USA
It is no mystery that household wealth has plunged in the U.S. 's and the flow of funds accounts is the best way to measure how much. First quarter data published last week shows that the drop has been enormous. From a peak of $64.3 trillion in the second quarter of 2007, household net worth fell to $50.4 trillion in the first quarter of this year. Even when scaled by disposable income, this is a massive fall. Given the size of the wealth plunge and the weakness in spending already seen in the second half of last year, it is no surprise that many are fearful about the consumer.
While the plunge in wealth is well known, one point that is less well known is that the stock market has contributed much more to the drop than has the housing market. The decline in financial wealth over the past year has been more than three times as large as the drop in housing wealth. The models of the wealth effect suggest that a dollar loss in either the stock market or housing wealth has a roughly similar effect on consumption, so the course of the stock market is likely to have a more important effect on consumption than the course of housing prices. In that context, the gain in the stock market over the past few months is a positive development for the consumption outlook. However, a change in wealth affects consumer spending over a several year period, so the recent rise does not come close to offsetting the negative effects of the plunge of the past few years.
Eurozone
Last week's industrial production data showed notable divergences within the major eurozone economies in April as further contractions were recorded in both Germany (-2.1 percent month on month, ex construction) and France (-1.4 percent month on month), while solid increases were observed (for the first time since early 2008) in Italy (1.1 percent month on month) and Spain (2.0 percent month on month). However, the improvements in Italy and Spain were largely a reaction to the sharp declines observed in March (-4.5 percent month on month and -3.2 percent month on month, respectively) rather than any signs of renaissance.
Moreover, despite the mixed signals in the latest month on month rates, a unifying theme was that in all four economies IP in April remained significantly lower than in the first quarter 's indeed, on that comparison, Italy was weakest of all (-3.5 percent) despite April's month on month rise. As a result, although there are some encouraging signs for IP in May (and further signs of stabilization over the remainder of the year are still expected), there seems little prospect of industrial sector output increasing over the second quarter as a whole in any of the major eurozone economies.
Accordingly, while the present forecast for eurozone second quarter real GDP is a decline by 0.4 percent quarter on quarter, the risks to that estimate have become more significantly skewed to the downside over the past week, with particular scope for additional weakness in non-construction investment. At the national level, eurozone second quarter GDP forecast is partly predicated on a second quarter reading for German GDP, where the latest data is currently consistent with another quarter of negative growth (albeit at a vastly reduced pace).
Central and Eastern Europe
Turning away from the focus on macro releases in the largest economies, Latvia has been the primary focus. Over the weekend and first part of last week, the Latvian authorities revealed a number of fiscal measures that would be sufficient to reduce this year's projected fiscal deficit from 12 percent to 7-8 percent of GDP. That would, especially with backing from the EU, be sufficient to release 1.3-1.5 billion euros from the IMF and EU and relieve the immediate pressure on the currency regime that has captivated the financial markets of the region and Scandinavia.
As was highlighted in previous weeks, the issue may be suppressed but will not go away, given the extreme challenges facing authorities to make the internal adjustment needed to sustain the currency peg until euro adoption. Even with the peg in place in the near term, contagion risks rest primarily with the Swedish banks due to loan quality questions, while real economic links to neighbors will be fairly limited due to the small size of the Latvian economy. On the modest risk that the Saeima (Latvian parliament) does not pass these measures it would greatly increase the risk of the peg being abandoned, as well as contagion risk for the other pegged/currency board regimes of the region and of Sweden.
*** Written using materials from Bloomberg and Reuters Research
