Market consensus believes that the eurozone is edging toward that moment when the scourge of deflation actually becomes a crippling reality. Eurozone data is constantly reminding investors that the region’s economy is barely limping along, as companies slash selling prices in a vain attempt to improve sales in the face of a weakening economy and evaporating new orders. Corporate deflationary reactions like this only hurt a company’s bottom line by squeezing profit margins even further. The obvious knock-on effect will limit resources for hiring and investing, which in turn only dampens any chances of an economic rebound, again putting the region into a bigger hole.
Eurozone Giants Ravaged by Tepid Growth
This morning’s European releases showed that private sector activity in the eurozone grew less rapidly than first estimated last month. The Markit composite purchasing managers’ index (PMI) rose slightly to 52.1 from 52.0 in September (the initial flash estimate was 52.2). Even the services PMI was revised down to 52.3 from 52.4. Collectively, this is further proof that there is no sign of a pickup in eurozone growth. Data like this will only pile further pressure on the European Central Bank (ECB) to beef up its stimulus program.
Digging deeper, it seems that the peripheral countries are still surprising, especially with Italy’s return to expansion. The growth activity in Ireland and Spain also accelerated during the month. Nevertheless, peripheral countries’ optimism is being diluted by questionable business and consumer confidence.
The real worry for Europe is Germany and France, the supposed collective backbone for Europe. Germany is losing momentum (53.9) and France continues to hover in contraction territory (48.2). Tomorrow, investors can expect the ECB to hone in on the uneven euro area growth scenario and how fragile it has become, especially after cutting its growth forecasts for this year and next. Policy members again cited the usual concerns: a lack of internal investment and political tensions in Ukraine and the Middle East. It’s not a surprise that the European Union’s executive arm expects the region’s inflation to remain well below the ECB’s target until 2016. The combination of low growth and low inflation perfectly illustrates why the ECB needs to be more aggressive with its stimulus measures lest disinflation spirals into crushing deflation.
ECB Leadership Discord
However, tomorrow’s ECB meet is expected to be flat. It’s too soon for the central bank to act aggressively by making large-scale purchases of government bonds and other assets. The rumored rising opposition to President Mario Draghi’s policies within the European Council could also limit his ability to get a firm majority backing his stimulus plan. This, too, reduces the probability of new ECB action in the short term.
For the techies, and in respect to the EUR, their pullback objectives have been met. The rumored ECB discord yesterday managed to push the single unit, not once, but twice to the desired spec-selling levels atop of €1.2565. The second run-up in the Asian session was met by a heavier hit from speculative selling, buoyed by the U.S. midterm election results, and this morning’s tepid PMI data. The EUR outright has also been pressured by its performance on the crosses, especially EUR/CHF (€1.2037) where the market is eyeing the Swiss November gold referendum. If passed, it could limit the Swiss National Bank’s future policy moves. A new seven-year high for USD/JPY (¥114.56) is also influencing the single unit as broad dollar gains begin to make an impact after the U.S. midterm Senate election results that are widely perceived to be good for businesses.
The market does have a tendency sometimes to read too much into political impacts. After all, an easing of the political gridlock in Washington is not guaranteed despite the election results. If that’s the case, then investors should be wary that the strong support for the mighty dollar could evaporate just as quickly. Trading sub-€1.2500 will boost the EUR bear’s ego, targeting something with a €1.2100 handle in the medium term, while EUR resistance remains close to €1.2567-75 for the time being. For deeper directional play, investors will wait to see what transpires at tomorrow’s ECB meet and what is said at the post-meeting press conference. With the Federal Reserve changing focus somewhat and pumping up the U.S. labor market, Friday’s nonfarm payrolls release becomes evermore important to investors worldwide.
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