Sunday, May 2, 2010

Euroland: PMI signals rebound on track


Euroland Manufacturing flash PMI increased from 52.4 to 54.1 in February thus beating expectations (consensus 52.6, Danske 52.7) while service PMI declined to 52.0 from 52.5 (Consensus 52.5, Danske 52.6). Manufacturing PMI is now at the highest level since August 2007.

Composite new orders were flat at 53.6, but manufacturing new orders increased slightly from 56.0 to 56.5 and manufacturing new export orders increased strongly from 53.8 to 56.0 – the highest level since December 2006.

Inventories of finished goods increased slightly from 44.5 to 44.9 and inventories of stocks purchases were almost unchanged – up from 45.4 to 45.5. The order-inventory balance is thus coming down indicating that the pull from the inventory cycle is slowing.
Employment expectations increased strongly driven by a jump in manufacturing employment expectations from 43.9 to 47.0 and a moderate increase in service sector employment expectations from 47.5 to 48.4. The composite index is now at the highest level since September 2008.

German composite PMI increased from 54.2 to 55.4 and German manufacturing PMI increased massively to 57.1 from 53.4. This is a very comforting indication that the German rebound is still on track despite the lack of growth in Q4. The manufacturing subcomponents show that new orders and in particular new export orders increased strongly while stocks where almost unchanged. German service PMI increased from 51.2 to 51.7. German manufacturing sector employment expectations spiked from 42.1 to 47.3. Composite PMI indicates a stable German labour market.

French PMI composite index fell to 55.7 from 58.0 previously. This is the lowest level in five months, but still signalling strong growth. Manufacturing PMI fell from 55.4 to 54.6 and service PMI fell from 56.3 to 54.7. New manufacturing orders declined from 58.8 to 55.1 – the lowest level since August last year. New export orders increased slightly. At the same time the indices for stocks of both purchases and finished goods increased notably, thus the prospects of a growth contribution from the inventory cycle are diminishing. Employment expectations in the manufacturing sector improved from 46.4 to 49.3 and are thus very close to signalling a labour market stabilisation in France.

Assessment and expectations

This is comforting reading. The European rebound remains on track despite the disappointing Q4 GDP data. New orders currently indicate growth of about 2% q/q annualised in Q1 10. German manufacturing PMI looks particularly strong now. It finally overtook French manufacturing PMI as we have been waiting for. This makes a lot of sense as the German manufacturing sector would benefit the most from a strong rebound in global trade.

There are signs that we have seen the better part of the growth contribution from the end of inventory reduction. Luckily the export engine is still at full speed. This should be enough to get domestic demand on the move and initiate the more sustainable recovery that we are all waiting for. It is essential that we see a recovery in private demand materialise before fiscal tightening kicks in. Otherwise we are about to see a very slow recovery in Euroland. In this regard it is very comforting that the employment expectations index increased from 46.2 to 47.8 – thus not very far away from indicating labour market stabilisation.

The new orders index continues to signal ECB on hold but skewed toward rate hikes. We expect that the ECB to deliver a first hike in November. This is somewhat later than we had previously communicated (August 2010). The implementation of the ECB exit strategy is also likely to be gradual with the ECB keeping full allotment in place at all auctions in Q3.

Composite PMI now signals that unemployment should be in decline by almost 0.1pp per quarter. The employment index, which tends to be a lagging indicator, is more downbeat as it signals a 0.2pp increase in the unemployment rate per quarter. We believe that the truth is somewhere in between – i.e. we are close to a labour market stabilisation.
PMI new orders indicate that the two-year government bond yield spread to the refi rate is 0.5pp too low. This gap is unlikely to close quickly, but we expect to see two-year rates increase about 30bp on a three-month horizon.

Looking forward we expect to see further increases in PMI, but the picture has become more mixed. The order-inventory balance still signals that PMI has some upward potential as does the OECD leading indicator. Our PMI model, on the other hand, signals that we do not have much further to go.

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