US growth: Should we be more optimistic?
The improvement in US activity has raised the prospect of a self-sustaining recovery as better payroll figures boost income and consumption. With yields at record lows, the Treasury market would be vulnerable to such a scenario. However, there are signs that the US economy is losing momentum and the data has begun to disappoint (see chart). More fundamentally, we doubt whether the recent falls in unemployment will be sustained, meaning that Fed policy is likely to keep Treasury yields underpinned for now.
The euro crisis: fundamental divergence
As the Euro crisis returns we look at the divergence in competitiveness across the region. Labour costs have risen more rapidly in the peripheral economies relative to their trading partners, undermining their ability to grow out of the crisis. We estimate that Spain and Italy need a real adjustment of 25 and 36% respectively - a monumental task made more difficult by structural changes in the world economy such as the emergence of China and Eastern Europe.
Recycling surpluses through Foreign Direct Investment (FDI) offers one route to a more competitive periphery. However, the pressing need for growth means that debt restructuring across the periphery, combined with a devaluation of the Euro against the US dollar, offer the best hope for the stricken region.
Eurozone: Momentum subsides as elections loom
It seems that the impact of the ECB’s 3-year LTRO 'bazooka' is wearing off. The ECB’s apparent reluctance to provide more liquidity has spooked markets causing the rally seen at the start of the year to reverse. Investors are once again pulling away from Spanish and Italian sovereign bonds, causing the cost of funding to rise and fears to return.
Moreover, the recent improvements in cyclical indicators appear to have been a red herring. The Eurozone composite PMI is now at its lowest level since July 2009 - a sign that the monetary union is set to double dip this year.
The political situation is not helping. A stalemate in the Greek elections could lead to the Hellenic state falling behind on austerity measures and angering its creditors, while a potential new President in France could unwind the EU's Fiscal Compact barely months after its agreement. Indeed, the Dutch government has just collapsed following disagreement on that very issue.
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