Rally in stocks and Bonds

·         Every cloud is entirely silver  It’s said that every cloud has a silver lining – that everything bad has something good about it – but nowadays its seems more like everything bad is entirely good and every cloud is entirely silver. Yesterday’s economic news was all-around bad, and as a result we had a rally in stocks, bonds and credit, as if it was the greatest news possible. The Eurozone capped off a string of bad economic indicators recently with lower-than-forecast GDP, showing that the continent’s economy is basically stagnating, while professional forecasters lowered their forecast for both growth and inflation this year. Meanwhile on the other side of the ocean, initial jobless claims were higher than expected, contradicting some of the recent better news on the labor market.

·         There was some traditionally good news yesterday:  Russian President Vladimir Putin travelled to a much-hyped meeting in Crimea and called for an end to the conflict “as soon as possible.” The cautious speech was taken as a signal that he wants to de-escalate the crisis. (Although personally, I doubt whether things are over quite yet:  two British newspapers reported seeing Russian armored vehicles enter Ukraine Thursday evening, while the Pentagon announced it would send around 600 US soldiers and their equipment, including tanks, to Poland and the Baltic states. The US presence in countries that border Russia is not going to make Mr. Putin particularly happy.)

·         In any event, hopes for an early settlement to the Ukraine strife plus thoughts that neither the ECB nor the Bank of England nor the Fed is likely to start hiking any time soon encouraged the flow back into any and all financial assets. Bond yields headed lower, with 10-year Bunds breaking through 1.0% for the first time ever and 10-year US Treasuries slipping below 2.40%. Bunds are now only 50 bps or so above JGBs, the bonds of a country where the central bank is buying up more bonds than the government can issue. The VIX index continued to decline and high yield bonds rallied as money came back into the credit market too. But the dollar remained stable against most of the G10 currencies and EUR/USD stayed within its recent narrow range and once again failed to break the 1.3330 support (low for the day:  1.3349). The commodity currencies were the main gainers, which is kind of odd when you consider that commodities didn’t do that well – copper was down, oil fell sharply as the supply glut continued, and agricultural commodities were generally lower too.

·         FX market implications:  carry continues to climb The general financial euphoria had its counterpart in EM FX, where carry trades are back in fashion. Almost all the EM currencies that we track gained against the USD (THB was the only exception). The best performing currency was BRL, which had fallen after an opposition candidate for President was killed Wednesday in a plane crash. The eastern European currencies did well too, outpacing the RUB’s gains. I expect to see more and more carry trades put on as DM bond yields fall and the higher yields available in EM become relatively more attractive. MXN and the Eastern European currencies (PLN and HUF in particular) seem the likely beneficiaries, in my opinion. Investors interested in putting on carry trades might want to consider buying these currencies against EUR, which I expect to decline further sooner or later, or JPY, where pressure is building for further measures to weaken the currency.

·         Today’s events: UK GDP, US IP, Canadian unemployment correction During the European day, the main event will be the second estimate of UK Q2 GDP. Following the disappointing inflation report on Wednesday and especially the halving of the wage growth forecast, a strong reading is needed for GBP to resume its upward path. The market forecast is as usual the same as the initial estimate, i.e. +0.8%.

·         In the US, industrial production and PPI for July are due out. Given the soft retail sales Wednesday, the greenback will need a solid industrial production to regain its glamour. It’s not clear whether the forecast of +0.3% mom, a rise from +0.2% mom in June, would be sufficient. The Empire State manufacturing survey and the preliminary U of Michigan consumer confidence sentiment for August are also coming out. The former is expected to decline while the latter is forecast to improve, leaving a mixed picture.

·         From Canada, we get manufacturing sales for June and existing home sales for July. The re-release of July’s employment report is also due out after Statistics Canada found an error in the original report published last Friday. (The revised report was originally supposed to be published on Thursday, but the release date was later changed.) We would expect CAD to strengthen if it comes in above 20.0k, the original market forecast for the figure. However, a disappointing figure combined with the estimated slowdown in manufacturing sales is likely to weaken CAD.

We have no speakers on Friday’s agenda.