EU – The Late Comer to the Game

The corporate sector is noticeably more leveraged in the Eurozone than in the US. This, I believe, that the recession that we see in the Eurozone is not a primary function in response to the headwinds blowing from the US. Its internal imbalances clearly need to be addressed as its corporate de-leveraging will trigger a sharp decline in non-residential investment and hiring. At this stage, I am jolly well know that the ECB is still in denial in acknowledging the uniqueness of the current situation as well as its response, albeit much-much later than the Fed.

In the short-term, the resistance of the Eurozone central bankers to aggressively easing monetary policy will continue to provide the EUR with broad-based supports, but with deteriorating economic conditions, this is a classic recipe for the EUR position to be very much over-valued and that may induce heavy short-selling in times to come.

I think it is very likely that the ECB will continue to cut its refi rate below the historical low of 2% as early as March as can be seen with the somewhat rising polarization of views among the ECB council members. The ECB is struggling to catch up with reality as the Trichet virtually ruled out a rate cut at the February meeting in three-weeks’ time.

The economic outlook is seemingly to suggest a much deeper downturn than it expected in December 2008 and I believe the economic data will be once again be worse than the ECB is now factoring in, tilting the balance firmly towards a new cut in March.

The rebound in ZEW index in December 2008 had failed to ease tensions on financial markets and the signs of a steep contraction in business activity in Germany are accumulating. French consumer spending will take a hit as unemployment is rising at an alarming rate, thus offsetting the boost in purchasing power triggered by the fall in energy costs. The run-up to Christmas was characterized by increasingly desperate retailers offering larger and larger discounts to tempt shoppers into stores. Price reductions up to 70% were not uncommon.