US bond yields tumbled to a new historical low on Tuesday as the Fed unexpectedly signaled its willingness to continue inflating stock market bubble in exchange for stability of credit markets.
After the unexpected remark of the head of San Francisco Fed Marie Daly that the economy will need more support than previously thought, the chances of new round of monetary easing increased significantly. The policy toolkit can be expanded with yield curve control in September or even negative interest rates. US Dollar, Fed funds rate derivatives and gold, as we see, started to aggressively price in these worries. And it’s only a tip of the iceberg.
The odds of a new leg of policy easing are increasing as the US outlook becomes more and more dim what can’t be said about its main peers like the EU. Retail sales in the Eurozone rose 1.3% in July (forecast -0.5%) and the prior month was revised upwards. High-frequency indicators for the US economy trumpet that July data will not be very successful in showing improvement of two key gauges of recovery – employment and consumer spending. At the same time, Republicans and Democrats in the United States failed to agree on aggressive fiscal support as negotiations to extend the increased unemployment benefits foundered last Friday. The release of weak ADP report may make dollar sell-off more intense today, as it will increase odds of aggressive Fed actions in September. The main move, of course, is expected on Friday on the NFP release.
EURUSD turned into offensive earlier than anticipated since the Fed signaled about a new stage of policy divergence with other Central Banks, in particular with the ECB. The room for the rally looks even bigger if we take into account that recent appreciation of the European currency occurred without corresponding rotation from American to European assets, i.e. bets that European assets outperform US ones. Looking at the flows into one of the largest European ETF, MSCI Eurozone iShares, we can see that until now investors were reluctant to invest into EU assets, maintaining substantial exposure to US stocks (especially defensive tech sector):
That is, the entire episode of recent EURUSD growth to 1.19 was accompanied by a net outflow from European assets (circled in red).
In a comparative perspective, medium-term Eurozone momentum may eventually start to look more promising which could ultimately spur European ETF inflows, similar to what happened in 2017. The chart shows that then the corresponding inflow strengthened the EURUSD growth wave to 1.25 level. Now, as we see, this factor of pressure still remains intact.
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