Fools never die

This title of a novel written by Mario Puzzo also fits to two statements, which were quoted in markets reports as a trigger ending the stabilization and sending stock markets south again. The first was the report in the Wall Street Journal. An unnamed executive of a European bank stated that the New York Fed would be concerned that the US units of several European banks would obtain sufficient funding for their operations in the US. As the responsible bank supervisor, it is quite normal that the NY Fed investigates the current situation. However, this unnamed banker must be rather stupid talking to the WSJ. He did not do his company a favor because European banks operating in the US came under general suspicion of having funding problems. It was not only European bank shares, which got sold off heavily, but also US banks and other companies. The New York Fed has not commented the report in the WSJ, which lets open another possibility. It might be today’s version of “blue horseshoe loves anacot steel” from the famous movie Wall Street. It is also possible that the story was launched by a short seller to make a quick profit.

Sweden’s central bank, the Riksbank, is becoming a risk-bank. In an environment, where participants in financial markets are already rather jittery, the chief economist of the Riksbank warned about a collapse of the interbank money market. If money market traders of a bank hear such a warning from the chief economist of the central bank, their reaction is easy to predict. They get even more cautious and reduce lending to other banks in the money market. Thus, the statement of this Riksbank official could just become a self-fulfilling prophecy.  

In a situation, where silence is golden and some comments were better not made, statements like those above trigger a further flight into the save haven of precious metals. Gold reached another record high last week at 1,874$/oz. Also silver posted a strong gain. Unlike in the first week of August, also the PGMs profited from safe haven buying despite fears of a global recession dominated stock markets.

Germany is no longer the growth engine in the eurozone thanks to the u-turn of the Merkel government in the energy policy. While the consensus forecast of economists was looking for a decline of GDP growth from 1.5% q/q in Q1 to 0.5%, the German economy expanded by only 0.1% in the past quarter. The index of energy production dropped from a monthly average of 91.9 in Q1 to 84.7 – a fall of 7.8%. This plunge of energy production is not only the result of a warmer than usual spring season, but is due to a larger extend by the order of the Merkel government to switch off seven older nuclear power plants. The Munich based ifo-institute estimates that the u-turn in energy policy has reduced the Q2 GDP growth by 0.2 percentage points.

In the US, there is a divergence between economic activity data and survey data. The July ISM manufacturing PMI declined sharply and also the production sub-index dropped. However, according to the data released by the Fed last week, industrial production rose far stronger than the consensus had predicted. Industrial output increased by 0.9% while the consensus was looking for +0.5%. Also the preceding month was revised up to +0.4%. However, the survey reports of business activities of two regional Federal Reserve Banks disappointed by unexpected strong declines. The Empire State survey for New York declined from -3.8 to -7.7 and the Philly Fed manufacturing index plunged from 3.2 to -30.7 while economists expected an increase for both indices.

As the chart shows, there is a good correlation between the ISM manufacturing PMI and the Philly Fed manufacturing index. Based on a regression analysis, our model predicts that the August ISM manufacturing PMI could come in at 49.5 and thus would signal contracting economic activity.

We have pointed out last week that recessions in the US were typically preceded by an inverted yield curve. This is not the case so far and given the Fed’s commitment to keep the Fed Funds target rate at the current exceptionally low level until mid-2013, it is rather unlikely that the spread between 10yr and 3mth US Treasury paper will get negative during this time span. Thus, the monetary conditions remain expansionary. Nevertheless, as long as the financial markets fear a recession, gold and silver will remain in demand and base metals might remain in a trading range with a risk to the downside.