Blain's Morning Porridge - May 23rd. Anger. And what's the developing theme for markets?
Blain’s Morning Porridge – May 23rd 2017
“Come the three corners of the World in arms, and we shall shock them. Naught shall make us rue, if England to itself do rest but true.”
I would like write what I really think about last night, but that’s not the brief for this market commentary. We are an angry nation this morning. History shows people who make us angry lose. Always.
Amber Rudd looked frighteningly competent on TV this morning. We are not the people who should be scared.
Risk off looks the order of the day as traders look for direction and fathom current events.
It feels like the focus is shifting. Trump remains myred in noise, and the US budget announcement looked the half-hearted start of a negotiation process – I guess that is the Trump way.
The big theme is recent Euro strength. Where does it go from here?
More than a few global investors have lost faith in the US recovery and Trump jump. Whatever the numbers say, China, Asia and Japan just are not convincing alternatives.
Europe might be another story. The potential for a new burst of European political get-togetherness led by Merkel and Macron at a time when Trump’s promises of tax reform and infrastructure growth are mired in the Washington swamp is an attractive one to sell the investors.
The Euro is leading the charge: its up from Euro/US$ of 1.04 in December to 1.12. I’ve attached the chart.
My Macro colleague, Martin Malone, ascribes the current uptick to ongoing “do whatever it takes to back the currency” from the ECB’s Draghi, and to economic performance finally kicking in across Europe. With the five-year average at 1.20 and the 10-yr at 1.30 there is plenty of room for further upside – he says.
The gains are relative. Europe’s growth number’s aren’t knocking the skin off the ball, but they are less volatile and it’s doing “relatively” well compared to the US, UK and Japan. We’ve seen expectations scaled back in these non-European democracies, while Europe is plodding on without surprising us.
Factors to watch from Europe to confirm the plodding uptrend will be 1) the unemployment rate continuing to fall, and 2) a narrowing output gap.
While the data is getting better across Europe, the question is does it remain ahead of the politics? There seems less to worry about – French elections were a doddle. Germany still loves Merkel. Even Portugal looks kinda sorted. The two festering pustules on the Eurozone’s posterior remain Italy and Greece. Italy is never going to get fixed – get over it -it’s probably better to just pretend it’s not a problem. Greece is likely to bullied into yet another agreement later this week.
With US stocks looking fully valued, it’s an easy argument to make that improving increasing economic performance expectations justify higher European stocks, a stronger Euro and tightening bond spreads. And of course, the strengthening Euro improves stock returns!
Another factor Martin points out is the divergence in fiscal policy between Europe and the US. Strict European policy means fiscal deficit has fallen to 1.5% of GDP with a current account surplus of 3%. The US fiscal deficit is 3% of GDP with a 2.7% current account deficit. Europe is in 1.5% surplus while the US is in 6% deficit. That’s a 4:1 relative differential in favour of the Euro!
While the speculators have been shorting the Euro these past 5 years, now they are long.
The story has moved on – its no longer about the US. Its about Europe..
I do note from a Bloomberg note that at $4.6 trillion the ECB’s balance sheet is now larger than the Fed’s $4.5 trillion and is still growing. Although the ECB taper will kick in soonish – if the market doesn’t wobble to much – that means continued distortion on all Euro assets.
Have I been wrong about Europe all these years?
Out of time..