The Dow and S&P 500 each lost about 0.4% last week, in a see-saw manner, reacting to various ups and downs of the Greek debt crisis. First, Greece “blinked” and offered to cut pension benefits, which the International Monetary Fund (IMF) had demanded. Although Greece did not offer to cut pensions as much as the IMF demanded, it was a significant move, since it lifted investors’ hopes that the country’s debts will be successfully restructured and their fiscal problems will be further kicked down the road.
Then, Greece abruptly walked away from negotiations on Wednesday. Greek creditors demanded that they submit an acceptable plan by Thursday night; otherwise the euro-zone finance ministers would give Greece a “take it or leave it” offer. Despite this ultimatum, the European Central Bank (ECB) still kept providing liquidity to Greek banks, which are experiencing outflows of up to 1.5 billion euros a day. (Last Saturday, more than one-third of Greek ATMs ran out of cash, as long lines formed at many bank ATMs. Then, on Sunday night, Greece announced that they would not let any banks open for business Monday.)
Last Friday, Greek Prime Minister Alexis Tsipras called for a surprise referendum on July 5th, in which Greece’s citizens would vote on whether or not they want to comply with euro-zone and IMF demands of significant pension cuts and other austerity measures. Apparently, Prime Minister Tsipras, who ran on the promise of no pension or austerity cuts, wants the citizens to vote again on his previous election promises.
Due to this surprise referendum, Germany and other major euro-zone countries have ceased negotiations. As of today (June 30), Greece owes the IMF 1.55 billion euros ($1.73 billion). It appears that Greece will likely miss today’s deadline. However, according to the IMF, missing a payment does not constitute a “default”! The loan is “delinquent.” Clearly, with the IMF saying that missing a substantial payment is not a default and with the ECB still pumping money into Greece’s banks, they have bent over backwards to rescue Greece.
Who knows how long Greek banks will stay closed? It’s possible that the Greek referendum could end the crisis or signal a Greek exit from the euro-zone. If the Greeks vote to accept austerity, the crisis could be over, but if they reject austerity, the crisis will escalate and the next step may be for Greece to exit the euro-zone and return to the drachma or the Russian ruble – which could also devalue their pension plans.
On Wednesday, the Commerce Department revised its estimate of first-quarter GDP growth up to a -0.2% annualized contraction, from the previous estimate of a -0.7% annual contraction. Business investment contracted by 2% in the first quarter, the biggest quarterly decline since 2009. Exports declined at a 5.9% annual pace (up from an initial estimate of a 7.6% decline) in the first quarter, while imports grew at a 7.1% annual pace (up from initial estimate of 5.6%), so trade remained a major drag on GDP.
The bad winter weather, the West Coast port slowdown, and a strong U.S. dollar were all cited as catalysts behind the weak GDP in the first quarter. Two of those three factors – namely the weather and the port slowdown – are no longer impeding growth, and the dollar is rising at a slower pace than it did in the first quarter, so economists now expect the second-quarter GDP to improve dramatically.
Most of Last Week’s Other Indicators were Positive
On Tuesday, the Commerce Department announced that sales of new single-family homes rose 2.2% in May to an annual rate of 546,000, the highest level since February 2008. April new homes sales were also revised up to an annual rate 534,000 vs. an initial estimate of 517,000. May’s new home sales pace is now up 19.5% vs. May of 2014. Homebuilder confidence is at a nine-month high. Since construction is a big component of GDP growth, strong new home sales bodes well for second-quarter GDP growth.
Also on Tuesday, the Commerce Department announced that durable goods orders declined 1.8% in May, due largely to a 35% plunge in commercial aircraft orders. Excluding aircraft and defense orders, however, durable goods rose 0.4% in May. The April report was revised down to a 1.5% decline from an initial estimate of a 1% decline, due to soft business spending, which is down 2.6% in the first five months of 2015 vs. the same months in 2014. Although business spending has been weak so far this year, it finally improved in May and I expect it to continue to improve in the upcoming summer months.
On Thursday, the Fed announced that consumer spending soared 0.9% in May, the largest monthly gain since 2009. In the last 12 months, consumer spending has risen just 3.6%, so May’s surge was welcome.
Finally, on Friday, the University of Michigan/Reuters announced that its consumer sentiment index had a final reading of 96.1 in June, significantly higher than its preliminary estimate of 94.6 and a 5-month high. A component measuring current conditions rose to 108.9 in June, up from 100.8 in May, while a barometer of consumer expectations increased to 87.8 in June, up from 84.2 in May. So overall, it appears that consumer spending will continue to improve, which is great news for overall GDP growth.
Europe Recovers While China Struggles
Despite the Greek tragedy, the rest of the euro-zone is prospering. Markit announced last week that its composite Purchasing Managers Index (PMI) for the euro-zone rose to 54.1 in June, up from 53.6 in May, reaching the highest level in more than four years. Meanwhile, China seems to be slowing down. The People’s Bank of China cut its benchmark interest rate and one-year deposit rate by 0.25% each and lowered its reserve requirement to banks with sizable lending to farmers and small businesses by 0.5%.
Clearly, China is trying to stimulate its domestic growth. However, as central banks around the world continue to cut key interest rates, it may become harder for the Fed to raise U.S. interest rates, since that would just make the U.S. dollar even stronger as well as run counter to the trend in the rest of the world.
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