Dark clouds gather over Europe as economic and political news take a turn for the worse

Tom Tong10/Dec/2012Currency Updates

Markets were spooked last week by a combination of gloomier than expected macroeconomic reports across Europe and the news of Monti´s resignation in Italy.

The lull over the European crisis dissipated quickly, as sovereign risk premia rose and the Euro tanked, bringing down financial markets worldwide in further proof that the main issue driving financial markets performance in 2013 will be once again developments in the European crisis.

GBP

The United Kingdom was not exempt from the wave of negative news engulfing the continent last week. The Autumn statement from the Treasury confirmed that the woeful macroeconomic performance will be worse than expected, and deficits will be higher, pushing the end of fiscal consolidation into 2018. Undeterred by this failure of austerity policies, the Chancellor announced yet another round of (admittedly modest) austerity measures.

Further negative news came from the industrial production report, which surprised to the downside falling 0.8% mom and provided further support for our expectation of negative growth in the fourth quarter. Given this dismal backdrop, Sterling performed surprisingly well, rising 1% against the Euro but keeping up against the US dollar to end the week flat.

EUR

Last week European authorities took some steps towards acknowledging the dismal reality. The ECB lowered dramatically its economic projections. The Central Bank now expects a full-year Europe-wide contraction of -0.3% for 2013. In spite of this shocking acknowledgeable, it decided not to ease policy further.

The Bundesbank also announced that Germany is back in recession, but also failed to change its austerian views even marginally. As recession spreads to the core, the periphery numbers are simply catastrophic. Spain lost an astounding 209,000 net jobs in November, i.e., nearly 2% of what remains of its labour force. In yet another setback for the austerian cult, Monti announced his resignation, and new elections in Italy are certain to bring to power a coalition that will be more hostile to these policies.

Unsurprisingly, the euro fell sharply against most major currencies save the Yen, a tendency that we expect to continue into 2013.

USD

Negotiations on the “fiscal cliff” issue continue to plod along at a dismally slow pace. However, macroeconomic news out of the US provided a nice backdrop to the European disaster. Payrolls in November grew by 146,000 in spite of the effect of Hurricane Sandy.

There were further pleasant surprises were construction spending and core orders for capital goods; these are tentative but welcome signs that the enormous pile of cash in corporate balance sheet, together with high levels of corporate profitability and record low real interest rates are finally beginning to filter through to higher capital expenditures. At any rate, we are increasingly comfortable with our above consensus call of 2.5% growth in 2013.

The contrast between this modestly healthy levels and the recession gathering pace across the Atlantic should result in healthy USD appreciation during the coming year.

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Written by Tom Tong

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