Tag Archives: #TPI

Declines and Duress

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In France, there’s a government mess
That lately’s been causing some stress
For French sovereign debt
With stocks under threat
Of further declines and duress

 

In one of the most colossal political blunders in recent memory, French President Emmanuel Macron completely misread the country and called a snap election after the European Parliament elections sent his party and allies to a significant defeat in June.  In what should not have been a surprise to anyone, his party was decimated in the national election, although the results have been even more unfortunate for the people of France as they have basically left the nation without a working government.  While there is currently a caretaker PM in place, Monsieur Barnier is almost certainly going to lose a no-confidence vote tomorrow as both the left and right express their displeasure at the situation.

Alas, the pattern we observe of late is that European citizens have been generally unhappy with the decisions made by their governments, with a universal issue being immigration policies, and when elections have been held, the parties in power have been shown the door.  Or they would have been except that they are extremely reluctant to leave office and are willing to do anything at all, except work with the anti-immigration parties (typically on the right) to govern their nations.  The result has been a series of election results with very weak minority governments and no power to do anything to help their citizens by addressing key issues.  Budgets are a problem; massive debt loads are constraining and economic activity is shrinking.  

France is merely the current fracas although we have seen the same things occur in Germany, the Netherlands, Austria, Sweden and much of Eastern Europe.  From our perspective, the issue here is what does it mean for the economic prospects of the euro (and other European currencies) and how might the ECB respond.  Consider that as poorly as things are going in Germany, and they are really having a tough time, a quick look at the performance of the DAX and CAC (as well as the S&P 500) shows that France is really a laggard right now.

Source: tradingeconmics.com

Since the dip in the beginning of August, French equities are essentially unchanged while even German equities have risen 15% alongside their US brethren.  During that same period, French 10-year yields have been rising relative to their German counterparts as fears over a French fiscal disaster rise.  In fact, there is now discussion that the ECB will need to use their TPI program, originally designed to support Italian debt, to prevent the spread between French and German yields from widening too far.  

If you were wondering why the euro has been having problems lately, this has clearly been a piece of the puzzle, and likely a key piece.  While the single currency has rallied slightly this morning, up 0.2%, the below chart speaks volumes as to the direction of travel.

Source: tradingeconomics.com

While yesterday I explained why I thought over time the dollar might eventually decline, right now, I think we need to look for the euro to test parity and potentially go below for the first time since November 2022.

As well, there’s another key nation
That’s seeking its ‘nomic salvation
Their currency’s falling
As pundits are calling
For stimulus midst their frustration

This brings our attention to China, where next week, the Central Economic Work Conference will be held as President Xi tries to shake the nation out of its economic lethargy.  There are high hopes for yet more stimulus despite the fact that the efforts so far have had a limited impact at best.  Perhaps the Chinese problem can best be described as they produce far too many goods for their own consumption and so run large trade surpluses angering their trade partners.  While President-elect Trump gets most of the press regarding his complaints about China’s economic behavior, it turns out that many countries around the world are pushing back.  This morning’s WSJ had an article on this very issue and it seems possible that President Xi may find himself even more isolated on the issue than before.

The natural solution is for China to consume more of what it produces, but that is far easier said than done, especially as the youth unemployment rate in China remains quite high, above 17%, while demographics continue to work against the country.  Arguably, one way to solve this issue would be for the renminbi to strengthen dramatically, simultaneously increasing the price of Chinese exports, so likely reducing demand, while increasing demand for imports.  Unfortunately, as can be seen below, the currency is moving in the opposite direction as the tariff threats from the US and elsewhere feed into the market psyche.

Source: tradingeconomics.com

It will be interesting to see if the PBOC is comfortable allowing the renminbi to weaken further.  It is currently at its weakest point since July, but also at levels where historically, the PBOC has entered the market over the past several years to prevent further declines.  With tariffs imminent, will this time be different?

Ok, let’s turn to the overnight market activity.  Asian equity markets were all strong overnight led by Japan (+1.9%) although we saw gains throughout the region (Korea +1.9%, India +0.75%, Taiwan +1.3%).  In China, Hong Kong (+1.1%) fared far better than the mainland (+0.1%) although both these markets closed well off early session lows after discussion of the economic conference and more subsidies made the rounds.  In Europe, screens are green this morning as well, seemingly on growing hopes that the ECB will be cutting more aggressively as data there remains soft, and comments from Fed Governor Waller yesterday indicated he was on board with further cuts despite the current data showing solid performance.  However, US futures are little changed at this hour (7:30) as focus begins to turn toward Friday’s NFP report.

