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Lousy European Data

05/02/2012

Consistent with the trading environment for April, this morning’s lousy European economic data is positioning the market to reverse the favorable conditions traced out with yesterday’s U.S. ISM Manufacturing. Simply put, the intense tug of war within the capital markets will persist. In the coming days, Friday’s U.S. jobs report looms large. In addition, Thursday’s European Central Bank (ECB) meeting becomes more important.
 
This morning’s European data lowlights:
 
•   Spain’s PMI sinks to 43.5, below last month’s 44.5 and estimates of 43.6 for this month
•   Italy’s PMI sinks to 43.8, well below last month’s 47.9 and estimates of 47.1 for this month
•   France’s PMI sinks to 46.9, below last month’s 47.3 and estimates if 47.3 for this month
•   Italy’s Unemployment Rate rises to 9.8% from 9.6% last month   
      o  Last month’s rate was revised higher this morning from 9.3% to 9.6%
•   Italy’s PPI shows deflationary pressures persist, recording a +2.7% year on year, down from last month’s +3.72%
•   Germany’s Unemployment Rate rises to 6.8% from 6.7% last month, still a two-decade low
•   Germany’s PMI (Figure 1.1) falls to 46.2 from 46.3 last month, in line with estimates of 46.2 for this month
 
I am most focused on Germany’s economic data. The PMI reading is the lowest since the 45.7 recorded in July 2009. Europe cannot withstand a significant slowdown from Germany. Markets have priced in 2012 German GDP slowing to +0.7% after recording +3.0% in 2011.  However, business confidence remains strong (Figure 1.2), and labor conditions are still near their best levels in two decades (Figure 1.3).
 
I view this morning’s German data as a “shot across the bow.” German economic data points need to be watched more closely, and the next focus will be the German IFO Business Climate Index on May 24. Although global capital markets may soften in the near term as a result of this morning’s German PMI, the evidence confirms that Germany is still structurally strong.   
 
Next up for Europe is Thursday’s ECB meeting. I do not expect a rate change nor the introduction of further quantitative easing measures. I do expect extremely dovish language in the post statement press conference assuring the markets that the ECB stands ready to support credit markets as it did with the two rounds of LTRO.
 
Of all the central banks considering further easing (FOMC, People’s Bank of China, and ECB), I expect that capital markets need the ECB to act in the most aggressive fashion. For investors, the change at ECB’s helm from Jean-Claude Trichet to Mario Draghi provides confidence that the ECB is prepared to aggressively act to ensure market stability. However, just not yet.
 
The strategy continues to be “hold serve.”  Although I expect the tug of war environment to persist in the near term, no major changes to portfolios should be considered. Corporate bonds remain the lone overweight and should be investors’ top opportunity focus.     
  
 
Figure 1.1 German PMI, December 2007 to Present

Source: Bloomberg
 
Figure 1.2 German Business Confidence, September 2011 to Present

Source: Bloomberg
 
Figure 1.3 German Unemployment Rate, May 1992 to Present

Source: Bloomberg

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