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While the German outperformance was notable in recent years, especially as other eurozone economies were engulfed in
the recent sovereign crisis, recent developments challenge this trend. In an increasingly protectionist world, plagued by
escalating trade tensions, the German economy is clearly suffering.
The country’s well-known Ifo business confidence index has been on a steep downtrend, with the expectations component
– highly correlated to gross domestic product (GDP) – falling to the lowest level in a decade in September. The fall in the
Ifo came alongside a decline in the composite purchasing managers index (PMI) to 48.5, showing outright contraction in
activity. Combined, the PMI and Ifo surveys point to negative quarterly growth in the order of -1.5% annualized late in the
third quarter, as shown in Figure 1.
Figure 1
It now seems very likely that Germany will experience a technical recession in mid-2019, with a slight -0.3% annualized
GDP decline in the second quarter possibly followed by a deeper fall afterwards.
And chances are rising that the recession will be more prolonged, given the deep slump in global manufacturing and the
consequent precipitous decline in German industrial data. Looking ahead, the German economy looks challenged on
several fronts:
1. Global trade wars: With exports representing around half of the economy, global trade tensions are having an
Looking ahead
Our base case for Germany over the next year is one of gradual improvement, given the potential easing of trade tensions
through 2020, and monetary stimulus getting some traction. But the reacceleration is likely to be slow.
The European Central Bank (ECB) has just embarked on a new easing program, but the data suggest that this may need
to be beefed up given growing downside risk and a continued decline in inflation expectations.
With negative rates in place and asset purchases having already been conducted for some time, monetary policy seems
almost out of steam. Germany’s ailing economy could well do with some fiscal stimulus, especially since the country can
afford it (with a budget surplus of around 1.5% of GDP). But recent comments from German officials have poured cold
water on that prospect, confirming our expectation that a fiscal regime shift in Germany is unlikely to happen soon.
Germany could be affected by the outcome of Brexit, as the U.K. is a key trading partner. Turkey’s recent woes and weak
currency have also had a significant impact. The uncertainty stemming from both situations may last longer than we wish.
Investment implications
The significant weakness of the German and eurozone economies, and of the global economy more broadly, have
supported European duration. In our portfolios, we tend to be underweight the short end of the bund curve, based on the
fact that the ECB has limited room to cut policy rates further. The longer end of the curve, on the other hand, should remain
supported, as monetary stimulus is likely to prove insufficient and largely ineffective in raising depressed inflation
expectations. Indeed, Figure 2 shows that eurozone five-year, five-year inflation breakevens are around 1.2%, close to all-
time lows.
In the periphery, meanwhile, the ECB’s engagement and positive developments in Italian and Europe-wide politics from a
market perspective point towards a supportive picture for Italian government bonds in the near term. But, medium-term
risks warrant caution, and argue against taking large risk positions here.
Figure 2
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