Market Economics

24 June 2011

Daily Economic Spotlight

Eurozone: Deeper Downturn?
Ken Wattret The markets have added another concern to the long list of worries about the eurozone following the latest round of PMI figures: specifically, a sharper than expected slowdown in growth. Junes PMI data for the eurozone were far weaker than expected The flash PMI data for June were alarming, with both the manufacturing and service sector indices falling at a much faster than expected pace in June. The manufacturing headline index fell from 54.6 to 52.0, its weakest level since December 2009 and seven points down on Februarys high (59.0). The cumulative fall in the two months to June was almost six points, the biggest since the aftermath of the collapse of Lehman Brothers. The sub-index of new orders fell below the 50 expansion threshold in June for the first time since late 2009, to 49.6, ten points below its cycle high. While comfortably in expansion territory still, the PMI for the service sector is also losing ground at a rapid rate, sliding from 56.0 to 54.2 in June. This compares to a cycle high of 57.2 in March. Chart 1: Eurozone Surveys Sliding
65 60 55 50 45 40 35 30
S hading = S ub-50 R eadings N ot Follow ed by Stagnation or R ecession

M anufacturing P M I: N ew O rders

25 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Source: Reuters EcoWin Pro

Combining the two sectors, the eurozone composite PMI dropped from 55.8 to 53.6 in June. This level is consistent with a q/q GDP growth rate of about 0.3-0.4%, well down on Q1's 0.8% rise. Note also the PMI data have had a tendency to slightly over-state the rate of eurozone GDP growth. The run of weak survey data is by no means over. The PMI figures generally lead some of the other sentiment surveys, so we are likely to see a catch down in the latter in the period ahead. Germanys Ifo business climate, out today, looks to be overdue a correction on the basis of the fall in the German manufacturing PMI in recent months. The same is true for the European Commission sentiment data which is out on Wednesday next week. The industrial sentiment index has the highest weighting of the various sectors, at 40%, pointing to a sharp fall in the headline index. with the core countries also losing momentum There was weakness in the PMI figures in the core as well as peripheral economies in June, with the French data particularly striking. Its composite PMI plunged to 55.4 from 60.3, the lowest reading since October last year. The deterioration was broad based but the services PMI fell particularly sharply, plunging to 56.7 from 62.5, a six-month low.

