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Europe: The Week Ahead (Oct 21-25): Wrenching Tales of Trade Wars and Brexit Battles

By:

Senior Market Analyst at Interactive Brokers

Investors will receive updates on euro area consumer confidence and manufacturing in the week ahead, while the European Central Bank (ECB) will unveil its next monetary policy move, amid a blanket of economic malaise.

Growth across the euro area has generally been beset by intensifying global uncertainties, including trade-related concerns, Brexit developments, as well as regional worries about manufacturing and political unease.

The anxieties have spurred a waning of European consumer confidence, with indicators continuing to flash distress signals, despite the latest month’s modest lift in sentiment.

Wednesday, October 23

  • Consumer Confidence (Oct – flash)

According to the European Commission’s Directorate‑General for Economic and Financial Affairs (DG ECFIN), for example, while flash estimates of consumer confidence increased in the euro area by 0.6, the level remains deeply in negative territory at −6.5.

The EC has summed-up the decline in euro area sentiment in September by attributing the downbeat tone to “a substantial deterioration” of confidence in industry and a “slight” decrease in retail trade, while consumer confidence improved and remained “broadly stable” in services and construction.

Among the largest euro area economies, the EC observed that its Economic Sentiment Indicator (ESI) decreased “significantly” in the Netherlands, Spain (both -3.1) and Germany (-1.2) and, to a lesser extent, Italy (-0.8).

Thursday, October 24

  • IHS Markit Eurozone Manufacturing PMI (Oct – flash)
  • ECB Monetary Policy Decision and Press Conference

Meanwhile, the region’s manufacturing sector has fallen more firmly into contraction territory, with September’s IHS Markit Eurozone Manufacturing PMI plunging to 45.7 from 47.0 in the prior month – the lowest reading in nearly seven years.

IHS Markit pointed out that the fall in the headline PMI was driven mainly by the “sharpest contraction” in new orders since October 2012, with all countries except Greece and the Netherlands suffering a reduction in new work, while Germany registered “a substantial fall” that was the greatest seen since April 2009.

Output, new orders and purchasing all fell sharply during September, with Input costs having decelerated at the joint-sharpest rate since April 2016.

Chris Williamson, chief business economist at IHS Markit, noted that the latest results send “increasingly grim signals for the fourth quarter,” with manufacturing output falling at a quarterly rate in excess of 1%, representing “a severe drag” on GDP in the third quarter.

Williamson said he thinks there is “likely worse to come,” with forward-looking indicators, such as the orders to-inventory ratio, deteriorating further, while businesses also “remain downbeat about the year ahead.” In fact, business optimism stood in September at around a seven-year low, amid trade war worries, signs of slowing global economic growth and geopolitical concerns, including heightened anxiety over a “disruptive” Brexit.

Moreover, the region is also likely bracing for households and the service sector to be impacted by a worsening labor market, as the pace of job cuts have accelerated to the fastest pace since early 2013.

When Doves Cry

Against this backdrop, the ECB in mid-September unleashed a multi-pronged plan to aid in the revival of stubbornly low levels of euro area inflation, while president Mario Draghi called for governments with “fiscal space” to act in an “effective and timely manner” to help combat the “the weakening economic outlook” and “continued prominence of downside risks.”

Among the actions undertaken by the ECB:

  • The interest rate on the deposit facility was cut by 10 basis points to -0.50%;
  • The asset purchase program (APP) was resurrected, starting with €20bn worth of purchases a month at the beginning of November;
  • A two-tier system for reserve remuneration was introduced, in which part of banks’ holdings of excess liquidity will be exempt from the negative deposit facility rate; and
  • A new series of quarterly targeted longer-term refinancing operations (TLTRO III) were rolled-out, with maturities extended to three years from two, and with lower rates under certain conditions.

Although the euro area’s macroeconomic landscape seems bleak, the ECB’s easing may have helped some equities and exchange-traded funds (ETF) to regain some ground.

The SPDR MSCI Europe Industrials UCITS ETF (EPA: STQ), for instance, which has among its top holdings industrial manufacturer Siemens (OTCMKTS: SIEGY), Airbus (OTCMKTS: EADSY) and French construction company Vinci (OTCMKTS: VCISY), has returned roughly 23.3% year-to-date in 2019 compared to around 15.6% for Germany’s DAX index, according to Bloomberg.

