Peter Schaffrik:
Welcome back to European Markets. My name is Peter Schaffrik and today is the 4th of September 2024. I hope you had a good summer. I was here all summer and the volatility was quite tough. Didn't really feel like summery markets. But now we're back and we face quite different challenges. So let's look at them. We're recording this two days before what is probably going to be the most important nonfarm payroll print out of the US, and also about one week ahead of the next ECB meeting. Leaving the US aside for a second, we think that next week will bring another 25 basis points of rate cuts, and the market thinks so too.
However, quite a few ECB speakers have been stressing the latest economic weakness that is coming through. Whilst others are stressing domestic price pressures. The curious thing is, we think both have a point. So let's take a look at that. What we've seen lately is quite a significant chasm opening up between manufacturing and services. You can see that very clearly in the chart on the screen at the moment. It shows the so-called purchasing manager indices, which are good leading indicators for GDP, broken down into those two segments. And as you can see, both of them were starting a recovery at the beginning of the year, but only one of them, services, has continued to recover into expansionary territory. Manufacturing remains firmly below the 50 divide and remains in a recession. Where does that come from? We think it has a lot to do with China.
The latest developments and how Chinese firms behave these days in international markets. In fact, we’ll single out three main things. First, the Chinese domestic weakness. Their domestic economy is in trouble, forces the Chinese firms into the international markets, and it creates overcapacity, which means they can sell at cheaper prices. Secondly, the Chinese firms have upstreamed over the last decade or so. Whereas back in the 90s and the early 2000s, they were competing on lower tech segments in the market, they're now competing in market segments that are much more relevant for European companies, specifically German companies.
Thirdly, Yuan currently is quite cheap, which means, again, it gives Chinese firms an edge over their European counterparts. This is not lost on the ECB either, and in fact, just this week the ECB has put a blog out with new analysis about this very subject. The chart that you're currently seeing is taken directly from this blog, and it shows the change over time in export share of Chinese firms in yellow, versus European firms in blue. I think the chart speaks for itself. European firms are losing market share in the international markets, vis-a-vis their Chinese counterparts and that is obviously putting downward pressure on particularly our manufacturing sector over here.
The second chart, also taken from the blog, I think is even more interesting and more insightful. It breaks down the developments into different segments of our economy, of our manufacturing sector. What you are seeing is on the x-axis is the change in relative pricing of Chinese firms, versus European firms, and on the y-axis, what you are seeing is the change in market share. The bubbles are different segments of our economy, or specifically of our manufacturing economy, and the size of the bubble shows the importance of these segments to our economy. And what you can see is, it's not only the small bubbles that are losing market share, it’s particularly also the big ones, automobiles would be the one that stands out.
As long as that's the case, we think that this environment that I've just highlighted, where the manufacturing side has a problem, is unlikely going to go away. Where does that leave us? Well, our domestic side is still going strong. The latest labour market data that we had, just last week, showed that we’re still adding jobs to the economy in this segment. That also means that probably the wage pressure is going to stay, even though lately it has come down, and that means that the hawks within the ECB have something to hang their hat on.
On the other hand, as long as the manufacturing sector is in a recession, it is very difficult to generate a much stronger recovery, if one smaller but important part of the economy is not joining in, it's difficult to lift the entire economy. Therefore, both have a point. What does it mean in terms of rate moves going forward? Well, we think the 25 basis points rate cut for September is baked in, probably the one in December as well. The question is what are they going to do with the October meeting? Will they start guiding for back-to-back rate cuts as the doves gain the upper hand? We think it's unlikely, but not impossible. We think this whole picture that I've just painted also means that we probably have more room to cut. Why? Because China, through that process, is also exporting disinflation. And even if our domestic side still stays elevated, it means the pressure through commodity markets and others on the whole, HICP basket is going to be more downwards than we previously anticipated.
For the time being, we still think that the ECB will keep cutting in a cut, pause, cut cycle, probably down to 3%. The market is pricing more, and a little bit more than what we are currently expecting cannot be ruled out. The guidance next week is probably going to be key. With that, I thank you for watching and I hope you're going to join me again next time.