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Tuesday, April 25, 2017

The euro move on the French election news is a runaway gap different from common gaps filled.

The dollar took a big hit as the French election resulted in the lower risk outcome, with Macron leading, 24% to 21%. Before the FX market opened Monday, LePen was ahead of Macron but both were the clear front-runners, so the euro was always going to open on a giant gap. Sure enough, the euro opened up at 1.0879 from 1.0725 at the Friday close for a gap of 154 points and proceeded to a high of 1.0933 before profit-taking set in and the inevitable dip to 1.0818.

A May 7 runoff between Macron and LePen was always the most likely outcome  so the degree of relief is a measure of just how fearsome any other outcome would have been. The CAC jumped 4.5%, the French-German 10-year spread contracted from 64 points to 42 points, and gold put in a spike low. Relief was widespread -- the Euro Stoxx 600 rose 1.97%. Dollar/yen rose 150 points on a gap to 110.58 before the usual retreat. Oddly, even US equity index futures are higher.

Oil may be recovering from a hard fall on Friday--in defiance of forecasts for $60. It’s up about 50¢ so far today. WTI closed down at $49.62 and Brent, $51.96. The WSJ reports both are down over $4 or 7% in the week, the biggest drop since March 10. The trigger was Wednesday’s report of a giant rise in gasoline stocks, plus on-going evidence that the shale producers just won’t quit. Besides, OPEC is being coy about the extension of the output cut, something the FT picks as a key driver (“confidence wavers”). And global stockpiles are still over the 5-year average.

Not making the front page amid the French hoop-la was the Fitch rating agency decision to downgrade Italy to BBB from BBB+.

• In the UK, Rightmove reported its house price index up 1.1% m/m in April and 2.2% y/y, not a bad number in its own right but the slowest in four years. UK housing data is hard to interpret because of chronic shortages.

• In Germany, the IFO business climate index rose to112.9 from 112.4. “Current conditions” rose to 121.1 from 119.5 and “expectations” fell back a little to 105.2 from 105.7.

• In Greece, the 10-year yield went to the lowest since 2014 yesterday after the news last week thart the government more than met the primary budget surplus target at 4.2%, confirmed yesterday by the European Commission. The FT reports “The fiscal outperformance, coupled with market relief at France’s first round election result, has driven the 10-year bond yield down 16 basis points lower to 6.2 per cent yesterday – its lowest level since November 2014.” The EC says the 4.2% number was a one-time gain but Greece is still on track for a 1.7% surplus this year and 3.5% in 2018. “Bailout monitors from the EU and IMF have returned to Athens to prepare the groundwork that will allow them to release around €6bn to the Greek economy before a summer repayments crunch.”

Euro/Usd Outlook: 

The euro gap and spike to 1.0933 exceeded the immediately preceding high from March and took it to the highest level since last November. You can see the entire move on this chart—it’s off on the left and started at the Aug 18 high at 1.1366. As noted below, this is a runaway gap and normally we do not expect it to be filled like a common, garden-variety gap—but we still have two weeks before the final vote, so don’t count on it. 

The Reuters 10-year yield index closed at 2.238% from 2.241% the day before and is quoted at 2.302% yesterday on the overall global drop in risk aversion.

The Bund yield is quoted at 0.342% yesterday from 0.233% Friday morning and 0.178% last Wednesday.

Market Insights:

The euro move on the French election news is a runaway gap, differentiating it from a common gap. Common gaps get filled. Breakaway gaps do not because they are a trend continuation move.

Breakaway gaps are based on hard news that promotes the existing trend and they always result in in a profit-taking pullback, an excellent opportunity to buy on the dip (and possibly the origin of that idea). Things are a little more complicated this time because the French election is in two-parts. We can easily see the market pull back repeatedly over the next two weeks as new polls come out. Ironically, the CFTC Commitments of Traders report on Friday had specs’ net euro shorts at the highest since March.

