Monday, March 25, 2019

Is Europe heading for a recession; what does the US yield curve inversion mean?

  • Dollar
  • Gold
  • Yen
  • Euro
  • Pound
  • Stocks


“Is Europe heading for a recession and what does this mean for the Euro” seems to be the most pressing question in investors' minds this morning. After Friday's abysmal PMI readings from Germany and France, the shared currency dropped to 1.13 in a matter of minutes, even though the Fed's meeting had propelled the currency to 1.1450 only a couple of days before, with more data coming in from Europe today. At the same time, the yield curve inversion in the 3-month/10-year US Treasury bonds flashes an early recession warning, with the Fed now scrambling to prevent it, while markets now predict a rate cut as the next move. Equities closed deep in the red as investors grow increasingly nervous, Gold moved to $1,315 but Oil retreated below $60.

The week starts with the Euro at the forefront following last week's disappointing production figures. Manufacturing in Germany contracted for the third month in a row while France's services sector also posted lower results. This pushed the composite Eurozone index to 51.3, just shy of the boom/bust 50 level, and following ECB's bearish projections earlier in the month, the shared currency looks vulnerable. And if that's not enough, President Trump fired a shot across the bow warning that tariffs on European auto imports might be next on his schedule.

These bearish drivers further elevate the German IFO Survey's significance, due to be released later today, where analysts are expecting a steady printing. Albeit, a potential miss here will seal the Euro's short-term fate as a break below 1.13 will clear the path towards 1.12. On the flip side, a positive printing will help the Single currency breathe a bit easier, but with the 1.1350 level appearing as the near-term ceiling for the currency, the broader bias points towards more weakness ahead.

Across the ocean, the US doesn't look to be in a much better state, even though its intrinsic characteristics make it easier to handle a slowdown. In any case, the bond market is flashing warnings signs even though the Fed just signaled a pause in its hiking schedule. The curve inversion in the 3m/10y yields is considered an early recession warning and with the Fed funds futures now predicting a rate cut from the Fed as the next step, markets are telling the US central bank that they may have been too late to stop tightening. Should the markets be right, and in most cases they are, the Dollar may see further weakness in the medium-term, with EM currencies and commodities likely to benefit as the other major currencies have troubles of their own.

Gold saw fresh gains on Friday moving to $1,315 on the back of investors' concerns following the warning slowdown signs in Europe and the US. Prices have now gained almost 3% from their monthly lows but if market participants continue to fret about a potential recession in Europe and the yield inversion in the US, more upside is likely for the yellow metal. The $1,320 level is the medium-term top and a break above this will drive prices to $1,325. Oil had to take a break from its rally at some point and retreated to $58.50 on Friday; however, as long as prices hold above the $58 mark, more upside is likely given OPEC's inclination to keep production cuts going.

Global equities ended last week deep in the red on Friday with the European and US markets close to 2% below water. A host of slowdown signs on both sides of the Atlantic are spreading worries among investors and this morning futures are pointing towards a bearish opening bell. Granted, Fed's decision to stop rate hikes and ECB's rumored plans to restart its quantitative easing efforts will provide equities with more room to breathe in the medium term so the selloff may be short-lived, but what lies ahead in the long-term remains a question. The best way forward may be to look for buying opportunities but for a medium-term horizon only.


  • German IFO Expectations - 1pm
  • German IFO Current Assessment - 1pm

All times are GMT +4.