EUR/USD Forecast: German recession risk overshadows any Fed-related gains

German Industrial Production dropped by a whopping 1.9% in November, far worse than an increase of 0.3% that was expected. To add insult to injury, October's figure was downgraded from -0.5% to -0.8%. The data, published on Tuesday, follow a disappointing read on factory orders for the same period. 

The economy of the euro zone's "locomotive" suffered an outright contraction in Q3. It shrank by 0.2%. The squeeze was expected and a retooling of automobile factories due to changes in emission regulations bore the blame. 

However, the recent signs show that the issues are broader. The global slowdown and the slump in exports are behind the squeeze in the continent's powerhouse. 

A recession is defined as two consecutive quarters of a drop in economic output and the industrial data in an industrial country points in that direction, but not all is lost.

German Economy Minister Peter Altmaier insists that the economy is in good shape and notes full order books. He may be right, but the hard data looks hard. He may be pleased by internal consumption which has improved: retail sales rose by 1.1% in November, better than expected. 

ECB set to downgrade growth prospects

Even if Germany does not suffer an outright recession, the recent figures point to weaker growth. Numbers from other countries are not that great. Italy, the third-largest economy also reported a squeeze of 0.1% in Q3 GDP amid its budget clash with the European Commission. The Gilets Jaunes protests in France have probably weighed on growth.

The worst fears may be overblown but growth is clearly slower than expected. The European Central Bank forecasts of 1.9% in 2018 and 1.7% in 2019 from mid-December seem over-optimistic. 

The ECB will release new official projections only in March but it convenes to make its policy on January 24th. If it acknowledges the slowdown, it may open the door to postponing the potential rate hike from September to late in the year, after President Mario Draghi ends his tenure in November. 

EUR/USD prospects - recovery over?

EUR/USD stabilized and advanced to the upper end of the tight 1.1215 to 1.1500 range in the wake of 2019. The primary driver was the dovish shift from the Federal Reserve. Fed Chair Jerome Powell opened the door to slow the pace of rate hikes and also changed his opinion about the reduction of the balance sheet. He is now open to changing the scheme. 

But when the US sneezes, the world catches a cold. Or to use another financial market saying: the dollar is the cleanest shirt in a dirty pile. Germany is catching a cold and the euro-zone is a dirtier shirt than the US.

All in all, the German data could drag EUR/USD down.