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EURUSD closed around 1.1128 in the U.S. session Monday, slumped almost -0.35% on subdued EU/German manufacturing PMI data, still deep into contraction, but the overall Eurozone economy may be bottoming out, avoiding a deeper slowdown. The data shows that the German manufacturing PMI was finalized/improved to 42.1 in Oct from a flash reading of 41.9 and Sep reading of 41.7. The Eurozone manufacturing PMI for Oct was finalized at 45.9 from the flash estimate of 45.7 and Sep PMI of 45.7. The French manufacturing PMI was finalized at 50.7 in Oct from a flash estimate of 50.5 and Sep PMI of 50.1.
Overall, the Eurozone manufacturing PMI contracted in its steepest decline for seven years, although German PMI improved slightly, at 2-month high; it was well below boom/bust line of 50.0, while Spain dropped to 78-month-of 46.8. Italy dropped to a 7-month low of 47.7; but France recovered to 50.7, at a 2-month low.
On German manufacturing PMI data, Markit commented that manufacturing slowdown now affecting jobs in certain goods-producing sectors, but that’s mainly restricted to contractors’ levels and the present manufacturing job loses are not like the severe one noticed during the period of GFC (2008). Markit also hoped that the German manufacturing PMI may be bottoming out gradually and everything will now depend on the speedy resolution of Trump trade war, be it with China or with the EU, especially Auto trade war rhetorics.
"The German manufacturing sector remains in recession and continues to pose a threat to the domestic economy through a rising number of factory job losses. Employment across the goods-producing sector is now falling at the fastest rate for the best part of ten years, though it should be said that the decline is nothing like that seen during the depths of the global financial crisis, and is so far mainly restricted to contractors”.
"The survey's more forward-looking indicators offer some glimmers of hope. The latest data for new orders and output expectations were still very weak in October, but nevertheless, the best seen in four months. It remains to be seen if the downturn in the German manufacturing has finally reached a nadir – much of course depends on developments in global trade, with the US set to decide next week whether to impose new tariffs on automotive imports from the EU”.
On French manufacturing PMI, Markit noted, although the French manufacturing sector recovered to some extent on new export, domestic demand continues to be subdued.
"Latest PMI data pointed to the quickest rise in French manufacturing production for four months, which helped support a slight improvement in business conditions. The survey results also pointed to an upward trend in employment, as staff numbers increased at the fastest pace since June”.
"That said, new orders fell marginally for the second month in a row, indicating continued weakness in demand conditions. Underlying data suggested that this weakness was centered on the domestic market, as firms posted a slight recovery in new export business during October”.
On Italian manufacturing PMI, Markit said the lingering manufacturing recession may prolong more amid weakness both in export and domestic front.:
“The Italian manufacturing sector continued its recent poor performance into October. At 47.7 the PMI remained below the crucial 50.0 no-change thresholds for the thirteenth consecutive month and signaled the sharpest deterioration in business conditions since March. Output contracted at a faster rate amid a backdrop of weaker demand conditions, both from domestic and export customers, whilst employment, purchasing activity and backlogs of work all continued to decline”.
"There was some respite on the price front, however, with cost burdens falling at the most marked pace since April 2016. Combined with a modest rise in output charges, there may be scope in the future for manufacturers to stimulate additional orders without eroding their profit margins. With the latest official data signaling a further decline of Italian manufacturing production, the recent downturn does not appear to be ending anytime soon”.
On final Eurozone manufacturing PMI, Markit noted that the manufacturing recession is now affecting employment in the goods-producing sector and the overall economy is suffering from both domestic and export slowdown amid Trump trade war and Brexit uncertainty coupled with some domestic structural issues, such as German auto emission norms.
“Eurozone manufacturing remained stuck in its steepest decline for seven years in October, meaning the goods-producing sector is on course to act as a severe drag on GDP again in the fourth quarter. The survey data are consistent with industrial production falling at a quarterly rate in excess of 1%”.
“Geopolitical concerns, ranging from Brexit to US trade policy, continue to create uncertainty, further dampening demand both at home and in export markets”.
“The focus of manufacturers remains on cost-cutting, reducing inventories and investment spending while also lowering payroll numbers at an increased rate. The steeper pace of job losses is especially worrying, as it magnifies the risk of the downturn spilling over into the household sector”.
“Producer prices, meanwhile, fell at a rate little changed on September’s three-and-a-half-year record as weak demand prompted companies to offer discounts, which is likely to feed through to lower inflation in the coming months”.
