Tags: Germany | euro | bank | ECB

Eurozone Is Close to Stagnation

By    |   Tuesday, 15 July 2014 02:24 PM EDT

The Markit Global Business Outlook Survey shows that global business confidence is showing signs of weakening, although it is above the lows seen a year ago. What is more worrisome is that the survey, which is based on responses from a panel of 11,000 companies that participate in the firm's worldwide manufacturing and service sector Purchasing Managers' Index surveys, also shows expected hiring dropping from 21 percent to 16 percent and expected investment intentions (capex) dropping markedly from 18 percent to 12 percent since February. The all-included "selling price" indicators' net balances, which include purchase prices, staff costs and other costs, is expected to fall from 24 percent to 16 percent in the coming year, which would be their lowest level since 2009.

The survey reveals a rather sobering picture of the global manufacturing performance, with: 1) U.S. investment and hiring intentions sliding lower; 2) the United Kingdom experiencing the highest optimism of the "G4" economies; 3) optimism waning in the "core" euro area, while it rises from very low levels in the "periphery" euro area; 4) emerging market optimism coming in at post-crisis lows; and 5) an upturn in Japan bucking the global trend.

I think long-term investors would do well taking notice of this relatively rare (conducted three times a year since 2009) and well-done survey when making future investment decisions, at least in the relatively near term. As I have said before: Take your time because the prices you'll have to pay for your investments have too much downside risk.

In addition, Eurostat reported that the seasonally adjusted industrial production in the euro area fell by 1.1 percent month-over-month and rose by 0.5 percent year-over-year.

France, which is the second most important economy of the euro area, saw its industrial production contract 4.2 percent year-over-year, which is simply an alarming level and is the worst of all the euro area countries (except for Malta), with no light at the end of the tunnel.

The German ZEW Indicator of Economic Sentiment, which is a leading indicator for the German economy, decreased 2.7 points and now stands at 27.1 points, which is close but still above its long-term average of 24.7 points. Declining retail sales and dropping industrial production as well as fewer incoming orders caused the drop.

The survey also shows Germany's current economic situation declined by 5.9 points to 61.8 points, which is a three-month low, while the indicator for the current economic situation in the euro area declined 3.8 points, and now stands at -31.5 points.

I don't think it's an overstatement to say that the data don't support the current wave of optimistic hype for broad-based investing in the euro area.

On Monday, European Central Bank (ECB) President Mario Draghi gave a speech to the European Parliament's Committee on Economic and Monetary affairs (Source: http://www.ecb.europa.eu/press/key/date/2014/html/sp140714.en.html) wherein he stated: "The ECB continues to stand ready to take action, if necessary, to further address risks of too prolonged a period of low inflation. This could also include the use of other unconventional instruments in line with our price stability mandate." Translated into clear language: Quantitative easing falls squarely in our mandate, which is certainly not the opinion of the Bundesbank.

He added, "Certainly, the appreciation [of the euro] that took place since mid-2012 had an impact on price stability. In the present context, an appreciated exchange rate [of the euro] is a risk to the sustainability of the recovery."

It seems to me he has no other choice than to try with the variety of instruments and influences he has at his disposal to cause a lower the exchange rate of the euro. Of course, we'll have to wait and see if he will be successful, but I think he will succeed. Of course, it would be against his will, no doubt about that, and by doing so he would enter in the currency war arena and let the euro become a very important global "funding currency" used in carry-trades, but above all, to serve the ultimate good, which is of course not in accordance to the view of the Germans, of having a weaker single currency that could return to its long-term average exchange rate since its inception, which is slightly below $1.20 per euro.

As communicated by the ECB, the euro/dollar exchange rate started on Jan. 8, 1999, at $1.1659 per euro; on Oct. 26, 2000, it reached its lowest point, at $0.8252 per euro, and on July 15, 2008, it reached its highest rate, at $1.599 per euro. The exchange rate today is around $1.36 per euro.

Also interesting was the statement at the end of his speech, when Draghi recalled the European Parliament's Committee on Economic and Monetary affairs the fact that many (especially investors at all levels and time horizons) seem to negate these days: "Over and beyond this focus on concrete short- and medium-term measures, we should bear in mind that Economic and Monetary Union still remains an incomplete structure."

I don't know if we will see frictions between the ECB and the German central bank once the euro would weaken more than the Germans would consider as acceptable.

On June 16, Jens Weidmann, a member of the ECB governing council and president of the Bundesbank, told the German Focus magazine: "Competitiveness cannot be brought about through a devaluation." Then in an interview with German daily Sueddeutsche Zeitung on June 23, he stated the ECB was not allowed to finance governments and should interpret their mandate narrowly on currency devaluation.

Long-term investors should wait and not take on high risks when considering investing in euro-denominated vehicles, because better times for long-term investing will come, but that's not tomorrow yet.

My personal preferences haven't changed for quite some time and I still prefer the United States as the safest location to invest in (although there also remains a lot to be done, but it's doable and within a reasonable time frame if there is political will to really help) and the dollar, which remains, at least for now and still for some time to come, the main reserve currency in the world as main portfolio currency.

I simply can't overlook all the geopolitical risks that are out there and that simply don't want to go away and could blow up at any time, as well as the deep structural problems the eurozone is still facing, for which it doesn't have quick doable solutions at hand, while at the same time the economy of the eurozone as whole is once again close to stagnation.

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I simply can't overlook all the geopolitical risks that are out there and that simply don't want to go away and could blow up at any time.
Germany, euro, bank, ECB
Tuesday, 15 July 2014 02:24 PM
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