Category Archives: European economy

As a spinoff from blogging for the past several years, I’ve discovered a way to predict the high and low of stock prices over periods, like one or several days, a week, or other periods.

As a general rule, I can forecast the high and low of the SPY – the exchange traded fund (ETF) which tracks the S&P 500 – with average absolute errors around 1 percent.

Recently, friends asked me – “how did you do Monday?” – referring to June 29^th when Greece closed its banks, punting on a scheduled loan payment to the International Monetary Fund (IMF) the following day.

SPY closing prices tumbled more than 2 percent June 30th, the largest daily drop since June 20, 2013.

Performance of the EVPA

I’m now calling my approach the EVPA or extreme value prediction algorithm. I’ve codified procedures and moved from spreadsheets to programming languages, like Matlab and R.

The performance of the EVPA June 29th depends on whether you allow the programs the Monday morning opening price – something I typically build in to the information set. That is, if I am forecasting a week ahead, I trigger the forecast after the opening of that week’s trading, obtaining the opening price for that week.

Given the June 29 opening price for the SPY ($208.05 a share), the EVPA predicts a Monday high and low of 209.25 and 207.11, for percent forecast errors of -0.6% and -1% respectively.

Of course, Monday’s opening price was significantly down from the previous Friday (by -1.1%).

Without Monday’s opening price, the performance of the EVPA degrades somewhat in the face of the surprising incompetence of Eurozone negotiators. The following chart shows forecast errors for predictions of the daily low price, using only the information available at the close of the trading day Friday June 26.

	Actual	Forecast	% Error
29-Jun	205.33	208.71	1.6%
30-Jun	205.28	208.75	1.7%

Forecasts of the high price for one and two-trading day periods average 1 percent errors (over actuals), when generated only with closing information from the previous week.

Where the Market Is Going

So where is the market going?

The following chart shows the high and low for Monday through Wednesday of the week of June 30 to July 3, and forecasts for the high and low which will be reached in a nested series of periods from one to ten trading days, starting Wednesday.

What makes interpretation of these predictions tricky is the fact that they do not pertain to 1, 2, and so forth trading days forward, per se. Rather, they are forecasts for 1 day periods, 2 day periods, 3 day periods, and so forth.

One classic pattern is the highs level, but predictions for the lows drop over increasing groups of trading days. That is a signal for a drop in the averages for the security in question, since highs can be reached initially and still stand for these periods of increasing trading days.

These forecasts offer some grounds for increases in the SPY averages going forward, after an initial decrease through the beginning of the coming week.

Of course the Greek tragedy is by no means over, and there can be more surprises.

Still, I’m frankly amazed at how well the EVPA does, in the humming, buzzing and chaotic confusion of global events.

European economy, financial forecasts, macroeconomic forecasting

The Greek Conundrum

February 17, 2015 Clive Jones

I’ve been focused on stock price forecast models, recently, and before that, on dynamics of oil prices.

However, it’s clear that almost any global market these days can be affected by developments in Europe.

There’s an excellent backgrounder to the crisis over restructuring Greek debt. See Greece, Its International Competitors and the Euro by the Turkish financial analyst T. Sabri Öncü – a PDF from the Economic and Political Weekly, an Indian Journal.

According to Öncü, the Greeks got in trouble with loans to finance consumption and nonproductive spending, when and after they joined the Eurozone in 2001. The extent of the problem was masked by accounting smoke and mirrors, only being revealed in 2009. Since then “bailouts” from European banking authorities have been designed to insure steady repayment of this debt to German and French banks, among others, although some Greek financial parties have benefited also.

Still, as Öncü writes,

Fast forward to today, despite two bailouts and adjustment programmes Greece has been in depression since the beginning of 2009. The Greece’s GDP is down about 25% from its peak in 2008, unemployment is at about 25%, youth unemployment is above 50%, Greece’s public debt to GDP ratio is at about a mind-boggling 175% and many Greeks are lining up for soup in front of soup kitchens reminiscent of the soup kitchens of the Great Depression of 1929.