“The severity of the downturn, alongside poor trends in employment and prices is especially disappointing given the ECB’s recent stimulus measures, underscoring how new ECB head Christine Lagarde is taking over the reins at a particularly difficult juncture for the Eurozone economy”.
On Monday, another Eurozone economic data shows that in Nov, the Sentix investor confidence improved to -4.5 from prior -16.8 and higher than the expectations of -13.8. The current situation index also improved to -5.5, up from -15.5, while the expectations index jumped to -3.5, up from -18.0, highest since May 2019.
Sentix said in its report that the global economy including Eurozone may be bottoming out and a deep recession/slowdown may be averted on easy monetary policy from ECB, Fed and other major central banks coupled with increased government spending/fiscal stimulus. The overall labor market is still robust in the U.S. and also in Eurozone. Germany is affected by the Trump trade war like all other major exporting countries in the world. And Germany is also being affected by its own issues of automobile disruption due to anti-pollution issues. But the German economy is also now recovering. Although there is no definitive trade deal yet, the Chinese economy is also recovering on an interim trade deal optimism, leading the overall Asian economy (ex-Japan).
An exclamation mark of the "first mover”
“The global economy could go through an important low just these days. This is indicated by the latest data from the Sentix economic indices. The overall index for Euroland rises by 12.3 points to -4.5, the expected values even jump by 14.5 points to their highest level since May 2019. Can the recession thus be averted? At any rate, hopes are pinned on new signs of recovery from China and the resilience of the US economy”.
Euro area: But no recession?
“The latest data from the Sentix economic indices give hope that a deeper recession can be averted in the Eurozone. Both the situation assessment of the investors surveyed by Sentix (+10 points) and the strong recovery of the expectation values (+14.5 points) surprise positively. Several factors contributed to this positive development. On the one hand, the turnaround in the ECB's monetary policy has been well received by investors. In the meantime, we are measuring a stronger rise in the money supply aggregates again, which, with a slight delay, usually also has a stimulating effect on the economy. Investors also expect growth to be supported by higher government spending”.
“On the other hand, the Chinese economy is sending signs of a possible upswing and the US economy, especially the labor markets, continues to be robust. The same also applies to the labor markets in Euroland, which are still in comparatively good shape. What is extremely good news for the equity markets should be less pleasing for investors in Bonds. In addition to central bank policy, which is still regarded as supportive, the thematic negative factors are already predominant. It is also more likely that the interest rate spread will widen from the long to the short term. Bonds are therefore likely to remain risky”.
Germany: Hopes for a shaken country
“As the world's leading exporter, Germany is not the only country particularly hard hit by problems in world trade. For some time now, the country has also been standing in its own way. Especially the self-dismantling of the most important industrial sector, the automotive industry, is a heavy burden on the German economy. Since the trend reversal that is now becoming apparent is also being led by the Asia ex-Japan region, the hope that the slide into recession can be averted is also nourishing hope for the German economy. In any case, expectations are sending a strong sign of life with an increase of +16 points”.
USA: Robust labor markets
“The Sentix overall index for the US economy rose significantly to +8.7 points, the highest level since May 2019. One reason for this is the stability of the labor markets and thus the consumer economy. Contrary to the expectations of many observers, employment continues to rise. Accordingly, investors are sharply correcting their assessment of the situation by +15.8 points!”
Asia ex-Japan: Chinese signs of hope
“According to the professional and private investors surveyed by Sentix, the Asia ex-Japan region is on the upswing again. The situation, expectations, and the overall index are all back in positive territory. And this is despite the fact that no agreement has yet been reached on the trade dispute with the USA. Should a positive agreement be reached here, this should secure the recovery process. But it should also be helpful that interest rates have been cut further around the globe and monetary policy has been relaxed”.
On Thursday (31st Oct), data shows that the German retail sales were subdued in Sep as it grew by +0.1% from the prior contraction of -0.1%, but below market expectations of +0.3% growth sequentially (m/m). On a yearly basis, the German retail sales although grew by +3.4% from prior growth of +3.1% (revised downwards from +3.2%), it was lower than the expectations of +3.5% growth (y/y).
On Thursday, the flash data shows that the Eurozone core CPI edged up to +1.1% in Oct from prior +1.0%, higher than the expectations of no change at +1.0% (y/y). The headline CPI dropped to +0.7% in Oct from prior reading of +0.8%, right on the expectations. The Eurozone HICP core CPI was unchanged at +1.2% in Oct, but higher than the expectations of +1.1%. As a pointer, ECB now follows HICP core CPI in its inflation targeting mechanism (price stability), but it’s far away from the symmetrical target of just below 2.0%.
