In our story, Mario Draghi, president of the European Central Bank (ECB), sounded the alarm yesterday with a call of “renewed weakening of economic growth and heightened uncertainty” in the Eurozone. He proclaimed that interest rates will fall as he cut the banks' key lending rate to .75% while slashing the deposit rate to zero. His friends at the Bank of England, the People's Bank of China, the National Bank of Denmark, and even lowly Kenya jumped on the easing band wagon.
The question is: Will the markets respond to more easy money, or will all the easing just be fodder for a failing global economy?
A Race to the Bottom
Yesterday’s ECB action was largely priced into the equity markets, as was the increased bond buying by the Bank of England. But China’s move was a surprise, and what stood out in my mind was the move by Denmark. Although a member of the European Union, Denmark maintains its own currency, the krone. The Danish Central Bank is now charging .2% on certificates of deposit.
You read that correctly. The interest rate for CDs in Denmark is now negative .2%.
The logic behind that is to prevent the krone from appreciating against the Euro. Countries around the world are trying to devalue their currencies so that they can maintain an edge in exports. For that theory to work, some country has to have a strong currency and a functioning economy for a weaker currency to have the desired economic effect of increasing exports. No one wins a race to debase, and there is some question as to whether any economy is functioning. This is the primary reason yesterday’s additional easing was greeted with a big yawn in the global markets.
Services Hang On While Manufacturing Slumps
In other news yesterday, and on the domestic front, the Institute for Supply Management (ISM) reported its monthly non-manufacturing index at a weaker than expected 52.1 for June. Although a reading above 50 indicates growth, it was 1.6 points lower than the May reading, with month over month declines in 7 of the 10 categories reported.
Still, the US is doing better than Europe’s core, Germany. Over the July 4th holiday, Markit Economics announced that the German services sector moved into contraction with a final reading of 49.9 for June compared to a prior flash reading of 50.3. Here again, a reading below 50 indicates contraction and follows Monday’s worst reading in 3 years for this core European country’s manufacturing sector.
It was the same in the US. On Monday the dismal ISM report on manufacturing moved below the critical 50 level to 49.7, well below consensus of 52. The report showed weaker month over month readings in 8 of 10 categories. Ironically, the broad market shrugged this off, as the weakness fired expectations of additional easing from the Fed beyond its extension of Operation Twist.
Notably, within both of this week’s ISM reports, the exports components moved into contraction. This suggests that all this easy money may provide short term support for equities and other asset prices, but it certainly does not appear to be benefiting our economy -- particularly in the area where it is supposed to help the most.
The Fox’s Den
The markets continue to demand more easing despite the lack of evidence that it helps the economy. This morning’s jobs number is a further indicator that the economy is not in recovery. Yesterday ADP announced private sector payrolls increased by 175,000 and everyone started upping their estimates for today’s non-farm payrolls. Expectations jumped to 100,000 from 90,000, but even the original estimate was not met. Only 80,000 jobs were created in June and the unemployment rate held steady at 8.2%. That is unlikely to spur the confidence necessary for a full-fledged recovery anytime soon.
The S&P 500 is trading at the top of its range, and may even push to 1400 as central bankers slash interest rates, but for this to become a sustained leg higher the economy needs to expand rather than just muddle along. If I am wrong and the economy is doing better than advertised, it will show up in corporate profits and the outlook for the second half of the year.
As I discussed in last week’s article “The Single Number to Watch This Earnings Season”, estimates are coming down but may still end up disappointing.
Unofficially, earnings season kicks off after the close on Monday with a report from Alcoa (AA). The information that will be released in the coming weeks will show us whether easy money is really stimulating business and the economy, or if falling rates are simply luring investors to the fox’s den where they may meet an untimely demise.
Price Shock Trader