It’s not clear why anyone thought
The ECB ever would not
Continue to buy
More bonds as they try
To safeguard ‘gainst risks they have wrought
So, when PEPP, next March, does expire
A new plan we’ll get to admire
As Christine will ne’er
Be set to foreswear
Her drive to push bond prices higher
If ever anyone was talking their own book, it was Greek central bank president Yannis Stournaras this morning on the subject of the ECB’s potential actions post-PEPP. “Asset purchases aim at favorable financing conditions, at smooth transition of monetary policy to prevent any kind of fragmentation in jurisdictions in the euro area. I’m sure that the Governing Council will continue to aim at this.” [author’s emphasis] These comments were in response to a report that the ECB is considering instituting a new asset purchase program when the emergency PEPP expires in March. This is certainly no surprise as I posited this exact outcome a month ago (Severely Distraught – Sep 7) and the idea has gained credence since then.
One of the features of the ECB’s APP (original QE program from 2015) is that they are required to purchase bonds based on the so-called capital key in order to give the illusion they are not monetizing national debt. This means that they must buy them in proportion to the relative size of each economy. Another feature is that the bonds they purchase must be investment grade (IG). This rules out Greek debt which currently is rated BB-, 3 notches below IG. The PEPP, however, given the dire emergency created by governments shutting down their economies when Covid-19 first appeared, did away with those inconveniences and was empowered to buy anything deemed necessary. Not surprisingly, purchases of bonds from the PIGS was far above their relative economic weight which has served to narrow credit spreads across the entire continent. If the PEPP simply expires and is not replaced, it is unambiguous that PIGS’ debt would fall sharply in price with yields rising correspondingly, and those nations would find themselves in far worse fiscal shape. In fairness, the ECB can hardly allow that to happen to just a few nations so they will continue their PEPP purchases in some manner or other. And I assure you they will continue to purchase Greek debt regardless of its credit rating.
It is useful to compare this future to that of the Fed, where Chairman Powell has indicated that as long as the payroll number this Friday is not a complete disaster (currently expected 500K), a reduction in the pace of QE is appropriate. On the surface, it would be quite reasonable to expect the euro to decline further given what is likely to be a divergence in relative yields. Yesterday’s ADP Employment report (568K) was better than expected and certainly seems to be of sufficient strength to support the Chairman’s view of continued strength in the labor market. Thus, if the Fed does begin to taper while the ECB discusses its next version of QE, I would look for the euro’s recent decline to continue.
Of course, the big question is, will the Fed continue to taper if the economic situation in the US starts to show much less impetus? For instance, the Atlanta Fed’s GDPNow forecast is estimating Q3 GDP growth at 1.333%, MUCH weaker than it had been in the past and a MUCH sharper slowdown than the Fed’s own forecasts. While the number may well be higher than that, it does speak to a run of weaker than expected economic data in the US. Inflation, meanwhile, shows no signs of abating soon. The Fed looks set to find themselves in a very uncomfortable position with the following choices: tighten into slowing growth or let inflation run much hotter than targeted for much longer than anticipated. (If I were Powell, given the trainwreck that is approaching, I don’t think I would accept the offer of reappointment should it be made!)
In sum, while the decision process in Europe is much easier with slower growth and lower inflation, extending monetary largesse still seems appropriate, in the States, some tough decisions will need to be made. The problem is that there is not a single person in any Federal position who appears capable of making (and owning) a tough decision. In fact, it is this lack of demonstrated decision-making prowess that leads to the idea that stagflation is the most likely outcome going forward.
But it is still a few weeks/months before these decisions will need to be made and, in the meantime, Buy Stonks! Well, at least, that seems to be the investor mindset as fleeting fears over contagion from China Evergrande’s slow motion bankruptcy and comments from Vladimir Putin that Russia would, of course, supply the necessary NatGas for Europe, have been sufficient to remind the equity crowd that a 5% decline from an all-time high price level is an amazing opportunity to buy more stocks. Hence, yesterday morning’s fears have abated and all is once again right with the world.
(As an aside, it strikes me that relying on a key geopolitical adversary to supply the life’s blood of your economy is a very risky strategy. But Putin would never use this as leverage for something else, would he? I fear it could be a very long cold winter in Europe.)
OK, with that in mind, let’s look at markets this morning. Equity markets are green everywhere ranging from the Nikkei (+0.5%) to the Hang Seng (+3.1%) with all of Europe in between (DAX +1.2%, CAC +1.35%, FTSE 100 +1.0%) while China remains closed. US futures are also firmer, currently pointing to a 0.75% rise on the open.
Bond markets are in pretty good shape as well. Yesterday, after substantial early session weakness, they rebounded, and this morning are continuing on that trend. While Treasuries are only lower by 0.2bps, in Europe we are seeing much better buying (Bunds -1.7bps, OATs -2.1bps, Gilts -1.2bps) with PIGS bonds (Italy -5.1bps, Greece -3.0bps) showing even more strength.
Commodity prices are consolidating after what has been a significant run higher with oil (-1.6%) and NatGas (-2.0%) both off highs seen yesterday morning. Gold is unchanged on the day while copper (+1.1%) has bounced along with other base metals. Ags, too, are a bit firmer this morning.
This positive risk attitude has seen the dollar cede some of its recent gains with AUD (+0.35%) leading the way in the G10 on the back of stronger commodity prices, followed by SEK (+0.3%) and NZD (+0.3%) both benefitting from better risk appetite as well. Only NOK (-0.1%) is under pressure on the back of the oil price decline. EMG currencies are universally stronger led by ZAR (+0.7%), PHP (+0.6%) and RUB (+0.5%). ZAR is clearly benefitting from the commodity rally while PHP was higher on some positive growth comments from the central bank there. The ruble seems to be benefitting from the view that a higher than expected CPI print there will force the central bank to raise rates more than previously anticipated.
On the data front, today brings only Initial (exp 348K) and Continuing (2762K) Claims. Given tomorrow is payroll day, these are unlikely to move the market. We also hear from Cleveland Fed president Mester, one of the more hawkish voices, discussing inflation, but my sense is all eyes are on tomorrow’s NFP to make sure that the taper is coming. As such, today is likely to continue to see risk appetite with higher stock prices and a soft dollar. But large moves seem unlikely.
Good luck and stay safe