Morning Commentary: Decoupling

Foreign Exchange - Morning Commentary
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
It has been known for a while that the German economy is struggling, and recent economic data has only underscored.  Should Germany’s final Q4 GDP reading come in negative, the markets will likely revive risks of a technical recession, especially in light of coronavirus and its negative impact on Q1 2020 GDP.   All of this would move the conversation for German fiscal stimulus back to center stage.  However, market narrative and reality can be disconnected. 

Fiscal rules in Germany bias fiscal policy to be reactionary rather than proactive.  Moreover, while the economy as a whole is struggling, consumer demand and the labor market remain strong despite manufacturing weakness.  This reduces the sense for urgency and the need to utilize the “escape” clause from strict deficit rules and allows for a one-off stimulus injection.  Critically, there remains a strong argument that a one-off stimulus package wouldn’t be an appropriate response anyways given that German economic weakness is due to weak external demand and structural issues internally.   

When looking at the German economy, former strengths have now become weaknesses.  Short term, the conscious decision to deeply integrate the German economy into the global supply chain makes the economy more vulnerable to SARS-CoV-2 concerns at a time when manufacturing is already weak.  Longer term, the evolution of the auto industry (move from internal combustion to EV as well as changes to how the world views mobility) means that one of Germany’s key industries is a source of uncertainty as it is going through big changes. 

Adding to this has been 5G and Germany’s delay in implementing its digital infrastructure, necessitating swift progress moving forward.  An easy choice would be to align with Huawei, but this has risks, including running afoul with the US.  This leaves Germany (and Europe) stuck in the unfortunate position of being squeezed by the US-China trade tension and negative impact of the SARS-CoV-2 virus.  

Broadly speaking, the German economy requires long term policy engagement and change that isn’t compatible with current rules.  Complex German politics—which have only gotten more complex with AKK’s resignation as party chair—make the political compromise needed for this long term policy engagement difficult to achieve.    
  • US markets are in risk off mode after Apple issued a profit warning due to supply/demand disruption resulting from the SARS-CoV-2 virus.  While this earnings warning shouldn’t come as a surprise, as Apple’s previous guidance didn’t include this shock, it does serve as a reminder of the disconnect between elevated equity prices and the large and unpredictable economic impact from the virus. 
  • German ZEW survey data disappointed with the expectations portion coming in at 8.7 against expectations for a 21.5 print and the current situation coming in at -15.7 against expectations for -10.0.  This print just further adds to the concerns that the German economy could be headed towards contraction. 
  • UK-EU tensions remain high.  The most recent headline has been the UK’s push back against the EU’s redline stance of “a level playing field” for achieving a trade deal.   
  • The RBA minutes was a tad more dovish than the statement that accompanied the decision.  Notably, while the bank held rates steady, members did review the case for a rate cut as only gradual progress has been made towards the bank’s goals. 
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