Tag Archives: #EU

Desperate Straits

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In Europe, the growth impulse faded
As governments there were persuaded
To lock people down
In city and town
While new strains of Covid invaded

Contrast that with here in the States
Where GDP growth resonates
Tis no real surprise
That stocks made new highs
And bond bulls are in desperate straits

There is no better depiction of the comparative situation in the US and Europe than the GDP data released yesterday and today.  In the US, Q1 saw GDP rise 6.4% annualized (about 1.6% Q/Q) after a gain of 4.3% in Q4 2020.  This morning, the Eurozone reported that GDP shrank -0.6% in Q1 after declining -0.7% in Q4 2020.  In other words, while the US put together a string of substantial economic growth over the past 3 quarters (Q3 was the remarkable 33.4% on this measure), Europe slipped into a double dip recession, with two consecutive quarters of negative growth following a single quarter of rebound.  If you consider how markets behaved in Q1, it begins to make a great deal more sense that the dollar rallied sharply along with Treasury yields, as the economic picture in the US was clearly much brighter than that in Europe.

But that is all backward-looking stuff.  Our concerns are what lies ahead.  In the US, there is no indication that things are slowing down yet, especially with the prospects of more fiscal stimulus on the way to help goose things along.  As well, Chairman Powell has been adamant that the Fed will not be reducing monetary accommodation until the economy actually achieves the Fed’s target of maximum employment.  Essentially, this has been defined as the reemployment of the 10 million people whose jobs were eliminated during the depths of the Covid induced government lockdowns.  (Its stable price target, defined as 2.0% average inflation over time, has been kicked to the curb for the time being, and is unimportant in FOMC discussions…for now.)

At the same time, the fiscal stimulus taps in Europe are only beginning to drip open.  While it may be a bit foggy as it was almost a full year ago, in July 2020 the EU agreed to jointly finance fiscal stimulus for its neediest members by borrowing on a collective level rather than at the individual country level.  This was a huge step forward from a policy perspective even if the actual amount agreed, €750 billion, was really not that much relative to the size of the economy.  Remember, the US has already passed 3 separate bills with price tags of $2.2 trillion, $900 billion and just recently, $1.9 trillion.  But even then, despite its relatively small size, those funds are just now starting to be deployed, more than 9 months after the original approval.  This is the very definition of a day late and a dollar euro short.

Now, forecasts for Q2 and beyond in Europe are much better as the third wave lockdowns are slated to end in early to mid-May thus freeing up more economic activity.  But the US remains miles ahead on these measures, with even NYC declaring it will be 100% open as of July 1st.  Again, on a purely economic basis, it remains difficult to look at the ongoing evolution of the Eurozone and US economies and decide that Europe is the place to be.  But we also know that the monetary story is critical to financial markets, so cannot ignore that.  On that score, the US continues to pump more money into the system than the ECB, offering more support for the economy, but potentially undermining the dollar.  Arguably, that has been one of the key drivers of the weak dollar narrative; at some point, the supply of dollars will overwhelm, and the value of those dollars will decrease.  This will be evident in rising inflation as well as in a weakening exchange rate versus its peers.

The thing is, this story has been being told for many years and has yet to be proven true, at least in any significant form.  In the current environment, unless the Fed actually does ease policy further, via expanded QE or explicit YCC, the rationale for significant dollar weakness remains sparse.  Treasury yields continue to define the market’s moves, thus, that is where we must keep our attention focused.

Turning that attention to market activity overnight, whether it is because it is a Friday and traders wanted to square up before going home, or because of the weak data, risk is definitely on the back foot today.  Equity markets in Asia were all red led by the Hang Seng (-2.0%) but with both the Nikkei and Shanghai falling 0.8% on the session.  Certainly, Chinese PMI data were weaker than expected (Mfg 51.1, Services 54.9) both representing declines from last month and raising questions about the strength of the recovery there.  At the same time, Japanese CPI remains far below target (Tokyo CPI -0.6%) indicating that whatever policies they continue to implement are having no effect on their goals.

European bourses are mixed after the weaker Eurozone data, with the DAX (+0.2%) the star, while the CAC (-0.2%) and FTSE 100 (0.0%) show little positive impetus.  Looking at smaller country indices shows lots of red as well.  Finally, US futures are slipping at this hour, down between -0.4% and -0.7% despite some strong earnings reports after the close.

Perhaps the US markets are taking their cue from the Treasury market, where yields continue to edge higher (+1.2bps) with the idea that we have seen the top in rates fading quickly.  European sovereign bonds, however, have seen demand this morning with yields slipping a bit as follows: Bunds (-1.8bps), OATs (-1.2bps) and Gilts (-1.3bps). Perhaps the weak economic data is playing out as expected here.

Commodities are under pressure this morning led by WTI (-1.9%) but seeing weakness in the Agricultural space (Wheat -0.7%, Soy -0.9%) as well.  The one thing that continues to see no end in demand, though, is the base metals with Cu (+0.3%), Al (+0.9%) and Sn (2.2%) continuing their recent rallies.  Stuff is in demand!

In the FX markets, the day is shaping up to be a classic risk-off session, with the dollar firmer against all G10 counterparts except the yen (+0.1%) with SEK (-0.55%) and NOK (-0.5%) the leading decliners.  We can attribute Nokkie’s decline to oil prices while Stockie seems to be demonstrating its relatively high beta to the euro (-0.3%). EMG currencies have far more losers than gainers led by ZAR (-0.7%), TRY (-0.65%) and RUB (-0.6%).  The ruble is readily explained by oil’s decline while TRY is a bit more interesting as the latest central bank governor just promised to keep monetary policy tight in order to combat inflation. Apparently, the market doesn’t believe him, or assumes that if he tries, he will simply be replaced by President Erdogan again.  The rand’s weakness appears to be technical in nature as there is a belief that May is a particularly bad month to own rand, it having declined in 8 of the past 10 years during the month of May, and this is especially true given the rand has had a particularly strong performance in April.

On the data front, today brings a bunch more information including Personal Income (exp 20.2%), Personal Spending (+4.1%), Core PCE Deflator (1.8%), Chicago PMI (65.3) and Michigan Sentiment (87.5).  Given the Fed’s focus on PCE as their inflation measure, it will be important as a marker, but there is no reason to expect any reaction regardless of the number.  That said, every inflation reading we have seen in the past month has been higher than forecast so I would not be surprised to see that here as well.

