More Than a Molehill

The House passed a stimulus bill
With price tag of more than three trill
Japan’s latest play
Three billion a day
Adds up to more than a molehill

But turning to Europe we find
Their efforts are quite ill-designed
Despite desperate needs
The trouble exceeds
The laws that their treaties enshrined

Apparently, it’s Stimulus Day today, a little-known holiday designed by politicians to announce new fiscal stimulus measures to great fanfare. At least, that’s what it seems like anyway. Last night, Japanese PM Abe announced Japan’s second extra stimulus package in just over a month, this one with a price tag of ¥117 trillion, or roughly $1.1 trillion at today’s exchange rate (which, if you do the math works out to just over $3 billion/day over the course of a year). For an economy with a total GDP of ~$4.9 trillion, that is a huge amount of extra money.

The BOJ has explained that they will not allow JGB yields to rise, which means that they are going to mop up all the issuance and the market (or what’s left of it) clearly believes them as 10-year JGB yields actually fell 1bp last night and are currently trading at -0.006%. It is certainly no imposition for the Japanese government to borrow money from the BOJ as it is essentially a free loan. The impact on the Nikkei was mildly positive, with the index rallying 0.7%, while the yen has edged lower by a mere 0.15% and remains firmly ensconced in its 106-108 range.

And one last thing, Japan lifted its state of emergency, as well, meaning lockdowns continue to dissipate around the world. Of course, the thing about stimulus during the Days of Covid is that it is not designed to boost growth so much as designed to replace activity that was prevented by government lockdowns. Unfortunately, none of the measures announced anywhere in the world will be able to fully offset the impact of all those closures, and so despite governments’ best efforts, the global economy is set to shrink in 2020.

But on this Stimulus Day, we cannot ignore what is likely a far more important piece of news emanating from Europe, the creation of a €750 billion (~$825 billion) fiscal stimulus package consisting of €500 billion of grants and the rest of loans. While the size of this package is dwarfed by the Japanese efforts, despite the fact that the EU represents an economy with GDP of more than €14.3 trillion, the importance stems from the fact that part of the funding will come from joint debt issuance. This, of course, has been the holy grail for the entirety of southern Europe as well as the French. Because this means that the Germans (and Dutch and Austrians) are going to pay for the rest of the continent’s problems. And since those three nations are the only ones that can afford to do so, it is certainly a big deal.

The timing of this cannot be ignored either as ECB President Lagarde, just this morning, informed the world that of the ECB’s GDP forecasts last month, the mild downturn scenario is now “out of date”, with a much greater likelihood that GDP will decline between 8% and 12% in 2020. The market response has been clear with the euro rallying 0.8% on the news and now higher by 0.3% on the day, and back above 1.10. Yields on the debt of the PIGS have also fallen nicely since the news hit the tape, with all four nations seeing a 5-6bp decline. And European equity markets, which seem to have anticipated the news, have climbed a bit further, and are now all higher by more than 1.25% with Spain’s IBEX leading the way, up 2.25%.

I guess the question is will the US Senate join in the festivities (you recall the House already passed a $3 trillion package last week) and agree to at least discuss the idea, although they have made clear the House bill is a non-starter. The thing is, as has been evidenced by the recent stock market performance in the US, there are many that believe no further government stimulus is needed in the US. Optimism in the stock market has been driven by optimism that the gradual reopening of the economy in certain states will start to accelerate and that before too long, the lockdown period will end. Along those lines, Los Angeles mayor, Eric Garcetti, last night decided that small retail stores would be allowed to open today. Similarly, New York mayor Bill DiBlasio has now said that the first steps toward reopening could take place in the second week of June. The point is, if economic activity is going to start to rekindle on its own, why is further stimulus needed.

With this as background, we have seen a pretty substantial reversal in the FX market this morning, mostly since the EU stimulus announcement. While the yen has not moved, the G10 has seen currencies reverse course from a 0.3%-0.5% decline to similar sized gains. In other words, the market has seen this as further evidence that risk is to be acquired at all costs. Certainly, if the EU can figure out how to effectively fund its weakest members without causing a political uproar in the Teutonic trio, then one of the key negative fundamentals for the single currency will have been corrected. This works hand in hand with my view of increasingly negative real interest rates in the US as a driver of medium-term dollar weakness. While I don’t expect the euro to run away higher, this is certainly very positive news.

Meanwhile, those EMG currencies whose markets are open have all reversed course as well, with the CE4 higher by an average of 0.45%, having been lower by a similar amount before the announcement. APAC currencies, which had suffered a bit overnight, have not had a chance to react to the news as their local markets had closed before the report. I expect that, ceteris paribus, they will perform better tonight. The one currency, though, that is not performing well today is the Chinese renminbi, and more specifically CNH, the offshore version. It is lower by -.35%, having fallen early in last night’s session as tensions continue to increase between the US and China. As I have maintained for a very long period, the currency is an important outlet for Chinese economic imbalances and further weakness is a far more likely outcome than a reversal anytime soon.

Yesterday’s housing data in the US was surprisingly robust, with New Home Sales falling far less than expected. Today, the only real release will be the Fed’s Beige Book at 2:00, which might be interesting, but can be expected to paint a very dire picture of the regional economies. But none of that matters anymore. The future is clearly much brighter this morning as the combination of Japanese and EU stimulus along with additional easing of US restrictions has investors primed to use all that stimulus money and pump up asset prices even further. What could possibly go wrong?

Good luck and stay safe