As this post is written, negotiations between the new Syrizia government and European authorities have broken down, but here is an interesting video outlining the opposing positions, to an extent, prior to Monday.

Bruegel’s Interview: Debt Restructuring & Greece

Austerity is on the line here, since it seems clear Greece can never repay its debts as currently scheduled, even with imposing further privations on the Greek population.

currency forecasts, European economy, financial forecasting, macroeconomic forecasting

Europe, the European Union, the Eurozone – Key Facts and Salient Issues

September 9, 2014 Clive Jones

Considering that social and systems analysis originated largely in Europe (Machiavelli, Vico, Max Weber, Emile Durkheim, Walras, Adam Smith and the English school of political economics, and so forth), it’s not surprising that any deep analysis of the current European situation is almost alarmingly complex, reticulate, and full of nuance.

However, numbers speak for themselves, to an extent, and I want to start with some basic facts about geography, institutions, and economy.

Then, I’d like to precis the current problem from an economic perspective, leaving the Ukraine conflict and its potential for destabilizing things for a later post.

Some Basic Facts About Europe and Its Institutions

But some basic facts, for orientation. The 2013 population of Europe, shown in the following map, is estimated at just above 740 million persons. This makes Europe a little over 10 percent of total global population.

The European Union (EU) includes 28 countries, as follows with their date of entry in parenthesis:

Austria (1995), Belgium (1952), Bulgaria (2007), Croatia (2013), Cyprus (2004), Czech Republic (2004), Denmark (1973), Estonia (2004), Finland (1995), France (1952), Germany (1952), Greece (1981), Hungary (2004), Ireland (1973), Italy (1952), Latvia (2004), Lithuania (2004), Luxembourg (1952), Malta (2004), Netherlands (1952), Poland (2004), Portugal (1986), Romania (2007), Slovakia (2004), Slovenia (2004), Spain (1986), Sweden (1995), United Kingdom (1973).

The EU site states that –

The single or ‘internal’ market is the EU’s main economic engine, enabling most goods, services, money and people to move freely. Another key objective is to develop this huge resource to ensure that Europeans can draw the maximum benefit from it.

There also are governing bodies which are headquartered for the most part in Brussels and administrative structures.

The Eurozone consists of 18 European Union countries which have adopted the euro as their common currency. These countries includes Belgium, Germany, Estonia, Ireland, Greece, Spain, France, Italy, Cyprus, Latvia, Luxembourg, Malta, the Netherlands, Austria, Portugal, Slovenia, Slovakia and Finland.

The European Central Bank (ECB) is located in Frankfurt, Germany and performs a number of central bank functions, but does not clearly state its mandate on its website, so far as I can discover. The ECB has a governing council comprised of representatives from Eurozone banking and finance circles.

Economic Significance of Europe

Something like 160 out of the Global 500 Corporations identified by Fortune magazine are headquartered in Europe – and, of course, tax slides are moving more and more US companies to nominally move their operations to Europe.

According to the International Monetary Fund World Economic Outlook (July 14, 2013 update), the Eurozone accounts for an estimated 17 percent of global output, while the European Union countries comprise an estimated 24 percent of global output. By comparison the US accounts for 23 percent of global output, where all these percents are measured in terms of output in current US dollar equivalents.

What is the Problem?

I began engaging with Europe and its economic setup professionally, some years ago. The European market is important to information technology (IT) companies. Europe was a focus for me in 2008 and through the so-called Great Recession, when sharp drops in output occurred on both sides of the Atlantic. Then, after 2009 for several years, the impact of the global downturn continued to be felt in Europe, especially in the Eurozone, where there was alarm about the possible breakup of the Eurozone, defaults on sovereign debt, and massive banking failure.

I have written dozens of pages on European economic issues for circulation in business contexts. It’s hard to distill all this into a more current perspective, but I think the Greek economist Yanis Varoufakis does a fairly good job.

Let me cite two posts – WHY IS EUROPE NOT ‘COMING TOGETHER’ IN RESPONSE TO THE EURO CRISIS? and MODEST PROPOSAL.