On Thursday, flash data shows that the Eurozone GDP growth slowed down to +1.1% in Q3 from prior growth of +1.2%, right on the expectations of +1.1% (y/y). On a sequential basis (q/q), the Q3 Eurozone GDP growth was unchanged at +0.2%, higher than the expectations of +0.1%. Overall, Eurozone GDP growth shows that the economy may be bottoming out.
Another data on Thursday shows that the Eurozone unemployment rate was unchanged at +7.5% in Sep and was higher than the expectations of +7.4%. Also, in Oct, provisional data shows that the German unemployment rate was unchanged at 5.0%.
In ECB talks, on Thursday (30th Oct), ECB VP Guindos said the ECB Monetary policy has not reached limits, but the negative impact is increasingly evident. Guindos also called for an appropriate fiscal stimulus as per EU27 states’ individual fiscal positions.
Overall, Guindos sounded less dovish as he batted for fiscal stimulus to treat the root cause of the Eurozone economic slowdown rather than treating it superficially by only monetary stimulus and also warned about too deep negative rates (collateral damage). Guindos urged policymakers/politicians to treat the actual ailments rather than symptoms only.
In the same Parliamentary testimony, the ECB GC member Visco, a known dove also sounded dovish as usual and said: “Eurozone inflation remains at an excessively low level and the risk of a de-anchoring of medium-long term expectations is appearing. Thus monetary policy will remain expansionary to sustain demand”.
On Monday, the much-awaited speech from new ECB President Lagarde has nothing for the monetary policy or economy. Lagarde said:
The English philosopher John Stuart Mill once observed that “a great statesman is he who knows when to depart from traditions, as well as when to adhere to them.”
It is with these words in mind that I would like to celebrate Wolfgang’s contribution to public life. You embody what I see as the model of “Germany in Europe”: the Germany that is an implacable defender of its values and a beacon of liberalism and democracy; but also the Germany that is ready to move when needed to uphold the European idea.
This event is not about the ECB. It’s not about monetary policy or other economic policies. It’s about you, Wolfgang. So I will not talk about monetary policy or anything related to it.
Earlier Monday, EURUSD made the session high of 1.1176 on hopes of Trump's auto trade war truce. On Trump auto trade war (with EU and Japan) auto trade war narrative, on Sunday, the U.S. Commerce Secretary Ross said there may not be any necessity of auto tariffs on EU and Japan as talks were positive and those auto companies are ready to invest more in the U.S.:
“The U.S. may not need to put tariffs on imported vehicles after holding good conversations with companies in the EU and Japan. We have had very good conversations with our European friends, with our Japanese friends, with our Korean friends, and those are the major auto-producing sectors. Our hope is that the negotiations we have been having with individual companies about their capital investment plans will bear enough fruit that it may not be necessary to put the 232 (tariffs) fully into effect, may not even be necessary to put it partly in effect”.
As a reminder, although Japan (Abe) has already made a ‘great’ trade deal with Trump (U.S.), EU is somehow slow on this front (as there may not be any high profile EU leader at the top post-EU President like China’s Xi, Japan’s Abe or India’s Modi to talk in equal terms with Trump). In May, Trump/U.S. has agreed for a 6-months temporary auto trade war Truce with the EU (Juncker), which is set to expire by Nov’19. The U.S. is now basically negotiating with individual EU and Japanese auto majors to invest more in the U.S. and avoid any possible tariffs in the future.
EUR was also boosted by U.S.-China tentative trade deal and smooth & soft Brexit optimism. The risk trade as-well-as EUR buoyed on the report of ‘consensus’ for the U.S.-China Phase One trade deal. The market was also boosted by Trump’s comments that he is thinking U.S. farm state Iowa as a possible location for the signing of the tentative trade deal with Xi mid-Nov. Further, on Sunday, Trump again confirmed that China's trade deal signing will be somewhere in the U.S.
As a reminder, export-heavy Germany, EU’s largest economy has significant trading/export with China and Britain and thus the EU market was boosted by fading concern of a no-deal hard Brexit and the familiar progress of U.S.-China tentative trade deal optimism as both the nations confirmed ‘consensus in principle’ for a tentative trade deal after the Friday concall. The EUR was also buoyed by an upbeat China Caixin manufacturing PMI data earlier in the day.
