The Eurozone Returns to Growth

Research Edge Position: Long Euro (FXE); Short UK (EWU), Short British Pound (FXB)


Eastern Europe driven by Western European improvement


The Eurozone exited its worst recession since World War II in Q3, with GDP expanding 0.4% quarter-over-quarter. Continued economic improvement from Germany and France helped lift output from Eastern European states, which rely heavily on Western Europe as markets for its exports.


Growth was seen across much of the region, yet importantly gains by larger Western European economies appear to have encouraged growth in the peripheral and struggling economies. Germany grew 0.7% quarter-on-quarter and France gained 0.3%. Italy rebounded from -0.5% in Q2 to +0.6% in Q3, driven by stimulus measures and increased export appetite from the likes of Germany and France. The Netherlands and Austria also came out of their technical recessions, registering growth of 0.4% and 0.9% respectively, from contraction of -1.0% and -0.5% in Q2.


Quarter-on-quarter Eastern Europe improved sequentially, with growth in the Czech Republic of 0.6% and likely in Poland when the state releases its numbers. One negative divergence remains Hungary, which although improving from its Q2 contraction of -2.0%, recorded -1.8% growth in Q3.


Greece and Spain also failed to grow in Q3, with both declining 0.3% quarter-on-quarter. Greece recently made headlines with its government debt expected to balloon to 12.7% of GDP this year, a heavy upward revision that concerned EU Monetary Affairs officials that said the government is doing little to counteract the rise and return to the EU target rate of 3% or less. Spain continues to work through the severe depreciation of home and property prices with unemployment bordering 20%, a nasty tail we believe will negatively impact the country over the longer term. 


We’ve been seeing an unwinding of the beta trade in Eastern European equity markets over the last weeks, coming off year-to-date highs that outpaced their Western European peers.  However, as emerging markets we expect these countries to feed off of improved fundamentals in the West and investor appetite to seek attractive (higher) yields.


We bought the Euro (FXE) yesterday in our model portfolio against our short position in the British Pound. The Euro remains in a bullish formation: the TAIL (3 years or less) line of support underpins the TREND (3 Months or more) which underpins the TRADE (3 weeks or less). We see the ECB’s interest rate of 1% as bullish for the Euro compared to the Fed’s at 0-0.25%, and like the ECB’s rhetoric of reducing its quantitative easing measures. Today’s positive Q3 Eurozone GDP gave a lift to the Euro versus the USD.


Matthew Hedrick


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