In the end, though, it is still the Treasury market that continues to drive all others.  If yields resume their rise, look for a stronger dollar and pressure on equities and commodities.  If they were to head back down, so would the dollar while equities would find support.

Good luck, good weekend and stay safe
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No Use Delaying

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In Europe, the powers that be
Are feeling quite smug, don’t you see
Not only have they
Held Covid at bay
But also, they borrow for free

Thus, Italy now wants to spend
More money, recession, to end
If Germany’s paying
There’s no use delaying
With Merkel now Conte’s best friend

The euro is continuing its climb this morning, as it mounts a second attack on 1.1600, the highest level it has traded since October 2018. While the overall news cycle has been relatively muted, one thing did jump out today. It should be no surprise, but Italy is the first nation to take advantage of the new EU spending plans as they passed a supplemental €25 billion budget to help support their economy.

Now, it must be remembered that prior to the pandemic, Italy was in pretty bad shape already, at least when looking at both fiscal and economic indicators. For instance, Italy was in recession as of Q4 2019, before Covid, and it was maintaining a debt/GDP ratio of more than 130%. Unemployment was in double digits and there was ongoing political turmoil as the government was fighting for its life vs. the growing popularity of the conservative movement, The League, led by Matteo Salvini. Amongst his supporters were a large number of Euroskeptics, many of whom wanted to follow in the UK’s footsteps and leave the EU. (Quitaly, not Italexit!) However, it seems that the economic devastation of Covid-19 may have altered the equation, and while Salvini’s League still has the most support, at 26%, it has fallen significantly since the outbreak when it was polling more than 10 points higher. Of course, when the government in power can spend money without limits, which is the current situation, that tends to help that government stay in power. And that is the current situation. The EU has suspended its budget restrictions (deficits <3.0%) during the pandemic, and Italy clearly believes, and are probably correct, that the EU is ultimately going to federalize all EU member national debt.

It seems the growing consensus is that federalization of EU fiscal policies will be a true benefit. Of course, it remains to be seen if the 8 EU nations that are not part of the Eurozone will be forced to join, or if the EU will find a way to keep things intact. My money is on the EU forcing the issue and setting a deadline for conversion to the euro as a requisite for remaining in the club. Of course, this is all looking far in the future as not only are these monumental national decisions, but Europe takes a very long time to move forward on pretty much everything.

This story, though, is important as background information to developing sentiment regarding the euro, which is clearly improving. In fairness, there are shorter term positives for the single currency’s value, notably that real interest rates in the rest of the world are falling rapidly, with many others, including the US, now plumbing the depths of negative real rates. Thus, the rates disadvantage the euro suffered is dissipating. At the same time, as we have seen over the past several months, there is clearly very little fear in the market these days, with equity prices relentlessly marching higher on an almost daily basis. Thus, the dollar’s value as a safe haven has greatly diminished as well. And finally, the appearance of what seems to be a second wave of Covid infections in the US, which, to date, has not been duplicated as widely in Europe, has added to confidence in the Eurozone and the euro by extension.

With all this in mind, it should be no surprise that the euro continues to rally, and quite frankly, has room for further gains, at least as long as the economic indicators continue to rebound. And that is the big unknown. If the economic rebound starts to falter, which may well be the case based on some high-frequency data, it is entirely likely that there will be some changes to some of the narrative, most notably the idea that risk will continue to be eagerly absorbed, and the euro may well find itself without all its recent supports.

But for now, the euro remains in the driver’s seat, or perhaps more accurately, the dollar remains in the trunk. Once again, risk is on the move with equity markets having gained modestly in Asia (Hang Seng +0.8%, Sydney +0.3%, Nikkei was closed), while European bourses have also seen modest gains, on the order of 0.5% across the board. US futures are also pointing higher, as there is no reason to be worried for now. Bond markets have behaved as you would expect, with Treasuries and bunds little changed (although Treasuries remain at levels pointing to significant future economic weakness) while bonds from the PIGS are seeing more demand and yields there are falling a few basis points each. Oil is higher on optimism over economic growth, and gold continues to rally, preparing to set new all-time highs as it trades just below $1900/oz. The gold (and silver) story really revolves around the fact that negative real interest rates are becoming more widespread, thus the opportunity cost of holding that barbarous relic have fallen dramatically. Certainly, amongst the market punditry, gold is a very hot topic these days.

As to the rest of the currency space, there are two noteworthy decliners in the G10, NOK (-0.5%) and GBP (-0.25%). The former, despite rising oil prices, fell following the release of much worse than expected employment data. After all, rising unemployment is hardly the sign of an economic rebound. The pound, on the other hand, has suffered just recently after comments by both sides regarding Brexit negotiations, where the essence was that they are no nearer a positive conclusion than they were several months ago. Brexit has been a background issue for quite a few months, as most market players clearly assume a deal will be done, and that is a fair assumption. But that only means that there is the potential for a significant repricing lower in the pound if the situation falls apart there. Otherwise, the G10 is broadly, but modestly firmer.

In the emerging markets, the picture is a bit more mixed with the CE4 tracking the euro higher, but most other currencies ceding earlier session gains. IDR is the one exception, having rallied 0.5% for a second day as equity inflows helped to support the rupiah. On the downside, KRW (-0.2%) suffered after GDP data was released at a worse than expected -3.4%, confirming Korea is in a recession. Meanwhile, the weakest performer has been ZAR (-0.6%) as traders anticipate a rate cut by the SARB later today.

Data in the US this morning includes the ever-important Initial Claims (exp 1.3M) and Continuing Claims (17.1M), as well as Leading Indicators (2.1%). But all eyes will be on the Claims data as the consensus view is weakness there implies the rebound is over and the economic situation may slide back again. Counterintuitively, that could well help the dollar as it spreads fear that the V-shaped recovery is out of the question. However, assuming the estimates are close, I would look for the current trends to continue, so modestly higher equities and a modestly weaker dollar.

