Monday, March 14, 2011

Are We Seeing Game Changing Events Take Place?

Over the last few weeks, we've seen a series of events that may prove to be economic game changers -- meaning, they will essentially slow down the U.S. economic recovery. Consider the following:

Middle East: we've seen regime change in Egypt and Tunisia and a civil war erupt in Libya. As a result, we've seen oil spike. While prices fell at the end of last week, we are hardly out of the woods, as prices are still above $100/bbl and have risen sharply in a short period of time. The average price at the pump has also been rising; consider the following chart of consumer prices:

That's sharp increase in prices has already impacted consumer sentiment:

It's as if it finally dawned on consumers, during the first part of this month, that oil prices have been spiking and risk slowing the economy and raising inflation. The consumer sentiment report for mid-March is really very dramatic, showing a 68.2 composite index which compares with 77.5 for the full month of February but is down even further, perhaps a dozen points or more, compared to the recovery-best strength during the second half of February. The weakness is centered in the leading component, the expectations index which fell more than 13 points to 58.3. This points to increasing overall weakness in future readings.

China: Two reports from China last week indicate the economy may be slowing. First,

China unexpectedly posted a trade deficit in February, according to official data released Thursday, and economists said this could reduce pressure on the country to allow its currency to appreciate.

The rate of growth for both import and export indicators tapered off considerably from the levels seen in January, distorted by the Chinese New Year holidays during the month.


China’s wholesale prices accelerated in February while consumer prices gained at faster rates than forecast, indicating authorities have more work to do in their battle to keep prices in check.

The monthly consumer price index rose 4.9% in February, unchanged from the reading in January but higher than the 4.8% increase expected in estimates compiled by FactSet Research.

These two stories indicate the following:

1.) For the last year, China has been raising reserve requirements and issuing orders to curtail lending. These are not working. China will more than likely have to engage in far more aggressive means to slow the economy -- such as raising interest rates -- to lower inflation. This means the economy driving world growth will see a slowdown, which could have repercussions for the world's recovery.

2.) With China's showing a trade deficit, expect international pressure on China to let the Yuan rise to slow. While the deficit's drop is probably temporary, the reality is you never know with economics; we could be witnessing a fundamental change.

Japan: One of the world's largest economics has had a devastating earthquake. 'Nuff said.

Last year, Barry over at the Big Picture posted a story that Contrarian Edge argued Japan would be the first sovereign default. At that time, Japan had nearly a 200% debt/GDP ratio. Will they be able to fund recovery?

Debt Downgrades: Two EU countries had their debt ratings downgraded last week.

First was Greece:

Moody’s Investors Service cut Greece’s sovereign-debt rating Monday by three notches to B1, infuriating the Greek government and temporarily denting the euro amid renewed worries about the ability of Greece and other debt-loaded euro-zone governments to avoid default.

The ratings agency, which also assigned a negative outlook to Greece’s ratings, highlighted the government’s difficulties with revenue collection and noted a risk that Athens might not meet the criteria for continued support from the International Monetary Fund and the European Union after 2013.

That could result in a voluntary restructuring of existing debt, the ratings agency said. Last June, Moody’s cut Greece's rating from A3 to junk status at BA1.

Second was Spain:

Spain moved back into the spotlight of Europe’s long-running debt crisis Thursday as Moody’s Investors Services cut the Spanish government’s debt rating.

The rating was downgraded one notch to Aa2 from Aa1, bringing it in line with the rating offered by Standard & Poor’s. Moody’s put the new rating on negative outlook, a signal that a further cut is possible.

Those are two large shocks to occur in short order. This leads to the broader problem of will the markets finally buy into the EU's solution?

Last year, the EU crisis what the primary reason for a slowdown in the economy. Are the items listed above sufficient to do the same? Obviously, no one knows for sure. However, that's a lot of trouble in a short period of time.