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The German PMI data showed manufacturing activity slowing, as elsewhere, most conspicuously in the slide in the new orders sub-index. Now at 51.5, this is only just above the expansion threshold (having peaked at 67.0 in April 2010). The services PMI for Germany did well, however, rising to 58.3 from 56.4, an indication that domestic demand in Germany remains robust. The composite PMI in Germany rose in June, albeit marginally from 57.1 to 57.3, indicative of the economy still growing at a decent clip. The q/q annualised growth rate in GDP implied by the current level of the composite PMI is around 4%, down on Q1s 6% growth rate but still pretty good going. The q/q growth rate in GDP implied by the current level of the eurozone composite PMI is broadly in line with what we had already forecast for Q2 and Q3: i.e. 0.4% and 0.3%, respectively, with growth for 2011 as a whole of 2.0%. It has got there faster than we anticipated, however, which raises the possibility of a deeper downturn than we assumed (i.e. the 0.3% q/q growth rate in Q3 being the low point of our forecast for this year). How long the global manufacturing slowdown lasts is pivotal to the broader economic outlook As Markit, the compilers of the data, highlighted in tandem with the release of Junes figures, when manufacturing activity weakens in a lasting way, the service sector normally follows, with a lag. The duration of the downturn in the manufacturing sector is therefore pivotal to how the economy performs from this point onwards. An important issue in this respect is the shortening of the lags between the business cycles in different regions. This was illustrated by the correlation analysis which we highlighted in these pages yesterday. Developments in Japan have been a key contributor to the weakness in global manufacturing activity over recent months but the signs there have been turning more positive. The Japanese manufacturing PMIs output subindex fell like a stone after the earthquake and subsequent energy supply disruption, plunging to just 35 in April. But it rebounded to 51.4 in May, the biggest increase in the series history. Some key companies in the auto sector have also talked about their output levels returning to pre-earthquake levels in June or soon after. No rebound as supply disruptions fade in Q3 would suggest it may be more than just a soft patch Given the short lags between countries business cycles, it is reasonable to assume that the pick-up in Japan should soon start to pass through to the rest of the world if, as we believe, disruption to supply chains has been one of the main reasons for the global slowdown. The litmus test for this view will be whether, and by how much, the PMI data outside Japan rise between now and August/September. If there is no rebound, then we will need to reconsider whether this is more than just a soft patch. The emphasis on Japan is not to suggest that the eurozones economic performance is dependent on Japanese supply chain disruption. There are severe domestic difficulties in the periphery of the eurozone which are going to act as a dampener on growth for a long time to come. These problems should again be evident in the full national breakdown of the PMI data for the eurozone on 1 July. The ECB has to contend with high inflation as well as lower growth Coupled with concern over events in Greece and the potential spillovers, the sharp slowdown in growth is adding further fuel to the debate about ECB rate hikes being curtailed beyond July. As we pointed out above, we see the near-term data flow reinforcing this trend. But there are other factors to consider. First, though the economy is weaker, the outlook for inflation has worsened. We expect the ECB to be revising up their inflation projections in the coming quarters. Second, the ECB already embeds a sharp slowdown in growth in its forecast: that its projection for 2011 growth is lower than our 2.0% forecast points to an even weaker profile for q/q growth rates from Q2 than we assume. Third, a growth rate of 0.30.4% q/q would still be above the ECBs definition of potential growth. That the manufacturing PMI has fallen below 50 three times in the past decade or so when the economy was merely experiencing a mid-cycle pause is also a consideration (Chart 1).
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US: Mostly More of the Same

Yelena Shulyatyeva The disappointing news kept coming on Thursday. The disappointing news continued to push stock markets and Treasury yields lower on Thursday. The morning started with a back-up in jobless claims in the payrolls survey week, followed by another bleak housing market reading as new home sales fell in May. In addition, the news on the fiscal front added to the grief as two Republican negotiators said they were pulling out of the bipartisan budget talks for now because the group has reached an impasse over taxes. Initial jobless claims bounced back up to 429k, eliminating a modest improvement in the week prior when claims fell 10k to 420k. Looking through the weekly volatility, the 4-week moving average for claims was stable at 426k. The Labor Department analyst mentioned no special factors affecting this weeks reading. Seasonal factors had expected a decline of 3.6% in unadjusted claims. Instead, unadjusted claims fell by only 1.4%, thus an increase in the seasonally adjusted number. The analyst also noted that due to technology issues claims data from six states had to be estimated adding uncertainty to the claims number in the payrolls survey week. Claims remain elevated but, nonetheless, have come off their recent highs (near 478k) suggesting some improvement in June hiring. Chart 2: Claims Back Up in the Payrolls Survey Week

Initial jobless claims bounced up in the payrolls survey week.

Source: Reuters EcoWin Pro

New home sales edged down in May. The level of new home sales just above 300k remains anaemic by historical standards.

New home sales declined less than expected in May edging down 2.1% m/m (whereas the market was expecting a 4.0% decline) to 319k from an upwardly revised 326k in the previous month. The level of new home sales just above 300k remains anaemic by historical standards. Activity was mixed among the regions as sales in the Northeast dropped 26.7% m/m, sales in the South picked up 2.4% m/m and housing demand was virtually flat in the Midwest and the West. The months supply measure edged down to 6.2 months in May from 6.3 months previously despite the decline in sales, driven by a 3.5% drop in new home inventory. The latter is certainly a positive development resulting in less oversupply of unsold properties on the market. New home inventories have been on a constant downward trend since 2007; declines have accelerated in the last year. This certainly helped reduce the months supply measure to the lowest level since April 2010.

One positive development was that the months supply measure edged down to 6.2 months in May from 6.3 months previously despite the decline in sales, driven by a 3.5% drop in new home inventory.

