Trading the Euro and Eurozone Economic Growth with PMI and ZEW

Last Updated on June 18, 2020 by Mark Ursell

The ZEW Indicator

The German ZEW Indicator of Economic Sentiment is a popular indicator for traders and investors looking for information about the strength of the eurozone’s biggest economy.  On Tuesday 19 February 2013 the ZEW beat expectations significantly and posted the highest level since April 2010. This article looks at the past history of the ZEW as a guide for GDP growth and how it can be used to guide trading and investing decisions.

The ZEW state the following about their indicator:

“The ZEW Indicator of Economic Sentiment is ascertained monthly. Up to 350 financial experts take part in the survey. The indicator reflects the difference between the share of analysts that are optimistic and the share of analysts that are pessimistic for the expected economic development in Germany in six months.”

via ZEW Financial Market Survey.

Comparing the ZEW with GDP Growth

I wanted to see how the ZEW indicator has performed as an early indication for the German economy and also the wider eurozone economy. I have looked at the data for the past five years comparing the ZEW with final quarterly GDP growth for both Germany and the eurozone.  The ZEW data has been scaled to match the GDP growth figures.

The results in the chart above show that the ZEW has been a useful guide to the direction of both German and eurozone GDP over the past five years. The correlation between the ZEW and the German and eurozone GDP growth over this period is 0.43 and 0.34 respectively.  It is also interesting to note how closely German GDP growth has matched eurozone growth; these two have had a 0.95 correlation over the past five years.

Looking at the chart we can see the matches between the data. In late 2008/early 2009 the ZEW bottomed out, well before the GDP figures did – incidentally at an excellent time to invest in stocks.  Observing the decline in the ZEW during the record German GDP growth in Q2 2010 would have shown that the pace of growth was bound to slow.

Recent Trends

The most recent data is the second largest 3-monthly change in the ZEW in the past five years indicating a very strong change of mood from fairly pessimistic to strongly optimistic. Given that the ZEW has tended to precede changes in the GDP growth rate it is likely that German (and also the eurozone economy) will see a significant improvement in growth in Q1 2013 (the flash GDP growth will be reported in the middle of May 2013).

Conclusions

The lack of GDP growth in Europe over recent years has been a major concern for the markets. An improvement in GDP growth will help to ease concerns about weak banks and over-indebted governments.  It will also help to reassure markets that the euro can survive as a viable currency for the current and future members of the monetary union. However, GDP growth is only one factor that moves financial markets and other economic and political factors also play a major part in moving prices.

Forex Market

If German and eurozone growth GDP does increase at a decent pace in Q1 2013 this will provide support for the euro. The ECB tends to be the most conservative of the main central banks and growth in German GDP will put pressure on the central bank to avoid further monetary easing. If there is growth in eurozone GDP, especially in the weaker periphery, this could encourage a gradual tightening in monetary conditions (for example through quicker repayment by banks of the LTRO funding).

Markets try to predict the market changes so if the economic data continues to show growth then the euro is likely to find support.

Trade Ideas: If eurozone economic data continues to improve then trading the euro against the commodity dollars could be good long-term trades.  Long EUR/AUD, EUR/NZD and EUR/CAD.  Particularly if there are signs of weaker economic growth in any of these countries.

Equity Markets

The effect of the higher German and eurozone GDP growth would be a positive factor for stocks. The eurozone is a major part of the world’s economy and has had very weak growth in recent years. It would be particularly beneficial for eurozone stock markets and individual companies that have been badly affected by the recession and loss of confidence in the euro.

Trade Ideas: If eurozone economic data continues to suggest growth then there could be good buying opportunities in European stock markets, particularly markets in the periphery. The CAC-40, IBEX and Italy-40/Italy-30 indices are still well down on the 2007 highs.  Also look for good companies operating in currently weak sectors such as consumer products, housing and banks.