Wednesday 2 May 2012

Growth divergence between US and Europe? It's the credit conditions stupid...

“The European Central Bank has a different task from that of the US Fed or the Bank of England”
Chancellor Angela Merkel.

Given many pundits have been noticing the growing growth divergence between the US economy and  the European economy as indicated by their respective PMI indexes, we thought it was time to provide further explanations. On the 4th of December 2011, in our conversation "A Tale of Two Central Banks", we explained why the difference approaches followed by the two Central Banks, the FED and the ECB would lead to different growth outcome: "This week analogy with Charles Dickens' masterpiece, relates to the different stance currently being taken in Europe in relation to what the ECB's role should be in the ongoing Europe sovereign debt crisis. Given recent macroeconomic set of data, for both the US and Europe, indeed we can say we have a Tale of Two Central banks."

In recent conversations as well we have been highlighting the growth differential between the US and Europe ("Shipping is a leading deflationary indicator"):
"We have long argued that the difference between the FED and the ECB would indeed lead to different growth outcomes between the US and Europe (US economy will grow 2.2% this year versus a 0.4% contraction in the euro area, according to the median economist estimates compiled by Bloomberg):
"Whereas the FED dealt with the stock (mortgages), the ECB via the alkaloid LTRO is dealing with the flows, facilitating bank funding and somewhat slowing the deleveraging process but in no way altering the credit profile of the financial institutions benefiting from it! While it is clearly reducing the risk of banks insolvency in the near term, it is not alleviating the risk of a credit crunch, as indicated in the latest ECB's latest lending survey which we discussed in our last conversation -The LTRO Alkaloid - 12th of February 2012."

In our March "Shipping" conversation we indicated as well:
"LTRO 1 and LTRO 2 will not enable Europe to escape a slower growth, credit crunch and a recession. Maersk is in fact shifting its business away from Europe as indicated by Christian Wienberg in Bloomberg in his article - Maersk Bets Against European Recovery as Recession Kills Trade:

“We think there will be negative growth in Europe this year and that is affecting our view of Asia-Europe trade,” Trond O. Westlie, chief financial officer of A.P. Moeller-Maersk A/S, the owner of Maersk Line, said yesterday in an interview in Copenhagen. “The solution that Europe is trying to take is different from the solution that the U.S. is taking. We believe that general growth will be higher in the U.S.”
We argued last year (It's the liquidity stupid...and why it matters again...August 2011) that:
"Lack of funding means that bank will have no choice but to shrink their loan books. If it happens, you will have another credit crunch in weaker European economies, meaning a huge drag on their economic recovery and therefore major challenges for our already struggling politicians."

The divergence between US and European PMI indexes - source Bloomberg:
Widest level reached since 2008, 8.90 between both PMI indexes.

The divergence between VIX and its European equivalent V2X - Source Bloomberg:
The highest point reached by VIX in 2011 was 48 whereas V2X was 51. VIX is around 17.20,  and V2X at 28, highlighting as well the rising disconnect between US and Europe in relation to risk perception.

It is all about Stocks versus Flows:
"We mentioned the problem of stocks and flows and the difference between the ECB and the Fed in our conversation "The European issue of circularity", given that while the Fed has been financing "stocks" (mortgages), while the ECB is financing "flows" (deficits). We do not know when European deficits will end, until a clear reduction of the deficits is seen, therefore the ECB liabilities will have to depreciate."

As our friends at Rcube Global Macro Research indicated, for tracking credit availability, you need to use the central banks’ credit surveys. As a reminder, for the Eurozone, the % of banks tightening their lending standards spiked to 35% in Q4:
"Since early February, one of the catalysts behind our bearish view has been based on the tightening of lending standards across the world, and more particularly in Europe.
Over the last month, apart from the BoE credit survey, data has indicated that the risk of a credit crunch has somehow receded."
- Source Rcube Global Macro Research.

"It is interesting to highlight not only that the actual net lending standards eased substantially, but that banks are also expecting net tightening to be close to zero next quarter." - source Rcube Global Macro Research:

"The main factor behind the improvement is the very substantial improvement in funding conditions." - source Rcube Global Macro Research:
But as our good friends Rcube put it in relation to Europe:
"However, we have to keep in mind that the survey was conducted near market tops (between the 23rd of March and the 5th of April). Since then, Spanish spreads have continued to widen, putting the size of the current ESM/EFSF firewall under question."

