Europe's Cage is Rattled a Bit

The little disturbance in Portugal's banking landscape hasn't been entirely overcome yet. New management has been installed at Banco Espirito Santo, but the problem is that the bank apparently sits on quite a few dubious assets, and the new management cannot wish them away. BES appears to have sunk a lot of money into former Portuguese colony Angola, and these loans are the subject of growing concern. On Tuesday, the stock of BES collapsed to a new low, but the losses have been recovered in Wednesday's trading session.

In parallel with the still growing worries about BES, Germany's ZEW institute issued its economic confidence indicator, which showed the 7^th monthly decline in a row. Wasn't there supposed to be a recovery?

A few excerpts from a Reuters summary:

“European stocks and the euro fell on Tuesday after shares in Portugal's biggest listed bank hit a record low, while a plunge in German economic sentiment pushed up borrowing costs for some peripheral euro zone countries.

Global stock markets have recently been supported by dovish policy measures from major central banks and signs that economies are recovering, though worries persist over the pace of growth in Europe and the health of the region's banks.

[…]

The banking sector was a sharp underperformer, with Portugal's Banco Espirito Santo  slumping 17.5 percent to a fresh record low. Traders blamed concerns over the bank's Angolan loan portfolio and the sale of a stake at a low price by the bank's founding family on Monday.

[...]

"The key takeaway is that the banking sector globally continues to struggle despite time having been bought, and policy being tremendously supportive," said Jeremy Batstone-Carr, head of private client research at Charles Stanley.

"The sector feels like a minefield."

Below are chart updates of BES and Portugal Telecom –  while the shares of BES managed to recover on Wednesday morning, Portugal Telecom's stock gave ground again and relinquished much of its earlier bounce. Our guess is that there is broad agreement that the company will have to write off a good chunk of its BES related investments.

The PSI-20 remains the worst looking stock market index in Europe, and the recent pressure on BES has also had an impact on the Euro-Stoxx bank index – the latter has however stopped declining for the moment after hitting a lateral support area. However, said support area also happens to be the neck-line of a potential head & shoulders top.

By now it's probably oversold – BES hits a new low on high volume and subsequently recovers with some verve, displaying typical penny stock behavior – click to enlarge.

Portugal Telecom – only holding on to about half of the day's rebound – click to enlarge.

The PSI 20 index definitely looks  technically challenged at this point – click to enlarge.

Euro-Stoxx bank index: support holds for now, but this could be an H&S top – click to enlarge.

ZEW Turns Into Party Pooper

ZEW's economic sentiment indicator for Germany keeps declining. This is is evidently the result of economic conditions worsening lately, otherwise there would be no reason for people to express pessimism in the survey. Apparently the “medium term outlook” is still holding up though. Euro area sentiment is declining as well. Here is the associated press release:

“The ZEW Indicator of Economic Sentiment for Germany decreased once more in July 2014. The indicator has lost 2.7 points and now stands at 27.1 points (long-term average: 24.7 points). The indicator has declined for the seventh consecutive time.

"Germany has experienced a slight dent in economic activity recently – retail sales declined and industrial production as well as incoming orders dropped. The current decrease of the ZEW Indicator of Economic Sentiment reflects this sobering development. On a general note, however, the medium-term economic outlook remains favorable”, says ZEW President Professor Clemens Fuest.

The assessment of Germany’s current economic situation declined by 5.9 points to 61.8 points in this month’s survey. The ZEW Indicator of Economic Sentiment for the Eurozone also decreased in July 2014. The indicator has lost 10.3 points compared to the previous month, now standing at 48.1 points. The indicator for the current economic situation in the euro area has declined by 3.8 points to minus 31.5 points.

The chart of the ZEW indicator looks like this:

The blue line is the long term average level, so the indicator remains just above the average – click to enlarge.

We have reason to believe that what bank lending growth there is in the euro area is mainly going toward funding governments. We conclude this from the fact that money TMS (currency and demand deposits) continues to grow, while lending to corporations and households is declining (lending to households has been flat-lining since late 2010, but has recently dipped to its lowest point since then). However, the downtrend in euro area money supply growth remains in force as well – even though there was a slight bump in the growth rate last month.

Total loans to non-financial corporations in the euro area – the year-on-year rate of decline currently at 3%, which is up from the 6% y/y decline rate in 2013, due to a brief bump in lending in early 2014 - click to enlarge.

Euro area money supply – still growing at just above 5%, but the downtrend in the growth rate remains in force so far – click to enlarge.

Is it a coincidence that the ZEW sentiment indicators are moving in the same direction as the euro area's money supply growth rate with a slight lag? No, it isn't. Every time the money supply expands, the economy gets a brief “shot in the arm”, as France's post-revolutionary inflationists already discovered. But eventually there comes a point when a choice must be made: either one allows the effect to dissipate by pulling back on the inflationary policy, or one risks currency trouble. In this particular case this is actually not the reason for the slowdown in money growth. Rather, the central bank is still hoping that the commercial banking system will eventually expand its lending, but as noted yesterday, threats of “QE” are already in the air.  If the money supply growth rate keeps falling, various measures of economic activity are likely to follow suit.

Conclusion:

All in all, the above underscores that Mario Draghi's recent pronouncements regarding the possibility of fresh money printing steps being implemented by the ECB must be taken seriously. In other words, eventually, he'll get around to doing more economic damage.

Charts by: 4-traders.com, BigCharts, ZEW, ECB