Market Economics, 24 June 2011 www.GlobalMarkets.bnpparibas.com

Chart 3: New Home Inventories Have Improved

Source: Reuters EcoWin Pro

However, distressed existing home sales continue to rob demand from new home sales. New housing prices still remain less attractive compared to the cheap existing stock.

However, distressed existing home sales continue to rob demand from new home sales and construction activity. All-cash purchases have risen and investors cash-in-hand bargaining power continues to pressure prices lower. The spread between new and existing home sales prices eased from its record highs but remains elevated by historical standards. New housing prices still remain less attractive compared to the cheap existing stock. As such, new housing demand will likely remain depressed throughout this year and next. Chart 4: Existing Sector Robbing Demand from New Home Sales

Source: Reuters EcoWin Pro

One thing remains certain. As Chairman Bernanke noted in his press conference on Wednesday that only part of the slowdown is temporary, and part of it may be longer-lasting. The back up in claims could reflect both the temporary factors (such as supply chain disruptions) and somewhat longerterm ones (such as the global slowdown underway in emerging markets, which has clearly impacted exports and manufacturing activity beyond the supply chain issues). Meanwhile, the depressed stance of the housing market is likely more structural in nature and will keep on weighing on the recovery for longer.

Market Economics, 24 June 2011 www.GlobalMarkets.bnpparibas.com

Key Data Preview

Chart 1: German Ifo Business Climate & Growth
7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 GDP (% y/y) 75 70 85 80 100 95 90 110 105 Ifo Business Climate (RHS) 120 115

BNP Paribas Forecast: Past the Peak Germany: Ifo Business Climate (June) Release Date: Friday 24 June Ifos business climate index has fallen relative to its peak in February this year (of 115.4) but remains exceptionally high by the standards of past expansions and indicative of robust economic growth (see chart). The moderation since February is due to a fall in the subindex of expectations which declined in each of the three months to May. This reflects a combination of unfavourable developments including prior oil price rises, supply chain disruptions caused by events in Japan, slower growth in China and policy tightening signalled by the ECB. The decline has been small in the context of the stream of adverse news, however, which highlights the underlying strength of the German economy. This is reflected in the assessment of the current business situation in Germany which hit another record high in May. On the basis that the expectations index typically leads the current conditions index by 3-6 months, a moderation in the latter is likely going forward. We forecast a fall in the headline business climate index in June, following declines in other survey data recently. The Ifo Institute has highlighted that inflationary pressures are picking up, with businesses confident in being able to pass on increases in their input costs.

Sources: Reuters EcoWin Pro

Jun (f) Headline Expectations Current Conditions

113.0 105.9 120.4

May
114.2 107.4 121.4

Apr
114.2 107.7 121.0

Mar
115.0 109.2 121.0

Key Point: The business climate index is moderating but remains consistent with strong growth.

Chart 2: French Hh Confidence

40 30 Diffusion Indices - Net balance 20 10 95 0 90 -10 -20 Good Time to Spend -30 -40 04 05 06 07 08 09 10 11 80 75 85 Good Time to Save Headline Index (RHS) 110 105 100

BNP Paribas Forecast: Recovering France: Household Confidence (June) Release Date: Friday 24 June French household confidence only started to recover in May, while the economy has been doing well for some time. The change occurred when gasoline prices eased allowing a decline in perceived inflation (gasoline prices have a major impact on perceived inflation, well beyond their actual weighting in family budgets). We expect more of the same in June as the survey, which is carried out in the early part of the month, did not capture the total impact of the decline in crude prices in May. Households are highly sensitive to purchasing power. The international economic backdrop is getting worse, but this is unlikely to affect household confidence. The latest employment data were strong and the recent evolution of the labour market has also been encouraging with an ongoing decline in unemployment. Confidence should continue to recover but not soar. Meanwhile, buying plans could improve more significantly since they are much weaker than the actual level of retail sales.
Normalised Index

Sources: Reuters EcoWin Pro

Diffusion Index, SA

Jun (f) 85 -26 -17.0

May 84 -28 -17.2

Apr 83 -24 -19.3

Jun 10 84 -22 -22.0

INSEE indices: Overall Buying opportunity EU Commis. Index: Headline

Key Point: The positive impact of lower oil prices should continue to drive confidence up.

