Euro Macro: Germany’s Ifo business climate in services drops – Germany’s Ifo business climate continued to decline in June. Although the part of the survey that gauges current business conditions stabilised, the part that gauges expectations declined by a full point, to 94.2. The expectations component of the survey tends to be the part that moves closest with GDP. At its current level, it is consistent with Germany’s GDP growth returning to negative territory after it bounced back to 0.4% qoq in 2019Q1 due to a weather-related one-off surge in construction activity, and sharply rebounding car sales. We have pencilled in a contraction of around -0.1 to -0.2% qoq for Q2, and expect growth rates close to zero in the second half of this year.
The details of the Ifo report reveal that the downturn in Germany’s manufacturing, which began at around the start of 2018 has spread to the services sector. Indeed, the business climate in the services sector has been falling noticeably since the start of this year after it had been resilient throughout 2018. The expectations component of the Ifo index for services has dropped particularly sharply since the start of the year, but the current conditions dropped noticeably as well. If we compare the historical patterns of the Ifo indicator for the services sector to the services sector PMI for Germany, as well as for the eurozone as a whole, the three series tend to move closely together, with Germany’s Ifo sentiment generally leading the services sector PMIs somewhat. This suggests the eurozone services sector PMI, which rose slightly in June, will decline in the months ahead. (Aline Schuiling)
Global FX: Crucial technicals turn negative on the dollar – EUR/USD has been in a tight range this year. The high was set at 10 January at 1.1570 and the low just below 1.1110 on 23 May. Option market volatility has also been relatively low. The main reason for this lack of direction in EUR/USD is that both currencies don’t look particularly attractive. On the one hand, weaker eurozone growth, the prospect of monetary policy easing by the ECB and political challenges in Italy weigh on the euro. On the other hand, the prospect of aggressive Fed easing is weighing on the US dollar. Changes in investor sentiment are also playing a crucial role. The prospect of Fed rate cuts has a negative impact on the dollar when investor sentiment is more constructive. This is because in such a environment there is lower safe haven demand for the dollar. Last week saw a combination of these different and opposing dynamics. At the start of the week, dovish comments from ECB’s Mario Draghi pushed EUR/USD below 1.12. But a day later the Fed surprised even more on the dovish side, resulting in a sell-off of the dollar across the board. The Fed’s communication triggered expectations of the possibility of a 50bp rate cut in July. This boosted general investor sentiment. The combination of optimistic investor sentiment and the narrowing of yield spreads between the US and other countries sent the dollar lower. EUR/USD broke above the 200-day moving average and the US dollar index dropped below this technical level last Friday. USD/JPY has already been below this level since the start of May. These developments clearly improve the overall technical outlook for EUR/USD and the odds have risen that the US dollar has entered a multi-year decline. We think that currently the market is too aggressive in pricing in rate cuts by the Fed, and our new ECB view of rate cuts is not fully anticipated by financial markets. If our view plays out, EUR/USD could easily drop below the 200-day moving average again in the near-term. We therefore maintain our year-end target for EUR/USD at 1.12. However, we think US dollar weakness is here to stay versus the Japanese yen. Narrowing yield spreads between the US and Japan and waves of risk aversion should support the yen versus the dollar. We have a year-end forecast of 100 in USD/JPY (Georgette Boele)