In the wake of Europe’s fiscal stimulus deal, investors are now looking to Washington to see whether another round of spending is negotiated. A weakening US dollar and deeply negative real yields provide additional layers of comfort in supporting equities and commodities such as gold, silver and oil.
Germany’s Xetra Dax earlier on Tuesday briefly joined the S&P 500, Nasdaq and China’s CSI 300 among the club of big equity benchmarks that have clawed back into positive territory for the year. The sealing of a deal for the eurozone’s €750bn recovery fund matters greatly for investors as it paves the way for the EU to borrow money and sell bonds.
An EU debt benchmark, or fiscal pooling, now underpins the euro and that should bolster investor confidence in the region. Here’s an FT explainer about how the fund will operate. The amount is small today, but over time a new triple-A eurozone bond will expand and provide global investors with an alternative to the US dollar and Treasury debt as this FT Insight column explores.
Anna Stupnytska, global macro economist at Fidelity International, speaks for many when she notes:
“EU bond issuance will create a precedent which could become a permanent feature of the institutional framework.”
“With fiscal policy finally stepping up to facilitate the post-Covid recovery, the ECB is no longer ‘the only game in town’.”
True, earlier gains for eurozone equities and Italian bonds faded, but the euro closed out trading above $1.15, surpassing the March intraday high of $1.1522. In turn, the Dollar index touched 95.05, just above its March closing low of 94.895.
Over at Goldman Sachs, the bank anticipates more upside for European shares given the cheaper valuations and a relatively smooth process of reopening economic activity. A stronger euro also beckons alongside this stronger global shift into the region.
A bullish risk mood weighs on demand for the US dollar, prompting Brown Brothers Harriman to make this interesting observation about the reserve currency:
“Recent price action whereby markets sell into dollar strength rather than buy the dollar dip supports our view that the market bias for the dollar [signals] further broad-based weakness ahead.”
Analysts at Deutsche expect other currencies across eastern Europe and Scandinavia should benefit from euro appreciation from here.
Still, the prospect of a sharp appreciation in the euro may face a near-term obstacle. The dollar retains its role as the beneficiary of risk aversion and amid the current reflationary optimism, some investors may well think the extent of this year’s recovery in equities from their March lows represents a moment for trimming some of their exposure.
Wall Street also needs to see further fiscal largesse that follows on from measures that end in July. For now, the reflation trade is blowing, with energy, financials, materials and industrials outpacing the S&P 500, while tech lagged on Tuesday.
Also, for those expecting a much weaker US dollar in the near term, the trade may well have become a little crowded. BCA Research highlight how its “Dollar Capitulation Index” loiters on the cusp of “oversold territory, which warns of a potential short-term rebound”.
Another way of looking at the “oversold” momentum is that should the dollar push through below minus 1.5 — a threshold not broken since 2016 — then the reflationary winds will freshen for both the global economy and asset prices. BCA outline the broader ramifications of a breakdown in the dollar:
“It would indicate that yields are at risk of rising significantly and would cause a strong performance of EM [emerging markets] and global equities relative to US ones. It would also likely result in an underperformance of tech against other cyclical sectors.”
The wild card is the nature of the coming economic recovery and its duration. A sharp rise in nominal government bond yields may test broader market sentiment. Central banks are suppressing real yields and with nominal yields stuck, that is pushing inflation expectations higher.
Commodities certainly like the look of this, but the jury remains out on whether there will be a V-shaped recovery. And it does beg the question as to whether investor sentiment at the moment runs the risk of being driven by reflation prospects that may ultimately prove fleeting.
Quick Hits — What’s on the markets radar?
History lessons are interesting for many in financial circles. Here’s one from DataTrek on what the current level of implied S&P 500 volatility and a barnstorming run in the Nasdaq — that is spurring bubble talk — may entail. Since 1990, a subdued level for the Vix — or below a reading of 20 — has generally provided the backdrop for a grinding rally in share prices. This makes sense, but DataTrek highlights how during the late 1990s (1997 to 2000), the Vix held above a reading of 20, which is its long-term average over the past three decades.
The upshot, argues DataTrek, is that the Vix “will tell us if it will be our fate to live through 1999 again” and its strategists add:
“This won’t be a sell signal, just as it wasn’t in 1997. But it will be a sign that we’re in a different sort of market from the ones we usually see after a crisis.”
Many thanks for your messages about my upcoming return to New York. The movers were very efficient — my wife provided plenty of tea — so I was able to pen this note from a minimalist-looking flat in south London this afternoon. Market Forces will run into next week and then we’re off to Heathrow and isolation in a briefly empty Westchester apartment.
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