Looking under the German Hood amp Reminders of May 2005

Fragmented eurozone politics over austerity implementation is quickly becoming the disorder of the day, while the IMF renews its calls for budget restraint during a doubledip-bound eurozone.

Today’s flash PMI from the eurozone and Germany allow a better look under the hood of the eurozone machine. We warned in Friday’s note that despite the rise in Germany’s IFO survey, we ought to give more scrutiny to the already falling PMI rather than the IFO and ZEW surveys.

This had been our thesis over the past two months, stating that the ZEW and IFO surveys involve responses from investors/managers (biased towards LTRO impact instead of econ/business effect) rather than PMI, which involves purchasing managers and decision-makers, segmented by output, new orders and inventories.

German flash manufacturing PMI deepened into contraction in April at 46.3 from 48.4—the lowest since July 2009. German flash services PMI edged up to 52.6 from 52.1. The French story showed the inverse, whereby flash services PMI fell sharply into contraction at 46.4 from 50.1, while its manufacturing PMI edged up to 47.3 from 46.7, yet remaining well in contraction.

Spain re-enters recession according to the Bank of Spain, which estimates a 0.4% contraction in Q1 following 0.3% decline in Q4 of last year. Thus, even if Spain has already raised more than half of its borrowing requirement for the year, the 2012 theme of paying attention to growth vs. obligatory austerity will become source of tension in the markets, especially if the ECB refrains from renewed long term refinancing operations and/or bond purchases.

Strong showing in French far-right does not ensure Sarkozy support. French Socialist challenger Hollande won 28.2% of the first first round elections ahead of centre right’s Sarkozy, who had 27%, both advancing into the second round. Whether the 20% votes for the far-right will abstain in the second round, or vote for Sarkozy’s centre right shall determine the balance of the second round due next month. But given National Front’s Marie Le Pen’s virulent attacks on Sarkozy’s Centre Right, her insistence to further legitimize her Party into future elections will be carried out by eroding any support, which may go to Sarkozy or Hollande. This way, further abstention in the second round would be an even greater vote for the far right. Meanwhile, Markets are fearing that a large victory by Hollande’s centre left may hamper the EU treaty and complicate the required austerity measures as required by the bond market.

France & Netherlands—just like in May 2005? eurozone’s political cracks remind us of May 2005, when the euro was knocked off that year by 10%. In late May 2005, France’s rejected a referendum for closer integration with the EU. three days later, the Netherlands rejected the same treaty establishing a single European constitution. Today’s resignation of the Dutch cabinet follows the breakdown of negotiations with the far-right Party over € 21 bln in budget cuts.

The chart below contrasts the weakening of German PMIs in the face of the eurozone crisis to the PMI’s resilience during the first round of the eurozone crisis in spring 2010. At that time, Germany’s DAX-30 consolidated around the 6,000 level despite a 20% decline in the euro during the first six months of the year. Looking at the Dax weekly chart, the index is now falling below its 100-week moving average, eyeing the next downside target near 6440, which is the combination of 100 WMA and the seven-month trendline support (from Sep low). A weekly close below 6400 risks triggering the return to 6000.