Bad employment reports continue, only 69,000 jobs created in May, unemployment hovers around 8.2%. Real personal income remains anemic and real disposable personal income is barely up for the year. These levels are normally associated with a recession. While the decline in gasoline prices since April help matters, the slow pace of job growth keeps income growth subdued. The Fed’s latest round of monetary easing was motivated by the economy’s failure to grow as quickly as the Fed forecast. We now expect the economy to grow between 1.9% and 2.4% this year. The Fed should and probably do more. Quantitative Easing would be the preferred option.
The euro zone is on the edge of collapse. If the single currency is not to break apart, Europe must design a system as a whole: a bank union capable of intervening directly in government debt. With bank runs accelerating in the periphery, a “muddle through” solution is no longer viable. Political developments in Germany, not Greece, will determine the euro’s fate. It is encouraging that preliminary talks are underway to turn the ESM bailout fund into a bank and perhaps even issue ‘eurobills’ or create a European Redemption Fund, but progress is at a glacial pace. It may take some massive market event to galvanize the sort of policy necessary to save the euro. The biggest challenge is to convince a skeptical German leader, Merkel.
Recent election results, especially in France and Greece are anything but pro-austerity. Reform is a must for entire Euro area, save Germany, where reforms were made in the run up to German re-unification, years ago. For the rest – the profligate euro area, they act and talk like welfare addicts convinced of their own righteousness, their own entitlement.
We believe France and Germany are hurtling to a confrontation over the euro area. Given the mandate Hollande was handed by the French electorate along with Spain, Italy and the Netherlands on its side and the September 2013 German general election may be the most detrimental for policy action.
Scrutiny will ultimately arrive and markets and policymakers will demand that France commit itself to structural reforms similar to that agreed to in Madrid and Rome earlier this year. The French are unlikely to comply. Something will have to give either French exceptionalism or Germany and the ECB finance its continued existence. German sentiment has turned decidedly negative to exceptionalism.