Europe's austerity backlash

Europe's austerity backlash
07/05/12 @ 07:23 GMT by Michael Derks, Chief Strategist

After the pounding meted out to risk assets overnight in response to the austerity backlash evident in both the French Presidential and Greek election results, both traders and investors can be forgiven for feeling quite unsettled. Although electoral disaffection with sustained harsh fiscal medicine is perfectly understandable, it is an open question as to what the realistic alternatives are when so many European sovereigns have so little financial manoeuvrability. Unfortunately, populist politicians are by and large merely reflecting the general mood rather than offering any particularly sensible alternative policy prescriptions. For Germany, the financial guardian of the whole euro project, this new anti-austerity backdrop risks morphing into an anti-German vendetta. Policy-making in Europe throughout this crisis has always been incredibly fractious but at least it had a chance of a sensible outcome with Germany at the controls. If the German captain is ordered off the bridge of the ship, then it is little wonder that markets fear Europe will rapidly run aground.

Commentary

An increasingly soggy eurozone. It was probably no great surprise to see the April services PMI data softer in the eurozone vs. the preliminary release, following on from the pattern that was seen in the manufacturing series. The eurozone aggregate number was revised one point lower to 46.9. Naturally, the weakness was concentrated in those peripheral nations under most scrutiny at this point in time, namely Spain and Italy. But the real story last week was the extent to which that weaker data permeated the core nations, which these days pretty much means Germany. The interesting thing from Thursday’s ECB press conference was the acknowledgement by the Bank of this weaker tone, but accompanied by hints (towards the end of the Q&A session) that a fuller assessment of the situation would be made at the June meeting. The ECB never shifts that quickly when it comes to changing rates, which is the nature of a committee of 23 people. It is notable however that the June meeting will see the latest staff forecasts published, so this could be in part the catalyst for a re-assessment of inflation risks in the eurozone.

Europe’s slowdown weighs on commodities. The accumulation of evidence over the past week that large swathes of Europe are in a deeper recession than expected has weighed heavily on commodity prices. Brent crude fell to USD 112 a barrel overnight; during March, Brent averaged USD 125, so for embattled consumers there is the hope that prices on the forecourt will soon reflect this recent downward move. Reduced oil demand has resulted in significant oversupply, with US crude inventories at a 21 year high. Also, some senior members of OPEC have repeatedly voiced their displeasure at the current level of prices. Coal prices for Asian power stations are at an 18m low, reflecting a marked slowing in power output in China. The gold price has also been disappointing, which is interesting in itself because gold has usually been excelling during those phases when risk appetite has waned. Unsurprisingly, high-beta currencies are suffering as well, with the Aussie approaching 1.01, its lowest level for the year, and the Kiwi now trading well below 0.80. That old adage, sell in May and go away, seems to be working once more.

UK property picture still cloudy. Obtaining a clear picture of the UK property scene has been even more tricky than usual this year. Boosted by the impending expiry of a stamp duty-exemption for low-cost residential properties and continued demand for London residences from offshore, house prices seemed to perk up in the first quarter. According to the Halifax survey, property values then dropped back by 2.4% last month, although Rightmove (which tracks listed prices) recorded a 2.9% MoM increase. One feasible explanation for the difference is that the Halifax survey conveys the experience of the lower-priced end of the market outside of London, whereas the Rightmove report reflects more the experience of the south of the country. Notwithstanding the ongoing balance sheet-pressures and difficulty accessing mortgage finance which the vast majority of home-buyers are continuing to deal with, there are a number of explanations for why house prices remain so resilient. Demand for houses in the South East remains very respectable relative to the supply – overseas buyers are prevalent, unemployment in the South East is much less evident than elsewhere in the country and the supply of property is simply not keeping pace with demand. Last year less than 100K new houses were completed, which is well below new household-formation of around 240K and the number of new properties being offered for sale is at a 15yr low. Migration to the UK remains strong – the UK is still highly regarded as a place to live in these difficult times. In the commercial property market, some light is shining through after an exceedingly tough few years since the GFC. Commercial property values rose by 6.6% over the year ended March according to a report prepared by the Industrial Property Databank. Values still have some way to go before they reach the peak achieved in 2007. In central London for instance, values are up more than one-third since late 2009, but still 20% below their mid-2007 peak. From the inside, the property picture looks mixed. However, from the outside, it is clear that foreign investors see value, and this is definitely providing the currency with a lift.

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