Can Europe Save Markets From Global Recession as China and the U.S. Struggle?
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Can Europe Save Markets From Global Recession as China and the U.S. Struggle?
By:Ilya Spivak
Maybe, but the European Central Bank faces conflicting pressures from stagnant growth and rising inflation
- The euro is trying to rebound against the U.S. dollar as yield spreads improve.
- ECB policy is stuck as growth and inflation clash while the Fed becomes more dovish.
- The Eurozone is unlikely to offset China and the U.S. as global recession looms.
The euro has quietly managed to grind higher against the U.S. dollar since the beginning of the year. The single currency set a low near the 1.02 level in mid-January. Since then, it has managed to rise as much as 3.5%, arresting a downtrend from mid-September that erased 9.2% of its value.
Prices have traded in lockstep with the spread between German and U.S. two-year bond yields for close to four years, suggesting the comparative outlook on European Central Bank (ECB) and Federal Reserve monetary policy is the catalyst at play. Tellingly, the latest bounce came as the yield spread cautiously began to move in the euro’s favor.
Growth and inflation at odds in Eurozone
Are the currency and bond markets telling us Europe might finally see a bit more economic vigor? As convenient as this would be at a time when global recession fears seem to be building, the answer is probably “no.” Indeed, these moves might imply the opposite.
The latest batch of S&P Global purchasing managers’ index (PMI) data put the Eurozone economy at a near-standstill for a second consecutive month. A three-month low on the pace of expansion in the service sector—the main driver of growth in the region—was especially eye-catching.
Meanwhile, inflation has moved stubbornly higher since briefly dipping below the 2% target in September. Incoming consumer price index (CPI) figures are expected to show that price growth accelerated for a fourth consecutive month to 2.5% year-on-year in January.
Europe is struggling to help itself—never mind anyone else
Taken together, this backdrop seems to explain why the markets see the European Central Bank (ECB) as the most dovish of the major central banks this year even as it refuses to dial up stimulus expectations. The rate cut path implied in benchmark ESTR interest rate futures has barely budged since the end of the third quarter.
The markets apparently acknowledge the economy’s weakness even as they doubt the ECB will have the necessary space from disinflationary progress to offer more support. That has anchored the priced-in outlook, even as traders’ appraisal of the Fed becomes more dovish amid cooling U.S. data flow.
Indeed, this is how yield spreads have managed to shift in support of the euro. The currency may well continue to draw support from this environment, but it hardly encourages a return to faster growth that might counterbalance weakness in China and stumbles in the United States.
Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak
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