Market Overview

EU Says Euro Zone Is Falling Into Recession

The European Commission (EC) released a report today saying that last quarter's economic contraction will extend into the first two quarters of 2012, sending the euro zone group of economies into a recession. Today's report from the European Commission forecast that euro zone economies will shrink 0.3 percent in 2012.

An earlier forecast by the European Commission predicted that the euro zone economies would grow by a modest 0.5 percent in 2012 but the European Commission reversed course today, saying that the euro zone group of economies will fall into recession during the the first half of the year, before returning to growth.

The factors that led to the European Commission revising its economic forecast included weakening of global demand, the low level of business and consumer confidence and tightening credit conditions for the private sector.

Although the EC said that it expects European economies to start growing again in the second half of 2012, it also said that the region was in danger of falling into a "deep and prolonged recession" if the sovereign debt crisis led to a credit crunch and domestic demand collapsed.

The report noted that the euro zone sovereign debt crisis and political unrest in the Middle East were two of the biggest downside risk factors for European economies, saying that "risks to the global growth outlook remain elevated. More pronounced contagion from the sovereign-debt crisis in the euro area to the rest of the global economy and stronger spillovers between the financial and real sector remain the largest downside risks. Moreover, an aggravation of geopolitical tensions in oil-exporting regions could lead to higher oil prices."

One of the problems posed by growing unrest in the Middle East is that it could send fuel prices higher. Euro zone inflation remains at a level higher than previously forecast by the EC, so rising fuel prices due to conflicts in the Middle East could send prices in Europe soaring. If that were to occur, consumer demand could fall further and the European Central Bank would be less likely to support economic growth by cutting interest rates.

The Europeans seem hopeful that an improving American economy could give the euro zone economies a much needed boost. The report said that "on the upside, global growth dynamics may prove to be stronger than currently envisaged in the forecast, in particular if the US economy were to rebound sooner (on account of a faster recovery in the housing market, stronger job creation and corporate investment)."

The European Commission also warned that there is a growing divergence in economic performance among members of the European Union, with growth expected to be highest in Latvia, Lithuania and Poland and lowest in Greece and Portugal. The report said that "divergence in country growth perspectives are also reflected in a number of indicators such as: unemployment rates, credit tightening, financing costs, fiscal consolidation needs and confidence."

There's widespread concern that the negative employment situation and the unpopular austerity measures in troubled southern euro zone countries like Greece and Spain could lead to more social unrest, which could pressure governments to roll back some of the less popular measures. As these economies fall deeper into recession, the pressure from unhappy citizens will only increase. If Europe is to avoid a recession, it must find a way to cut deficits and boost economic growth at the same time, not just choose one over the other.


ACTION ITEMS:

Bullish:
Traders who believe that the euro zone economies will perform better than expected during 2012 might want to consider the following trades:
  • Go long the euro or European stocks. ETFs like the CurrencyShares Euro Trust (NYSE: FXE) and the iShares S&P Europe 350 Index (NYSE: IEV) could move higher if the European Commission is underestimating the euro zone's economic performance for 2012.
Bearish:
Traders who believe that the European Commission's warning that the euro zone is falling into recession is just the latest red flag for Europe's economic prospects may consider alternative positions:
  • Short European banking stocks like Banco Santander (NYSE: STD), Lloyds Banking Group (NYSE: LYG) and Deutsche Bank (NYSE: DB). European banking stocks could be among the worst performers if Greece defaults, Europe falls further into recession or another credit crunch occurs.
  • Short the euro or go long the yen with ETFs like the ProShares UltraShort Euro (NYSE: EUO) and the CurrencyShares Japanese Yen Trust (NYSE: FXY). Japan's weakening of the yen could prove to be a buying opportunity if Europe's sovereign debt crisis and trouble in the Middle East lead to a deep recession in Europe.
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

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