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The long game

Without delving too deeply into the tangled, existential mess that is the Eurozone integration story, it is worth mentioning that the ECB’s policies have gradually worn away one of the fundamental obstacles to completion of the project, mutual government bond guarantees. Put simply, core nations—prominently, but not exclusively Germany—have insisted that their constituents won’t stand in favour of fiscal integration (e.g. EU budgets, guaranteeing each nation’s debt as a group, etc.) because of past sins and differences in economic composition. Of course, this is a vast oversimplification, but one of the most visible manifestations of these objections was the yield spread versus the benchmark German Bund, or domestic borrowing cost over and above their ‘prudent’ core neighbours.  The Italian Prime Minister was once quoted as eating BTP (Italian Government Bonds) yields with his breakfast it was that much a proxy for the political pressure on Italy.

Without a doubt, serious reforms have improved the fundamental footing of these nations—Greece is a wonderful example—but the decline in yields hasn’t been entirely due to improved fiscal stewardship. Slowing global growth and resultantly lower investment returns are driving investors towards riskier assets and raising their price closer to safer investments. ECB asset purchases have accelerated this dynamic with two particularly interesting outcomes: one, market appetite for risk has driven borrowing costs for periphery nations much closer towards that of their core neighbours, and two, ECB tiering has defended riskier, periphery banks much like their safer core counterparts. Essentially periphery nations are starting to look more and more like core Eurozone nations, undermining some of the most compelling arguments against integration, at least in the short-term.

Bottom line: With the playing field levelling to this extent, we can’t help but think much of this is designed to reduce the political obstacles for a last push towards integration. There are valid arguments for and against integration, but behind the scenes, the ECB has seemingly worked to defend the EU project. Tiering particularly has opened the door to more rate cuts—just when it seemed we were at the bottom of interest rate policy settings—and could flatten the field even further in time.

italian greek.png

Source: Bloomberg

The week ahead

GBP

Sterling’s September rally may come to an end early in the week as the trade-weighted index hits the 200-daily moving average. On the political front this week, UK Prime Minister is beginning negotiations with European Commission President Jean-Claude Juncker to find a new Brexit deal. The Pound will likely be volatile as headlines regarding negotiations emerge. Thursday will be a key day for the Pound as the Bank of England (BoE) release the latest monetary policy summary and update its official bank rate.

  • The first major UK data release is on Wednesday morning when we see September’s year-on-year CPI inflation data. The expectation is a tick lower, putting UK inflation below the 2.0% target at 1.8%.
  • Joining the BoE monetary policy announcement on Thursday is September’s month-on-month Retail Sales stat. It’s excepted to dip back into negative territory at -0.2% following August’s surprising expansionary reading.

USD

A light week of US data means Wednesday evening will be the most significant part of the week for the US Dollar as the Federal Reserve updates its main policy rate along with a statement and press conference. The US Dollar Index remains near the top of its year-to-date trading range and recently found support at its 50-daily moving average. 

  • The US Industrial Production month-on-month stat will be released on Tuesday and it’s expected to show a bounce back into positive territory following August’s -0.2% reading. This month, it’s forecast to expand by 0.2%.
  • The Philly Fed Manufacturing Index will be released on Thursday afternoon and is an important leading indicator of the health of the US supply side. The readings have been deteriorating this year, but the past two months have beaten expectations. The expectation is a deterioration from last month and stands at 10.9.

EUR

Following last week’s volatile trading surrounding the European Central Bank’s dovish policy update, this week is light on the data front and could be a less volatile week for the common currency.

  • The German ZEW Economic Sentiment Survey will be released on Tuesday and indicates the general sentiment of economic conditions felt by institutions. A reading above zero is positive sentiment, and September’s reading is expected to be -38 – a tick higher than last month’s -44.1.
  • Eurozone inflation figures will be released on Thursday and are expected to remain unchanged from August with year-on-year CPI at 1.0% - well below the ECB’s target of close to 2.0%. 

All content is written by the Global Reach Trading Desk. The opinions expressed are not the view of Global Reach Group and are not intended as investment advice.