The ECB’s fear of deflation
Inspired more euro creation
They’ll keep buying bonds
Until growth responds
In every EU member nation

Investors responded by buying
As much as they could while still trying
To claim, it’s quite clear
That early next year
Economies all will be flying

Madame Lagarde is clearly getting the hang of what it means to be a central banker these days, at least at a major central bank. The key to success is to listen to how much easing the pundits are expecting and deliver significantly more than that. In the mold of Chairman Powell back in March, Lagarde yesterday exceeded all expectations. The ECB increased its PEPP by €600 billion, extended the minimum deadline to June 2021 and explained they would be reinvesting the proceeds of all maturing purchases until at least the end of 2022. They, of course, kept their other programs on autopilot, so the APP (their first QE program) will still be purchasing €20 billion per month through at least the end of this year. And finally, they left the interest rate structure on hold, so the deposit rate remains at -0.50%, but more importantly, they didn’t adjust the tiering. Tiering is the ECB’s way of limiting the amount of bank reserves that ‘earn’ negative interest rates. So, if the ECB decides that rates need to be cut even lower, they will be able to adjust the tiering levels to help minimize the damage to bank balance sheets. This is key in Europe because banks remain far more important in the transmission of monetary policy than in the US and negative rates have been killing them.

With this increase in accommodation, the Eurozone has finally created a support structure that is in concert with the size of the Eurozone economy. Adding up the pieces shows the ECB buying €1.5 trillion in assets, the EU having already created a €500 billion cheap lending program and now close to agreeing on an additional €750 billion program with joint borrowing and grants as well as loans. Add to that the individual national support (remember Germany just plumped for €130 billion yesterday) and the total is now well over €3 trillion. That is real money and should help at least mitigate the worst impacts of the economic shutdowns across the continent.

And so, can anybody be surprised that markets responded favorably to the news. Equity markets throughout Europe are higher this morning with the DAX (+1.8%), CAC (+2.3%) and the rest of the continental bourses all looking forward to more free money. Of course, the risk-on attitude has investors swapping their haven bonds for stocks and risky bonds, so bund yields have risen 1.5bps (Dutch bonds are up 2.5bps) while Greek yields have fallen 3bps. Italy and Spain are unchanged on the day, as there is no real selling, but just more interest in equities in the two nations. Finally, the euro, although currently slightly softer on the day (-0.15%) traded to a new high for this move at 1.1384. Except for two days in early March, as the virus story was disrupting markets, this is the highest level for the single currency since last July.

Technically, it is pretty easy to make the case that the euro is breaking out of a multi-year downtrend, although that is not confirmed. When viewing fundamentals, the question at hand is whether the Fed or ECB has more accommodative monetary policy. Clearly, despite the recent EU package, the US has been far more accommodative fiscally. And while the longer end of the US yield curve continues to sell off (10-year yields are now up to 0.85%, 20 bps this week, with 30-year yields at 1.66%, also 20bps higher on the week), the 2-year T-note remains anchored at 0.2% with a real yield firmly negative. Recall, there is a strong correlation between real 2-year yields and the value of the dollar, so those negative yields are clearly weighing on the buck. While it will not be a straight line, as long as the market continues to believe that central banks will not allow a market correction, the dollar should continue to slide.

Away from the euro, the dollar is soft almost across the board again today, with only PLN (-0.5%) having fallen any distance in the EMG bloc, and the Swiss franc (-0.3%) the only real loser in the G10. The Swiss story seems to be a technical one as the EURCHF cross has broken higher technically after the ECB announcement yesterday and continued with a little momentum. Poland is a bit more mystifying as there does not appear to be any specific news that would have led to selling, although the trend for the past 3 weeks remains clearly higher.

On the plus side, the big winner today is IDR (+1.55%) after the central bank governor, Perry Warjiyo, commented that the rupiah remains undervalued amid low inflation and a declining current account deficit.

With this as a backdrop, this morning brings the US payroll report with the following forecasts:

Source: Bloomberg

Remember, Wednesday’s ADP number was much lower than expected at -2.76M, still remarkably awful, but nonetheless surprising. However, data continues to be of secondary importance to the markets. I expect this will be the case until we start to see a recovery in earnest, but for now, we seem to be trying to define the bottom. The dichotomy between the destruction of the economy via lockdowns and the ebullience of the stock markets remains a key concern. The positive spin is that we truly will see a very sharp recovery in Q3 and Q4 with unemployment rolls tumbling back to a more normal recessionary level, and the bulls will have been right. Alas, the other side of that coin is that forecasts of permanent job destruction and decimated corporate earnings will prove too much for the central banks to overcome and we will have a longer-term decline in equity prices as the recession/depression lingers far longer.

For now, the bulls remain in charge. Today’s data is unlikely to change that view, so further dollar weakness seems the best bet. However, be aware of the risk of the other side of the trade, it has not disappeared by any stretch.

Good luck, good weekend and stay safe
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