Key Takeaways:

  • Eurozone economic growth surprised both our and consensus estimates to the upside in Q3.
  • Momentum in several key drivers has inflected, however, and we are keen to reiterate our bearish outlook for Eurozone growth here in Q4 and beyond.
  • Trending disinflation will make Draghi’s dovish taper look increasingly prescient, ultimately benefitting investors on the long side of Italian, Spanish and Portuguese bonds, on the long side defensive equities in lieu of the European Financials and on the short side of the EUR.

This morning’s economic releases across the pond confirmed consensus’ bullish bias on the Eurozone, with the preliminary proclamation of 3Q17 Real GDP growth beating estimates and accelerating to a near 7-year high of +2.5% YoY. Driving growth higher throughout the quarter was the ongoing acceleration in Europe’s manufacturing and export economy.

#EuropeNOTSlowing? - Eurozone Real GDP Estimates

#EuropeNOTSlowing? - Eurozone Industrial Production YoY

#EuropeNOTSlowing? - Eurozone Exports YoY

We were obviously early (read: “wrong”) to call for a slowdown in Eurozone economic growth in the third quarter. We are, however, keen to reiterate our belief that the European recovery has peaked and is set to trend lower over the intermediate term.

#EuropeNOTSlowing? - Eurozone GIP Model

What gives us confidence in reiterating these bearish forecasts are:

A) Decelerating global demand, as indicated by the now-trending negative inflection in the “Old China” economy (CLICK HERE for more details):

#EuropeNOTSlowing? - China Imports YoY

B) Decelerating domestic household consumption growth, as indicated by the now-trending negative inflection in Real Retail Sales:

#EuropeNOTSlowing? - Eurozone Real Retail Sales YoY

C) A sharp uptick in demographic headwinds across the currency bloc over the next 3-5 years (CLICK HERE for more details):

#EuropeNOTSlowing? - Pillar 1 Demographic Risk

#EuropeNOTSlowing? - Economic Gravity in the Eurozone

All told, if the choice is to either bet on our models or side with investor consensus that remains pervasively bullish on the European economy, we’ll bet on our models all day long. The that tune:

  • At +85,553 net long futures and options contracts, the EUR remains the 8th most crowded long position across all of the many factor exposures we track throughout the global macro universe in 1Y Z-Score terms.
  • The EUR is the 6th least skewed factor exposure across all of global macro.
  • The EUR has implied volatility discounts (vs. realized) on a 30-day (-13.0%), 60-day (-11.1%), 3-month (-15.6%) and 6-month (-6.9%) basis.
  • Implied volatility across European equity indices are among the cheapest across all of global macro.
  • Per HSBC, European equity funds this year have recovered all the outflows they registered in 2016, resulting in cumulative inflows reaching their highest level since 2007.

#EuropeNOTSlowing? - Eurozone Confidence   as Consensus as Consensus Gets

#EuropeNOTSlowing? - FXE Volatility Skew

#EuropeNOTSlowing? - FX Implied Volatility Premium Comparison

#EuropeNOTSlowing? - Implied Volatility Percentiles

Feel free to chase these consensus setups if you want – hopping on the bandwagon at the tail-end of a fantastic 3-plus year European growth recovery is just not a position we are ever going to take within the confines of our process. That being said, however, the one long bias we do feel comfortable adopting in Europe here is anything positively exposed to now-trending Eurozone disinflation, as well as the high likelihood that the ECB fails to ever sustainably accomplish its inflation mandate.

#EuropeNOTSlowing? - Eurozone CPI Estimates

#EuropeNOTSlowing? - Eurozone Headline CPI

#EuropeNOTSlowing? - Eurozone Core CPI

#EuropeNOTSlowing? - Eurozone PPI

Capital keys might prevent Draghi from buying all of the Italian, Spanish and Portuguese government bonds in sight over the next 1-3 years, but that doesn’t mean you can’t. Moreover, pending spread compression is really positive for European defensives relative to their Financials counterparts.

#EuropeNOTSlowing? - Eurozone 10Y Govt Bond Yields

Keep your head on a swivel,

DD

Darius Dale

Managing Director