Good luck and stay safe
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A Blank Check

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While much of the nation’s a wreck
The good news is there’s still Big Tech
Whose prices ne’er fall
Thus, keeping in thrall
Investors who wrote a blank check

One cannot but be impressed with the performance of the tech sector in US equity markets.  It seems that no matter what else happens anywhere in the world, a small group of companies has unearthed the secret to infinite value, or at least a never-ending rally in their share prices. Yesterday’s price action was instructive in that a group of just seven companies, all tech titans, added nearly $300 billion in value, which was greater than the entire NASDAQ’s 2.5% gain. While we all are happy to see equity markets continue to rally, it certainly is beginning to appear as though some of these valuations are unsustainable, especially if the V-shaped recovery doesn’t materialize. One other thing to consider about the values of these companies is that if there is a change in the White House, it is almost certain to bring with it significantly higher corporate taxes (39.6% anyone?), which will almost certainly result in a repricing of the future stream of earnings available to shareholders. But for now, clearly nothing matters but the fact that these companies are market darlings and are set to continue to rally…until they stop.

In Europe, those twenty plus nations
(Ahead of their summer vacations)
Have finally agreed
To help those in need
With billions in brand new donations

However, arguably the biggest story in the markets today is that the EU finally did agree to a spending plan to help those nations most severely impacted by the Covid recession. It was inevitable that this would be the result as the political imperative was too great for four smaller nations to prevent its completion. To hear the frugal four, though, is quite amusing. They seem to believe that their “principled” stand, where they each get a larger rebate from the general pool of funds (each is a net payer into the EU budget), and their demands that this is a one-time solution to an extraordinary event means that in the future, debt mutualization will not expand. If there is one thing that we know about government programs, it is that they always expand, and they never die. There is no such thing as a one-time program. Debt mutualization is now the standard in the EU, and one should expect nothing less. Redistribution from the North to the South of the continent is now a permanent feature.

The market reaction to this news is mostly what one would have expected. European equity markets have rallied, with those in Italy (+2.2%) and Spain (+1.9%) leading the way higher, although the strength is broad-based. As well, European government bond markets are also performing appropriately, with the havens seeing a modest rise in yields while the risk bonds, like Italian and Greek debt, falling as investors have greater assurances that they will now be repaid. After all, with debt mutualization, Greek and German debt are basically the same!

Finally, looking at the FX markets, we find the euro slightly softer on the session, having briefly traded higher, but now falling victim to what appears to be a buy the rumor, sell the news type event. But the euro has been a stellar performer for the past two months, rising 4.5% in that period as the market narrative has turned back to some previously discredited themes. Notably, we continue to hear a great deal about the dollar’s twin deficit issue and how that will undermine the greenback. In addition, given the ongoing risk rally, the idea of needing a safe haven currency, has simply faded from existence. In fact, this morning there is now talk that the euro, with its new solidarity, is really a haven asset. PPP models continue to point to the euro being undervalued at current levels with forecasts creeping ever higher. In fact, one large bank is out calling for 1.30 in the euro by the end of next year.

Of course, there is a great irony in the discussion of a stronger euro, the fact it is the absolute last thing Madame Lagarde and her ECB compatriots want (or need). After all, one of the key reasons for them to cut interest rates below zero was to undermine the euro in order to both import inflation and help European exporters become more price competitive. You can be sure that if the euro does start to break higher, we will hear a great deal more about the inappropriate price action of a rising euro. For now, all eyes are on 1.1495, which was the spike high seen in March, and which is currently serving as a resistance point for the technicians. A break there is likely to see a test of the 1.17-1.18 level before the end of the summer.

As to the dollar overall, it continues its recent weakening trend, with only a handful of currencies modestly softer and some decent moves the other way. For instance, Aussie is the top pick in the G10 this morning, rising 0.85%, as a combination of risk appetite and a short squeeze is doing the job nicely. But we are also seeing strength in NOK (+0.6%) and CAD (+0.5%), both of which are benefitting from oil’s rally today (WTI +2.8%). In the EMG space, it should be no surprise that RUB and ZAR (both +0.8%) are the leaders as the oil and commodity price rallies are clear supports. In fact, the bulk of this bloc is firmer this morning with only a handful of currencies (RON, CNY, SGD) in the red, and there just by a few basis points. Overall, it is fair to say the dollar is on its back foot again today.

With no data due today, and none of note released overnight, the FX market seems set to take its cues from the equity space and the broad risk themes. And it is pretty clear that the broad risk theme today is…buy more risk!

Herbert Stein, a very well-respected economist in the 1960’s was quoted as saying, “that which cannot continue, will not continue.” His point was that while exuberance may manifest itself periodically, it always ends when reality intrudes. Right now, it feels like risk assets, especially that formidable group of tech names, is completely disconnected with the economic reality and best-case prospects. The implication is this cannot go on. But that doesn’t mean it won’t go further before it ends. The narrative is risk assets are the thing to own, and as long as that is the case, the dollar is likely to remain under pressure.

Good luck and stay safe
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They’ll See the Light

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In China, a new rule applies
Which helped stocks close on session highs
The news was released
Insurers increased
The size of their equity buys

Meanwhile, Brussels has been the sight
Of quite a large policy fight
Four nations refuse
Their cash to misuse
But in the end, they’ll see the light

Once upon a time, government announcements were focused on things like international relations, broad economic policies and the occasional self-kudos to try to burnish their reputation with the electorate, or at least with the population.  But that ideal has essentially disappeared from today’s world.  Instead, as a result of the ongoing financialization of economies worldwide, there are only two types of government announcements these days; those designed to explain why the current government is the best possible choice, and those designed to prop up the nation’s stock market.  Policy comments are too hard for most people to understand, or at least to understand their potential ramifications, so they are no longer seen as useful.  But, do you know what is seen as useful?  Explaining that institutions should buy more stocks because a higher stock market is good for everyone!

Once again, China leads the way in this vein, with Friday night’s announcement that henceforth, Insurers should can allocate as much as 45% of their assets to equities, up from the previous cap of 30%.  Some quick math shows that this new regulation has just released an additional $325 billion of new buying power into the Chinese stock market, or roughly 4% of the total market capitalization in the country.  It cannot be a surprise that the Shanghai Exchange rallied 3.1% last night, which was, of course, exactly the idea behind the announcement.  In fact, lately, the Chinese have been really working to manipulate the stock market there, apparently seeking a steady move higher, probably something like 1% a day, but have been having trouble reining in the exuberance of the large speculative community there.  So, all of their little nudges higher result in 3%-5% gains, which they feel could be getting out of hand, and so they need to squash them occasionally.  But for now, they are back on the rally bandwagon, so look for some steady support this week.

