Spend the Recession Away? Not the Thrifty Germans

Economic

Summary:

Latest surveys point to further consumer gloom. Govt energy caps seen not as timely as elsewhere. Now higher borrowing costs start to weigh.

A drop-off in spending by inflation-hit consumers was one of the main reasons Germany fell into recession in the first quarter, even as other countries in the region managed to avoid it.

What's more, even with inflation starting to ease across Europe, the signs are that Germany's famously thrifty shoppers are not ready to spend their way out of recession - meaning the region's largest economy will have to look elsewhere for growth.

"Germans are cautious by nature," said Stephan Fetsch, Germany's head of consumer goods at KPMG. "Unless they feel safe about the future, they remain reluctant to spend."

German output shrank 0.3% in the first three months of the year to mark a second straight quarter of negative growth, notably weighed down by a 1.2% fall in household spending that contrasted with modest gains in France and Italy.

Its economy - described in a Sentix survey on Monday as "the biggest problem child in the euro zone" - is at a crossroads. Economists polled by Reuters are split on its second quarter fortunes: views ranged from a 0.3% GDP fall to a 0.5% gain, with a median forecast of 0.2% growth.

Household consumption, which like elsewhere accounts for broadly half of GDP in Germany, will be key to the outcome.

However, German consumer sentiment remains below its pandemic low in the spring of 2020 and the consumer barometer from the German Retail Association (HDE) shows a similar picture.

"A significant boost in private consumption is not expected in the coming months," the retail association said on Monday in the presentation of the barometer for June.

A number of factors are behind the subdued mood.

German consumers were hit particularly hard by high energy prices, being more dependent on Russia gas. Yet the government package wasn't as generous as in other countries, said Holger Schmieding, chief economist at Berenberg.

Carsten Brzeski, Global Head of Macro at ING, further noted that Berlin introduced policies to cap energy price rises later than those introduced in France and Italy, predicting that private consumption would continue to stagnate this year.

Despite inflation easing, German consumers remain extremely cautious and, used to years of access to low prices thanks to discount retailers, remain reluctant to spend at what many perceive as excessively high prices.

"Germany is the big retailers nation and the discount was born here," KPMG's Fetsch said. "The general hunt for the best value is a very German trait."

Now, an additional factor is starting to make itself felt: 375 basis points' worth of European Central Bank interest rate hikes since July 2022 which are making borrowing more expensive and saving more profitable.

Commerzbank's senior economist Joerg Kraemer calculates that on average, five quarters pass between the first interest rate hike and the hit to the economy, suggesting a further contraction in the economy in the second half of this year.

"The German consumer has reasons to be scared and the result of all the economic uncertainty is usually an increase in precautionary savings," said Michael Burda, economics professor at Humboldt University Berlin.

The German government still hopes the economy can turn itself around this year.

For ING's Brzeski, the decisive factor will be Germany's exporting performance - a longstanding strength which is nonetheless often subject to sharp swings.

While latest trade data on Monday showed a surprise 1.2% rise in German exports in April, boosted by deliveries to a re-opening China, that far from made up for the sharp 6% plunge the previous month.

Source: ZAWYA

To stay updated on all economic events of today, please check out our Economic calendar

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Warren Takunda

Traders' Opinions

Central Bank

In an unexpected move, the Reserve Bank of Australia (RBA) raised its cash rate by 25 basis points to 4.1% in June, marking the second consecutive rate hike after a similar increase in May. The decision caught many analysts off guard, defying market expectations for a pause. This article delves into the implications of the rate hike, its impact on various sectors, and the subsequent market reactions.

RBA's Inflation Concerns and Tightening Measures

The RBA's decision to raise interest rates stems from concerns over persistently high inflation in Australia. With the country's consumer inflation reaching 7% in the first quarter of 2023, albeit down from the previous quarter's 7.8%, inflation remains above forecasts. The central bank aims to curb rising price expectations, prevent inflation from becoming ingrained in the economy, and ultimately steer inflation back within its target range of 2-3%. Australia's Surprising Rate Hike Sends Ripples Through Financial Markets_2

Australia's Surprising Rate Hike Sends Ripples Through Financial Markets_2

Market Reactions and Currency Impact

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The Australian dollar (AUD) experienced a significant surge following the RBA's rate hike announcement. Appreciating nearly 1% against major currencies, the AUD rose above $0.665, reaching its highest level in three weeks. This rally reflects the market's positive response to the central bank's efforts to address inflationary pressures and restore confidence in the economy.

