Budget

Reading Between The Lines: Why Eurozone Improvement is Being Ignored

Published on the Front Page of Huffington Post Business

Markets have shrugged off improvement in the Eurozone because more is needed for stability. Rising demand for German goods, an improving business climate and stability in Spanish housing should have given markets cause for celebration. However, after the substantial rally we’ve seen, and the headwinds yet to be tackled within the region, caution has crept back into markets.

Absence of Growth and Currency Risk

There is deep concern over Europe’s ability to kickstart growth, as austerity measures dampen economic expansion and a strong euro stifles exports. The increase in demand for German factory goods interestingly was driven by demand within the euro area. Domestic demand was weak and the currency still source of concern abroad. Furthermore, despite an overall improving business climate, uncertainty in the political and economic landscape going forward is causing delay in hiring and investment.

Spain Precarious and Firepower Lacking

Once again hitting the headlines, Spain could derail European stability, as corruption charges are directed at the government while they continue to grapple with a large budget deficit. The latest data points to a possible floor in Spanish housing prices but defaults on bank loans due to the real estate bubble remains elevated and there is only limited further financial aid available directly from the rescue fund. In order to meet its main obligation of lending to struggling countries, additional direct bank aid has been rumoured to amount to less than €100bn, nowhere near enough to contain future turmoil!

Reform and Unity Needed

With France expected to have slipped back into recession, Draghi, the European Central Bank President, is right to warn that the region is not in the clear yet. What’s needed now are structural reform and closer fiscal and political unity. Only with a return of confidence, based on improving fundamentals, can stability return.

rafa-sanudo-euro-crisisstock market

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What may drive markets this week?

Inflation, hard-to-beat expectations and political stalemate provide a significant downward risk to market this week. (Quoted in the Weekend edition of the Financial Times)

Last week was dominated by disappointing manufacturing data from Europe and China, whilst markets shrugged off a less than impressive Budget. After such a substantial rally year to date, this correction is healthy.

Graph showing the correction in world equity markets over the past week (S&P 500 in white, Eurostoxx 600 in orange, FTSE 100 in yellow); put in context of the substantial upward move year to date. Source: Bloomberg

Graph showing the correction in world equity markets over the past week (S&P 500 in white, Eurostoxx 600 in orange, FTSE 100 in yellow); put in context of the substantial upward move year to date. Source: Bloomberg

This week, issues concerning Europe’s firepower, the US consumer and broader economic growth will determine the direction of markets. Inflation, hard-to-beat expectations and political stalemate provide a significant downward risk to market, although upward momentum could always drive them further.

As fuel price inflation dents sentiment in the US, the consumer may be squeezed and figures for income and spending may disappoint. Furthermore, the opportunity for upside surprises in durable goods orders and Q4 GDP growth is limited as forecasted figures are already high.

A two-day meeting of Europe’s finance ministers will be closely watched for signs of an expansion in the firepower of the rescue fund. The deadline to do so draws near and the pressure for progress grows. However, Germany remains staunchly against such a move and, even if achieved, the figure reached may still not be enough.

IMF Revelations: The End of European Dominance & The Rise of Emerging Markets?

As “super-injunctions” are labelled “pointless” by the rise of ‘new’ social media sites, the world seems a smaller place for those wanting to hide potential transgressions.  Indeed, such accusations can have broad ramifications as the head of the International Monetary Fund this week steps down from his leadership position. Could this trigger the end of European dominance at the IMF and even pave the way for Emerging Market leaders to acquire a more appropriate size of the power pie?

Jurisdiction Arbitrage: The Super-Injunction Flaw

Last week, an anonymous twitter user exploited a ‘jurisdiction arbitrage’ to name celebrities whose identities are being protected by a series of ‘gagging-orders’. The Twitter site is based in the US and therefore “outside the jurisdiction of the British courts”. Furthermore, not only would the user himself be “difficult to trace” but the number of other users who forwarded on the names and could be charged represented a “mass defiance” and “unlikely” any of them would be pursued. Therefore potential wrong-doers can, for the moment at least, be named and shamed in some form of media. Just how dangerous can these revelations be?

Revelations at The IMF

This week legalities are once again in the headlines as Dominique Strauss-Kahn, (now the former) head of the International Monetary Fund, stands accused of politically damaging indiscretions. Regardless of the outcome of the case, the political impact has been made and focus is on identifying his potential successor.

The European Bias

Historically the IMF Managing Director has been European and the World Bank President American but nowhere in the “Articles of Agreement’ is this mentioned. So where did this bias come from? It dates back to the Bretton Woods conference, where the fund was formed and this informal agreement struck. In the aftermath of World War II, European economic stability played a large part in the health of the world’s economy and voting power reflected the balance of power. The US has a 16.7% share, Germany 5.9% and the UK & France 4.9% each; leaving the ‘door open’ for ‘behind the scenes’ negotiations. Unsurprisingly, since this time, there have been 10 Managing Directors, all of them European.

Flaws of a European Successor

Proponents of a continuation of European dominance point to the IMF’s crucial role in stemming the European Sovereign Debt crisis. A German government spokesman, Christoph Steegmans, maintains that the leader needs to understand “Europe’s particularities”. Interesting then that there has been no talk of electing an official from the Middle East as Egypt requests a $4bn loan to ‘fill its budget gap’. With all the turmoil, doesn’t a leader need to understand the ‘particularities’ of this region too? Instead, focus is on German candidates (including Axel Weber, the former head of the Central Bank who recently withdrew from the race to succeed Trichet as head of the ECB). A favourite amongst pundits is French finance Minister Christine Lagarde. Bank of Canada Governor, Mark Carney has even been given odds of 10-to-1 by a British bookmaker. Gordon Brown’s name has even been thrown into the ring but was quickly opposed by our PM Cameron due to the record budget deficit which continued to build during his tenure. Here lies the crux of the issue, since the EU and ECB have yet to solve the debt crisis, is it time for someone else to have a go?

Opportunity for Developing Markets

The economic balance of power is changing. China has overtaken Japan as the second largest economy and it has been argued that it will surpass the US’s share of global GDP in a decade. Back in 1973, the developing nations asserted more of their power as a group led by Indonesia and Iran vetoed the nomination of a Dutch candidate (seen as too closely aligned to the interests of wealthy nations). With this in mind, candidates from South Africa, Turkey, Singapore, Indonesia, Mexico and a Chinese official who advises the IMF already have been mentioned in the press. Brazil too has contributed to the discussion, as their Finance Minister argues for a “new criteria”. Indeed changes to IMF governance were decided in 2008 and last year, shifting 5.3% of the voting share to emerging markets. Although nothing has yet taken effect. However, with the increased contribution of funding coming from these regions and the negativity within these countries expressed against too much focus on the developed world, change is warranted.

Investment Conclusion

As ever, economic issues can often lie opposed to equity market movement. But changes (or continuation) of dominance could affect short-term sentiment for various country’s financial markets. Exploit any over-reaction in the short-term whilst remaining focused on quality in the longer-term. The shift of economic power is well underway, let’s see if the political powers play catch up….