EUROPE AND GERMANY NEWSLETTER

Feb. 20, 2015

Aureliano Gentilini Head of Research

“The torment of precautions often exceeds the dangers to be avoided. It is

sometimes better to abandon one's self to destiny.”

– Napoleon Bonaparte (1769-1821)

EUROPE AND GERMANY NEWSLETTER

THE EUROZONE’S DAY OF RECKONING HAS ARRIVED. GERMANY HOLDS A TOUGH STANCE DISMISSING THE GREEK PROPOSAL FOR A SIX-MONTH EXTENSION TO ITS LOAN AGREEMENT AS A “TROJAN HORSE”.

With only a week left until the expiration of the

bailout program, Germany plays strong-arm

tactics as Greece dances on the brink of the abyss,

trying to secure funding to keep the country

afloat. Negotiations among Eurozone leaders may

be drawn out until next week.

» The Eurozone remains divided between fiscal hawks and doves, with countries such as Portugal and Spain remaining reluctant to grant Greece a softer deal after they bore austerity measures in return for financial aid. On the other side of the Atlantic, Washington remains sympathetic to the Greek urge to relieve austerity measures. Greece, in reiterating its pledge to meet all financial obligations, asked for an extension to its "Master Financial Assistance Facility Agreement" with the Eurozone. The country did not commit to the full bailout program, which would imply adhering to binding austerity measures and harsh economic reforms. At the same time, the modest increase above the cap, agreed on Feb. 18 by ECB on funding available to Greek banks under its Emergency Liquidity Assistance scheme, outlined the pressure for a compromise. It is estimated that in January only 12 billion euros left the banking system as Greeks remain wary of the capital controls that were imposed in Cyprus in 2013. In the FX market, the euro is hanging over a pile of OTC euro currency derivatives to the tune of 26.45 trillion US dollars notional amount, according to the latest Bank of International Settlements data. If the

debt stand-off were past the point of no return, the impact on the currency market would be disruptive. » Much ado about nothing. Stock market trends on both sides of the Atlantic and the Pacific appeared to decouple from information flows arrival originating in the real economy, edging to fresh record highs. European stocks hit seven-year highs on Feb. 19 close as the Greek debt standoff appeared to come to a solution. The STOXX Europe 600, the EURO STOXX 50, and the DAX returned 3.91%, 4.08%, and 2.88%, respectively, month to date at Feb. 19 close. » Credit default swaps (CDS) have been implying a 70% chance of default by the Greek government in recent trading sessions. Chances of default factored in CDS prices fluctuated around dangerous levels, despite easing from the recent high posted on Feb. 12 as markets were underpinned by expectations of a resolution in the Greek debt standoff. In the fixed income market, yields on Greek government benchmarks edged upward until the midweek, with the Greek government benchmark yield curve continuing to feature an inverted shape. On Feb. 19 close, the yield on the two-year Greek government benchmark ended at 17.132%, 141 bps below the week’s high. On the other hand, despite record low yields in the long-end segment of the yield curve and negative yields in the short- to medium-end segment, auctions of German Bunds continue to be well bid as flight to quality drivers remain at play. At the latest auction on Feb. 18, bids for the EUR4 billion 10-year Bunds on offer amounted to EUR4.8 billion with an official bid to cover ratio at 1.4. As the Bundesbank held back EUR0.665 billion for market fine tuning, Germany sold EUR3.335 billion of 10-year Bunds with a coupon of 0.50% at an average yield of 0.37%, down from 0.52% at the previous auction.

EUROPE AND GERMANY NEWSLETTER

» The ZEW indicator of economic sentiment for Germany rose for the fourth month in a row to hit a 12-month high in February, despite the Ukraine crisis and the Greek crises. As the quantitative easing program announced by the ECB and the better-than-expected GDP growth rate for Q4 offered a silver lining, the ZEW indicator of economic expectations rose 4.6 points month-on-month to 53.0. The indicator of the current economic situation for Germany climbed 23.1 points to 45.5 in February, its highest reading since July 2014. At the same time, market sentiment regarding economic expectations for the Eurozone showed signs of improvement. ZEW's indicator of economic sentiment for the Eurozone increased by 7.5 points to a reading of 52.7 in February, marking the highest reading since June last year. Also, increasing 8.7 points in February, the indicator for the current situation in the Eurozone has reached a value of minus 48.4 points. » Swiss ZEW investor sentiment nosedived by 62.2 points in February to a negative reading of -73.0, the largest monthly drop in the history of the indicator. The fall came as market participants reacted to “Francogeddon”, as the Swiss National Bank (SNB) unexpectedly discontinued the 1.20 floor on the euro/Swiss franc exchange rate. At the same time, dropping 45.9 points in February, the indicator for the current situation in Switzerland has reached a value of minus 5.4 points. » Survey readings released throughout the week do not depict a bright scenario for Sweden. After the Riksbank bolted into the currency war saga and cut its repo rate on Feb. 12, five-year inflation expectations among money market participants remained anchored at 1.7% in February, well below the central bank’s 2% target. In the current scenario, the Riksbank faces a policy conundrum, with the monetary stance pendulum oscillating between further easing and the start of a tightening cycle. Sweden is expected to post a solid 2.7% GDP

