Germany’s DAX Index has soared 11% since the beginning of November. Yields on French 10-year government bonds have eased from 3.5% in October to 2.8%. Even Italian Bonds dipped below 4% from a 5% yield earlier this year.
If this economic picture is so rosy, why are economists from Europe to the New World so worried?
The answer is that Europe’s economy is extremely weak and the European Central Bank will surely drop their interest rates shortly in a preemptive bid to try stopping a major recession. Germany’s economy, the largest in eastern Europe, already fell into a recession earlier this year.
European bond markets are currently pricing in two rate drops by next June and another three before October. This would bring their main interest rate down to 2.75%.
Economists have two primary areas of concern…
Wage Growth
European wage deals in its highly unionized environment are normally carved in stone for multiple years. As a result, when inflation peaked last year, Germany’s real wages basically dropped to their 2015 levels when accounting for price increases.
Lower wages mean less spending, which normally translates into an overall recession, but they’re now recovering lost ground.
And if wages continue to grow, we might see another uptick in inflation which would be similar to what happened here back in the 70’s. This would in turn probably require the European Central Banks to again raise interest rates in a few months when they might be in the middle of a recession.
That would be a catastrophe.
The Health of The Overall Economy
Europe has been fighting a slump in demand, especially from China, and soaring energy prices for quite some time. The consumption booms in many portions of Europe are fading quickly. Higher interest rates have slowed purchasing and consumption in both the business and personal sectors.
It should be noted that many Europeans rely even more heavily on financing purchases than we do in America. Given the payroll taxes many pay being as high as two thirds of their gross paycheck, they cannot save to make even the medium-sized purchases that most Americans would never consider financing.
As such, higher interest rates affect the spending habits of Europeans more than they do back here in the good old US of A.
Let me leave you with this.
Why is this important? Why am I writing about the European Economies? Am I just a hopeless Europhile? Am I thinking about moving?
Please understand that our economy and the economies of our closest trading partners are so intertwined that when they have a problem, we’ll have one as well. If the whole of Europe recesses, so will we.
This is true of any of our major trading partners; especially China. People used to say that when America sneezed, the whole world caught a cold. But the opposite is now true as well.
This is my way of telling everyone to be conservative and cautious. We aren’t out of this mess by a long shot.
Horde your cash like a Viking King. Trim the fat. Be conservative in your planning. Hold off on initiating new projects.
The current stock market rally we’re seeing in the US shouldn’t be considered an overall indicator of our economy. Look at what’s happening in Europe with the German DAX.
Stock market’s usually rally after Central Banks stop raising interest rates. They normally do this about 5 months before a recession begins.
Be careful. The business you save might be your own.
We’re all going to get through this. Let’s get through it together.
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