Fundamental Update
Europe’s PMI round-up
The final readings for September’s PMI surveys were released this week with the service sector survey results announced this morning. The composite PMI survey for the Eurozone was revised up a touch from 45.9 to 46.1, after upward revisions to both the services and manufacturing surveys. This is still deep in contraction territory and the September data suggests that the Eurozone may have seen a 1% contraction in its GDP over Q3.
The Eurozone readings have been fairly flat since May, albeit at a low level well below the 50.0 mark, which divides expansion from contraction. Thus, as we enter the fourth quarter there is no sign that momentum in the Eurozone has improved and the weak economic fundamental back drop remains.
Irish eyes are smiling
Ireland has been the major outlier, its service sector PMI rose to 53.9 in September and the manufacturing survey was 51.8 - both in healthy expansion territory - which suggests that the Irish economy could fare better than the overall Eurozone economy for the rest of this year. However, Ireland is a small component of overall GDP, and its improving fundamentals should do little to benefit the rest of the currency bloc.
The manufacturing sector out-performs services
The detail of the PMI’s show that the manufacturing sector has fared better than the service sector in the currency bloc in recent months, which is especially evident in the employment sub-sections. This is to be expected as austerity in countries from the Netherlands to Italy and Spain dampens domestic demand. Added to that the decline in the euro - it is down more than 6% over the last 12 months on a trade-weighted basis- may benefit exports and the manufacturing sector.
The market impact:
The PMI surveys have confirmed what many feared – the Eurozone economy experienced a sharp contraction in the third quarter of this year. The most worrying part of these surveys is that there is no sign that a pick-up in activity is imminent and we could be mired in recession for some time.
However, the markets managed to brush off the bad news and EURUSD popped above 1.29 earlier this morning. There are a couple of reasons for EURUSD’s resilience: the market expects Spain to apply for a bailout – potentially as early as this weekend. Although Madrid has denied that an aid request is imminent, the market is willing to call its bluff because Spain has a huge EU20bn bond redemption coming up later this month, which may force it to go cap and hand to the Eurozone authorities. The second reason is that EURAUD continues to surge today and is above 1.2650, this is benefitting other euro crosses. Likewise, the dollar index continues to struggle on its way to test 80.00 as the bulls get fearful about fighting the Fed. QE3 could keep a lid on euro gains for the medium-term. Thus, the euro is benefitting from other currencies’ weaknesses.
The outlook for EURUSD is fairly cloudy, so we have divided it up into short, medium and long-term views.
Short term: The euro is range bound. Losses are supported around the 200-day sma at 1.2830, as the prospect of a Spanish bailout could cause a mini-rally in the single currency. In the very near-term gains are being stumped around 1.2970 on the way to 1.30. Momentum seems to be on the upside.
Medium-term: If Spain requests financial aid then we may see EURUSD start to rally. This event may cause a break above 1.30, and we may even test 1.3170 – the resistance zone from mid-September. If we can get above this level then 1.33 is the next resistance zone that may thwarts the bulls.
Long-term: A Spanish bailout request is a positive development in our view, as it leads to the ECB taking a greater role in helping to stabilise peripheral debt markets. However, it is only a temporary measure and it hard to see how falling bond yields can boost growth when Spain will need to embark on a strict austerity diet for the at least the next 18-months to meet its 2013 deficit target included in last week’s budget announcement. This is likely to weigh on growth in the region, which is euro negative. So after a pop higher post an aid request, we could see the single currency meander lower towards 1.27 over the rest of the quarter. Dollar weakness may stop this pair from falling off a cliff, hence why we expect this cross to be range bound over the next few months.
Figure 1: Eurozone manufacturing and services sector PMI’s
Figure 2: EURUSD daily chart – this cross could be range bound over Q4.