Hence the importance of tracking the ECB lending surveys. As Bloomberg indicates on the 2nd of May, the ECB Loan survey recovery is key positive for EU Growth Prospects:
"The correlation between euro zone expected corporate loan demand and GDP evolution has been strong since 2003. Should the survey continue to prove a useful leading indicator, its rebound in 1Q could prove to be a turning point for GDP. Euro zone GDP is currently forecast to shrink 0.4% in 2012 and grow 1% in 2013, according to Bloomberg consensus." - source Bloomberg.

Eurozone Corporate Loans and Mortgages Outstanding (Eur bn) versus Change in Expected Demand for Corporate Loans and Mortgages - source Bloomberg:
"ECB lending surveys on expected demand for corporate and mortgage loans in the coming three months have rebounded in 1Q, as the ECB's measures deferred liquidity concerns and markets recovered. Euro zone corporate loans have fallen 175 billion euros since January 2009 highs, and a reversal of current trends is vital for GDP growth to take root." - source Bloomberg

But unfortunately as Spain is concerned, Corporate lending has been cut by 19 billion euro:
"Since the first ECB three-year facility, Spanish monetary financial institutions increased gross central bank borrowings by 210 billion euros while cutting corporate loan supply by 19 billion. With renewed focus on growth strategies as well as austerity, Spain will need its banks to lend while it delivers on 37 billion of austerity measures." - source Bloomberg.

The European Banking Association requirement of reaching a Core Tier 1 Capital of 9% by June 2012, has been for some countries akin to shooting oneself in the foot, as it has been for Portugal - source Bloomberg:
"Portuguese banks may have to squeeze lending further to meet commitments the country made to creditors in its 78 billion-euro ($103 billion) aid program, undermining efforts to fuel growth through loans to businesses.
The CHART OF THE DAY shows that a slowdown in savings growth may make it harder for banks to reduce the ratio of loans to deposits to 120 percent as pledged in the bailout. Deposits rose 0.4 percent in January, the same as the previous month and a fraction of the 1.4 percent pace in November. That’s putting pressure on banks to trim the ratio by curbing new lending." - source Bloomberg.

Moving on to the US, the recently released Quarterly Senior Loan Officer Survey shows that the US credit channel has eased further - source Rcube Global Macro Research:
"While non-price terms (lending standards) eased somehow, price terms eased more substantially. The % of banks that are increasing their spreads of loan rates over their cost of funds has reached the second lowest level since the 1990s. Demand has also peaked up and is now as high as in 2004/2005." - source Rcube Global Macro Research.

On another note CreditSights in their review of the April Loan Officers Survey indicated the following:
"As was the case in January and October 2011, the April survey included questions about lending to European banks and "euro-exposed" firms. Banks reported tightening standards (but to a lesser degree than in January) and domestic respondents reported increased demand owing to reduced competition from European banks."

So when it comes to the divergence between US and Europe, well as the title goes, it's the credit conditions....
"Demand has also peaked up and is now as high as in 2004/2005." - source Rcube Global Macro Research.

US Private Sector Credit Growth and Fed Funds - Rcube Global Macro Research:

And my Rcube friends to conclude their recent note on US Private Sector Growth:
"Looking now at how the information impacts our credit and volatility models, we believe the survey is another indication that both equities and credit spreads should re-test their March levels. Our US high yield model shows a large deviation from fair value, with our fair value currently at 425bp vs. 600bp on the ML US Master II index."

So from a credit point of view, we agree with our Rcube friends, US HY is behind the Fitted Value:

"Our credit availability indicator, which is an average of price and non price factors, is behind the FV drop." - Rcube Global Macro Research

"We avoided a major credit crunch" - Mario Draghi - 9th of February 2012. Press conference after the bank's monetary policy.

He added at the time:
"We are indeed concerned by the slowing down of credit."
He also said that the central bank's "primary interest is in lending to the real economy. "That's where we see most of the credit tightening."
He noted 3 categories where lending had tightened:
Corporate, housing and consumption. "In some countries you've got credit tightening in all these three categories"
About LTRO 1 impact:
"The impact of the first LTRO is still unfolding".
Stay tuned!

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