Weekly Economic Commentary • Principal Global Investors
Covering the week ended June 6, 2014 — Published on June 12, 2014
Draghi Fires a Good-Sized Bazooka
"If you've got a squirt-gun in your pocket, you may have to take it out. If you've got a bazooka, and people know you've got it, you may not have to take it out."1 Well, European Central Bank (ECB) President Draghi persuaded investors that he had a real bazooka. His commitment to "do whatever it takes" to protect the euro, "and believe me it will be enough," was so convincing that he never had to use it. That is, until now; and upon firing, it looks to be effective.
Draghi's commitment in 2012 kept the currency union intact. Since then, however, he's had to wrestle with a meager recovery, high unemployment, too-low inflation, and banks with bad loans that were reluctant to lend. After two years, his words had run out of steam. On Thursday, Draghi announced a series of steps to stimulate bank lending and enhance liquidity. The ECB:
- Lowered the interest rate on main refinancing operations (MROs), the primary ECB policy tool, from 0.25% to 0.15%.
- Cut the rate on the bank deposit facility from zero to 0.1%, a negative rate, which will apply to all reserve holdings above minimum requirements, or about €125 billion.
- Sliced the rate on the marginal lending facility by 0.35% to 0.40%. All rate changes will take effect June 11.
- Created a new facility to enhance bank lending. The ECB will conduct a series of targeted longerterm refinancing operations (TLTROs). All TLTROs will mature September 2018 and carry a fixed rate set at 0.1% above the MRO. Banks using the facility can borrow 7.0% of their outstanding loans to households and business, excluding mortgages, as of April 30.
- Extended the time it would offer banks whatever liquidity they need (rather than auction fixed amounts, known as full allotment) through overnight loans and three-month LTROs with the current expanded collateral requirements to year-end 2016.
- Suspended the weekly sterilization of liquidity injected under the Securities Markets Program, where the ECB directly purchased government bonds of countries that had requested bailouts. This could amount to an estimated €164 billion.
- Will intensify the preparatory work necessary for direct purchase of asset-backed securities (ABSs) to "enhance the functioning of the monetary policy transmission mechanism."
1 U.S. Treasury Secretary Hank Paulson, July 2008.
Are We There Yet?
For above-trend growth in the U.S. economy, that depends on where one looks. Recent payroll reports have suggested we're getting closer, and Friday's data was solid and well above the worried whisper numbers.
Payrolls Looking Better
After five years, payrolls have finally recovered all of the 8.71 million jobs lost from the peak in January 2008 to February 2010; that was a rate of over 348,000 lost jobs each month, a tragedy of the first order. May's 217,000 payroll adds followed three months of average 237,500 job gains. The gains were broad-based, with 62.7% of industries showing gains. Over the last year, an average of 61.6% of all job categories have shown job gains, higher than any 12 months since the tech bubble burst.
Besides the new record high of 138.5 million jobs, this was the first time job gains exceeded 200,000 for four straight months since January 2000. The manufacturing workweek hit 41.1 hours, a record since data began in the 1940s. Average hourly wages are rising at the best year-over-year pace of the cycle at 2.4%, with total payroll earnings up at well over a 5% annualized pace over the last three months. April's big job gains held up under revisions of only 6,000 to 282,000. The number of full-time workers jumped 312,000, while those working part-time fell 78,000. The widest measure of unemployment, the so-called U-6 Index, ticked down again to 12.2%, the lowest of the recovery.
Other U.S. Data Recovering
Vehicle sales hit a 16.7 million annual rate in May, matching the highest monthly rate since July 2006. And the three-month average rate of 16.3 million is the best three months since April 2007. The Federal Reserve's Beige Book was more upbeat in its latest issue. Purchasing manager indices show solid growth with increasing momentum. Bank loan growth is still surging. Household net worth is soaring, now up to $82 trillion in the first quarter, a new all-time high on the back of rising stock and house prices.
Will Investment Pick Up?
The key to hitting above-trend economic growth is better wage and salary income and increased capital spending. Why hasn't it happened yet? We’ve called it PCRD, Post Crisis Relapse Disorder, where one wakes up every morning thinking the recession is still going. The financial crisis was so severe, so sudden, so unexpected, profits were hit so hard, cash and liquidity was so hard to come by, and businesses have very deep scars left from the slump. It left businesses (as well as households) feeling they had to be very careful about spending, that they needed fortress balance sheets with plenty of cash because the outlook was so uncertain and relapse could be just around the corner.
Around the World in Short Order
In Japan, the worst may be over from the impact of the three-point rise in the value-added tax to 8% on April 1. Purchasing manager indices for May have recovered about half of the April drop. The Shoko Chukin survey of small businesses suggests that service activity is firming. Wages are rising and the employment survey indicates job gains progressing at a 0.7% pace in April over the prior year. Job openings are up and applicants are down so the opening-to-applicant ratio is 10.8, nearly the best since the mid-1990s.
Economic growth in China may be bottoming but is surely quite weaker than the 7.5% official target. While still low, purchasing manager surveys have picked up for several months. Home prices fell a bit in May, the first drop in 23 months. Luxury sales in Hong Kong have fallen off a cliff, likely due to the crackdown on ostentatious spending and corruption. Exports are strong and we believe growth will stay in the 6% to 7.5% range for the intermediate term.
The Eurozone recovery is fragile and halting. Retail sales did rise a nice 0.4% monthly in April after a 0.7% pickup in the first quarter. Business surveys dropped some in May: manufacturing to 52.2 from 53.4; the composite Purchasing Managers Index (PMI) to 53.5 from 54.0 in April; but, services actually rose 0.1 to 53.2 based on a strong jump to 56.0 in Germany. First-quarter growth was left unrevised at a measly 0.7% annual rate. The composite PMI is consistent with second-quarter growth of about 1.5%. The action by the ECB noted above should help solidify the recovery.
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