Friday, February 15, 2019

US vs Eurozone comparisons

Here are four charts that look at key aspects of the US and Eurozone economies: swap spreads, industrial production, equity prices, and exchange rates. By now everyone knows that the Eurozone has its problems, especially with the UK's bumbling attempt to exit the Eurozone trade agreement, France's violent protests, Germany's struggle to assimilate millions of muslim immigrants, and Italy's refusal to address its fiscal deficit. But if you think things are bad in the US, you've been reading too much fake news. 

Chart #1

Chart #1 compares 2-yr swap spreads—my all-time favorite financial indicator—in the US and Eurozone. Here we see that swap spreads have been extremely well-behaved in the US, trading within a normal range of 10-30 bps for most of the past 5 years. This is a clear sign that the financial fundamentals of the US economy are sound: systemic risk is low and liquidity is abundant. The Fed has not made any move that would disturb this. The Eurozone, in contrast, has been struggling with above-average systemic risk and liquidity shortages for the better part of the past 3 years, even as many Eurozone bond yields trade in negative territory; low interest rates are not necessarily stimulative. Eurozone yields are low because growth and opportunity are in very scarce supply.

Note in particular how Eurozone swap spreads began to surge in the first half of 2011, some 3-6 months before a recession hit, and how they began to decline well in advance of the end of the Eurozone recession. This is yet more proof that swap spreads can be excellent leading indicators of economic and financial market health. I have more background on swap spreads here, and numerous charts on swap spreads over the years here.

Chart #2

Chart #2 compares industrial production in the Eurozone and the US. Here we see how Eurozone industrial production declined throughout its 2011-2013 recession, whereas US industrial production kept rising and has now moved well ahead of the Eurozone. The recent decline in Eurozone industrial production hints strongly at a recession, but the Eurozone's relatively stable and only moderately elevated level of swap spreads argues against a Eurozone recession.

Chart #3

Chart #3 compares equity market performance in the US and Eurozone. Note how both markets suffered a setback in the run-up to the Eurozone's 2011-2013 recession, then proceeded to rally throughout the course of the recession. Equity markets can indeed be leading indicators of economic troubles, but not always. In any event, the industrial side of the US economy has zoomed far ahead of its Eurozone counterpart over the past decade. The US is, by this measure, the most dynamic of the advanced economies on the planet.

Chart #4

Chart #4 compares the value of the Euro/dollar exchange rate to my calculation of the Purchasing Power Parity of the Euro. (The PPP value of one currency versus another is driven by changes in relative inflation, and in theory it is the rate which would make prices in both economies roughly equal. In this case, since Eurozone inflation has been lower than US inflation since 1995, the PPP value of the Euro has been slowly rising since 1995.) Over the past decade, as Eurozone industrial production has lagged US industrial production (and by inference the US economy has outperformed), the nominal value of the Euro has been falling, from a high of 1.60 to now 1.13. This supports my view that the current strength of the dollar is largely driven not by tight money or higher interest rates, but by the fact that the US economy is simply a much more attractive place for capital.


Benjamin Cole said...

Great post.

Currency exchange rates, I will confess, totally confuse me.

Japan has been running large national budget deficits and operating an "ultra easy" monetary policy for years and years.

The Yen has actually strengthened against the dollar in the last year, mildly.
The Bank of Japan cannot hit its 2% inflation target.

Adam said...

Thanks Scott,
One thing to ask you. On calculating real rates. There are inflaton swaps of a diffetent maturity. Can we just deduct a given tenor of inflation swaps from a given tenor of nominal yields?

xav said...

Nice post as always.

What would be the difference between your PPP adjusted exchange rate and the Real exchange rate (nominal adjusted for inflation)?

Johnny Bee Dawg said...

European Socialism is a huge heavy wet blanket that keeps down economic growth and opportunity (and interest rates) there. They do as well as they do because the USA exists.

The US is the best economy on the planet because we are currently the country who's policies are best unleashing the most freedom and potential of its citizens. For now. The more that is throttled by the Big Government Swamp, the less prosperous we will be. Once Trump leaves office and we revert to DC culture, we will slide back into the Obama-type malaise...or even worse if the AOC's keep gaining power in our Congress.

Scott Grannis said...

