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Italy’s Stagnant Economy the Most Likely Trigger to Europe’s Existential Crisis

September 5, 2018

With the focus on Turkey and the potential related fallout in other emerging markets in recent weeks, it is easy to forget about the Eurozone. Yet the current Italian government is likely to trigger a renewed existential crisis in the Eurozone once the Europeans return from the beach and the Italian Government comes up with a budget for 2019 which is likely to put it in direct conflict with the Maastricht Treaty.

BROKEN BRIDGES UNDER THE EURO

Italian real GDP has risen by only an annualized 0.4% since 1Q99 and is up only an annualized 0.1% in real GDP per capita.

The collapse of a motorway bridge in Genoa last month resulting in 43 deaths, and Italian Interior Minister Matteo Salvini’s exploitation of that event by blaming Brussels-imposed austerity, is a reminder of what is coming.

Having driven over that particularly rickety bridge on more than one occasion, this writer is not surprised to hear about what happened. Similarly, driving through Italy in recent years always serves as a reminder just how poor Italy has become under the euro. Remember, Italy has recorded almost no growth since the formation of the euro at the beginning of 1999, nearly 20 years ago. Italian real GDP has risen by only an annualized 0.4% since 1Q99 and is up only an annualized 0.1% in real GDP per capita terms over the same period (see following chart).

ITALY REAL GDP AND REAL GDP PER CAPITA

Italy real GDP and real GDP per capita

Source: CLSA, Datastream

The Italian issue is raised again in part because it is timely with the end of the summer holiday season. The view here remains that a systemic event in financial markets is more likely to be triggered by Italy and the Eurozone than other candidates currently discussed by pundits, be it a Donald Trump-triggered trade war, a much anticipated (by talking heads) Chinese currency collapse or overvalued Wall Street FANG stocks.

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US vs. China–Is it ‘Art of the Deal’ or Economic Warfare?

July 4, 2018

If monetary tightening remains the main risk for global stock markets, the threat of a trade war continues to dominate the headlines.THE DONALD’S DEALMAKING

Some of those in Washington pushing this policy view China as some kind of strategic rival for global leadership. For such people this is about far more than just tariffs.

The question raised by Donald Trump’s trade agenda with China remains, in essence, extremely simple. It is whether The Donald is engaged in a typical ‘Art of the Deal’ negotiation, where he can suddenly turn on a dime and declare a ‘win’, or whether he is really seriously trying to stop Chinaupgrading its economy by targeting ‘Made in China 2025’.

Such a stance would amount to an act of economic warfare. On this point, it should be understood that some of those in Washington pushing this policy view of China as some kind of strategic rival for global leadership. For such people this is about far more than just tariffs.

The markets had been assuming that the American president would not take this too far. But, as discussed here before, concerns have grown as it has increasingly looked like Trump is supporting Robert Lighthizer’s (US Trade Representative) and Peter Navarro’s (White House Economic Adviser) agenda.

HOW LIKELY IS ECONOMIC WARFARE?

On July 6, first the US and then Chinese 25% tariffs on US$34 billion worth of goods are due to go into effect. If bilateral negotiations do not resume before that date, then the chances of the US and China entering a so-called trade war grow significantly.

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Italian Politics: The Calm Before the Next Storm

June 11, 2018

Europe remains a potential source of angst for financial markets in the form of another existential crisis for the Eurozone. True, stock markets have relaxed over the past week in part because of relief that another Italian election has been avoided for now and in part because US dollar upward momentum has stalled (see following chart).US DOLLAR INDEX

US Dollar Index - June 2018

Source: Bloomberg

CONFLICT IN ITALY — WHEN WILL IT COME TO A BOIL?

The coalition government’s economic policies will likely conflict with the fiscal rules set by Brussels.

On Italy this is likely just the calm before the next storm given the Five Star and League coalition government’s economic policies are almost inevitably going to be in conflict with the fiscal rules set by Brussels — though the confrontation may take longer to come to a boil because of the presence of technocrats in the new government, a compromise required by Italian president Sergio Mattarella for the government to be formed on June 1.

There will also doubtless be hopes on the part of the political establishment that the differences in ideologies between the left of centre Five Star and the right-wing League will become evident in the everyday practice of trying to run a government resulting in due course in both ‘populist’ parties being discredited in the eyes of the electorate.

ITALIAN 10-YEAR GOVERNMENT BOND YIELD AND SPREAD OVER 10Y GERMAN BUND YIELD

Italian 10Y government bond yield and spread over 10Y German Bund Yield

Source: Bloomberg

THE ECB AND THE EUROSYSTEM — ITALY’S GREATEST CREDITOR

The other point to consider with an Italian populist government now in place is how the ECB will react in terms of the signals sent given that the ECB and the Eurosystem is the single largest holder of Italian government debt.

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The Liquidity Punch Bowl

January 29, 2018

THE LIQUIDITY PUNCH BOWL

It is appropriate with the inauguration of this weekly column to look at the “Big Picture”. The biggest risk to world stock markets, and asset prices in general, in 2018 is that G7 central banks (led by the Federal Reserve) are finally attempting to normalise monetary policy nine years after the American central bank commenced quantitative easing in December 2008, in the midst of the so-called “global financial crisis”.

Since late 2008, G7 central banks, comprising the Fed, the Bank of Japan, the European Central Bank and the Bank of England, have committed to massive balance sheet expansion (through the purchase of mortgage and government debt). Their balance sheets continued to rise in aggregate during 2017 even though the Fed itself stopped expanding its own balance sheet in November 2014. Aggregate assets of G7 central banks increased by 17.2% last year to $15.2tn at the end of 2017, up from US$4.3tn at the beginning of 2008 (see following chart).

Sources: Bloomberg, Federal Reserve, Bank of England, ECB, Bank of Japan, CEIC Data, CLSA

That the Fed has commenced balance sheet reduction from last October is a risk for stock markets since it amounts to another form of monetary tightening, in addition to interest rate hikes. That it has not yet caused market fallout reflects two factors:

  1. The Fed is beginning extremely tentatively by decreasing its reinvestment of principal payments from maturing bonds.
  2. Other G7 central banks are still expanding in aggregate, albeit at a slower pace. This is why there will be much focus on what the European Central Bank will do in coming months. For now, it looks like G7 central bank balance sheets will start to contract in aggregate in 2019 rather than 2018. 

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Olduvai IV: Courage
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Olduvai II: Exodus
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