Why VW is Bad for the Euro

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Market Drivers September 23, 2015

Euro approaches 1100 as EZ PMI in line
CNY PMI Manufacturing hits a fresh low
Nikkei closed Europe 0.59%
Oil $46/bbl
Gold $1127/oz

Europe and Asia:
CNY PMI 47 vs. 47.5

EUR EZ PMI 52 vs. 52.2

EUR EZ PMI Svc 54 vs. 54.1

North America:
CAD Retail Sales 8:30

There was a lot more volatility in Asian and early European trade today as slew of PMI reports hit the markets creating busy two way trade in Aussie and euro, while cable came under a very vicious stop hunt that saw the pair fall more than 70 pips in a matter of minutes as 1.5300 figure was tested.

In Asia the Caixin Flash Manufacturing PMI printed worse than expected at 47 versus 47.5 eyed and 47.3 the month prior. This was the worst reading since the credit crunch of 2008 and suggests that Manufacturing sector in China is seeing no uptick in demand at all. Almost all the subcomponents of the report decreased at a faster pace with Backlog of work the only bright spot in the release as it showed a rise.

The manufacturing sector in China remains in a steep contraction and that is likely to continue to weigh on Australia as the need for raw materials will remain limited. The Aussie dipped to 7020 in reaction to the news but found some support ahead of the key 7000 figure. The market remains divided about the extent of the impact of China with bulls arguing that the Australian economy can adjust by pivoting towards tourism and services, while bears continue to press the case that the country will fall into a recession soon precipitating further rate cuts from the RBA which could push AUD/USD towards the .6000 level.

Meanwhile in Europe the EZ Flash PMI readings came in just slightly lower than expectations with Manufacturing printing at 52 vs. 52,2 while services was at 54 versus 54.1 eyed. Both reports were slightly lower than the month prior but remained comfortably above the 50 boom/bust line suggesting that the EZ recovery remains steady. More encouraging was the rise in French PMI numbers which saw Manufacturing expand above 50 only for the second time in more than a year. If France could see a pickup in demand it could provide a counterweight to the slowdown in Germany, but the one unanswered question is how the recent problems with VW will impact German industry.

VW remains a key player in German manufacturing base and the spate of corruption and possible criminal charges facing the automaker could have widely negative impact on German industry as a whole. Already the German DAX has felt the wrath of investors as the equity markets sold off in the wake of the revelations about cheating the clean air standards. If the reputational damage begins to translate into much slower sales for VW globally, the knock on effects for Germany and the EZ could be very unpleasant.

All of this suggests that the ECB will have to maintain a highly accommodative monetary policy for the time being in order to offset any shocks to demand. That in turn explains the persistent weakness in the EUR/USD which has only seen anemic countertrend rallies so far and looks likely to test the 1.1100 level later in trading today.

The markets are continuing the play the monetary policy divergence theme as they anticipate that the Fed will hike rates in December while ECB will remain staunchly dovish.

With no US data on the docket today, FX flows may be driven by action in bond and equity markets with the dollar continuing to show a strong bid for the third day in a row.

Boris Schlossberg
Managing Director

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