The ECB’s more accommodative monetary policy runs alongside several other global central banks that have committed to dovish paths, including the U.S. Federal Reserve, the Reserve Bank of Australia, as well as the Swiss National Bank and the Swedish Riksbank.

The accommodation, combined with volatility-inspired market moves, have spurred many countries’ long-term government bond yields to record lows.

Yields on 10-year U.S. Treasury notes, UK gilts, German bunds, and French bonds, for example, have plummeted by more than 50bps to 100bps from March to late September, while Italy’s 10-year bond yields fell by around 175bps, amid the nation’s struggle to form a new government and ahead of its national election set for November 10.

In fact, during the March to September timeframe, the entire yield curves of Germany, Switzerland, France, the Netherlands and Sweden had all turned negative.

The euro also faces the potential for further declines in the near-term.

Marc Chandler, chief market strategist at Bannockburn Global Forex, noted that before “the buying dried up,” the euro had rebounded Wednesday to $1.1060 after holding trendline support near $1.0990 in the prior day’s trading session. However, he added that a break of the $1.0990 level “would warn of losses toward $1.09 in the coming days.”

The currency has shed roughly 5.6% of its value against the U.S. dollar from January 9 to the end of September, according to the IBKR Trader Workstation (TWS).

No Air Lift for Exports

Somewhat ironically, while the euro’s depreciation should bolster the region’s exports, the International Monetary Fund (IMF) blamed export weakness for its downgrade of euro area growth in its October 2019 World Economic Outlook (WEO).

The IMF cut its expectations for euro area growth to 1.2% and 1.4% in 2019 and 2020, respectively, from 1.3% and 1.6% in July.

European exports have been the target of U.S.-imposed tariffs recently, with the World Trade Organization (WTO) formally agreeing Monday to allow the U.S. to apply close to US$7.5bn worth of levies annually on the region’s goods and services.  

The authorization was granted as a result of the WTO’s rulings, which had found that the EU and certain of its member states failed to remove subsidies for the European aircraft manufacturer Airbus, causing U.S. rival Boeing (NYSE: BA) to suffer lost and impeded sales. 

U.S. Trade Representative Robert Lighthizer said that for years “Europe has been providing massive subsidies to Airbus that have seriously injured the U.S. aerospace industry and our workers,” and after nearly 15 years of litigation, the WTO has confirmed that the U.S. is “entitled to impose countermeasures.” 

As such, a range of EU imports will be subject to the new WTO-approved levies beginning October 18, with the bulk imposed on goods from France, Germany, Spain, and the UK – the four responsible for the illegal subsidies, according to the USTR. 

The USTR added that while it has the authority to apply a 100% levy on affected products, they have limited it to 10% on large civil aircraft and 25% on agricultural and other products.

Among the items subject to the additional duties are certain types of Italian cheese, Spanish olive oil, Irish and Scotch Whiskeys, as well as a variety of German tools, biscuits, waffles and coffee.

The Road Ahead

Overall, the IMF lowered its global growth outlook to 3.0% for 2019, its lowest level since 2008–09 and a 0.3% downgrade from the April 2019 WEO.

The Washington, D.C.-based organization underscored how manufacturing activity has “weakened substantially” – to levels not seen since the global financial crisis – while increasing trade and geopolitical tensions have promoted greater uncertainty over the future of the global trading system and international cooperation more generally, “taking a toll on business confidence, investment decisions, and global trade.”

The IMF added that while increased monetary policy accommodation has “cushioned” the impact of these tensions on financial market sentiment and activity, its overall outlook “remains precarious.”

While updates on euro area consumer confidence, manufacturing, and the ECB’s monetary policy decision roll-out in the week ahead, investors will also likely be keeping their eyes open to other upcoming events in Europe, notably for any signs about a clearer path for Brexit, as the EU Summit commences, as well as the unfolding of Spain’s elections.

In the meantime, select the Event Calendar option in the IBKR Trader Workstation for a full list of U.S. and global corporate events and earnings, dividend schedules, economic data, IPOs and more.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Disclosure: Author Security Holding: No Positions

The author does not hold any positions in the financial instruments referenced in the materials provided.

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