Europe’s economy has withstood very large shocks, but June data is beginning to cast doubt on whether it can remain resilient against recession. The region also faces new uncertainty about next winter’s energy supplies and the ECB’s plans to protect the periphery as rates rise.
Europe’s June Purchasing Manager Indexes (PMIs) weakened across the board. Manufacturing growth had been coming down for months; in June, services, too, slowed more noticeably. Service providers’ new orders, backlogs, future business expectations, and employment all declined. Businesses have reported the fading of pent-up demand from the pandemic, as well as a fall in banking and real estate activity. Consumer confidence continued to deteriorate. The details of manufacturing PMIs were weaker. New orders were already in contractionary territory; in June, backlogs moved into contraction, too.
Euro zone consumer confidence indicators
Sources: European Commmission, Growth for Knowledge (GfK), National Institute for Statistics and Economic Studies (INSEE).
War refugees join the labor marketDespite strength in Europe’s labor market through the month of May, the more recent German unemployment rate reading for June showed a jump from 5.0% to 5.3%. The German labor agency said that this increase is due to Ukrainian refugees now being recorded by job search agencies. The European Central Bank (ECB) estimates that refugees can increase the European labor force by as much as 1.3 million people. While the refugee flows can help alleviate the labor shortage issues in the long run, in the short run refugee flows tend to be inflationary.
The euro zone headline inflation increased to 8.6%, while the core inflation ticked down to 3.7% year over year in June. Food inflation continued to rise at a rapid pace. The month-over-month increase in energy prices was small, but the annual inflation remains high at 41.9%. Services inflation eased a bit thanks to the temporary reliefs the German government introduced against the surging cost of living. Examples include cheaper public transport tickets and a cut to fuel taxes, which reduced transportation inflation. Starting in July, the renewable energy tax on power bills will also be removed, which is likely to pressure some inflation components lower. The other services components remained strong.
Concerns about gas supplies for winterRussian gas flows via the Nord Stream 1 pipeline came down significantly in June. The disruption is attributed to maintenance and is expected to last until late July. However, if the Russian supply is not restored by the end of July, Europe runs the risk of insufficient gas storage for the winter. Rationing of gas supplies, outlined as the third or “emergency” stage of the Emergency Gas Plan Germany implemented on March 30, is expected if the Russian flows do not pick up.
ECB’s rate increases could heighten fragmentation riskTurbulence in rate markets was high during June, and equally so in European rates. With the ECB getting more hawkish, German 10-year Bund yields rose on some days even more than the U.S. 10-year yield. The rise in Bund yields came with widening peripheral spreads.
At the June ECB meeting, the Government Council (GC) concluded that the conditions to raise interest rates had been met. The Committee intends to raise the policy rate by 25 bps in July and is gravitating toward a 50-bps hike in September, followed by a gradual but sustained path of interest-rate increases toward the neutral. Some members want to go beyond neutral. As long as inflation remains high and economic contraction is not in sight, the ECB is likely to continue increasing the policy rate.
Despite speculation, the ECB might introduce a new tool to prevent fragmentation (a sudden rise in sovereign bond yields of countries on the periphery, such as Greece, Italy, Portugal, Spain, and Ireland), the June meeting ended without an announcement. As the pressure on peripheral yields mounted, the ECB held an emergency meeting to address the spreads.
Source stories and ECB President Lagarde’s comments indicated that the tool would go into effect when spreads widened beyond certain thresholds. However, some hawkish GC members, have been cautioning against using tools to cap risk premia.
The new antifragmentation tool is proposed to be named “Transmission Protection Mechanism,” but it is not clear if it will be ready by the next ECB meeting on July 21. The tool would work by selling some securities to buy peripheral assets. Alternatively, banks that are selling the peripheral securities to the ECB will be required to hold the cash from the transaction at the ECB’s deposit facility.
Despite delays, peripheral spreads narrowed later in June, in part because of the ECB’s efforts to provide a backstop. Like the U.S., the region faces the difficulties of reducing inflation without further reducing growth, but with the added risk of fragmentation.
This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon as research or investment advice regarding any strategy or security in particular. Any mention of specific securities is intended to help illustrate Putnam’s research process and should not be considered a recommendation or solicitation to purchase or sell the securities. Potential market trends and opportunities were selected without regard to whether such trends and opportunities, or relevant securities, were profitable and are intended to help illustrate our investment and research process. It should not be assumed that any investment in these securities was, or will prove to be, profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are currently held in a Putnam portfolio or that securities sold have not been repurchased. The securities mentioned are not necessarily held by Putnam for all client portfolios.
This material is prepared for use by institutional investors and investment professionals and is provided for limited purposes. This material is a general communication being provided for informational and educational purposes only. It is not designed to be investment advice or a recommendation of any specific investment product, strategy, or decision, and is not intended to suggest taking or refraining from any course of action. The opinions expressed in this material represent the current, good-faith views of the author(s) at the time of publication. The views are provided for informational purposes only and are subject to change. This material does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Investors should consult a financial advisor for advice suited to their individual financial needs. Putnam Investments cannot guarantee the accuracy or completeness of any statements or data contained in the material. Predictions, opinions, and other information contained in this material are subject to change. Any forward-looking statements speak only as of the date they are made, and Putnam assumes no duty to update them. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those anticipated. Past performance is not a guarantee of future results. As with any investment, there is a potential for profit as well as the possibility of loss.
This material or any portion hereof may not be reprinted, sold, or redistributed in whole or in part without the express written consent of Putnam Investments. The information provided relates to Putnam Investments and its affiliates, which include The Putnam Advisory Company, LLC and Putnam Investments Limited®.
For informational purposes only. Not an investment recommendation.
This material is provided for limited purposes. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Putnam product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice. The opinions expressed in this article represent the current, good-faith views of the author(s) at the time of publication. The views are provided for informational purposes only and are subject to change. This material does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Investors should consult a financial advisor for advice suited to their individual financial needs. Putnam Investments cannot guarantee the accuracy or completeness of any statements or data contained in the article. Predictions, opinions, and other information contained in this article are subject to change. Any forward-looking statements speak only as of the date they are made, and Putnam assumes no duty to update them. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those anticipated. Past performance is not a guarantee of future results. As with any investment, there is a potential for profit as well as the possibility of loss.
Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
Putnam Retail Management.