But on Monday, there was some skepticism on U.S.-China tentative trade deal after Chinese media downplayed the same: Chinese government is reportedly taking a cautious approach in choosing a venue for the US-China Phase One deal signing and will avoid giving too many concessions. China's Ministry of Commerce also cast doubt on claims President Trump that China could buy up to $40 billion to $50 billion of American agricultural products a year, noting that the peak for Chinese imports of U.S. farm goods was $29 billion in 2013.
But the report also said: Trump-Xi trade deal could be signed in the U.S., China or a third country. The WH NSA O'Brien also said: "We're close" to phase one agreement on trade with China”. But there is also a renewed skepticism about a long term permanent (comprehensive) trade deal as China reportedly doubts such deal with Trump, considering the huge demand (asks) for concessions from China and Trump’s whimsical nature.
On Brexit saga, the British PM Johnson virtually blinks and abandoned his ‘threat’ for a ‘do or die’ Brexit (no-deal hard exit) in the Conservative Party election manifesto, while the focus would be to get Brexit deal done.
The Eurozone economy may be bottoming out. It now seems that ECB may not run the QE-2 very long and may close it after 6-12 months as there is a real scarcity of eligible bonds to buy. Also, there would be no hard Brexit (no-deal) and we may have soon a tentative trade deal between U.S. and China by Q1-2020, just before the U.S. election, the ECB has no reason to run QE-2 for any longer-term (say 2-5 years).
As the primary cause of current spate of synchronized global/EU slowdown is Trump trade war uncertainty, looking ahead ECB under new leadership of Lagarde may rely more on forward guidance (jawboning) rather than any real action as Trump may logically conclude his trade war agenda by Q1-2020, just before the U.S. election and also the fact that ECB is now almost out of weapons, thanks to Draghi pro-active stimulus package, all at one shot.
As there is a high probability of a smooth Brexit (with the deal) and U.S.-China trade truce by Q1-2020, like the Fed, ECB has no urge to go for further easing and it may stop QE-2 after 6-12 months (by 2020). Draghi’s successors Lagarde may like to keep ECB’s arsenal strong enough to fire a ‘bazooka’ rather than a ‘water pistol’ in time of real need (recession). Thus ECB will now use its forward guidance (jawboning) for a less dovish monetary policy stance going ahead.
Overall, EURUSD jumped almost +0.79% last week and soared around +2.31% in Oct on less dovish ECB talks and progress of U.S.-China trade truce coupled with soft & smooth Brexit. Thus, EURUSD is well-off the Sep low of 1.0885 and made a high of 1.1181 in Oct.
Technically, whatever may be the narrative, EURUSD has to sustain above 1.12100 for a further rally to 1.12600*/1.13100-1.13700/1.14100 and further to 1.14500*/1.15200-1.15700/1.16200 in the near term (under bullish case scenario).
On the flip side, sustaining below 1.12000-1.11800, EURUSD may fall to 1.11100/1.10700*-1.10200/1.109800* and further to 1.09400/1.09000/1.08700*-1.08300 in the near term (under bear case scenario).
In ECB talks, on Thursday (30th Oct), ECB VP Guindos said the ECB Monetary policy has not reached limits, but the negative impact is increasingly evident. Guindos also called for an appropriate fiscal stimulus as per EU27 states’ individual fiscal positions.
Guindos said in a prepared speech in a Presentation of the ECB Annual Report 2018 to the Committee on Economic and Monetary Affairs of the European Parliament: Relevant texts
The ECB’s monetary policy in 2018 and its impact on the euro area economy
Our monetary policy measures continued to contribute to very favorable financing conditions, supporting the euro area expansion throughout 2018. Lending rates for euro area firms and households remained close to their historical lows and growth in bank lending volumes continued the gradual upward trend observed since the beginning of 2014.
Firms, in particular, benefited from our purchases of bonds from the non-bank corporate sector, via the corporate sector purchase program. This program has made market-based financing more affordable for corporations and freed up lending capacity in banks’ balance sheets, which has had a positive impact on credit supply, in particular for small and medium-sized enterprises.
While monetary policy supported domestic demand, the growth momentum moderated in 2018. For the year as a whole, GDP rose by 1.8%, compared with 2.4% in 2017. This was mainly due to weaker global trade, as well as some temporary factors at both the domestic and global levels. One such factor was the transition to new car emissions standards, which caused some bottlenecks in the European car production sector.
Measures of underlying inflation remained generally muted throughout 2018, but there was no risk of deflation, and inflation was projected to be on a gradual upward path. The underlying strength of the domestic economy, underpinned by our accommodative monetary policy, and tighter labor markets, which were pushing up wages, supported our confidence that inflation was indeed on its way to converge to levels below, but close to, 2% over the medium term.
