The Daily Prophet: Euro Bond Reprieve, Stocks Breather and Enigmas

Connecting the dots in global markets.

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It's been a tough year already for the euro-denominated bond market. Investors are on the defensive, with prospective French presidential candidate Marine Le Pen pledging to take her country out of the euro bloc should she win, Italy reeling from a near crisis in its banking industry and bracing for its own potential elections, and Greece again fighting with its creditors.

As we've seen so many times since the financial crisis, the response by central bankers is to print more money. An account of the European Central Bank's Jan. 18-19 meeting released today indicated that officials will relax the application of some rules on bond buying to help maintain their “substantial” expansionary policy, opening the door to more purchases of debt from nations in the periphery. The ECB said “limited and temporary deviations” from the guidelines known as the capital key “were possible and inevitable.”

“Mention of capital-key flexibility is like a red rag to a periphery bond bull,” said Richard Barwell, an economist at BNP Paribas Investment Partners in London. 

What's good for euro bonds is generally good for the euro, and today an index measuring the shared currency against a basket of developed market peers rose the most this month. The two-day gain of 0.75 percent is the biggest since the first week of January. The euro has been under pressure recently as economic data came in a bit weaker than forecast. A Citigroup Inc. index that tracks the number of data points that surprise to the upside relative to those that disappoint has fallen top its lowest level since November.

Stock traders took a breather today after pushing the S&P 500 Index up for seven straight days and the MSCI All World Index to a new record. The gains took global equities to levels that indicated momentum had gotten ahead of itself, based on a measure known as relative strength. Some clues suggest that this break may only be the pause that refreshes. That's because the parts of the market that have trailed since Donald Trump was elected president in November, such as real estate, utilities, consumer staples and telecommunications, are now catching up with sectors more closely tied with economic growth. "A lot of big investors had doubts about this Trump rally, and are now scrambling to unwind negative positions and turn bullish” said Stephane Barbier de la Serre, a strategist at Makor Capital Markets. 

There's a big mystery in the bond market, and it suggests traders are very sanguine about the prospects for faster inflation. In fact, it may suggest that the Federal Reserve is in no danger of falling behind the curve when it comes to controlling prices. That can be seen in the difference in yields between five- and 30-year Treasuries. The gap has narrowed since the U.S. elections as longer maturity bonds outperformed. If traders really believed inflation was about to take off, then long-term bonds would tend to underperform. Inflation erodes the value of fixed-income payments over time, so the more payments you have coming, the more you are at risk of losing purchasing power.

Demand for U.S. wheat is rising, as the U.S. Department of Agriculture said today that export sales surged 7.9 percent in the week ended Feb. 9, more than double a year earlier. That helped push prices up prices for wheat futures for May delivery by more than 1 percent to as high as $4.77 a bushel on Chicago Board of Trade. Prices haven't been that high since August. Total sales commitments for delivery by May 31 are up 39 percent from a year ago, to a three-year high.

Moody's Investors Service is due to provide an update on the U.S.'s Aaa credit rating Friday. Although no change is expected, investors will be watching closely for any sign that the firm is getting worried about America's rising debt load, given that the Trump administration's growth programs are dependent on debt and deficit spending. Moody's said last month in a note that as Trump's "policies start to take shape, any actions to address the rising burden of entitlement spending will be particularly relevant.'' While robust revenue growth during the last eight years helped shrink the fiscal deficit from around 9.8 percent of gross domestic product to 3.2 percent in 2016, Moody's noted that U.S. federal debt levels in 2016 were already the highest for any Aaa-rated country, at 77 percent of GDP.

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