Morning Brief – Thursday 4th

La-En-Garde!

The bond market was on guard yesterday, with money flooding into fixed income assets in anticipation of an even longer than foreseen period of accommodative monetary policy. Record yields were produced once again yesterday both within Europe and across the Atlantic. The reason? Among the leading causes of yesterday’s bond rally is the prospect of having Christine Lagarde, serving International Monetary Fund head, as the future President of the European Central Bank.

Besides Lagarde, who is also France’s former Minister of the Economy and Finance it is worth noting, are a surprising collection of nominees that have been put forward for the top jobs. The appointments will have to gain the approval of the European Parliament, however, if all goes to plan, the posts will look something like this: European Commission, a German Minister who’s been by Angela Merkel’s side as a cabinet member since her first chancellorship; Council President, a former Belgian Prime Minister of fire who has only just left his national office; a Spaniard as head of foreign policy; and yet another Italian as European Parliament President. There’s a lot wrong with this list at first sight with perhaps the exception of Josep Borrell as chief foreign policy guru man! Without boring you with the intricacies of each candidate, expect hiccups to each of their appointments and therefore potential volatility as the impact their presumed position has created in European equity, fixed income and currency markets is unwound in the blink of an eye.

The yield on Germany’s 10 year bond tumbled to within a whisker of the ECB’s deposit rate of -0.4%, extenuating its shocking rally into negative territory throughout 2019. Italy too, rallying off the back of positive fiscal negotiations and dialogue with the bloc, moved from 1.8% yield on a ten year note down to below 1.6%. Rallying bond markets usually spell headaches for the domestic currency, however the Euro, despite the rise of bond prices across the board, was relatively stable through yesterday. This is due to two factors – firstly, global, not just European, monetary expectations were falling with the Dollar’s own 10 year note hitting a 30 month low of 1.94%. When rewards are falling across the world, relative rewards are de facto limited, alleviating selling pressure from any one asset in favour of another. Secondly, with Italy’s dramatic rally being driven by the expectation that it and the Commission will not proceed with the excessive deficit procedure, risk surrounding the Eurozone decreased, limiting any justification for Euro short-selling.

The expectation that Lagarde, if confirmed as the next ECB President by the European Parliament, will be as dovish as her predecessor Mario Draghi stems from her endorsement of his policy moves throughout his tenure holding the reigns of the young bank. His 2012 speech, the “whatever it takes” moment, that paved the way to an un-funded spending plan of trillions of Euros by the central bank was hailed by Lagarde at the IMF as a successful and prudent move. So with inflation lagging and cuts baked in ahead of her potential arrival the expectation is that she could be one to follow through with further cuts into negative territory and even reintroduce elements of the asset purchase program. To see Euro weakness, keep an eye out for signals from the IMF chairwoman confirming this expectation and news of her intentions for her time in the top spot. For Euro strength, you’ll need to see signals of her defiance for the need for further monetary support and endorsements for more hawkish appointments to her staff perhaps including her rival for the nomination, German Bundesbank President, Jens Weismann.

Following that Euro focussed analysis all that’s left to say is happy 4th July and American Independence Day. Enjoy a relatively quiet day in the States amid thinner liquidity and limited action but get ready for tomorrow’s Labour Market data – it promises to be a big one!

Discussion and Analysis by Charles Porter

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