61.7 %

The Greek statistics agency has released figures showing that youth unemployment at the end of 2012 had reached 61.7%. 61.7% ! How long before the country a) has to request more loans from the ECB or b) the fabric of society starts to fray ?

2013 . Better than expected ?

2013. Better than expected ?

2012 went out with more of a whimper than a bang. The eurozone didn't collapse. Greece didn't descend into anarchy. Spain kept its banking system functioning. The US hasn't ( yet ) rolled over the fiscal cliff into recession. China had a smooth and peaceful transfer of power within the governing Communist party. North Korea didn't invade the South.

Outlook
What about 2013 ? At this stage 2013 looks uneventful. A bridge year that will either transition into an accelerating recovery or lead us towards a protracted period of low growth and political volatility. If the world economy can stay on an even track then by mid- year  a stronger than expected recovery should take hold leading to a more broadly based upside in early 2014. Expect extreme volatility in currency markets as Japan, Britain and the EU try to export their way to recovery. However, if the US economy slows because of heavy handed budget sequestration  then global growth could stall. In this case 2013 may be looked back on as a year that led to further retrenchment, pain and uncertainty.

Eurozone
After a turbulent year the PIGS ( Portugal, Italy, Greece, Spain ) are heading towards current account surpluses in 2013. Ireland is already there and Spain is catching up. Italy might get there by the end of this year if Signor Berlusconi can avoid reversing recent tax increases on property. Overall, the slow , painful process of wage and employment adjustments is finally bearing fruit. Competitiveness is returning to southern Europe. Unit labour costs have fallen 7% from their peak in Spain and 18% in Eire. The first steps towards a trade agreement between the US and the EU would be  a major boost to these early signs of recovery. Our worry is that it will take a long time, half a decade at least, probably more, before these economies return to levels of activity approaching those seen in 2008. No government has preparted its citizens for this extended era of austerity. The political implications of this have yet to be studied and considered by markets.

The US.
It ws no great surprise to anyone, other than Fox News and presumably Mitt Romney, that President Obama was re-elected. America is increasingly non-white and secular. The electorate reflects this change. The loss was a blow to the Republicans. It was also a blow to Democrats looking for a mandate for radical change. They didn't get it. The fiscal cliff may yet reappear. Defense will certainly be trimmed as America becomes less pro-active in foreign policy.

The EU
Barring a Greek exit the most challenging issue facing Brussels in the coming year is how to respond to the possibility of a British in/out referendum.  The departure of the UK from the EU would lead to a profound change in the composition and emphasis of the Council of Minsters. Germany, which is already the de facto head of the Eurozone and indeed the EU, would see its power further increased. France would on the surface welcome the departure of the UK. This would make it more likely that a program of standardizing taxes and working conditions would be implemented. The EU could then become more statist and protectionist. However, there are an ever increasing number of French Foreign Ministry advisors who are worried that the departure of the UK would serve to weaken Frances position. Could France alone prevent Germany from exercising its power ? Where Berlin leads most of the other 27 members would automatically follow. There are those in Paris who see this as a nightmare.

Most British Tory Prime Ministers of the 20th century have been able to balance the tribal insticts of their party against the greater national interest. This is not the case with David Cameron who is knowledgeable about tactics but woefully short on grand strategy. His expected call for a referendum will most likely split his party buy also leave a poisoned chalice for the next, Labour, PM . 

Uncertainties.
Saudi Arabia - King Abdullah is old. The succession remains clouded. 
Syria - A proxy war between Iran on one hand and the Gulf States and Saudi on the other. Western liberals cry out for intervention but what form of government could replace Assad ? Egypt and Tunisia don't auger well for a peaceful regime change . Don't assume the price of oil is on a straight line down because of increasing US output.
China - We all know that territorial disputes with Japan can't escalate. Don't we ?
North Korea - Bankrupt, beset by famine, yet with the spoused aim of building nuclear tipped missiles that can hit the US. Can China and the US work on a peaceful transition of power ?
India and Pakistan - An unresolved territorial dispute that's festered for two thirds of a century. Will the collapse of Pakistans civil society lead to heightened tension between these nuclear armed neighbours ?
South Africa - The Rand seems to  be in free fall. What is it telling us about the economy and broader socierty ?
Italy, Greece and Spain - Political venality remains the order of the day.  Will their populations continue to accept austerity ?

Conclusion
We remain optimistic that the global economy is slowly on the mend. The one overriding  concern is the complacency that has settled over Europes decision makers. Bank deleveraging implies that credit contraction will continue to beset the EU for the rest of this year and beyond. The scope for a political accident in Greece, Portugal, Spain or Italy remains high and undiscounted. European banks mirror this complacency. France. Italy, Spain and Holland ( FISH ) all have much work to do to restore their financial sectors to health.



 

What then ?

Just back from Spain. Signs of the downturn obvious. Restaurants empty, For Sale signs sprouting. Tax collection falling because official tax rates ( ie 85% inheritance tax ) are set at ridiculous levels. Most worrying thing is that most Spaniards I talk to, for the large part highly educated, assume that everything is going to return to the way it was in 1 or 2 years time.

