Market Overview

Euro Area Enters Second Recession in Four Years

Euro Area Enters Second Recession in Four Years

In the seemingly never-ending negative news cycle emanating from Europe, data released by Eurostat overnight revealed that the Euro Area has slipped back into recession for the first time in four years, officially marking the much feared and publicized double-dip recession. Relative strength in core countries such as France and Germany was weighed down by weakness in other nations including Spain and the Netherlands.

The most shocking data point was the massive contraction of the Dutch economy in the third quarter. Eurostat reported that the Dutch economy shrank an astounding 1.1 percent in the quarter as compared to the second quarter, or at a 1.6 percent annualized rate. Further, the unemployment rate in the Netherlands increased 0.2 percent to 6.8 percent in October. The Netherlands is important to the Euro Area not due to its size (relatively, compared to France and Germany, it is much smaller), but due to its AAA bond rating; the Netherlands is already on negative watch for many of the ratings agencies and the weakening economic news could lead to a downgrade, which would hurt the credit rating of the European Stability Mechanism.

Notable economies that maintained relative strength in the third quarter were France, Germany and Slovakia. The French economy grew 0.2 percent in the third quarter, better than economist estimates of a flat, 0.0 percent growth reading and better than the -0.1 percent rate of growth in the second quarter. Also, Germany's economy grew 0.2 percent in the third quarter, in line with economist estimates but slightly weaker than the 0.3 percent rate of growth seen in the second quarter. However, recent industrial production data indicates that the German economy may have already slowed further in the first half of the fourth quarter. Lastly, the Slovak economy, however small, grew a whopping 2.2 percent in the quarter, better than estimates of 2.0 percent growth int he quarter but slower than the second quarter's rate of 2.6 percent growth.

Despite strength in the above nations, weakness could be seen in peripheral nations in the third quarter. Spain's economy contracted at a 0.3 percent quarterly rate, the same as in the previous quarter and in line with economist estimates. Also Italy's economy contracted at a 0.2 percent quarterly rate, better than expectations of a 0.5 percent contraction and better than the previous 0.7 percent quarterly contraction, however still showing contraction. Lastly, the Czech economy contracted at a 0.3 percent quarterly rate, worse than the previous reading and estimates of a 0.2 percent quarterly contraction.

Despite the relatively bearish news, the euro gained overnight on hopes that the EU would extend the bailout of Greece and lessen some of the bailout conditions. Also, hopes of Spain asking for a bailout increased as a rumor circulated that Spain could preempt the European Central Bank's Outright Monetary Transaction (OMT) program and could go directly to the International Monetary Fund for aid. Should this be the case, Spain may be able to get a better deal but could strain relations between the Iberian economy and the rest of Europe. However, these rumors were later denied by Spanish officials. As of writing, the EUR/USD traded 1.2761, 0.21 percent higher than Wednesday's New York close.

Bond yields fell in Europe, with French 10-year government bond yields declining 1.2 basis points to 2.087 percent. French yields were aided by a strong auction in which France sold nearly $11 billion of 3-, 4-, and 5-year bonds as yields fell and the bid-to-cover ratio remained strong. Also, as inflation has been declining, France sold some inflation indexed bonds that attracted three times the amount of bids than supply, a great increase in demand for these bonds.

The new data may tie the hands of ECB at its next interest rate decision. Economists have been calling for another rate cut by the bank for months now and the GDP data combined with more current indicators suggest that the bank needs to do more to stimulate the economy. As ECB economists are against outright QE, they will have to cut rates to enact any meaningful policy. The ECB did launch programs such as the Longer-Term Refinancing Operations (LTRO) and the OMT, however these programs were only launched to tackle specific problems in the economy; the LTRO's were enacted to unfreeze essentially dead credit markets in Europe and the OMT was enacted to stabilize government bond yields and to restore the transmission mechanism of monetary policy. All in all, unless credit markets begin to show signs of stress again, expect no more non-traditional policy from the ECB.

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