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How to Trade Strengthening Euro Zone Economy via ETFs

Though global growth worries keep hitting the headlines, the Euro zone economy has started showing some strength of late. The flash IHS Markit Eurozone Manufacturing PMI index increased to 53.3 in October 2016 from 52.6 in September as well as came ahead of market expectations of 52.6.

The reading came in the highest since April 2014 thanks to inflows of new orders increased at a faster clip and payroll growth shot up to the highest since May of 2011. As per IHS Markit, ““October saw the extent of manufacturing supply chain delays hit one of the highest in five years.” And since supply shortfall translates into higher prices, there is a definite reason to be bullish on Euro zone inflation.

If this was not enough, the IMF upped its growth forecast for the Euro zone in early October inspite of Brexit fears.  The growth forecast of the region was raised to 1.7% for 2016, from 1.6% projected earlier, mainly on low energy prices and ECB’s policy stimulus.

In fact, the Euro zone witnessed an uptick in IMF growth projections for 2017 as well from 1.4% to 1.5%. The growth momentum will likely slow down to account for the harsh impact of a likely ‘Hard Brexit’ (read: 5 ETFs to Bank on as Global Growth Concerns Loom).

If these were not enough, consumer prices grew 0.4% year over year in the month – the quickest pace of growth since October 2014. The reading followed a 0.2% jump in each of the prior two months and met the preliminary numbers as well as economists’ estimate.

How to Profit Out of It?

While things are still quite fragile and will take more time to return to the pre-crisis level, an improving trend opened the door for Euro ETF investing. This is especially true given that the currency Euro has been battered lately against the U.S. dollar, plunging to the eight-month low.

Plus, ECB president Mario Draghi indicated recently that “the central bank doesn’t want rates to stay negative for a protracted period.” Thanks to this comment, FXE gained about 0.2% on October 25, 2016.

At the current level, there is as much as 71% probability is there for a Fed rate hike in December. While this news is negative for Euro investing as the move will strengthen the greenback further against a basket of other currencies, investors should note that much of this expected Fed action is priced in at the current level. So, a hefty appreciation in the greenback or depreciation in euro is less likely, going forward.

There are ETFs like Guggenheim CurrencyShares Euro Trust ETF FXE and Ultra Euro ETF ULE to go long on Euro (read: Will Euro ETFs Stand Steady or Fall Like a 'House of Cards'?).

Having said this, we would like note that the common currency may not sustain its joy ride for long as some investors feel that the ECB may extend monetary stimulus in December, as per Bloomberg.

This is especially true given that the ECB still views inflationary pressure in the common currency bloc as feeble and expects it to be 0.2% this year, one-tenth of a percentage point below the forecast reached in the previous quarter. The 2017 forecast remained the same at 1.2% while the forecast for 2018 was pushed down to 1.4% from 1.5% estimated three months ago.

Draghi noted in the October meeting that “It’s quite clear that our decisions in December will tell [financial markets] what we [plan to] do in the coming months.” On a separate note, IMF also indicated that an uptick in domestic demand that would enhance prices "decelerated in some of the larger euro area economies after successive quarters of stronger-than-expected growth.”

It all depends on how inflation and growth shape up till December. As of now, the trend is relatively bullish. Some analysts even expect economic activity to pick up in Q4. So, investors can play euro ETFs for as long as the trend is their friend.

Other Bets in Euro Zone

On the basis of PMI expansion, investors can also playiShares MSCI Germany EWG and Recon Capital DAX Germany ETF DAX. The flash IHS Markit Germany manufacturing PMI was 55.1 in October 2016 versus 54.3 in September and market expectations of 54.3.

Investors can also playiShares MSCI Spain Capped ETF EWP or iShares Currency Hedged MSCI Spain ETF (HEWP) depending on future currency movements. The end of the 10-month long political impasse – as opposition socialist party decided to allow the acting prime minister Mariano Rajoy to rule for the second term – will likely give Spanish stocks a boost.

Some other Europe ETFs that have been in the green lately are iShares MSCI Austria Capped EWO and iShares MSCI Poland Capped EPOL (see all European Equities ETFs here).

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CRYSHS-EURO TR (FXE): ETF Research Reports
ISHARS-MS POLND (EPOL): ETF Research Reports
ISHARS-GERMANY (EWG): ETF Research Reports
ISHARS-SPAIN (EWP): ETF Research Reports
ISHARS-AUSTRIA (EWO): ETF Research Reports
PRO-ULT EURO (ULE): ETF Research Reports
RC-DAX GERMANY (DAX): ETF Research Reports
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