German IFO to Keep Optimism Alive?

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Yesterday the Euro got a boost after French and particularly German PMI data substantially beat expectations. Of course, that was more measuring the current situation.

The IFO survey is important because it asks businesses to evaluate their future expectations. This includes insight into investment trends over the next six months.

Germany is returning to lockdown for the holidays, which could keep sentiment depressed. However, with many major traders looking to take the next two weeks off, a substantial portion of the market is already looking ahead to next year.

Furthermore, as the covid vaccine is rolled out over the period and we just received more information on just how effective they are. This means that there are substantial reasons for the businesses to be optimistic that over the next six months, economic activity will finally be able to return to normal. However, will the survey reflect this?

What We are Looking for:

The IFO is divided into two parts: the current assessment and expectations. The latter is generally more market-moving, especially in this environment. It is the combination of the two that gives us the headline result.

The dividing line between positive and negative in terms of the situation or outlook is 100. Results below that show that businesses think things are heading in the wrong direction.

IFO Business Climate is projected to slip slightly to 90.0 compared to 90.7 in November. Note that in November we were already seeing a spike in covid cases, and authorities were already talking about reinstating lockdowns. So, last month’s reading ought to already accounted for some of the current sales environment.

The Key Components

IFO Expectations survey is expected to improve to 92.5 compared to 91.5 in the prior reading. Remember that this is where businesses expect things to be in six months’ time, after the full rollout of the vaccines. A result below 100 shows businesses are not expecting a meaningful recovery at least until the middle of next year.

The IFO Current Assessment index is expected to drop a full point to 89 compared to 90 prior. This would be a deepening of the downturn we saw starting in October.

Interestingly, optimism about the outlook started falling before the current assessment did, and both remain in contraction. The inevitable conclusion from that is German businesses are likely to hold off on capital spending that might boost the economy.

The Potential Market Reaction

The projected results are relatively far away from 100, a few decimals of a miss or overshoot of expectations are not likely to have a major impact on the markets. Traders are more likely to care about the trends.

So if expectations drop below 91, it would show a reversal in optimism, and likely sap risk sentiment. On the other hand, it could substantially beat expectations, and still be in line with the market’s outlook.

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