Oh, the irony.
Days after sending the euro plunging and sparking a rally in EGBs by pairing the announcement of APP wind down with data-and-state-dependent forward guidance on rates, the ECB will hold its central banking forum in Sintra from Monday to Wednesday this week.
Why is that ironic? Well, because it was Mario Draghi who sparked a mini-rates tantrum last year with hawkish comments at the very same Sintra forum.
That spike you see in bund yields at Sintra 2017 represented the worst selloff for German bonds in almost two years. Here’s some context with the recent plunge in bund yields to 0.19% (intraday) that accompanied the Italian bond selloff:
Last year’s Sintra rhetoric amounted to putting the most hawkish spin possible on a still dovish monetary policy stance and now here we are a year later (nearly to the day), and Draghi has just put the most dovish spin possible on a decisively hawkish turn in monetary policy.
It’s an interesting juxtaposition and there will be no shortage of fanfare in terms of parsing what comes out of Sintra anno 2018 in light of the Fed’s hawkish turn and Draghi’s “classic“.
Last year’s pow wow capped off a steady tightening in the UST-Bund spread in favor of the euro, which had been in motion since the snap wider following the U.S. election. It also came amid an unwind of long USD positioning and a shift to bullish euro bets.
It was, in short, an important moment in the evolution of the transatlantic policy divergence narrative which has waxed and waned over the past two years. Waning entails the policy divergence narrative (i.e., Fed policy becoming tighter relative to the ECB, which was already starting from behind in the normalization push) giving way to a policy convergence narrative (i.e., the Fed tapping the brakes as the ECB got more aggressive). 2017 began as a policy divergence story predicated on the notion that Trump’s fiscal policies would stimulate the U.S. economy which would in turn prompt the Fed to hike fairly aggressively while the Eurozone recovery remained fragile and the ECB remained commensurately gun shy. That narrative was what made “long USD” and “short USTs” the two “no-brainer’ trades going into 2017.
That didn’t pan out. The market ultimately faded the time table on Trump’s fiscal policies, the U.S. economy did not accelerate as quickly as some had hoped and the Eurozone economy held up well, prompting Draghi to sound an upbeat tone, most notably at the above-mentioned Sintra conference in late June 2017.
The policy divergence story thus morphed into a policy convergence narrative and rate differentials (i.e., the UST-Bund spread that Gross is betting on) moved steadily in favor of the euro. Ultimately, the dollar long was unwound (red arrow):
Fast forward to Q4 2017 and the outlook for the tax cuts changed materially and with it, the prospects for late-cycle fiscal stimulus brightened (of course the use of the term “brightened” assumes you think late-cycle fiscal stimulus is a good idea, but that’s another debate).
As the rates market began to price in the GOP tax cuts and what stimulus would likely mean for growth in the U.S., rate differentials began to move back in favor of the dollar, although initially, the greenback stubbornly refused to keep pace with the favorable shift (thanks in part to market jitters about the deterioration of the U.S. fiscal position and the extent to which Trump’s trade stance amounts to a weaker dollar policy by proxy).
But the correlation between the greenback and U.S. yields and also between the dollar and rate diffs has begun to reassert itself of late.
After last week, the policy divergence narrative has been fully restored, with the Fed leaning decisively hawkish and the ECB’s new forward guidance on rates effectively pushing the first hike in Europe to at least 9 months from the end of APP.
That was reflected in the market’s reaction to Draghi last Thursday…
… and was very pronounced in the dollar:
So this is clearly something worth keeping an eye on. The topic of the Sintra meeting this year is “Price and wage-setting in advanced economies” and you can view the full schedule here.
Just a day after Sintra winds up, we’ll get the BoE. You might recall that there was a time when a May hike from Carney seemed highly likely. But that was before the U.K. economy all but flatlined in Q1 (the worst quarter for growth since 2012) and subsequent data betrayed more weakness. Ultimately, they remained on hold and all eyes shifted to August. As ever, the Brexit discussions cloud the outlook.
