Stocks tread ranges ahead of FOMC, pound at 3-month high

Morning Note

Some of the biggest share price gains registered this week have been among companies that have filed for Chapter 11 bankruptcy protection – the likes of Hertz, JC Penney, Pier 1, Whiting Petroleum, as well as firms like Chesapeake Energy and California Resources which are about to file for bankruptcy. This is downright speculation, gambling by any other way of it looking at it.

Retail investors – many trading for free with Robinhood accounts – are snapping up penny stocks and driving up the shares of companies whose stock is essentially worthless. Most of these investors probably don’t realise that common stock comes precisely bottom of the pecking order in bankruptcy proceedings. Even if they don’t go bankrupt and restructure, shareholders get wiped out. It’s a sign of a frothy market – just make sure you are not the greater fool holding the stock when the music stops.

Europe opens higher, stock markets await clarity on recovery and policy support

Stocks took a breather yesterday with a decent pullback, though European bourses opened a little higher this morning ahead of the Federal Reserve statement this evening. Asian shares were mixed, with Tokyo a tad higher and Chinese shares a little weaker.

Chinese inflation figures were soft, with producer prices down 3.7%, the worst drop in 4 years, and consumer prices rising by 2.4%, down from 3.3% in April. Meanwhile data crossing this morning showed French industrial production declined 34% in April – but the market long ago chose to ignore any backward-looking data.

European stocks opened higher after yesterday’s selloff, now bouncing around ranges before there is more clarity on economic recovery and any further policy support.  On the former, there are concerns about two-consecutive days of record numbers of hospitalisations in Texas as lockdown restrictions lift, but broadly optimism about reopening is trumping doubts about second waves and a slow, lacklustre recovery.

It turns out pubs won’t reopen by Jun 22nd, but the bigger worry is how you get children back to school – that should be a priority. Meanwhile, I have grave doubts about the state of the UK employment market come the autumn as furlough schemes end and businesses have reopened to a big fall in demand. Such circumstance don’t bode well for civil order, which is already looking strained in places.

Markets await FOMC statement, Nasdaq above 10,000

On the latter, the FOMC statement is due later today (see yesterday’s note). There has been chatter about yield curve control and more dovish forward guidance, but the Fed may prefer to wait until September before it strikes. The recent recovery should give it time to think, albeit it will be keeping a close watch on longer-dated yields moving up, which may be a worry.

However, I think its focus is keeping a lid on the front end and allowing some steepening should not be a concern. I think I said a year ago that we should no longer pay any attention to the dots – they’re meaningless guesses. But there could be some optimists on the FOMC seeking to pencil in a hike in 2022. More broadly, I think the Fed will signal it accepts there will be no V-shaped recovery even if the recent data has been encouraging.

US stocks were weaker as the rally paused for breath with the S&P 500 down 0.78% at 3207. The Dow snapped a 6-day winning streak with a 1% fall. The Nasdaq was of course still higher and broke 10,000 for the first time ever. Boeing shares have been on a tear lately but tripped up with a 6% drop as it revealed it delivered just four jets in May and saw another 18 orders cancelled.  IATA says 2020 will be the worst year in the history of the aviation industry. Vroom went zoom with a 117% gain on the first day of trading to $47.90. Apple shares rose another 3% to a fresh all-time high on reports it would use its own chips in its devices, helping to drag the Nasdaq into record territory.

Dollar offered, cable hits fresh 3-month high

In FX the dollar is offered across the board with both risk proxies and the yen making gains. The pound has broken out to fresh 3-month highs with GBPUSD clearing 1.2760. EURUSD was higher around 1.1350, trying to take out the Jun 5th peak at 1.1382. The ECB’s Muller said PEPP needs to be temporary and should not be increased if at all possible. He also said low inflation expectations are a short term risk, so take what he says with a pinch of salt.

Expectations for a dovish Fed may be a factor but we are seeing this as part of an unwinding of the strong dollar pandemic trade that was built on USD liquidity squeeze. Nevertheless, the dollar index continues to make new lows and may well take 95 handle before long having broken down through the last Fib support. Key support is seen around the 94.50/60 area.

Oil steadies ahead of EIA inventories data after surprise API build

Crude oil (Aug) was steady a little above $38, about $2 off Monday’s highs, after API data yesterday showed a surprise build in US crude inventories that has reignited oversupply fears. US crude stocks climbed 8.4m barrels in the week to Jun 5th, vs expectations for a draw of 1.7m barrels. The EIA data today is forecast to show a draw of 1.8m barrels. But the forecasts have been way out for weeks, with an average consensus miss of about 5m barrels, so I wouldn’t be putting too much faith in the expectations.

Natural gas prices spiked aggressively lower overnight and though paring losses are still trading down by around 2% today after the IEA said 2020 would see the largest demand shock in the history of the market.

Equities head for strong finish, all eyes on the bond market, NFP jobs report

Morning Note

No V? The lack of a V-shaped recovery may not be worrying stock markets too much, but it is a source concern for consumers who lost confidence over the course of May. Perhaps this was due to the glacial pace of easing of lockdown restrictions and annoyance at the government; or perhaps it was economic – worries about job losses and a big drop in house prices finally sinking in and offsetting the novelty of being furloughed.

