Tons of economic data in the U.S. this week plus eyes will be on Europe as Angela Merkel and Nicolas Sarkozy get together to try to figure out something to address the growing crisis in Europe. The markets reacted positively to the announcement of the meeting, the two leaders will need to emerge with some sort of concrete plan for that to last:
Monday: A holiday in much of the world, from the Feast of the Assumption in Italy and Greece to Independence Day in India and Korea. No such luck in the US.
- In economic data we get the Empire State factory index, TIC data and the NAHB Housing index.
- We get earnings from: Estee Lauder, Lowe’s, SYSCO and Urban Outfitters and Agilent Technologies.
Tuesday:
- In economics, we get weekly ICSC-Goldman Sachs and Redbook retail indexes, import and export prices, housing starts and industrial production and capacity utilization for July.
- We get earnings from Home Depot, Wal-Mart, TJX, Dell and Analog Devices.
Wednesday:
- In economic data, we get MBA Mortgage Applications, PPI for July and EIA petroleum inventory data.
- We get earnings from Deere, Staples, Target, JDS Uniphase, Limited, NetApp, and Abercrombie & Fitch.
Thursday:
- In economic data, we get weekly jobless claims, July CPI, the Philadelphia Fed index, and leading economic indicators and existing home sales for July.
- We get earnings from Sears Holdings, Ross Stores, GameStop, J.M. Smucker, Salesforce.com, Autodesk, Hewlett Packard, Intuit and Gap.
Friday: New York Fed President Bill Dudley speaks. And that’s it, mercifully.
Less than a month ago, Sarkozy travelled to Berlin on the eve of a crucial summit of euro zone leaders and after seven hours of talks, he and Merkel agreed to sweeping new measures, including a second rescue package for Greece and greater powers for their rescue fund.
But those decisions have failed to reassure investors, in part because they can only go into effect once national parliaments have approved them — a process that could drag on into October.
At the meeting Tuesday, which will be followed by a joint news conference scheduled for 1630 GMT, the leaders are likely to send a strong signal about their commitment to getting these new steps approved quickly, even if this is largely out of their control.
They will also discuss improving economic governance in the euro zone, possibly agreeing to regular meetings of leaders from the currency bloc — a longstanding French demand — and enlarging the role of European Council President Herman van Rompuy to make him a spokesman for the euro.
These steps could bring greater policy discipline in the 17-nation currency bloc, which has regularly sowed confusion in the markets by talking with many disparate voices.
In addition, Merkel and Sarkozy could spell out in more detail plans to boost fiscal cooperation between Berlin and Paris. The key question is how far they are prepared to go here.
As far back as December, at a meeting in Freiburg, they spoke about better aligning their tax and labor policies. To impress nervous investors, they will surely have to go much further than that.
One bold option would be joint Franco-German bond issuance, a step that would stop well short of the much broader Eurobond idea Berlin dreads, but send a strong signal that Europe was moving in this direction.
However this approach would also carry risks. Markets could see it as a sign that two separate classes of public debt were emerging in the bloc and punish big countries like Italy if they were excluded.
German officials told Reuters Friday not to expect any sensational announcements of this kind, suggesting instead that the focus of the meeting would be on streamlining governance and integration.
“What we have is mostly solvent nations which are running into liquidity problems because markets are making it too expensive for them to roll over their debt. Is the answer to that more political integration? I don’t think so,” said Daniel Gros, director of the Center for European Policy Studies.
“It’s become clear that the political response to this crisis is insufficient. What you need is real firepower and only the European Central Bank has that.”
Alas, all is not well in Europe. The big question continues to be: can European economies manage their aggressive austerity plans against a backdrop of lagging growth? And the growth outlook is darkening. Today, France, which found itself at the middle of the week’s debt-downgrade and banking panic, reported disappointing growth figures. From the first quarter to the second, the French economy failed to expand at all, held back in large part by a drop in household consumption. For now, French officials are declaring that they’ll keep to their deficit-reduction goals.
What’s worse, the euro-zone economy as a whole is rapidly losing momentum. Industrial production across the euro area fell by 0.7% from May to June. Production dropped in every large euro-zone economy, including a 1.7% decline in France and a 0.8% dip in Germany, which is widely considered the currency area’s bulwark against a return to recession. Activity dropped across southern Europe, falling in Italy for a second consecutive month. That’s especially bad news for an economy facing an accelerated austerity push.
Falling output will reduce the effectiveness of fiscal consolidation, both by negatively impacting revenues and by cutting the denominator in the debt-to-GDP calculation. Disappointing fiscal progress may lead to more market trouble, raising sovereign borrowing costs. Or it might lead governments to push for more aggressive austerity still. Or both. One thing is for sure: a return to euro-zone recession would set the stage for a prolonged crisis environment, through which the survival of the currency area will constantly be in question.
QE is no longer the cure. It has now become a poison.
Which would explain why the Fed did not announce more QE at the last FOMC meeting, despite rampant calls for the opposite.
It’s now very possible that the majority of the FOMC voting committee believes more QE could plunge the system into a desperate capital preservation frenzy, resulting in nothing else than self-imposed and voluntary capital destruction.
That the system is so broken, it doesn’t matter how much liquidity the Fed creates because it won’t be able to get any further than the immediate banking community. And that’s because banks still can’t find enough credit worthy people to lend to. That the majority of loans still have a greater default risk than the banks are prepared to weather. That loans equal capital deterioration. And only loans to the most credit worthy people (of which there are not enough) are worthwhile.
If banks do indeed perceive that capital deterioration risk from lending is much greater than a self-imposed haircut on the most liquid and safe security, they’re prepared to take that haircut — especially in a world with no alternative — because it guarantees some sort of remaining capital preservation. The haircut, of course, is the negative interest rate.
If that is the case, the worse thing the Fed could do is more asset purchases. It would only take out more supply of quality collateral out of the market, heightening the pressure to take a self-imposed haircut just in order to get your hands on the security. A fact echoed by the number of above par bids at this week’s 30-year Treasury auction.
Earlier this year, disruptions in Libya and the resurgence of demand from the emerging economies sent oil prices up sharply, a development that many economists believe contributed to the slow growth for 2011:H1. The chaotic markets of the last few weeks saw oil prices drop back down to where they had been in December. Will that be enough to revive the struggling U.S. economy? There is some evidence suggesting that it may be too late.
I recently completed a survey of a large number of academic studies that found a nonlinear economic response to oil price changes. One very well-established observation is that although oil price increases were often associated with economic recessions, oil price decreases did not bring about corresponding economic booms. For example, when oil prices plunged in the mid-1980s, the oil-producing states in the U.S. experienced what looked like their own regional recession. An oil price increase that just reverses a recent price decrease does not seem to have the same economic effects as a price move that establishes new highs.