Interestingly, however, this was clearly not seen as a global risk-on signal as equity activity elsewhere has been far more muted.  The rest of Asia was basically flat (Nikkei +0.1%, Hang Seng -0.1%) and Europe has seen a mixed session as well, with small gains by the DAX (+0.3%) and losses by the CAC (-0.3%).  In other words, investors realize this is simply Chinese activity.  PS, US futures are basically unchanged on the day as well.

At the same time, there is a critical story building out of Europe, the outcome of the EU Summit. This began with high hopes on Friday as most people expected the Frugal Four to quickly cave into the pressure to give more money away to the PIGS.  However, after three full days of talks, there is still no agreement.  Remember, their concern is that the EU plan to give away €500 billion in grants to countries most in need (read Italy, Spain and Greece), is simply delaying the inevitable as they will almost certainly waste these funds, just like they have each wasted funds for decades.  And the frugal four nations were not interested in throwing their money away.  But in the end, it was always clear that with support from Germany and France, a deal would get done in some form.  The latest is that “only” €390 billion will be given as grants, so a 22% reduction, but still a lot of free cash.

While no one has yet signed on the dotted line, you can be sure that by the end of the day, they will have announced a successful conclusion to the process.  The funny thing is that regardless of the outcome of the Summit, it seems to me that the entire package, listed at €750 billion, is actually pretty small.  After all, the CARES act here had a price tag of $3.2 trillion, four times as large, and the EU economy is going to suffer just as much as the US.  But that is not the way the market is looking at things.  Rather, they have collectively decided that this package is a huge euro positive and have been pushing the single currency higher steadily for pretty much the entire month of July (+2.5%), with it now sitting just pips below the spike high seen in March, and back to levels last seen, really, in January 2019.  How much further can it rise?  Personally, I am skeptical that it has that much more room to run, but I know the technicians are really getting excited about a big breakout here.

As to the rest of the FX market, activity has been fairly muted with the dollar slightly softer against most G10 and EMG counterparts.  On the G10 side, NOK and SEK lead the way higher, both up by 0.45%, as in a broad move, these higher beta currencies tend to have the best performance.  JPY is a touch softer on the day, and a number of currencies, CAD, NZD, CHF, are all within just basis points of Friday’s close.

We are seeing similar price action in the emerging markets, with one notable loser, IDR (-0.5%) as traders there continue to price in further policy ease by the central bank after last week’s 25bp rate cut. On the plus side, the CE4 are leading the way higher, with gains between 0.3% and 0.6%, simply tracking the euro with a bit more beta.  But really, there is not too much of note to discuss here.

On the data front, it is an extremely quiet week upcoming as follows:

Wednesday Existing Home Sales 4.80M
Thursday Initial Claims 1.293M
  Continuing Claims 16.9M
  Leading Indicators 2.1%
Friday PMI Manufacturing 52.0
  PMI Services 51.0
  New Home Sales 700K

Source: Bloomberg

In addition, there are no Fed speakers on the docket as it seems everybody has gone on holiday.  So, once again, Initial Claims seems to be the key data point this week, helping us to determine if things are actually getting better, or we have seen a temporary peak in activity.  With the ongoing spread of what appears to be a second wave of Covid, there is every chance that we start to see the rebound in data seen for the past two months start to fade.  If that is the case, it strikes me that we will see a bit more risk-off activity and the dollar benefit.  But that is a future situation.  Today, the dollar remains under modest pressure as traders respond to the perceived benefits of striking a deal at the EU.

Good luck and stay safe

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Second Wave

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In Q2 we learned to behave
Like primitives stuck in a cave
In order to stem
The virus mayhem
And millions of lives, try to save

But Q3 has shown that we crave
More contact than lockdown, us, gave
Thus, it’s not surprising
Infections are rising
And now we’ve achieved second wave

If I were to describe market behavior of late, the word I would use is tentative. Investors and traders are caught between wanting to believe that the nonstop stimulus efforts on both fiscal, and especially, monetary fronts will be sufficient to help the economy through the current economic crisis (conveniently ignoring the extraordinary build up in debt), and concerns that there is too much permanent damage to too many businesses to allow for a swift recovery to a pre-Covid level of activity. Adding to the fear side of the equation is the resurgence in the number of infections worldwide, especially in places that had seemed to eradicate the virus. News from Hong Kong, Australia, China and India shows that the virus is making a resurgence, with several places recording more cases now than when things started five to six months ago. And of course, we have seen the same pattern in states that were first to reopen here at home.

Meanwhile, the medical community continues its extraordinary efforts to find a vaccine, with several promising candidates making their way through trials. Perhaps the best medical news is that it seems doctors on the front line have learned how to treat the disease more effectively, which has reduced the number of critical cases and helped drive down the fatality rate. Alas, an effective vaccine remains elusive. Ironically, the vaccine’s importance in many ways is symbolic. The idea that there is a way to avoid catching the bug is certainly appealing, but if the flu vaccine is any harbinger of the outcome, a minority of people will actually get vaccinated. So, the vaccine story is more about a chance for confidence to be restored than about people’s health. Perhaps this sums up the state of human affairs these days better than anything else.

And yet, while no politician anywhere will allow confirmation, it certainly appears that we are seeing a second wave of infections spread worldwide. From the market’s perspective, this has been a key concern for the past several months as a second wave of economy-wide shutdowns would end all hopes of that elusive V-shaped recovery. And the only way to justify the current levels of asset values is by assuming this crisis will pass quickly and things will return to a more normal framework. Hence the trader’s dilemma. Is the worst behind us? Or is a second wave going to expand and delay the recovery further? Perhaps the most telling feature of this market is the changed relationship between the S&P 500 and the VIX index. Prior to the Covid-19 outbreak, an equity rally of the type seen since late March would have seen the VIX index collapse toward 15, the level at which it traded for virtually all of 2019. But this time, 30 has become the new normal for the VIX, a strong indication that investors are paying for protection, despite the cost, as there remains an underlying fear of another sharp decline beyond the horizon. Hence, my description of things as tentative.

