June PMI data reveals challenges in German industry and impacts the euro

Euro drops below 1.07 amid weak PMI data in Europe

by Faruk Imamovic
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June PMI data reveals challenges in German industry and impacts the euro
© Getty Images/Sean Gallup

The weak preliminary June PMI (Purchasing Managers Index) data in Europe reflect a crisis in the German industrial complex, not only caused by electoral uncertainty. This situation will also have an impact on the euro (EUR) in the short term, as the euro is also suffering from electoral uncertainty in France. We maintain our view that the EUR/USD is moving towards around 1.05.

Germany and the impact on the euro

In Germany, industrial production has been declining continuously for six years. This development is due to several factors: energy shortages, public policies aimed at decarbonization and the costs associated with it, the decline in demand for capital goods from China due to construction abandonment there, growing competition from the United States thanks to tax subsidies and other incentives, and a drastic loss of market share in the automotive sector to China. Germany's global auto exports have fallen to about 3 million units from 4.5 million units per year before the pandemic, while China's exports have risen to 5 million from 0.9 million. China is flooding the market with cars in regions where German brands were previously more dominant, including Russia, Mexico, the UK, Australia and the Middle East.

These structural issues in Europe's manufacturing industry are expected to play out for years to come and continue to weigh on PMI data. In addition, protectionist tendencies are increasing as governments seek to protect their industries and the political landscape becomes increasingly polarized. For example, Canada, which is integrated into North American auto supply chains, is now also preparing a series of tariff-based restrictions on China.

PMI data from Europe hurt the euro this morning, and it is now well below 1.07. Our view is that EUR/USD is moving toward around 1.05. Even after the French elections, it will be difficult for EUR/USD to launch a structural rally, with the ratio likely settling around 1.05. Notably, the UK PMI Composite was also weaker than expected, mainly due to a slump in the services sector. However, traders were less inclined to push the GBP lower than the EUR, perhaps because they were already convinced by the Bank of England's more dovish stance the day before.

USD/EUR
USD/EUR© Getty Images/Dan Kitwood
 

Claudia Sheinbaum and economic stability in Mexico

In Mexico, President-elect Claudia Sheinbaum's cabinet selections have helped cement her economic policy credibility. Her appointments indicate a commitment to fiscal responsibility and central bank autonomy, which has calmed markets. Mexico's central bank Banxico is expected to focus on peso (MXN) stability on June 27, and we expect the USD/MXN ratio to stabilize around 17.50.

Sheinbaum's appointments, particularly that of Marcelo Ebrard as economy minister, have boosted market confidence. Ebrard was an early contender for the presidential nomination within Sheinbaum's MORENA party and is expected to run in 2023. Combined with the re-nomination of Rogelio Ramirez de la O as finance minister, Ebrard will not support policies that could harm Mexico's growth over the next six years.

Despite the large budget deficits projected for 2024, Sheinbaum is expected to push tax reforms and structural changes in fiscal management to regain investor confidence. However, she has rejected comprehensive tax-based reform and would instead favor selective tax increases and spending cuts. A deficit of 3.5% of GDP in 2025 would not be a disaster for Mexico and would be roughly comparable to deficits of the post-pandemic era.

Mexico's debt-to-GDP ratio is low compared to other emerging markets and most developed countries, at around 50% of GDP. The country is relatively immune to negative trade shocks, including oil price shocks. The initial market turmoil following the general election in June suggested that the current government of President Andres Manuel Lopez Obrador (AMLO) would be able to push through its reforms without opposition from Congress. However, the new cabinet selections suggest that fiscal responsibility and the autonomy of the central bank are being respected, which is bolstering market confidence.

Claudia Sheinbaum
Claudia Sheinbaum© Getty Images/Hector Vivas
 

Political risks in Brazil

In Brazil, on the other hand, the erosion of the independence of the Central Bank (BCB) continues, worrying markets. President Luiz Inácio "Lula" da Silva has again expressed his dissatisfaction with the central bank's policies. There are concerns that Lula will put a compliant successor at the head of the BCB. The main problem for the Brazilian real (BRL) remains the politicization of monetary policy. We forecast the USD/BRL ratio to rise to 5.50 by year-end.

Lula's administration has a strong influence on industrial policy and could push Brazil increasingly towards China as the global economy continues to deglobalize. These factors contribute to us having lost confidence in the stability of the BRL and expect the USD/BRL ratio to continue to rise in 2024. Lula has criticized the BCB's high interest rates, arguing that these policies only favor the financial market and speculators while ordinary Brazilians suffer.

The independence of the BCB remains a key concern, and Lula is expected to appoint a more dovish candidate as the new BCB governor, which could threaten Brazil's long-term economic stability and create further uncertainty.

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