"Market Underestimates Eurozone Economic Weakness, Says Nomura"

As the economic slowdown in the eurozone intensifies, market attention is focused on the European Central Bank's (ECB) interest rate decision on the 17th of this month, with expectations for a rate cut heating up.

On the 9th, Nomura Securities pointed out in a research report that while the market has gradually reflected expectations for a slowdown in the eurozone economy, there is still an underestimation of the risks of economic recession and the scale of the ECB's rate-cutting cycle.

Nomura forecasts that the ECB will cut the deposit rate by 25 basis points to 3.25% in October and expects a total of 175 basis points in rate cuts by 2025.

Goldman Sachs shares the same view on the ECB's October interest rate decision and believes that Europe's weak economy, diminishing inflationary pressures, and the ECB's dovish inclination provide support for a rate cut.

Nomura: The market underestimates the risk of a eurozone recession

Nomura's judgment on the future of the eurozone economy is relatively pessimistic, believing that the market underestimates the possibility of a recession.

Although mainstream economists estimate the probability of a recession in the eurozone within the next 12 months to be 30%, Nomura raises this probability to 40%. The bank points out that unless the eurozone labor market relaxes quickly (such as companies stopping the hoarding of labor), or geopolitical tensions escalate suddenly, there is no obvious direct cause for an economic recession in the short term.

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The report notes that the swap market expects the ECB's deposit rate to fall below the neutral rate level within the next two years. Based on the spread between 1-year and 5-year swap rates, the market believes that the ECB needs to maintain an accommodative monetary policy to address the downside risks to economic growth.Specifically, the current spread is at -30 basis points, while before the release of the US labor market report, the gap had approached 50 basis points.

However, Nomura believes that in a soft landing scenario, the policy rate will return to a neutral level, rather than falling below the neutral level.

The market has overpriced the neutral rate (5-year 1-year swap rate = 2.45%), and this will become increasingly apparent as persistent inflationary pressures subside. We are becoming increasingly convinced that the neutral rate may be lower than market expectations.

Nomura expects that consumer growth in the Eurozone will be weak in 2024 and 2025, with the Eurozone economy growing by only 0.7% in 2024 and only slightly rebounding to 1.0% in 2025.

 

Is a rate cut next week a "done deal"? Nomura: The ECB may initiate a series of rate cuts, putting pressure on the euro and European stocks.

 

Previously, several high-ranking ECB officials have spoken out in favor of a 25 basis point rate cut in October. ECB President Lagarde has expressed increased confidence in controlling inflation. Nomura believes that the ECB will adopt a steady rate-cutting strategy in the next policy cycle to address slowing growth and waning inflationary pressures.

Nomura expects that the European Central Bank will cut the deposit rate by 25 basis points to 3.25% on October 17th. This decision is mainly due to lower-than-expected HICP (Harmonized Index of Consumer Prices) inflation in September, deteriorating economic growth prospects, and central bank officials' speeches that tend to support rate cuts.

Furthermore, the ECB will start a series of rate cuts in October 2024, cutting rates by 25 basis points each time, until June 2025, ultimately reducing rates to 1.75%. Overall, the ECB will cut rates by 175 basis points next year, while the market only expects a cut of 145 basis points.Under these circumstances, the Euro/USD will face greater resistance. This is because the strong performance of the US employment report has intensified market skepticism about a rate cut by the Federal Reserve in November, while the European Central Bank is expected to cut rates again in October. The status of the Euro as the best funding currency among G10 countries is further consolidated.

In terms of the stock market, although the Euro Stoxx 50, a major European index, is still close to its historical high, Nomura's research report points out that the demand for stock downside protection among investors in the options market has risen significantly, indicating that the market is becoming increasingly aware of economic downside risks. This increased aversion to risk reflects, from the side, the market's concern about the economic prospects of the Eurozone.

Specifically, since mid-July 2024, the rise in the volatility of Euro Stoxx 6-month 10 Delta put options relative to call option volatility has been significant, a change similar to market performance during the 2015 European debt crisis. Nomura's analysis suggests that this may be an early signal of fatigue appearing after the strong performance of the European stock market. If this trend continues, it will have a self-reinforcing negative effect on the economic slowdown in the Eurozone.

Goldman Sachs: Economic weakness, reduced inflation pressure, and the ECB's dovish inclination support rate cuts.

Similar to Nomura's view, Goldman Sachs also believes that the ECB will announce a 25 basis point cut in the deposit rate at its meeting on October 17. In a research report on the 10th, Goldman Sachs stated that this expectation is based on three main factors:

First, weak European economic activity data. Goldman Sachs pointed out that since September, European economic activity data has further weakened. The PMI fell sharply in September, with the composite PMI falling below 50. National surveys such as Germany's Ifo survey also confirmed this weakening momentum. In addition, future surveys indicate a bleak outlook for economic activity.

Second, wage and inflation pressures have eased. Goldman Sachs stated that compared to the September forecast, the slowdown in wages and inflation has been faster. Wage growth was strong in the first quarter, but the main wage indicators cooled in the second quarter, falling from 4.7% to 4.2%, and are expected to further decline to 3.9% in the third quarter. Recent inflation data also shows greater progress than expected, especially with core inflation falling in September and expected to remain weak in October and November.

Finally, the dovish rhetoric released by the European Central Bank further supports rate cuts in the Eurozone. President Lagarde pointed out in her speech at the European Parliament that recent data has strengthened the Council's confidence in inflation returning to 2%. Other Council members also acknowledged that the downside risks to growth are beginning to emerge and generally support a 25 basis point rate cut in October.