German DAX and Bunds Show Bullish Sentiment Ahead of ZEW Survey, Euro to Rebound?

How Could The Markets React? 

European financial assets have continued to reflect optimism over the future of domestic growth, as equity markets and bond yields continue trending higher through recent trade. This bullish outlook has seemingly escaped the domestic currency, however, as the Euro has fallen nearly four percent off of December’s 18-month highs against the US dollar. Many Euro bulls hope that tomorrow’s German ZEW data may provide the much-needed spark to drive the currency off of recent lows, but such an outcome greatly depends on the actual ZEW survey figures. According to consensus estimates, markets expect that Economic Sentiment—a measure of outlook for the following 6 months—will rebound to its best print since September. German investors have consistently proven bearish on the future of economic growth, but a previous bounce off of 13-year lows suggests that the worst may be past us. As such, we will watch for a further retracement for the headline Economic Sentiment index, with risks remaining to the upside for domestic equities, bond yields, and the European currency. 

Bonds – Euro Bund (German Bond) Future

German bonds prices have remained on a fairly clear downtrend, as a bullish outlook on the European economy has forced traders to reconsider investments in domestic debt. This is most clearly visible in Bund Futures, with the March contract just several points above its previous 5-month lows. All of this is enough to suggest that investors are expecting economic data that will continue to impress, and tomorrow’s German ZEW report is no exception. A positive outcome would likely push Bund prices further off of recent lows, boosting yields and the attractiveness of the Euro as a higher-yielding currency.

FX – Euro vs. US Dollar

The extended weekend for the US markets has effectively taken the steam out of the EURUSD pair’s decline. With plenty of time to fundamentally position themselves and consider technical levels, the benchmark pair could be set for a strong move.  All that is lacking now is a trigger. Looking ahead, tomorrow’s German ZEW survey of investor confidence may offer the perfect catalyst for a move – be it a rebound or an extension of January’s sharp slide. As of the most recent revision to predictions, the consensus for the report calls for a pick up in the Expectations component, while the Current Situation figure cools. The outlook for the German economy has been heavily depressed going into the end of 2006 specifically due to the planned sales tax hike that took affect on January 1st. In November, the uncertainty surrounding this policy change reached a flash-point after the outlook component marked a 13-year low. However, since then, investors have begun to revalue their dour expectations for economic activity as a deluge of positive data has suggested consumers are well positioned to weather the burden of a 19 percent sales tax. In the year through 2006, estimates show Europe’s largest economy topped a six-year high. Furthermore, unemployment has reached a four-year low while consumer confidence has subsequently marked a five year high. Now, as the tax hike finally takes effect and the markets start to measure the pressure on economic functioning, euro traders will see whether their projections in previous months were overblown. Should the indicator surprise to the upside (especially on the current and expectations reads), the presence of support around the 1.29 figure will act as a spring board for bids. On the other hand, if the bleak expectations prove warranted, then EURUSD may find the impetus for an eventual move to 1.25.

Equities – German DAX Index Futures

German equities, like their global brethren, have relentlessly appreciated over the past months. In fact, by the close of Monday’s session, the benchmark DAX Index was able to mark a new, nearly-five year high. Equities have been firmly bid as domestic and foreign investors look to take advantage of economic growth at six-year highs. Already, this growth has shown clear benefits for both the business and consumer side of the economy. Consumers have been rewarded with unemployment at four-year lows and competitive wages. Alternatively, German firms have enjoyed demand from strong domestic consumption, as well as growing orders from outside the national boarders. In November, factory orders grew 1.5 percent as industrial production accelerated 1.8 percent. Going forward, the ZEW confidence indicator could be key in defining the future direction in equities. Already, the DAX has shown signs that its steady ascent is hitting pockets of sell orders. This may be an indication of institutional selling. Should the investor sentiment survey print a disappointing number, it may catch retail and international investors off guard and trigger a wave of panic selling. Conversely, if the indicator proves investors are confident the economy and the consumer will weather the sales tax hike, money managers and investors still holding money on the sidelines may enter the market with the belief that a top is not yet in sight.