IIFT Daily Note with Peter Brown

David’s note for today.

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Daily Note – The last king of Europe

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Spain: The last King of Spain?

Eurozone: The fight against deflation gets real

United States: Manufacturing sentiment improves

United Kingdom: Weird goings on in the housing market

China: Steady as she goes

Good morning,

The abdication of the King of Spain is a strange lesson in the nature of politics. Juan Carlos was the hero of the transition from Franco to the eventual reign of the prince of the Spanish left – the redoubtable Philipe Gonzalez. Philipe ruled the roost for more than a decade and for a generation of Europeans was the face of the new Spain. However, when the new Spain was threatened by an attempted coup in the 1980s, it was King Juan Carlos – not the new politicians  -who stood up to the conspirators and faced them down.

As a Republican, who finds the notion of monarchies repellant, I must admit to having a certain regard for Juan Carlos, not because of what his reign became but because of what it was.

However, sometimes, in the same way as there can be a run on a bank, there can be a run on an idea and even a run on a personality. It seems that in Spain, there was a run on the King, people just stopped believing him.

Similarly, there now may be a run on Europe. By this I mean a rejection about the way Europe is run. The anointed new President of the European Commission is Mr. Juncker who is supposed to be a shoe-in for the job.

But he is part of the problem, technocratic, aloof and undemocratic.

If he gets the job, it would be a clear signal to the people that the European elite has learnt nothing from recent elections. If the elite continues to behave this way, there will indeed be a political revolution, the beginnings of which we saw last week.

At least Juan Carlos of Spain knew when his time was up and in order to save the monarchy in Spain, he had to sacrifice himself. Might the European political elite be so politically savvy? Could they entertain sacrificing themselves? I doubt it.

And this all means that Europe’s only response to deflation will be further monetary easing with no fiscal boost. This policy will simply drive up inequality to unseen levels and make more legitimate the groundswell against the elites.

The next installment of this story will play out this week with the ECB having to move  on deflation at the end of the week. This morning we just got more evidence of deflationary pressure all over Europe with consumer prices hardly budging in May.

Outside Europe, equities made marginal new highs again yesterday but failed once again to demonstrate any great conviction.

The USD was up across the board after some weak data in G10. Most of the focus was on the ECB and what they might do later this week. The  EUR/USD traded back through $1.36. We reduced our short Euro position, booking some gains.

Fixed income sold off to start the week. Ahead of some key events later this week, we closed our US 10 Year short investment for some solid gains.

Gold fell just $2.70 despite a 0.08% move in 10 yr UST yields.

In the East, Chinese manufacturing data came in better than expected, suggesting that maybe the government’s efforts to stimulate may be working already. Base metals participants interpreted the news favourably – all metals ended up.

Finally, last night we reduced our long China investment back to equal weight (100%) from over weight (150%). We have had some very solid gains here (about 10%) in recent weeks against the consensus. Taking our cash off the table for a tidy profit here seems appropriate, don’t you think?

Eurozone: The fight against deflation gets real

Table 1 3 June

As we head into the much-hyped ECB meeting on Thursday, German inflation dropped to +0.6%yoy in May after +1.1% in April. This piles more pressure on Draghi. The annual rate of the energy and food component both declined in May to -0.8% and 0.5% respectively. Some one-off factors contributed to the downside surprise, but this can’t explain the weakness in the underlying inflationary pressure in Germany.

For example, the inflation rate for rents for apartments (which make up 20% of the total index) has been moving sideways for seven months now. Bear in mind this is German inflation and Germany is the standout European growth performer in recent years.

Up to now, people thought deflation was a Catholic affliction affecting the likes of Italy, Spain and Portugal – not anymore. Deflation is an equal opportunity curse and the fight against deflation in the Eurozone has just got real.

Figure 1: German CPI YoY %

Chart 1 3 June

European manufacturers are getting depressed. The final manufacturing PMI came in at 52.2 in May – 0.3pt below the flash figure (and the consensus expectation) and down 1.2pt from the April reading.

A small upward revision in France only partially offset a sizable downward revision in Germany. Spain was the only major country to improve on the month. Both the Spanish and the Italian manufacturing PMIs now stand above those of Germany and France (see chart below). It is interesting to note from that chart the extent to which German and French confidence has begun to fade away.

Figure 2: Eurozone Manufacturing Sentiment

Chart 2 3 June

United States: Manufacturing sentiment improves

Table 2 3 June

There is really nothing major happening in the data in the US. Yesterday we saw some evidence that the manufacturing sector is chugging along and prices may be ticking up a bit. See below: the chart of “prices paid”.

I expect US inflation to pick up, but am not scouring the data to bolster my case. Let’s allow the recovery to do its thing because, as the economy moves forward, so too will prices.

Figure 3: United States ISM Manufacturing Sentiment – Prices Paid

Chart 3 3 June

After yesterday’s data, we now expect US Q2 GDP to be about 3.5%

United Kingdom: Weird goings on in the housing market

Table 3 3 June

Something weird is happening in the UK. Despite better employment, income and wage data, house prices may be moderating. Lots of comment focuses on the fact that in the last year prices have risen by 12%, but in recent weeks that momentum has slipped back dramatically.

Mortgage approvals declined from 66,500 in March to 62,900 in April. This was a slightly larger decline than was expected. Mortgage approvals have fallen for 5 consecutive months from their recent peak at 75,800 in January.

This is perplexing me as I expected UK housing activity to remain frothy. Maybe all the talk of bubbles  has affected the average person, but I think not. I would be very surprised if the UK housing market doesn’t strengthen again in the months ahead.

Figure 4: United Kingdom Mortgage Approvals vs House Lending

Chart 4 3 JuneElsewhere in the UK, we saw a small decline yesterday in manufacturing sentiment, driven by falls in employment (55,300 to 54,300), output (61.8 to 61.3) and orders (59.9 to 59.4). The Manufacturing PMI has now been around its current levels since August last year, suggesting stable growth levels in the UK but with no further acceleration.

Figure 5: United Kingdom Manufacturing Sentiment

Chart 5 3 June

China: Steady as she goes

Table 4 3 June

Our anti-consensus China bet has played out well for us. I believe that the consensus is wrong on China and that it will manage to avoid a massive crash. We have invested accordingly.

The official Chinese PMI indicator released during the weekend was stronger than expected, rising to 50.8 in May from 50.4 in April. The most important components –  new orders and production indexes – both rose and the increase in new orders was particularly large, which is encouraging. The stronger PMI reading will likely ease market and policy makers’ concerns about economic growth. But I believe the government will still implement further policy measures supporting growth until there is more solid evidence of stronger growth from hard (as opposed to survey) data.

Portfolio: Reducing exposure after some solid gains.

Table 5 3 June


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