Cyclical Lift and Policy Stimulus Support European Risk Assets

Cyclical Lift and Policy Stimulus Support European Risk Assets
author-image
Author:
PUBLISHED:
TAGS:

Cyclical Lift and Policy Stimulus Support European Risk Assets

The eurozone composite Purchasing Managers Index (PMI), a key high-frequency indicator of growth in the region, took a step back in July, falling 0.5 points to 53.7 and erasing June’s gain. The deterioration comes after a decline in consumer confidence in the month, and a reported decline in industrial production in May.

We would not get carried away with the signal from these data. Production in the spring was affected by volatile developments in the mining sector. Consumer confidence remains elevated despite the decline. And, looking through monthly volatility, the eurozone PMI remains consistent with above-trend growth of 1.5%–2% in annualized terms (see chart).

Greece was casting a shadow on the cyclical outlook in Europe; but, with a deal now reached with lenders and key parliamentary votes passed in Athens, we think Greece should not have a big influence on the business cycle.

In this context, we believe there are four reasons to think that eurozone growth will likely remain above-trend in coming quarters.

  • Fiscal conditions have improved, with the fiscal stance in the region finally being neutral this year after many years of consolidation.
  • Credit conditions are improving meaningfully, partly on the back of the European Central Bank’s (ECB) quantitative easing program.
  • A weaker euro is helping the external sector.
  • Lower oil prices are helping household incomes.

From an investment perspective, the combination of solid growth, significant policy accommodation and improvements in Greece – for now at least – bodes well for risk assets in the eurozone.

In our view, Italian and Spanish government bond spreads to German Bunds have room to compress further from the current level of around 120 basis points, partly on the back of continued asset purchases by the ECB, which we think will continue until September 2016 at least. Corporate credit is not cheap in absolute terms, but we think the asset class should offer attractive returns in the current environment of good growth and significant policy support. Banks in particular offer interesting opportunities in this context, following the significant recapitalizations of recent years. Finally, we believe European equities should also perform well ahead, bolstered in part by a good earnings season.

SHARE THIS

PIMCO’s industry-renowned experts analyze the world’s risks and opportunities, from global economic trends to individual securities.

RECENT POSTS

By Month

Categories

Disclosures

Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. Equities may decline in value due to both real and perceived general market, economic and industry conditions.