Last week was relatively quiet in the eurozone with different topics dominating the headlines. Since there were no central bank or other important meetings, markets had some time to digest the available information and also focus on economic data.
The data that came out last week, however, was mostly disappointing. It confirmed that the periphery is still suffering. Spain’s June industrial output (workday adjusted) dropped 6.3 percent year over year, which was more than the negative 6.2 percent estimate.
In addition, the deficit projection was raised to 4.5 percent of GDP in 2012 instead of the 3.5 percent, which was mandated by European officials in April. In Italy, nonperforming—or bad —loans rose a whopping 15.8 percent, a pace clearly not sustainable. Italy’s industrial production numbers came in below expectations—a drop of 1.05 percent last month.
According to Goldman Sachs, this is not good news for Italy’s plan to reduce the budget deficit. “The recessionary dynamic is likely to mechanically weaken tax revenues this year, creating hurdles for the fiscal consolidation that is otherwise well underway. ... We believe that the domestic economy—in particular private sector consumption and investment—currently faces strong headwinds (fiscal adjustment, financing conditions) that may end up harming sequential growth dynamics by more than we currently foresee.”
German and Dutch Data Also Weak but Markets Rise
What is more worrying is that Germany is also beginning to falter and soon might not be able or willing to support the eurozone periphery with transfer payments any longer.
Last week’s industrial production fell 0.9 percent in June compared to previous months, which was worse than consensus expectations of a 0.8 percent drop. In May, that number still stood at a positive 1.7 percent. German factory orders also fell from a positive 0.7 percent to a negative 1.7 percent in June. Another core country that reported a disappointing economic number was the Netherlands. Industrial production there slid from a negative 0.3 percent to negative 0.6 percent whereas economists had expected an increase.
Financial markets were not impressed by this slew of bad data, although the euro only lost a modest 0.1 percent, closing at $1.23 last Friday in New York trading. Stocks even rallied 5.3 percent with the EURO STOXX closing the week at 2423.
Given the absence of positive news flow and the lack of firm central bank commitments, the rise in equity markets was certainly fuelled by hope for additional stimulus as the economic situation deteriorates. Another aspect is that volumes are always light during the heat of the summer and even a slight change in sentiment can push prices dramatically. Lastly, investors always point out that the stock market acts as a discounting mechanism and looks up to nine months into the future, which may indicate that the worst economic data is already out and there are brighter times ahead.
Prominent Commentators Don’t See Reason For Rally
PIMCO’s bond boss Bill Gross commented in an interview with the Financial Times: “Even [French President] Mr. Hollande in left-leaning France recognizes that the private sector is critical for future growth in the EU. He knows that, without its partnership, a one-sided funding via state-controlled banks and central banks will inevitably lead to high debt-to-GDP ratios, rating service downgrades, and a downhill vicious cycle of recession.”
The head of the world’s largest bond fund thinks that ultimately the objective of the rescue attempts of European policymakers is to secure private sector funding for ailing governments. In the same interview he notes, however, that these endeavors have not been very successful and that private sector reluctance to invest in struggling countries might force the European Central Bank to engage in this type of “one-sided funding.”
Chief economist of Citigroup Willem Buiter shares a similar view on the bank’s research platform Velocity, and thinks, “The euro area is continuing to bumble and stumble to its eventual resolution. There still is the risk of disaster—of wholesale disintegration of the monetary union—but that is still pretty much a tail risk.”
The Week Ahead
This week could see a resolution between the conflict of prominent market commentators and financial markets participants. There will not be a major eurozone or central bank meeting, but several smaller pointers as to where the biggest trading zone in the world is heading could come later this week.
One of the more interesting backward indicators is the eurozone’s second-quarter GDP, coming after the United States reported in early August. Economists expect a decline of 0.3 percent over the quarter.
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