Where are we at in Europe? We expect European equity and credit markets to trend sideways in the summer months, short of any blow-ups we could see from Italy, Portugal or spillover from Greece. We do not see any particular catalysts ahead: we’re forecasting the ECB to be on hold in wait-and-watch mode to see if economic conditions improve in the fall. Headline risk should remain a governing factor. Here we highlight Italy – both the tenuous nature of the existing coalition along with fears around its inability to establish a budget for next year. Sentiment could shift given the likelihood that the country delays a one percentage point hike (from 21% to 22%) in the VAT that was scheduled to take effect in July for at least three months.
Recent Italian sovereign bond issuance has priced debt higher versus previous auctions, a new development for the periphery versus year-to-date performance of mostly lower issuance. However, we expect both Italy and Spain, despite fluctuations, to remain grounded under 5% on the 10YR. Draghi’s OMT put remains a force behind this call.
Another EU Summit completed—what was accomplished?
- EU leaders increase the funds set aside to combat youth unemployment to at least €8B from a previous target of €6B.
Hedgeye Takeaway: While this funding is a start, the structural imbalances across the Eurozone, especially the need for labor market reform, will take years to amend, with no guarantee of success. We think the alarming rates of unemployment (Eurozone at 12.2%), especially youth unemployment that is above 50% across some peripheral states, will continue to guide long-term below-mean growth.
- There were discussions around proposals by the European Investment Bank (EIB) and European Commission (EC) to generate €55B-€100B of new loans to small and medium sized enterprises (SMEs).
Hedgeye Takeaway: The ECB has had no success unclogging the credit channel. Loans to the SMEs are critical to restart and encourage lending; however we have our doubts on this sum given the unsuccessful LTRO packages that handed out 1 Trillion EUR in nearly free money.
- Discussion around a framework for the Banking Union, including that bail-in agreements will exempt deposit holders of less than €100K.
Hedgeye Takeaway: Following Cyprus, Eurocrats are incentivized to ensure that deposit holders with less than €100K in deposits are not on the hook for a bail-in. We expect more guidelines on the shape of a Banking Union after German elections in September.
Data: The Haves versus the Have Nots
Continuing with our thesis on the region, the data out this week reminds us that our bullish bias on Germany versus our bearish bias on the periphery remains intact.
- Eurozone Confidence – figures will grind slightly higher throughout the summer, led by Germany.
Bullish Bias – Germany
- Figures this week all looked better. The Unemployment Rate remained at 6.8% in JUN with the Unemployment Change down-12K to 2.94MM. The GfK Consumer Confidence survey rose to 6.8 JUL (exp. 6.5) vs 6.5 JUN. Retail Sales remain positive at 0.4% MAY Y/Y vs 2.7% APR and CPI rests at a healthy 1.9% in JUN (Preliminary) Y/Y vs 1.6% MAY
Bearish Bias – The Periphery
Retail Sales fell across the periphery: Spain -4.5% MAY vs -2.6% APR; Greece -14.7% APR Y/Y vs -5.9% MAR; and Portugal -3.5% MAY Y/Y vs -2.1% APR. Data across Italy continues to be atrocious, and Italy Economic Sentiment fell to 76.1 JUN vs 80.2 MAY. Also, Spain’s housing market continues to feel the hit, with the Total Housing Permits down -16.5% APR vs -35% MAR.
Enjoy the weekend,
Matthew Hedrick
Senior Analyst
