This post will discuss the weak economic conditions that have started to proliferate in the Euro-zone once again, marked by declining rates of production, consumption, inflation, and overall growth, all of which are exacerbated by a recently-strong Euro.
There was a period in mid-to-late-2012 when the financial aspect of the Euro-zone sovereign debt crisis appeared to be easing and the ailing economy appeared to be improving. To start, both Italian and Spanish sovereign bond yields compressed rapidly, to much narrower levels relative to their German counterparts. Then, as a sign of confidence in the region, the Euro rallied swiftly, especially against the Japanese Yen and the U.S. Dollar, culminating in a rally into $1.3710 on February 1, from $1.2041 on July 24. Conditions appeared to be improving.
But, as the saying goes, “don’t judge a book by its cover.” The period of calm that enveloped the Euro-zone over the past half-year warranted a second review, and as 4Q’12 GDP figures have showed, the broader region is now embroiled back in a recession equivalent to the deepest depths of the 2008 to 2009 global financial crisis.
Speaking from the point of having a budget surplus, Germany among other core Euro-zone countries have insisted that leaders in heavily indebted periphery countries embark on acute austerity programs, intended to correct any budget imbalances with a very heavy, swift hand over the next few years. The ramifications have been dramatic: record high unemployment rates in Italy, Greece, and Spain; substantial unpopularity among French, Italian, Greek, and Spanish politicians; social unrest across the continent; and relevant questions over the viability of the European Union as a whole in the long-term.
Now that austerity is creeping into the core of the region and growth begins to slow, we turn our attention to the Purchasing Managers’ Index readings from the major Euro-zone countries, to effectively gauge where growth is heading in the 2H’13. It’s evident here as well that growth rates should continue to contract, and that the crisis is going to get worse before it gets better, if anything.
With all of the major PMI readings (except for Germany) at or below the growth level of 50.0 (the further away from the 50.0 line, the stronger the condition; above 50.0 is growth, below 50.0 is contraction), businesses are signaling continued weak conditions that are likely to persist for the foreseeable future. Seemingly, over the past two months, the region’s fundamentals have gotten worse, as any recovery on the horizon has been wiped out amid a sharp turn lower in sentiment, led by a very weak French PMI Services reading. When the weak growth situation is considering in context of the burgeoning political problems again, it’s clear that the Euro will struggle this year as markets turn to the European Central Bank for help. The EURUSD could slip below 1.3000 in the 1Q’13, but ultimately should finish the year in the 1.2500 to 1.2750 range.
This series of eight posts will focus on the major themes affecting currency markets. The seventh post in this series will discuss how the political situation in Europe is pushing the monetary union back to the brink.