More Evidence Of A European Slowdown

Includes: ERO, FXE
by: Ralph Shell

Reports yesterday confirmed that the economic slowdown that has been plaguing the countries in Southern Europe is moving north. The German Manufacturing PMI (M/M) was down to 45.7 from 47.4 last month. The Services PMI slipped to 49.3 from last month's 49.7. Continuing, the German IFO Business Climate, Current Assessment, and Expectations surveys are reflected unchanged or negative expectations.

Another report was released in Amsterdam by Heineken N. V. today. Its revenue grew at 7.1%, but it noted there was a "positive currency translational effect." This resulted in an earning boost from profits in the Nigerian naira, the British pound, and the Mexican peso versus a weaker euro. For the nine-month period, the global volume of Heineken and its affiliates was higher, however the exception was a 4% sales drop in Western Europe. Is it possible that slower beer sales is a leading indicator?

There is other data that suggest the euro-area debt crises has become worse. The Eurostat reported government debt at the end of the 2nd quarter was 90% of GDP compared with 84.9% a year ago. The highest ratios of government debt to GDP were in Greece 150.3%, Italy 126.1%, Portugal 117.5% and Ireland 111.5%.

The biggest percentage increase in 2012 from the previous year's debt to GDP was 13.4%. This was in Greece, and should serve as an indictment how ineffective, perhaps destructive, the Troika's austerity plan is.

For the euro (FXE, UUP, UDN, EURUSD) it looks like the Draghi rally, prompted by his claim he would do whatever it takes to save the euro, has run its course. The recovery top was established around 1.3170 in mid September. After a retracement, the euro staged another rally but stalled at the 1.3140 area.

With the European debt crisis unresolved it is difficult to make a bull case for the euro. Yesterday the euro rallied when the Greek finance minister said the Troika auditors had approved the Greek austerity efforts and the next tranche of bail out money would be coming in November. This was denied by a German official and the euro then retreated.

Spanish banks have many problems. They hold billions of euros of bad real estate loans. The EU has provided a €100B, which it insists are loans to the Central Government, and it would lend this money to the troubled banks. There are problems with this approach. The government debt-to-GDP ratio would rise beyond an accepted level for the Spanish government. Also the €100B is probably not enough to re-capitalize all of the ailing banks.

Further, there is no assurance the banks holding the bad paper will reduce prices to a level where the market will buy them. The real estate market cannot recover until the price is written down to the current market level.

In Europe there is no shortage of potential troubles that can hurt the euro. In addition to Greece and Spain, the French economy under Hollande and his socialist friends is contracting, and the capitalization of the French banks is in danger.

Political instability is Europe, with each new election, will remain a threat as long as the economy fails to recover. Though the seeds of the economic destruction may have been planted in years prior, current incumbent politicians will pay the price. Who knows what plans the new politicians will then bring to office.

It is easy to not be bullish on the euro, but this is hardly a reason to be USD bullish. The U.S. economy is slowly recovering. Today the monthly U.S. Durable Goods, was a positive 2%, better than expected.

But the growth rate at 1.5/2.0% is hardly good enough to increase employment and please the Fed's Bernanke. Until the U.S. economy recovers the Fed is going to continue with QE3. This expansion of the Fed's balance sheet will increase the money supply, which, over time, depreciates the USD. Combine this with practically free money until 2015, there is then a big incentive to fund foreign investments with USD loans.

There are reasons to be bearish on both currencies. This probably implies we are going to move forward in a trading range. Support appears to be around the 200SMA, which is about 1.2835, a level where you buy the EUR. Resistance should be around 1.3130 where you sell the EUR. Eventually we will break out of this range, but until, then best treat this a pair, trapped in a trading range.

Disclosure: I 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. I have no business relationship with any company whose stock is mentioned in this article.

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