US economic data has been improving lately, but Mr. Market's no longer in a mood for celebrating. The US equity market has tumbled sharply in recent days. Meanwhile, the appetite has surged again for the safe haven of US Treasuries. Is all this just noise, or a warning signal that the recent acceleration in the US macro trend has already run its course? No one really knows the answer at this point, in part because you can still make a compelling case for both narratives. Clarity is coming, however, and perhaps as early as this week, once we see updated numbers on US payrolls for December.
Meantime, there's a dark side to consider by way of the deteriorating trend in Europe, which is beginning to rattle sentiment in the US. In a sign of the times, consumer price inflation in the euro area turned negative last month on a year-over-year basis for the first time in five years, according to today's monthly update from Eurostat. “Inflation will most likely fall even further in January and remain extremely low all year long,” says Evelyn Herrmann, an economist at BNP Paribas. “We expect the ECB to announce a broad-based asset-purchase program including government bonds.”
The combination of deflation and stagnant growth (or worse) for Europe overall is a toxic combination. Germany is still the exception, as today's encouraging unemployment report reminds. But the key question is whether the Continent's macro problems in general will pinch the US in the months ahead?
Adding to fears that more trouble lies ahead is the spike in uncertainty related to the potential for a Grexit–the possibility that Greece may leave the euro after elections later this month. While some analysts think such an event would have a minimal impact on Europe's already stressed macro trend, that's only a guess, and probably an overly optimistic one. In truth, a Grexit injects a huge unknown into Europe's near-term future that's already suffering from any number of hefty challenges. The worst-case scenario: a Grexit triggers the disintegration of the currency union. That's a low-probability risk, for now, but in the current climate no one's discounting the threat.
