Eurozone: Market volatility triggers higher spreads of Eurozone sovereigns

Eurozone: Industry production shrinks

Eurozone: Market volatility triggers higher spreads of Eurozone sovereigns

Eurozone economy – industry PMI outlook

Next week (23.10), the release of October flash industry PMI data for Germany, France and the Eurozone will deliver the first indication regarding the economic development in 4Q14. Recently, the data weakened further, standing only slightly above the growth threshold level. In the current difficult market environment, we do not expect a significant improvement of the poll data. The August industrial production data for the Eurozone, which was released this week, was weak. Based on current data (July and August), the Eurozone industrial production in 3Q declined 0.5% when compared to 2Q. Overall, the weak data confirms our view of slight negative growth for the Eurozone in 3Q. However, given the fact that, throughout the last three years, the Eurozone managed to remove major economic imbalances (e.g. significant current account deficits of peripheral countries turned into surpluses), while credit growth has been quite subdued in the same period, we deem the scenario of a deep recession of the Eurozone quite unlikely. Nevertheless, in the current market environment of low inflation combined with economic stagnation, the question regarding the debt sustainability of certain Eurozone countries has come back into focus for markets.

Eurozone sovereign spreads increase

As the uncertainty caused by the high volatility on equity markets spread into other asset categories, spreads of Eurozone sovereign government bonds widened – in some instances significantly – to Germany, in the course of this week. Concerns over the economic outlook in the US and Eurozone triggered the movements. In an environment of high asset valuations, this led to general risk aversion and safe haven flows into German government bonds and US Treasuries. Eurozone sovereign bonds were also affected by discussions over the coordinated fiscal policy. France already announced some weeks ago that it will not reach the Maastricht deficit criterion by 2015, but instead by 2017, which would constitute a clear breach of the Excessive Deficit Procedure. Two rating agencies have already reacted and changed the outlook for the rating from stable to negative. Italy is not in an Excessive Deficit Procedure, but the 2015 budget is not in line with mid-term goals, as the structural deficit will be above the target. The same is true for Austria, but here the structural deficit will be only 0.1 percentage point higher than the target. The European Commission has until the end of November to evaluate the budget proposals of member countries. The most likely outcome should in our view be that France will be asked for a redraft. Should France not adhere to the recommendations set out by the Council, measures as far reaching as fines could be implemented. The crucial question will be whether, in such an event, other member countries would actually impose consequences on France. This will be a test of the credibility of the EU’s common fiscal policy, as huge political obstacles might prevent such pressure on a big Eurozone country. Further, the weak economic outlook could trigger discussions on softening the EU’s fiscal consolidation stance. However, in the short term, the sentiment on global capital markets will be decisive for the further course of sovereign Eurozone spreads; at present, it is hardly possible to assess how much longer the high volatility will persist.

Can Eurozone countries support investments despite empty coffers?

In order to support the Eurozone economy, there are more and more calls for public investments. The realization, however, will be difficult. Apart from Germany, none of the other major countries currently have the necessary financial flexibility to fund public investments. Therefore, a possible capital increase of the European Investment Bank (EIB) by the member states comes into play, because these funds would involve a positive multiplier effect. For example, the capital increase of 2013 worth EUR 10bn enabled the EIB to finance additional investment projects worth around EUR 60bn. We do not believe that misuse of the ESM (European Stability Mechanism) in favor of public investment projects will happen, because the ESM, by providing financial assistance to Eurozone members experiencing financial difficulties, is an important component of the comprehensive EU strategy to safeguard financial stability.