This week's credit cross-post from Macronomics, enjoy!
Looking at France's recent PMI print for manufacturing coming at 48.5 but most importantly services coming at 48.8 which in the French economy represent around 80% of the GDP versus 76% for the rest of the European union and given it has been a while since we have not used our beloved maritime analogies, we thought it would be nice to re-acquainted ourselves in our chosen title this week:
Previously on
MoreLiver’s:
KEVA
/ Merja Ailus / Keskusta special (updated)
Credit - In the doldrums
"There are many countries in the world that when they reached the
middle-income stage, they witnessed serious structural problems such as
growth stagnation, a widening wealth gap and increasing social unrest." - Li Keqiang
Looking at France's recent PMI print for manufacturing coming at 48.5 but most importantly services coming at 48.8 which in the French economy represent around 80% of the GDP versus 76% for the rest of the European union and given it has been a while since we have not used our beloved maritime analogies, we thought it would be nice to re-acquainted ourselves in our chosen title this week:
"The doldrums is a colloquial expression derived from historical maritime usage,
in which it refers to those parts of the Atlantic Ocean and the Pacific
Ocean affected by the Intertropical Convergence Zone, a low-pressure
area around the equator where the prevailing winds are calm. The low
pressure is caused by the heat at the equator, which makes the air rise
and travel north and south high in the atmosphere, until it subsides
again in the horse latitudes. Some of that
air returns to the doldrums through the trade winds. This process can
lead to light or variable winds and more severe weather, in the form of
squalls, thunderstorms and hurricanes." - source Wikipedia
Colloquially, the "doldrums" are a state of inactivity, mild depression,
listlessness or stagnation which we think clearly characterizes for us
the French situation in particular and the European situation in
general.
Therefore this week we will focus our attention on France and ask
ourselves an interesting question, can you have a credit-less recovery
in Europe?
In relation to France, if the Services PMI contracts at such a rapid
pace, it still doesn't bode well for France's unemployment levels with
president Hollande hoping to overturn the trend by year end. In that
specific case the trend is definitely not the friend of French president
Hollande as services represent the number one employment sector in
France (34% of total employment in 2010 according to INSEE).
We were not surprised either to see Germany's Flash Composite Output
Index jumping to a 10-month high of 54.3 from 53.2 in October. The
services index also climbed to a 9-month high of 54.5 from 52.9, the
manufacturing PMI climbed to a 29-month high of 52.5 from 54.5, and the
manufacturing output index increased to a 3-month high of 54.0.
The reason for Germany's racing ahead have all been explained not only in the title of a previous post of ours "Winner-take-all" in February 2013 but also in the contents should you want to dig further on the subject:
"In similar fashion to the winner-take-all computational principle,
when ones look at the growing divergence between France and Germany when
it comes to PMI, in the pure classical form, it seems only the country
with the highest activation stays active while all other see their
growth prospects shut down"
We have updated the graph displaying Manufacturing PMI for both Germany and France - graph source Bloomberg:
As a reminder, in our first credit post of the year, namely the "Fabian Strategy", we sounded the alarm in relation to France being clearly in the crosshair in 2013:
The story for 2013 in Europe we think, will be France:
In relation to France, in our conversation "A Deficit Target Too Far" from the 18th of April 2012, we argued: "We also believe France should be seen as the new barometer of Euro Risk with the upcoming first round of the presidential elections. Whoever is elected, Sarkozy or Hollande, both ambition to bring back the budget deficit to 3% in 2013 similar to their Spanish neighbor. We think it is as well "A Deficit Target Too Far" on the basis of our previous French conversation (France's "Grand Illusion").
In relation to France, in our conversation "A Deficit Target Too Far" from the 18th of April 2012, we argued: "We also believe France should be seen as the new barometer of Euro Risk with the upcoming first round of the presidential elections. Whoever is elected, Sarkozy or Hollande, both ambition to bring back the budget deficit to 3% in 2013 similar to their Spanish neighbor. We think it is as well "A Deficit Target Too Far" on the basis of our previous French conversation (France's "Grand Illusion").
Back in November 2012 in our credit conversation "Froth on the Daydream" we argued:
"Should industrial production print fell
to -3.3%, we believe France will no doubt be in recession, putting in
jeopardy its overly ambitious target of 3% of budget deficit in 2013 (A Deficit Target Too Far")."
