Won’t Be Repaid

Said Merkel and French Prez Macron
This calls for a grant, not a loan
When speaking of aid
That won’t be repaid
By nations where Covid’s full-blown

The euro is firmer this morning, up a further 0.35% after yesterday’s 0.9% rally, as the market responds to the news that German Chancellor Angela Merkel and French President Emanuel Macron have agreed on a plan for EU-wide assistance to all members. This is the first time that there has been German support for a plan that includes grants to nations, not loans to be repaid, and that these grants are to be distributed to the membership, not based on the capital key, but rather based on where the money is needed most. The funding will come from debt issued by the European Commission and paid out of that entity’s budget. In sum, while this is not actually Eurozone bond issuance, it is a clear step in that direction.

Of course, nothing in the EU is easy, and this is no different. Immediately upon the announcement, Austrian Chancellor Kurz explained that there is no path forward for grants, and that Austria is happy to lend money to those countries in need. Too, the Dutch, Danes and Finns are none too happy about this outcome, but with Germany on board, it will be very difficult to fight. Even so, French FinMin LeMaire made it clear that it will take time to complete the procedure (and he is 100% behind the idea) with the first funds not likely available before early 2021.

However, the importance of this step cannot be underestimated. The tension within the Eurozone has always revolved around how much Germany and its frugal northern neighbors would be willing to pay to the more profligate south in order to maintain the euro as a functioning currency. When looking at which nations benefit most from the single currency, Germany tops the list as the euro is certainly weaker than the Deutschemark would have been in its stead, and thus Germany’s export industries, and by extension its economic performance, have benefitted significantly. It appears that Chancellor Merkel and her administration have now done the math and decided that spending some money to maintain that export advantage is a smart investment. While in the past I have been suspect of the euro’s longevity, this appears to be the first step toward a joint fiscal policy resulting in a far stronger basis for the euro. While there will no doubt be rough seas for this process ahead, if Germany and France are on board, they will ultimately drag everyone else along. This is arguably the most bullish long-term euro story since its creation two decades ago.

The other bullish news for markets yesterday was the announcement that a tiny biotech company in Massachusetts, Moderna Inc, with just 25 employees (although a $29 billion market cap) has seen extremely positive results from a Covid vaccine trial. Apparently, it not only does the job, but does so with limited side effects to boot. While it has yet to undergo larger phase 2 and phase 3 trials, it is certainly extremely bullish news.

The combination of these stories was extremely beneficial for risk assets yesterday, which explains the 3+% rallies in US equity indices, the sell-off in Treasuries (10-year yields rose 7bps) and the dollar’s overall weakness. That bullishness followed through overnight with Asian equity markets gaining nicely (Nikkei +1.5%, Hang Seng +1.9%, Shanghai +0.8%) and Europe starting in the green as well. However, those early gains in Europe have turned red now, with what appears to be profit taking after yesterday’s substantial gains. Clearly, European equity markets were the main beneficiaries of the Franco-German announcement on debt although Italian debt has not done too badly either, with yields on 10-year BTP’s falling 22bps since Friday’s close.

Put it all together and we have a very positive backdrop for the near-term. While data continues to be dreadful, with today’s poster child being the 856K jump in Jobless Claims in the UK last month, we already know the market is looking through the bad news toward the recovery. Of much more importance to market sentiment is the prospect for the reopening of economies around the world. This is where the vaccine story supports everything, because undoubtedly, if there was a widely available vaccine, the stories of devastation would diminish and confidence would quickly return. And while there will certainly be changes in the way people behave going forward, they are not likely to be as dramatic as once imagined. After all, if people are confident they are immune to Covid-19 after a vaccination, they will likely return to their previous lifestyle as quickly as they can.

So, with that overall bullish framework, we cannot be surprised that the other key haven assets, the dollar and the yen, are under pressure this morning. Yesterday’s dollar weakness has extended this morning virtually across the board. In the G10 space, it is the high beta currencies, NZD (+0.85%) and SEK (+0.6%) leading the way, but even the pound, after that terrible employment data, is higher by 0.5%. Only the yen (-0.2%) has ceded ground to the dollar this morning in what is clearly a straight risk-on session.

The EMG bloc is much the same, with every currency on the board firmer vs. the dollar this morning led by HUF (+1.4%) and CZK (+1.2%) as clear beneficiaries of the mooted EU financing program. Remember, this €500 billion can be spent anywhere desired by the Commission. But we are also seeing commodity currencies benefit as MXN (+1.0%) and ZAR (+0.8%) continue to perform well. In fact, over the past two sessions, one is hard-pressed to find a currency that has not appreciated vs. the dollar.

On the data front, beyond the awful UK data, we did see a much better than expected German ZEW Expectations outcome, printing at 51.0, although the current conditions index remains horrendous at -93.5. But the future is much brighter this morning, adding to the euro’s strength. At home, we see Housing Starts (exp 900K) and Building Permits (1000K), neither of which is likely to have a big impact, although stronger than expected data would surely add to the overall positive risk feeling this morning.

As well, Chairman Powell will be testifying to the Senate Banking Committee, but after Sunday night’s performance it is not clear what they will ask that he has not already answered. The Fed is all-in to do everything possible to support the economy. Arguably, the bigger question is will they be able to stop once things have evidently turned better. History shows that once government programs get going, they are virtually indestructible. In this instance, that implies ongoing Fed largesse far past when it is needed, thus much lower interest rates than are appropriate. Combine negative real rates in the US with a bullish structural story in the EU and we have the recipe for a much weaker dollar over time. This week could well be the beginning of a new trend.

Good luck and stay safe
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