Looking at markets this morning, tentative is an excellent descriptor. In the equity space, Asian markets were mixed, with the Nikkei (-0.3%) on the weak side with the Hang Seng (+0.5%) was the strong side. But given the type of movement we have seen lately, neither really displayed anything new at the end of the week. European markets are also mixed with the DAX (+0.5%) the best performer while Spain’s IBEX (-0.5%) is the worst. Again, a mix of performances with no evident trend. US futures are currently pointing higher although only the NASDAQ (+1.0%) is showing any real strength.

Meanwhile, Treasury yields have slipped again, with the 10-year down to 0.60%, its lowest level since mid-April and just 4bps from its historic low. That is hardly a sign of economic confidence. In Europe, the picture is mixed but yields are essentially within 1bp of where they closed yesterday as traders are unwilling to take a view.

Finally, the dollar, too, is having a mixed session, although if I had to characterize it, I would say it is slightly softer overall. The euro is higher by 0.3% this morning as there is hope that the EU Summit, which began a few hours ago, will come to an agreement on their mooted €750 billion pandemic plan that includes joint borrowing. Of course, the frugal four still need to be bought off in some manner but given the political determination to be seen to be doing something, I would look for a watered-down version of the bill to be agreed. However, the best performer today is CHF (+0.5%) in what appears to be some profit taking on EURCHF positions after the cross’s strong rally this week.

In the emerging markets, IDR is the big underperformer today, falling 0.5% overnight as traders position for future rate cuts by the central bank. While they cut 25bps yesterday, they also came across as more dovish than expected implying they are not yet done with the rate hatchet. On the plus side, ZAR (+0.6%) is top of the charts as investors have been flocking to the front end of their yield curve after a much lower than expected inflation print. The view is that the SARB has further to cut which will drive front end yields down, hence the buying. (The dichotomy between the two currencies is fascinating as both are moving on rate cut assumptions, but in opposite directions. Hey, nobody ever said FX was rational!) But we are seeing more gainers than losers as the CE4 track the euro higher and several APAC currencies also moved modestly higher overnight. Remember, one of the emerging narratives has been the dollar’s imminent decline on the back of the twin deficits and lost prestige in the world community. So, every time we see a day where the dollar declines, you can be sure you will see stories on that topic. And while the twin deficit story is certainly valid from a theoretical basis, it has never been a good short-term indicator of movement in the currency markets.

On the data front, yesterday saw US Retail Sales print at a better than expected 7.5%, but Initial Claims fall less than expected, with still 1.3 million first time claims. As I have mentioned, that number continues to be the timeliest indicator of what is happening, and it is certainly not declining very rapidly anymore. Today brings Housing Starts (exp 1189K) and Building Permits (1293K) at 8:30 and then Michigan Sentiment (79.0) at 10:00. Neither of these seem likely to have a major market impact. Rather, as earnings season progresses, I expect the ongoing reports there to drive equity markets and overall risk appetite. For now, nobody is very hungry for risk, but a few good numbers could certainly change that view, pushing stocks higher and the dollar lower.

Good luck, good weekend and stay safe
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A Vaccine’s Required

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Mnuchin and Powell explained
That Congress ought not be restrained
In spending more cash
Or else, in a flash
The rebound might not be maintained

Meanwhile, as the quarter expired
The data show growth is still mired
Within a great slump
And hopes for a jump
Are high, but a vaccine’s required

I continue to read commentary after commentary that explains the future will be brighter once a Covid-19 vaccine has been created. This seems to be based on the idea that so many people are terrified of contracting the disease they they will only consider venturing out of their homes once they believe the population at large is not contagious. While this subgroup will clearly get vaccinated, that is not likely to be majority behavior. If we consider the flu and its vaccine as a model, only 43% of the population gets the flu shot each year. Surveys regarding a Covid vaccine show a similar response rate.

Consider, there is a large minority of the population who are adamantly against any types of vaccines, not just influenza. As well, for many people, the calculation seems to be that the risk of contracting the flu is small enough that the effort to go and get the shot is not worth their time. Ask yourself if those people, who are generally healthy, are going to change their behavior for what appears to be a new form of the flu. My observation is that human nature is pretty consistent in this regard, so Covid is no scarier than the flu for many folks. The point is that the idea that the creation of a vaccine will solve the economy’s problems seems a bit far-fetched. Hundreds of thousands of small businesses have already closed permanently because of the economic disruption, and we are all well acquainted with the extraordinary job loss numbers. No vaccine is going to reopen those businesses nor bring millions back to work.

And yet, the vaccine is a key part of the narrative that continues to drive risk asset prices higher. While we cannot ignore central bank activities as a key driver of equity and bond market rallies, the V-shaped recovery is highly dependent on the idea that things will be back to normal soon. But if a vaccine is created and approved for use, will it really have the impact the market is currently anticipating? Unless we start to see something akin to a health passport in this country, a document that certifies the holder has obtained a Covid-19 shot, why would anyone believe a stranger is not contagious and alter their newly learned covid-based behaviors. History shows that the American people are not fond of being told what to do when it comes to restricting their rights of movement. Will this time really be different?

However, challenging the narrative remains a difficult proposition these days as we continue to see the equity bulls in charge of all market behavior. As we enter Q3, a quick recap of last quarter shows the S&P’s 20% rally as its best quarterly performance since Q4 1998. Will we see a repeat in Q3? Seems unlikely and the risk of a reversal seems substantial, especially if the recent increase in Covid cases forces more closures in more states. In any event, uncertainty appears especially high which implies price volatility is likely to continue to rise across all markets.

But turning to today’s session, equity markets had a mixed session in Asia (Nikkei -0.75%, Hang Seng +0.5%) despite the imposition of the new, more draconian law in Hong Kong with regard to China’s ability to control dissent there. Meanwhile, small early European bourse gains have turned into growing losses with the DAX now lower by 1.5%, the CAC down by 1.4% and the FTSE 100 down by 1.0%. While PMI data released showed that things were continuing on a slow trajectory higher, we have just had word from German Chancellor Merkel that “EU members [are] still far apart on recovery fund [and the] budget.” If you recall, there is a great deal of credence put into the idea that the EU is going to jointly support the nations most severely afflicted by the pandemic’s impacts. However, despite both German and French support, the Frugal Four seem to be standing their ground. It should be no surprise that the euro has turned lower on the news as well, as early modest gains have now turned into a 0.3% decline. One of the underlying supports for the single currency, of late, has been the idea that the joint financing of a significant budget at the EU level will be the beginning of a coherent fiscal policy to be coordinated with the ECB’s monetary policy. If they cannot agree these terms, then the euro’s existence can once again be called into question.