The first quote highlights the problems (and lure) of a common currency to a weaker economy, such as Greece.

Right from the beginning, the original signatories of the Treaty of Rome, the founding members of the European Economic Community, constituted an asymmetrical free trade zone….

To see the significance of this asymmetry, take as an example two countries, Germany and Greece today (or Italy back in the 1950s). Germany, features large oligopolistic manufacturing sectors that produce high-end consumption as well as capital goods, with significant economies of scale and large excess capacity which makes it hard for foreign competitors to enter its markets. The other, Greece for instance, produces next to no capital goods, is populated by a myriad tiny firms with low price-cost margins, and its industry has no capacity to deter competitors from entering.

By definition, a country like Germany can simply not generate enough domestic demand to absorb the products its capital intensive industry can produce and must, thus, export them to the country with the lower capital intensity that cannot produce these goods competitively. This causes a chronic trade surplus in Germany and a chronic trade deficit in Greece.

If the exchange rate is flexible, it will inevitably adjust, constantly devaluing the currency of the country with the lower price-cost margins and revaluing that of the more capital-intensive economy. But this is a problem for the elites of both nations. Germany’s industry is hampered by uncertainty regarding how many DMs it will receive for a BMW produced today and destined to be sold in Greece in, say, ten months. Similarly, the Greek elites are worried by the devaluation of the drachma because, every time the drachma devalues, their lovely homes in the Northern Suburbs of Athens, or indeed their yachts and other assets, lose value relative to similar assets in London and Paris (which is where they like to spend their excess cash). Additionally, Greek workers despise devaluation because it eats into every small pay rise they manage to extract from their employers. This explains the great lure of a common currency to Greeks and to Germans, to capitalists and labourers alike. It is why, despite the obvious pitfalls of the euro, whole nations are drawn to it like moths to the flame.

So there is a problem within the Eurozone of “recycling trade surpluses” basically from Germany and the stronger members to peripheral countries such as Greece, Portugal, Ireland, and even Spain – where Italy is almost a special, but very concerning case.

The next quote is from a section in MODEST PROPOSAL called “The Nature of the Eurozone Crisis.” It is is about as succinct an overview of the problem as I know of – without being excessively ideological.

The Eurozone crisis is unfolding on four interrelated domains.

Banking crisis: There is a common global banking crisis, which was sparked off mainly by the catastrophe in American finance. But the Eurozone has proved uniquely unable to cope with the disaster, and this is a problem of structure and governance. The Eurozone features a central bank with no government, and national governments with no supportive central bank, arrayed against a global network of mega-banks they cannot possibly supervise. Europe’s response has been to propose a full Banking Union – a bold measure in principle but one that threatens both delay and diversion from actions that are needed immediately.

Debt crisis: The credit crunch of 2008 revealed the Eurozone’s principle of perfectly separable public debts to be unworkable. Forced to create a bailout fund that did not violate the no-bailout clauses of the ECB charter and Lisbon Treaty, Europe created the temporary European Financial Stability Facility (EFSF) and then the permanent European Stability Mechanism (ESM). The creation of these new institutions met the immediate funding needs of several member-states, but retained the flawed principle of separable public debts and so could not contain the crisis. One sovereign state, Cyprus, has now de facto gone bankrupt, imposing capital controls even while remaining inside the euro.

During the summer of 2012, the ECB came up with another approach: the Outright Monetary Transactions’ Programme (OMT). OMT succeeded in calming the bond markets for a while. But it too fails as a solution to the crisis, because it is based on a threat against bond markets that cannot remain credible over time.

And while it puts the public debt crisis on hold, it fails to reverse it; ECB bond purchases cannot restore the lending power of failed markets or the borrowing power of failing governments.

Investment crisis: Lack of investment in Europe threatens its living standards and its international competitiveness. As Germany alone ran large surpluses after 2000, the resulting trade imbalances ensured that when crisis hit in 2008, the deficit zones would collapse. And the burden of adjustment fell exactly on the deficit zones, which could not bear it. Nor could it be offset by devaluation or new public spending, so the scene was set for disinvestment in the regions that needed investment the most.