Whatever the cause, GfK’s UK consumer confidence index slipped to –36 in the second half of May, down from –34 in the first half and near the –39 printed in July 2008. Meanwhile, Japanese household spending fell even further in April, declining more than 11%. This was the fastest drop in spending since 2001 and built on a 6% drop in March.

Stock markets fell yesterday, pausing what’s been a robust risk-on rally in June, whilst bond yields snapped out of their funk. European stock markets suffered a broad decline. The Nasdaq hit a record intra-day high but ended down 0.7% on the day. The Dow eked a small gain, but the broad S&P 500 index declined 0.34%, though held the 3100 handle after dropping as low as 3090.

European stock markets rebound, eyes on bonds after ECB QE hike

Today, European stock markets rallied back to their highs of the week in the first half hour of trading, with the FTSE rising above 6400 and the DAX at 12,700. Both set to complete a very strong week of gains, with a German stimulus package and ECB bond buying helping to lift sentiment. The DAX’s breach of the 61.8% retracement was a very good bullish signal –  since then, in the last week it has cleared the 200-day line and advanced through the 78.6% level, up close to 10% since last Friday’s close. The FTSE is over 5% higher this week.

Eyes on the bond market again: after being somewhat subdued by central bank actions for many weeks US 10yr yields broke out to 0.85% even as stocks slipped up, whilst 2s couldn’t move beyond 0.2%. I think you have to look deeper into what the central banks are doing here as well as the amount of issuance. The Fed is reducing the pace of asset purchases, but investors think it will need to keep a lid on the front end of the curve for a long time by keeping its target rate at zero.

The move in US yields seemed to be a result of the ECB move to increase QE by a further €600bn. I’m not sure we can draw any immediate conclusions from this sharp move in US rates, but it will be very interesting to watch how the Fed responds to this development. Does it seek to influence the yield curve – yield curve control like the Bank of Japan, or does it let bond markets function?

If investors are dumping longer-dated bonds, and driving up yields, it may be that the inflation trade is on – given the tsunami of issuance and central bank intervention, it is logical enough to expect a bout of inflation coming round the bend, even if the immediate pressures from the pandemic are deflationary. Or it may just be a signal that the bond market thinks the worst of the crisis is over and we can chill out a bit – the move up in yields and drop in the Vix under 25, combined with the rally in equities should all be telling us that things are hunky dory.

When you look at the economic data, however, it’s hard to be to very optimistic. One to watch.

US nonfarm payrolls report on tap

The US nonfarm payrolls print is the last big risk event of the week, and seen at –8m, albeit Wednesday’s ADP number was just –2.76m vs –9m expected. Last month showed a massive –20m drop, but it only really told us what we already knew after several weeks of dreadful weekly initial claims numbers. Yesterday, US initial jobless claims fell to 1.9m but the continuing claims number rose 650k from last week to 21.5, ahead of expectations.

The fact that this number is rising is a worry that either businesses are not rehiring very fast, or worse, workers laid off simply don’t want to go back to work because they earn more now being unemployed thanks to the expanded benefit package. One report indicated about 40% of US workers are better off not working.

WTI oil, Brent oil near highs as OPEC again suggests moving meeting

Oil was near the highs with WTI (Aug) above $38 and Brent (Aug) above $40.50 as OPEC brings its off-again, on-again meeting forward from June 9th to June 6th (tomorrow) – at least that is the current understanding.

At various stages this week it’s been taking place yesterday, next week and not at all. Russia and Saudi Arabia want to get this extension over the line before the start of the new trading week. The meeting taking place on a Saturday does raise the prospect of a gap open on Sunday night.

Dollar unwind continues, euro higher on ECB stimulus

In FX, the dollar continues to get hit in an unwind of the pandemic trade that pushed it aggressively higher. EURUSD has advanced with the ECB stimulus which is going to give the politicians a better chance of agreeing to fiscal stimulus as per the EC’s budget proposals.

EURUSD broke above 1.1350 to trade around 1.1370 – eyes on the 1.1450 target still. GBPUSD is up around 1.2640, near to breaching the 200-day moving average, despite worries about Brexit talks going nowhere and the British parliament rejecting any extension of the transition period. The break by the pound above the twin peaks of the April highs opens up the path back to 1.28 and then 1.31, but the 200-day line offers a big test first.

Candlestick price chart for the pound sterling to US dollar FX pair

Stocks weaker as US continuing claims rise, ECB goes big

Equities
Forex

European shares held losses and Wall Street opened lower as the June rally in stocks paused for a wee breather, with tensions around Hong Kong resurfacing and US jobs data indicating a lacklustre recovery in the labour force.

The ECB seems to have passed the test today but we are still unsure on OPEC’s moves and the ensuing effects on oil prices, which could affect other risk assets. Meanwhile US jobs numbers were disappointing.

US initial jobless claims fell to 1.9m but the key continuing claims number rose 650k from last week to 21.5m, which was ahead of expectations. It’s a worry that we are not seeing this number coming down as it suggests employers are not calling their staff back as quickly as had been hoped.

Tomorrow is nonfarm payrolls day, of course, with expectations for the headline print to come in at –8m jobs but we note the ADP number yesterday was just –2.76m vs –9m expected.

