June 14, 2020

(WEEKLY PANDEMIC) MARKET COMMENTARY – FINANCIAL REPRESSION AND THE SOVEREIGN CARRY TRADE

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In Short

Covid crisis easing off in Europe, but worsening globally. The total number of new Covid cases has just reached a new high, at 130k per day on average over the five days to 13 June. That is about 45k more than a month ago.
(WEEKLY PANDEMIC) MARKET COMMENTARY – FINANCIAL REPRESSION AND THE SOVEREIGN CARRY TRADE
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Highlights:

  • Chinese data on Monday may vindicate hopes of a V-shape recovery. Yet we warn against extrapolating 1/ an early bounce driven by pent-up demand and 2/ Chinese trends to the broader economy. The ‘swoosh’ scenario for the global economy remains very credible. 
  • The sharp risk sell-off on Thursday was a reminder that the policy-induced rally has limits in a difficult pandemic and economic environment, but nothing more. 
  • Our reading from the FOMC: a genuine desire to maintain both short- and long-term rates lower for longer.
  • The coming week sees important events in three key political areas: the US election, Brexit and the EU recovery fund (RF). USD and GBP are likely to stay on the defensive. Eventually we expect the RF to exert steepening pressures on the EUR 10-30y core curves. 
  • The EU regulatory move to reduce bank capital requirements from losses on government bonds reflects the desperate need to keep sovereign yields low. We see evidence from banking balance sheets that the sovereign carry trade is back, and supporting spread compression. Domino effects will also benefit IG credit – though valuation there is no longer standing out, following sharp compression in April and May.

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(WEEKLY PANDEMIC) MARKET COMMENTARY – FINANCIAL REPRESSION AND THE SOVEREIGN CARRY TRADE

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