Recap 8-22-13: EM FX Reserve Flow Effects, Europe in the 90’s


One factor that may be affecting the US treasury market is the move in EM asset prices. As some EM central banks have begun to intervene in the FX markets, they have been selling their FX reserves, which are mostly in US and EU government bonds. The bottom chart shows the US treasury holdings of “official” foreign entities such as central banks, with the bottom panel showing the rolling 3m change in the holdings. Now, the flow isn’t crazy, but on a 3 month basis, it has gone from ~+80bn per quarter to -80bn, not peanuts, given the Fed is doing 85bn a month. The 160bn swing over 3 months equates to an average monthly change in the RATE of flow of -53bn. If we look at all flows (including private) the change has been even more dramatic, from ~+150bn / quarter to -150bn. Of course, this negative flow is not likely to persist, but given the deteriorating trade surpluses all over EM, the continuation of EM purchases of treasuries seem likely to slow in the coming years.

Separately, the Germany PMI prints were much stronger than the French PMI prints, with the former surprising to the upside and the latter surprising to the downside. This trend of better German manufacturing output vs the rest of Europe (RoE) has persisted since 2006, driven by the still wide labor cost differentials. But there is a bit more to the story than that. The chart below shows that over the past few years, even as the German trade surplus with the RoE has declined, (yellow line) it has significantly increased its trade surplus with the world outside Europe, (orange line) which means its overall trade surplus is now back to 2007 levels! (white)

The weakening of the Yen may well slow or reverse this trend, but there hasn’t been an impact on the trade data so far. This likely means that as the world continues to recover from the crisis, the ECB will have to increasingly deal with a 2 speed Europe: Germany (growing well above potential and with inflationary risks, and also the country benefitting the most from better growth elsewhere) on one hand and the RoE (still in a depression) on the other. However, it is worth observing that this process HAS to happen. With the root of the problem there being the wide labor cost differentials, the only options for rebalancing is an increase in Germany labor costs, a decrease in RoE labor costs, or a combination. Downward wage stickiness means decreasing labor costs are very difficult outside recessions, so the least bad way is simply to allow Germany to run at a higher inflation rate than RoE. To the extent that this runs counter to the ECB’s mandate, however, suggests that the ECB may keep policy tight. When combined with the currency strength that results from the massive German trade surplus, we are likely to see an even longer and more exacerbated rebalancing period.

The last time European (ex Germany) unemployment rates were at these levels was in the mid-late 90’s. (chart below has UER for France in white, Italy in orange, Spain in yellow, and Germany in Green) Back then, unemployment stayed stubbornly high for the 3 largest economies for 5 years, finally starting to fall in 1999:

Historians point to multiple causes for that period of stagnation, but austerity was probably at the very least a contributory factor. The Maastricht Treaty mandated a maximum central government deficit of 2% of GDP by 2000, which drove substantial austerity efforts starting in the mid 90’s. Interestingly, consensus estimates for budget deficits for 2013 are quite similar to 1997 levels.

Obviously, 2013 is very different from 1997, but I thought it was worth noting how long unemployment can stay elevated in the EU. This EU commission study of Germany economic performance in the 90’s is quite interesting (thanks Danny!)

Finally, if you are not worried about the NSA privacy intrusion, read this bit from an NYTimes article from 1983:

“precedent had been established in 1971, when the N.S.A. was the lead agency in the Nixon Administration’s attempt to stop newspapers from printing the Pentagon Papers, the bureaucratic history of the war in Vietnam.”

Now, it’s reasonable to argue that the NSA should be able to access emails and such. What’s NOT reasonable is that there is minimal oversight of the agency, and the oversight that exists is simply a politically appointed judge, (whose job depends on keeping some government bureaucrats happy) and press FOIA requests for information that is several years old. Our government hasn’t failed because there are checks and balances in place. IMO, responsible citizens should make sure that continues.


  • August PMI Data shows continued improvement:
  1. China HSBC Mfg Flash PMI jumped to 50.1 vs 48.2 exp and 47.7 prev
  2. EU Mfg PMI improved to 51.3 vs 50.7 exp and 50.3 prev. Services PMI improved to 51 vs 50.2 exp and 49.8 prev. Both French measures disappointed, while German measures beat.
  3. US Markit Prelim PMI increased to 53.9 vs 54.2 exp and 53.7 prev

US Jobless Claims increased to 336k last week vs 330k exp and 320k prev

CA Retail Sales declined to -0.6% MoM vs -0.4% exp. The Ex Auto measure was even weaker, at -0.8% vs 0.0% exp

Upcoming Data:

  • Fri: UK 2Q GDP, Canada CPI, EU Consume Confidence, US New Home Sales
  • Mon: US Durable Goods Orders
  • Tue: German IFO, Fed’s Williams speaks, ECB’s Coeure speaks, US Consumer Confidence, ECB’s Asmussen speaks, South Korea Business Survey
  • Wed: BoE’s Carney Speaks, US Pending Home Sales, Australia Private CapEx