Position: Short France (EWQ)
While we typically don’t give credence to any one economic survey, the latest reading from ZEW aligns with our fundamental view on Germany. The 6 month forward-looking economic sentiment number fell off a cliff, registering 28.7 in June versus a Bloomberg forecast of 42.0 and the previous month’s reading of 45.8, while the current situation reading improved sequentially, registering -7.9 versus a forecast of -15 and the previous month’s reading of -21.6 (see chart below).
What’s our read-through on Germany?
In the last weeks we’ve pulled back on our long call on Germany, which was part of our Q2 theme call Sovereign Debt Dichotomy, even though the DAX is in positive territory YTD with the performance spread over Spain’s IBEX at 22% YTD.
The fundamentals still look bullish for Germany: unemployment has improved over the last months, down to 7.7% (versus Eurozone average of 10.1%), a weaker Euro is benefiting the country’s export base, and inflation looks stable over the medium term. We think this is showing up in the improvement in current sentiment survey. However, we caution that sovereign debt contagion in the region and poor go-forward prospects for Chancellor Angela Merkel’s coalition government could provide formative headwinds over the medium term, which look to be reflected in the economic sentiment survey.
While we’re not calling for new elections in Germany, the government is a real concern that we’ll have on our radar, one that would be a significant destabilizing catalyst in Europe should elections need to be called. What’s clear is that Merkel’s coalition has lost its majority in the upper house of parliament (Bundesrat) since losing a critical election in the economically important state of North Rhine Westphalia in early May. Her choice to fund the Greeks as part of the €110 Billion loan package was a main point of contention that lost her the election and has since eroded her support. Further, her recently-issued four year €80 Billion package of austerity measures, which we view as largely positive, is being met with fierce opposition at home.
The next piece of the puzzle for the government is finding a replacement as President following the resignation of Horst Koehler last month after he made an inappropriate comment related to the country’s economic interest in being involved in the Afghanistan war. While the position is largely ceremonial, the void has nevertheless added further uncertainty to Merkel’s party. The announcement of the next President is scheduled for June 30th.
The cocktail of German bank exposure to countries with sovereign debt risk combined with the future uncertainty of the government are downside risks that we’ll be monitoring acutely. Stay tuned.