Euro-zone problems continue

Earlier in the week, we found out that the euro-zone unemployment rate held at a record 12.0% in February, highlighting the difficult problems being faced by policy makers on the other side of the Atlantic.



Today, the European Central Bank offered little comfort with the exception of touting its past achievements that have kept the woefully under-capitalized banking system from blowing apart at the seems.

I guess we really should be thankful for small favors.

ECB President Mario Draghi still believes the euro-zone will experience  a gradual recovery in the second half of the year, but he added a caveat - that any recovery is “subject to downside risks.”

It sounds as if he may be losing a little faith in his own forecast. At 75 bp, monetary policy is accommodative, but he’s not offering much more stimulus.

A rate cut was discussed “extensively,'” but a 25 bp or even a 50 bp rate reduction would be mostly symbolic. And don’t expect much in the way of fiscal stimulus.

Europe’s in a mess, and its weak banking system isn’t in a position to supply needed credit.

All this shouldn’t be lost in the U.S. investor. Sure, the market has pierced all-time highs, but weak sales in Europe seem likely to hinder profits at home.

Keep an eye on comments from the multinationals, as they report profits.

Cyprus keeps it interesting

We watch Europe quiet down, at least for a while, and then problems resurface. This time it's Cyprus.

The European Central Bank has done a remarkable job of holding the financial system in Europe together, but what is truly needed is economic growth. Until the recession in Europe ends, its under-capitalized banking system will remain under considerable stress.

Still, muted market reaction in the U.S and in Europe - a lack of reaction in Spanish and Italian debt yields - is signaling a lack of anxiety over contagion.

Monday is the deadline for Cyprus to accept German/IMF terms. If Cyprus rejects, its banking system will collapse, and we will likely see some renewed volatility, as the market tests ECB President Draghi's pledge to do whatever it takes to preserve the euro.

If Cyprus cries "uncle" (it really doesn't have much choice and that is what markets are pricing in), we limp through the latest euro-zone debt crisis.

Cyprus hopes to trip up the bulls

Over the weekend, news broke that Cyprus will levy a tax on its depositors to help with a bailout of its faltering banking system.

Not surprisingly, we saw a run on ATM machines in the country, but no bank lines as the financial institutions were closed today and are expected to be closed until Thursday.

The uncertainty created by the situation on the tiny island in the eastern Mediterranean shook global markets amid concerns that we might evenutally see a repeat in larger countries like Spain or Italy. The last thing we want to see is Italian depositors lining up around the block, demanding their life savings.

Stocks in the U.S. opened lower but pared losses by the close. In a flight to safety, Treasuries jumped as trading began but came off highs as cooler heads prevailed. Even better, junk bond fund fully recovered from early losses. Want a canary in the cold mine? High-yield funds are the closest you'll get.

What we saw today was an attempt by U.S. markets to sort through the noise.

But let's take a step back. Cyprus is barely 0.25% of euro-zone GDP, and countries such as Greece, Italy, Spain, Portugal, and Ireland have failed to sink the euro.

I don't have a crystal ball, but it seems unlikely that a cataclysmic euro-zone event might originate with Cyprus. Volatility? Probably. Stocks never move in a straight line.

Bottom line - Europe's problems have subsided and the relative calm in the credit markets has been a boon to U.S. stocks - think the removal of a roadblock. As we saw today, euro-zone woes haven't been put to rest.

Moody’s and Fitch frown on EU’s historic accord

Last Friday’s agreement to keep the euro zone from splintering was billed as an historic accord that would require deeper fiscal integration with the threat of sanctions if member states didn’t abide by tough budget rules.

On modest volume, stocks gained ground on Friday but credit markets were a bit more cautious.

Much like the October 27 agreement to save Greece, scrutiny and the glare of the spotlight are already giving rise to the naysayers.

Moody’s noted prior to the opening this morning, “The communiqué issued by European policymakers after the recent euro area summit offers few new measures and therefore does not change our analysis of the rising threat to the cohesion of the euro area and the further shocks to which it and the wider EU remain prone.”

Not wanting to be left out of the fun, Fitch Ratings at midday added, “The gradualist approach imposes additional economic and financial costs compared with an immediate comprehensive solution. It means the crisis will continue at varying levels of intensity throughout 2012 and probably beyond.”


Counterparty risk: Rising overnight bank deposits at the European Central Bank highlight growing fear in Europe.

Both agencies warned that downgrades remain a possibility. Stay tuned.

