France in the gun

From 4cast comes this take on the pressure on the French economy and the implications for the EFSF:

While the latest euro PMIs are really no surprise, they nonetheless continue to spell trouble. Through the chequered details currently available (German and French breakdowns heading in opposite directions, with France services weaker, and German manufacturing weaker), there is one basic message – the overall eurozone is clearly in a recession of some variety or other. The only genuine question appears to be how long and severe that downturn is. What remains a particularly concern is not only the recessionary levels now reached, but the extreme pace of deterioration still being registered.

Indeed, looking at both the current weak PMI level and the trajectory, over the relatively short history available the current readings are now consistent with virtually 100% odds of a recession (or at least OECD defined ‘downturn’).

With no clear signs of a let up in sight (beyond some levelling in the German reading), the current trajectory continues to look every bit as bad as the 2008 crash so far – the slump from the mid 50s to the mid 40s every bit as fast as the 2008 slump, if not faster:

Such readings continue to shine a bright spotlight on ECB policy. The composite PMI has tended to lead the ECB refi rate by a couple of months and current readings would still ordinarily be demanding aggressive easing action of over 150bp in past cycles. Of course, that is neither possible on this cycle, nor the primary option being undertaken – with ECB moves to date instead focusing on the non-conventional options: ongoing sovereign debt purchases; a second round of covered bond purchases that is likely equivalent to a sizeable 50bp+ rate cut in its own right; and the reintroduction of unlimited 1yr money starting with this weeks tender that is expected to see some EUR75bn+ of bids, even with excess liquidity levels are high levels. Those measures mark a sizeable if difficult to quantify alternative response to date, though it is clearly the case that the Bank will remain under ongoing pressure to review its refi rate hikes as well ahead, especially, as some board members have noted, when the December forecasts are considered.

What’s more, after a spell of euro core catch up where growth rates have crashed from the early year highs, we are now looking to be back into non-core led weakness, which does not bode well in terms of either resilience to austerity measures or in terms of negative feedback from funding stress to growth and back again:

With the overall and France and German figures already seen, it looks like the rest have plunged back onto a 44 handle on the flash estimate. That would be the weakest since July 2009 but perhaps as importantly would suggest that the ex Franco-German contingent are again slumping, with a 3mth decline of over 2 standard deviations again, resuming the earlier summer crash that preceded the latest crisis. The signs are not good – financial conditions deterioration combined with austerity continue to drive waves of fresh non-core contraction, which in turn place extra burden on tax revenues, financial and credit conditions, and back again to sovereign bond performance.

Spanish bad loans, to give one example, have continued to accelerate with the latest data, and are now back to their highest since the mid 1990s. Bank balance sheet strain is coming from a number of directions:

Negative feedback between banking and sovereign pressures, austerity measures, and growth remain very much alive with the latest PMI data and that remains a pressing concern even as euro plan discussions are ongoing. As the EFSF has again today acknowledged, the EFSF’s rating and capacity in the end comes down to the AAA members who underwrite it. France remains the pressing concern as a renewed recession substantially increases the risk that one or more rating agency will place it on negative rating over the next three months, implying downgrade risks by the end of Q1.

France’s current PMI pace of deterioration is consistent with an exceptionally vicious deceleration in GDP growth that is at face value as sharp as the 2008 recession vintage. A deceleration in this ballpark would quickly drag yr/yr GDP from sub trend to more like -1% or worse by H1 2011. That sort of pace if maintain of course is again sharply widening the output gap.

This remains one of the big concerns for the next leg of the crisis and one that could quickly chip away at any hard fought EFSF plans this week. There is inevitably a tight relationship between the output gap and the budget deficit gap especially over the short-run, however much austerity measures try to make structural adjustments against the grain:

Were France’s output gap to widen from a hoped-for end 2011 of around -3% to more like -5% into 2012, then on recent best fit nonlinear regressions, that would, everything else constant, push the deficit out to more like 9%+ rather than the 4.5% pencilled in, or require extreme action that further hammered growth.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

Latest posts by Houses and Holes (see all)


  1. The “plans” to deal with the crisis are still based on best-case scenarios and steeped in denial. The Eurozone leaders are way behind the curve because it is too painful to acknowledge reality. Hence we can expect a new crisis and a new “solution” every three months or so, as it becomes apparent that the last “solution” was understating the problem by a ridiculous margin.
    So the current plan to recapitalise the banks with 100 billion Euros assumes that Europe is recovering and deficits are being reduced. Six months from now they will admit that Europe is actually back in recession and they really need 500 billion Euros to recapitalise the banks.
    But 500 billion will actually be another best-case figure, the real figure will be in the trillions and nationalization of the banks will be the only option.

    The lesson from Lehman Brothers is that the real problem is ten times larger than the leaders admit to, the acknowledged problem is just the tip of the iceberg.

  2. Ignore all that — and the Euro bond yields blowing out again overnight — its Risk Awwwwwwn Baby on the equity markets.

  3. I agree but when will the equity markets
    catch-up to the bond markets. Unfortunately I don’t have enough capital to short the daylights out of the equity markets

  4. Will private equity pump Eu100 billion into the banks?

    Consider, bank assets are deteriorating and downstream write-offs still await. At the moment, the markets will not lend to banks even on short terms. At least debt is intended to be repaid. Equity on the other hand is subscribed in perpetuity. Who is likely to make such investments – such benefactions to the All-Europa Sovereign Debt Relief Fund? This is a transparent attempt at illusion. There will be no equity infusions for the Euro banks.

    The next alternative step is supposed to be recapitalization by Sovereigns. This is also illusory. The debt-struck Euro States do not have the ability to recapitalize their banks. If they could do so, surely they would do it right now. (This is out of the question, as they scarcely have the means to service their current obligations.)

    So in 2012, the banks will supposedly be required to seek capital support – really, nothing more than new guarantees in any case – from the EFSF, which may well by then be exhausted.

    Recapitalizing the banks is the smallest task on the Euro agenda. And yet this is to be wished away, undone and/or postponed.

    • It seems like its mostly psychology. Unless the current Euro plan turns out to be really crap, markets will be happy. And as long as Euro leaders keep promising to do everything they can to stand behind their neighbors and banks, then the rally will continue to drag out the needed correction.

      I wonder who ends up making the call on whether the bank haircuts will be voluntary. I mean, if Nations can simply always blackmail banks then it never need be involuntary.

      For example. You must take 90% haircut on the debt OR we let Greece default and you lose it all. Asking for 50-60% cuts is hardly different or voluntary.