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April 23rd, 2012

Growth measures published Monday put European economies in the market’s crosshairs again. Germany’s purchasing manager index (PMI) for manufacturing fell to 46.3 in April, the worst reading in 33 months and stoking fears that the troubles at Europe’s star-crossed economies have indeed reached the core. After popping 2.6 points higher to a six-month best (51.0) in January, Germany’s PMI has fallen for three straight months, leaving the 12-month cumulative decline at 15.7 points the worst since plumbing the depths of global recession in May 2009. Seemingly succumbing to woes at Europe’s periphery, Germany’s wobble spells new pessimism for dealers.

One year ago, only three countries (Japan, Australia and Greece) had manufacturing PMIs below 50. Of the four (of 25) countries that have reported so far for April, all four PMIs were below 50. Three of those countries (France, Germany and euro area) have year-ago declines in excess of ten index points.* Greece’s PMI appears poised to fall below 40 in April and Spain’s (the second worst PMI through March) is not far behind that distinction. Dealers fear that last year’s virtuous growth cycle has become a vicious recession cycle.

* For the U.S. ISM PMI to post a double-digit 12-month decline and a 32-month low, April’s headline index would have to fall to 49.7. In the latest Reuters News survey, however, the consensus among 13 respondents has April ISM rising 0.1-point to 53.5. Estimates range from 52.7 to 55.0. Nomura Securities (e: 54.4) is presently the high forecast among primary dealers.

Declaring an end to the first quarter’s “temporary bright spot” in business sentiment, Societe Generale Cross Asset Research wrote, “Monday’s European data painted a pretty dismal picture of a region slipping back into recession, with activity again being adversely affected by the re-emergence of sovereign tensions. Worryingly, the slowdown seems to be spreading to Germany. Renewed sovereign tensions and tighter financial conditions are again having an entirely predictable impact on foreign orders. This almost certainly means GDP for the euro area as whole will fall again in Q1 but also suggests there is little evidence of even a weak recovery taking hold in Q2. Quite the reverse in fact, with potentially even German resilience, beginning to be tested.” SG points out that Germany’s service sector activity “held up rather well at 52.6, roughly the position it has held since the start of the year. Tellingly however, service sector employment dropped three points in Germany; slipping back below the key 50 level which suggests this resilience may prove short lived.”

In the view of Barclays Capital Research, “Four issues have been dominating moves in market confidence in recent months: US growth, Chinese growth, the European crisis and oil prices.” BarCap economists described Monday’s readings on German manufacturing PMI (46.3 – weakest since July 2009) and the French services PMI (46.4 – second weakest reading since July 2009) as “particularly troubling” and having the potential to overtake concerns about growth in the US and China. “Worries about Chinese and US growth and oil prices are all overdone at present, in our view. As the worries subside, risk appetite should strengthen. But the issues facing the euro area remain very problematic, both politically and economically. We continue to expect European currency underperformance, and that the USD is likely to be the strongest performing of the large, liquid currencies, despite recent range trading relative to the EUR.”

XTB Online Trading agreed that the PMI stood in stark contrast with other indicators from Germany but they warned, “Since the Ifo used to be “late” in signaling a shift in the business climate, we are assigning a greater weight to the PMI and the direction it is pointing at is not optimistic at all. A weak macroeconomic outlook might successfully deny an improvement in the fiscal outlook on the old continent.” For HSBC Global Research, “The signs of stabilization evident in the first quarter PMIs appear to have run their course, with the forward-looking indicators pointing to further weakening in the coming months and the composite PMI currently consistent with a renewed deepening of the recession at the beginning of Q2. The fall in employment levels were the major cause of concern, as this would hit the already fragile purchasing power, impeding future recovery. The headline available data also suggest that the rate of contraction steepened in the periphery.”


Although Germany’s PMI disappointed to the downside, Deutsche Bank Global Markets Research is “not overly worried, considering how well the Ifo index holds up.” The Ifo Business Climate Index increased in April for the sixth consecutive month, which for DBGMR “points to positive growth momentum in construction and retailing.” Last week, Ifo’s April business climate survey for the German service sector showed an improvement for the business situation but a fall in expectations. Monday, Germany’s service sector PMI (52.6) not only showed expansion in April, it edged out consensus (52.3). Nevertheless, DBGMR added, “The continued divergence of the more export-oriented manufacturing PMI and the Ifo supports our view that weak export demand especially from EMU dampens growth prospects in Germany.” According to DBGMR’s model and assuming no change for May or June, Germany’s second quarter average PMI would be consistent with a contraction in GDP of 0.3% qoq in Q2, down from -0.1% qoq in Q1. The economist team writes, “In cumulated terms over 1H, that would be a bit worse, at -0.4%, than our current projections of an overall decline of GDP of 0.3%. Probably more importantly, while in our forecasts the pace of GDP contraction peaks in Q1 2012, the PMI data for April are actually consistent with a further deterioration in the spring. Today’s data clearly creates a negative risk to our baseline.”

The round-trip on euro zone PMIs over the past 12 months will not be lost on the Fed as it meets Tuesday and Wednesday to decide on U.S. monetary policy. Dealers do not expect the FOMC to take the weakness abroad fully in hand but it the Committee’s statement is likely to revert to the phrasing used in the January 25 communiqué that stated, “Strains in global financial markets continue to pose significant downside risks to the economic outlook.” Germany may continue to exhibit remarkable resiliency but its April PMI data prove that the mighty oak is no longer immune to the decaying growth in the forest that surrounds it.


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