Friday, 31 January 2014

Europe just got a little bit more Japanese

"Harmony makes small things grow, lack of it makes great things decay." - Sallust, Roman historian

One should obviously never read too much from volatile monthly macro data points. Still, isn’t this morning simultaneous release of December German retail sales (-2.5% (!) vs +0.2% expected) and Eurozone January headline CPI data (+0.7% vs +0.9% expected) a scary symbol of the deflationary Japanese-like picture developing in Europe?

The consensual bullish European pitch involves, among other things, a German consumption pick-up to rebalance intra-zone current account imbalances. The trouble is, judging by recent consumption data, the German consumer doesn't seem extremely confident about its upcoming prospects. With no real demand improvement from Northern Europe, the deflation threat may quickly clearly come back with a vengeance to haunt an extremely bullish yield-seeking investors community, who kept the last year bidding up Southern Europe assets.

No doubt that another few rounds of weak inflation data will put the lights back on those Debt/GDP ratios that fell out of fashion recently. The heat should rapidly be mounting again on the ECB to act.

On a side note, these developments could prompt some investors to revisit the short EUR/USD trade. 
Many people have been burned last year by this almost european version of the JGB "widowmaker". Retrospectively, massive eurozone current account surpluses were probably too strong of a force vs the FED/ECB divergence bet. If deflation scares gather steam in Europe, then the latter could have its day.

Eurozone - Harmonised Index of Consumer Prices (source Bloomberg)

"All things are subject to decay and when fate summons, monarchs must obey." - John Dryden, English poet

Stay tuned!

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