Rallies on thin ice

The week started on a slow but hopeful note for European markets, with expectations that Trump’s latest 50% tariff threat on European imports would accelerate negotiations. And that’s what the latest headlines suggest. As a result, the Stoxx 600 rebounded around 1% yesterday, the DAX led gains with a 1.68% advance, the CAC added 1.21%, while the Swiss SMI index also gained 1.21%—on echoes that Switzerland could also ink a deal with the US in the coming weeks – a deal that would bring the 30% tariff rate down to 10%

So, yes, that market optimism fascinates me!  European markets are flirting with ATH levels, US futures were also up yesterday, but the reality is that with every piece of incoming information, the collective welfare deteriorates. Today, we are in a worse position than we were a month ago. And a month ago, we were in a worse position than we were three months ago. The global trade negotiation period was supposed to last 90 days, and now, it ends all of a sudden. The tariffs won’t be brought below the 10% ‘universal’ level and market rallies are triggered not by good news, but by the least bad of the options, once Trump or his administration softens a previously crazy stance. Oh well...

Moving forward, fresh deals between the US and major trade partners could further boost market sentiment and send indices on both sides of the Atlantic to fresh ATH levels—but whether that optimism lasts is yet to be seen. The economic data, especially the inflation metrics, will be crucial.

FX rates are crucial for equity valuations, as well, provided that they have a direct impact on companies’ costs and revenues. They reflect monetary policy, and/or they influence policy decisions—hence borrowing costs. As such, European Central Bank (ECB) Chief Lagarde believes that the turmoil in the US dollar and US bonds could strengthen the euro’s position as a reserve currency. The latter would increase sovereign bond demand for the euro area. That additional demand could help lower borrowing costs on top of the ECB’s supportive policy, and help European companies secure cheaper funding. Then, it will be up to the European companies to move and innovate, and up to the European regulators to let them do so.

The US dollar, on the other hand, is better bid this morning, but remains under pressure from trade tensions and the worsening perception of the US’s ballooning debt.

The debt issues are also making the headlines in Japan. The 30- and 40-year JGB yields have recently spiked to the highest levels on record, and the 10-year yield hit the highest since 2009. Political pushes for tax cuts and spending hikes are refocusing investor attention on fiscal cracks, just as the Bank of Japan (BoJ) looks willing to slow purchases and tighten monetary policy. And when you think that the BoJ holds almost half of the outstanding 10-year debt, the fallout could hurt.

On the other hand, higher yields will attract Japanese investors, especially the institutional ones, back to Japanese markets, partly by dumping their UST holdings. That could put further pressure on US debt and weigh further on the dollar. The USDJPY rebounded near 142 on the back of a sudden retreat in Japanese yields before a 40-year auction and a certain rebound in the US dollar—but the trend remains in favour of the Japanese yen.

As per the Japanese bonds, liquidity remains poor in the JGB space, and I’d rather prefer German bonds for diversifying US exposure.

Still in Asia, the latest data revealed that Chinese industrial profits rose 1.4% y/y in the first four months of the year—up from a 0.8% advance in Jan–Mar, thanks to policy support. On the trade front, there’s no fresh news about the US-China trade negotiations, but there is progress on the China-EU front, as policymakers are willing to respond and tame the impact of the deterioration of their relations with the US. The CSI 300 is breaking below the 50-DMA despite encouraging data, while the HSI is retreating from the May peak. On the individual front, BYD dropped almost 15% since last Friday’s peak following reports of significant price cuts in a promotional campaign, raising concerns about margin pressure. But the move showcases the strength of demand as BYD sales accelerate at an impressive speed globally. Therefore, price pullbacks are interesting opportunities to enter—or to strengthen—existing positions.