Position: Long Germany (EWG); Short EUR-USD (FXE)
Most of Europe reported its Q3 GDP results today. Below we include a table of select economies to highlight two points:
1.) The rate of GDP improvement in Q2 was very likely the best on a quarter-over-quarter basis for 2010 as Austerity’s Bite dampens growth and consumer and business confidence into year-end and in 2011.
2.) The divergence in growth prospects for 2010 follow our theme of the Sovereign Debt Dichotomy—Germany’s fiscal conservatism will help positively positions its economy for growth, while the PIIGS will continue to wilt under fiscal imbalances.
Today we see an inflection in what has been an expedient rise in the credit risk over the last three weeks in Europe’s periphery, namely the PIIGS (Portugal, Ireland, Italy, Greece, Spain). In the chart below we calculate the spread between 10YR government bond yields of the PIIGS and Germany’s 10YR Bunds. We think the slight compression in government yields day-over-day from the PIIGS is a reflection of German Chancellor Angela Merkel’s supportive comments at the G20 yesterday that “preparations are in place” for any aid requests by European Union countries facing debt crisis.
The supportive comments from Merkel follow recent statements that tout tax consequences for European countries that fail to meet budget reduction targets, and a permanent rescue system to make bondholders foot part of the cost of any future debt crisis. While the weight of gravity may also be pushing down yields for a few days, we’d expect (PIIGS) yields to continue to ramp up alongside investors’ credit risk fears. One catalyst to keep on the calendar is Ireland’s ability to pass through €6 billion in spending cuts and tax breaks on December 7th to tackle part of its massive 2010 budget deficit.
Below we chart our quantitative levels for the equity indices of the PIIGS. Of note is that all indices are broken on the immediate term TRADE duration, a bearish indicator. Further, Ireland’s Dow Jones Index, Spain’s IBEX and Greece’s ATHEX Composite are broken on both the TRADE and intermediate term TREND durations. In contrast, Germany’s DAX is trading comfortably above both its TRADE and TREND lines, an outright bullish signal in our model.
In the Hedgeye Portfolio we remain long Germany (EWG) and short the EUR-USD (FXE) as the region’s credit risk continues to weigh on the Euro. Our TRADE range for the EUR-USD is $1.36-$1.39.