Meanwhile risk sentiment looked to be a little weaker as scuffles were reported in Hong Kong as protestors try to mark the Tiananmen Square anniversary. The situation in Hong Kong and related US-China tensions remain a significant, under-appreciated tail risk for equity markets.

The S&P 500 opened about a third of one percent lower but held 3100 even as the Vix declined to take a 25 handle. After the ECB meeting the DAX tested lows of the day at 12,321 before recovering to the 12,400 support.

The ECB surprised with a slightly bigger expansion of its Pandemic Emergency Purchase Programme (PEPP) than was expected, perhaps as it saw this as a good opportunity to front load the scheme rather trying to top up later down the line as limits approach. This does provide it ample room for the rest of the year without the market chatter resurfacing about whether and when it needs to do more.

The ECB took three steps: the PEPP envelope is being widened by an additional €600bn to €1.35bn, the scheme will last at least until June 2021 and it will reinvest proceeds at least until the end of 2022. This is emergency QE forever – or at least we are in a situation where the ECB has no option but to be on a war footing just to keep the show on the road. What price peace?

Staff projections were interesting – inflation is now seen at just 0.3% in 2020 vs 1.1% expected in March before magically picking up over the next two years. May showed outright deflation in 12 of the 19 countries using the euro and the weakest HICP inflation in four years. Growth is seen –8.7% under the ECB’s baseline scenario.

Christine Lagarde said she expects a rebound in Q3 and the staff projections indicate growth bouncing back to 5.2% in 2021. But she cautioned that weaker demand will exert a longer-lasting pressure on inflation. Inflation for 2022 is seen at just 1.3%, down from 1.5%, despite this massive amount of stimulus.

This is already well short of the 2% target and of course the ECB is very good at missing its target when the stimulus as ever has decreasing marginal effects. What’s clear is that we are at the limits of monetary policy efficacy.

More interesting perhaps for the future of the EZ – Finland has just said it cannot accept the EC’s recovery package as it stands – it will be a long slog getting this budget and bailout fund approved by all members.

German bund yields reversed their earlier fall to trade flat, whilst the euro pared some of its gains after spiking through the important Fibonacci level at 1.1230, with EURUSD last at 1.1350. GBPUSD was off its lows having bounced off the 1.2510 support to move back to 1.2540.

Equities pause after strong gains, FTSE reshuffle confirmed, ECB meeting ahead

Morning Note

Corporate PR is not something that worries traders regularly. Sometimes bad press is bad for the stock – look at Facebook and Cambridge Analytica. Sometimes the optics are just a bit galling for some of us. Take HSBC, which saw fit to promote overtly anti-Brexit propaganda with its ‘We Are Not an Island’ ad campaign.

Now, along with Standard Chartered, it is backing controversial national security in Hong Kong that will destroy freedom in the territory supposedly enshrined by the 1984 Sino-British joint declaration. It’s in tough spot of course – most of its revenues come from Greater China. It needs Beijing on side, but equally it should probably take a moment to put its political views in context next time. Shares are down a third YTD and have halved in the last two years.

Stimulus supports global stock markets – more PEPP from the ECB today?

Meanwhile stimulus everywhere is supporting equity market gains. Germany has agreed a €130bn stimulus package to reinvigorate its economy, while Australia has unveiled its fourth, A$680m programme, aimed at boosting the construction sector. The European Central Bank (ECB) will today likely stretch its pandemic asset purchase programme by another €500bn.

Stocks roared higher on Wednesday, with all the major indices marking another day of progress, but the rally has paused and stocks are off slight ahead of the ECB meeting and US jobless numbers today. The FTSE 100 closed above 6380 as bulls drive it back to the Marc 6th close at 6462. The DAX moved aggressively off its 200-day moving average and has support at 12,400 despite a slight pullback today.

The S&P 500 rose 1.4% to clear 3100 and moved close to the 78.6% retracement level. It now trades with a forward PE of 22.60. The Dow rallied another 500 points, or 2%, before running into resistance on the 200-day moving average around 23,365 on the futures after the cash close. The Nasdaq is only a few points from its all-time high.

Although we are seeing a mild pullback at the European open this morning, the dislocation between markets and the real economy is frankly unsustainable. On that front we have the weekly US jobs number today – we’re looking at continuing claims as the more important number as a gauge of how swiftly the US economy is getting going again. Continuing claims are seen at 20m, down from 21m last week. Hiring should be exceeding firing now, but it will be a long slog back to where things were. Riots and curfews in big metropolitan areas don’t help.

ECB economic projections to detail the Covid-19 hit in Europe

The ECB meeting today will also help guide our view of how bad things are in Europe as we focus on the new staff projections. The ECB has detailed three scenarios for GDP in 2020 relating to the damage wrought by the pandemic: mild -5%, medium –8% and severe –12%.

Christine Lagarde said last week that the “economic contraction likely between medium and severe scenarios”, adding: “It is very hard to forecast how badly the economy has been affected.” Indeed there is actually no way of really know how badly Q2 went. We have various sources estimating pretty seismic falls; INSEE says French GDP will contract by 20% in the second quarter. Estimates for Germany suggest a roughly 10% decline.