In the bond markets, yields are edging higher with 10-year Treasuries up 2bps while most European sovereigns are higher by between 1bp and 3bps.  France is an exception this morning as that TPI talk has traders thinking there will be a price insensitive bid for OATs soon.

In the commodity markets, oil (+1.2%) is rebounding nicely from yesterday’s selloff although continues to trade below that $70/bbl level.  In the metals market, yesterday’s declines, which seemed to have been driven by the much stronger dollar, are being reversed in silver (+0.8%) and copper (+1.0%) although gold is essentially unchanged on the day.

Finally, the dollar, after a ripping rally yesterday, is backing off a bit, but not very much.  In fact, there are a number of currencies which are still sliding somewhat, notably CNY (-0.2%) and SEK (-0.2%) with the only gainer of note this morning being CLP (+0.6%) as it follows the price of copper higher.  Broadly speaking, the current setup remains quite positive for the dollar I believe.

On the data front, this morning brings only the JOLTS Job Openings report (exp 7.48M) and a bit more Fedspeak.  Yesterday’s ISM data was stronger than expected but still, at 48.4, below the key 50.0 level indicating manufacturing is still in a funk.  Perhaps better news was that the Prices Paid survey declined to 50.3, potentially indicating reduced inflation pressures.

While the market keenly awaits Chairman Powell’s speech on Wednesday as well as the NFP release on Friday, I sense that there is limited appetite to take on new positions.  Implied volatility is climbing as uncertainty reigns over the market but has not yet reached extremely high levels.  For hedgers, this is when options make the most sense.

Good luck

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Trussed

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The markets are worried that France
If given a half-decent chance
Will vote for Le Pen
And so, seems the ten-
Year OAT is now looked at askance
 
But ECB “sources” have said
There’s no TPI straight ahead
The French, rather, must
Show they won’t be “Trussed”
Else traders will leave them for dead

 

On an otherwise quiet summer morning, the ripples from the European Parliament election continue to grow. Not only did French President Macron dissolve parliament there and call new elections, but it appears the German government is far closer to falling as well.  However, right now, France is the story of note.

Elections in France are a two-stage affair where multiple candidates run for specific seats and then the two largest vote-getters in each district have a runoff a week later, if nobody won an outright majority.  Additionally, as is common throughout Europe, it is not a two-party affair like in the US, but there are several political parties vying for seats.  What makes this election so different from previous votes is the fact that the parties on the right are leading in all the polls.  Historically, throughout Europe, the right wing was anathema given that so many believed anything right of center would lead to the second coming of the Nazi Party.  This is the main reason that Europe has been consistently left of the US politically since the end of WWII.

However, what we have seen over the course of the past decade, and what has accelerated rapidly in the post-Covid era, is that many citizens of most Western countries are feeling dissatisfied with the politics of the left.  Immigration, which is obviously a huge issue in the US, is no less a problem in Europe.  The other key policy discrepancy is in the politics of global warming climate change global boiling, as it has become clearer each day that the policies that have been enacted, and those promised, have done nothing but raise the price of energy and the cost of living for all Europeans with no corresponding benefit to the climate.

The upshot is that many citizens throughout the continent are ready for a change, and this is beginning to frighten financial markets.  This can be seen in the chart below from tradingeconomics.com that shows German 10-yr yields in blue on the right-hand axis and French 10-yr yields in green on the left-hand axis.  While the spread has been creeping higher for the past six months, it has widened dramatically in the past week and is now at its widest (80 basis points) since the Eurozone crisis in 2013.

Source: tradingeconomics.com

It is not clear to me why financial markets are so concerned with excess spending by the right, as compared to excess spending by the left, but that seems to be the pattern.  (Recall the UK’s issue in October 2022 when Liz Truss, the newly minted PM, proposed a great deal of unfunded spending and the UK Gilt market sold off so sharply it put a number of insurance companies at risk and forced the BOE to buy gilts despite their efforts to shrink the balance sheet.)