We also indicated in our February 2013 conversation "Winner-take-all" the following:
"While the French government has decided to revise its growth outlook
for the year, the overly ambitious fiscal deficit in France of 3% will
not be met and even the revised growth outlook of 0.2% to 0.3% will not
be reached."
To that effect we justified our negative stance using a definitely scary
graph displaying, French industrial production (white line), French GDP
(orange line) and French Services PMI (blue line, data available since
2006 only) which we thought was telling the story on its own at the time
and still is, we think - source Bloomberg:
Of course the divergence story between Germany versus France, is not
only a growth divergence story, it is also an unemployment divergence
story - source Bloomberg:
We concluded our February note with this statement at the time:
"After all the "Japonification" of Europe is a story of a broken
monetary policy transmission channel, leading to liquidity constraints
to the private sector with and therefore no impact whatsoever to the
real economy, so no potential for economic growth to resume in France in
particular and Europe in general."
In relation to Europe's PMI data from November, France we think is the
worrying outlier, as indicated as well by Nomura from their recent note
from the 21st of November 2013 entitled "Modest recovery ongoing as
trend stabilises":
"In France the PMI data for November were disappointing, suggesting the economy is losing momentum.
The composite output PMI was 48.9 (from 50.5 previously), the lowest
reading in five months and consistent with the three-month moving
average declining marginally to 49.8 from 49.9 in October. While almost
negligible in size, the fall in the three-month moving average of the
French composite index is the first in eight months and it points to
some possible downside risks to our French GDP forecast of 0.2% q-o-q
for Q4.
The weakness in the French data was evident in the manufacturing and
services sectors. The manufacturing PMI dropped to its six-month low of
47.8 in November from 49.1 previously (consensus: 49.5). There
was no bright spot in the detailed report. In particular, manufacturing
new orders fell by more than 2 points to 46.1, signalling little chance
of revival in the sector in the near term. Moreover, new export orders dropped by 3.6 points to 48.5 and the employment index slipped to its five-month low at 48.2.
In the services sector, the headline index declined by 2 points to 48.8 (consensus: 51). One
element of concern was the sharp 4 point fall in the employment service
index to 46.7, which underpins the subdued nature of the recovery in
France. The new business sub-index is the only bright spot in
the services report, which rose to 49.3 from 48.5. However, it remained
below 50, thus not sufficient to bring the sector out of contraction in
the near term." - source Nomura
and Nomura to conclude their report:
"The data also show a greater divergence in economic performance between Germany and France, with the data for France confirming the services sector remains the laggard as we have highlighted in the latest edition of our business cycle positioning tool Galileo" - source Nomura
If indeed the services sector remains the laggard, then at some point
the French president will have to stop being delusional about the
probability of reversing the unemployment trend before year end. It will
not happen.
Moving on to the subject of the possibility of a credit-less recovery in
Europe, Bruno Cavalier from French broker Oddo, came-up with an
interesting report on the 20th of November. We have long argued that no
credit, meant no loan growth and no loan growth meant no economic growth
and no reduction of budget deficits. In his note Bruno Cavalier argues
that the argument relating to the possibility of having a recovery
without bank lending is incorrect in his note. He indicates that the
credit ratio to GDP has fallen from 55% since 2009 to 46%. Obviously
this credit ratio varies tremendously from one European country to
another. For instance, since the peak figure of 1st quarter 2009, it is
down by 50% in Ireland, 30% in Spain and 20% in Greece.
EMU: Loans to the private sector - graph source Thomson Reuters, ECB, Oddo Securities:
EMU: Loans to the non-financial corporations - graph source Thomson Reuters, ECB, Oddo Securities:
Bruno Cavalier quotes a report that shows that out of 388 economic
recoveries identified in 50 countries on several decade from researchers
of the IMF (Abiad, Dell’Ariccia & Li (2011),
“Creditless recoveries”, IMF working paper 11/58). They have
established that one out of five recoveries is credit-less. He indicates
that often, these credit-less recoveries have been preceded by
financial crisis. The work of Abiad and Dell'Ariccia, shows that
although credit might be constrained, a recovery is possible. Another
study by the BIS, quoted by Bruno Cavalier (Takats & Upper (2013), “Credit and growth after financial crises”, BIS working paper 416),
shows that in recoveries following a financial crisis, correlation
between credit and growth are non-existent for the two first years
following the crisis and turn slightly positive (but weak) in the
consequent two years.
