Fed Rate Cuts Can't Heal Europe's Economic Wounds
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The recent unexpected interest rate cut by the Federal Reserve has sent ripples of enthusiasm across the European capital marketsOn September 19, European stock indices soared collectively, with the Eurozone’s Stoxx 50 blue-chip index closing up by 2.24%. The broader Stoxx 600 index also performed strongly, with a closing figure of 521.67 points, edging closer to its historical high of 525.05 points achieved on August 30. A standout performer was the German stock market; the DAX index opened significantly higher following the announcement of the rate cut and maintained a bullish trajectory throughout the dayNotably, this drive propelled the index to surpass the 19,000-point milestone for the first time in history.
Historically, European equities have responded positively to rate cuts by the FedInvestors tend to view such reductions as catalysts that ignite interest in assets like stocks, primarily because lower borrowing costs can encourage business investment and expansion
Moreover, rate cuts typically benefit the bond and real estate markets, which might enjoy increased mortgage demandThis optimistic sentiment, however, does require some nuanceThe impetus for such cuts must be evaluated — if they are sparked by fears of a potential recession in the U.S., the implications can be much graverTraders, however, appear to maintain an optimistic outlookSteven Bell, Chief Economist for Europe, the Middle East, and Africa at Columbia Threadneedle Asset Management, commented, “We don’t see any catalysts for a downturn, so for now, we’re enjoying the process.” Raphael, Capital Markets Strategy Director at Tickhau Asset Management in Paris, added, “The risk of policy missteps is always present, but we will only know in the futureOverall, the positive backdrop that has driven European stocks to reach historical highs still exists.”
Despite the buoyant stock market sentiment, the macroeconomic scenario in the Eurozone presents a stark contrast
- Signs of Economic Slowdown in the UK
- Increased Uncertainty in Global Capital Markets
- Surge in U.S. Bond Yields
- Reflections on Stock Valuation
- Is the January Effect in the Stock Market Real?
On September 23, a survey conducted by S&P Global and Hamburg Commercial Bank indicated that the Eurozone’s manufacturing Purchasing Managers’ Index (PMI) for September came in at an initial reading of 44.8, falling short of market economists' median expectations of 45.6. The services PMI also declined to 50.5, significantly below the anticipated 52.4. Consequently, the composite PMI for the Eurozone dropped to 48.9, again undershooting expectations (50.6), marking an eight-month low.
What’s more alarming is that the private sector in the Eurozone has recorded its first contraction since March this yearThis development intensifies concerns regarding the region's economic recovery prospectsEven though inflation is easing and wages are rising, consumers are displaying a cautious demeanor, reluctant to ramp up spendingAdditionally, sluggish external demand has placed greater pressure on Europe’s manufacturing sector, particularly German factories
The struggles faced by German automakers like Volkswagen exemplify this issueCyrus DeLaRubia, an economist at Hamburg Commercial Bank, remarked, “The Eurozone is heading toward stagnation,” emphasizing that the rapid decline in backlogged and new orders indicates that economic activity will likely continue to weaken, signaling even greater economic challenges in the forthcoming months.
Analysts generally attribute the Eurozone’s economic malaise to the underperformance of major economies like Germany and FranceGermany’s manufacturing sector is grappling with a multitude of challenges that include weak global demand, increasing foreign competition, and domestic structural issuesIn September, Germany’s composite PMI slid from 48.4 to 47.2, indicating an acceleration of manufacturing contraction, while the service sector is nearly stagnantGermany, being the largest economy within the Eurozone, presents a significant drag on the recovery of the entire region.
Simultaneously, France is experiencing a noticeable slowdown in economic momentum
Although the Paris Olympics briefly provided an economic boost, that rebound effect disappeared swiftly, leading to a significant decline in service sector activityOverall, France's composite economic activity indicators reflect that after the growth observed in August, the economy finds itself contractive once again, with the service sector particularly hard hit, showing a decline in growth.
The complex and severe geopolitical realities add a layer of urgency for European policymakersTwo days after the Fed’s rate cut, European Central Bank President Christine Lagarde pointed out during a speech at the International Monetary Fund headquarters that “Europe is facing the most severe pandemic since the 1920s, the most serious conflict since the 1940s, and the gravest energy shock since the 1970s.” These compounding disruptions, particularly ongoing supply chain issues, have irrevocably altered the operational dynamics of the global economy.
Faced with intertwined internal and external challenges, the prospect of further rate cuts to stimulate economic activity has become a heated topic of discussion among market participants
Some analysts believe that with the Fed’s decision to cut rates, the 50 basis points aggressive reduction has opened up greater accommodative space for other central banksStefan Gerlach, Chief Economist at Swiss Bank Yngson, opined that although the European Central Bank has consistently opposed the option of consecutive rate cuts, the significant reduction by the Fed might prompt the ECB to consider lowering rates again next month, marking a potential third cut since June.
However, there is considerable dissent against the idea of the European Central Bank merely mimicking the Fed’s movesDirk Schumacher, an economist at French Trade Bank, asserted that unless the Fed's rate cuts yield tangible impacts on the Eurozone's fundamental data, the notion that the ECB needs to follow up with rate cuts in October purely based on the Fed's action is absurd and would not be accepted by ECB management.
The stubbornness of persistent inflation poses significant constraints on the ECB's decision-making