1 – I don’t think that a government will be able to work consistently and efficiently in Italy. The sole reason is that each party has a different thinking of Italy’s position in Europe. Some are clearly Europeans (Bersani), some clearly ask for an exit (Grillo) and for the third it depends on opportunities (but skeptical with Euro). How can it be imagined that a coalition could work. If it is possible at a regional level with no real macroeconomic questions, it is hard to imagine for a government to have so divergent ways of thinking.
This means that new elections will take place in the coming months.
I don’t believe in a new technical government. Mario Monti’s government was perceived as a technical one and failed. Monti’s failure at the general elections (4th and far from the first three) is a measure of the lack of popularity for this kind of government. A new technical government would lead to a deeper polarization of the Italian society and probably counter-productive.
In short there are three kinds of risks
• The economic situation is very weak in Italy. To give few figures: GDP change was -2.2% in 2012, Households purchasing power was down by almost 4% in 2012 and exports momentum is low by lack of competitiveness. This means that with a low momentum in world trade, an impulse on activity from exports cannot be expected. Internal demand is very weak. In a government of transition before the elections we cannot expect some new measures that could change the trajectory.
This means that the economic dynamic will weaken before the elections.
People who are not happy with the current situation could vote more massively against the “system”
• The second kind of risks is that this anti euro stream can be legitimated by Italian vote and give more power to Anti Euro parties in other countries. In the Euro Area unemployment rate was at 11.9% in January, an historical high. In Italy, Portugal, Greece and Spain unemployment is already high and these countries are those which adopted austerity policies. France could be the next candidate. The political legitimacy from the Anti-Euro vote would be to say that Euro is a too strong constraint and some different choice has to be tried.
• The third kind of risks would come from a higher probability but still low of something that could go wrong in the Euro Area. This would renew business uncertainty and associated with it low investment from companies as they do not know the institutional framework.
In other words, the Italian situation, as Italy is the third powerful country in the Euro Area, everything that could affect its trajectory will affect European trajectory.
2 – The second point is about fiscal policy in the USA. In fiscal year 2013 the Congressional Budget Office (CBO) expects a budget deficit at -5.3% of GDP after -7% in 2012.
This improvement will come from higher receipts due to growth, to the new measure coming from the fiscal cliff resolution (mainly a 2% charge on wages) and the sequestration which means that expenditures will be cut.
On this latter point to understand the situation we have to go back to August 2011. Discussions on debt limit agreement were associated with expenditure cuts that were supposed to be organized by an ad hoc commission. Cuts should have been between 1 200 and 1 500 USD Billion on 10 years. As no agreement was signed there are automatic cuts that started on March the 1st. Cuts will be done without distinctions.
The impact on 2013 fiscal year will be USD 85 Billion.
The CBO has calculated that the two measures (fiscal cliff resolution and expenditure cuts) will cost 1.25% of growth on 2013 civil year. Sequestration only will subtract -0.6% of GDP growth and 750 000 jobs.
3 – In this fiscal environment Ben Bernanke said that he was not expecting changing its monetary policy. And we could understand that if there is more uncertainty of fiscal policy the Fed has to compensate. At another presentation on interest rates he said that long term interest rates depend mainly on inflation expectations and monetary policy stance. The first is conditioned by central bank credibility. Bernanke noted then that expectations were stable as the Fed is credible. So interest rates will depend on monetary policy and the way monetary policy change will be announced. Clearly he said that he didn’t want to say something that could weaken the Fed’s position and feeding higher interest rates expectations. With fiscal uncertainty and the fragility of the recovery he clearly said that he didn’t want to take this kind of risks.
We can expect low interest rates for a long time period.
4 – The new government in China has taken measures to limit real estate speculation. (I will come back later on this issue)
5 – The main question for UK is growth and what Moody’s mentioned in its press release is that Cameron’s strategy to stabilize public finance and to boost growth has failed. Since Q3 2010 GDP trend is flat and it presents a break compared to what was seen before.
The main point is that in a poor global environment (world trade is growing slowly since spring 2011) with strong internal constraints after an excessive real estate credit cycle, you cannot be successful by adopting an austerity policy. In other words, usually fiscal policy’s task is to smooth shocks on the economy, with austerity policy the adjustment process is displaced to the private sector. If the global environment has a strong momentum a trade-off is possible between lower government impulses and exports impetus. Currently this is not the case and consumption and companies’ investment trends are still lower than before the crisis. Austerity policy cannot resume confidence in that environment.
As growth numbers stay low, government targets for public deficit and public debt cannot be attained leading to stronger targets, adding then more constraints on consumers and companies and at the end leading to lower growth numbers. This vicious loop will continue as far as the government maintains its austerity policy.
If as the government said they will not change their strategy after the downgrade, the current economic trend will not be changed deeply. We will not change our view and others rating agencies could follow Moody’s.
Can they go further than one notch? No if UK does enter in a new recession, instead….
6 – On the global economic outlook we noticed that the improvement seen at the end of 2012 is probably weaker than expected.
But the current period is complicated to explain as there are some up and down in Asia due to the Chinese New Year. So probably January figures were too strong and February’s too low.
If we compare the first two months of 2013 to the last 2012 quarter we see that there is an improvement almost everywhere. But there is no break that could change the world economic trajectory.
We can see that on the chart where we notice that US surveys are almost strong. On the symmetry Japan and the Euro Area are still weak (below 50) even if in Europe Germany is doing better (index at 50). France is diverging. Its momentum is currently very low and the divergence with Germany is problematic.
Within Europe we notice that Spain is doing better in this survey but keeps still below 50. We notice also UK drop in February. This increases the risk of a third dip.
7 – Strong capital goods orders in the USA in January. That’s probably the best news of the week. This means that productive investment is improving rapidly and that’s very positive for the business cycle in the USA
8 – Home sales are still oriented on the upside in the USA. That’s one reason of Bernanke will to keep interest rates low. This has two economic implications: 1 – It will create a lot of jobs; 2 – There will be a wealth effect as the real estate market is more robust and prices are on the upside. This will reduce uncertainty and that’s pretty positive.
9 – Inflation rate in the Euro Area was at 1.8% in February from 2% in January
10 – Improvement on the German labor market in January on employment and in February with lower unemployment. This is consistent with upturn on companies’ surveys.
11 – Spanish GDP number for the fourth quarter was negatively revised. In its first estimate the Spanish Central Bank said that GDP was down by -0.6%. At its first estimate the INE (statistical administration) said it was -0.7%. The final figure is -0.8% (these numbers are not annualized). Internal demand is very weak and pulls down these numbers. For the whole year GDP was down by -1.4% – Carryover growth for 2013 is negative at -0.9%
12 – Low growth in India with GDP growth at 4.5 % in Q4 2012 compared to Q4 2011. Before the crisis, GDP growth was between 9 and 10 %. This change in trend reflects a lower momentum in the manufacturing sector which is conditioned by low world trade dynamics. Service sector is also on a low pattern and that’s why RBI, as inflation rate is getting lower, could reduce again its interest rates.
13 – In 2012, GDP growth in Brazil was just 0.9% after 2.7% in 2011. The problem in Brazil is that there is not enough investment that leads to low productivity. The labor market is under pressure close to full employment but GDP growth is too low. Brazil has to switch its growth process from extensive productivity (when I want to increase my production I hire someone to produce more) to a more intensive process (I invest to improve productivity of people that are already working). This goes through investment and that currently Brazil weakness that does not allow delivering higher wages for all.