As I mentioned earlier, many are asking the question what will the ECB do if the Italian bond situation gets out of control. Who knows and much will be determined by what the Germans will allow. Putting this aside, the direction of inflation may also determine the extent to which the ECB will have the latitude to act. I know, we all assume there is no inflation, especially in Europe and which I of course disagree with. Well, this morning if you missed it, Germany printed a 2.2% y/o/y CPI rise for May, well more than the estimate of up 1.8%. This matches the quickest pace of gain since March 2012, more than 6 years ago.

GERMAN CPI in MAY

Spain reported also today its EU harmonized CPI May figure at 2.1%, well more than the forecast of up 1.7%. That is up from 1.1% last month. France reports its CPI tomorrow as does Italy. We also see CPI for the whole Eurozone tomorrow. The estimate is for a headline gain of 1.6% and core rate rise of 1%. I think Draghi might just get what he wants sooner than later.

According to ADP, the economy generated a net 178k private sector jobs in May, 12k less than expected and April was revised down a rather sharp 41k to 163k. The service side, the biggest, added only 114k jobs, the smallest amount since September. The goods side on the other hand contributed 64k, the 2^nd most since last February with construction being the main reason as Spring is upon us.

Smoothing out the monthly noise has the 3 month average at 180k vs the 6 month average of 212k and which compares to the2017 average of 185k, 173k in 2016 and 211k in 2015 and vs 235k back in 2014.

Bottom line, at least as of now I can only attribute the slowdown in job hirings over the past 3 months to the inability to source enough qualified warm bodies rather than any change in the demand for them. Someone at ADP today said “The hot job market has cooled slightly as the labor market continues to tighten.” Another said “job growth is strong, but slowing, as businesses are unable to fill a record number of open positions. Wage growth is accelerating in response, most notably for young, new entrants and those changing jobs. Finding workers is increasingly becoming businesses number one problem.”

To visual the problem, here is a chart again comparing the pool of available labor (April data) relative to the size of the job openings available (March data).

Italy sold 5 yr and 10 yr bonds that went off without a hitch. After all, investors were given a gift compared to where yields were over the past 5 years. The 5 yr bond sold at a yield of 2.32% vs .56% in April. The 10 yr bond saw a yield of 3% vs 1.70% in April. The results are providing relief as the 2 yr yield is down by 81 bps to back below 2% and the 10 yr yield is lower by 19 bps to 2.97%. After selling in 8 of the last 10 days that eliminated its gain for the year the MIB index is up 1.4%.

In response to the calm for the day in Italy, Spanish, Portuguese and Greek bonds are rallying but the safe haven markets of Germany, France and the UK are seeing bond selling. In terms of volatility now entering European bond markets, this is just a dress rehearsal I believe of what is to come as we get closer to the end of ECB QE and they attempt to end NIRP in 2019. To remind all, at its peak of buying the ECB was purchasing 7 times the net issuance of Eurozone countries. At its peak of buying the Fed was buying 25%.

In looking for what the spillover is, here is a chart of the Credit Suisse European High Yield overall yield index which bottomed at 1.90% in November and closed at 3.65% yesterday.

The euro is bouncing on the European stability today. My friend Helene Meisler yesterday pointed out that the Daily Sentiment Index on the euro closed at 4. Yes, that means 96% bears and 4% bulls. I’d say that’s a good setup for a bounce in the euro. We’ll see how long it lasts.

What’s happened in Italy the past few weeks has many asking, ‘What’s the ECB going to do?’ I honestly don’t know if they can do anything. On one side we have Italian yields spiking but on the other German yields are plunging. The ECB is limited by the capital key in what they can purchase of any one country. Also, the inflation trend may actually be going their way and therefore could further tie their hands. Germany is expected to say today that May CPI rose 1.9% y/o/y from 1.6% in April and that would be the biggest one month increase since April 2017.

To this point, Spanish CPI hit 2% in May, a jump from 1.1% in April and well more than the forecast of up 1.7%.

After a string of disappointing economic data out of Germany, April retail sales surprised to the upside with a 2.3% m/o/m gain, well more than the forecast of up .5%. A lot of the economic slowdown in the past few months for the whole Euro region was on the weather so hopefully spring is bringing the bounce back. Also helping is a still solid labor market. The German unemployment rate in May fell to a new reunification low of 5.2% and the number of unemployed fell by 11k (estimate was decline of 10k).

On the other hand, French consumer spending declined by 1.5% m/o/m. The estimate was for a rise of .2%. Much of this was energy/utility related however.

Lastly out of Europe, the May economic confidence index fell a touch to 112.5, a 9 month low from 112.7 in April and down for a 5th straight month but that was above the estimate of 112. There was little change in confidence in Germany but declined in France, Italy and Spain. Expectations for growth this year are still around 2%.

The continued rally in US stocks before yesterday has brought another rise in the number of bulls in the weekly II data. Bulls rose to 50, a two month high, from 49.1 last week. Bears remained the same at 19.2% and that’s the lowest since early April. The spread between the two is at a two month high at 30.8. The extreme seen in January between the two saw Bulls above 60 and Bears below 50.

