Even as U.S. markets reasonably bask in “soft-landing” hopes - a fresh downturn in Europe’s biggest economy raises more serious questions on the eastern side of the Atlantic.
The weakness of German industry can hardly be a big surprise to anyone who has been paying attention. The past two years have featured Ukraine-related energy shocks, intensified Chinese competition in the auto sector, a fumbling attempt to break into electric vehicles and a painful borrowing squeeze.
For ING economist Carsten Brzeski, following German macro data is “like a long stroll on the boulevard of broken dreams.”
But even by the standards of the past couple of years, the latest news is alarming.
Although Germany’s economy showed tentative signs of recovery earlier this year, the country’s business surveys in September point to a relapse. This is largely due to stumbling China, Germany’s largest trading partner and with whom it exchanged a quarter of a trillion euros worth of imports and exports last year.
Germany’s manufacturing sector appears to be in deep contraction yet again, according to both S&P Global’s reading and the homespun Ifo survey.
S&P Global’s index combining both factory and service sectors suffered the deepest downturn in seven months in September. Ifo’s manufacturing index cratered to its lowest point since the COVID-19 pandemic lockdowns in June 2020.
Germany’s top economic institutes are now set to downgrade their full-year 2024 forecast to show gross domestic product shrinking 0.1%, which would mark a second consecutive annual contraction.
That sort of shallow recession might not yet be a “hard landing” per se - and Germany’s euro zone peers are doing better. But it shakes faith in whatever might be defined as a “soft” touchdown.
The European Central Bank is offering some help, with two interest rate cuts already in the books this year.
But its moves have been in smaller clips than the jumbo cut unloaded by the Federal Reserve last week and there appears to be foot dragging in Frankfurt’s “Eurotower” about the pace of further reductions.
POLITICAL FOOTBALL
Despite the business fug, you’d be hard-pressed to find much angst in headline German market metrics.
Blue-chip German stocks hit record highs last week. And even though unhelpful for struggling German exporters, the euro is close to its best levels in two years against the dollar - with its real effective exchange rate index close to the highest in a decade.
Where you’re more likely to see “hard-landing” worries reflected is in the widening credit spreads - or risk premiums - on high-yield bonds. While so-called junk bonds benefit from interest rate cuts, the impact is modest in comparison to the hit they typically take from earnings weakness and recession-fueled default fears.
But - just like their U.S. equivalents - euro “junk” bond spreads are close to the narrowest they’ve been since the Ukraine invasion and the ECB tightening of early 2022.
The elephant in the room is the auto sector - estimated to account for about 7% of the European Union’s GDP and even more in Germany.
As BlackRock’s credit team pointed out, that sector represents about 6% of the Bloomberg Pan-European Investment Grade debt index and almost 11% of the high-yield equivalent. And dour returns make it among the worst-performing sectors both this month and in the current quarter.
JPMorgan’s European credit team earlier this month said it has been underweight autos all year, citing “significant headwinds” from lower-cost Chinese rivals and energy problems.
And it’s been another rough month for Germany’s “champions,” with Volkswagen’s unprecedented plan to shut factories on its home turf and a BMW profit warning that sent its share price plummeting.
Both companies blamed a mix of Chinese competition and rising labour and energy costs in an industry that’s clearly ailing more broadly. The STOXX 600 Autos and Parts share index has underperformed the wider market by some 15% this year.
As JPMorgan’s team note: “The sector has become one of the main political footballs in the emerging global trade war.”
China’s latest stimulus measures this week may shift the demand picture a bit, and German auto shares did get a lift on Tuesday.
But with U.S. elections nearing and escalating tariff wars and protectionism now a constant threat, it seems unlikely that the drag on the German industrial world will dissipate anytime soon.
It’s tough to see how Germany stops sputtering - whether it can be just contained to autos is a bigger question.
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