EU Index Erodes; Germany Lags; Questions Are Raised...

In February, the European Commission economic sentiment index from the monetary union declined to 95.4 from January’s 96.1, a surprise development. This drops the reading below even its December level but above its November level. Declines are logged in three of five sectors with the industrial sector, the retail sector, and the services sector, each weakening month-to-month. The construction assessment was unchanged between January and February while consumer confidence increased to a -15.5 reading in February from -16.1 in January.

The paths of these sectors are illustrated in the chart. It shows that all sectors declined sharply during COVID and then marked various degrees of recovery that were short-lived. This recovery, the wake of Russia’s invasion of Ukraine, has since turned into a decaying phase that remains in force with the exception of services, a sector that continues to move sideways at a reading that is below its historic median level. Consumer confidence, the weakest reading in terms of its net diffusion, is the only sector that shows some degree of recovery in progress.

Overall sentiment month-to-month In February, each of the largest monetary union economies showed declines in their overall sentiment readings. Italy fell the most, dropping by 1.6% month-to-month, followed by Germany that fell by 0.7%, France fell by 0.3%, and Spain fell by 0.2%. Among the remaining thirteen countries, seven of them logged month-to-month declines in February. This shows mixed performance among the rank-and-file members of the monetary union juxtaposed to more concerted weakness among the largest economies. In January, there had been only one of the BIG-4 economies that showed a decline and only three other economies that showed declines.

The rankings Turning to rankings, the ranking of the overall monetary union index is at its 31st percentile, putting it in the lower one-third of its queue of historic observations. All the BIG-4 economies have rankings below their respective 50th percentiles with Germany the weakest in its 15.6 percentile, and Spain the strongest, at nearly its 47th percentile. France sits in its 42.8 percentile with Italy at its 43rd percentile. Among the remaining countries, percentile rankings range from a high of a 60.7 percentile standing for Cyprus, followed by a 56.9 percentile standing for Greece- the only two countries with rankings above their 50th percentile - to a low ranking of 7% for Estonia, 11% for Malta, 13% for Austria, and 15.6% for Finland. There's a considerable spread of rankings outside of the top-4 economies; however, the center of gravity is clearly well-below 50 with a long tail of weakness.

Surprise weakness The EU Commission indexes for February are surprising and weaker than expected. They come with more concern about the Russia-Ukraine war given the emerging ambivalence from the split in U.S. politics as the U.S. points to elections in November of this year. The absence of U.S. financial support and the face of a domestic political split has placed more burden for Ukraine support on Europe and this may be one factor adversely affecting sentiment. While there is a lot of rhetoric directed at the U.S. and concern that Donald Trump could be re-elected, the simple fact is that his bombast was prompted by widespread European failure to spending their promised proportion of funds on defense. For a time, Germany refused to spend its 2% of GDP on defense, choosing instead to reduce it level of debt! Is it any wonder Trump below a gasket? Ironically, European nations may now have to spend even more if they begin to think the U.S. is a less dependable ally.

Global conditions Global economic conditions remain touch and go and the bright spot which has been the decline in global inflation has reached a slowdown phase with inflation rates beginning to look a little more stuck while still above their target ranges after what was some unexpectedly fast progress on inflation made last year. Both the ECB in Europe and the Federal Reserve in the U.S. have begun to warn about the risks of cutting rates too soon; these warnings come on the heels of markets having nearly thrown rate-cut parties in anticipation of rate reductions later this year. Are central banks taking away the punch bowl even before party-goers have a sip?

The outlook The outlook seems to have changed and while Europe is looking weaker in a lot of ways, the U.S. economy has begun to look a little more resilient and that poses a different sort of risk for everyone. The U.S. bond market and interest rates globally are particularly at risk because if U.S. interest rates cannot proceed lower, it will be more difficult for Europe to cut rates, and bonds may prove to be over-priced at current levels. Conditions have changed. It's time, once again, to hang on to every single economic report as though policy depended upon it - because it does.