‘Unprecedented’

“No laughing matter”. That’s how one bank described the escalating consular battle between the US and China.

Now that the media has figured out China’s San Francisco mission may be harboring a fugitive whose crimes include wearing a PLA uniform in a yearbook picture (it’s a little more serious than that, but there’s room for humor), one imagines tensions will ratchet higher still.

Mike Pompeo is scheduled to give a speech Thursday called “Communist China and the future of the free world” — in California, no less.

“Barely a day goes by without some new line in the sand being crossed between the US and China, and this is diplomatically almost unprecedented”, Rabobank’s Michael Every said Thursday. “But then so much else is too nowadays”, he added.

Indeed. Take Italian 10-year yields for example. They’re back below 1%. Not “unprecedented”, but certainly astounding considering the circumstances. Europe’s heavily indebted “problem child” (which suffered mightily during the pandemic) now enjoys borrowing costs that are just ~40bps above those for the US. And just four months on from the lockdown.

You can thank “unprecedented” action from the ECB and an equally “unprecedented” accord at the EU political level for BTPs’ good fortune. The ECB has deviated materially (chart) from the capital key in its pandemic purchase program in favor of Italy, which will receive more than €80 billion in grants (chart) under Europe’s new jointly guaranteed recovery fund. Those same efforts at bolstering the region’s economic fortunes amid the worst downturn in the post-War era are largely responsible for the euro’s rally to the strongest since 2018.

“The euro’s performance versus the dollar has not only been impressive, but defied my expectations”, former trader Richard Breslow said Thursday. “It’s trading today right at the halfway point of the move down from the 2018 highs to the 2020 lows. Lots of eyes will be on it”.

“I still have reservations about the euro’s reaction to the Recovery Fund deal, but it was more a catalyst for a weaker dollar in general than a driver of a stronger euro”, SocGen’s Kit Juckes remarked. “In nominal trade-weighted terms, the euro is now stronger than it was at the peak in 2018, which may give someone at the ECB a nosebleed”. I talked about that on Wednesday in “Dollars At A Discount (Long Live The King)“.

Apparently, EUR/USD options volumes were four times USD/JPY options on Wednesday. “There is talk euro shorts are being squeezed out and that strength in the shared currency will soon fade [but] demand for EUR calls with strikes at 1.20 and above suggests otherwise”, Bloomberg’s Mark Cranfield said.

And this gets us back to the real story (figuratively and literally) which is the dollar sitting at the lowest since March and heading for a fifth day of losses.

“The geopolitical tensions and worsening virus cases in the US are triggering expectations that the Fed will have its foot on the stimulus policy pedal harder”, Vishnu Varathan, head of economics and strategy at Mizuho, said. “This is putting pressure on the dollar”.

In turn, we see real rates pushing inexorably lower, and likely to go lower still, at least at shorter maturities, in “arithmetic” fashion if breakevens manage to keep drifting higher.

The consequence of that, of course, is a surge in gold, which looks to have a date with “unprecedented” levels.