Bond Yields Hit Three-Month High

In response to the rate hike, the yield on Australian 10-year government bonds spiked above the 3.8% mark, reaching its highest level since early March. This surge indicates market expectations of further tightening measures by the RBA to rein in inflation. The central bank's aggressive monetary policy tightening, with a total of 400 basis points rate increases since May 2022, demonstrates its commitment to achieving its inflation target.

Stock Market Dips Amid Rate Hike

Following the RBA's decision, Australia's stock market experienced a setback, with the S&P/ASX 200 Index falling 1.2% and closing at 7,130. The decline came after a three-day advance and affected various sectors, including finance, mining, energy, technology, and consumer-related stocks. Notable losses were seen among index heavyweights such as Westpac Banking, Newcrest Mining, Woodside Energy, Block Inc, and Wesfarmers.

Current Account Surplus Falls Short

Australia's Surprising Rate Hike Sends Ripples Through Financial Markets_6

Australia's Q1 current account surplus came in lower than expected, reaching AUD 12.3 billion, compared to market expectations of AUD 15 billion. While the goods and services account surplus widened due to lower import prices, a rise in the net primary income deficit offset some gains. The net primary income gap expanded to AUD 28.5 billion, reflecting a decrease in income credits following a record high in the previous quarter.

Private House Approvals Continue to Decline

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Private house approvals in Australia registered a third consecutive decline in April 2023. On a seasonally adjusted basis, approvals fell by 3.8% month-on-month to 7,939 units. Notably, Victoria, Queensland, and New South Wales witnessed declines, while South Australia and Western Australia experienced modest growth.

The RBA's unexpected decision to raise interest rates by 25 basis points reflects its determination to tackle persistently high inflation in Australia. While the rate hike has bolstered the Australian dollar and bond yields, it has prompted a decline in the stock market. Going forward, the RBA's actions will be closely monitored as it aims to steer inflation back within its target range and ensure a balanced economic recovery.

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Thomas

Russia-Ukraine Conflict

Millions of litres of water burst through a gaping hole in a Russian-controlled dam on Tuesday, flooding a swathe of the war zone in southern Ukraine, threatening scores of villages and cutting off water supplies.

Ukrainian and Russian forces blamed each other for the breach.

The Nova Kakhovka dam, which holds water equal to that in the Great Salt Lake in the U.S. state of Utah, supplies water to Ukraine's Crimean peninsula, annexed by Russia in 2014, and to the Zaporizhzhia nuclear plant, also under Russian control.

The U.N. nuclear watchdog, the International Atomic Energy Agency, said on Twitter it was closely monitoring the situation but that there was "no immediate nuclear safety risk at (the) plant" which is also in southern Ukraine.

However, Ukraine's state atomic power agency Energoatom said the water level of the Kakhovka Reservoir was rapidly lowering, posing an "additional threat" to the facility, Europe's largest nuclear power plant.

Some 22,000 people living across 14 settlements in Ukraine's southern Kherson region are at risk of flooding, Russia's RIA news agency quoted the Moscow-installed head of the region as saying. Kherson is one of five regions, including Crimea, that Moscow claims to have annexed.

Unverified videos on social media showed water surging through the remains of the dam with bystanders expressing their shock. Water levels raced up by metres in a matter of hours.

A Russian-installed official in the town of Nova Kakhovka said on Tuesday residents of around 300 houses had been evacuated, state-owned news agency TASS reported. He said it would likely be impossible to repair the dam.

Counter-Offensive

The dam breach came as Ukraine prepares to launch its long-awaited counter-offensive to drive Russian forces from territory they have seized during more than 15 months of fighting.

Russia said it had thwarted another Ukrainian offensive in eastern Donetsk and inflicted heavy losses. It also launched a fresh wave of overnight air strikes on Kyiv. Ukraine said its air defence systems had downed more than 20 cruise missiles on their approach to the capital.