“We expect the BoE to repeat the message of the May inflation report, highlighting its data-dependent nature,” Barlcays wrote over the weekend, adding that “with data published since the May IR printing either in line or on the soft side of expectations, we see little scope for a hawkish surprise.”
For what it’s worth, here’s BofAML’s take (excerpted from a longer preview):
Bank of England to take ‘holding position’. A data heavy weak confirmed the uncertain, but potentially difficult for the BoE, outlook. Trying to pin down what shocks are driving the current data configuration is tricky: low wage inflation and sliding services inflation despite low unemployment, strong retail sales despite weak income growth are among some of the issues. Add in the difficult to calibrate effects of recent Brexit noise and protectionist moves and we assume the BoE will stay on hold in August and next week will issue a ‘holding statement’ after their policy meeting. Something along the lines of ‘if all goes well we can hike, let’s see’.
Of course the marquee event next week will be OPEC. This is obviously difficult to handicap and Iran added a new wrinkle over the weekend by suggesting that the Saudi-led push to hike supply may be subject to a veto. Specifically, Iran is calling for OPEC and Russia to resist pressure from Trump. There’s some color in that linked post from Barclays and here’s a quick preview from Bloomberg:
Iran’s comments show that OPEC members are set to clash when they meet later this week in Vienna to discuss the proposal to end global output cuts. The historic 24-nation pact has succeeded in its goals of balancing oil markets and lifting crude prices, and the two biggest producers want a relaxation of quotas as soon as next month. But while Saudi Arabia and Russia are pumping below capacity, many countries in OPEC including Iran and Venezuela would struggle to raise output even if their quotas were increased.
OPEC and its allies could consider a production increase of as much as 1.5 million barrels a day, Russian Energy Minister Alexander Novak said on Thursday. That would be enough to offset the supply losses from Venezuela and Iran foreseen by the International Energy Agency. Saudi Arabia has been discussing different scenarios that would raise production by between 500,000 and 1 million barrels a day, according to people familiar with the matter.
BofAML’s take on three possible outcomes is useful as well:
First, we see an output increase announcement, maybe data-dependent, that targets a modest deficit. Our baseline is for a combined 200k b/d quarterly average ramp from Russia, Saudi, UAE, and Kuwait through end 2019 that adds up to a total of 1.2mn b/d, although we expect flexibility to meet any output gaps left by Iran, Venezuela, or other producers. Second, the cartel could change its stated OECD total oil inventory level target to days of forward demand coverage, a more useful metric, in our view. Third, OPEC+ could add new policy tools such as relative price levels, term structure, and volatility to better assess market conditions.
I imagine I’ll be writing a ton more about this as the week progresses, but in the meantime, here’s a possibly helpful graphic from Barclays that runs through some of the recent comments from OPEC ministers (and also from Putin):
Moving on, emerging markets will be watched closely for further signs of deteriorating sentiment and FX fuckery.
The last couple of weeks have been a rollercoaster for the likes of the Turkish lira, the Brazilian real and especially the beleaguered Argentine peso. There’s a summary of last week’s action here, but from a kind of 30,000 foot level, this is where we are:
Argentine Minister Sica Sees ARS at 29/USD at ’Good’ Level: LPO
— Walter White (@heisenbergrpt) June 17, 2018
I guess that depends on your definition of “good”.
Trade tensions will be on the frontburner (again). Trump reignited the trade war with China on Friday by going through with tariffs on $50 billion in Chinese goods and reports suggest the administration is ready and willing to publish a list tied to the imposition of levies on another $100 billion of imports should China decide to respond, which of course they will.
So those are some things to look for in the week ahead and anything notable that I missed in terms of developed markets is probably mentioned in the following calendar from BofAML, which I’ll present without further comment because at 1,500 words, you’re probably tired of reading this by now.