How can the new anti-fragmentation tool fail?

Outlook: It’s another big data day, with inventories possibly the one to watch (in the event inventories get “too high” and wholesalers and retailers start to slash prices to clear the warehouses).

Like it or not, trade (for May) is no longer a mover-and-shaker, while consumer confidence is increasingly seen as not useful. Case-Shiller house prices are lagging and we already know the horrendous price gains.

The Atlanta Fed GDPNow for Q2 is a 0.3% annual rate, from zero last week. This sounds okay but annualizing a tiny gain to get 0.3% is not really impressive. Worse, there is no agreement on GDP for the second half and whole year. Estimates range everywhere from negative to zero to 2% to 3.5%. Notice that the Blue Chip advisors, whoever they are, are still optimistic. The Atlanta Fed is less pessimistic but consider the numbers–it’s due to real gross private domestic investment growth “improving” from -9.0 percent to -8.1 percent. Negatives for investment are a surefire harbinger of recession.

We remain puzzled by the rocks getting thrown at the ECB’s new anti-fragmentation tool when it hasn’t been disclosed yet. The date for announcement in July 21. The FT is running a news story asserting that whatever it is, it likely won’t work, just as the existing programs, especially Draghi’s OMT, fall short (mostly because the country on the receiving end has to give up some control as well as much information, something Spain backed away from).

How can the new anti-fragmentation tool fail? Observers say “let me count the ways.” It has to be big, bigger than anyone now thinks in case of crisis and contrary to the ECB moderation norm. It has to be stuffed full of conditions, like OMT, that receivers won’t be able to stomach, like budget controls. The FT essay ends with this: “In March 2020, ECB president Christine Lagarde (in)famously stated the central bank is “not here to close spreads . . . There are other tools for that and other actors to actually deal with those issues.” That is wrong. The other tools are ineffective and the other actors – namely fiscal authorities – are not stepping up. Markets are calm at the moment, but with tepid growth, high inflation and high deficits and debt burdens in the eurozone, a damp squib for an anti-fragmentation tool could spark another crisis.”

A couple of FX sites grabbed onto comments by someone named Pierre Wunsch, an economist and governor of the Belgian central bank. He said the “anti-fragmentation tool should have no limits if market moves are unwarranted.” Oh, dear. That word “unwarranted” always entails personal judgment and opens the door for wild behavior; it’s a good thing the ECB is so laggardly and slow to act. Besides, “no limits” is not how deals get made between the austerity-embracing north and the “profligate” south. We can but hope the sane and wise Mr. Draghi is contributing mightily to the effort to build the tool.

Apparently the ECB fears a fragmentation crisis, though, as bond-buying ends under a different program on Friday. Today ECB chief Lagarde announced new “flexibility” in applying the PEPP (pandemic) facility. Bloomberg reports “Italian bonds trimmed declines Tuesday, narrowing the 10-year yield premium over its German counterpart -- a key gauge of risk in the region -- by six basis points to 191 basis points, the lowest since Thursday.”

To take stock: commodity prices stopped falling, so we have stories about cotton and copper, etc. See the chart from Trading Economics. We have almost no uncertainty about the Fed in July–75 bp–and little but uncertainty about the BoE and the ECB. The UK faces political unhappiness, if not actual turmoil, and for some reason its bond yields are gyrating (down a lot yesterday but back up again today).

Risk sentiment is all over the place and we can’t say it it’s risk-on or risk-off today. You’d think it’s risk-on given the equity markets, but they are pretty flaky (as they should be given earnings likely falling short of expectations). The CAD seemingly rose alongside the price of oil, but never has there been a more unreliable correlation (it works best when there is a crisis). The AUD, our canary in the coalmine for global growth, is struggling to break upside resistance. So, for the moment, we can’t see anything coming down the pike to shore up interest in the dollar.

Tidbits: Stock market stories are wobbly–if a gain depends on China cutting quarantines in half, we got nuthin’–and data is overwhelming. So let’s pay attention to juicier stuff, like the prison sentence for Ghislaine Maxwell today and the identity of the mystery witness in the suddenly announced Jan 6 hearing today. Then there is the flurry of new court cases and other work on invalidating the Supreme Court’s Roe decision. After all, the remedy for a bad or unpopular judgment lies in the US Congress. This is capable of being fixed toot sweet, if we have the guts.

Note to Readers: The US is about to go into the July 4 holiday weekend. We will not publish any reports on July 1, 2022 until Wednesday, July 6th.

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