Reuters could not independently verify the reports and it was unclear whether any of the latest fighting marked the beginning of Ukraine's long-anticipated counter-offensive.

The Southern Command of Ukraine's military accused Russian forces of blowing up the Nova Kakhovka dam, which is 30 metres (yards) tall and 3.2 km (2 miles) long. It was built in 1956 on the Dnipro River.

"The scale of the destruction, the speed and volumes of water, and the likely areas of inundation are being clarified," the Ukrainian military said on Facebook.

Ukraine's military intelligence agency later said on Telegram that Russian forces had blown up the dam "in a panic", in what it said was "an obvious act of terrorism and a war crime, which will be evidence in an international tribunal".

Russian news agencies said the dam had been destroyed in shelling while the mayor of Russia-controlled Nova Kahhovka city was quoted as blaming an act of terrorism - Russian shorthand for an attack by Ukraine.

The Russian installed head of the Kherson region said evacuation near the dam had begun and that water would reach critical levels within five hours.

The Kakhovka Hydroelectric Power Plant has been "totally destroyed" and cannot be restored after a detonation inside the engine room, Ukraine's state hydroelectric company said.

Ukraine's President Volodymyr Zelenskiy will hold an emergency meeting over the dam blast, Oleksiy Danilov, secretary of Ukraine's National Security and Defence Council, said on Twitter on Tuesday.

Ukrainian Attacks

Russian President Vladimir Putin sent troops into Ukraine on Feb. 24 last year in what the Kremlin expected to be a swift operation, but its forces suffered a series of defeats and regrouped in the country's east.

Tens of thousands of Russian troops dug in over the winter, besieging Bakhmut for months and bracing for an expected Ukrainian counter-attack to try to cut Russia's so-called land bridge to the Crimean Peninsula.

Ukrainian officials have made no mention of any broad, significant new campaign, although in his nightly address on Monday, Ukrainian President Volodymyr Zelenskiy was enigmatic, hailing "the news we have been waiting for" and forward moves in Bakhmut in Donetsk.

Russia says it thwarted a major Ukrainian attack in the Donetsk region over the weekend and on Tuesday the defence ministry said a fresh Ukrainian assault had also been repelled.

Russian forces inflicted huge personnel losses on attacking Ukrainian forces and destroyed 28 tanks, including eight Leopard main battle tanks and 109 armoured vehicles, it said. Total Ukrainian losses amounted to 1,500 troops.

There was no immediate comment from Kyiv about Russia's assertions. Russia and Ukraine have often made claims of inflicting heavy human losses on each other which could not be verified.

Writing on Telegram, Russia's Wagner militia leader Yevgeny Prigozhin said Moscow's claims of huge Ukrainian losses were "simply wild and absurd science fiction."

The Washington Post reported that some U.S. officials thought Ukraine's counter-offensive was underway, but White House national security spokesperson John Kirby declined to comment on whether this was the case.

"I'm not going to be talking for the Ukrainian military," he told a briefing, adding that the United States had done "everything we could ... to make sure that they had all the equipment, the training, the capabilities to be successful."

The success or failure of a counter-offensive, expected to be waged with billions of dollars worth of advanced Western weaponry, is likely to influence the shape of future Western diplomatic and military support for Ukraine.

In its evening report on Monday, Ukraine's General Staff made no mention of any large-scale offensive, nor did it suggest any deviation from the usual tempo or scope of fighting along front lines that have not changed significantly for months.

Source: The Japan Times

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Damon

Commodity

Crude oil fully pared post-OPEC gains yesterday, as Saudi's lonely production cuts and the quota transfer from African countries to UAE raised question about the hit-power and the health of the cartel.

As a result, the barrel of American crude fell below the $72pb mark. The risks are now tilted to the downside because the OPEC meeting was the major upside risk for oil bears and it's cleared for now.

Oil stocks kicked off the week on a depressed note. Exxon tested the 200-DMA yesterday but failed to clear resistance amid the very short-lived post-OPEC oil rally. Exxon closed Monday's session 0.44% lower, and Chevron lost 0.48%. Still, it's more interesting to have a positive exposure to oil stocks than to oil itself, as oil companies accumulated a big amount of cash during the post-pandemic and Ukrainian war months, and they can simply acquire smaller rivals to boost revenue and growth.

