The Eurozone, On the Margin

Research Edge Position: Long Germany (EWG)


We’ve been writing about improving fundamentals in Western Europe for months now, and have recently cautioned that we expect this improvement to slow sequential due to the rate of the ramp itself, a strong Euro, and the headwind of rising unemployment. Below are the salient data points from the Eurozone this week:


Reuters PMI data for the Eurozone, Germany, and France in October show sequential improvement, excluding a second straight month of contraction in German Services. Importantly the numbers are all above the 50 level that signals expansion, yet as noted we expect the rate of improvement to slow in the coming months as the aforementioned macro factors weaken confidence and future expectations. 


For the region’s largest economy, German business and investor confidence are showing signs of slowing.  Last week the German ZEW survey of investor and analyst expectations fell to 56 in October from 57.7 in the previous month. And today, in a survey from the Ifo institute, German business confidence rose to 91.9 in October from 91.3, while Current Expectations gained a meager 20 bps to 87.3 in October. If tops and bottoms are processes, not points (Keith McCullough), we’re noticing a sequential deceleration in improvement, and we’ll be looking for confirmation over the next two months.


Across much of the data the tail from stimulus packages—especially the auto rebate programs—is noticeable. French consumer spending rose 2.3% in September M/M, with spending on automobiles up 10%.  And Germany reported today that construction orders rose 3% in August Y/Y, from -8.4% in July, indicative of a boost in road construction. Manufacturing numbers as well as confidence have been receiving a sizable boost from stimulus incentives.



Eurozone inflation fell to -0.3% in September year-over-year, from -0.2% in August Y/Y. As stated in previous work, we expect inflation to increase at a relatively stable rate. As we come off of last summer’s manic energy prices on an annual compare in back half of Q4, energy prices should yield inflationary numbers.  We still contend that the uneven rate of inflation/deflation across the region will remain a political football for the ECB when it considers raising rates as certain countries are experience lower levels, like Ireland at -3% or Portugal -1.8%. We continue to like Germany’s mild deflationary environment right now, at -0.5% in September Y/Y, as a catalyst to stoke consumer spending as the economy melts up.



Unemployment tipped higher to 9.6% in August.  In our post “Jobless Recovery in Europe” on 10/8 we argued that a jobless recovery in the Eurozone may be more bullish than in the United States because of the significantly stronger foundation of social services than those available to US citizens and due to the historically higher levels of unemployment throughout Europe.  That said, we expect rising unemployment to dampen sentiment and spending in aggregate.



A “weighty” Euro remains on our radar screens for as a macro catalyst it makes Eurozone exports less competitive. Although rear-view, Eurozone exports were down 5.8% in August sequentially, which dropped the trade balance to 1 Billion EUR from 6 Billion EUR in the previous month when exports rose 4.7% month-over-month. Rhetoric is heating up from the likes of Trichet that the Euro is too strong versus the USD, however if we’re right on our call on the USD (we’re currently short UUP in our model portfolio) the Euro should continue to melt high as the Buck burns.  Currently the Euro is trading at $1.5032.



Matthew Hedrick

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