EU strike rescue deal, DAX breaks out

Morning Note

After 4 days of uneasy talks, EU leaders agreed to a €750bn rescue package for the bloc which includes €390bn in grants. Although short of the €500bn in grants first proposed, it nevertheless marks a significant moment for the EU. The Frugals were brought round (bought off) by increasing their rebates – they can thank Margaret Thatcher for that. The agreement is a classic EU fudge that papers over the schisms but is nonetheless a step forward towards ever closer union, and this time it’s fiscal. 

 

This has been hailed as Europe’s ‘Hamiltonian moment’ as it involves mutual debt issuance. It’s not quite that – we are not talking about mutualisation of countries existing debts. Nevertheless, it sets an important precedent in securing the idea of fiscal coordination, if not union. Italian yields fell to their lowest level in months, with the benchmark 10yr BTP under 1.12%.  

 

The deal ought to be a positive for the euro and we can look for further gains. EURUSD was well supported above 1.140 and moving higher to test near-term resistance at 1.1470 before we can look for the 1.15 target, the March high. A break here would mark an 18-month peak for the cross and could be chased higher with momentum favouring the euro. The next level would be the Jan 2019 highs around 1.1570. However with the deal perhaps not ticking every box in terms of the amount of fiscal aid on offer, the euro may not be released from its range just yet.

 

Sterling is also on the front foot, with GBPUSD rising to 1.27 and achieving its best level in over a month. With the pressure off in terms of the pandemic rescue package and 7-year budget agreed, there may be hope that the EU is in a better position agree to a Brexit deal. The pressure on the dollar left the dollar index testing support around 95.50. 

 

European equities were higher on a cocktail of the EU budget deal and the ongoing daily dose of vaccine news. AstraZeneca and Oxford University’s candidate is showing promise, whilst there are positive signals from several other quarters. The DAX in Frankfurt surged 1.5% to make a fresh post-Covid high at 13,250. London and Paris remain within their Jun-Jul ranges.  

 

The Nasdaq jumped 2.5% as the likes of Amazon, Alphabet, Apple, Microsoft and Facebook all rose. Amazon shares leapt 8% and continued higher in after-hours trade to break $3,200 after two brokers upgraded their price target to $3,800. Despite positive vaccine news, this was not a reopening trade as such. In addition to Amazon, other ‘Covid-proof’ stocks were very strong with Peloton up over 10% and Zoom almost 9%. The S&P 500 rose 0.8% as tech lifted the boats.

 

Retail may be going through its worst recession in memory, but not everyone is losing out. UK grocery sales rose 10% in the four weeks to July 11th, with Tesco sales +12%, Sainsbury’s +10.2% and Morrisons +15.7%. 

 

UK borrowing is surging – £128bn in the second quarter – but rates on gilts are negative out to 7 years, so there is very little worry about repaying it. The political pressure and inclination to raise taxes will increase, however. 

 

Gold rallied through $1824 to make a fresh 9-year high as US real rates continued to edge lower, with 10yr TIPS down to –0.84%, their weakest in seven years. The entire curve keeps going deeper into negative territory with 5yr TIPS at –1.08% and 30yr TIPS have slipping to –0.30%.  

 

Crude oil has made a push back above $41, looking for a breach of the Jun highs at $41.60 to trigger further gains. Reversal could signal bulls’ exhaustion. 

Dutch PM Rutte ‘not optimistic’ ahead of EU summit, Netflix misses

Morning Note

European stocks were choppy and likely set for a volatile finish to the week as EU leaders gather in Brussels for a key summit, with market participants squarely focused on whether the EU can agree to a broad recovery fund as part of the talks over the bloc’s budget for 2021-27.

Whilst the EU seems to be edging closer to a deal and Merkel and Macron should ultimately get the consensus they need for something like a €500bn-€750bn package of support, there is a risk the market has put too much on this particular meeting and is left disappointed if there is no final decision taken this weekend.

We may get an agreement in principle on the fund that will be made up of a mix of grants and loans, with details on the total money value and attached reform requirements to be finessed. Even that might be a stretch though – Merkel warned this week that it could take until the end of the summer to achieve a deal and today said talks would be tough.