$3500 per headset

Apple revealed its much-expected VR headset yesterday, just after its stock price hit a record, but the $3500 headset failed to convince investors that it will be the next big thing. It's too expensive to democratize and rivals' efforts haven't paid much so far. Giving a fancy design to a product of little-interest may not be the next big thing for Apple.

Elsewhere in tech, Nasdaq 100 is up by more than 35% since the start of this year, and according to a Deutsche Bank report the volume of call-option buying in tech and Mega Cap Growth stocks is now approaching the highest levels of the pandemic era – despite the Federal Reserve's (Fed) 500bp rate hike, and its pledge to do more. For now, there is no major sign of a reversal in appetite for Big Tech.

But we have signs that the major central banks are not done surprising to the hawkish side just yet. The Reserve Bank of Australia (RBA) hiked the interest rates by 25bp to 4.10% at today's meeting, defying economists' expectations of status quo. 'Fighting inflation' remains the primary focus, the bank said. The AUDUSD jumped past the minor 23.6% retracement on February-May retreat and cleared the 50-DMA at 0.6660. The surprise hawkish move, along with a rebound in iron ore price could further support the positive move and send the pair above its 200-DMA, which stands a touch below the 67 cents level.

Another scandal?

Bitcoin fell more than 5% yesterday after the SEC accused Binance and its CEO Zhao of being 'engaged in an extensive web of deception, conflicts of interest, lack of disclosure and calculated evasion of the law'. Big cryptocurrency institutions' misfortune could shake the market, but the cryptocurrencies, themselves, remain impressively resistant to scandals in crypto exchanges, and price dips could be interesting opportunities to buy the assets.

In the medium run, rising interest rates pause a higher risk to cryptocurrency valuations than another crypto-exchange scandal.

Source: Swissquote Bank

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Devin

Bond

Forex

Range trades are a near-term catalyst to our USD-EUR rates tightening view

The Saudi oil production cut and calm market conditions paving the way to another flurry of debt issuance are the two most salient bearish risks for core government bonds this week. That said, the Fed went into its pre-meeting quiet period with the probability of a 25bp hike on 14 June well below 50%, and we think there is little the European Central Bank (ECB) can say to really cause a hawkish rethink of its rates trajectory. We take as evidence the lack of market reaction to various officials – including Christine Lagarde and Joachim Nagel – stating that inflation remains too high. The main reasons, we think, are that markets are already pricing two 25bp ECB hikes by the end of the summer and that central banks have been explicit that economic data will determine the path for monetary policy.

We see this as a recipe for rates to remain within their range. Core bonds erased their early sell-off in the U.S. session yesterday thanks to signs of a cooling service sector displayed in the ISM services reading. Is this enough to change the prevailing narrative? It isn't, but Treasuries went into the release very close to the top of their recent range in yields which we suspect made short-term investors all the more enthusiastic about buying the morning dip. The same cannot be said of Bund yields, which started the week close to the bottom of their range, making them less appealing to range traders.

This state of play, high dollar and low euro rates, happens to contradict our expectation of narrowing rates differentials and we expect this dynamic to reverse. In the short term because the lack of market direction should limit further U.S. Treasury sell-off and further Bund rallies, and later because tangible signs of a decline in core inflation occurring in the U.S. are so far lacking in Europe. This should allow a fall in USD rates later this year, even as their EUR peers remain elevated for a while longer.

High but stable rates volatility is a boon for risk appetite

The implication for markets outside of rates is positive. After a year of being tormented by the relentless rise in borrowing costs in 2022, few investors are sorry to see yields lacking in direction. Realised and implied volatility remain high compared to their 2021 levels, but well below their late 2022 peak. Until rates make a decisive break lower on a dovish pivot by central banks, current levels of volatility can be thought of as the new normal. This stabilisation has been enough to boost risk appetite in other markets. Whether lower rates volatility is the cause or another symptom of lower macro uncertainty, it has come with valuations in some risk assets that belie recession calls.

This is visible in many corners of financial markets. Eurozone sovereign spreads, much like some measures of swaption implied volatility, are approaching their lowest levels in a year. Similarly, although the factors may also include money market dynamics, swap spreads are shedding their risk premium acquired during the latest bout of U.S. regional banking stress. At the front-end of the curve, the credit premium received by investors is painting an upbeat picture. We will stop short of extrapolating this to other markets, but a continuation of the current rates volatility status quo seems to suit most markets.

