Euro crashes amid signs world economy is decoupling from the European disaster

Tom Tong09/Jan/2012Currency Updates

Signs are piling up that the fragile economic recovery is gaining some steam outside Europe. Business surveys in the US, UK and Asia, employment numbers in the US are coming in generally better than expectations, though these are admittedly modest. The contrast between these moderately encouraging figures and the unfolding European catastrophe could not be starker. To the litany of disastrous macroeconomic and fiscal news from Europe (outside Germany), central bank data indicated that deposits leaked at an accelerating rate from Spanish and Italian banks in October and November. Coming on top of yet more negative surprises in EU employment data and retail sales, the Euro dropped sharply throughout the week. The traditional FX correlation has been inverted by the European crisis, and the US dollar now rallies as the US economy accelerates. With this trend now firmly established, the US dollar rallied over 1% in trade-weighted terms over the past week.


The gap we described last week between relatively positive sentiment surveys and negative output data did not begin close last week. The combined PMI survey is coming out at levels consistent with barely positive growth, whereas the output data available through October indicate clear contraction. Overall, we stick to our prediction of a shallow recession in the UK, and think that output began to contract in the fourth quarter of 2011. However, we must acknowledge the positive surprise in all three PMI sentiment indices last week. The rebound in services, to a clearly expansionary 54, is particularly important. FX markets acknowledged these positive news out of the UK and allowed Sterling to keep up with the general dollar rally, ending the week nearly flat against the greenback and up over 1.5% against the Euro.


The European situation goes from bad to worse. After the terrible report on the Spanish fiscal overshoot and dip into recession the week before, we received a bundle of depressing figures from the Eurozone as a whole last week. Retail sales contracted, unemployment rose more than expected, and the PMI sentiment surveys all remain clearly in contractionary territory. Further, banking data indicated that the outflow from Spanish and Italian banks, though manageable for now, accelerated through November. The fact that the Euro managed to sell off in response to these news, in spite of highly supportive positioning data and good performance in risk assets worldwide , is a sign of the overwhelming negative consensus that has developed around the Eurozone prospects. For once, we are happy to remain lined up with the consensus view, and remain heavily bearish the common currency.


The steady stream of positive macroeconomic reports out of the United States continued last week. PMI sentiment surveys in manufacturing and services both remain comfortably above 50, consistent with moderate economic growth. More importantly, another decent employment report confirmed that the recovery is at long last filtering through to increased hiring: 200,000 jobs were created in December, and unemployment dropped again to 8.5%. A bullish view on the dollar has been a centerpiece of our worldview. We do not expect the current appreciation trend to change until European and German policymakers change their disastrous austerity policies.


Written by Tom Tong

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