cold War in bringing the international monetary order to its knees.  

Today's news is more mundane.  The main news item is the affirmation of UK's Q2 GDP of 0.8%.  The year-over-year rate was revised to 3.2% from 3.1%.  This is the strongest year-over-year pace since Q4 07.  However, it could very well mark the cyclical high water point.  

Sterling has been confined to about a quarter of a cent below $1.6700.  It held the 200-day moving average (~$1.6667) and this appears to have spurred a light bout of short-covering.  For its part, the euro is trading inside yesterday's ranges, which was inside Wednesday's range.  While the euro has carved out a shelf in the $1.3335-45 area, the upside has been terribly limited.  It has not traded above its 20-day moving average since the middle of July.  It is found near $1.3410 today.  Only a close above it on a weekly basis, would help lift the tone into next week.  

The German 10-year yield at 1% (and the poor GDP data) has fanned talk of the "Japanification" of Europe, and the US 10-year yield posted its lowest close in more than a year.  Japan's 10-year yield has slipped below 50 bp to a 16-month low.  

Today's North American session features US industrial production and PPI.  Little light will be shed on the key issue for investors about the momentum of the US economy.  Wholesale price pressures may have eased a little, suggesting that what is thought of as pipeline pressures remain modest.  The TIC June TIC data will also be reported.  The behavior of the China and Russia are likely to be the focus.  Recall that central banks, including the PBOC, like private sector participants, appear to have increased their duration. Extending maturities ahead of the end of tapering and the rate hike that is expected next year seems largely defensive in nature.  

Canada restates its July employment data.  A 20k increase in the headline employment is forecast, but the breakdown between full and part-time work may be key.  The report that the BOC recalled showed a 60k loss of full time jobs.  The US dollar appears to be rolling over against the Canadian dollar, and is slipping through the CAD1.09 level.  The immediate target is CAD1.0850-70.