The rise in US mortgage rates continues to weigh on mortgage applications. Apps to purchase a home fell for the 5th straight week, down by 1.9% w/o/w. It’s down by 7.5% over this time frame and is at the lowest level since early March. They do remain though up by 2.3% y/o/y but high home prices and a rising cost of funding has clearly slowed transactions. Refi’s fell 4.7% w/o/w and by 27% y/o/y. They are down for 6 straight weeks and the index level sits at the lowest level since December 2000. Yes, near an 18 yr low.

Japan finally got some good economic news. Retail sales in April rose 1.4% m/o/m, better than the up .5% predicted. The consumer has really been the missing piece of the Japanese recovery because of lame wage increases but we have seen a recent uptick. Consumers though don’t believe it will last because also out was May consumer confidence and the Income Growth component fell to the lowest level since September.

The Conference Board Consumer Confidence index for May was 128, as expected and compares with the initial print of 128.7 in April but which has been revised down to 125.6. While the headline index is 2 pts below the high in this cycle, the Present Situation component did rise to a 17 year high. Expectations remain about 3 ½ pts below its recent high. Reflecting a record amount of job openings, those that said jobs were Plentiful rose 4.2 pts to the highest level since March 2001. Reflecting though the skills mismatch and difficulty in finding the right workers, those that said jobs were Hard to Get was up .3 pts to a 4 month high. Those expecting an increase in Income fell .5 pt and unfortunately is down for a 3^rd month.

The answers to the employment question was mixed as there was a rise in both those expecting ‘more jobs’ and ‘fewer jobs.’ They came out of those expecting ‘the same.’

Notwithstanding the rise in confidence m/o/m, spending intentions all weakened. Those that plan on buying an auto fell almost 1 pt to near the lowest level since July 2016. Those that plan on buying a home dropped 1.4 pts to 5.5, the weakest read since October 2016 (high prices now combined with rising mortgage rates). Those that plan on buying a major appliance fell 3.2 pts but after rising by almost 5 pts last month.

Lastly and of note, one year inflation expectations rose to 5% from 4.7% last month. That matches the highest print since October 2015 and most likely is in response to higher gasoline prices which is a price that most people see every day.

AVERAGE GALLON OF GASOLINE according to AAA

Bottom line, as seen in the chart below, confidence remains near the high in this cycle but I want to emphasize again that this is just a current snapshot and not an indicator to use in trying to predicting future behavior. To this point, in the last growth cycle we peaked in July 2007 and May 2000 in the one before. We troughed in March 2003 and again in February 2009.

CONSUMER CONFIDENCE

The unwind of everything the ECB tried to suppress in the Italian bond market is now truly extraordinary and scary in its rapidity. The 163 bps (as of this writing) spike (or crash in bond price) takes the yield to 2.53%, the highest level since September 2012, just a few months after Mario Draghi said “whatever it takes” in wanting to save the euro. The yield was about .60% when negative interest rate policy took hold in June 2014. The 10 yr jump is more tame, only 43 bps to 3.10% and that is about where it was in June 2014. I’ve called for a while the European bond market as an epic bubble that at least in Italy so far is coming undone. It’s however intensifying again in the flight to safety countries such as Germany, France and the UK. I can’t even begin to know how Mario Draghi deals with the mess that he sowed the seeds for.

Yes, Italian politics are a mess right now but they always are. Yes, Italy’s debt level is at a dangerous level of 130% of GDP but it’s been above 100% since the early 1990’s. While some fear Italy will leave the euro, most citizens don’t want to. My point is these fears are not new and therefore I believe more of the excuse/catalyst for a popping of a bubble that got inflated by the ECB and was unsustainable anyway.

ITALIAN 2 YR YIELD

ITALY DEBT TO GDP RATIO

Italian banks are loaded up with Italian bonds and are leading the Euro STOXX bank index lower by 4%. This index is now down 13% over the past two weeks to the weakest level since February 2017.

Elsewhere, the Japanese labor market remained tight as a drum in April with the unemployment rate holding at 2.5% as expected, just off the lowest level since 1993. The jobs to applicant ratio held at 1.59, the highest since 1974. There are finally signs that this is translating into quicker wage increases for Japanese workers but if the BoJ is successful in generating a higher cost of living, it will be all for naught.

In a good measure of global trade, Hong Kong exports in April rose 8.1% y/o/y, a similar pace as seen in March but a bit below the estimate of up 9.2%. Exports to the US rose 11.7% y/o/y and were up 13% to China. Imports grew by 11.1%, also around the gain seen in March and also slightly below the forecast of up 11.9%. Bottom line, global growth in April was still good but as seen in the Citi Global Economic Surprise index near a 2 1/2 year low, not as good as originally estimated.

While this data is now old news in light of what is going on in European bond markets, April money supply growth (M3) was up by 3.9% y/o/y as forecasted, a bit quicker than the 3.7% pace seen in March but still near the slowest since 2014. Loan growth to households and businesses grew at the same pace as in March. Considering what is happening to the stocks of the European banks over the past two weeks, this data in coming months will be most interesting to watch.