Thus, Europe ended up with both low total investment and an even more uneven distribution of that investment between its surplus and deficit regions.

Social crisis: Three years of harsh austerity have taken their toll on Europe’s peoples. From Athens to Dublin and from Lisbon to Eastern Germany, millions of Europeans have lost access to basic goods and dignity. Unemployment is rampant. Homelessness and hunger are rising. Pensions have been cut; taxes on necessities meanwhile continue to rise. For the first time in two generations, Europeans are questioning the European project, while nationalism, and even Nazi parties, are gaining strength.

This is from a white paper jointly authored by Yanis Varoufakis, Stuart Holland and James K. Galbraith which offers a rationale and proposal for a European “New Deal.” In other words, take advantage of the record low global interest rates and build infrastructure.

The passage covers quite a bit of ground without appearing to be comprehensive. However, it will be be a good guide to check, I think, if a significant downturn unfolds in the next few quarters. Some of the nuances will come to life, as flaws in original band-aid solutions get painfully uncovered.

Now there is no avoiding some type of ideological or political stance in commenting on these issues, but the future is the real question. What will happen if a recession takes hold in the next few quarters?

More on European Banks

European banks have been significantly under-capitalized, as the following graphic from before the Great Recession highlights.

Another round of stress tests are underway by the ECB, and, according to the Wall Street Journal, will be shared with banks in coming weeks. Significant recapitalization of European banks, often through stock issues, has taken place. Things have moved forward from the point at which, last year, the US Federal Deposit Insurance Corporation (FDIC) Vice Chairman called Deutsche Banks capitalization ratios “horrible,” “horribly undercapitalized” and with “no margin of error.”

Bottom LIne

If a recession unfolds in the next few quarters, it is likely to significantly impact the European economy, opening up old wounds, so to speak, wounds covered with band-aid solutions. I know I have not proven this assertion in this post, but it is a message I want to convey.

The banking sector is probably where the problems will first flare up, since banks have significant holdings of sovereign debt from EU states that already are on the ropes – like Greece, Spain, Portugal, and Italy. There also appears to be some evidence of froth in some housing markets, with record low interest rates and the special conditions in the UK.

Hopefully, the global economy can side-step this current wobble from the first quarter 2014 and maybe even further in some quarters, and somehow sustain positive or at least zero growth for a few years.

Otherwise, this looks like a house of cards.

European economy, forecasting interest rates, macroeconomic forecasting

Negative Nominal Interest Rates – the European Central Bank Experiment

September 8, 2014 Clive Jones 2 Comments

Larry Summers, former US Treasury Secretary and, earlier, President of Harvard delivered a curious speech at an IMF Economic Forum last year. After nice words about Stanley Fischer, currently Vice Chair of the Fed, Summers entertains the notion of negative interest rates to combat secular stagnation and restore balance between aggregate demand and supply at something like full employment.

Fast forward to June 2014, when the European Central Bank (ECB) pushes the interest rate on deposits European banks hold in the ECB into negative territory. And on September 4, the ECB drops the deposit rates further to -0.2 percent, also reducing a refinancing rate to virtually zero.

The ECB discusses this on its website – Why Has the ECB Introduced a Negative interest Rate. After highlighting the ECB mandate to ensure price stability by aiming for an inflation rate of below but close to 2% over the medium term, the website observes euro area inflation is expected to remain considerably below 2% for a prolonged period.

This provides a rationale for lower interest rates, of which there are principally three under ECB control – a marginal lending facility for overnight lending to banks, the main refinancing operations and the deposit facility.

Note that the main refinancing rate is the rate at which banks can regularly borrow from the ECB while the deposit rate is the rate banks receive for funds parked at the central bank.

The ECB is adjusting interest rates under their control across the board, as suggested by the chart, but worries that to maintain a functioning money market in which commercial banks lend to each other, these rates cannot be too close to each other.