The inflation projections will also be closely watched after HICP inflation in May slipped to its weakest in 4 years and outright deflation was recorded in 12 of the 19 members of the euro. Markets will also be keen to see what the ECB Governing Council makes of this development three years after Draghi declared the war on deflation won. Aside from the economy and inflation, the market is happily expecting an increase to PEPP of €500bn.

FTSE quarterly rebalancing confirmed

The FTSE quarterly rebalancing has been confirmed with Avast, GVC Holdings, Homeserve and Kingfisher entering the FTSE 100, and Carnival, Centrica, EasyJet and Meggitt dropping into the FTSE 250. EasyJet and Carnival have really taken a beating since the pandemic hit and longer term their business models are a problem if people don’t go on cruises, or if you enforce social distancing on planes.

Centrica has had a rough old time of things as its UK customer base has shrunk drastically, whilst earlier this year the company booked a number of one-off impairment charges relating to its oil & gas assets and nuclear power plant stake – a process it has since put on hold. Its main appeal of course was a steady income from a traditionally iron-cast dividend, which it has suspended.

Entering the FTSE 250

888 Holdings

AO World

BB Healthcare Trust

Calisen

Carnival

Centrica

Civitas Social Housing

EasyJet

JLEN Environmental Assets Group

Liontrust Asset Management

Meggitt

Oxford Biomedica

Scottish American Investment

Exiting the FTSE 250

Avast (promoted)

Bakkavor Group

Elementis

Forterra

GVC Holdings (promoted)

Homeserve (promoted)

Hyve Group

JPMorgan Indian Inv Trust

Kingfisher (promoted)

Marstons

Mccarthy & Stone

Senior

Stagecoach Group

In FX, the dollar has regained a little ground against major peers. GBPUSD failed to make the move stick above 1.26 to take out the Apr double top level and is now looking to test support around the 1.25 round number and the 23.6% retracement at 1.2510. EURUSD has eased off the 3-month highs struck yesterday but looks well supported for the time being at 1.12 – the ECB meeting today will deliver the usual volatility so watch out.

Oil has pulled back amid uncertainty over the OPEC+ meeting. Price dropped sharply yesterday before paring losses as it looked like the meeting would not take place today because of a dispute over compliance. Now we understand Russia and Saudi Arabia have agreed between themselves to extend the deepest level of cuts by another month, meaning the tapering from 9.7m bpd to 7.7m bpd will take place in August.

But they want non-compliant countries to play ball this time and over-comply going forward to make up for it. Whilst I think OPEC and Russia can just about keep the cuts on track, there are clear signs that this deal is a huge ask for many within OPEC and may unravel over the summer if prices hold up. Russian energy minister Novak was on the wires this morning saying oversupply was down to 7m bpd in May and could move to deficit of 3-5m bpd in July.

Chart: Dow runs into 200-day simple moving average

Candlestick chart of Dow Jones Industrial Average Index

Week Ahead: Central banks on tap, NFP faces massive Covid hit

Week Ahead

The economic calendar is packed full of top-tier releases this week, starting with manufacturing PMIs from China and the US. The RBA, BOC, and ECB all announce their latest policy decisions – and, in the case of the ECB, potentially ruffle a few more feathers in Germany. And, of course, we have the latest US nonfarm payrolls report to round off the week. 

China Caixin Manufacturing PMI – does the headline reflect the story?

China’s Caixin Manufacturing PMI slipped back into negative territory in April, missing market expectations of another print just above the 50 mark. A look at the sub-indexes painted a rather more messy picture than the headline number. 

New orders slumped for a third month and export orders dropped the most since December 2008. Order backlogs rose, while supplier delivery times improved and input costs fell on the collapsing oil prices, pushing the headline number higher. 

May’s reading is expected to hold just below 50 – but once again, the vastly different performance of those sub-indexes is likely where the true story will lie. It looks like Chinese industry has a lot further to go yet before growth returns properly. 

US ISM PMIs to stabilise

US manufacturing collapsed last month, with the index diving to 41.5 from 49.1 in March. Despite being the worst drop since April 2009, the reading was still better than market expectations of 36.9, although this was because of a surge in supplier delivery times. While usually a sign of a strong economy, deliveries were held up by supply shortages due to the Covid-19 pandemic. 

Things are expected to have stabilised in May, but getting back into growth territory (a reading above 50) could take a while; Oxford Economics doesn’t expect output losses to be recouped until 2021. 

The decline in non-manufacturing is expected to moderate slightly, with the index forecast to tick higher to 44.2 from 41.8. 

RBA, BOC, ECB interest rate decisions

The Reserve Bank of Australia is the first of three central banks to hold monetary policy meetings this week. Rates are already at a record low 0.25%, which is effectively zero, and the board has no appetite for taking them negative. 

ASX 30 Day Interbank Cash Rate Futures for June show markets are pricing in nearly 50-50 odds of a cut to zero, but many analysts think the RBA has done all it will do, and that rates will remain unchanged for two or three years. 

This week’s Bank of Canada rate announcement coincides with the start of Tiff Macklem’s tenure as governor. Senior deputy governor Carolyn Wilkins said recently that the BOC could look at adjusting its asset purchasing programme with the aim of stimulating the economy, rather than just enhancing the liquidity of financial markets, although policymakers may not be ready for such a move just yet.  

