After central bank intervention and political decisions in the prior weeks, the market is shifting its focus to economic fundamentals again. Forward-looking purchasing manager indices imply a reduction in eurozone GDP of 0.6 percent.
After the European Central Bank announced its Outright Monetary Transaction program, which so far has not been activated, and the Federal Reserve announced another round of quantitative easing (QE3), the Dutch election and the German Supreme Court ultimately resulted in positive euro outcomes the week before last.
In a respite from central bank intervention and political bickering, the markets could focus on economic fundamentals again, despite bleak overall fundamentals for the eurozone.
PMI Indicates Third-Quarter Recession
Markit Economics published its widely followed “flash” survey of purchasing managers’ sentiment on Sept. 20, and the results were not pretty.
The flash composite purchasing managers’ index (PMI) survey, which is based on 85 percent of the replies that Markit usually collects in any given month, decreased to 45.9 from 46.3 in August. Readings below 50 indicate that the economy is currently contracting. The service sector was especially hard hit, declining to 46 from 47.2 in August, marking a 38-month low.
According to Chris Williamson, Chief Economist at Markit, this indicates that another recession has taken hold across the Atlantic. “The eurozone downturn gathered further momentum in September, suggesting that the region suffered the worst quarter for three years. The flash PMI is consistent with GDP contracting by 0.6 percent in the third quarter and sending the region back into a technical recession.”
Looking into details of specific countries, Germany’s economy seemed to stabilize in September, benefitting from a weaker euro during the preceding months. The composite PMI in Europe’s largest economy rose to 49.7 from 47 in August, almost making it back into expansion territory.
While it is important for Europe that the German economy is doing well, markets have always been suspicious about too large of a divergence between Germany and other countries, especially the periphery. This time, however, it seems that France is also struggling more than expected, which could cause potential problems to the several bailout mechanisms that exist for the peripheral countries, such as Greece, Italy, and Spain, as France has always been the second largest bearer of risk after Germany.
Therefore, it is worrying to see France’s composite PMI drop to 44.1 from 48, marking a level that has not been seen since the depths of the great recession in 2009.
Markets were hardly moved, however, due to a relatively dull trading week in the United States. The EURO STOXX index lost 0.68 percent to close at 2,577. The euro did post a significant decline of 1.14 percent to $1.298, which is hardly surprising given the previous weeks’ rally.
The Week Ahead
This week will be interesting, as Spain, Italy, France, and Germany will present their 2013 budget plans to their respective parliaments. Italy already lowered economic growth projections and raised its expected deficit to 1.8 percent of GDP. This would be considered good, if the country did not already sport a massive 120.9 percent debt-to-GDP ratio as per the end of 2011.
Germany is expected to announce a deficit projection of 0.5 percent for 2013—best in class among the bigger countries. Again, the problem could be France, which already has an elevated 86.5 percent debt-to-GDP ratio and will likely post a budget deficit of 4.5 percent in 2012. Next year, the government is leaning toward a deficit of 3 percent, but most economists think its growth projections are too optimistic and therefore the deficit will be higher.
Spain, so far, has not met a deficit target it promised to the European institutions in return for support, so the country will be under particular scrutiny. If Spain fails to deliver, bond-market vigilantes may drive yields up to a point where it will be forced to ask the European Union for a bailout.
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