So, bottom line, the deposit rate was lowered to − 0.10 % in June to maintain this corridor, and then further as the refinancing rate was dropped to -.05 percent.

The hope is that lower refinancing rates will mean lower rates for customers for bank loans, while negative deposit rates will act as a disincentive for banks to simply park excess reserves in the ECB.

Nominal Versus Real Interest Rates and Bond Yields

If you want to prep for, say, negative yields on two year Irish bonds, or issuance of various European bonds with negative yield, as well as the negative yields of a variety of US securities in recent years, after inflation, check out How Low Can You Go? Negative Interest Rates and Investors’ Flight to Safety.

An asset can generate a negative yield, on a conventional, rather than catastrophic basis, in a nominal or real, which is to say, inflation-adjusted, sense.

Some examples of negative real interest rates of yields –

The yield to maturity on the 5-year Treasury note has been below 2 percent since July 2010, and the yield to maturity on the 10-year Treasury note has been below 2 percent since May 2012. Yet, looking forward, the Federal Open Market Committee in January 2012 announced an inflation target of 2 percent—implying an anticipated negative real yield over the life of the securities. Investors, facing uncertainty, appear willing to pay the U.S. government—when measured in real, ex post inflation-adjusted dollars—for the privilege of owning Treasury securities.

And the current government bond yield situation, from Bloomberg, shows important instances of negative yields, notably Germany and Japan – two of the largest global economies. Click to enlarge.

Where the ECB Goes From Here

Mario Draghi, ECB head, gave a speech clearly stating monetary policy is not enough, at the recent Jackson Hole conference of central bankers. After this, the financial press was abuzz with the idea Draghi is moving toward the Japanese leader Abe’s formulation in which there are three weapons or arrows in the Japanese formulation– monetary policy, fiscal policy and structural reforms.

The problem, in the case of the Eurozone, is achieving political consensus for fiscal policies such as backing bonds for badly needed infrastructure development. German opposition seems to be sustained and powerful.

Because of the “political economy” factors , currency and banking problems in the Eurozone are probably more complicated and puzzling than many business executives and managers, looking for a take on the situation, would prefer.

A Thought Experiment

Before diving into this conceptually hazardous topic, though, I’d like to pose a puzzle for readers.

Can banks realistically “charge” negative interest rates to commercial customers?

I seem to have cooked up a spreadsheet where such loans could pay a rate of positive real return to banks, if the rate of deflation can be projected. In one variant, the bank collects a lending fee at the outset and then the interest rate for installments is negative.

The “save” for banks is that future deflation could inflate the real value of declining nominal installment payments, creating a present value of this stream of payments which is greater than the simple sum of such payments.

I’m not ready for primetime television with this, but it seems such a world encapsulates a very dour view of the future – one that may not be too far from the actual situation in Europe and Japan.

Money black hole at top from Conservative Read

currency forecasts, developed country forecast, European economy, financial forecasts, Quantitative Easing (QE)

Something is Happening in Europe

September 8, 2014 Clive Jones

Something is going on in Europe.

Take a look at this chart of the euro/dollar exchange rate, and how some event triggered a step down mid week of last week (from xe.com).

The event in question was a press conference by Mario Draghi (See the Wall Street Journal real time blog on this event at Mario Draghi Delivers Fresh ECB Plan — Recap).

The European Central Bank under Draghi is moving into exotic territory – trying negative interest rates on bank deposits and toying with variants of Quantitative Easing (QE) involving ABS – asset backed securities.

All because the basic numbers for major European economies, including notably Germany and France (as well as long-time problem countries such as Spain), are not good. Growth has stalled or is reversing, bank lending is falling, and deflation stalks the European markets.

Europe – which, of course, is sectored into the countries inside and outside the currency union, countries in the common market, and countries in none of the above – accounts for several hundred million persons and maybe 20-30 percent of global production.

So what happens there is significant.

Then there is the Ukraine crisis.

Zerohedge ran this graphic recently showing the dependence of European countries on gas from Russia.