The European Central Bank is expected to leave rates unchanged, although the pandemic emergency purchase programme (PEPP) is likely to be extended and expanded. Christine Lagarde will face questions about Germany’s ruling on the ECB’s quantitative easing programme during the post-meeting presser. Read our full preview on the ECB monetary policy meeting here.

Last week Isabel Schnabel, a member of the ECB board who joined in January, shrugged off the ruling, suggesting it was for the Bundesbank and Germany’s government to resolve the issue. 

“I’m sure there is going to be communication between the Bundesbank and the German parliament and the German government, and one will have to find a solution,” Schnabel told the Financial Times last week. “If the ECB can be constructive in supporting that process, we will of course do so.” 

Australia quarterly GDP: the end of three decades of growth

First-quarter economic data is expected to show that the Australian economy contracted -0.8% on the quarter and -1.2% on the year. Australia is expected to fall into recession for the first time in three decades this year, with GDP dropping -10%. 

Last week, Prime Minister Scott Morrison outlined the government’s plans to help revive the economy, but he also warned that any recovery was likely to take between three and five years. 

Eurozone retail sales and Germany factory orders

The collapse in Eurozone retail sales is expected to have worsened at the start of Q2. Analysts are forecasting a month-on-month decline of -18.6% during April, after a -11.2% drop in March. Year-on-year sales are predicted to have cratered -24%. 

Germany’s April factory orders data will likely reveal some similarly painful numbers. Orders fell -15.6% in March and economists are expecting a -21.3% drop when the April data is published on Friday.  

US NFP – jobless rate to hit 20%?

After tanking -20.5 million last month in the worst drop on record, this week’s US nonfarm payrolls report is expected to show another decline in employment of up to -5 million. The jobless rate, which leapt to nearly 15% in April, is likely to print just shy of 20%. Economists expect unemployment will peak around 25%, although Goldman Sachs analysts have suggested it could climb higher. 

Join Markets.com chief market analyst Neil Wilson for live analysis of the market reaction to the US nonfarm payrolls report with our free webinar.

Heads-Up on Earnings 

The following companies are set to publish their quarterly earnings reports this week:

After-Market 02-Jun Zoom Video Communications – Q1 2021
Pre-Market 03-Jun Campbell Soup – Q3 2020
After-Market 04-Jun Broadcom – Q2 2020
After-Market 04-Jun Slack – Q1 2021
05-Jun Toshiba Corp – Q4 2019

Highlights on XRay this Week 

Read the full schedule of financial market analysis and training.

07.15 UTC Daily European Morning Call
From 15.30 UTC 02-June Gold, Silver, and Oil Weekly Forecasts
12.50 UTC 03-June Asset of the Day: Indices Insights
19.30 UTC 04-June Daily FX Recap and Looking Forward
10.00 UTC 05-June Supply & Demand – Approach to Trading

Key Economic Events

Watch out for the biggest events on the economic calendar this week:

01.45 UTC 01-Jun China Caixin Manufacturing PMI
14.00 UTC 01-Jun US ISM Manufacturing PMI
01.30 UTC 02-Jun Australia Company Operating Profits (Q/Q)
05.30 UTC 02-Jun RBA Interest Rate Decision
07.15 – 08.00 UTC 02-Jun Eurozone Member State Finalised Manufacturing PMIs
08.30 UTC 02-Jun UK Finalised Manufacturing PMI
01.30 UTC 03-Jun Australia GDP (Q/Q)
01.45 UTC 03-Jun China Caixin Services PMI
07.15 – 08.00 UTC 03-Jun Eurozone Member State Finalised Services PMIs
08.30 UTC 03-Jun UK Finalised Services PMI
14.00 UTC 03-Jun Bank of Canada Interest Rate Decision
14.00 UTC 03-Jun US ISM Non-Manufacturing PMI
14.30 UTC 03-Jun US EIA Crude Oil Inventories
01.30 UTC 04-Jun Australia Retail Sales / Trade Balance
09.00 UTC 04-Jun Eurozone Retail Sales
11.45 UTC 04-Jun ECB Interest Rate Decision
12.30 UTC 04-Jun ECB Press Conference
14.30 UTC 04-Jun US EIA Natural Gas Storage
06.00 UTC 05-Jun Germany Factory Orders
12.30 UTC 05-Jun US Nonfarm Payrolls

ECB preview: Welcome to Japan?

Equities

The European Central Bank (ECB) convenes next week (June 4th) and is expected to increase emergency asset purchases as it continues to show it will ‘do whatever it takes’. With the scope of the Covid damage becoming a little clearer and deflation rearing its ugly head again, the ECB will stick to the old playbook of more QE to fight it. As ever the market will wonder whether this is ‘enough’, and as ever the answer will come back in the negative.

ECB monetary policy outlook: Japanification?

Eurozone inflation sank to its weakest in 4 years in May, data on Friday showed, only making further expansion by the ECB all the more certain. HICP inflation declined to 0.1% for the euro area, but outright deflation was recorded in 12 of the 19 countries using the single currency. Things have changed a lot since Mario Draghi declared victory over deflation in March 2017.

