Friday, November 18, 2011

Is The US De-Coupling from Europe's Woes?

Is the US dancing while Europe is burning?

The news from Europe remains troubling, to say the least. Yields on Italian and Spanish bonds remain elevated, despite the best efforts of the European Central Bank (ECB).

The 17 members of the European union continue to squabble, and the rhetorical levels continue to move higher in each passing day.

Liquidity is drying up as banks desperately try to reduce their sovereign credit exposures.

Ambrose Evans-Pritchard of the London Telegraph writes this morning that Asian buyers are also trying to reduce their European bond holdings:

Asian investors and central banks have begun to sell German bonds and pull out of the eurozone altogether for the first time since the debt crisis began, deeming EU leaders incapable of agreeing on any coherent policy...

Traders say Asians are taking profits on Bunds and pulling out, with signs that even China's central bank is shaving holdings. Mid-east wealth funds have remained firm.

Meanwhile, Spanish Prime Minister Zapatero is insisting that ECB step up its intervention in the capital markets to try to keep interest rates low:

José Luis Rodríguez Zapatero, Spain’s prime minister, on Thursday became the latest leader to demand that the bank find a solution to the euro crisis, saying that “this is what we transferred power for” and that it had to be a bank “that defends the common policy and its countries.”

Mr. Zapatero made his unusually blunt statements on a day when markets sagged further and contagion continued its seemingly inexorable spread from the small economies on Europe’s periphery to Italy, Spain and even France at the core. Spain was forced Thursday to pay nearly 7 percent on an issue of 10-year debt, the highest since 1997, while investors demanded the largest premium for buying French as opposed to German debt in the decade-long history of the euro.

At the same time, however, both the U.S. economy and our markets remain remarkably unaffected by the euro crisis.

Many businesses report that activity remains reasonably strong, and in some cases improving. Warren Buffett remarked the other day that only 5 of the 70 businesses owned by Berkshire Hathaway are showing any signs of weakness, and all of these are related to housing.

Recent US economic data also show signs of strengthening, as Neil Irwin reports in this morning's Washington Post:

... following a year of one economic disappointment after another, a variety of economic indicators are pointing in a more positive direction... reports showed strong results on two key measures of economic activity in October: A 0.5 percent gain in retail sales and a 0.7 percent gain in industrial production. Also welcome news: Inflation is becoming more subdued, with consumer prices falling 0.1 percent in October. That leaves the Federal Reserve more flexibility to take action if the economy worsens.

Putting all the recent evidence together, forecasting firm Macroeconomic Advisers projects that the economy will have grown at a 3.2 percent annual rate in the final three months of 2011, compared with a 1.4 percent average pace of growth through the first nine months of the year.

Our markets also appear slightly confused. Although Treasury bond yields remain at historically low levels - indicating there is still a strong desire for safety among a large class of investors - stocks continue to trade with a good tone, and have largely held on to October's gains.

We will see.