Re "Can we just deduct a given tenor of inflation swaps from a given tenor of nominal yields?" I'm not familiar with inflation swaps, but I am very familiar with TIPS. With the latter, deducting the real yield on, say, a 2-yr TIPS from the nominal yield on 2-yr Treasuries is not going to always give you a meaningful result. That's because the real yield on short maturity TIPS is influenced by the fact that the inflation adjustment that is used with TIPS is not seasonally adjusted, and there is a definite seasonality to inflation.. With the 5-yr tenor, in contrast, that effect largely disappears.

Scott Grannis said...

Re " What would be the difference between your PPP adjusted exchange rate and the Real exchange rate (nominal adjusted for inflation)?" There is no similarity between the two, because a real exchange rate is usually calculated relative to a trade-weighted basket of currencies. The PPP exchange rate I'm calculating is an inflation-adjusted rate using just two currencies, in this case the Euro and the dollar. Also, I am using as a reference point a base year which is theoretically the year in which there were no obvious trade imbalances/price differentials between the two countries involved.

ForexMaster said...

Thanks a lot Scott for this post.
Reading from France, sad how things evolve here, in Europe.

The Cliff Claven of Finance said...

Industrial Productions charts tell the story
of the US and Eurozone real economies better:

Vespasianus said...

I think the charts tell most of the story here. Europe is a place to retire and enjoy life, but not to work and invest. Of course, people here don't realize that the first thing will only be possible in the future if they stimulate the second.

The tax pressure is insane. The regulations, asphyxiating. As an anecdote: I was offered a promotion in the work that I did not accept, because it involved raising the tax bracket and I was going to earn less.

I am amazed there are politicians in the USA who still believe Europe is a model in terms of social or economical development. Apart from gun controls, if I were American I would not import anything from Europe's model.

Adam said...

Re Europe,
Smaller part of the continent, like Poland are doing very ok. Very well educated workforce, improving infrastructure, very good climate, a lot of global business pouring into the country.

Johnny Bee Dawg said...

I wonder what Poland's immigration policies are like?
Oh, wait...

Benjamin Cole said...

Europe looking soggier by the day.

The ECB may go back to QE.

Odd fact: Germany is the world's preeminent exporter running up $292 billion of net (yes, net) exports in 2018, or about $3,500 per resident of 82 million.

Germany has about 45% of GDP in the public sector.

Germans workers work an average of 1,350 hours a year, vs. 1,750 in the US. German workers get 10 weeks off a year that American do not.

How does a nation run heavy taxes, work less, and successfully export so much?

Unknown said...

Hi Scott, Just a note to say that I very much appreciate your columns. They are a refreshing change from the "feelings" of most commentators and give solid information rather than speculation!

Scott Grannis said...

Larry: thanks! All: I've been traveling around Patagonia the past several days, including a cruise that took us to Cape Horn but which left us incommunicado (no internet!) for 4 days. Hoping to find time to reconnect soon. From what little I've managed to see, both Chile and Argentina are doing fine these days, and there's loads of tourism supporting the economies in the south. It's gorgeous country but distances are large and people are scarce.

brave chicken said...

Mixed Factory Orders and Shipments Data
by Gerald D. Cohen February 27, 2019

Factory shipments shrank 0.2% (4.1% y/y), the third consecutive monthly decrease. Despite this weakness, shipments rose at a 0.8% annual rate in Q4 as strong August data created a healthy starting point for the quarter.

brave chicken said...


The Atlanta Federal Reserve is projecting GDP grew 1.8 percent in the October-December quarter, which would be the slowest in nearly two years. Economists are forecasting that the economy grew about 2.9 percent in 2018, which would the best performance since 2015 and better than the 2.2 percent logged in 2017.

"This is as good as it gets for the first Trump administration," said Joe Brusuelas, chief economist at RSM in New York.

Growth in consumer spending, which accounts for more than two-thirds of U.S. economic activity, is expected to have slowed considerably from the third quarter's robust 3.5 percent rate, but still benefits from a strong (part-time/low-wage) labor market.

With consumer spending slowing, some of the imports probably ended piling up in warehouses. That is expected to have accelerated inventory accumulation, which could offset some of the anticipated drag on GDP growth from the trade deficit.