Make Way for Debt Mutualization in Europe

Global CIO Commentary by Scott Minerd

“While the Northeast braced for Sandy and the rest of the country turned its attention toward the election, there were two significant developments in the European Union. The first was that the Troika, comprised of the European Commission (EC), the International Monetary Fund (IMF), and the European Central Bank (ECB), recommended cutting peripheral countries’ official debts, which includes debt held by institutions. This would follow the haircut on publicly owned debt that occurred a few months ago. The other major development is that it is now likely that an agreement will be reached on budgetary regulation.

The proposed debt-relief program is significant because the Troika owns those obligations. Writing off a large portion of Greece’s debt would be a major step forward in clearing up the present crisis and getting the immediate concerns about Greece off the table. The catch, however, is that the initiative remains politically unpopular among German voters, and Dr. Merkel and her cabinet are acutely aware of this as they head into an election year.

ECB President Mario Draghi and Germany’s finance minister, Wolfgang Schäuble, are now working much more closely with one another. The two have been in agreement on a number of topics recently. Schäuble was openly supportive of Dr. Draghi’s testimony in front of the Bundestag in late October, when Draghi managed to relieve some of Germany’s concerns over the inflationary risks in his policies. Between that and Dr. Draghi’s endorsement of what I would call the “Über Budget Regulator” that originated in Germany and will be proposed in December, the ECB and the core are cooperating to a greater degree than ever. There will inevitably be fits and starts but it appears Europe will continue moving toward federalization.”

Economic Data Releases

Another Solid Jobs Report is Promising for the Economic Expansion and Recovery in the U.S. Labor Market

Last week's U.S. economic data was positive overall, with non-farm payrolls increasing 171,000 in October, and upward revisions of 84,000 for the previous two months. Following the 873,000 gain in September, the household employment survey posted an increase of 410,000 jobs in October. In spite of this, the unemployment rate increased to 7.9% due to an increase in the labor force participation rate, which rose to a four-month high. In other sectors, the ISM manufacturing index rose to 51.7, its highest level in five months. The non-manufacturing index fell to 54.2 in October, the first downturn in fourth months. The Conference Board Consumer Confidence Index rose to 72.2 in October, the highest level since February 2008.

Further Economic Stagnation in the Eurozone While China Seems to be Stablizing

The latest PMI reports from Europe provide little hope of relief for the ongoing recession there. The eurozone PMI composite, which covers both manufacturing and servicing sectors, fell to 45.7 in October, the lowest level since June 2009. Further declines in manufacturing and service PMIs have been reported in October for Germany, France, Italy and Spain. Economic data in the U.K. deteriorated further last week. U.K. industrial production fell 1.7% in September, the second consecutive month of decline. The manufacturing PMI in the U.K. has been in contraction for six consecutive months and the service PMI fell to its lowest level since December 2010. In China, the official manufacturing PMI rose to 50.2 in October, the first time it has expanded in three months. China’s non-manufacturing PMI also rebounded to 55.5 in October from 53.7 in September.

Chart of the Week

Eurozone Monetary Financial Institutions’ Lending to Non-Financial Corporations YoY Percent Change*

Despite two rounds of Long-Term Refinancing Operations (LTRO) and the European Central Bank’s announcement of its bond purchase program, credit conditions in the Eurozone’s real economy remain tight. In September, the Eurozone Monetary Financial Institution's (MFI) lending to nonfinancial corporations fell 1.4% YoY, the largest decline in 24 months. Lending to nonfinancial corporations in the eurozone's peripheral nations fell 5.8% YoY to the lowest level since August 2007. Meanwhile, business lending in the rest of the Eurozone also fell to 0.9%, the slowest growth since February 2011. The continued contraction in business lending seems to have spread throughout the entire Eurozone and suggests that the recession on the continent will continue in the absence of credit expansion.

Source: European Central Bank, Haver Analytics, Guggenheim Investments. Data as of 9/30/2012. *Note: The Eurozone monetary financial institutions exclude central banks. GIIPS refers to Greece, Ireland, Italy, Portugal and Spain.

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