Market Economics, 24 June 2011 www.GlobalMarkets.bnpparibas.com

Key Data Preview

Chart 3: US Disruptions Likely to Take Toll BNP Paribas Forecast: Disruptive May US: Durable Goods (May) Release Date: Friday 24 June Durable goods orders are expected to decline by 0.7% m/m in May. The significant fall we expect reflects modest Boeing aircraft orders and the heavy impact of the supply chain disruption on vehicle and parts orders as a result of the events in Japan. Meanwhile, we look for orders ex transportation to increase by 0.1% m/m. Defence orders should post a small rise after Aprils decline. Consistent with the volatility cycle in core capital goods orders and the impact from the supply chain disruption, we expect a small decline for the month. Recall that non-defence capital goods shipments ended Q1 up 3.0% q/q a.r., in line with the equipment and software component of GDP which it closely tracks.

Sources: Reuters EcoWin Pro

% m/m

Durable Goods Ex-Transport

May (f) -0.7 0.1

Apr -3.6 -1.6

Mar 4.6 2.6

Feb -1.1 -0.6

Key Point: Supply chain disruptions are likely to continue to take their toll on durable goods orders.

Todays Events
Fri 24/06 GMT 06:45 07:00 07:00 07:30 08:00 08:00 08:00 08:00 08:00 08:00 09:30 Local 08:45 09:00 09:00 09:30 06:00 06:00 10:00 10:00 10:00 10:00 10:30 France Spain Neths Germany Consumer Confidence : Jun PPI m/m : May PPI y/y : May Producer Confidence : Jun Retail Sales (BBK, Real, sa) m/m : May Retail Sales (BBK, Real, sa) y/y : May Ifo Business Climate : Jun Ifo Current Conditions : Jun Ifo Expectations : Jun Retail Sales y/y : Apr BoEs King Speaks at Financial Policy Committee Press Conference Durable Goods Orders m/m : May GDP (Final, saar) q/q : Q1 GDP Deflator (Final, saar) q/q : Q1 Corporate Profits (Rev, saar) q/q : Q1 Previous 84 0.6% 7.3% 3.1 0.3% 0.6% 114.2 121.4 107.4 -2.0% Forecast 85 0.1% 7.2% 1.5 0.7% -0.4% 113.0 120.4 105.9 0.6% Consensus 84 n/a n/a 2.5 0.7% 1.3% 113.4 120.8 106.3 -0.7%

Italy UK

12:30 12:30 12:30 12:30

08:30 08:30 08:30 08:30

US

-3.6% 1.8% (p) 1.9% (p) 1.3% (p)

-0.7% 1.8% 1.9% 1.3%

1.5% 1.9% 1.9% n/a

Release dates and forecasts as at c.o.b. prior to the date of publication:

Source: BNP Paribas

Market Economics, 24 June 2011 www.GlobalMarkets.bnpparibas.com

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BNP Paribas Hong Kong Branch is regulated as a Registered Institution by Hong Kong Monetary Authority for the conduct of Advising on Securities [Regulated Activity Type 4] under the Securities and Futures Ordinance. BNP Paribas (2011). All rights reserved. Market Economics Team Paul Mortimer-Lee Ken Wattret Luigi Speranza Eoin OCallaghan Global Head of Market Economics 44 20 7595 8551 Chief Eurozone Market Economist, 44 20 7595 8657 Germany Head of Inflation Economics Eurozone, Italy Inflation, Switzerland, Ireland 44 20 7595 8322 44 20 7595 8226 Gizem Kara Dominique Barbet Julia Coronado Scandinavia Eurozone, France Chief Economist North America 44 20 7595 8783 33 1 4298 1567 1 212 841 2281 1 212 841 2258 1 212 471 7996

Yelena Shulyatyeva US Bricklin Dwyer US, Canada

Market Economics, 24 June 2011 www.GlobalMarkets.bnpparibas.com