Recap 7-29-13: More Thoughts on Europe


One EU topic that hasn’t gotten much airtime but should be considered is likelihood of pent up wage cuts. The SF Fed noted that in the US, “Evidence shows that pent-up wage cuts reflecting downward nominal wage rigidity have been an important force during the most recent recession and recovery… The spike in workers who are experiencing no wage changes has reached record levels.” With the EU well behind the US in the recovery process, this is likely to be a substantial factors going forward. This is probably MORE relevant for the EU than the US because EU wages more closely follow realized inflation, and the ECB’s mandate is to target inflation only. With labor market rigidities worse in Europe than the US, it seems likely that this will take even longer to resolve there. The chart below shows nominal EU wage growth vs EU headline CPI. The bottom panel charts the difference. (i.e. real wage growth) What’s interesting is that real wage growth averaged “only” -1% over the past 3 years. While that is a terrible data point, it seems quite good in light of the fact that since unemployment bottomed at 7.3% in 4Q 2007, owing to the spike in 2009, real wage growth in the EU since 2007 is still +1.3%.

Having said all that, last week’s EU PMI was pretty good, as was the ECB lending survey. Note that Spanish core deposits have now reached the pre-outflow levels! (May-11) EU bank problem remains centered around a lack of equity, but things are clearly slowly improving. However, with all of the prior ECB easing actions several quarters old, EU M1 growth appears to be peaking, so the ECB will need to maintain momentum. Not much is expected at the ECB meeting, which I find surprising given that, despite the “unprecedented” change in ECB communication, front Euribor futures are only up ~5bps from pre-meeting levels, while Eonia and EU repo rates remain elevated. One would think that an “unprecedented” change should result in an outsized market response, and the lack of such a response should worry the central bank in that it implies a lower level of market credibility. But the ECB has always been somewhat of a dysfunctional central bank, so maybe they are OK with this. In any case, it was interesting that in a joint interview, ECB board members J.Asmussen and B.Coeure called for more transparency by releasing minutes of governing council meetings. They believe publishing names, votes and the substance of discussions would help the institution to improve communication, just as establishing a monthly press conference did at the beginning of the euro. Both were candidates for chief ECB economist, and are among the most vocal ECB members. Furthermore, both have made dovish noises in the past, so perhaps they hope that the minutes will allow the market to better reflect the small number of hawkish voters. That’s all speculation at this point, but it does seem interesting that both of these voters are pushing for even further communication, which presumably includes guidance, by the ECB.

In other matters – this Summers vs Yellen debate seems to be getting a lot of headlines. I don’t really like discussing topics like these, but I really hope that it isn’t Summers. His head strong, imperial attitude is a very major risk at the helm of the Fed – not only because the Fed is trying out new policy instruments (which will necessitate an attitude toward hearing opposing opinions) but also because the Fed is by design broadly independent. As a result, if the new Fed chair makes a mistake but insists against evidence and opposing opinion that he did not, we are all in a lot of trouble. In addition, the most effective tool in the Fed’s policy tool box right now is forward guidance, the effectiveness of which is dependent on a stable FOMC core. Imagine if half of the Fed talks like Plosser or Fisher, dissenting against the chairman. Actually, that’s easy – just imagine that the Fed was the ECB!!

Finally, a recent JPM piece on the performance of active managers showed that, although the vast majority of managers underperformed their benchmarks, Small Cap Value managers stood out.

I am not aware of any other research that supports this observation that active small cap value managers can consistently outperform, (if any readers know of any research, I would appreciate hearing about it!) but I suppose it makes sense that managers that focus on long term value in a space that is not covered by Wall St. analysts have a better shot than others. In any case, perhaps this suggests that an exception should be made for the general rule of thumb that passive investments are preferable for expressing asset class specific views.


  • Italy Business Confidence improved to 91.7 vs 91 exp and 90.2 prev
  • US Pending Home Sales declined -0.4% MoM vs -1.0% exp and +6.7% prev
  • South Korea Mfg Survey declined to 73 in Aug vs 78 prev
  • Citi: Active cellular handsets in developed markets (DM) are now equivalent to 137% of the DM population, characterizing these markets as replacement-only. Using carrier estimates of peak penetration (85%), smartphone saturation will be achieved as early as 2014.

Upcoming Data:

  • Mon: AustraliaBuilding Approvals, RBA Governor Stevens speaks
  • Tue: US Consumer Confidence, Japan PMI, Australia Private Sector Credit Growth
  • Wed: Month End, Japan Housing Starts, Germany Retail Sales, Unemployment, EU CPI, Unemployment, Canada GDP, US ADP Employment, 2Q GDP, Chicago PMI, FOMC, China PMI
  • Thu: EU PMI, BoE, ECB, US Jobless Claims, ISM
  • Fri: US Employment,