- The euro is at an 8-month low, signaling the European Central Bank's fight against deflation may soon bear fruit.
- While the Markit Flash Eurozone PMI shows a steady and on-going recovery in the periphery, price and cost levels are moving in the wrong direction.
- Major investors are snapping up distressed assets, betting that the swirl of financial signals points to an elusive recovery that is finally on the horizon.
Mario Draghi, President of the European Central Bank (ECB) is likely breathing a little easier these days. After further loosening monetary policy back in June, including negative interest rates, currency markets spent most of the remaining days of the month fighting the ECB's desire to get a lower euro (NYSEARCA:FXE). July has featured a neat reversal featuring an ever so steady march, even sneaking, out of the euro, sending the currency to an 8-month low against the U.S. dollar.
An 8-month low on the euro adds more confirmation of a double-top for FXE
Interestingly, European stock market indices have also fallen along with the euro. The SPDR Euro Stoxx 50 (NYSEARCA:FEZ), an index of the stocks of 50 of Europe's largest companies, has generally fallen since the ECB moved aggressively against deflation. Similar declines have occurred in the indices across the eurozone, including the United Kingdom.
Just another bump in the road for FEZ's uptrend?
Source for charts: FreeStockCharts.com
The current decline for FEZ places it back where it ended 2013 and a severe under-performance versus the S&P 500 (NYSEARCA:SPY) which is trading at new all-time highs and a 7% year-to-date gain. The just released Markit Flash Eurozone PMI® provides a good example of the economic contrasts in the eurozone that are generating mixed signals.
The Markit Flash Eurozone PMI is extremely important because it tracks eurozone GDP very closely. The PMI enjoyed a strong rebound in 2013 while in 2014 the pace of growth has slowed considerably, suggesting that GDP growth will remain in stall mode for some time.
The eurozone has stalled in 2014
Source: The Markit Flash Eurozone PMI
Most significant to monetary policy and the euro is what the PMI had to say about price levels:
"Output prices meanwhile continued to fall, with the rate of decline accelerating slightly on June. Average selling prices have now fallen continually since April 2012, although the rate of decline remains only modest and far weaker than that seen at the height of the financial crisis. A marginal rise in manufacturing factory gate prices was offset by a drop in charges levied for services."
I am surprised to see that the rate of decline in output prices actually accelerated in the wake of the ECB's move to further loosen monetary policy. This is clearly bad news and gives the ECB plenty of scope to figure out ways to loosen policy further and help drive the euro lower. But… in the very next paragraph, Markit also describes growing cost pressures:
"Some rising cost pressures were evident. Average input prices in manufacturing rose for a second successive month, growing at the steepest rate for seven months, while service sector input costs also rose, albeit to a slightly lesser extent than June."
Yet more bad news except rising input prices might act as a counterweight against looser monetary policy. The net effect is likely a squeeze on margins that can only further suppress the appetite to hire workers.
A key nugget of good news is that the eurozone outside of France and Germany is still experiencing relatively unabated improvement. The "rest of eurozone" region has essentially caught up to Germany for the first time since the financial crisis on both PMI and employment indices.
Can the periphery maintain its gains relative to the core eurozone countries?
Source: The Markit Flash Eurozone PMI
This steady improvement in the core is encouraging major investors to place big bets on recovery in the area even with the prospect of investing in a falling currency. For example, the Wall Street Journal recently reported on major investing institutions fighting each other for a loan package full of distressed Spanish mortgages:
"Around €2.6 billion worth of the loans in the Hercules portfolio are performing, meaning borrowers are up-to-date on their payments; €1.1 billion are "subperforming," or up to 90 days overdue, and €2.7 billion are nonperforming, or more than 90 days overdue, according to a person familiar with the deal."
That elusive eurozone recovery better be around the corner…Next up is to see how the ECB responds, if at all, to the opposing movements in output prices and input costs with a falling currency as backdrop.
Be careful out there!
Additional disclosure: In forex, I am short the euro