Daily Economic Briefing: April 22, 2010

Daily Economic Briefing: April 22, 2010

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• Our core view since early 2009 has been that the structural drags emanating from household and corporate sector deleveraging and rising sovereign credit concerns will be more than offset by the powerful cyclical forces springing from a sharp behavioral shift away from pessimism and retrenchment toward cautious optimism and expansion. The manufacturing boom that began in 3Q09 is at ground-zero of this cyclical lift. Assuming even modest gains in March, global manufacturing looks to have surged 9.7% annualized in 1Q10, only a small step-down from the outsized gains 3Q09 and 4Q09.
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• Today’s flash April PMI out of the Euro area underscores how cyclical factors are dominating structural drags. Even as sovereign credit woes plague parts of the region, economic activity is accelerating into 2Q10 for the region as a whole. The output component of the manufacturing PMI jumped to its highest level since the peak of the 1990s expansion. Including the service sector reading, the composite PMI jumped further in April to a level that is now consistent with our forecast of 3% annualized GDP growth in 2Q10, but well above consensus.
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• Consistent with the continued boom in global manufacturing, export volumes are also expanding at a rapid clip. As reported today, Japan real exports jumped 2.8% in March on the heels of a robust 1.1% gain in February. Export growth to Asia remains strong and is picking up to the US even it slows to Europe. More broadly, economic activity in Japan is expanding even stronger than we had expected and will likely lead to a 1Q10 upward revision.
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• Despite stronger growth in Japan, recent rhetoric from the BoJ suggests a change in the bank’s reaction function that will put more emphasis on fighting deflation. Consequently, we now believe the BoJ will slightly expand its unconventional polices in June. Our Japan economist, Masaaki Kanno-san, notes the move is intended to “send a message that the BoJ continues to support the economy, even if its direct impact on the economy is limited.”
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• While some structural drags are slowly moderating (household deleveraging), sovereign credit concerns will likely be a part of the developed market landscape for years to come. In Greece, CDS spreads and government debt yields both shot up today on a growing sense that the liquidity crisis is quickly morphing into a solvency crisis (or was one all along), a belief that is amplified by today’s Eurostat estimate that the Greek 2009 debt position could be revised up to 115% of GDP.
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• While the Greece debt saga is of its own import, the bigger concern is one of contagion. Any such spillover will work through two channels: credit risk and macro risk. For those economies facing the most severe fiscal challenges (the Greece, Spain, Portugual, Ireland, and Italy to a lesser extent), the credit risk fallout has lifted 10 year debt yields in recent weeks. By contrast, the macroeconomic risk from a slower recovery that keeps the ECB on hold longer is pushing yields down in the larger, more fiscally sound parts of the region. Of note, UK 10-year gilt yeilds have been relatively unchanged in recent weeks.
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• In contrast to the fiscal woes of its Western European neighbors (and showcasing the growing role the EM will have in this expansion), Russia borrowed $5.5bn from foreign markets today with relative ease, the second largest EM placement ever and the first for Russia since its 1998 default.
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Page 2 of 2: G4 sentiment sends mixed signals

As the global recovery has taken root, household consumer sentiment has improved markedly from the record lows posted during the depths of the downturn. Still, the level of sentiment remains quite depressed. G4 consumer sentiment remains roughly a full standard deviation below where it was running prior to the downturn. And yet, retail sales volumes are now growing back in line with their pre-crisis pace.

With sentiment trailing the recovery in consumer spending growth, and given the importance placed on animal spirits in affecting aggregate demand—particularly during business cycle turning points—this disconnect could be interpreted as highlighting downside risk. Indeed, with labor markets still soft in most of the developed markets, households still struggling to delever their balance sheets, and fiscal authorities just now beginning to wrestle with the difficult task of unwinding stimulus to control deficits, it is understandable that sentiment is weak.

At the same time, labor markets are improving and the resulting rising in labor income is expected to replace fiscal stimulus as it fades. Moreover, financial markets continue to heal and asset prices are now marching upward (with US house prices at least stabilizing for now). In whole, the disconnect in consumer sentiment reflects a divergence between a downbeat current situation and expectations for a brighter future. Indeed, this is precisely what is being signaled by the G4 consumer sentiment data. The current conditions component of this index remains quite depressed while the expectations component has moved up and, as of March, stood back at the level seen prior to the financial crisis.

In terms of the impact this divergence has on consumer spending, it appears the expectations component dominates. That is, for the G4, the expectations component of consumer sentiment has tracked growth in developed markets retail sales volumes much more closely than the current conditions component over the past five years. Consequently, the state of household sentiment accords well with continued solid gains in consumer outlays. At the same time, the current conditions component is making a marked improvement.

Curiously, movements within G4 consumer sentiment are hard to understand, leaving us with the same concerns noted above. Indeed, despite the fact that much of the strength seen of late in retail sales growth has come from the US, the expectations component of US consumer sentiment has faded of a late. And despite the fact that retail sales has trended down in the UK in recent months, the expectations component of sentiment has shot up. That this indicator tracks developed market retail sales volumes is a bit of a mystery and will require further analysis.

ENDS

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