Speaking in Berlin yesterday evening, Christine Lagarde, the new European Central Bank President, echoed Mario Draghi’s much-derided line from the September ECB Press conference; without fiscal stimulus, it is unlikely the common currency will rebound. We expressed similar sentiments in Monday's weekly commentary. Not surprisingly, the German pushback was immediate. Alexander Dobrindt, a contemporary of waning Angela Merkel and leader of the CSU (Christian Social Union), called on Lagarde to reverse her predecessor’s course and end the policy of ultra-low rates. Only two days into her new role, it’s already clear Lagarde has her work cut out for her.
Irrespective of the fiscal disagreement at the heart of EU declining growth, the Stoxx 600 index—a broad equity index of EU assets—is only 2% off all-time highs. Looking at government borrowing costs reveals a similar pattern. Comparing French 10-year government bond yields versus their slower, more fiscally constrained Italian cousins and you’ll see the difference in borrowing costs continues to narrow. To put this into context, according to Bloomberg, France is projected to grow at 1.3% in 2019 versus 0.1% in Italy. Likewise, inflation projections for Italy show 0.7% in 2019 versus France’s 1.5%. Italy also carries a larger debt burden relative to GDP than France, despite a slower pace of growth. In that light, it begs the belief that the cost of Italian government debt should continue to decline and the same said bond prices should continue to rise.
None of this is news, really, except that this morning we’ve seen the EU Service Purchasing Managers' Index (PMI) data surprise a bit to the upside, indicating a small improvement in conditions within the largest sector of the EU economy. Certainly, this is welcome news, but it should be greeted soberly given already high valuations.
Bottom line: The market has been waiting to pounce on good news, and given how flat the market has been since last week, the EU PMI data might provide an opportunity for movement. Irrespective, we agree with Madame Lagarde that a larger, more fundamental shift is required to improve EU conditions meaningfully. Suggestions that growth can spontaneously emerge from nothing, absent fiscal spending, or an EU banking union, is a pleasant fiction. German Finance Minister, Olaf Scholz, made some interesting conciliatory statements on the need for a banking union, a position vehemently opposed by previous ministers.
The pair traded in a cagey range yesterday, unwilling to demonstrate any bias in either direction while the UK’s political uncertainty raged on. The 1.29 level continues to pose immediate near-term resistance. Gains for both the Sterling Index and Dollar Index left the pair little changed by the close of play yesterday.
The Euro came under some selling pressure yesterday as the pair sailed back above the key 1.16 handle. The UK Services PMI stepped out of contraction, posting a reading of 50.0 flat, which helped to maintain Sterling’s gains throughout the day.
Yesterday, the US Dollar remained well supported by quiet optimism over the possibility of a US-China trade deal later in November. The Greenback was also buoyed by a positive print in US services data, which bettered market expectations, rising from 52.6 to 54.7. This morning, a good German Factory Orders figure has provided some respite for the Euro, but sentiment remains favoured to Dollar strength.