At any rate, back in 2022, the ECB created a new program, the Transmission Protection Instrument (TPI) to help them prevent Italian BTPs from collapsing during the pandemic, thus maintaining what they believed to be an appropriate spread between bunds and BTPs.  While that spread peaked at 250bps, it is now a much more sedate 155bps, and despite Giorgia Meloni being a right-wing PM, the markets seem comfortable.  

However, with the ructions in France, there are many questions as to whether the ECB will dust off the TPI again to prevent a greater dislocation of French OATs vs. bunds.  Remember, too, that Madame Lagarde may have a personal vested interest in France, given her nationality, but as of yet, there has been no willingness to discuss using this tool.  However, if OATs continue to widen vs. Bunds, you can be certain this discussion will heat up even more.  We have already seen French stocks fall sharply, with French bank stocks down more than 10% in the past week.  It is movement like this that typically draws a response from central banks.  And of course, the euro is not immune to this situation as evidenced by its nearly 2% decline since the beginning of the month.  We will need to watch this closely until the elections at the end of the month and the second round on July 7th.

Beyond that, however, markets remain relatively dull.  Friday’s weaker than expected Michigan Sentiment data combined with the higher than expected inflation expectations was not very well received by risk assets (other than Nvidia and Apple) although by the end of the day, US major indices closed near flat.  Japanese shares fell sharply (Nikkei -1.8%) while the rest of Asia closed with much smaller declines, albeit they were declines.  In Europe, this morning, the picture is mixed with the big three markets, UK, Germany and France, all little changed on the day (a change for France of late) although there is more movement elsewhere but no consistency with both gainers and losers of up to 0.5%.  And following its recent pattern NASDAQ futures are edging higher this morning while DJIA futures are falling although neither has moved very much.  Arguably, the question is how long can the Magnificent 7 6 3 1 continue to rally in the face of increasing headwinds?

In the bond markets, yields are creeping higher with Treasuries (+2bps) bouncing off recent lows while European sovereigns all have shown similar yield gains except French OATs (+7bps) as the stress there continues to grow.  However, Asian bonds did little overnight with JGBs slipping one more basis point and now back to 0.92%, nearly 15bps lower than its peak at the end of May.  Things in Japan just take a verrryyy long time to play out.

In the commodity markets, oil (+0.25%) has managed to eke higher this morning, but the metals markets remain under pressure (Au -0.5%, Ag -1.0%, Cu -1.6%) as confidence in the economy ebbs alongside significant position reductions as metals had been one of the market themes for the first half of the year.  While I still like the long-term story, it seems clear there is no love for the space right now.

Finally, the dollar is mixed this morning with modest gains and losses overall across both G10 and EMG blocs.  The biggest winner is ZAR (+0.7%) which continues to retrace post-election losses as the new coalition government is gaining adherents in the investor community.  Alas, MXN (-0.2%) continues to feel pressure as concerns grow that president-elect Sheinbaum is going to be far more left leaning than markets expected.  In the majors, there is not much of distinction today with both gainers and laggards, although more laggards than gainers.  It should be no surprise that JPY (-0.25%) is pushing back to 158 given the yield moves overnight.

On the data front, there is some important stuff to be released this week, as well as a plethora of Fedspeak.

TodayEmpire State Manufacturing-9.0
TuesdayRetail Sales0.2%
 -ex Autos0.2%
 IP0.3%
 Capacity Utilization78.6%
ThursdayInitial Claims235K
 Continuing Claims1810K
 Philly Fed4.5
 Housing Starts1.38M
 Building Permits1.45M
FridayFlash PMI Manufacturing51.0
 Flash PMI Services53.3
 Existing Home Sales4.09M
 Leading Indicators-0.4%

Source: tradingeconomics.com

In addition to the data, we hear from seven Fed speakers with Richmond’s Thomas Barkin regaling us twice.  I would contend the narrative is searching for a direction other than BUY NVIDIA, as we continue to see a mixed picture.  While the NFP was strong, it appears data since then has softened.  If this remains the case, then the talk of a Fed cut sooner rather than later is going to really start to come back.  While July is only priced for a 10% chance of a cut, the market has September in its sights with a nearly two-thirds probability currently priced.  If the data weakens, that is viable.  In that scenario, I would expect the dollar to suffer and everything else to rally.  But we need to see a lot more soft data to reach that point.

Good luck

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