Markets are performing well today thanks to the nomination of Lagarde at the ECB and Trump tweet about the intention to nominate Judy Shelton and Christopher Waller to the Fed board, who are likely to be in favor of lower rates, additional stimulus, and sooner rather than later, in line with Trump’s strategy
Lagarde’s nomination, still to be approved but likely to proceed, could be translated into a clear message that the ECB council might change its rate forward guidance and start a new phase of Quantitative Easing.
Yields have extended their downturn with US 10Y at 1.95% (lowest since 2016) and German 10Y at the same level of the ECB deposit rate on speculation about more policy easing to come.
Markets are are currently pricing in a 25bp cut in July, with a 20% chance of 50bps being cut. This probability has moved down since Powell’s speech last week, as markets were previously pricing in a 50% chance of 50bps being cut. The 25bp vs. 50bp debate should be settled after non-farm data is released this Friday. Sep and Oct meeting both have another 25bp cut priced in, with two more priced in through the end of 2020.
Gold has spiked back above 1400$ and as I have always believed it is an important asset class for our clients for 2019 and 2020.
There is also importantly a new massive shift in positioning as last week were covered 15bn$ of shorts across the Eurostoxx600, 8% of outstanding shorts, 3rd biggest week since 2003.
The short base on the Eurostoxx 50 is now the lowest it has been over the last 5-years, only 1.1% of free-float.
Despite the S&P hitting a record high, some Fed members are pointing to the low rate of inflation acknowledge the severe downturn in global trading volumes and the worldwide contraction in the PMI manufacturing indexes (in over 40 countries).
The situation is partially similar to late-summer 2007 when stocks were near record highs but the economy was showing clear signs of weakness.
We are starting to offload some longs that we have bought at the end of May/beginning of June as we prefer to pull the foot from the accelerator once again. With many equity and fixed income asset classes posting double-digit returns for 1H19, we recommend some defensive trades focused on preserving the strong performance YTD. We expect low single-digit returns for most asset classes for the remainder of the year.
The next important catalysts are: Payrolls number on Friday (a low number would not be good for markets), Q2 earning season starting from next week. Between now and the end of summer we would also be prepared for trade tensions to rise between US and Europe as WTO arbitration ruling on Airbus subsidies is expected during the summer. If positive, it would allow the US to implement tariffs on up to $11bn worth of EU products.
Coming back on Lagarde, her background in fiscal is evident (FinMin in France, IMF with interventions during sovereign crisis).
Her nomination is a surprise given speculation had long revolved around the likes of German central bank head Weidmann, French ECB members Coeuré and Villeroy de Galhau and former Finnish central banker i Liikanen.
While Lagarde lacks monetary policy experience, she is a former French finance minister and played a key role in securing bailouts for troubled Eurozone economies following the global financial crisis. Her experience at the IMF would help her deal with any political pressure from European governments.
We are therefore possibly going ahead to an era of further fiscal integration and where the debate is likely to become even more political.
Fiscal is likely to be an important factor for an hope of H2 rebound in Europe and the recent Italian discipling into budget’s discussions are helping too.
In Lagarde’s post G20 statement she said that the global economy has hit a rough patch, with trade chief among the risks. She advised central banks to continue to adjust their policies with incoming data.
In the past, Lagarde praised Draghi’s ‘whatever it takes’ commitment to preserve the euro, and has argued that governments with fiscal space should use it to cushion downturns.