The on-going financial fragmentation in Europe can be seen in the
differences in loan rates between core countries and peripheral
countries - graph source Thomson Reuters, ECB, Oddo Securities:
Where we agree with Bruno Cavalier from Oddo Securities is the
importance of tracking Bank Lending Survey which are done on a quarterly
basis by the ECB.
EMU: Credit conditions (z-score, supply & demand mixed) - graph source Thomson Reuters, ECB, Oddo Securities:
We argued in the past that the growth divergence between US and Europe were due a difference in credit conditions.
The divergence between US and European PMI indexes is all about credit
conditions. This is why the US is ahead of the curve when it comes to
economic growth compared to Europe. We have shown this before but for
indicative purposes we will use it again, the US PMI versus Europe and
Leveraged Loans cash prices US versus Europe - source Bloomberg:
The widest level reached since 2008, between both PMI indexes was 8.90.
Whereas investor sentiment combined with an excess of demand over supply
pushed the average price of S&P/LSTA Index loans up a quarter-point
to a fresh post-credit-crunch high of 98.88 cents on the dollar in
2013.
Another survey we have been using specifically on France to track
financial conditions has been a monthly survey in French published by
the AFTE (Association of French Corporate Treasurers). In our conversation "The European crisis: The Greatest Show on Earth", we indicated:
"When it comes to credit conditions in Europe, not only do we
closely monitor the ECB lending surveys, we also monitor on a monthly
basis the “Association Française des Trésoriers d’Entreprise” (French Corporate Treasurers Association) surveys."
In order to comprehend the opinion of French corporate treasurers on the
evolution of banks' margins, the AFTE calculates a difference between
the average interest rate applied to new corporate loans and the 3
months Euribor rate. The series below stopped in October and continue to
indicate some stability in banks' margin on new corporate loans below
one year. New credits above a one year maturity provided to French
corporate treasurers remains at elevated levels:
What has been improving though for French corporate treasurers according
to the latest November survey is access to financing. There is a slight
improvement in the latest survey, but conditions remain tough for
French companies:
While the rebound from the lows of the end of 2011 (which was due to the
acute liquidity crisis faced by the European financial system), the
LTROs have somewhat improved financial conditions for French corporate
treasurers, nevertheless conditions remain tough at -6.2% of negative
opinions still.
The latest AFTE survey ties up with Bruno Cavalier's note indicating the
difference of opinion between bankers and small to medium size
enterprises (SMEs) treasurers. Bankers indicate a lack of demand, while
corporate treasurers indicate that financial conditions are still too
restrictive, too tight.
SMEs which cannot get or accept a bank loan because cost was too high - graph ECB, Oddo Securities:
Share of SMEs which only get part of the loan they ask for - graph ECB, Oddo Securities:
Bruno Cavalier in his note concludes that given the on-going
fragmentation in Europe and the credit rationing that follows, it
reflects three parameters, risk aversion, difficulties of refinancing
for banks and the balance between their risks and recapitalization
needs. While the ECB will remain accommodative and the upcoming Asset
Quality Review (AQR) in 2014, he thinks we cannot expect a strong
rebound for credit availability in the coming months or quarters, but as
balance sheets get cleaned up, the following credit cycle that will
follow should comfort the economic recovery.
Touching again on the subject of credit-less recovery, another paper
from the World Bank published in May 2013 by Naotaka Sugawara and Juan
Zalduendo entitled "Credit-less recoveries - Neither a Rare nor an Insurmountable Challenge" made some interesting points:
"Private sector credit plays a crucial role in helping a country to recover from an economic recession.
For instance, credit provided by commercial banks can re-energize the
investment expenditure of enterprises and is an important option in
handling household finances. While a recovery without private sector
credit is possible, the empirical evidence suggests that such recoveries
occur at a much slower pace. Indeed, a credit-less recovery, defined as
a recovery from recession without a pick-up in real bank credit to the
private sector, is not an unusual event but has been observed both among
advanced and emerging economies.1 Even with different samples, the
literature tends to find that the share of credit-less recoveries is
around 20 to 25 percent of all recoveries." - Naotaka Sugawara and Juan Zalduendo, Credit-less recoveries - Neither a Rare nor an Insurmountable Challenge
Growth Performance, eight quarters before and after trough - source Credit-less recoveries - Neither a Rare nor an Insurmountable Challenge:
"In both country groups, though especially in the group of
advanced economies, growth rates two years (or, eight quarters) before a
trough, t-8, are similar between credit-less and credit-with events.