Nevertheless, core HICP inflation remains stable at 0.9%, which will give some comfort to policymakers. The decline in the oil price passed through to petrol pumps, with energy –12% year-on-year.

Recovery in oil prices should boost the headline reading going forward but the core reading may not be able to withstand the pressures of demand destruction and mass unemployment. The reading today only means the ECB will keep its foot to the floor with increased asset purchases.

However, in reality, given the ECB is already at the absolute limits of monetary policy efficacy, it cannot actually do much about this and only hope that consumer confidence comes back and for energy prices rise – and for global money printing efforts by central bank peers to stoke a round of inflation, which some think will be the outcome post Covid-19.

The concern of course is that Europe, like Japan, has driven itself into a vicious cycle of deflationary tendencies and negative interest rates that will be very hard to escape, particularly as it contends with long-term, perhaps permanent, damage to productivity and economic activity due to the pandemic.

Eurozone economic projections

There will be a lot of focus on the staff macroeconomic projections, although the extreme uncertainty around the extent of damage to the Q2 readings and speed of recovery forecast for Q3/4 means a lot of this remains guesswork.

The ECB has detailed three scenarios for GDP in 2020 relating to the damage wrought by the pandemic: mild -5%, medium –8% and severe –12%. Various comments indicate we can now rule out the mild scenario. Christine Lagarde said this week that the “economic contraction likely between medium and severe scenarios”, adding: “It is very hard to forecast how badly the economy has been affected.”

There is no way of really know how badly Q2 went. We have various sources estimating pretty seismic falls; INSEE says French GDP will contract by 20% in the second quarter. Estimates for Germany suggest a roughly 10% decline.

We know that tough lockdown measures that started to be introduced across Europe in March produced a noticeable impact on Q1. Whilst economic activity is emerging from the cold again as June begins, there is little doubt that April and May saw considerable declines in output.

More PEPP announced after the ECB monetary policy meeting?

The ECB seems all but certain to increase the size of its Pandemic Emergency Purchase Programme (PEPP). The €750bn limit looks likely to run out by the autumn and the ECB will want to push the envelope by a further €500bn.

Germany’s Constitutional Court ruling has obvious repercussions for the Bundesbank, but that ruling relates to ‘normal’ QE and not PEPP, which would tend to argue in favour of expanding this programme now during the emergency, rather than trying to top up later on.  Moreover, the ECB wants to make sure that the ‘whatever it takes’ message gets through to the markets to avoid dislocations in bond markets.

Finally, whilst our focus is on the ECB in the coming days, the most important thing for the EZ and the euro is not Ms Lagarde and co, but the frugal four and the EU’s rescue fund. The European Commission’s 7-year budget including the €750bn rescue fund were only published this week so a final decision is not expected any time soon.

Budget talks look set to be long and arduous – the numbers of budget contributors highlight that Sweden, Denmark, Austria and the Netherlands pay their fare share and some: all contribute more than 3% of GDP vs 2.2% by France and 3.9% by Germany. Which is why Germany throwing its weight behind the bailout grants (as opposed to loans) is so crucial. Ultimate the EU will work out a fudge to keep the frugal four on board- the question is whether it can somehow achieve debt mutualisation and make its ‘Hamiltonian’ moment real.

EURUSD chart analysis

The dollar was offered on Friday with DXY sinking to its weakest since mid-March and test the 61.8% retracement of the Covid-inspired rally at the 98 round number support.

This helped push EURUSD higher as the pair cemented the breach of the 200-day simple moving average on the upside. Bulls looking to take out the late March swing high at 1.1150, which could open up a pathway to the 50% long-term retracement at 1.1450.

FX update: Pound blown off course by Frosty Brexit talks, euro tests 200-day line

Forex

Sterling got a smack and the euro pulled back from its highs of the day as Britain’s chief Brexit negotiator confirmed what we already knew; that UK-EU talks are not going very well at all. Whilst a classic last-minute EU fudge is still broadly anticipated by the market, the language from David Frost was not optimistic.

GBPUSD moved sharply off the 1.23 handle, turning lower to test 1.2250 before paring those losses. EURGBP pushed higher and looked towards the May 21st swing high at 0.90, a two-month peak. Undoubtedly sterling becomes increasingly exposed to headline risks around Brexit as we move out of the worst of the Covid-19 pandemic and back into the cut-and-thrust of negotiations.

Speaking to MPs, Frost said the EU’s current mandate handed to chief negotiator Michel Barnier is – in certain key areas –  not likely to produce an agreement, adding that the EU must change its stance in order to reach a deal with the UK. He said that the policy enshrined in the EU’s mandate is not one that can be agreed by the UK. Interesting to see sterling come back a touch as Mr Frost said it’s still the early stages of talks and the UK is still setting out its position – this seems rather optimistic given the timelines previously mentioned.

Whilst we knew that there had been precious little progress in the latest round of talks, the language indicates the two sides are very far apart still. We should however note that adopting this tone is part of the game – the UK’s position remains to take a hard line and, with Mr Cummings still in place, I would think this will remain the case. When questioned, Mr Frost said he reports to the PM, not to Mr Cummings. Of course, we all know where the real power lies.