Perhaps what is more interesting is that as European equity markets turn lower, and US futures with them, the bond market is under modest pressure as well this morning. 10-year Treasury yields are higher by more than 2bps and in Europe we are seeing yields rise by between 3bps and 4bps. This is hardly risk-off behavior and once again begs the question which market is leading which. In the long run, bond investors seem to have a better handle on things, but on a day to day basis, it is anyone’s guess.

Finally, turning to the dollar shows that early weakness here has turned into broad dollar strength with only two currencies in the G10 higher at this point, the haven JPY (+0.4%) and NOK (+0.2%), which has benefitted from oil’s rally this morning with WTI up by about 1% and back above $40/bbl. In the emerging markets, only ZAR has managed any gains of note, rising 0.4%, after its PMI data printed at a surprisingly higher 53.9. On the flip side, PLN (-0.6%) is the laggard, although almost all EMG currencies are softer, as PMI data there continue to disappoint (47.2) and concerns over a change in political leadership seep into investor thoughts.

On the data front, we start to see some much more important data here today with ADP Employment (exp 2.9M), ISM Manufacturing (49.7) and Prices Paid (44.6) and finally, FOMC Minutes to be released at 2:00. Yesterday we saw some thought provoking numbers as Chicago PMI disappointed at 36.6, much lower than expected, while Case Shiller House Prices rose to 3.98%, certainly not indicating a deflationary surge.

Yesterday we also heard the second part of Chairman Powell’s testimony to Congress, where alongside Treasury Secretary Mnuchin, he said that the Fed remained committed to doing all that is necessary, that rates will remain low for as long as is deemed necessary, and that it would be a mistake if Congress did not continue to support the economy with further fiscal fuel. None of that was surprising and, quite frankly, it had no impact on markets anywhere.

At this point, today looks set to see a little reversal to last quarter’s extremely bullish sentiment so beware further dollar strength.

Good luck and stay safe
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A Line in the Sand

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The news out of Europe is grand
A virus response is now planned
Except for the fact
It’s not widely backed
It might draw a line in the sand

As well, what the data has shown
Is hope for the future has grown
Most surveys explain
The worst of the pain
Is past, though there’s much to bemoan

Equity markets continue to power ahead in most nations as the ongoing belief remains the worst of the damage from the global shutdowns is past, and that activity will quickly return to pre-virus levels given the extraordinary support promulgated by governments and central banks around the world. For example, Italian Consumer Confidence fell only to 94.3, a far better result than the 90.0 expected. Similarly, Eurozone Economic Confidence edged higher, to 67.5 from April’s revised 64.9 reading, also offering the chance that the worst is behind us. In fact, we have seen this pattern repeatedly over the past several weeks, where May readings (Empire Mfg, Philly Fed, Michigan Sentiment) rebounded from the extraordinary levels seen in March and April, although they remain at levels associated with extremely deep recessions. And maybe, hopefully, that is exactly what this data means. The bottom is in and it is straight up from here. Of course, the slope of this recovery line remains highly uncertain.

This morning we have also learned a bit more detail about the last major economy to announce a support package, as the EU’s mooted €750 billion package will be combined with €1.1 trillion of additional spending by the EU from its own budget…over the next seven years. That’s right, the EU has determined that the best way to support its member nations in the midst of a crisis is to promise to spend some additional money for nearly the next decade. And when you do the math, this stimulus adds up to less than 1% of the EU’s annual GDP, by far the smallest effort made by any major government. Adding injury to this insulting package is the fact that it remains highly uncertain as to whether even this can get enacted.

Remember, the underlying problem in Europe remains that the frugal north has been unwilling to support the profligate south. In fact, the telling comment was from a Dutch diplomat where he said, “Negotiations will take time. It’s difficult to imagine this proposal will be the end-state of those negotiations.” So, the headline spin is Europe is finally getting around to putting up some economic aid directly to those nations in greatest need. But the reality remains far from that outcome. Markets, of course, are happy to believe the words until they are proven wrong, but history suggests that the promised €1.85 trillion in total aid will actually be far less than that in the end.

Will it matter if the money never comes? Perhaps not. Perhaps, the natural course of events will see growth start to pick up again and demands for government support will fade into the background. Of course, it seems equally likely that EU support will be delivered by flying pigs. But hey, you never know!

Turning to markets now, risk remains the place to be for investors as equity rallies continue unabated. After another standout performance in the US yesterday, Asia did well (Nikkei +2.3%, Australia +1.3%), except for Hong Kong, where the Hang Seng fell 0.7% after the Chinese National People’s Congress approved (by 2,878-1) the measure allowing China to crack down directly on Hong Kong’s citizens regarding subversion, secession and terrorism, if deemed to be necessary by Beijing. This has opened yet another front of disagreement between the US and China and simply served to elevate tensions further. As yet, the situation remains a war of words and financial actions (like tariffs), but the situation appears to be edging closer to a point where a more kinetic outcome is possible. If that were the case, you can be sure that Covid headlines would become page 6 news and markets would need to reevaluate their current bullish stance.

Meanwhile, European markets have responded positively to the promise of EU support with all markets there higher by between 0.5% (DAX) and 1.7% (Italy’s FTSE MIB). This makes perfect sense as Italy will certainly be the largest beneficiary of the EU program while Germany will simply be picking up the tab. And finally, as I type, US futures are mixed with the Dow higher by 0.5% while NASDAQ futures are lower by -.4%.

Interestingly, bond markets around the world have rallied alongside stocks with yields edging lower in the US, 10-year Treasury is down 1 basis point, but seeing much greater price gains (yield declines) throughout Europe where France (-5bps), Spain (-4bps) and Greece (-3.5bps) are leading the way. Even bunds have seen yields decline, down 2.5bps, on the back of ongoing weakness in German regional CPI readings.

And what of the dollar, you may ask. In truth, today is the very definition of a mixed session. In the G10, four currencies have edged lower by about 0.1% (CHF, NOK, CAD, AUD) while two have edged higher, SEK +0.2%, NZD +0.1%, and the rest are essentially unchanged. With movement this small, there is no specific story driving things.

