It seems that the virus mutated
In Spain, which has now complicated
The efforts by France
To alter their stance
On lockdowns, with new ones created
In Germany, too, there is trouble
With cases, this week, set to double
So, Madame Lagarde
Will simply discard
Her fears, and inflate the bond bubble
The second wave of infections, or perhaps the third, is clearly washing over Europe with Covid-19 cases surging across the continent. The situation has deteriorated so rapidly that, in short order, both Germany and France have ordered lockdowns, closing restaurants, bars, gyms and theaters for the next month. Public gatherings are being restricted to ten people drawn from only two families as hospital beds throughout both nations fill up quickly. Research to be released this morning has identified a new strain of the virus that apparently originated in Spanish farm workers during the summer and has been the main version in the latest outbreak. It seems that it was spread by people returning to their homelands from Spanish holidays.
Meanwhile, Spain and Italy are also contemplating nationwide lockdowns as infections surge there, and even countries that saw a limited outbreak last spring, like the Czech Republic, are under severe pressure now. Add it all up and you have a recipe for a fourth quarter of negative growth on the continent. Seemingly, the only part of the Eurozone economy that is performing well are German capital goods exporters as their main market, China, has been rebounding.
With this as background, now consider that you are Christine Lagarde and chairing the ECB policy meeting today. While the ECB has made significant efforts to support every Eurozone nation during the current crisis, clearly the situation remains fraught. Is there anything that she can do to shore up confidence?
The punditry is pretty united in their views at this time, not expecting any policy changes at today’s meeting in the belief that the council will want to wait for updated economic forecasts in December before adding to the PEPP. Estimates for an increase in that QE program have coalesced around €500 billion. If anything, the only expectations for today are for Lagarde to essentially promise that the ECB will announce the expansion of their policy accommodation in December. While this may well be the outcome, if there is one thing we should have learned from Signor Draghi’s time in Lagarde’s chair, it is that acting sooner than expected and larger than expected are the only ways for the ECB to alter the narrative. And right now, the narrative is leaning toward the ECB is powerless to prevent the next downturn.
With this in mind, and recognizing that Lagarde, while perhaps not the most sophisticated economic mind on the council, is clearly the best politician, and with the new gloom and doom reports coming in daily, if not hourly, I think there is a decent probability that the ECB acts today. After all, if they are certain they are going to increase the PEPP program in December, what is the advantage to waiting. And while I don’t think that a rate cut is in the cards yet, there is a non-zero probability of that too. News earlier this week, that didn’t get much press in the US, highlighted that small German banks, of which there are nearly 1800, have started to charge depositors to maintain deposits from the first euro. So, savings accounts are going to be
taxed subject to negative interest. If banks are starting to pass on the costs of ECB monetary policy, then the ECB is likely to be far more comfortable in cutting rates further as they recognize that the banking system there is likely to have halted the decline in lending spreads. Hence, my out of consensus view is we see some definitive action from the ECB this morning.
Leading up to that meeting, with the announcement to be made at 8:45 this morning (Daylight Savings time has already occurred there), markets are rebounding modestly from yesterday’s risk reducing session. I’m sure you are all aware of he size of the decline in stock market indices yesterday, with US markets falling ~3.5%, their worst single day performance since June. What was quite interesting about the session, though, was while equity risk was abandoned, haven assets, which had a bid early in the session, lost their luster as well. In fact, Treasury bonds wound up the day unchanged, and yields there are actually almost a basis point higher this morning.
A quick tour of equity markets shows that Asian markets were somewhat lower (Nikkei -0.4%, Hang Seng -0.5%, Shanghai +0.1%), although they all closed well off the worst levels of the session. European bourses are ever so slightly higher, on average, with the DAX (+0.4%), CAC (+0.1%) and FTSE 100 (+0.3%) all in the green. The big outlier here is Spain’s MIB (-0.95%), which is feeling the pain of the latest story about the genesis of the new strain of the virus, as well as responding to the announcement by PM Sanchez that the national state of emergency has been extended for six months, meaning lockdowns are almost certainly coming there soon. US futures, meanwhile, are currently up about 0.5%-0.7%, although that is well off the earlier session highs. The question remains is this a modest trading bounce, or was yesterday an aberration?
Unlike the Treasury market, with a modest uptick in yields, Bunds and OATs are both rallying with 1 basis point declines. It seems I am not the only one who thinks the ECB may act today, as any early action should see an uptick in demand for European paper. Oil, on the other hand, is having another tough day, down 3.5%, and at $36/bbl, WTI is back to its lowest level since mid-June. Fears over slipping demand alongside growing supply are infiltrating the market.
As to the dollar, early price activity was mixed, but it is seeing some demand in the past hour and is now largely higher on the day. NOK (-0.95%) is the laggard again, following oil lower, but we are seeing weakness, albeit modest weakness, from SEK (-0.4%) and EUR (-0.2%). Certainly, if I am correct in my view on the ECB, we should see the euro decline further. On the plus side, only JPY (+0.25%) is gaining on the greenback as the BOJ’s lack of policy action combined with a background of fear over the new lockdowns and their impact on economic activity, has some Japanese investors taking their money home. This is a trend that has legs.
EMG currencies have also turned from a mixed bag to a nearly universal decline, although the losses are not enormous. For a change of pace, MXN (-0.7%) is the laggard today, suffering from the ongoing oil price declines, and pushing TRY (-0.6%) back to only the second worst performing currency. But EEMEA currencies are all lower in the 0.3%-0.5% range. In fact, the only gainer today is CNY (+0.25%) which continues to benefit from investment inflows as the Chinese economy continues to be the world’s top performer.
On the data front, today we see the most important points of the week. Initial Claims (exp 770K) and Continuing Claims (7.775M) have been falling but remain substantially higher than even during the worst recessions in the past 75 years. Of possibly more interest will be this morning’s first reading of Q3 GDP (exp 32.0%), which while it will be a record, will not make up for the loss in Q2. And right after those are released, we hear from the ECB, so the 30 minutes between 8:30 and 9:00 have the chance for some fireworks.
In the end, it appears to me that risk will continue to be shed leading up to the election, and with that activity, we will see the dollar (and yen) grind higher.
Good luck and stay safe