Today's events and market view

The release most likely to move euro markets today is the ECB's consumer expectations survey and more specifically the questions on their inflation outlook. Eurozone retail sales are expected to edge modestly up after their slump in March. There will also be construction PMIs to look out for from Germany and the UK.

Bond supply takes the form of a 30Y gilt sale from the UK, to which Germany and Austria will add respectively 10Y/23Y linker and 10Y/13Y bond auctions. The EU has also mandated banks for the sale of 7Y and 19Y debt via syndication.

Klass Knot, Mario Centeno, and Boris Vujcic are on the list of ECB speakers for today.

Weak factory orders in Germany released this morning add to the sense of anemic growth. We think this is more likely to result in an even more inverted yield curve in the near term rather than significantly lower rates overall as the ECB is laser-focused on its inflation fight.

Source: ING

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Samantha Luan

Forex

USD: RBA hike questions whether the Fed could do something similar

The dollar opens Europe a little weaker and is about 0.5% off yesterday's highs. The sharp drop from those highs came on the back of the softer May ISM services data, where both activity and price levels supported the US recessionary narrative and further questioned the quality of Friday's strong NFP jobs report. However, the US data calendar is now pretty quiet for the rest of this week and the market may well hold positions into next week's May CPI data and the June 14th FOMC meeting.

Delivering some food for thought ahead of that FOMC meeting was last night's surprise hike by the Reserve Bank of Australia (RBA). Having paused its aggressive hiking cycle in April, the RBA hiked another 25bp, citing increased upside inflation risks and – like many central banks around the world – frustrated that core inflation was not falling more quickly. The RBA's move to restart its tightening cycle may throw extra focus on tomorrow's Bank of Canada (BoC) meeting after paused rate hikes at its March and April meetings. A 25bp BoC rate hike tomorrow (now priced with a 43% probability) would probably cause ripples across core bond markets around the world and could keep the dollar bid on the view that the Fed might be closer to hiking than first thought. Let's see.

So while the dollar is slightly offered today, we think investors may be reluctant to rebuild dollar shorts until next week's double event risk of CPI/FOMC has been overcome. In the meantime, FX volatility levels continue to sink and the high yielders – especially the EM high yielders – are in demand. It is no doubt a crowded trade, but there is still a lot to like about the Mexican peso which offers 12.5% implied yields through the three-month forwards.

DXY should trade well within a 103.50-104.50 range today.

EUR: Volatility sinks

Both traded and realised volatility levels in EUR/USD are dipping back to pre-invasion levels in February 2022. Despite tight liquidity conditions, FX markets are taking their cue from the rates market. Here, measures like the MOVE index – a yield curve weighted index of 1-month US Treasury implied volatility –- have fallen to the lowest levels of the year, presumably on the view that the Federal Reserve will not be doing a lot with the policy rate over the coming months.

In other times, low volatility might have seen the dollar used as a funding currency for pro-cyclical trades. However, 5% overnight deposit rates make the dollar far too expensive to be a funding currency. This serves as a reminder that we need to see genuinely soft US data – particularly price data – and for the Fed to respond to it in order to see the dollar embark on a major cyclical bear trend. The steeply inverted US yield curve tells us that we are not at that point yet.

With US two-year yields holding onto around three-quarters of their rise since Friday's jobs report, it may be too early to expect EUR/USD to add to yesterday's gains. EUR/USD may trade well within a 1.0680-1.0780 range into tomorrow's Bank of Canada meeting. It may also take its cue from this week's China data, including May trade data released tomorrow and aggregate financing data later in the week.

GBP: A lot more focus on the mortgage time bomb

The UK press is spending a lot more time focusing on the UK mortgage time bomb, where 600,000+ mortgage holders are due to refinance in the next six months and could find themselves paying 400bp more in interest on their mortgages. So far, this threat to the UK consumer has yet to show up in the pricing of the Bank of England cycle, where the Bank Rate is still priced some 90bp higher at 5.40% by year-end.

