Overnight Sentiment: European Economic Implosion Sends Risk Soaring

If there was one catalyst for the market to be "convinced" of an imminent coordinated liquidity injection, as Zero Hedge first hinted yesterday, or simply a 25-50 bps rate cut from the ECB as some other banks are suggesting and Spain's ever more desperate Rajoy is now demanding, it was the overnight battery of European Flash PMI, all of which came abysmal, throughout Europe, the consolidated Eurozone PMI posting the worst monthly downturn since mid-2009, the PMI Composite Output and Manufacturing Index printing at a 35 month low of 45.9 and 44.7 respectively. PMIs by core country were atrocious: France Mfg PMI at 44.4 on Exp of 47.0 and down from 46.9, a 36 month low; German Mfg PMI at 45.0 on Exp. of 47.0 and down from 46.2. The implication, as the charts below show, is that GDP in Europe is now negative virtually across the board. Adding insult to injury was the UK whose GDP fell 0.3%, more than the 0.2% drop initially expected. The cherry on top was German IFO business climate, which tumbled from 109.9 to 106.9 on Expectations of 109.4 print, as the European crisis is finally starting to drag the German economy down, or as Goldman classifies it, "a clear loss in momentum." What does it all add up to? Why nothing but a massive surge in risk, as the market's entire future is now once again in the hands of the #POMOList, pardon, the central banks: unless the ECB steps up, Europe will implode due to not only political but economic tensions at this point. Sadly, as in the US, by frontrunning this event, the markets make it more improbable, thus setting itself up for an even bigger drop the next time there is no validation of an intervention rumor: after all recall what sent stocks up 1.5% yesterday - a completely false rumor of a deposit insurance proposal to come out of the European Summit. It didn't, but that didn't prevent markets to not only keep their massive end of day gains, but to add to them. it is officially: we have entered the summer doldrums, when bad is good, and horrible is miraculous.

More on the overnight action from BofA:

Market action

Asian equity markets finished mixed with the Hang Seng falling 0.6% and the Shanghai Composite sliding 0.5% due to weak economic data in China. In particular, the HSBC manufacturing PMI hit a seven month low in China. On the flip side, the Indian Sensex managed to finish 1.7% higher, the Korean Kospi rose 0.3% and the Japanese Nikkei rose 0.1%. 

One would think that the lack of clear resolve or concrete details on how to improve the economic and fiscal situation in the Euro area at last night's informal EU summit, along with very weak May flash PMI reports and a weaker than expected German ifo business climate report would send equity markets swooning. But that is not the case as equity markets in the aggregate are enjoying a solid rally of 0.9% in Europe. Meanwhile at home, futures are pointing to a 0.4% rally in the S&P 500 later today. 

Earlier today, Treasuries were rallying across the curve with yields down roughly 2bp in both the long and 10-year Treasury. However, that rally started to unwind around dawn in NY. Now the 10-year Treasury is up 2bp to 1.75% and the long bond is 1bp higher at 2.83%. In Europe, gilts and bunds are also backing up while yields among the region's periphery countries are falling but Spain's 10-year yield is still trading above 6%. 

The dollar is selling off modestly against a basket of currencies with the DXY index trading 0.1% lower. The euro continues to weaken against the dollar hitting its lowest exchange rate since the summer of 2010. In the commodities space, crude is trading at $90.33 a barrel up 0.46% while gold is off 0.3% to $1,557 an ounce.

Overseas data wrap-up

As expected the informal EU summit last night was not a game changer for the Euro area. The summit focused on ways to use existing tools for supporting growth in the Euro area but in our view they will not be sufficient to help the Euro area avoid a recession this year. The press conference statement suggested an intense debate on the road to further integration, with strong disagreement between France and Germany. 

On Greece, there was a repeat of support for Greece but that Greece must respect the reform agenda; in our view, it is unlikely Euro area leaders will agree to any changes to Greece's bailout package before the June 17 elections. Meanwhile according to a leading German newspaper Die Zeit, the ECB and the Bundesbank have set up working groups which are exploring the consequences of a Greek exit and Reuters reports that the European Working Group agreed that each member state should have contingency plans for a Greek exit in place. Also take a look at today's Wall Street Journal, "Europe Girds For Greek Exit." 

