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This Does Change Things: Germany Factory Orders Plunge, ECB Action Expected

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by: Tim Worstall
Summary

German factory orders have plunged 8.6% on a y on y basis. German manufacturing is very much more of the economy than it is in other countries.

This is a significant enough effect that we probably will see a change in policy.

We can expect perhaps a cut in ECB rates, the market certainly seems to think so.

These macroeconomic numbers

The reason we look at these varied macroeconomic statistics is that we want to know, divine, if and when the economy is going to turn. We know very well that we've not abolished the business cycle and quite clearly we want, as investors, to be differently orientated in a recession than we are in an expansion.

This latest number out of Germany indicates that we could be at one of those turning points. At least for the German economy, and that's the largest national share of the eurozone one too.

The specific German factory orders number.

We have to remember that manufacturing is much more important to the German economy than it is to any other rich nation bar Switzerland. The manufacturing share of GDP is around double that of the UK, US or France for example, up in the 20 to 25% range. Thus manufacturing matters in Germany in a manner that it doesn't elsewhere.

A year on year fall of 8.6% in factory orders is thus a real thing, something to take note of:

The big news of the day is the sharp decline in German factory orders, down 2.2% in May versus estimates for a 0.2% decline. This will worry the European Central Bank and raise expectations of more monetary stimulus in the near future.

That's from AJ Bell. Exactly what is happening matters though:

In particular, the outlook for foreign demand has deteriorated considerably. The tentative spring recovery in global trade has thus turned out to be very short-lived. In view of the lingering trade uncertainties and elevated inventory levels, a swift recovery for German industry is not in the cards. Germany’s export economy, which is strongly geared to industrial goods, will clearly remain under pressure.

So far, domestic demand has been holding up relatively well, but it is only a matter of time before the weakness in industry also affects investment activity and consumption in a more pronounced manner.

That's from Allianz SE. And a bald statement of the numbers:

Manufacturing orders dropped 2.2 per cent in May from the previous month, widely missing the estimate of economists polled by Reuters for a fall of 0.1 per cent. The figure was down 8.6 per cent from the same month in 2018, according to official data from the Federal Statistics Office.

Again, the why matters:

Foreign orders at German manufacturers slumped 4.3 per cent in May, on a month over month basis. Orders from the eurozone were off 1.7 per cent, with those outside the bloc tumbling 5.7 per cent. Domestic orders rose 0.7 per cent.

It's not actually weakness in the German economy at all. It's a weakness in export orders, and exports to outside the eurozone as well.

This really means China

The thing to understand being that Germany makes the machines that make machines. Thus they've been uniquely placed to benefit from the Chinese economic expansion. Which needs to order lots of this sort of industrial machinery. And when the Chinese economy starts to slow its expansion - no one at all thinks it is actually shrinking as yet - then that's going to rebound onto the German economic model.

The numbers again

As a chart for these numbers:

Germany factory orders
(Germany factory orders, from Federal Statistical Office via Bloomberg)

One month's numbers do not a change of policy make, but the year on year difference is large here.

So, what will be done?

This rather depends upon how the European Central Bank parses the information. That the Chinese economy is slowing down, thus affecting German manufacturing exports, isn't something that eurozone monetary policy can do much about. So a lowering of interest rates as a direct response isn't going to happen.

But, of course, any slowdown in the economy can be at least partially reversed by looser monetary or fiscal policy. Even if it's going to make no difference at all to exports to China it can and would still lead to being expansionary for the domestic economy, this boosting output and employment, even as those missing exports depress both.

Which is why we do expect the ECB to be loosening monetary policy.

The investor takeaway

We're likely to see a cut in the ECB deposit rate. Given that Bunds are already below the current one this does seem likely. As Commerzbank suggests:

On Friday, Commerzbank changed its forecast on ECB stimulus, predicting a 20 basis-point cut in the deposit rate this month, larger than previously anticipated.

The slowdown itself is more about trade wars and perhaps China's economy. But we'll see at least some monetary stimulus in Europe and the eurozone as a result.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.