Deciphering The Dismal Reality In Europe From The Hopeful Green Shoots
European corporates continue to report considerably more negative surprises in production than expectations a mere three months ago - with the divide now at extreme levels. As Morgan Stanley notes though, there remains a 'hope' for green shoots in the euro area on the back of the ECB's OMT announcement and an apparently more robust China. Unfortunately, as these ywo simple charts indicate, the reality is that business surveys are pointing to a continued slide and that recent resilience is unlikely to last. In fact, in Morgan Stanley's view, incoming data and anecdotal evidence would suggest Q4 could be even worse than had been expected and the recessionary envionment will drag well into next year.
Via Morgan Stanley:
Investors on a mission to spot green shoots: Recently, we have started to receive more and more questions from investors on whether we are seeing any tentative green shoots in the euro area on the back of the ECB’s OMT announcement and an improving global outlook. These questions often reflected encouraging dynamics in Asian exports – typically a good early indicator for a turnaround in the global trade cycle – as well as better-than-expected outcomes for 3Q GDP (and an especially strong one) in the UK and the US just this past week.
Coupled with the ECB’s announcement on unlimited OMT bond purchases and a tightening in peripheral government bond spreads, this has caused avid euro area data watchers to ask whether 3Q activity could also have been firmer than expected in the euro area, especially after this week’s first 3Q GDP flash estimates released in Spain and Belgium. According to these data, the Spanish economy would have contracted at a slower pace of ‘only’ 0.3%Q, despite another austerity package being implemented over the summer. After the Belgian economy printed a stable GDP number in 3Q today, this could suggest that euro area 3Q GDP could have been firmer than we were forecasting (we are looking for -0.3%Q in non-annualised terms).
Alas, we have to conclude that the resilience is unlikely to last: In our view, the October business surveys already sent a clear warning sign not to get too comfortable in the deceptive sunshine of an Indian summer. Like the weather currently, where sunshine will likely soon give way to the first autumn storms, we would urge investors to prepare themselves for the coming winter chills.
In our view, incoming data and anecdotal evidence would suggest that 4Q could be even worse than we had expected so far, and that the outright contraction in headline GDP could also drag into the early part of next year. Relative to our baseline forecasts, it is actually the core countries, notably Germany and France, which recently gave rise to fresh concerns on the back of a marked slowdown in global capex (Germany) and an ambitious austerity programme (France). Meanwhile, peripheral economies such as Spain and Italy seem to have been more resilient than we feared initially – and the recession there appears to be unfolding somewhat more mildly than anticipated.
The deteriorating cyclical outlook for the euro area as whole as we head into the winter supports our out-of-consensus call for December rate cut: We continue to expect a reduction in all three key policy rates by 25bp when the ECB staff are forced to revise down their growth estimates once again and when they roll out 2014 inflation forecasts. Such a step would bring the deposit rate into negative territory for the first time in the ECB’s history. While the deposit rate cut could be more controversial on the Governing Council than a refi rate reduction, we believe that without a cut in the deposit rate – which is the binding lower limit for short rates – a refi rate reduction would not have much of an impact.