Euro 8217 s German Rally

As the US debt ceiling deadline approaches and the US govt remains partially shut for the third straight week, figures from Germany remain robust. The Bundesbank said last month Germany’s economy had an “extraordinarily good” consumer climate, supported by the lowest unemployment rate in over 20 years.

Germany’s major business and sentiment surveys have strengthened markedly. Ifo Business confidence rose for a fifth straight month in September to the highest level since April 2012, ZEW investor sentiment climbed hit a three-year high and GfK consumer confidence hit six-year highs. Tuesday’s release of the Oct ZEW survey will be closely monitored and whether its expectations index will rise for the sixth straight month.

Three weeks after storming Parliament with the biggest share of the vote in 23 years, Angela Merkel’s Christian Democrats (311 seats in lower house) are set for their third meeting with either the Social Democrats (193 seats), or with the Greens (63 seats) to complete talks forming a ruling coalition. Merkel will firmly insist on her opposition to income tax increases and joint Eurozone bonds, while allowing ground for accepting a statutory minimum wages.

Yet, neither the SPD nor the Greens are in a great hurry to join Merkel’s CDU. The SPD will decide next Sunday whether to enter into formal negotiations with Merkel’s CDU/CSU bloc. But there exists the possibility that Merkel will remain without government by end of November. Such would be a daunting political reality for the Eurozone, considering Italy’s close shave with a parliamentary dysfunction 2 weeks ago.

Euro’s Disinflationary Risk

Looking ahead, currency traders are reaching the point when the euro’s valuation raises question about excessive strength and complacency. The economic contraction continues to ease (but remains) in Greece, Italy and Spain, while the ECB’s latest worry is not a default or a failed bon auction, but endangering the recovery with a rapid jump in bond yields. Markets are aware that any talk of LTRO will or renewed rate cut is simply a rhetorical trick to talk down yields rather than a warning of current conditions. One aspect of worry is the 1.1% inflation- the lowest in 3 ½ years. For a central bank widely focused on price stability, this presents a clear challenge. The recovery in Germany did not help raise prices. ECB president Draghi may consider a few interventionist words to rein the euro’s appreciation and avoid the risk of disinflation.

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