The final release of first quarter GDP in Germany confirmed that the country grew at a 0.5% qoq pace. This report contains the underlying details and we learned that the primary driver of the strength of 1Q GDP was due to an uptick in exports which rose 1.7% qoq which was 0.8pp more than expected. Private consumption was also stronger than expected rising 0.4% while on the flip side investment spending was much weaker than expected falling 1.1% due to a slowdown in the construction sector. 

The German ifo business climate index fell for the first time in seven months to 106.9 in May from 109.9 in the prior month. Consensus was looking for a slightly smaller slide to 109.4. Looking at the details of the report both the current index and the expectations index fell. In other words, the business climate turned lower in May and businesses expect it to worsen over the next several months. 

Absent a Greek exit that sends Euro area GDP into a nosedive (-4% yoy in 2012) our European economists expect Germany to avoid a recession this year and grow 0.6% yoy as private consumption and exports drive the economy. However, both the increased uncertainty surrounding Greece and the ifo survey point to downside risks to the economic outlook. 

First quarter GDP growth in the UK was revised 0.1pp lower to 0.3% qoq. Looking at the details, consumer spending was weaker than expected as consumers continue to struggle with high unemployment and weak growth. Our UK economist expects the UK economy to remain flat this year as the recession in the Euro area acts as a drag on the UK's growth. 

The flash Euro area composite PMI showed further deterioration for May, with activity dropping below its trough last fall. The index fell from 46.7 to 45.9 - the lowest level since the summer of 2009. The decline was driven by the manufacturing sector, where conditions in both Germany and France reportedly softened over the month. Services PMIs were broadly flat in May, with Germany continuing to outperform significantly. These reports are consistent with a material softening in the economic backdrop for the second quarter. Growth could potential contract 0.5% qoq after zero growth in the first quarter. 

The HSBC flash Chinese manufacturing index fell to 48.7 in May down from 49.3 in the prior month. In our opinion, markets tend to pay less attention to the HSBC flash Chinese manufacturing index and put more weight on the official Chinese PMI mfg. index which is released on the first of each month. Lately the HSBC measure has been understating the official measure. 

Today's events

At 8:30 am the US economics team will be sorting through the initial jobless claims and durable good orders reports. Initial jobless claims are expected to rise marginally to 372,000 for the week ending May 19 from 370,000 the week prior. Durable goods orders are expected to contract 1.5% mom in April after a 4.0% drop in March. Boeing orders slowed markedly over the month. We expect this to translate into a 40% drop in nondefense aircraft orders. Outside of transportation, durable goods orders are expect to rise just 0.3%, which is a fairly tepid bounce after a 0.8% drop in March. Under our forecast, core durable goods orders are flat in April after a 0.1% drop in March, leaving us on track for 6% CapEx growth in Q2. 

French PMI vs GDP:

German PMI vs GDP:

European Composite PMI vs GDP:

Comments on German IFO from Goldman:

Germany : Big decline in "current conditions", signaling clear loss of momentum in Q2


Bottom line: A sharp decline in the assessment of current conditions signals a clear loss of momentum during Q2.


The Ifo index showed a surprisingly big decline in May to a level of 106.9 after 109.9 in April. We and consensus had expected a more moderate decline. The sub-index of "current conditions" recorded a decline to 113.3 after 117.5, while "expectations" declined to 100.9 after 102.7.


After moving sideways over the last three months, the Ifo index is now back to the level seen in Q4 last year. It is noteworthy that the assessment of current conditions declined even more strongly than the "expectations" component. Given that there is less "judgment" involved in the "conditions" part of the survey - companies are much better informed about their current order books and production level than what the situation will be in six months time - the drop in "conditions" is a credible signal that the German economy lost quite a bit of momentum during Q2.


The relative high starting level, GDP was up +0.5%qoq at the beginning of the year, is probably part of the explanation of the relative decline in momentum. That said, the decline looks too steep to be just a normalisation. Moreover, the PMIs, as this morning's release showed, are also pointing to a genuine weakening in the underlying trend.


The fundamental picture for the German economy remains strong: no fiscal tightening, rising domestic demand on the back of very favourable financial conditions, and no private sector de-leveraging. This does not mean, however, that the German economy will be immune to cyclical swings in external demand or a potential "confidence shock" from the rising tensions in the Euro area. Today's Ifo report shows that these risks are indeed real.

And the MarkIt PMI European Composite release