The EMG bloc has seen a similar split with gainers and losers, but here there has been a bit more substance to the moves. The worst performer is Turkey, with the lira down 0.6% after data showed Central bank borrowing continued to increase as the country tries to stockpile hard-currency reserves. But we also saw KRW decline 0.45% after the BOK cut rates to 0.50%, a new record low, and promised to do even more if necessary, implying that QE is on the table next. On the plus side, CZK has been the biggest gainer, up 0.4% after their government financing auction drew a bid-to-cover ratio of 10.72, demonstrating real demand for the currency.

On the data front, we see a great deal here at home as follows: Initial Claims (exp 2.1M), Continuing Claims (25.7M), Durable Goods (-19.0%, -15.0% ex transport) and Q1 GDP (-4.8%) all at 8:30. With the market clearly looking forward, not back, despite what will certainly be horrific data, it seems unlikely that there will be much reaction unless there is a real outlier from these expectations. Remember, the working assumption is already that Q2 GDP is going to be record-breaking in its depths, so will any of these really change opinions? My guess is no.

Overall, the dollar has been under pressure for the past two weeks and as long as risk appetite remains robust, I think that situation will apply.

Good luck and stay safe
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More Than a Molehill

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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
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Undeterred

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Said Christine, we are “undeterred”
By Germany’s court that inferred
QE is lawbreaking
As there’s no mistaking
Our power, from Brussels’, conferred

Thus, QE is here til we say
The ‘conomy’s finally okay
More bonds we will buy
And don’t even try
To hint there might be a delay!

Last week, when the German Constitutional Court ruled that the ECB’s original QE program, PSPP, broke EU laws about monetary financing of EU governments, there was a flurry of interest, but no clear understanding of the eventual ramifications of the ruling. This morning, those ramifications are beginning to become clear. Not surprisingly the ruling ruffled many feathers within the EU framework, as it contradicted the European Court of Justice, which is the EU’s highest court. This is akin to a State Supreme Court contradicting the US Supreme Court on a particular issue. At least, that’s what the legal difference is. But in one way, this is much more dangerous. There is no serious opportunity for any US state to leave the union, but what we have learned over the course of the past several years is that while the German people, on the whole, want to remain in the Eurozone and EU, they also don’t want to pay for everybody else’s problems. So, the question that is now being raised is, will Frau Merkel and her government be able to contain the damage?

In the end, this will most likely result in no changes of any sort by the ECB. There will be much harrumphing about what is allowed, and a great deal of technical jargon will be discussed about the framework of the EU. But despite Merkel’s weakened political state, she will likely manage to prevent a blow-up.

The thing is, this is the likely outcome, but it is certainly not the guaranteed outcome. The EU’s biggest problem right now is that Italy, and to a slightly lesser degree Spain, the third and fourth largest economies in the EU, have run are running out of fiscal space. As evidenced by the spreads on their debt vs. that of Germany, there remains considerable concern over either country’s ability to continue to provide fiscal support during the Covid-19 crisis. The ECB has been the only purchaser of their bonds, at least other than as short-term trading vehicles, and the entire premise of this ruling is that the ECB cannot simply purchase whatever bonds they want, but instead, must adhere to the capital key.

The threat is that if the ECB does not respond adequately, at least according to the German Court, then the Bundesbank would be prevented from participating in any further QE activities. Since they are the largest participant, it would essentially gut the program and correspondingly, the ECB’s current monetary support for the Eurozone economies. As always, it comes down to money, in this case, who is ultimately going to pay for the current multi-trillion euros of largesse. The Germans see the writing on the wall and want to avoid becoming the Eurozone’s ATM. Will they be willing to destroy a structure that has been so beneficial for them in order to not pick up the tab? That is the existential question, and the one on which hangs the future value of the euro.

Since the ruling was announced, the euro has slumped a bit more than 1.25% including this morning’s 0.2% fall. This is hardly a rout, and one could easily point to the continued awful data like this morning’s Italian March IP release (-28.4%) as a rationale. The thing about the data argument is that it no longer seems clear that the market cares much about data. As evidenced by equity markets’ collective ability to rally despite evidence of substantial economic destruction, it seems that no matter how awful a given number, traders’ attitudes have evolved into no data matters in the near-term, and in the longer-term, all the stimulus will solve the problem. With this as background, it appears that the euro’s existential questions are now a more important driver than the economy.

But it’s not just the euro that has fallen today, in fact the dollar is stronger across the board. In the G10 space, Aussie (-0.7%) and Kiwi (-0.8%) are the leading decliners, after a story hit the tapes that China may impose duties on Australia’s barley exports to the mainland. This appears to be in response to Australia’s insistence on seeking a deeper investigation into the source of the covid virus. But the pound (-0.65%), too, is softer this morning as PM Johnson has begun lifting lockdown orders in an effort to get the country back up and running. However, he is getting pushback from labor unions who are concerned for the safety of their members, something we are likely to see worldwide.

Interestingly, the yen is weaker this morning, down 0.6%, in what started as a risk-on environment in Asia. However, we have since seen equity markets turn around, with most of Europe now lower between 0.3% and 1.3%, while US futures have turned negative as well. The yen, however, has not caught a bid and remains lower at this point. I would look for the yen to gain favor if equity markets start to add to their current losses.

In the EMG space, the bulk of the group is softer today led by CZK (-1.1%) and MXN (-1.0%), although the other losses are far less impressive. On the plus side, many SE Asian currencies showed marginal gains overnight while the overall risk mood was more constructive. If today does turn more risk averse, you can look for those currencies to give back last night’s gains. A quick look at CZK shows comments from the central bank that they are preparing for unconventional stimulus (read QE) if the policy rate reaches 0%, which given they are currently at 0.25% as of last Thursday, seems quite likely. Meanwhile, the peso seems to be preparing for yet another rate cut by Banxico this week, with the only question being the size. 0.50% is being mooted, but there is clearly scope for more.

