Eurozone leaders have been slow in acknowledging weakening economic conditions, notes Landon Whaley.
This week’s “Headline Risk” continues with yet another central bank crying dovish. According to Bloomberg, ECB Governing Council member Francois Villeroy de Galhau said last week that the Eurozone’s growth slowing is significant and that the ECB could change its interest rates guidance if the slowdown proves to be more than “temporary.”
We’ve been discussing the Eurozone’s problems since November 2017, well before they became headline fodder late in 2018. Throughout 2018, there were very few growth-accelerating data points, and after June, all the data started to deteriorate at an increasing pace. This is why equity markets from Germany, France, Italy and Spain all went into crash mode before U.S. markets came apart in Q4 2018.
We are15 months into this slowdown, with a slew of market downturns and the ECB is waiting to see if the slowdown is temporary!
As we pointed out in Monday’s Gravitational Edge, Italy is currently in a recession, and Germany (the economic locomotive of the EU) just barely escaped one of its own. After German growth contracted in Q3 2018, it managed to grow marginally in Q4 2018. Germany sidestepped the technical definition of a recession — two consecutive quarters of contracting growth — but is clearly not out of the woods.
Technicality aside, nearly every single data point out of the Eurozone over the last two months has been at, or close to, recessionary levels. In fact, most of the data points over the last few weeks have hit brand new cycle lows, which means growth is deteriorating at a rate we haven’t seen since 2012.
The Eurozone’s industrial production declined 4.2% in December, the slowest growth rate since November 2009. Germany factory orders hit a new cycle low of -7% in December, Italian retail sales contracted 0.6% year-over-year, and Spanish industrial production declined 2.9% from November to December’s contraction rate of -5.5%.
In addition, Eurozone auto sales have been slowing for five months. In January, auto sales contracted 4.6% for the EU as a whole, but some of the real outliers included Spain (-8%), Austria (-11.6%), Ireland (-12%) and the Netherlands (-18%).
It’s not just one guy from the ECB belatedly coming around to reality. On Feb. 8, 2019, Benoît Cœuré, another member of the Governing Council, said, “… we don't think that we have enough elements to conclude that we're facing a lasting and serious slowdown of the eurozone economy.”
On Feb.15, Cœuré said that the economic slowdown is “clearly stronger and broader” than the ECB expected. And he added, “We have to adapt to that.”
Last year, we aptly named our Eurozone macro theme “Draghi’s Dilemma” because we knew Super Mario wanted to normalize policy but that the data wouldn’t let him. We knew that Super Mario was going to stubbornly stay the course on the ECB’s own path of normalization despite deteriorating data. We further knew that once enough slowing data points had smacked these folks in the face, they too would cry dovish.
So here we are, less than two months after Draghi said, “Risks surrounding the euro area growth outlook can still be assessed as broadly balanced” and we can hear Prince out of the halls of the ECB. A dovish policy pivot certainly puts a tailwind under EU equities, but it provides a continued headwind to the euro, which is heading for at least 1.10.
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