Stocks warm to elusive eurozone solution

Stocks finished last week in a favorable fashion amid signals from eurozone leaders that a solution, or at least some type of stop-gap measure that provides breathing room, is at hand.

The Sunday deadline was pushed back to Wednesday, but that didn’t hinder the bullish mood on the Street on Friday.

Despite the optimism that has been aided by numerous sound bites, credit markets don’t seem to be buying it. Yields on European bonds have been rising, and tension in the credit markets has yet to abate.

3-month LIBOR Rate

Source: FreeStockCharts.com

European leaders are aware of the consequences of not getting a deal done. I suspect a compromise is in the works, but will it be as far-reaching as some equity players are hoping for?

ECB holds the line on rates, hints at move in July

The European Central Bank (ECB) kept its benchmark rate at 1.25% following a quarter point bump in April, the first such tightening in over two years.

ECB President Jean-Claude Trichet said he continues “to see upward pressure on overall inflation, mainly owing to energy and commodity prices,” and will continue to “closely monitor” upside risks to price stability.

However, Trichet refrained from using the key signal “strong vigilance,” which would have strongly implied a rate hike at the June meeting.

Unlike the Federal Reserve, which has a dual mandate that focuses on price stability and unemployment, the ECB has a single mandate that focuses only on inflation.

That does not mean that the ECB operates in a vacuum, automatically hiking rates when inflation moves above its target of “close to, but below 2%,” but it does set off alarm bells among central bankers, as they ramp up the hawkish rhetoric.

The lack of a concrete signal for a June rate increase is helping to lift the dollar against the euro.

Additionally, the caution the ECB is displaying is effectively telegraphing to the financial markets that the bank is concerned about economic conditions and fears that a more aggressive path, which would likely strengthen the euro, could further complicate the situation in southern Europe.

ECB holds rates steady but hints at near-term increase

The European Central Bank (ECB) kept its key interest rate unchanged at 1.0% but hinted that an increase in rates at the next meeting might be forthcoming.

In his press conference, ECB President Jean-Claude Trichet said the current stance in monetary policy is "very accommodative" and has been lending considerable support to economic activity.

But he warned, "Strong vigilance is warranted with a view to containing upside risks to price stability."

Trichet would not commit to higher interest rates at the April meeting, which is not a surprise, but he did say such a move is possible, as he appears to be laying the groundwork for a shift in monetary policy.

Unlike the Fed, which has a dual mandate of maintaining the highest level of employment that is consistent with price stability, the ECB's primary objective is price stability, with a goal of keeping the headline CPI “below, but close to, 2% over the medium term.”

The Fed, unlike the ECB, focuses mainly on core inflation, which excludes food and energy, but like the Fed, it doesn’t want to rock financial markets with surprise rate hikes and does telegraph its intentions before acting.

According to the latest data, inflation in February rose to 2.4%, according to Eurostat’s flash estimate, up from 2.3% in January.

(Source: ECB/Eurostat)


Despite its main aim of keeping inflation under wraps, the ECB does not operate in a vacuum and is aware of the problems that southern Europe is facing.  But it is a much more hawkish group than the Federal Reserve and appears ready to act to prevent rising prices from getting entrenched in the eurozone.  Expect a new round of criticism it the central bank bumps up rates, especially given the problems in parts of Europe.

Not surprisingly, the euro is reacting favorably versus the dollar.

Production strong in Germany, but sentiment sours some

ZEW sends a mixed signal

A couple of key reports from Germany this week are sending out mixed signals.  Industrial production in September surged by 2.7% following an impressive 1.8% rise in the prior month.  Foreign demand provided much of the boost as the global economy continues to power ahead, bolstering Germany’s export-dependent economy.

However, institutional sentiment, though still has high levels, pulled back some in the latest month. The respected ZEW survey fell 4.9 points in November t0 51.9 points but remains well above the historical average of 26.9.

The Center for European Economic Research pointed out that analysts remain cautious as to how private consumption will evolve, especially due to the uncertainties that abound in the labor market.

Sentiment among analysts started in an uptrend late last year and continued to surge through much of the first part of 2009.  The initial optimism was a bit premature, in my view, but Europe’s largest economy has started on the road to recovery.

IFO shows Germany business confidence improves

Business confidence in Europe’s largest economy continues to gather steam amid signs that the global economy is improving.

Germany’s IFO Business Climate Index increased by 0.6 points to 91.9 in October, the best reading in just over a year. Moreover, expectations regarding future growth continue to push ahead.

