The Pivotal Story – Europe

Article |
 
01 December 2017

Moving on up

From Australia’s standpoint, it is clear that most of the current global economic narrative that we hear does focus on the growth and the happenings in the United States economy. While the US is obviously important, we should not lose sight on events elsewhere, in particular in Europe.

What has been happening of late in the Eurozone is fascinating and validates our view that there continues to be a noticeable shift in European economic growth; transitioning from patchy cyclical growth to a more broad based virtuous growth cycle.

For some time, a key missing ingredient in the growth of developed economies has been business investment. Indeed this is still the case in Australia, at least, for the moment. This has provided some level of frustration to authorities as evidenced by recent quotes from the Reserve Bank of Australia:

“For a number of years, we were repeatedly disappointed that non-mining business investment was not picking up.” Philip Lowe Governor RBA

One of the ongoing themes in the global economy since the financial crisis has been the long-lasting paucity of business investment spending. This has been despite conditions that, in the past, have been very favourable for investment spending, such as low borrowing rates, strong corporate balance sheets and solid profitability.” Guy Debelle Deputy Governor RBA

European middle class incomes on the rise

In contrast, if we look at recent data from Europe, it reveals that middle class incomes are continuing to rise and importantly this is not just in northern European countries. Spain and Italy are experiencing a lift in middle class incomes. The consequent impact of this uplift in income is now being reflected in increased business activity. If we examine the European Purchasing Managers Index (PMI) survey on manufacturing, it has increased steadily since 2006. In fact it has recently hit its highest level since 2006 ( a level of 60 as at 24.11.17) The PMI survey tracks sentiment of manufacturers of a country or region. A reading above 50 suggests expansion in areas that include new orders, inventory levels, production, supplier deliveries and the employment environment.

KEY REGIONAL PURCHASING MANAGERS INDEX (PMI): MANUFACTURING

Source: Bloomberg

Given its weak contribution to world growth over the last decade, this revived European story is pivotal for world markets. The rapid fall in European unemployment, albeit from a high level, is assisting in creating a more virtuous growth cycle. The European economy is shifting away from being overly reliant on increased activity in the US and China, to one where rising employment generates more income and thus business investment.

In fact, European interest rates have been acting like a magnet – dragging down the yields of other key bond markets. The ECB have commenced a shift in policy to unwind the over reach elements of the asset purchase program. By allowing longer dated interest rates to drift higher relative to cash rates, the appetite for the banking sector to provide finance to European businesses improves. In turn, retain profits increase and the capital position of the sector improves. 

Conclusion

In all, the combination of reduced asset purchases by the ECB as well as the actions by the Fed in reducing its balance sheet progressively, should allow longer dated European bond yields to lift and the upward pressure under way in the US to take effect. With regard to Australia, this translates to pressure for higher long dated yields. Although as we do not expect cash rates in Australia to rise for more than a year, meaning short dated bonds are set to perform well.

For more information please contact

Chris Dickman

Chris Dickman


Senior Portfolio Manager and Co-Founder – Altius Asset Management
chris.dickman@altiusam.com