Dutch PM Rutte said this morning he’s ‘not optimistic’ ahead of the talks. Indeed, I would not expect much more than a political declaration affirming member states commitment to achieving some kind of a deal.

This not an ordinary summit – what’s being talked about is mutual debt issuance for the first time. A deal would be a major breakthrough for the EU and show that the bloc has the ability to respond to an era-defining crisis with one voice.  Merkel is throwing all her political capital behind the European Recovery Fund, so there more than just EU solidarity riding on it.

The Frugal Four of Sweden, Austria, Denmark and the Netherlands remain the main barrier to achieving a deal as they are still to be convinced on why they should be sharing the burden of weaker states, but most countries will be out to fight their corner too. At least they are all back in a room and can talk through the night to trade horses and get something done – not so easy on Zoom, albeit it’s an absolute hangar of a room.

ECB’s Lagarde dismisses tapering chatter

Yesterday, the ECB left rates on hold as expected and Christine Lagarde appeared to push back against the tapering chatter by saying the ECB would use the full PEPP envelope of €1.35tn ‘barring surprises’. She also seemed confident member states would agree on the fiscal response to the crisis, which gave the euro a little nudge up at the time.

EURUSD is back under 1.14 this morning – a recovery fund deal would likely take it over 1.15 and set it up for further gains. Near term the support is around the 1.12 region.

Stocks on Wall Street finished lower on Thursday, led by a decline in tech. It’s probably too early to say this is part of a rotation out of growth into value – which could be a trade to consider if you assume that a vaccine is coming and things get back to normal – but there may be an element of profit-taking in big tech as investors take stock of events and consider the uncertainty over the pandemic, reopening rates, stimulus, earnings outlooks and stretched valuations in some corners of the market vs many stocks being in the bargain basement, among others.

Netflix subscribers and earnings growth miss

Netflix shares plunged 9% to $480 in after-hours trade as the company signalled weaker subscriber growth and profits missed expectations. Revenues were a tad better than forecast at $6.15bn, and as I expected, net subscriber additions in excess of 10m were ahead of estimates for about 7.5m, but earnings per share were a little soft at $1.59 vs $1.80 expected.

But guidance on future growth in subscribers was soft with the company only anticipating 2.5m net adds in September quarter. Maintaining Covid-era subscriber growth was always a tall order, if not impossible, but 2.5m would represent its weakest growth rate for a long time.

Although EPS was a miss, it was largely down to the timing of a California research and development tax credit charge. Netflix earnings have always been lumpy and net subscriber adds has always been a greater guide. The company expects 16% operating margin in 2020 and 19% for 2021, which CEO Reed Hastings said was ‘tamping down the expectations’.

Competition remains a headwind as new streaming services come online, but increasingly even social media is considered a rival. Netflix cited TikTok as a competitor – good news then that the US wants to ban the Chinese social media app.

There are of course questions about whether Netflix will manage to attract eyes in the way it did during lockdown – cinemas reopening, bars and restaurants luring people off the sofa etc, whilst the impact of Covid-related shutdowns on production is still being understood. Moreover coronavirus has simply pulled forward a lot of net adds from the coming quarters – expect slower growth but the company remains in a very good place.

US jobless claims mixed, homebuilder sentiment climbs

Economic data from the US was mixed. Initial jobless claims hit 1.3m, almost unchanged from the prior week. The improving trend has all but halted and may reflect the spike in coronavirus cases that has coincided with renewed lockdown measures in a number of economically important states such as Texas and Florida. California’s decision to roll back reopening signals worse could be ahead.

Continuing claims fell to 17.3m vs the 18m last week, which was a tad better than the 17.6m expected. The total number of people claiming benefits in all programmes for the week ending June 27th fell to 32m a decrease of 430k from the previous week. What’s clear is the rate of change is not moving in the right direction – getting back to pre-Covid levels will take a long time.

However, homebuilder sentiment rose 14 points to 72 in July, according to the National Association of Home Builders/Wells Fargo Housing Market Index (HMI). That’s where the index reached in March before the crisis hit and it slumped to 30 in April.

Oil and gold are both still in consolidation mode. WTI (August) cannot make a move beyond $41 stick, whilst gold is still crabbing sideways around the $1800 level and appears to set its new low and near-term support at $1796. US real rates (10yr TIPS) made new 7-year lows at –0.79%.

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