Positions: Long Germany (EWG); Short Italy (EWI), short Eastern Europe (ESR)
Below we recap the important policy decisions and data points out of Europe this week:
In a Q&A session after the ECB announced no change to its key interest rates this morning, ECB President Jean-ClaudeTrichet said that an “increase of interest rates in the next meeting is possible… but not certain.” Despite all attempts by Trichet to be close-lipped on future actions by the governing council, the sentence was largely interpreted by the market as proof that the ECB will hike in the near-term.
And both the EUR and European equity markets cheered on the news. The EUR-USD rose to an intraday high of $1.3966 and European equity indices gained to close up +50 to 150bps today.
Trichet also made it clear that today’s decision was based on data taken from mid-February, and therefore did not include the recent move in crude prices, which created further speculation that greater inflationary readings next month may boost the probability of an interest rate hike.
Our position remains that both the ECB and BOE will act to address their respective inflation pressures well before Ben Bernanke does, as The Bernank chooses to ignore the looming pressures of domestic and global inflation. On this basis we’d also expect the broader US market to underperform many of its European peers.
In comments today, Trichet said the range for Eurozone inflation (CPI) has shifted upwards to between 2.0% and 2.6% in 2011 and between 1.0% and 2.4% in 2012, mainly due to “the considerable rise in energy and food prices.”
This week we received new monthly Eurozone CPI and PPI numbers that confirm the rising tide of inflation. CPI rose 2.4% in February year-over-year versus 2.4% in January; and PPI increased 6.1% in January Y/Y versus 5.3% in December. The PPI report showed that energy prices jumped 13% from a year earlier.
European PMI Slowing?
European February Manufacturing and Services PMI reported this week show mixed signals. As we chart below, we believe the 60 level is a heavy resistance line for PMI numbers going back historically. If we look at the Manufacturing data, we largely see an improving trend for Europe’s largest economies, but caution that both Germany and the UK should slow on the margin in the coming months as they’re already well through the 60 line.
Services PMI show that Germany failed at the 60 line this month, as France improved just short of 60. Importantly there’s a clear spread in the Services readings between the UK and Germany. We continue to see fundamental drags in the UK economy due to its austerity programs and rising inflation, both of which are choking off real growth.
Germany’s Bullish Strut
German retail sales were released today and showed an improvement of +2.6% in January year-over-year versus -0.5% in December, or +1.4% in January month-over-month. Also, the German unemployment rate, reported earlier in the week, fell 10bps month-on-month to 7.3% in February. We remain bullish on Germany and are currently long the country via the etf EWG in the Hedgeye Virtual Portfolio. The DAX remains broken on a TRADE basis (3 weeks or less), however it is trading comfortably above its TREND (3 months or more) line at 7,016.
For another week we see attention shift away from Europe’s sovereign debt contagion to uprising in MENA and therein the implications for crude prices. On a bullish note, in an auction today Spain saw solid demand for €1.15 Billion of bonds due 2014 and 2016, with yields coming in considerably lower versus a previous auction of similar maturity. However, risk still loom large in Portugal, with sentiment rising this week that the country will require a bailout in the next weeks. We continue to monitor government yields as a proxy for this risk (see chart below). Stay tuned.