German Dax may stumble on escalating trade war with China

·         Despite the ECB pivot, Germany may be now on the verge of a recession as the manufacturing-savvy economy (led by automobiles) may suffer

·         Escalating trade war narrative with China after EU imposes 60% tariffs on Chinese EVs, may cause more harm to Germany/France/Italy than China

·         EU may also face Trump trade war tantrum 2.0, if Trump is again reelected in Nov’24 US election

·         Now Germany may be termed as the sick man of the EU; lingering political & policy paralysis and escalating trade war with China affecting the German economy

As per ECB, the Oct’24 back-to-back rate cut decision stems from an updated assessment of inflation, which shows disinflation progressing well. In September, headline inflation (CPI) in the Eurozone fell to 1.7%, below the ECB’s official target of 2.0% for the first time in more than three years. While inflation is expected to rise in the short term, it should decline toward the 2% target in 2025. Wage growth and domestic service inflation remain high, but pressures are easing. The ECB remains committed to sufficiently restrictive rates to ensure inflation reaches its medium-term goal, using a data-driven, flexible approach without committing to a specific rate path.

But despite average core HICP disinflation stalled in Q2 and 6MRA remaining around 2.8% against pre-COVID levels of 1.3%, the ECB goes for back-to-back rate cuts. ECB’s actual target of +2.0% core inflation is equivalent to 1.5% core HICP (w/o food, energy, tobacco, and alcohol). EZ real GDP growth for CY23 was +0.4% and the current ECB estimate for CY24 is only +0.8% against pre-COVID trend rate/potential +2.0%. EZ Harmonized unemployment average rate is now 6.5%, unusually high for an AE; ECB should be given a Fed-like dual mandate of maximum employment and price stability. As per the German government statistics department, German unemployment is now around 6.0% from 5.0% a few months ago, which was also the pre-COVID level.

But in reality, the ECB may have decided to front-load some 2025 rate cuts in 2024 and thus also go for a consecutive -25 bps rate cut in Oct’24 as the German economy is now going through a rough patch; in almost recession or rather than visible stagflation like scenario (lower GDP growth rates, higher unemployment and even sticky core inflation). The export-savvy German economy is largely dependent on the automobile industry, while China is the biggest trading partner/client (for German exports).

Now after decades of stagnation in innovation, and required fiscal policies, Germany is far behind China in terms of EVs. Chinese dominance in EV/automobiles is not only affecting Germany, but also some other industrialized states/Countries like France, Italy and Spain. The same is also true for most other consumer durable goods for Germany as well as the entire Europe/EU.

Additionally, the German economy is too dependent on manufacturing rather than services in Spain, France, Italy, and other southern EU/Economies (like travel & tourism, banks & financials). Overall, slowing China, subdued global exports/trading activities amid intense geopolitical fabrications and weak domestic consumption are affecting the EU/European economy and also Germany. EU and US are now unable to compete with Chinese EVs even after imposing almost 60% import duties.

German employment rate is now around 6.0% since Dec’23 against pre-COVID average levels of 5.0%, while average real GDP growths (y/y) for the last 5-QTRs is now negative, while core CPI rate is around +3.0% for 2024 (Since September) from +1.5% on an average in 2029 (pre-COVID). Germany, Europe’s largest economy may have to soon announce targeted fiscal stimulus and thus ECB has to provide the lowest possible borrowing costs for the Government to support the economy.

Also, a lower EUR is beneficial for export-heavy German and EU economies. ECB may not allow EURUSD to stay above 1.15 levels and may prefer to keep it between 1.05-1.15 rather than 1.15-1.25 zones to keep the balance between EU economic growth (in terms of higher exports) and price stability (imported inflation). Overall, it seems that the EURO economy is not designed to withstand positive real interest rates for long and thus decades of zero/negative real rates along with excessive fiscal austerity and lack of even targeted fiscal stimulus is causing deflation/stagnation-like economic scenarios. Also, the lack of proper policy cohesion is negative for the EU and China is outpacing it quite comfortably.

EU is also quite dependent on imported fuel/energy (oil/NG) and thus Russia-Ukraine war and subsequent EU/G7 sanctions and various trade restrictions are negative for the EU. As the largest producer of military equipment and oil, the US may be the biggest beneficiary of the Ukraine war and also Russia to some extent, while the EU/Europe is the biggest loser. The same almost applies to the lingering Gaza war.

The common concept of EU/EUR may be also not very beneficial as all the member states have common monetary authority (ECB) while having individual fiscal authority; i.e. unlike the US, China, India, and other independent G20 large economies, individual EU member states can’t print money at will to fund higher fiscal spending to boost the economy. Thus ECB is now almost begging for a common/cohesive fiscal policy to boost the economy as monetary stimulus has limited effect. In the process, EUR has now turned into a carry trade/funding currency globally like Yen to some extent against USD, which is a growth currency and remains the ‘king’ (global reserve currency). EUR is also losing ground to Chinese CNY in the global trading settlement currency.

