Wednesday, May 25, 2011

Germany catching a cold

Well, the choppiness across markets continues, with Asia selling off on the back of potential US bank lawsuits and rumours of a Spanish and/or Greek snap election, only for Europe to reverse most of the overnight move. Or then again, like yesterday it could just be a case of "fill the gap" and then roll-over again. TMM still sense that punters are trying to hold onto long risky asset positions, or at least still attempting to follow the JBTFD strategy and it doesn't seem to us that there has yet been a capitulatory "baby with the bathwater" moment as of yet.

It is particularly striking that the PhD community has only just begun to downgrade their 2Q11 GDP forecasts, with JPM overnight lowering theirs from 3% to 2.5%. While TMM's survey-based GDP proxy underperformed the official GDP figures in early-2010 (largely, we believe, due to the impact of the fiscal stimulus), since then it has re-converged, and after implying a brief growth spurt in Q1, it has come off sharply, and is now consistent with 1.5% annualised rates of growth. Now TMM completely accept the idea that this is downwardly biased by seasonal issues related to the timing of Easter, but even if we generously add 0.7% to that figure, we still sit at 2.2% while consensus are at 3.3%. TMM reckon the PhD community have some capitulation to do, and with them, erstwhile risky asset longs.

The other argument TMM have heard is that "it's all just the Japanese supply chain effect". Sure, some of it is - the obvious stuff like Toyota etc - but if this were really the driver of the slowdown, then it would show up in inventory/sales ratios... and the below chart of ISM Orders/Inventories shows a clear downtrend.

Continuing along the lines of TMM's belief that global growth has rolled over and is moving into a soft patch and, ultimately, growth scare, we decided to take a closer look at the post-crisis powerhouse that is Germany. Yesterday's IFO survey seemed to point to continued vigorous growth, but TMM are sceptical given that Germany is leveraged to China and the rest of Europe, and still has shown itself unable to sufficiently produce its own domestic demand. So, along these lines of thinking, TMM decided to construct a set of FCI-like models for IFO, the Manufacturing PMI and, most importantly, GDP. The logic behind using the components of an FCI is that it can provide a basis for the conditions of domestically-generated growth.

So, first off, the IFO (see chart below: IFO - blue line, model - red line). The model fit here has been OK, but not brilliant, and despite financial conditions having flattened out over the past year, the IFO has gone on to hit highs not seen since 2006. TMM are aware that the construction of the IFO survey has changed recently, so that may be behind some of the divergence, and possibly, the strong cash position of small-medium German corporates (who make up the bulk of the survey responses) may well be reason here, with less need for financing.

Next up, the Manufacturing PMI (see chart below - blue line, red line - model). As this is primarily made up of larger companies, it is more reflective of global demand growth and, given their funding nature, more sensitive to financial conditions. The fit is much better here, and shows the PMI falling to around 55, so still decent growth but not at the exceptionally strong rates seen over the past year or so. Given the tightening path the ECB is on, it is likely that this will continue to drift lower.

Finally, GDP (see chart below - blue line, model - red line). Q1 2011 saw a very strong print from Germany, that is flattered by a high rate of Government Spending (+1.3% vs. expectations of just 0.2%), something that TMM reckon will revert in the next print. Indeed, apart from that, the model does a pretty good job of predicting German GDP, and the direction is clear: sub-trend growth.

To summarise, it seems that while German SMEs aren't doing too shabbily, outperforming what one might expect given financial conditions, that is yet to show up as significant domestic demand (Q1's was just 1.1%, following on from -0.2% the previous quarter). The more important large corporates look set to experience the squeeze in financial conditions as the ECB moves to hike rates and worries regarding collateral damage from the PIGS widen credit spreads. It seems clear to TMM that German growth is also moving into a mid-cycle slowdown along with the rest of the world and that is the last thing Europe needs.

However, with Schatz yields 20bps lower (see chart below) in just a week (see chart below) it's hard to get too long of the front end here. TMM are still holding their September 107.40 calls, though, which given the slow motion train crash occurring in Greece (which could be particularly disastrous should the proposed austerity referendum fail), look like a good bottom drawer trade for what they expect to be a choppy month of trading as markets try and make sense of where we are in the global cycle.

And TMM didn't even mention Marmite.

10 comments:

Anonymous said...

