European Economic Conditions Weigh on Bond Yields and Currencies
European government bond yields and currencies experience a significant decline due to deteriorating economic conditions. This article explores the impact on markets and potential implications for interest rates.
Troy D. Hanson
August 23, 2023
The European government bond yields and currencies experienced a significant decline on Wednesday due to alarming surveys that showcased deteriorating economic conditions across the continent. This discouraging data may dissuade central banks from pursuing further interest rate hikes.
In August, the Eurozone composite purchasing managers index, a combined measure of reports from the manufacturing and services sectors, plummeted from 48.6 to 47. This was the weakest level recorded in 33 months. Notably, Germany— the largest economy in the bloc—suffered particularly as activity reached its slowest point since the COVID-19 shutdowns in mid-2020.
Across the English Channel, a similar survey conducted for the United Kingdom revealed a surprising contraction in economic activity. In July, the survey indicated a slight expansion at 50.8, but this abruptly dropped to 47.9 in August, reaching a 31-month low.
These worse-than-expected readings prompted a swift reaction in fixed income and forex markets. Analysts speculate that this news may lead to less aggressive interest rate hikes by both the European Central Bank and the Bank of England, as they aim to manage inflation.
Mark Wall, chief European economist at Deutsche Bank, expressed concerns regarding the PMI data's continuous sharp decline, stating that it would test the ECB's growth optimism. He also suggested that persisting weaknesses in manufacturing could indicate a more enduring and structural shock to competitiveness.
The Impact of Weakening Services on European Markets
The recent weakening in services has caught the attention of market analysts, who believe it reveals a stronger monetary transmission than anticipated. While many are expecting the European Central Bank (ECB) to pause in September, there is uncertainty regarding whether inflation is at the level desired by the ECB. It is important to note that a pause should not be mistaken as a peak in economic performance.
Reflecting these market sentiments, the 10-year German bund yield, which serves as the eurozone's benchmark (BX:TMBMKDE-10Y), experienced a decline of 11 basis points, settling at 2.537%. Similarly, the equivalent duration British gilt (BX:TMBMKGB-10Y) also saw a decrease of 13.5 basis points, reaching 4.519%.
As a consequence of these developments, the U.K. pound (GBPUSD) fell by 0.8% to $1.2636, placing it just above a two-month low. Meanwhile, the euro (EURUSD) initially showed strength but eventually lost 0.3% against the dollar, reaching $1.0809, its lowest point since mid-June.
Despite the concerning Purchasing Managers' Index (PMI) data from the services sector, European markets remained resilient. Investors shifted their focus towards the falling implied borrowing costs and weaker currencies, which may improve international competitiveness.
London's FTSE 100 (UK:UKX) experienced a notable increase of 1%, with interest rate-sensitive sectors like utilities and real estate groups performing well. Frankfurt's DAX 40 (DX:DAX) also saw growth of 0.4%, benefiting from energy companies' positive performance. Paris' CAC 40 (FR:PX1) rose by 0.3%, primarily due to luxury goods exporters' stock gains.
A particularly noteworthy development was the performance of Adyen (ADYEN), the Dutch payment processor. Despite recent declines in its shares, a report revealed that fund manager Cathie Wood had purchased shares, causing a rise of over 5%.
In conclusion, the impact of weakening services on the European markets is a phenomenon to be considered. While some expect a pause from the ECB, the desired level of inflation remains uncertain. Despite the negative PMI data, European equities demonstrated resilience and optimism due to decreasing borrowing costs and weaker currencies. These developments also provided opportunities for growth in sectors such as utilities, real estate, and energy. Notably, Adyen experienced a significant boost with Cathie Wood's investment, highlighting potential opportunities in the payment processing sector.