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Capital Markets

Bond Outlook by bridport & cie, May 2 2012

How interesting to see if, how and when Merkel and Schäuble react to a widespread rebellion against an excess of austerity and a desire for a serious growth programme.

The rebellion against “austerity alone”, and in favour of “austerity light”, plus a programme for growth, is gaining strength. We would like to say that it will reach a climax at the June EU summit, but the very concept of a climax in the context of EU decision making is an oxymoron. Last week, we asked what the German attitude to the rebellion might be. This week there are some tantalising hints:


  • Merkel says that pursuing growth will be on the agenda for the forthcoming EU summit. However, her emphasis is on growth measures without cost or debt increase: “Growth does not have to cost money and can be achieved through structural reforms”
  • Schäuble, at a meeting with members of Spain’s government, insisted that austerity was not an end in itself but a stepping stone to sustainable growth


Such comments are not exactly capitulation of the German leaders to the forces of rebellion, but do at least suggest the possibility of dialogue. Draghi has now entered the fray with a comment of a more political nature than associated with central bankers, with his call for a “growth compact” to accompany the “fiscal compact”.


Within the UK, a parallel act of calling for austerity-light and growth is taking place between the Opposition and the Coalition. The real question is not however about Labour’s views, but those of the Liberal Democrats within the Coalition; to avoid its breaking up, it is very likely that the Conservatives will take a step to lighten austerity measures.


If the opinion polls are right and Hollande becomes the new President of France, the rebellion will gather strength. Merkel is already rejecting any renegotiation of the fiscal compact. We can but hope that the more anti-economic aspects of Hollande’s election pledges, like more government employees and more retirees, can be averted by reality, and pressure from other European leaders.


The French hankering for short work weeks, early retirement, and more government employees epitomises how Europe has been spending beyond its means. In the USA, spending beyond ones means has apparently taken a different route, in high consumer spending and the huge external deficit. However, the American criticism of Europe’s welfare state could do with a little self-reflection with regards to underfunded Social Security and Medicare.


Sometimes it is too easy to blame the problems of the West entirely on irresponsible governments or social forces. It should not be forgotten however that the entire crisis is happening against a background of a rise in China’s manufacturing power and its mercantile policy of growth through exports supported by an artificially cheap currency and suppressed domestic consumption. Signs are that a shift is taking place in the balance of world manufacturing. China is no longer so competitive, and is moving to allowing growth in domestic consumption. Western manufacturers, led by the USA and UK, are repatriating some of their production and discovering advantages in logistics and the adjustment of product design and mix to match demand.


Beyond the current Western crisis, there is a serious hope of cheap and plentiful energy supply from fracking, while China is heading for a serious demographic decline. The return to sustainable growth may not be too distant.


Macro Focus

USA: consumer spending climbed in March and incomes picked up, indicating the biggest part of the economy will help sustain the expansion. Business activity expanded in April, but at a slow pace, with manufacturing data improving (ISM’s factory index rose to 54.8). Orders for durable goods fell in March depressed by a pullback in demand for aircraft that masked gains in business investment. Signed contracts to buy homes rose as low interest rates drew buyers back into the market


EU: confidence declined more than economists had forecast. Consumer sentiment fell to 92.8 from a revised 94.5 in March. Inflation slowed to 2.6 %. in April as energy costs increased at a weaker pace than a year ago. Divergence between north and south continues: German retail sales rebounded in March, while Spain’s economy contracted in the first quarter, putting the euro region’s fourth-largest economy into its second recession since 2009


UK: the economy slid into its first double-dip recession since the 1970s. GDP fell 0.2 % from the fourth quarter of 2011, when it declined 0.3 %. But recent publications show some signs of stabilization. This week, consumer confidence rose to 53, the highest since June, from 44 in February and this is confirmed by manufacturing confidence which recorded its strongest reading in two years. Bank of England Governor Mervyn King has 10 days left to make up his mind on whether he can risk halting stimulus for an economy trying to shake off recession


Switzerland: the KOF economic indicator increased in April from 0.09 to 0.04 for a third month, adding to signs that the economy is regaining some strength. The SNB said it posted a loss in the first quarter as a strengthening franc eroded currency holdings. The consolidated loss was CHF 1.73 billion after a profit of CHF 1.86 billion a year earlier

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