Just about everything that could have gone right did go right for US equities to start the new week.
Jerome Powell set the tone with what amounted to a pledge of unlimited support for the economy via the Fed’s emergency lending powers. His remarks came during an otherwise somber interview with “60 Minutes”, which was filmed last Wednesday, but aired in full on Sunday evening.
A trio of additional bullish catalysts contributed to the euphoric vibe.
- First, oil surged another 10% on top of a furious three-week rally, with Monday’s leap aided by news that demand in China has returned to pre-virus levels
- Second, optimism around a vaccine added to the good vibes engendered by pictures of happy beachgoers and packed bars in states where lockdowns have been lifted
- Third, the icing on the cake came from Angela Merkel and Emmanuel Macron, who together floated a joint plan for a €500 billion European recovery fund, a move clearly designed to nudge recalcitrant politicians in hawkish eurozone nations to support burden-sharing when it comes to facilitating a bloc-wide recovery
“The fund is meant to be temporary, funded by the EU through borrowing on the markets and will be part of the next EU multiannual budget”, ING writes, noting that it’s designed to “provide direct fiscal stimulus through grants and funds will go to the industries and regions of the EU that have been most hit by the crisis”.
“With their new proposal, Germany and France appear to have crossed the Rubicon on sharing the financial pain from the pandemic”, Bloomberg opinion columnist Ferdinando Giugliano wrote Monday afternoon. “The shift by the Germans from their usually conservative position is all the more noteworthy, and the financial markets certainly see it that way”.
Italian yields plunged, and bunds sold off, bear steepening the German curve. Monday was among the best sessions for European equities in a decade and the BTP-bund spread narrowed more than 22bps on the day.
The euro rose the most in weeks, which in turn pressured the dollar lower, adding to the bullish cross-asset impulse.
Christine Lagarde, speaking to Handelsblatt, Les Echos, Corriere de la Sera and El Mundo, called the news “ambitious, targeted and, of course, welcome”.
The ECB has been at pains to promote fiscal unity in the face of the crisis and has pledged to buy more than €1 trillion in assets in 2020. Even as the central bank comes under fire from a German high court, the market still sees total purchases for this year summing to €1.5 trillion by the time it’s all said and done.
That’s a lot of heavy lifting, so any sign that fiscal policymakers are prepared to take some of the burden off monetary policy is a huge relief for Lagarde.
“Every fiber in my body wants to short German bunds because this seems to finally be the moment where Europe comes together under a single fiscal roof”, Kevin Muir, formerly head of equity derivatives at RBC Dominion, and better known for his exploits as “The Macro Tourist” wrote, in his daily note. “I am not going down that road anymore”, he went to promise. Here’s a short excerpt from Kevin:
I have seen this play out too many times. European leaders make steps towards a fiscal union, the market gets all excited, and then in a few days, political reality sets in like the breath-stealing-whoosh of the Ice Bucket challenge.
Shorting the bund is a widowmaker. This time may be different – but it’s not a trade anyone will be excited about getting into.
In any event, this is a serious step towards a fiscal union in the eurozone and that, in turn, means markets have one more “game changer” to ponder.
The myriad bullish catalysts produced the best day for US stocks since early April. Small caps had one of their best sessions versus the S&P 500 in a decade.
Needless to say, all of the above is bearish for bonds, and generally conducive to a steeper curve. Long-end yields cheapened materially in the US, steepening the 2s10s and 5s30s by more than 5bps.
In the simplest possible terms, the week started on a dramatically pro-cyclical note.
Of course, all the usual disclaimers apply. Sino-US tensions are worsening materially. The “here and now” (if you will) reality for the US economy is that tens of millions of people have lost their jobs in the space of eight weeks. Fed officials have warned that a wave of bankruptcies looms. The outlook for corporate earnings is the most uncertain it’s ever been. And, now, there’s a new firestorm in Washington, after Donald Trump on Monday admitted to dismissing State department IG Steve Linick as a personal favor to Mike Pompeo.
If you’re buying, caveat emptor.