European Disinflation Continues

by: John M. Mason


European inflation drops once more... and is expected to drop further.

The 10-year German bund continues to trade near historic lows.

Investors seem to be saying that economic growth is not going to be very strong, now and in the near future.

This is not inconsistent with what is happening in America.

Latest news out of the eurozone is that the European disinflation is still continuing.

A "flash estimate" was issued this morning by Eurostat, the European Commission's statistics bureau. It showed that inflation in July was at an annual rate of 0.4 percent, down from the June figure of 0.5 percent.

"Inflation could fall further, Fabio Fois, economist at Barclays, said: 'A further decline to 0.3 per cent in August is likely; this would be a new cyclical low. Weakness in prices persists, especially those for energy goods.'"

These numbers are not inconsistent with the expectations that are apparently built into the structure of bond yields on the continent. Just on Tuesday, the yield on the 10-year German bund hit a record low of 1.119 percent and closed at 1.200 percent for the day. These were historic lows.

Today, the 10-year bund was trading to yield 1.16 percent.

Whereas forecasts for this security in December 2013 were for higher rates by the end of 2014, the surprise has come as interest rates have moved in the opposite direction.

Investors seem to have accounted for weak economic growth along with weak expectations of inflation bond market investments.

As of 10:00 am in the United States, European stocks took a turn to the lower side. The Europe Dow was off almost 21 points, the Stoxx Europe 600 was down 3.5 points, Germany's DAX was down over 130 points, and in England, the FTSE 100 was down almost 18 points.

Also at 10:00 am in the United States, the S&P 500 was down by almost 150 points.

And, investors continue to be confused. The release in the United States of the second quarter GDP numbers brought some positive hope. The Financial Times trumpeted on its front page "US Economy Roars Back With 4% Growth In Second Quarter."

Year-over-year, however, the growth rate was only at 2.4 percent for the second quarter. This is up from a revised figure for the first quarter of 1.9 percent. It is down from the 3.1 percent figure of the fourth quarter of 2013.

Most forecasts for the United States in 2014 are for America to grow in the 2.0 percent to 2.5 percent range with analysts leaning toward the lower number. Looking forward, many analysts and agencies are looking for close to a 2.0 percent annual rate over the next couple of years.

For the eurozone, the European Central Bank is only predicting that the economy will grow by 1.0 percent this year and will rise to 1.8 percent in 2016.

Thus, the major Western nations are not looking at very robust growth in the near future.

The banking systems seem to reflect much of the same thing.

The European Central Bank indicates that bank loans in the eurozone shrank by 1.7 percent from a year earlier. The ECB noted that this is the 26th consecutive contraction in loans outstanding.

American banks, although loans are increasing within the system, still face large loan delinquency problems, something that has gotten quite a bit of attention in the past week with the release of a study by the Urban Institute titled: "Delinquent Debt in America."

The result of this research showed "Roughly 77 million Americans, or 35 percent of adults with a credit file, have a report of debt in collections."

But, these numbers don't tell the whole story. The report states that there are roughly 22 million adults that do not have credit files. This is roughly 9 percent of the population.

"Many of the lowest income consumers cannot access traditional credit, like a credit card, so do not have the associated debt. Nonetheless, people with limited or no access to traditional credit may still have delinquent debts. They may have an unpaid utility or medical bill, for example that ends up in collections and results in a negative report on their credit file. They may also owe money to friends or family, or have loans outside the financial mainstream."

Europeans are not immune to this problem. And, banks and other financial institutions that have a lot of "bad debt" on their books are not as likely to lend as freely as are banks that have cleaner balance sheets.

The European economy is growing, as is the United States economy. However, the growth in either area is not that robust and does not look like it is going to be that robust.

As I have written many times before, the problems are structural and not cyclical. Still many economists are still treating the situation as a cyclical one. That is why they keep looking for the "good news" in almost every statistical report that comes out. In addition, many people are looking for an economic justification for the historically high stock markets.

At some time, analysts… and politicians… are going to have to realize that more, longer-run solutions are going to have to be introduced and not just short-term solutions that will get the politicians through the next election.

There are two concerns that we should be aware of going forward. First, the American economy is not growing very rapidly. The eurozone is in even worse shape. How much are these two trading areas going to play off of one another? If the eurozone moves into a period of deflation, how much will this impact US growth? And, how much will the American situation hurt Europe?

Second, there are many "shocks" that could hit these economies… and the world… that could worsen the situation. For example, what will the growing burdens of sanctions on Russia do to the European economy?

But, there is also the Middle East explosion… which includes more situations than just the Israel-Gaza problem.

I think that the bond markets, both in the Europe and in the United States, are reflecting investor realization that the economies in both areas are not as strong as was thought, even just seven or eight months ago. A conclusion like this, I believe, is important for our understanding of the stock market and where it has been. Weak economies do not produce sustainable growth of earnings.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.