Available survey indicators continue to signal an ongoing stabilization of economic activity, according to the European Central Bank. “In particular, the euro area should benefit from a recovery in exports, the significant macroeconomic stimulus under way, and the measures taken to restore the functioning of the financial system.”

Germany is heavily dependent upon exports and was hit hard by the global recession.

ZEW still upbeat but slips in latest month

The influential ZEW survey, which measures institutional in Germany, slipped 1.7 points in October to 56.0.  Though a little below expectations, the level remains well above the historical average of 26.7.

Sentiment among analysts in Europe’s largest economy has soared since late last year, and in my view, got a little ahead of itself (see June 16 post Germany optimism on upward trajectory).  Germany’s economy is export based and an improvement in the global picture, along with a rise in 2Q GDP, suggests a recovery has likely begun.

However, risks remain and Europe’s banking system still faces headwinds from unrealized loan losses. Hence, sentiment may be peaking.

Germany’s business climate continues to brighten

The rate of growth slowed in September but Germany’s business climate continued to improve, rising for the sixth consecutive month.  The IFO Business Climate Index increased from 90.5 in August to 91.3 in September, the best reading in one year.

The survey of 7,000 business in Europe’s largest economy suggests that the slow recovery will continue amid improvement in global conditions.  Germany’s economy is dependent on exports, and the dearth of demand late last year and early this year hit GDP very hard.

IFO in Germany in upward trend

Germany’s export-dependent economy continues to benefit from a solid acceleration in economic activity in Asia.  The IFO Business Climate Index improved for the fifth-consecutive month, rising from 87.4 in July to 90.5 in August.

Europe’s largest economy was hit extremely hard by the recession, but GDP unexpectedly improved in 2Q amid gains overseas.  Headwinds remain, including problems in the banking industry, but conditions appear to be stabilizing as business confidence improves.

Based on the graph below, manufacturing appears to be entering an upswing.  Still, without a solid recovery in the US, prospects for the economy will likely be limited.

ECB's Weber warns against withdrawing rate cuts too quickly

Despite an unexpected gain in Germany and France's GDP last quarter, I found some refreshing comments coming from a top European Central Bank policymaker in a Financial Times article published yesterday that indicated the central bank won't be pulling the rug out from under its stimulative policy anytime soon.

Axel Weber, Germany’s Bundesbank president, said, "The recovery we are now seeing is based largely on public sector support measures – the loose monetary policy, help for the banking sector and the stimulus package."

Weber went on to say that it's too early to start pulling back on the stimulative monetary policy because "the economy is not yet standing on its own feet, and the financial markets are still reliant on central bank help.”

That's good news for a central bank that has been traditionally very hawkish and almost completely focused on inflation.

Germany’s ZEW rises to best level in three years

The ZEW Indicator of economic sentiment in Germany jumped 16.6 points to 56.1 points in August, the best reading in over three years and well above the historical average of 26.5 points.

The institute that compiles the respected survey of analysts noted, “A repeated rise of incoming orders and increasing exports have brightened the economic perspectives for Germany in the next months.

In line with the increase of the overall economic expectations for Germany the expectations for all surveyed sectors of the German economy and for the export-oriented sectors particularly, have noticeably improved.”

Germany did post an unexpected gain in 2Q GDP, and prospects for the global economy, especially Asia, have improved.

A recovery does appear to be taking hold in Europe’s largest economy. But in my view, the survey is reflecting runaway optimism in an environment that should reflect a more cautiously optimistic tone.

GDP in Germany, France expands

Helped by stimulus spending, preliminary data showed that 2Q GDP in Germany, Europe's largest economy, and France, Europe's second largest economy, unexpectedly increased by 0.3% from the prior quarter, versus forecasts of a decline by about the same amount.

Unlike the US, where the quarterly changed is annualized, GDP in Europe is reported by the percentage changed versus the previous quarter.

As a result of the unexpected strength in France and Germany, eurozone GDP fell by just 0.1%, signaling the worst in Europe is over.

Germany is especially dependent on exports, and recent gains in manufacturing and growth in emerging markets are helping to offset headwinds from weak consumer spending and rising unemployment.

Germany industrial production eases

Following an upwardly revised and outsized gain in May of 4.3%, industrial production in Germany unexpectedly dipped by 0.1% in June, according to preliminary data.

The decline comes as a disappointment given yesterday’s strong 4.5% increase in industrial orders, which was the fourth-straight monthly rise.