The US-led program of imposing sanctions on Russia – key individuals, companies, banks perhaps – flies in the face of the physical dependence of Germany, for example, on Russian gas.

On the other hand, there is lots of history here on all sides, including, notably, the countries formerly in the USSR in eastern Europe, who no doubt fear the increasingly nationalistic or militant stance shown by Russia currently in, for example, re-acquiring Crimea.

As Chancellor Merkel has stressed, this is an area for diplomacy and negotiation – although there are other voices and forces ready to rush more weapons and even troops to the region of conflict.

Finally, as I have been stressing from time to time, there is an emerging demographic reality which many European nations have to confront.

Edward Hugh has several salient posts on possibly overlooked impacts of aging on the various macroeconomies involved.

There also is the vote on Scotland coming up in the United Kingdom (what we may, if the “yes” votes carry, need to start calling “the British Isles.”)

I’d like to keep current with the signals coming from Europe in a few blogs upcoming – to see, for example, whether swing events in the next six months to a year could originate there.

energy forecasting, European economy, geopolitical risk, global business forecasts

Geopolitical Risk

March 3, 2014 Clive Jones

USA Today has a headline today What Wall Street is watching in Ukraine crisis and a big red strip across the top of the page with Breaking News Russia issues surrender ultimatum to Ukrainian forces in Crimea.

But the article itself projects calming thoughts, such as,

History also shows that market shocks caused by war, terrorism and other fear-rattling events tend to be short-lived.

In 14 shocks dating back to the attack on Pearl Harbor in December 1941, the median one-day decline has been 2.4%. And the shocks, which also include the Sept. 11 terror attacks and the 1962 Cuban missile crisis, lasted just eight days, with total losses of 7.4%, data from S&P Capital IQ show. The market recouped its losses 14 days later.

Similarly, the Economist February 26 ran an article The return of geopolitical risk noting that,

If there is a consensus, it is probably that geopolitical risks have a tendency to go away. Think back over the last 24 years, going all the way back to the Kuwait crisis, and you will recall that markets sold off initially but recovered as the conflicts turned out either to be shorter, or less economically damaging, than they feared. Hence, while the markets have sold off today, the declines have hardly been substantial (between 0.8% and for the FTSE and 1.4% for the Dax at the time of writing).

Professional organizations in the geopolitical risk space offer to provide information to companies operating in risk-prone areas or with vital interests in, say, natural gas markets globally.

One of these is Stratfor, founded by George Friedman in 1996, with subscription services and reports for purchase by business and other organizations. For the interested, here is a friendly but critical review of Friedman’s supposedly best-selling The Next 100 Years: A Forecast for the 21^st Century (2009). Friedman actually predicts the disintegration of Russia in the 2020’s, following a re-assertion of Russian power westward, toward Europe. Hmmm.

Currently, Stratfor is highlighting the potential for the emergence of extreme right-wing groups in the Ukraine. This is a similar focus to one developed in an excellent article in Le Monde Diplomatique Ukraine beyond politics.

I don’t want to comment too extensively on the US role in the Ukraine, or the inevitable saber-rattling and accusations that not enough is being done.

Rather, I think it’s important to look at one particular graphic, presented initially by Business Insider and extensively tweeted thereafter.

So from a purely predictive standpoint, it seems unlikely the United States can originate and see implemented significant economic sanctions against Russia – since then, clearly, Russia has the power to retaliate through its control of significant natural gas supplies for western Europe.

The risk – plunging western Europe back into recession, again threatening the US economic recovery.

Economic rationality may provide some constraints to wild responses and actions, but the low performance of many economies since 2009 creates a fertile environment for the emergence of hot-heads, demagogues, and madmen.

So, what I guess I worry about is that the general geopolitical dynamics seem to be moving into greater and greater vulnerability to some idiotic minor event which functions as a tipping point.

But then again, the markets may go forth to a new stabilization very shortly, and it will be business as usual, with more than a modicum of background noise from politics.

Business Forecasting