Euro Zone Stagnates, but Euro Doesn't Sell-Off

The euro zone economy stagnated in Q2, as the rest of the region offset the unexpected 0.2% contraction in the German economy.  The implied yield of the German bund future dipped below 1.0%, though the yield in the cash market held in slightly better.  The euro itself, did not make a new lows.  Indeed, last week's low for the euro (~$1.3333) remains intact. 

 In six of the past seven sessions, the euro has recorded lows between $1.3333 and $1.3349 (today).  That it has not fallen lows reflects, we suspect, market positioning and the over-sold technical condition.  During this period, the euro has been capped in the $1.3400-$1.3415 area.  A break higher, especially in context of the less than favorable economic news, would likely trigger stops, and sign a proper correction, rather than this flattish consolidation.  That said, the $1.3450-$1.3485 area may offer more formidable resistance.  

The Bundesbank has warned that the German economy stagnated in Q2, but the 0.2% contraction was still a bit of a shocker. The year-over-year rate slowed to 0.8% from 2.5% in Q1.  It marks the first time since Q1 13 that the stagnation of the French economy was better than German economic performance.  The French economy was expected to have expanded by 0.1%.  Details of the composition of the economic activity will be made in future releases.  

Separately, the ECB's monthly report contained  new results of the Survey of Professional Forecasters.  Next year's inflation expectation was shaved to 1.2% from 1.3%, while the long-term forecast edged higher to 1.9% from 1.8%.  These results do not contradict Draghi's claim that inflation expectations remain anchored.  

At the same time, the July CPI was confirmed in line with the flash reading.  The year-over-year rate is at 0.4%.  Next month the ECB staff will update its forecasts.  The risk is that it will pare its 0.7% 2014 CPI forecast. 

Sterling’s recent losses were extended earlier today; partly a function of the momentum following the dovish Quarterly Inflation Report and partly as a function of the return of the RICS measure of home prices returning the February levels.  Sterling fell to a three-month low just below $1.6660 (and ahead the target we suggested near $1.6630).  However, it has subsequently stabilized,  though it has not been able to resurface above $1.6700.  We do see sterling as over-extended technically.  We suspect the risk is for a move toward $1.6730-50 before the weekend.  Ahead of next week’s CPI and MPC minutes (though the dovish MPC member Miles did speak on the BBC today),  we anticipate some backing and filling. 

Japan disappointed economists with a soft core machinery orders report.  The 8.8% rise in June was a little more than half of the gain the consensus expected after the record 19.5% slide in May.  It is the first gain in three-months and leave Q2 orders off 10.4%.  Of course, Q2 GDP was released earlier this week, but the importance of this report is that it is a lead indicator of capital expenditures.   The report confirms other data and surveys and businesses are extremely cautious, and do not have much confidence in the state of the economy. 

The dollar initially rose to about JPY102.65.  Each day this week, the dollar has risen above the previous day’s high and held above previous day’s low.  This is impressive given that US yields have yet to find traction.  The US 10-year yield is slipping below 2.42% today.  The disappointing retail sales report, and the subsequent reductions in GDP forecasts, gave the bulls more fodder.  The Atlanta Fed produces a GDP-Now tracking report.  It puts Q3 GDP at 2.8%.  Previously many economist had expected a string of quarterly GDP reports (at an annualized rate) of 3% of better. 

At a high level, a key take away from this week’s data and official reports is that growth among the high income economies is not secure, and that if anything, the first rate hikes by the BOE and Federal Reserve are unlikely to be delivered as early as some of the optimists had anticipated.  The odds of a rate hike this year by the Bank of England have fallen off, but also ideas that the Fed would hike rates in the first part of 2015 also seems more remote. 

The economic calendar for North America is light.  Another sub-300k weekly initial jobless claims is likely, but is not a market mover.  Import prices also are not the stuff that moves the capital markets, but a sharp deviation from the consensus forecast of a 0.3% decline, could impact expectations for tomorrow’s PPI report. 

Canada’s new house price index is being overshadowed by the unusual step of restating the July employment report, due tomorrow.  Recall that the initial report showed 200 net new jobs were created, well below expectations.  Rather than revise the data, as is often the case, the restatement suggests a more profound error was made.  The US dollar is slipping below CAD1.09 for the first time since August 1.  Support for the greenback near CAD1.0860 may be sufficient ahead of tomorrow’s reports to stem the decline.  On balance, however, we expect the re-statement to be supportive of the Canadian dollar, which has been a laggard recently.