As previously noted time is running out fast for the talks and we become less sure that either side has the political will and capital to expend on this when dealing with the economic catastrophe of the pandemic. The EU focus is on sorting out a rescue fund that all members can sign up to. Political capital is being spent on that more readily.

Chatter around the Bank of England looking at negative rates is another weight on sterling right now. Indeed it’s a crossroads moment as we deal with a massive increase in government debt, run huge twin deficits and exit the EU whilst in the midst of the worst global recession since the 1930s. There are a lot of downside risks for GBP.

Chart: Pound under pressure: EURGBP moves up to test near-term resistance, GBPUSD drops sharply

Meanwhile, EURUSD also pulled back from its highs, before recovering the 1.10 handle. The euro had earlier moved higher and European equities extended gains after the European Commission laid out plans for an additional €750bn stimulus fund. Ursula von der Leyen set out plans to distribute €500bn in grants – as per the Franco-German proposals – with an additional €250bn in loans on top. She said this would take the EU’s total recovery fund to €2.4 trillion.

A German government spokesman said Berlin was happy the EU had taken up elements of the plans set out last week by Angela Merkel and Emmanuel Macron. Macron urged the EU to move forward quickly. But a Dutch official said budget talks would ‘take time’, indicating a still rather frosty approach to the rescue fund from certain corners – it’s far from a done deal.

Chart: EURUSD analysis

The EC plans took the cross through the 200-day simple moving average around 1.1010 but there was not an immediate follow-through and the Brexit chatter knocked it back before it retook the 200-day line. Bulls need to see a confirmed push above this to unlock the path back to 1.1150, the March swing high. Failure calls for retest of recent swing lows at 1.0880.

FX strategy: euro, pound push up as dollar offered on risk appetite return

Forex

The euro and Sterling were on the front foot on Tuesday, with cable stretching its advance to near a 2-week peak. Whilst the dollar was offered on a broad return of risk appetite, the euro also seemed to get some lift from the ECB, which is giving signals it’s ready to do even more.

Bank of France Governor Francois Villeroy de Galhau, a key member of the ECB’s Governing Council, told a conference on Monday that there is room for the central bank to act ‘rapidly and powerfully’.

Speaking to CNBC subsequently on Tuesday he said there is a need to be flexible with the current round of coronavirus asset purchases, suggesting that the ECB shouldn’t need to bound to capital keys that dictate how many government bonds it can purchase based on the size of each country’s economy.

The German Constitutional Court ruling earlier this month expressly stated that the capital key was essential to avoid distorting markets, so this could fuel further disquiet among those hawks who have been set against the ECB’s bond buying.

Meanwhile, we await to see whether the EU states can agree a fiscal response, with Denmark, Austria, Sweden and the Netherlands countering the Franc-German proposal for a €500bn bailout fund to be financed by the European Commission issuing bonds. The so-called ‘Frugal Four’ want only a short-term emergency scheme financed by loans.

EURUSD chart analysis

Prices are in recovery mode following a rejection of the lows yesterday at 1.0870. EURUSD extended to 1.09730 – with this high formed we can look to recover the 1.1020, the May 1st peak which could open up a breakout from the two-month range.

GBPUSD chart analysis

Meanwhile GBPUSD pushed up to a 2-week high at 1.23 after the 1.2160 support area held and we saw a push through the 1.2250 channel. A break to the upside calls for a return to 1.25/1.26 and the Apr double top highs. Failure to sustain the move beyond 1.23 calls for retest of the 1.2160 support and thence the swing low at 1.2080 comes back into focus.

Negative rates: not now Bernard

Morning Note

Not Now, Bernard is a children’s story about parents who don’t pay attention and don’t notice their son has been gobbled up by a monster, which they duly allow into the house. One could make parallels with central banks and the monstrosity of negative rates.

Last week a strange thing happened: Fed funds futures – the market’s best guess of where US interests will be in the future – implied negative rates were coming. The market priced in negative rates in Apr 2021. It doesn’t mean they will go negative, but the market can exert serious gravitational pull on Federal Reserve policy. Often, the tail wags the dog, and the market forces the Fed to catch up. Of course, given the vast deluge of QE, it’s not always easy to read the bond market these days – central bank intervention has destroyed any notion of price discovery.

Now this is a problem for the Fed. Japan and Europe, where negative rates are now embedded, are hardly poster children for monetary policy success. Nevertheless, the President eyes a freebie, tweeting:

As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the “GIFT”. Big numbers!

The Fed needs to come out very firmly against negative rates, or it could become self-fulfilling. Numerous Fed officials this week are trying their best to sound tough, but they are not brave enough to dare sound ‘hawkish’ in any way. Minneapolis Fed president Neel Kashkari said Fed policymakers have been ‘pretty unanimous’ in opposing negative interest rates, but he added that he did not want to say never with regards to negative interest rates.

It’s up to Fed chair Jay Powell today to set the record straight and make it clear the Fed will never go negative, or the US will go the way of Japan and Europe. Powell has to push very hard against this market mood. Too late says Scott Minerd, Guggenheim CIO, who believes the 10-year yield will eventually hit -0.5% in the coming years. Powell speaks today in a webinar organized by the Peterson Institute for International Economics. If he doesn’t lean hard on the negative rate talk it will cause a fair amount of mess on the short end.

