European shares cautious after Wall Street soars

Morning Note

Risk on resumes? Wall Street enjoyed one of its best days this year as hopes grew for a Covid-19 vaccine The Dow rallied 900 points, up almost 4%, while the S&P 500 rose 90 points, or 3.15%, to 2953, closing at its highest since March 6th. The close was just a little shy of the 2954 peak on Apr 29th, the most recent swing high.

European shares were firmer at the open before losing steam quickly. The FTSE 100 added to yesterday’s gains to trade above 6100 again on the open but then followed Frankfurt and Paris. US futures were off their highs. Asian markets were green across the board.

Indices are now at or slightly above the top of the recent trading ranges since the March trough. The question we have now is whether it makes sense for equities to take another leg higher and re-approach record highs against a backdrop of the worst economic slumps in decades. Hence, we would expect some pullback around these levels even if bulls muster again for a fresh drive. Economic reality may eventually hit home, the question is whether we first see a new leg higher and post-Covid high made.

Moderna shares rose 20% to $80 after the company said its early-stage human trial for a coronavirus vaccine produced positive results, with Covid-19 antibodies seen in all 45 participants. It’s early days but markets are prepared to see the glass half full at this stage. Four years is the fastest it’s taken to deliver a vaccine – for mumps in the 1960s. Technology may have moved on, but pinning all your hopes on a vaccine seems overly optimistic, which suggests these moves are driven by algos playing the news.

A vaccine – not treatment – is key of course to resuming life as normal – no social distancing on planes or in bars. It’s the holy grail right now and markets are prepared to take a leap of faith.

News from Europe is further supporting risk appetite with the old Franco-German engine at work. Merkel and Macron have agreed to push for a €500bn EU fund which would be in the form of grants not loans. With Germany on board now it should drive the holdouts in the Netherlands and Austria to agree. It will be funded by the European Commission borrowing money – coronabonds in all but name. This is an important breakthrough for the EU – at least it should be.

UK unemployment claims jumped, and wages fell, but the unemployment rate actually fell to 3.9% because of the furlough scheme keeping employees in their jobs. This is in marked contrast to the US, where there is no furlough scheme. The worry is that furlough simply delays the inevitable when companies do reopen, and at massive cost. For markets this could be seeing a big rise in unemployment and therefore hit to the economy even as cases of Covid-19 are fading.

After breaking out to new 7-year highs above $1764 yesterday gold has backed off and tested support at $1725 as the risk rally tempered the bulls’ passion. US 10 year Treasury yields advanced to 0.74% but have since pulled back to 0.70%.

WTI (Jun) seems to have safely negotiated today’s expiry after another big gain for crude on Monday indicated further confidence that oil markets are rebalancing more quickly than feared. Front month WTI traded at $32, with August now at $32.59. Brent futures traded above $35. Given the extent of the recent gains, there is ample room for a pullback from these levels.

In FX, the dollar was weaker apparently on better risk appetite, lending support to major peers. GBPUSD continued to break free from Sunday’s lows as better risk appetite boost sterling. Cable rallied into resistance at 1.2250, the past support level, and has now added around 1.5% this week. The pound continues face pressure though as a risk proxy – as previously noted sterling has become a RoRo (risk-on, risk-off) currency of late, as well as doubts around progress on talks between the UK and EU. The British government has just announced a new tariff regime for the post-transition world that would see 60% of imports without tariffs.

Today Jay Powell speaks at 3pm as he faces questions from Congress. In a prepared testimony he said: “We are committed to using our full range of tools to support the economy in this challenging time even as we recognize that these actions are only a part of a broader public-sector response.”

Chart: S&P 500 facing big test at the top of the range: confirmation of the breach of the late Apr swing high and push above the 61.8% retracement at 2934 opens path back to 3140 and the early March swing highs.