On the data front, to the extent this still matters, this week brings a modicum of important news:

Tuesday NFIB Small Biz Optimism 85.0
  CPI -0.8% (0.4% Y/Y)
  -ex food & energy -0.2% (1.7% Y/Y)
Wednesday PPI -0.5% (-0.3% Y/Y)
  -ex food & energy 0.0% (0.9% Y/Y)
Thursday Initial Claims 2.5M
  Continuing Claims 24.8M
Friday Retail Sales -11.7%
  -ex autos -6.0%
  IP -12.0%
  Capacity Utilization 64.0%
  Empire Manufacturing -60.0
  Michigan Sentiment 68.0

Source: Bloomberg

But, as I said above, it is not clear how much data matters right now. Certainly, one cannot look at these forecasts and conclude anything other than the US is in a deep recession. The trillion-dollar questions are how deep it will go and how long will this recession last. Barring a second wave of infections following the reopening of segments of the economy, it still seems like it will be a very long time before we are back to any sense of normalcy. The stock market continues to take the over, but the disconnect between stock prices and the economy seems unlikely to continue growing. As to the dollar, it remains the ultimate safe haven, at least for now.

Good luck and stay safe
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To Aid and Abet

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The treaties that built the EU
Explain what each nation should do
The German high court
Ruled that to comport
A challenge was in their purview

But politics trumps all the laws
And so Lagarde won’t even pause
In buying up debt
To aid and abet
The PIGS for a much greater cause

Arguably, the biggest story overnight was just not that big. The German Constitutional Court (GCC) ruled that the Bundesbank was wrong not to challenge the implementation of the first QE program in 2015 on the basis that the Asset Purchase Program (APP) was a form of monetary support explicitly prohibited. Back when the euro first came into existence, Germany’s biggest fear was that the ECB would finance profligate governments and that the Germans would ultimately have to pay the bill. In fact, this remains their biggest fear. While technically, QE is not actually debt monetization, that is only true if central banks allow their balance sheets to shrink back to pre-QE sizes. However, what we have learned since the GFC in 2008-09 is that central bank balance sheets are permanently larger, thus those emergency purchases of government debt now form an integral part of the ECB structure. In other words, that debt has effectively been monetized. The essence of this ruling is that the German government should have challenged QE from the start, as it is an explicit breach of the rules preventing the ECB from financing governments.

The funny thing is, while the court ruled in this manner, it is not clear to me what the outcome will be. At this point, it is very clear that the ECB is not going to be changing their programs, either APP or PEPP, and so no remedy is obvious. Arguably, the biggest risk in the ruling is that the GCC will have issued a binding opinion that will essentially be ignored, thus diminishing the power of their future rulings. Undoubtedly, there will be some comments within the three-month timeline laid out by the GCC, but there will be no effective changes to ECB policy. In other words, like every other central bank, the ECB has found themselves officially above the law.

While the actuality of the story may not have much impact on ECB activities, the FX market did respond by selling the euro. This morning it is lower by 0.5%, which takes its decline this month to 1.2% and earns it the crown, currently, of worst performing G10 currency. The thought process seems to be that there is nothing to stop the ECB in its efforts to debase the euro, so the path of least resistance remains lower.

Beyond the GCC story though, there is little new in the way of news. Equity markets have a better tone on the strength of oil’s continuing rebound, up nearly 10% this morning as I type, as production cuts begin to take hold, as well as, I would contend, the GCC ruling. In essence, despite numerous claims that central banks have overstepped their bounds, it is quite clear that nobody can stop them from buying up an ever larger group of financial assets and supporting markets. So, yesterday’s late day US rally led to a constructive tone overnight (Hang Seng +1.1%, Australia +1.6%, China and Japan are both closed for holidays) which has been extended through the European session (both DAX and CAC +1.8%, FTSE 100 +1.4%) with US futures pointing higher as well.

In the government bond market, Treasury yields are 3.5bps higher, but the real story seems to be in Europe. Bund yields have also rallied a bit, 2bps, but that can easily be attributed to the risk-on mentality that is permeating the market this morning. However, I would have expected Italian and Spanish yields to have fallen on the ruling. After all, they have become risk assets, not havens, and yet both have seen price declines of note with Italian yields higher by 10bps and Spanish (and Portuguese) higher by 5bps. Once again, we see the equity and bond markets looking at the same news in very different lights.

As to the FX market, it is a mixed picture this morning. While the Swiss franc is tracking the euro lower, also down by 0.5% this morning, we are seeing NOK (+0.4%) and CAD (+0.2%) seeming to benefit from the oil price rally. Aussie, too, is in better shape this morning, up 0.2% on the broad risk-on appetite and news that more countries are trying to reopen after their Covid inspired shutdowns.

The EMG space is similarly mixed with ZAR (+1.25%), RUB (+1.0%) and MXN (+0.6%) the leading gainers. While the ruble’s support is obviously oil, ZAR has benefitted from the overall risk appetite. This morning, the South African government issued ZAR 4.5 billion of bonds in three maturities and received bid-to-cover ratios of 6.8x on average. With yields there still so much higher than elsewhere (>8.0%), investors are willing to take the risk despite the recent credit rating downgrade. Finally, the peso is clearly benefitting from the oil price as well as the broad risk-on movement. The peso remains remarkably volatile these days, having gained and lost upwards of 5% several times in the past month, often seeing daily ranges of more than 3%. Today simply happens to be a plus day.

On the downside, the damage is far less severe with CE4 currencies all down around the same 0.5% as the euro. When there are no specific stories, those currencies tend to track the euro pretty tightly. As to the rest of APAC, there were very modest gains to be seen, but nothing of consequence.

On the data front, yesterday’s Factory Orders data was even worse than expected at -10.3% but did not have much impact. This morning brings the Trade Balance (exp -$44.2B) as well as ISM Non-Manufacturing (37.9). At this point, everybody knows that the data is going to look awful compared to historical releases, so it appears that bad numbers have lost their shock value. At least that is likely to be true until the payroll data later this week. The RBA left rates unchanged last night, as expected, although they have reduced the pace of QE according to their read of what is necessary to keep markets functioning well there. And finally, we will hear from three Fed speakers today, Evans, Bostic and Bullard, but again, it seems hard to believe they will say anything really new.

Overall, risk appetite has grown a bit overnight, but for the dollar, it is not clear to me that it has a short-term direction. Choppiness until the next key piece of news seems the most likely outcome. Let’s see how things behave come Friday.

Good luck and stay safe
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