However, the growth gap gets wider and becomes quite noticeable at least
a year (i.e., four quarters) prior to the trough t. In the year the
recovery occurs, credit-less episodes experience slow growth rates;
however, this gap narrows after a year from the trough. By eight
quarters after the trough, growth in credit-less recoveries is 1.5
percentage point lower than that in credit-with recoveries in developed
countries. For emerging markets, the growth gap is even wider four and
five quarters after the trough, but it also narrows during the rest of
the second year following the trough. As a result, the growth
differential in the group of emerging markets ends up at broadly the
same level as in advanced economies." - Naotaka Sugawara and Juan Zalduendo, Credit-less recoveries - Neither a Rare nor an Insurmountable Challenge
They concluded their paper with these points:
"Credit-less recoveries are neither rare nor insurmountable challenges. The
empirical evidence suggests that such recoveries occur at a much slower
pace and are only somewhat more common among emerging markets.
But recoveries do eventually occur. In fact, economic performance is in
large measure correlated with the depth of the correction triggered
during the economic adjustment that precedes the trough; specifically,
the size of the downturn and the extent of external adjustment that
typically accompany a recession (from the current account adjustment to
developments in exchange rates). Also, openness has a dual role. Trade openness decreases the likelihood of a credit-less recovery as trade is a more stable source of financing.
Conversely, capital account openness might have a large impact by the
deleveraging process that typically follows a recession. But one must
also be careful as to what this implies for countries going forward as
the pre-recession period might have also meant large benefits in terms
of growth.
As to policies during the recession, policymakers must be aware
that excessive fiscal loosening might end up exacerbating the likelihood
of a credit-less recovery, though more research would be needed to
understand better their medium- to long-term implications. In
contrast, monetary policy seems to play a more beneficial role by not
increasing the likelihood of a credit-less event, especially in advanced
economies. Finally, the country choice to avail itself of an
IMF-supported program is negatively correlated with the likelihood of a
credit-less recovery. Seeking an IMF program tends to help countries
recover with an increase in private sector credit. The relationship
becomes statistically meaningful when the economic conditions at the
trough are controlled for.
And what can be concluded from the estimation about the likelihood of
credit-less events in ECA? Here the model seems to suggest that indeed
many countries in the ECA (Europe and Central Asia) region were likely
to experience a credit-less recovery—and they indeed did. But one must
also draw hope from the fact that investment—and presumably eventually
growth—typically recovers 8 quarters after a trough. This would suggest
that a credit-less recovery is not a reason for extreme concern. More
worrisome is that the region is now facing a renewed negative external
shock."
But when it comes to Europe, the situation is more complex due to the
single currency than warrants the World Bank and Oddo Securities. In a
Bruegel Policy Contribution of February 2013, the author Zsolt Darvas in
his note entitled "Can Europe Recover Without Credit?" argues the following:
"Data from 135 countries covering five decades suggests that
creditless recoveries, in which the stock of real credit does not return
to the pre-crisis level for three years after the GDP trough, are not
rare and are characterised by remarkable real GDP growth rates: 4.7
percent per year in middle-income countries and 3.2 percent per year in
high-income countries.
• However, the implications of these historical episodes for the current European situation are limited, for two main reasons:
• First, creditless recoveries are much less common in high-income
countries, than in low-income countries which are financially
undeveloped. European economies heavily
depend on bank loans and research suggests that loan supply played a
major role in the recent weak credit performance of Europe. There are reasons to believe that, despite various efforts, normal lending has not yet been restored. Limited
loan supply could be disruptive for the European economic recovery and
there has been only a minor substitution of bank loans with debt
securities."
• Second, creditless recoveries were
associated with significant real exchange rate depreciation, which has
hardly occurred so far in most of Europe. This stylised fact
suggests that it might be difficult to re-establish economic growth in
the absence of sizeable real exchange rate depreciation, if credit
growth does not return." - Zsolt Darvas - Bruegel Policy Contribution.
One of the most important point which has sustained credit markets in
Europe, has been the strong issuance levels in the bond markets and the
arrival of new issuers due to the on-going deleveraging process of
European Banks and the acceleration of "dis-intermediation" as large
corporates become more reliable on bonds for financing rather than on
bank loans which are generally more difficult to get due and service due
to covenants.