Everyone notes that the two winners in the First round of the French election are non-Establishment, meaning not belonging to the existing mainstream political parties. This is not strictly true. LePen’s party has been around so long it needs to be considered “established” if not Establishment. Macron’s policy stance is thoroughly conventional and not all that different from Fillon’s. Fillon has now said he will back Macron, implying his bloc of votes will go along and deliver a resounding Macron victory. We don’t know where the far-left Melenchon voters go next. Weirdly, they could go to far-right LePen in an overall anti-Establishment move.

Political analysts are breathing a sigh of relief that Brexit and Trump were not the death of polls, after all. Some suggest that a multi-party system is better than the two-party system on the grounds that voters become accustomed to having a populist party in the mix. We doubt it. Multi-party systems have resulted in unstable coalitions and in some instance, months and months with no leadership at all.

In the US, Trump is supposed to roll out a tax plan and possibly a new health care plan as well this week, with critics saying there has not been sufficient time and staffing to deliver true plans and we are likely to get nothing more than rhetorical bluster and self-congratulation. Here’s the problem: the government runs out of spending authority on Friday, which will be Trumps’ 99th day in office. We probably won’t get a government shut-down but only a short-term extension in the form of a “continuing resolution” that does no more than kick the can down the road. Trump insists the budget contain funding for a border wall (that he said Mexico will pay for) while the border tax is not among the tax reform proposals, a broken promise in spades.

The Treasury is already gearing up for a loss of wiggle room. It must pay some obligations before others. Remember that stupid billion-dollar coin that supposedly the president can issue and borrow against? This was a loophole dreamed up during the Obama years. Obama was too dignified and conventional ever to do such a thing, but Trump is neither. And on Saturday, the press holds its annual White House Correspondents Dinner. The host and various speakers take turns ridiculing the president and any other easy target at these events. Obama himself ridiculed Trump at one of them. It’s a glorious opportunity to make fun of Trump but Trump has already said he is chickening out and will not attend.

Talk by Congress and the White House will likely override hard data this week, which is mostly about the housing market. We are worried about the Atlanta Fed GDPNow forecast due on Thursday for Q1 GDP. Last week it was a lousy 0.5%. The New York Fed, meanwhile, gets 2.7% for Q1. Granted, discrepancies between forecasts is common, but this one is a doozy. If the Atlanta Fed is correct, the US economy is far weaker than we thought. If the NY Fed is right, the US economy is far stronger than we thought and providing a strong push to the Fed for the June rate hike.

So which is it? The IMF is optimistic about a global recovery that will deliver 3.5% this year. Maybe the US will deliver 1-1.5% in Q1 but a big acceleration in Q2. The real problem is that inflation is fading back (in both the US and Europe), implying that the Trump reflation trade, while not a dead duck, will be much delayed. See the chart from the FT.

Meanwhile, N. Korea said it is prepared to strike aircraft carrier Carl Vinson, finally turned around and headed for the Sea of Japan. The NYT reports Chinese Pres Xi telephoned Trump yesterday morning to urge him not to respond in kind to a nuclear test by N. Korea, which may still be pending despite N. Korea not acting on April 15 as expected.

For some reason, the major news outlets failed to pick up a CBS report on a series of N. Korean statements on Saturday that it will respond with nuclear war if it is attacked. It’s not clear that the carrier nearing the Korean cost constitutes an “attack.”

N. Korea said, among other things, Trump administration officials are “spouting a load of rubbish” and “seeking to bring nuclear aircraft carrier strike groups one after another to the waters off the Korean Peninsula.” CBS reports “The recent escalation in tension will be front in center in Washington on Monday. Diplomatic sources tell CBS News that U.S. Ambassador Nikki Haley will escort Security Council members to Washington for a series of meetings with members of Congress before heading to the White House for a photo-op and lunch with President Trump. The high-profile visit will give U.N. diplomats an unusually high level of access to the president.”

Oh, dear. We can say, again, that we don’t know how big a financial market effect these matters have. But confidence in the US economy and current stewardship has to be low and falling—although we have yet to see foreign fund managers run away from US auctions.

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