What happens if structural youth unemployment of more than 50% continues past mid-decade. What is likely to make it fall ? The € crisis may not be over. It may simply be playing itself out at a less frentic pace.

The unexpected

The unexpected.
High summer. Although trading volumes are low markets seem happy enough. Oil prices have stabilized. The threat of a 'fiscal cliff ' seems to be receding and housing starts are up 25% y-o-y. Mr.Draghi's promise to do ' what it takes ' to save the € has removed some of the ' end of the world as we know it 'nervousness that characterised much of Q2 trading.

We however are concerned about two issues that are currently off the radar but may well be soon on it..

The Mid-East. 
The Syrian civil war continues. Turkey, the Gulf States , the Lebanon and Iran are all being drawn further and further into it. The Kurds are also becoming involved.  Stinger missiles and T-62 tanks have found their way to the rebels in Aleppo. Rumours that Saudi Arabia's new intelligence chief Prince Bandar has been assassinated by Syrian agents continues to swirl through the Riyadh exchange. Israel seems to be ever more insistent that action must be taken against Tehran and its nuclear pretensions. Domestic reports say that the Defence Minister Barack believes the government should act in the runup to the US Presidential elections. Egypts new fundamentalist President has fired the two most pro-western military leaders. Russia wants to evacuate its citizens from Syria but doesn't have the physical means to do so. Unrest has flared up in Saudis eastern province. Libya remains unstable. Taking all this together is there a chance of an oil price shock ? Something is stirring across the whole region.

Italy. 
It's not ( in our view ) Spain or Portugal or Greece or Ireland that will spook markets. It's Italy that presents the major threat to the Eurozone. Former Prime Minister Berlusconi is making plans to stage a comeback. He understands that the easiest option for Italian industry is to restore competiveness through a major devaluation. Hence the accelerating capital flight out of the country. Italian GDP at the end of Q2 was at the same level as it was at the same time in 2003. By year end it is likely to be on a par with the GDP level recorded at year end 2000. A lost 12 years! If the downturn in the economy continues ( as is probable ) then Italy could soon be back GDP levels last seen in  1997. With interest rates rising, GDP falling, and inflation remaining low there is ample scope for an 'Italian surprise '.

Enjoy August. September will soon be here and with it a raft of undiscounted conundrums for the market.

Delaying the inevitable ?

So the Greeks voted to stay in the €.  That at least is the spin that the French and German newspapers have put on yesterdays vote for New Democracy. The reality is that the new Greek government lacks a mandate to implement further austerity . It relies heavily on the vote of the over 50's. The under 50's voted for renegotiating the measures agreed with the ECB , IMF and EU. This morning the view in Athens amongst the leading pollsters is that new elections, with a very different outcome ,  will follow early next year .

The conclusion must be that the Euro will hold together for the rest of this year. In 2013 it now appears almost certain that Greece will drift out of the common currency . After all New Democracy is the governing party that got Greece into this mess and which has been irritatingly slow in applying the reforms that the ECB and European Commission have asked for . The long expected Grexit scenario still is in play . 

With growth slowing and unemployment rising pressures within Spain and Italy to move away from austerity are also growing . Rapid progress needs to be made on structuring a banking union and political / fiscal union if the crisis is to be resolved . If the next two EU summits fail to come up with real steps towards implementing these two measures then the risks of the Euro splintering into a hard Deutschemark bloc and a soft  , constantly devaluing , southern tier will grow. Where France positions itself between these two poles  is perhaps the biggest and most intriguing question of all. Will it lead the southern bloc and give up pretensions to being Germanys equal ? Or will it stick by Germanys side and put in place the steps needed to trim its deficit ?

All eyes on Greece.

Following the May 6th elections , the new government in Athens must now put in place further budget cuts . These have to be implemented by the end of June . Failure to do so will mean that The IMF will withold its next financing . The Greek authorities would then , literally , run out of money . A managed approach to austerity would then be replaced by chaos . 

The future of the €uro lies in Athens . Markets will be watching closely to see whether a coalition government can be formed in order to implement the changes. If not fresh elections will follow.  The chances of a Greek withdrawal from the common currency are real and rising . The new French President, Monsieur Hollande , may soon find out just how much the Paris banks are on the block to Greece.

End of austerity ?

An interesting week ahead in markets . Sterling / € at 1.23 today . The pound fast becoming a safe haven despite the UK's dire fundamentals . 1.25 possible by the end of the week .The €-zone rapidly heading for a political and financial confrontation , if not a full blown crisis. On one hand cash rich Germany . On the other profligate southern Europeans and their champion , the likely new French President, Francois Hollande . Will Germany listen to France and  accept the need for an easing of austerity ? If it doesn't what will happen to the Franco-German axis ? How will markets respond ? How will the UK ever generate growth if sterling continues to strengthen ? With unemployment at 24% what can the Spansih government do to stave off social unrest ? How will Italy's voters respond to the lengthening recession ? What happens if the Greeks vote against further budget reductions in their parliamentary elections on May 6th ?