Overall it continues to be a stagflation/stagnation-like scenario for the Eurozone economy (despite a decade of NIRP/ZIRP) due to excessive fiscal austerity, and lower productivity, almost half of the US; average pre-COVID EZ unemployment rate of around 7% is almost double that of the US even after some fiscal measures to suppress the actual unemployment in EZ, which may be around double-digit, if correctly measured. The EU/Europe needs innovation, proper labor & fiscal policy reform to boost the manufacturing sector to compete with China and normalize the employment situation.

The ideal average Harmonized EZ unemployment rate should be around 4.5% (minimum unemployment rate) against US 3.5%. The present 6MRA is 6.5%, which is although is on the lower side since at least 1995, still structurally very high compared to US/AE amid almost double-digit figures in Spain, Greece, Sweden, France, Italy, etc due to lack of sufficient manufacturing activities and over-reliance of travel & tourism.

Industrial countries/states like Germany has an unemployment rate of around 5.0% in Jan’20 (pre-COVID) against average EZ unemployment rate levels of 7.5%. The EU has an unusually high unemployment rate, coupled with excessive dole money (unemployment & social security benefit-Helicopter money/Rabin Hood politics), decades of fiscal austerity to create additional economic activities are causing higher inflation/stagflation and lower productivity.

The EU's unemployment rate tends to be higher than that of the U.S. and China due to several structural, economic, and policy differences:

·         Labor Market Structure:  The European/EU labor market, especially in countries like Spain, Italy, and Greece, has higher levels of structural unemployment. These countries face long-term issues such as high youth unemployment and mismatches between job seekers' skills and market demands. This contrasts with the U.S., which generally has a more flexible labor market where hiring and firing is easier, allowing quicker adjustments to economic changes.

·         Economic Growth: Europe/EU has experienced slower economic growth in recent years compared to both the U.S. and China. While the U.S. economy has rebounded robustly post-COVID-19, supported by technology, innovation, and consumer spending, Europe has been slower to recover, partly due to energy price surges and weaker demand. China, despite facing its economic challenges, still has significant state-driven initiatives and investment-led growth that keeps its unemployment lower.

·         Regulation and Labor Laws: European/EU countries tend to have stricter labor laws and stronger worker protections, such as long notice periods, generous unemployment benefits, labor union influence and even 4-day work weeks (weekend holidays from Friday itself). While these protections are beneficial for employees, they can make employers hesitant to hire, particularly in uncertain economic times, leading to higher unemployment rates. In contrast, the U.S. and China have relatively more flexible employment laws, which encourage quicker job creation but also make jobs less secure.

·         Unfavorable Demographics and Aging Population:  Europe/EU has an aging population, and while this can lower labor force participation, it also strains social security systems, resulting in higher taxes and lower growth potential. Additionally, younger workers often face higher unemployment, especially in Southern Europe. In contrast, China, despite its aging population, has been able to maintain lower unemployment due to large-scale urbanization, rapid industrialization, and state-driven job creation policies.

·         High Youth Unemployment: Europe/EU, particularly Southern European countries, struggles with persistently high youth unemployment. Economic policies, lack of MASS job creation in growing/manufacturing sectors, and challenges in educational systems are significant contributors. The U.S. and China, despite their youth challenges, have better frameworks for integrating younger workers into the labor force.

Conclusions:

In brief, the EU's higher unemployment rate is driven by slower economic growth, stricter labor laws, structural labor issues, and an aging population/unfavorable demography, while the U.S. and China benefit from more dynamic labor markets and faster economic growth. The US is benefiting from liberal immigration laws, while China is also benefiting from its huge population and relatively younger demography/labor force. The EU now needs proper immigration laws, labor reform along proper fiscal policies.

EU economic growth may be hampered more, while the unemployment rate may surge high due to an escalating trade war with China, which is its 2nd largest trading partner after the US. Also, if Trump is again reelected in Nov’24 US election, the EU/Europe/UK and especially Germany, and France may face a Trump trade war tantrum again.

Looking ahead, apart from the likely scenario of Trump trade war 2.0 (if Trump reelected again), the EU may face a financial meltdown as China retaliates against EU tariffs. France and Italy, already burdened with massive public debt, now see their luxury sectors under siege. With China imposing heavy duties on French cognac and Italian fashion, major brands like LVMH are at risk. The EU’s decision to tax Chinese EVs has escalated tensions, and the survival of these economies hangs in the balance.

After the EU imposed almost 60% import duty (tariffs) on Chinese EVs (against the earlier normal 20%), China now targeting EU luxury sectors and companies like LVMH and French Cognac face 30% to 39% import duties. China is the largest/2nd largest (after the US) client for high-value premium EU/European luxury items and cars/large engines (like Mercedes from Germany). China may have also imposed additional tariffs on German and Italian cars in response to the EU’s EV tariffs on it, which was mainly orchestrated by France, while Spain opposed.