In EUR/GBP, 0.8550 has been the best level of the last year for sterling (EUR/GBP bounced off 0.8565 last week) and we doubt investors want to chase sterling through those levels anytime soon. GBP/USD is consolidating in a 1.2350-1.2550 range and should stay there if we are correct with our EUR/USD call.

CEE: NBP starts thinking about rate cuts again

Today, we have a number of hard data on the calendar in Romania, Hungary and the Czech Republic. Industrial data in the Czech Republic should be the main focus, confirming the weakness of the economy. Later today, we will see a decision from the National Bank of Poland. We expect, in line with the market, that rates will remain unchanged, so the statement released later may be more interesting.

However, we will get the main portion tomorrow during Governor Adam Glapinski's press conference. The May inflation number fell from 14.7% to 13.0% year-on-year, below market expectations, and even the outlook for further disinflation is better than previously thought. The governor can therefore be expected to raise the topic of rate cuts later this year again. Although this is not our baseline scenario, our economists see an increasing likelihood of such a move. The market at the moment is pricing in roughly 80bp of cutting this year and roughly 150bp by the May meeting next year. That is more than we expect, but markets can be expected to accept the governor's dovish narrative and be open to pricing in even more easing for now.

Despite our expectations yesterday, the whole region strengthened and the positive mood after the US payroll numbers seem to have prevailed over the decline in interest rate differentials. We can expect this direction along with higher EUR/USD to support CEE FX today as well. On the other hand, as we mentioned yesterday, the Polish zloty and Hungarian forint should run into overcrowded market positioning. Therefore, we expect that the Czech koruna should benefit the most from this situation, as it can offer a more balanced market position and, moreover, has already demonstrated the highest beta against EUR/USD within the region in recent weeks, heading below 23.50 EUR/CZK for the first time since mid-May. On the other hand, a dovish NBP narrative may be seen in the Polish zloty market rather after the press conference on Wednesday only.

Source: ING

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Warren Takunda

Traders' Opinions

The Swiss franc, often regarded as a safe haven currency, experienced a depreciation against the US dollar in early June, reaching its lowest level in two months. This decline can be attributed to slowing inflation in the Swiss economy, which has dampened expectations of further monetary tightening by the Swiss National Bank (SNB). In this article, we will delve into the recent inflation figures, their implications for monetary policy, and the potential challenges facing the SNB.

Cooling Inflation Figures

During the month of May, Swiss consumer prices registered an annual increase of 2.2%, marking the slowest pace of growth in 15 months. These figures fell well below the expectations set by the central bank. Moreover, core inflation, which excludes volatile components, decelerated to 1.9%, dipping below the SNB's upper limit of 2% for the first time in 11 months. These indicators reflect a broader moderation in price pressures and contribute to a more dovish outlook for the SNB.

Policy Implications

The recent inflation data presents a conundrum for the SNB. On one hand, the central bank acknowledges that the current interest rate of 1.5% remains low, indicating room for potential tightening measures. On the other hand, the deceleration in inflation and the dip in core inflation below the upper limit pose challenges to the bank's previous expectations of further tightening.

SNB Chairman's Perspective

Chairman Jordan of the SNB has provided insight into the central bank's stance on the matter. He stated that the risks of overtightening the monetary policy are low, aligning with market expectations of a 25-basis-point hike this month. However, Jordan emphasized that inflationary risks remain on the upside, suggesting that the bank will need to strike a delicate balance between addressing inflation concerns and maintaining accommodative policies.

Market Reactions

The Swiss franc's depreciation against the US dollar following the release of the inflation data reflects investors' perception of the SNB's dovish outlook. Traders are adjusting their expectations for future monetary policy decisions, which, in turn, influences the currency's value. The recent depreciation serves as a reminder of the impact that economic indicators can have on currency markets.

Conclusion

The recent cooling of inflation in Switzerland has introduced a new dynamic to the policy landscape for the Swiss National Bank. While the current data supports a more cautious approach to tightening, policymakers believe that the interest rate remains low and that inflationary risks are still present. Balancing these factors will be crucial for the SNB in the coming months as they determine the appropriate course of action. Market participants will closely monitor any hints or announcements from the central bank to gauge the future trajectory of the Swiss franc and the broader Swiss economy.

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