For some time now, European economic data has disappointed, and it looks like the worst is yet to come. This morning’s release of German Factory Orders shocked markets; new orders fell 8.6% year-on-year, the worst drop since 2009. ING described the release as ‘devastating’ because, combined with the weakest labour market performance since 2002, it undermines any hopes for an industrial sector rebound. Yesterday, European Central Bank (ECB) policymaker Olli Rehn admitted that the slowdown in the Euro Area economy should no longer be considered a ‘temporary dip’, and the ECB will seek to utilise the policy instruments at its disposal.
The ECB’s policy of negative rates and asset purchases has artificially accentuated sovereign bond prices and caused buyers to ignore scandalously low yields in the process. This current bout of economic weakness has raised the prospect for more central bank easing and resulted in a ‘bond-buying frenzy’ and pushed much of Europe’s government debt into negative yield territory. The worrying irony of this confluence of factors is that markets appear blind to the rising default risk, which stems from falling economic growth, instead, only interested in the myopic purchase of appreciating bonds.
Bottom line: While we have commented on bloated asset prices before, the EU situation is a rather striking example of dysfunction. The only factors underpinning these toppy bond prices is the prospect that the ECB will backstop each sovereign issuance and the prospect that increased ECB easing will rescue the fragile economic backdrop. Both assumptions are overly optimistic in our judgement.
Chinese currency devaluation and its effect on the US economy has been a key motivation for the US-China trade war, but this argument seems to be more political device than valid grievance. For decades, the People's Bank of China (PBoC) has used a controlled floating exchange rate regime for many reasons, including to improve trade competitiveness. The historical rationale for Yuan devaluation was more apparent when China focused on manufacturing, and a weaker currency was of direct benefit to exports, but the Chinese aspiration for higher value business leaves this argument a relic of times long past. More recently, China’s central bank has actually strengthened the currency, using it as a natural regulating mechanism of the domestic economy.
When we dig deeper into its motivations, it’s clear the primary focus is no longer the level of exchange rate, but rather the prevention of dramatic changes in valuation, which may result in capital flight. As central banks around the world ease monetary policy to combat slowing global growth, Yuan depreciation may actually make more sense, but leaves China open to fresh US criticism.
Bottom line: Trump’s view on China’s currency devaluation is too simplistic and ignores the economics of China’s financial structure. As a result, the easing of trade tensions between the two nations seems unlikely unless global growth can recover. However, the paradox is that the trade war is a major cause of slowing global growth in the first place.
As expected, there was virtually no action yesterday as a result of the US holiday. This morning the Dollar is on the front foot due to the poor German Factory Order data and anticipation of US employment data later today. Sterling remains side-lined during the race to number 10 endgame.
The trade-weighted Euro Index declined through the 100-day moving average and looks to be in the spotlight today, increasing the prospect of further intraday selling. On the pair little has shifted, since the economic and political prospects are equally unflattering.
In advance of today’s eagerly awaited US employment data, the Dollar is gaining as the Euro depreciates. The pair’s position at 100-day moving average support levels seems tenuous at best.
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.