If the trade war between the EU and China escalates along with the Trump trade war tantrum 2.0, then the EU/Europe may face serious economic headwinds. Chinese tourists are also a vital part of the EU/European travel & tourism service industry. In the scenario of an intensified cold war, the EU travel & tourism industry may also suffer from Chinese revenue/tourists. China may target the EU’s consumer goods, automobile and also farm/agri sectors, but may not act hard on the airplane industry like Airbus for its interest as it’s still dependent on Airbus and Boeing for its commercial airplane requirements.

China is also planning to impose at least 25% additional tariffs on EU luxury cars/EVs, while even after 50-60% EU/US tariffs, Chinese EVs may be still a cheaper option in the EU/US, while Chinese manufacturers like BYD can make some money/profit; but Tesla made EVs in China may have to suffer loss in that scenario. Thus various EU/US MNCs, highly dependent on China are lobbying intensely to avoid an escalated trade war with China. A standard Chinese EV's average price tag is around $20K against $50K in the US. EU/US is far behind China’s massive industrial capacity and the EU is also far behind in terms of innovation and natural resources, vital for EVs. China has the largest quality labor force with a cheaper rate like $500/M on average against the US’s $5000/M.

China has also developed a robust and sophisticated business/manufacturing ecosystem system that is difficult for other EU/US nations to replicate. The Chinese ecosystem consists of an intricate network of suppliers’ component manufacturers and Distributors all working closely to create unparalleled efficiencies supported by a robust & rapid transportation/logistics system. China is also developing African infra to create jobs and a huge market and to reduce its dependence on the US/EU amid the growing cold/trade war and other geopolitical issues. Western countries (US/EU) are now basically envious of China’s development and rising superpower capacity thus treating China as an enemy country instead of a strong competitor. US/EU wants China to change its political and policy/SOE/PPP system, but China will never allow it.

China’s thrust on infrastructure development has resulted in an extensive network of highways high-speed Railways and ports facilitating the movement of goods and reducing Transportation costs for manufacturers this infrastructure combined with China's strategic geographical location has made it an ideal hub for Global Supply chains despite COVID-related disruptions.

China's rise in high-tech manufacturing is particularly noteworthy the country has made significant strides in sectors such as semiconductors Quantum Computing and artificial intelligence China is now involved in every stage of production including the most high-tech sectors including areas like 5G, 6G, and IoT. China is also dominant in refining and processing Metals a capability that is crucial for Industries like EV manufacturing this dominance is supported by government subsidies which have allowed China to develop unparalleled expertise in these areas. Unlike the EU/US, China does not believe in ‘Helicopter Money” and thus always prefers targeted monetary and fiscal stimulus. EU is far behind China and an escalated trade war with China may cause more harm than any benefit. EU may see higher unemployment numbers in the coming days and an all-out recession in the event of the double whammy of China and Trump trade war 2.0 (if Trump is reelected again).

Market Wrap:

Germany’s DAX-40 surged almost +17% till now for 2024 (YTD), slightly above its global peers DJ-30, which gained almost +15% on synchronized global rallies amid synchronized global easing (monetary stimulus). Apart from the ECB, and Fed pivot, export-heavy and China-savvy Dax-40 was also boosted by China’s recent targeted monetary and fiscal stimulus to bring out the economy from post-COVID slumber. China is now trying to spur domestic demand/consumption more so that its excess capacity/production can tally, helping it to avoid a deflation-like scenario.

As a result, Chinese-savvy German automakers like Porsche, Daimler, Continental, VW, and BMW, were all boosted and helped the index (DAX 40) to scale a fresh life time high (LTH) of almost 19787; also hopes & hypes of ECB pivot to avoid an all-out recession for the German economy, largest in the EU/Europe helped along with mixed/upbeat report card of blue-chips. ECB is providing Germany with relatively lower borrowing costs to fund deficit spending and implement proper fiscal & regulatory policies to stimulate domestic demand and also to be able to compete with China, the US, Japan and Korea. German 10Y bond is now trading around +2.2%, after scaling a recent high around +2.90% one year ago.

Looking ahead, like all other major indices, DAX 40 is also now trading around a historical bubble zone and thus bound to correct to some extent, whatever may be the narrative; it may be escalated Gaza and Ukraine war tensions or something else. But the German economy, especially the automobile sector may suffer more due to an imminent trade war narrative with China and may also the US under Trump, if Trump gets elected in the Nov’24 election.

Weekly-Technical trading levels: DAX 40

Whatever may be the fundamental narrative, technically DAX 50 (19765) now has to sustain above 20000 for any further rally to 20200/20400-20500/20700 and 20900/21050-21200/21500 and further 21700/21900-22000/22200 in the coming days; otherwise, sustaining below 19950-19850, DAX 40 may again fall to 19650/19500-19375/19150 and 19000/18750-18600/18450-18175/17600 and 17375-17100 in the coming days.