Still, industrial production can be volatile in Europe’s largest economy and the huge rise in May, coupled with rising orders, signals that a rebound may be set to occur.

The country’s economy is heavily dependent upon exports, and the huge drop in demand late last year took a heavy toll on Germany. But China’s economy is moving along nicely and indications the US is set to follow are raising hopes that Germany may see growth this year.

The European economy, however, is likely to shrink for the rest of 2009 before gradually recovering next year, according to the European Central Bank. See ECB calls rates appropriate, BoE increases bond buys.

ECB call rates appropriate, BoE increases bond buys

The European Central Bank kept its  key lending rate unchanged in August at 1.0% as had been widely expected.  The ECB said in its press release that “current rates remain appropriate,” signaling no further rate reductions are likely needed.

The central bank added that economic activity over the remainder of this year is expected to remain weak. But there are growing signs that the global recession is bottoming out.

Recent surveys of the eurozone suggest that the pace of contraction is clearly slowing down, and after a period of stability, a gradual recovery is forecast to begin next year. 

Nonetheless, worries about the banking system remain, and the ECB once again called for banks to strengthen their capital.

In the meantime, the Bank of England held its main interest rate at 0.5% as forecast by nearly all analysts.  The BoE voted to continue with its program of asset purchases financed by the issuance of central bank reserves and to increase its size by £50 billion to £175 billion.

There have been increasing signs that output in the UK’s main export markets is stabilizing, the BoE said.  The pace of contraction has moderated, but the central bank added that the “recession (in the UK)appears to have been deeper than previously thought.”

Germany’s IFO business climate at 9-month high

The IFO Business Climate Index in Germany increased from 85.9 in June to 87.3 in July, reaching its highest level since October 2008. 

The institute that conducts the survey of 7,000 German businesses said firms are “no longer quite so dissatisfied” with current conditions, and it “seems that the economy is gaining traction.

The expectations component of the survey rose from 89.5 to 90.4, the highest reading in over a year.

Germany’s economy, which is the largest in Europe, is heavily dependent on exports, and it fell on hard times when global demand shut down late last year.

The rise in business confidence is partly related to improving exports and the more upbeat situation in China, while the US economy seems poised to expand in the second-half of the year.

As the chart above reveals, the economy has not yet emerged from the economic slump, but sentiment indicates the recession is easing.

The improvement bears watching as Germany, which had been among the hardest hit in Europe by the recession, could  surprise on the upside.

Eurozone outlook still subdued

An interesting piece put out last week by the three leading European economic institutes signaled that the 16-nation economy will remain in a recession through the end of the year, but the steepest declines in economic activity are over.

The report said that GDP dropped 2.5% quarter-over-quarter (q/q) in 1Q, after a fall of 1.8% in 4Q 2008. Economic prospects remain subdued, but the contraction of activity is likely to be less sharp in the coming quarters. Real GDP is forecast to shrink by 0.6% q/q in 2Q and by 0.4%, respectively, in 3Q and 4Q.

The fall in industrial production is likely to continue but at a progressively slowing pace: recent business surveys indicate an improvement in production sentiment but the "economic environment remains unsupportive."

With inflation well below the European Central Bank's target of "close to but below 2%," and the key lending rate still stubbornly stuck at 1.0%, central bankers in Europe still have room to cut as worries remain about how the major bank's will weather the recession next year. Another words, the ECB could be more supportive.

Inflation, which is its sole focus based on its mandate, is expected to rise to 1.0% by the end of the year, up from -0.1% currently. Yes, there is plenty of room to relax policy even more.

ZEW winning streak comes to an end

Germany’s closely-followed ZEW Indicator of economic sentiment unexpectedly ended its string of eight-consecutive monthly increases, falling from 44.8 in June to 39.5 in July.  The historic average  is 26.3.

The Center for European Economic Research (CEER) said “considerable risk for the future development of the German economy is whether lending to firms and households works out.

“In contrast, the surprisingly positive figures for incoming orders and industrial production have positively affected business expectations.”

Those of you who have viewed my comments in the past know I believe analysts got way ahead of themselves. The survey began to reflect improving levels of confidence in November just as the impact of the credit crisis was ready to cripple economic output in Europe’s largest economy.

And from the chart above, you can see the large swings that have occurred in sentiment over the decade. Germany’s IFO appears to be doing a better job reflecting current and future expectations and has not been subjected to the big mood swings seen in the ZEW.