Zsolt Darvas made this very important points in his paper:
"Using US firm-level data, Becker and Ivashina (2011) interpret switching by firms from loans to
bonds as a contraction in credit supply, conditional on the issuance of new debt. They
find strong evidence of substitution of loans by bonds during periods
characterised by tight lending standards, high levels of non-performing
loans and loan allowances, low bank share prices and tight monetary
policy. They also find that this substitution behaviour has predictive power for bank borrowing and investment of small (out-ofsample) firms, which are not able to issue bonds.
In a related paper, Adrian, Colla and Shin (2012) also document the
shift from loans to bonds in the composition of credit in the US, and
argue that the impact on real activity comes from the spike in risk
premiums, rather than contraction in the total quantity of credit.
Gertler (2012) adds, by sketching a simple conceptual framework, that credit spreads are a more useful indicator of credit supply disruptions than credit quantities. Gertler (2012) cites Gilchrist and Zakrajsek (2012), who conclude that the
increase in spreads during the recent financial crisis was likely
symptomatic of unusual financial distress, and not just the reflection
of the increased default risk faced by borrowers.
Certainly, the above-mentioned studies analysed data that was available at the time of writing and therefore their sample periods end between 2009 and 2011. Since then, a number of attempts were made by European governments and the European Central Bank to help restoring normal lending and therefore the finding that credit supply was limited up to 2009 or 2011 may not
necessarily imply that such limitations exit now as well. However, European banks still suffer from a large, €400 billion, capital shortfall according to the OECD (2013); the share of non-performing loans continues to be high; bank share prices are low even after the recent increases; and banks need to meet tight capital, liquidity and leverage requirements, even though some of the Basel III requirements were relaxed in January 2013 (Basel Committee, 2013). These factors suggest that credit supply may remain constrained in the EU." - Zsolt Darvas - Bruegel Policy Contribution.
We also agree with the author's final conclusion:
"If credit growth does not return, economic recovery may prove to be
difficult in the absence of sizeable real exchange rate
depreciation." - Zsolt Darvas - Bruegel Policy Contribution.
For illustrative purposes, we looked at Spain's non-financial loans
versus GDP growth to illustrate the case of a the credit-less recovery
discussed - graph source Bloomberg:
But Spain being in the colloquial "doldrums", namely a state of
inactivity, mild depression, listlessness or stagnation, some of that
air returns to the doldrums through the trade winds, could lead to light
or variable winds and more severe weather, in the form of squalls,
thunderstorms and hurricanes ahead in Europe, when one looks at the
unemployment issues particularly hindering the economic prospects for
peripheral countries.
One just has to glance casually at the Spanish "Misery" index to fathom
the uphill struggle face by our European politicians - graph source
Bloomberg:
The misery index is calculated by adding the 12-month percentage change
in the consumer price index to the jobless rate. Arthur Okun, an adviser
to Presidents John F. Kennedy and Lyndon Johnson, created the indicator
in the 1960s.
So for us, unless our "Generous Gambler" aka
Mario Draghi goes for the nuclear option, Quantitative Easing that is,
and enters fully currency war to depreciate the value of the Euro, there
won't be any such thing as a "credit-less" recovery in Europe and we
remind ourselves from last week conversation that in the end Germany
could defect and refuse QE, the only option left on the table for our
poker player at the ECB:
"The
crux lies in the movement needed from "implicit" to "explicit"
guarantees which would entail a significant increase in German's
contingent liabilities. The delaying tactics so far played by Germany
seems to validate our stance towards the potential defection of Germany
at some point validating in effect the Nash equilibrium concept. We do
not see it happening. The German Constitution is more than an "explicit
guarantee" it is the "hardest explicit guarantee" between Germany and
its citizens. It is hard coded. We have a hard time envisaging that this
sacred principle could be broken for the sake of Europe."
On a final note, we think the outlook for the US could be further
boosted by fall in Oil imports, making the exit strategy for the Fed as
difficult as it was for the team of Apollo 13 and the heroin of visually
stunning movie Gravity to land back to earth - graph source Bloomberg:
"U.S. oil imports are close to a 22-year
low, a trend that is expected to continue through 2014 from increased
domestic shale drilling. About 10.5 million barrels a day were imported in 2005, with about 8.5 million barrels coming from seaborne trade. That
number has decreased to 5 million barrels, according to Teekay Tankers.
Crude tanker ton-miles will decline, though product tankers should
benefit from an increase in U.S. refined exports." - source Bloomberg.
"Happiness, to some, elation; Is, to others, mere stagnation." - Amy Lowell, American poet.
Stay tuned!