Risk, risk, risk

Outlook

We are still waiting for the market-moving data this week: ADP, GDP and the Fed tomorrow, and flash eurozone inflation on Thursday. It’s possible that the EU announcement of third-round sanctions later today could get a rise out of markets, too. We also get Case-Shiller this morning, expected up 9.9% y/y in May after 10.1% in April—but looking too far back and covering only 20 cities. Besides, we already know the housing mar-ket zoomed up too far, too fast and is now decelerating.

We don’t know what to make of yields. The US 10-year rose on Monday but fell back so far today. The FT makes much of the Bund 10-year yield falling to a record low 1.13%. Bloomberg has 1.12% and notes this is lower even than at the height of the peripheral sovereign risk crisis in June 2012, when the Bund was at 1.127%. Bloomberg attributes the rise in bond prices/drop in yields to existing ECB stimulus and pending QE, with month-end contributing and oh, yes, a safe-haven bid because of sanctions against Russia.

We would probably attribute more to the sanctions than to the ECB and possible QE. Still, both yield sets seem to point to a rise in sovereign risk fear, and yet Spain is getting 2.46%, less than the US. On what planet does this make sense? One idea is that sovereign risk in Spain is a whole lot less than overall risk from the sanctions, not that Spain is exactly immune but it’s not Germany, either. Another idea is that on the real basis, subtracting inflation, Spain deserves 2.46% on zero inflation or even a bit of deflation. The real rate really is 2.46%. The real rate in the US is 2.47% minus about 2% inflation, or a great deal less at 0.47%. We don’t buy the inflation-alone view. It neglects the riskiness of the Spanish banking sector—that story vanished from the front pages in a blink—or any other upcoming risks, like the sanctions against Russia, the bank audits due in October, and possibly Mr. Draghi’s QE.

Meanwhile, the US 2-year, supposedly the proxy for pending rate changes, continues to rise. It is now up 4 bp to 0.54% (while the German 2-year is 0.04%). As Market News has been pointing out for some time, if anyone expects a rate hint from the Fed, they are engaging in wishful thinking. The yield curve is flatter, not steeper as one would expect if inves-tors really believe in a hike anytime even remotely soon. The WSJ even notes that the equity rally can continue because the Fed is quiet and acquiescent.

This is the context in which to think about both GDP and payrolls. Both are expected to disappoint. If disappointment gets fully built in, of course, then we don’t get the expected outcome but rather the opposite (sell on the rumor, buy on the news). So, is disappointment built-in? GDP at about 3% just offsets -2.9% in Q1 for basically zero growth in the first half. Maybe this outlook gets some credit for steady-Eddie 10-year yields. As for payrolls, most forecasters are in the 225,000 area, less than June’s stunningly high number but not chicken-feed, either. A low number (say 150,000) pushes yields lower and undermines the dollar, while a high number (250,000 and more) pushes yields higher. But if the consen-sus is right, 3% and 225,000, nothing much happens. That leaves data from Europe (inflation and flash PMIs) to push currencies, and they are not likely to be euro-favorable, especially with the big black cloud of Russian sanctions looming over the European and especially the German economy.

This is a roundabout way of saying that the euro rout is real and infecting other currencies, like the pound. The yen re-mains a mystery, jittering up and then down but on the whole, well-correlated with the 2-year yield differential and thus the current dollar/yen rise justified. (We will find something else to justify a drop if and when it comes—analyzing the yen these days is a fool’s game, and never more so than attributing the yen’s moves to disenchantment with Abe). We don’t buy the idea of the euro returning to the 2012 peripheral crisis levels around 1.2200-1.2400, but we don’t see 1.3800-1.4000, either. We will get a corrective upmove at some point, possibly Friday when all the chips are on the ta-ble, but the euro is not likely to re-enter one of its usual Teflon rallies this time. The euro is not universally disliked, but it’s losing its halo.

Note to Readers: We will not publish any reports starting next Thursday, July 31 to Wednesday, August 6. It’s the first time in over 20 years we will not cover the payrolls report. Remember: spikes, often two-way. Stay away.