TMM, excuse my ignorance but I was hoping you could explain what a FCI model is.

abee crombie said...

likewise.. can you elaborate on what your model is comprised of ...

nice post though... shatz was well behind the curve, its taken a long time for it to turn... conversly in the US, the short end I think has priced all of this in already.. might be a good spread...

FX said...

Definitely looking the tough domino in the field, -ve 1.38 first 8mths 2010, -ve 1.42 Jan 2010 - Feb 2011, looking at it with a lag vs China imports, run along side survey measures, you sure get a feel for their optimism, yeah? ....you reckon our Bavarian traders may be suffering some sort of normalcy bias around these levels, now?.....I bet someone out there is overlaying an effective fx model over GE that exposes their fx advantage vs the rest of our DM trading partners....I'll go a little further and treat any movement in survey indicators with twice the amount of sensitivity, up or down.

Leftback said...

Agree, it seems as though we have to have one big impulsive move downwards before this market has finished digesting the global slowdown. When we reach the point where energy and commodities find a sustainable level, it will probably be safe to get long the market again. Until then, pairs trades will be in vogue. Long defensives, short cyclicals still seems like the trade that is least crowded.

Re: Marmite. The Danes are bonkers, it's hard enough to find anything to eat in Copenhagen apart from breakfast. LB lost about ten pounds in a week there last summer, lousy tourist restaurants and the prices were reminiscent of 1980s Tokyo.

USDJPY still seems to be locked to the short end of the yield curve. If the slowdown is priced in to rate expectations, USDJPY should be poised to rise from here, no?

Leftback said...

Energy up today in the face of increased supply and slowing economic data? Smells to me like an engineered squeeze to create an exit rally. Let's see if trapped longs take this opportunity to unwind more of the exhausted DGDF trade this week....

CV said...

God, you Brits are so sensitive on this Marmite stuff :). The word in the Danish press this afternoon is that we are duly backtracking and it is now allowed with a "permission" to sell. I mean, it is not as if it tastes good or anything ...

On the market, it is all very sensitive at the moment. If it is still the old themes that hold you would want to buy right about now as the SP500 seems to be flirting at the 100dma support, but it may be different. AUD/USD seems to be having a rough time too and vis a vis TMM yesterday, I agree on the ZAR too.

Also I don't get the Squid here, first they are bearish on commods and now they are bullish?! What gives, did they suddenly find out that they had a little bit of copper stashed in Shanghai close to expiry?

USD/JPY is my big bet for Q2 and thus, I stand shoulder to shoulder with LB here (aka the Peanut gallery). I think the BOJ will continue to expand its balance sheet as QE2 levels off, but if it turns into a rout, we can expect the Beard to turn even more dovish.

Claus

Anonymous said...

Still no sign of the real money guys running for cover from what I can see, so we remain in the Voldermont driven frustration fest that we have grown to hate. They are the bid every day in Euro (and the rest) and that has the unhappy knack of turning short term 'sentiment' in other risk buckets as well.
As much as I can agree with the world having to wake up to global growth falling over story I suspect the leg we really need to fall is equities. Real money have parked way to much cash in that bucket at rich levels that it needs to hurt them before things get ugly. These guys still believe the teflon gloves prevent any harm coming to them.
Break that thought process and we may have a game to watch. db

WellRed said...

Just having a look through the various charts to try to get a grasp on this week's risk rally . Oddly, it seems to end at the FI arena.

Someone said it before me, but it seems like the bond market is starting to price in a slowdown ahead of the equity market. Unlike late last summer though, spreads are widening out (in addition to yields on govies falling) which reinforces my feeling of impending pain in risk markets.

So far as I can tell, Anon @ 8:45 has hit the nail on the head here.

Thoughts?

Leftback said...

This may be widely known, but one or two may appreciate some data on who is exposed when the can of Greece can no longer be kicked down the road:

http://www.ritholtz.com/blog/wp-content/uploads/2011/05/GREECE_G_20110528000900.jpg

Some of the exposures are quite large and probably too large to be hedged by taking CDS positions. The French and German banks are in the frame, as has been discussed here on several occasions.

Skippy said...

Thanks LB. I am still fascinated(confused) that risk was bought on this latest Eurobollox. Seems to me that the road (for the can) is nearing (the inevitable?) dead end.