Eurozone Turmoil: Job Cuts, Industrial Strains, and Market Shifts Amid ECB and Tariff Tensions

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This morning, the German sovereign curve opened with minimal movement compared to the previous day. The specific changes included:

• 3M: +3.7bp

• 6M: +1.0bp

• 2Y: -1.2bp

• 5Y: -1.1bp

• 10Y: -0.2bp

  
  

Eroding Rate-Cut Expectations

The market's anticipation of a larger-than-expected ECB rate cut at the December 12 meeting has started to fade, with doubts over its accuracy growing. By Monday's close, overnight indexed swaps (OIS) reflected only a 34% probability of a rate cut exceeding 25 basis points. This marked a significant shift from Friday when weaker-than-expected services and manufacturing PMI data for the Eurozone led markets to price in a 50:50 chance of a 50bp cut. Concerns about the Eurozone's accelerating economic slowdown have tempered expectations of a more aggressive policy move.

Implied ECB Rate Cuts from OIS curve, 26/11/2024

Trump’s Tariff Plans and the Euro

U.S. President-elect Donald Trump has reaffirmed his intention to impose a variety of tariffs on goods from Mexico, China, and Canada. However, Europe was notably absent from his list, providing the euro with some temporary relief. While this omission might offer a short-term reprieve, Germany’s deep trade ties with China continue to fuel policymakers’ concerns over the potential fallout of a trade war between the world’s two largest economies.

Pre-Election Market Sentiment

Leading up to the U.S. elections, traders were pricing a 30bp rate cut on the OIS curve for the ECB’s December meeting. The weaker PMI readings, however, quickly reshaped market sentiment. By Friday, markets were already recalibrating, bracing for a potential 25bp to 50bp cut as fears of an economic slowdown intensified.

In conclusion, the Eurozone market dynamics remain volatile, influenced by shifting expectations around ECB policy and external pressures like U.S. tariff policies and global trade tensions. Stay tuned for more updates as we approach key central bank decisions.

Industrial Strains Highlight Structural Weakness

The struggles within Germany’s industrial sector have intensified, with Thyssenkrupp becoming the latest major player to signal trouble. Its steel division plans to cut 40% of its workforce by the end of the decade, reflecting broader structural pressures. This announcement follows Ford Motor decision to lay off thousands of workers and Volkswagen’s consideration of factory closures—a stark indication of the headwinds facing Germany’s manufacturing base.

These cuts underscore a troubling mix of factors plaguing the region:

• Stagnating investment

• Weak domestic demand

• Rising energy costs

  
  

Combined with the dismal November PMI readings, these issues heighten recession risks and add pressure to the ECB to act.

Risks for the Euro

The euro faces growing bearish sentiment amid these economic strains. Increasing concerns about a potential recession have pushed expectations of parity between the euro and the U.S. dollar closer to reality. Traders have also left room for further downside, as short positions in the currency continue to rise.

Political uncertainty compounds the situation. Germany’s snap elections and the transition to Trump’s administration in January add another layer of unpredictability. These factors may push the ECB further toward an expansionary monetary stance. Notably, policymakers have already hinted at the possibility of moving interest rates below the neutral level if the economic cycle worsens.

Outlook

As structural weaknesses in Germany become more pronounced, and with external risks like global trade tensions simmering, the eurozone’s economic outlook remains fragile. The ECB’s response will be crucial in shaping the trajectory of the euro and the region’s broader recovery. Traders and policymakers alike will be watching closely as these dynamics unfold in the months ahead.

Stay tuned for more insights into the evolving Eurozone landscape.