Europe’s recovery and Greece’s ‘special case’

Although the euro is now headed up after it overshot to the downside, I believe the European recovery has legs and will continue indefinitely as long as a calamity in Greece doesn’t pull Europe down.

Markit came out with a number of important figures for Europe’s economy today. Here are the headline numbers for the Eurozone, Germany and France:

• The Flash Eurozone Services PMI Activity Index rose to 54.3 in March from 53.7 in February
• The Flash Eurozone Manufacturing Activity Index rose to 53.5 in March from 52.1 in February
• The Eurozone Composite Index hit a 4-year high at 54.1 in March
• Flash Germany Services Activity at 55.3 in March vs. 54.7 in February
• German Manufacturing PMI at 8-month high of 52.4 in March vs. 51.1 in February
• German private sector composite index now at 55.3 for March, output increased at the strongest rate in 8 months
• French private sector composite output index at 51.7 in March vs. 52.2 in February, 2nd straight month above 50
• France Services Activity Index at 52.8 in March from 53.4 in February
• French Manufacturing still below 50 at 47.1 in March vs. 47.0 in February

Most of these numbers show a recovery that is gathering steam. This is certainly true in both Germany as an individual country and the Eurozone as a whole. France’s recovery is still somewhat uneven, however. As I wrote 11 days ago about upgrading German and European growth prospects, we are seeing a basing effect in the eurozone, combined with a lift from lower oil prices and a tail risk under-girding from quantitative easing. Think of QE as a bridge to a longer-term growth strategy and the implementation of a more resilient institutional architecture.

The truth, though, is that we have heard very little of late about changing the Eurozone’s institutional architecture. And that’s worrying because it signals that there is no political appetite for this. And without changes, we are going to be in crisis when the next cyclical downturn hits. The anemic growth in France and Italy as well as the political radicalization assures this.

Right now, the crisis focus is on Greece. And I think it is fair to say that Greece has been successfully isolated as a special case. If one looks at market-based measures of distress like CDS levels, bond yield and bond spreads, Greece is completely decoupled from the rest of the periphery. So what is happening there is having no market impact. It is the political impact that we need to assess.

If Greece doesn’t make it through the 4-month bailout extension into a new agreement as I believe is highly likely given the Greek government’s political mandate, we will see a default within the eurozone and capital controls. It is hard to gauge what this means for markets, for the economy or the politics. However, I believe Greece has been well isolated and that a default in and of itself is not something that will lead to catastrophe. If the default does not lead to Greece’s departure from the eurozone, it could end up being the best outcome in that it reduces the NPV of Greece’s loan payments but minimizes redenomination risk elsewhere in Europe.

Politically, we need to gauge France, Italy, Ireland, and Spain regarding radicalization and the move toward anti-euro factions. But I think this is mostly relevant when the economy is headed down. And right now it is headed up. For now, I think we can look at upside in EUrope, rather than downside, Greece notwithstanding.