growth rate for 2015; however, tame long-term inflation expectations may negatively impact wage negotiations, determining in turn a knock-on effect on price dynamics. Then, a deflationary spiral may become a self-fulfilling prophecy. At the same time, Swedish consumer confidence declined to 97.4 in February, from a slightly downwardly revised reading of 98.4 in January. Similarly, manufacturing confidence dropped to 106.8 points from a marginally upwardly revised 107.4 points in the previous month. The overall sentiment index for Sweden eased to 104.8 in February from 105.6 in January. » Q4 readings for 2014 showed a healthy labor market in Germany. The number of persons employed amounted to over 43 million for the first time since German reunification. Compared with the same quarter of a year earlier, the number of persons employed increased by 412,000 or 1.0%. For both Q2 and Q3 of 2014, the year-on-year rate of increase was 0.9%. Compared with Q3 of 2014, the number of persons employed in Q4 of 2014 rose by 165,000 units (+0.4%). The year on year increase in the overall number of persons employed in Q4 of 2014 was mainly attributable to the growth in the service sector. The largest absolute employment increases were observed for public services, education, health (+116,000, or +1.1%), followed by trade, transport, accommodation and food services (+110,000, or +1.1%) and business services (+103,000 or +1.8%). » The Eurozone recorded a seasonally adjusted current account surplus of 17.8 billion euros for December 2014, with early estimates for the full year showing a surplus of 240.3 billion euros. Compared to the same quarter a year earlier, the current account surplus increased 4.95% in the last quarter of 2014. The improvement mainly reflects a higher surplus in the balance of trades in goods, which is attributable not only to improving external demand, but also to a lower nominal euro amount of imports due to a decreased oil bill.

EUROPE AND GERMANY NEWSLETTER

LIGHT AND SHADOWS – DAX CONSTITUENTS

» Bayer is close to selling its diabetes devices unit to Panasonic Healthcare Holdings Co Ltd and the unit could be valued at between 1.1 billion US dollars and 2.3 billion US dollars. US private equity firm KKR owns a 80% stake in Panasonic Healthcare. Bayer also announced that the head of its healthcare division, Olivier Brandicourt, would quit on Apr. 2 to become CEO of French peer Sanofi. » Deutsche Boerse saw net revenue climb to 545 million euros in the last quarter of 2014, the highest level in three years, as the German exchange benefited from increased trading volumes on uncertainties over the Ukrainian conflict and financial stability in Greece. Net revenue for 2014 rose 7% to 2.043 billion euros, Deutsche Boerse said on Feb. 18. The positive trading momentum is expected to carry on into early 2015, with the company forecasting 2.3 billion euros in net revenue. » BASF has joined forces with Norway's Yara to invest 600 million US dollars to build an ammonia plant at BASF's site in Freeport, Texas. The ammonia plant will be owned 68% by Yara and 32% by BASF. In addition, Yara will build an ammonia tank at the BASF terminal, bringing Yara's total investment to 490 million US dollars. BASF and Petronas Chemicals Group Berhad agreed to build a new production plant for 2-Ethylhexanoic Acid at the site of their existing joint venture, BASF PETRONAS Chemicals, in Kuantan, Malaysia. » Industrial group ThyssenKrupp issued a dual tranche bond of 1.35 billion euros. The first tranche, which has a maturity of 5 years and 9 months,

totals 750 million euros and carries a coupon of 1.75% p.a. at an issue price of 99.328%. The second tranche has a maturity of 10 years and amounts to 600 million euros. It carries a coupon of 2.5% p.a. at an issue price of 98.818%. » New car sales in Europe rose 6.2% in January, led by retail incentives and new product launches. For the same month, European sales of Volkswagen's brand rose 8.3%, and registrations of Daimler's Mercedes vehicles and BMW cars increased 12.7% and 4.9% respectively.

“THE TORMENT OF PRECAUTIONS OFTEN EXCEEDS THE DANGERS TO BE AVOIDED. IT IS SOMETIMES BETTER TO ABANDON

ONE'S SELF TO DESTINY.”

– Napoleon Bonaparte (1769-1821)

EUROPE AND GERMANY NEWSLETTER

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Feb. 20, 2015

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