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How Will The Markets React?

Looking forward to a rather busy week from the German economic calendar, Tuesday’s IFO report will kick things off on a strong note. Along with the GfK consumer and ZEW surveys, the IFO sentiment indicator has grown in prominence in recent months as traders and economists look for the timeliest gauges for gathering their bearings on first quarter growth. Though leading indicators have always been of value to financial markets and academics, their importance in Germany has intensified since the government decided to hike the value added tax from 16 to 19 percent. Optimists have attached themselves to the idea that strong hiring and investment trends may have allowed both consumers and businesses to weather the additional tax on income and revenue. However, as time passes, indicators are increasingly supported a cooling in economic activity. As evidence of restrained activity on both the firm and consumer fronts, factory orders for January dropped 1.0 percent while retail sales for the same month dropped 4.3 percent (the most since April of 1999). These numbers are hard to ignore given their timing and potential impact on overall growth trends. As it stands, Germany expanded at its fastest pace in six years in 2006 on the back of both domestic and foreign demand. Since then, the European Central Bank has lifted the benchmark lending rate another 25 basis points to 3.75 percent and the euro has appreciated against its major trade partners. This only adds to the anxiety. For March’s numbers, analysts expect the IFO business climate read to fall for the second time from its record high to 106.5. A decline for the month would coincide with the already released GfK consumer sentiment survey, but contradict the ZEW investor confidence indicator. Another report that has tossed its vote in the hat is the Belgium Business Confidence number. Often considered a leading indicator for its German counterpart, the indicator cooled in March – offering a distinct bearish bias.

Bonds –10-Year German Bund Futures

Bunds have carved out their own direction in the past few active sessions. The nearby futures contract rounded out a high at 116.63 back on March 14th and has since accelerated declines with little impetus from German economy data. Coincidently, as serious economic fuel comes back to the markets, government bunds have closed in on support. Seen at 115.11 in futures, the technical level was formerly resistance for a period of consolidation that lasted for much of January and February. This is a good launching point for an expected decline in business confidence. Should the IFO number hit the wires as expected, or below estimates, the outlook for growth and further rate hikes could diminish significantly – and take bund yields with it.






FX – EUR/USD

While the Euro saw a New York session rally today against the greenback on the release of weaker-than-expected US new home sales, the pair could be forced to turn lower should the Ifo survey of German business confidence fall in line with or below expectations. The figure is estimated to ease back for the third consecutive month in March as the relatively strong Euro takes a toll on exporters. Additionally, the expectations component will likely decline as well, especially with the European Central Bank maintaining their tightening bias and leaving the door open to rates at 4.00 percent. The decline of the Belgian Business confidence survey – a leading indicator for the Ifo report – bodes particularly ill for the indicator and could take the EURUSD pair down towards support near 1.3250. However, the correlation between the two gauges has diverged over the past few months, thus, robust Euro-zone growth and a tightening labor market could actually lead to a surprise gain and carry Euro up to last week’s highs of 1.3411.






Equities – German DAX Index

European equities gave up some of last week’s gains today as sentiment declined amidst increased geopolitical tensions after Iran refused to release fifteen captured British servicemen, subsequently sending crude oil prices up to hit a new high for 2007. The German DAX Index closed the session down 1 percent to 6828.82 led by automakers Volkswagen and DaimlerChrysler. Volkswagen plunged 3.2 percent to 113.95 euros after rival carmaker Porsche said it planned a buyout offer for VW shares at a steep discount to Friday’s closing price. DaimlerChrysler lost 2.9 percent to 60.23 euros after the Detroit News reported that General Motors Corp.’s bid for Chrysler was rejected for being too low.

Shares could take another hit on the release of Ifo German business confidence, which is anticipated to fall for the third consecutive month to 106.5 from 107.0 as the steadily rising Euro and mounting ECB interest rate expectations takes its toll on companies and consumers alike. Indeed, the Belgian Business confidence survey declined for the same month, and since Belgium conducts 95 percent of its trade within EU, the survey is often used as a leading indicator for the much more important IFO reading. Thus, a decline in the sentiment report could easily push the German DAX Index down below the 50 day SMA at 6779.75. However, if the figures point to resurgence in optimism, price could ascend once again towards yesterday’s high of 6,903.82.