Against this background, we decided to end net asset purchases by December 2018. At the same time, we moved back to using our policy interest rates and the forward guidance on their likely future path as the principal tool for preserving the ample degree of policy accommodation that was still needed.
As a result, we enhanced our forward guidance on policy rates, adding an explicit date-based component to the state-contingent component. This anchors interest rate expectations more firmly. In particular, the combination of the two components reflected our commitment to provide the accommodation needed to deliver on our mandate of price stability.
Our forward guidance on the key ECB interest rates has been reinforced by our ongoing reinvestments of the sizeable stock of acquired assets. These reinvestments will maintain the size of our securities portfolio and, together with the forward guidance on the reinvestment horizon, continue to support favourable financing conditions.
The ECB’s recent monetary policy decisions
In the second half of 2018, the pace of the euro area economic expansion started to moderate more strongly than expected. Incoming information continued to disappoint in early 2019, suggesting that moderation would extend into the current year.
The impact of the temporary domestic factors dampening growth has turned out to be longer-lasting than anticipated, and the global economy has become less supportive. The persistence of uncertainties related, in particular, to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets have appeared to dent economic sentiment. In our latest staff projections, the euro area growth outlook for 2019 has been revised down substantially, to an annual growth rate of 1.1%.
The effect of the adverse factors weighing on growth is expected to unwind over time. Growth is expected to come in at 1.5% in 2021, unchanged from previous projections. Supportive financing conditions, further employment gains, and rising wage growth, and the ongoing – albeit slower – expansion in global activity, will continue to underpin the euro area expansion.
Nevertheless, the weaker growth momentum will leave its mark on domestic price pressures, slowing the adjustment of inflation towards our aim. Underlying inflation continues to be muted and our staff projections see a somewhat slower path for headline inflation, which is now foreseen to reach 1.6% at the end of 2021. Significant monetary policy accommodation, therefore, remains essential.
At our March meeting, we decided to adjust the date-based leg of our forward guidance. By confirming that rates would remain at their current levels at least through the end of 2019, we extended the period of very low-interest rates further by minimizing expectations of a rate hike before the end of this year. Of course, the second, state-based leg of our forward guidance continues to provide additional accommodation.
Furthermore, we observed that while bank lending conditions remain very favorable, the weaker outlook could affect the terms and conditions under which banks extend credit to businesses and households. It was, therefore, essential to preserve bank lending conditions by making sure that the refinancing needs of banks stemming from maturing bank bonds and outstanding targeted longer-term refinancing operations (TLTROs) would not jeopardize the transmission of monetary policy.
We, therefore, launched TLTRO-III, a new series of quarterly refinancing operations, starting in September 2019 and ending in March 2021, each with a maturity of two years. Banks will be entitled to borrow up to 30% of the stock of eligible loans at a rate indexed to the interest rate on the main refinancing operations over the life of each operation. Like the current TLTRO program, TLTRO-III will feature built-in incentives for credit conditions to remain favorable for the euro area economy.
Overall, the measures are taken in March signal our determination to provide the accommodation needed to underpin the economic expansion and ensure that inflation remains on a sustained path towards our inflation aim.
Moreover, the absence of clarity related to the outcome of the Brexit process contributed to higher political and policy uncertainty. Thanks to the preparations made by public authorities and the private sector, a no-deal scenario poses manageable risks to the overall euro area financial stability. However, some vulnerabilities remain which could generate more adverse effects if they interact with risks currently affecting the euro area outlook.
After the speech, Guindos warned in the Q&A:
“The collateral effects of the ultra-loose monetary policy are increasingly significant. Hence, monetary policy can’t be the only response to the economic slowdown in the Eurozone. The monetary policy can provide liquidity in the case of the risk of Brexit or trade wars, but it’s not the solution to these issues, which are the factors behind the slowdown. We can alleviate the situation but we can’t resolve it”.
“I wouldn’t say that monetary policy has in any way reached its limits, but I would say that the negative impact on financial stability is increasingly evident, which means it needs to be complemented with fiscal policy. The advantage of negative rates is that it has boosted investment, consumption and that’s behind the recovery. But on the negative side, some real estate markets in Europe are of overly buoyant valuations of assets, and banks’ earnings have also taken a hit. The labor market in the euro area is starting to feel the pressure of the economic slowdown in the region. The risks in the Eurozone are increasing, but rates are at an appropriate level”.
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