UK 2yr yields turn negative, RBNZ doubles QE

Another strange thing happened this morning – UK interest rates also went negative. The 2yr gilt yield sank to an all-time low at -0.051% as markets assessed how much stimulus the UK economy is going to need (more on this below).

Inflation may or not be coming; deflation is the big worry right now as demand crumbles. The Covid-19 outbreak, or, more accurately, the response by governments, creates a profoundly deflationary shock for the global economy. Just look at oil prices. And yet, as central banks approach the precipice of debt monetization and Modern Monetary Theory, inflation could be coming in a big way.

So, we move neatly to the Reserve Bank of New Zealand (RBNZ), which last month said it was ‘open minded’ on direct monetisation of government debt. Today’s it has doubled the size of its bond buying programme but kept rates at 0.25%. The kiwi traded weaker.

German judge slams ECB

Sticking with central banks, and Peter Huber, the German judge who drafted the constitutional court’s controversial decision was reported making some pretty stunning remarks about the European Central Bank. Speaking to a German publication he warned the ECB is not the ‘Master of the Universe’, and, according to Bloomberg, said: ‘An institution like the ECB, which is only thinly legitimized democratically, is only acceptable if it strictly adheres to the responsibilities assigned to it’. These are pretty stunning and underline the extent to which this decision upends the assumption of ECJ oversight in the EU and over its institutions. Remarkable.

US stocks tumble on talk of lockdown extensions

US stocks had a dismal close, sliding sharply in the final hour of trading as Los Angeles County looked set to extend its stay at home order for another three months and Dr Fauci warned of reopening too early. The S&P 500 fell 2% and closed at the session low at 2870. The close could leave a mark as it broke support and we note the MACD crossover on the daily chart. European markets followed suit and drove 1-2% lower – this might be the time for the rollover I’ve been talking about for the last fortnight.

Pound off overnight lows after Q1 GDP decline softer-than-expected

Sterling is softer but off the overnight lows after less-bad-than-feared economic numbers. GBPUSD traded under 1.23 having tested the Apr 21st swing low support at 1.2250 ahead of the GDP print. The UK economy contracted by 5.8% in March. However, the –1.6% contraction in Q1 was less than the –2.2% expected, while quarter-on-quarter the economy contracted -2% vs –2.6% expected. GBPUSD bounced off its lows following the release, but upside remains constrained and the bearish MACD crossover on the daily chart still rules. We know it’s bad – the extension of the furlough scheme does not indicate things will be back to normal this year.

Oil markets are still looking quite bullish. A number of OPEC ‘sources’ yesterday suggested the cartel would stick to the 9.7m bpd cuts beyond June. API figures showed a build of 7.6m barrels, though there was a draw on stocks at Cushing, Oklahoma of 2.3m barrels. Gasoline inventories fell 1.9m barrels, but distillates continued to build by 4.7m barrels. EIA inventory data is later today is expected to show a build of 4.8m barrels.

European stocks mixed, oil rally runs out of gas

Morning Note

Germany’s top court laid down a challenge to the European Union: who is the final arbiter in European law? Apparently, they don’t think it is the ECJ. German judges think the ECB needs to show buying bonds under QE was proportionate – by what yardstick? They have 3 months to comply or the Bundesbank won’t be allowed to play.

The ECB is clearly not amused. In a very brief update, the central bank said it ‘takes note’ of the judgement by the German Federal Constitutional Court but remains ‘fully committed’ to its price stability mandate.

Finally, it added simple: “The Court of Justice of the European Union ruled in December 2018 that the ECB is acting within its price stability mandate.” Quite clearly the German court cannot overrule the ECJ – that’s the whole point, it’s why we wanted out. Italy’s PM Conte agrees, noting that ECB independence is at the heart of European treaties.

The euro has held onto losses to test the 1.0820 level this morning, as German factory orders declined 15.6%, more than the 10% expected. As I noted yesterday, anything that casts doubt on the ability of the ECB to provide the backstop to the bond market is a concern and is euro-negative.

It also seems this decision will likely kill of any hope of collective debt issuance to tackle the current crisis. And a challenge to the PEPP bond buying by the ECB from the same German actors looks likely. There is yet a tail risk that the Bundesbank is forced not to take part in ECB bond buying in three months’ time – this would cause chaos.

The S&P 500 rose yesterday but closed where it opened at 2868, some 30 points off the highs of the day. The lack of any real conviction has led to a mixed start to trading for European markets, where Monday’s rebound looks to be under threat.

Oil rallied strongly but pulled back from the highs as traders realised once again that storage is still a problem. Whilst clearly there are signs of supply and demand rebalancing because lockdown measures are being lifted, but it’s going to be a slow process and it’s hard to see it righting itself before the Jun WTI contract is up.

Crude oil inventories rose 8.4m barrels, according to data from the American Petroleum Institute (API) late on Tuesday. The more closely watched EIA inventory data is released at 15:30 London time and is forecast showing a similar kind of build around 8m barrels. Front month WTI bounced off resistance at $26 to pull back to under $24.50 in early European trade.

Today’s ADP payrolls print will be an amuse-bouche for the weekly jobless claims starter on Thursday followed by Friday’s nonfarm payrolls main course.

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