Polarity in the European economy

Polarity in the European economy, German economy improves while further deterioration is recorded in the French economy.

Europe's composite PMI (preliminary estimate) dropped unexpectedly in February to a level of 47.3, compared to 48.6 in January and expectations for a rise to 49.0. The decline, following three months of increases, signals the expectations for further economic contraction in the first quarter of 2013.
France's composite PMI continued to decline to a level of 42.3 (42.7 in January) and it indicates a further quarterly contraction of the second largest economy in Europe. Germany's composite PMI declined to a level of 52.7 (compared to 54.4 in January), but its relatively high level is still encouraging.

More in Germany, The ZEW and IFO surveys also indicate the expected recovery of the German economy during the first quarter of 2013, following a quarterly sharp drop of 0.6% during the fourth quarter of 2012. The Business Climate of the IFO survey rose for the fourth consecutive month to its highest level in ten months. The IFO survey examines managers’ expectations in the manufacturing and services sectors. The ZEW survey, which examines investors' assessments of the economic situation in six months, jumped to its highest level since April 2010.

To summarize our comments regarding the European economy, we note that the European Commission lowered last Friday its forecast for growth in 2013 to a level of 0.3%, compared with the previous forecast in November 2012 to an expansion of 0.1%. According to the new forecast, the German economy will grow in 2013 by approximately 0.5% and the French economy by 0.1%. The Commission expects the French deficit will be higher than the government's target (3.7% of GDP compared to a target of 3.0%), another indication for the growing concerns of the developments of the French economy.

Fed signals a possibility for a sooner than expected end of QE3

Is the Fed changing its approach? The Fed's January interest rate decision minutes indicated the committee members’ change of approach. According to the protocol, "many participants also expressed concerns about potential costs and risks arising from further asset purchases". Moreover, the minutes revealed that some participants argued that it might be time to reduce the volume of purchases, regardless of the pace of recovery in the labor market, while examining "the efficacy and costs of such purchases". Until recently, markets assumed that the Fed would continue the program of bond purchases until the unemployment rate drops to a level of approximately 7.0%, but now there is a big question mark around that assessment. According to the minutes, the Fed will examine the asset purchases in its next meeting in March, with hopes that Fed Chairman, Ben Bernanke, will provide more insight regarding the move next week, during the semi-annual Congressional testimony. We note that immediately after the publication of the minutes, U.S. stock indices fell sharply, the dollar strengthened and Treasuries yields actually declined. All that in light of the risk increase in the markets and despite fears that the Fed will reduce the volume of U.S. debt purchases.

U.S. politicians continue to wrestle on the issue of the automatic cuts ("sequester") which are supposed to apply at the beginning of March. If no compromise is reached soon, some transverse automatic cuts will take effect, totaling at approximately $85 billion in 2013 and approximately $1.2 trillion over the next decade.

President Obama held a press conference last week to increase the political pressure on Republicans. Obama required the approval of Republicans (who control the Congress) to postpone budget cuts. Obama stressed that these cuts “are not smart, they are not fair, they will hurt our economy and they will add hundreds of thousands of Americans to the unemployment rolls". Recall that the U.S. Budget Office estimates that the U.S. economy will grow this year by 1.4%, mainly due to taxes increases in the beginning of the year and the expected spending cuts.

Economic releases and events of the week

• Sunday: general elections in Italy on Sunday and Monday
• Monday: U.S. Conference Board Consumer Confidence for February
• Tuesday: Fed Chairman two-day semi-annual congressional testimony starts, U.S. Durable Goods New Orders for January
• Wednesday: Eurozone Consumer Confidence Indicator - final estimate for February, Eurozone Economic Sentiment Indicator for February, ECB's president Speaks in Munich
• Thursday: second estimate for U.S. GDP growth in the fourth quarter of 2012, expectations for a growth of 0.5% vs. -0.15 in the preliminary data
• Friday: U.S. Personal Income and Personal Spending, both for January, U.S. ISM Manufacturing PMI for February, Germany Retail Sales for January, Eurozone Unemployment data for January, Manufacturing PMI in the Eurozone and China - final estimate for February