ECB keeps the taps running, as bonds pick up baton from equities
As we approach the end of the week, it is the bond market that is stealing the limelight. Equities have had a good run, the FTSE 100 is up 300 points so far this week, while the S&P 500 is comfortably above the psychologically important 3,000 level at 3,100. However, the big leaps higher that we saw earlier this week, particularly in Europe, have stalled on Thursday as the ECB has turbo charged the bond market.
ECB to the rescue …
If anyone was trading Italian or Greek 10-year bond yields lucky them! The yield on Italian debt fell 16 basis points after today’s ECB meeting (when yields fall, prices rise), while Greek yields fell 13 basis points. Movement of this scale in the bond market has been almost unheard of in recent years, in contrast the equity market is fairly quiet, with small losses across the board.
So, what did the ECB do to boost demand for Southern European government debt? It boosted the size of its bond-purchasing scheme by EUR 600bn to a new total of EUR 1.35 trillion, which was higher than expected. This will go some way to soaking up the extra debt European economies will be selling in the coming months to fund economic recoveries after the pandemic. The fact that the interest rates for Italy, one of the worst hit European countries, have slumped on Thursday, is also going to help with this recovery. The Italian and Greek governments can now borrow for 10-years at 1.41% and 1.4% respectively, this could lead to a surge of cheap money flowing into these economies in the coming years, which is something to cheer about. For the doomsayers, this will be a red warning light for inflation coming down the line, but the market is taking the view that these are extraordinary times and it is right for the ECB to throw the kitchen sink to avoid a deflationary economic spiral, and consider the risks of inflation later on.
Why it is time for the FTSE MIB to outperform the German Dax
Due to this gift from the ECB, it is not surprising that the Italian FTSE MIB is one of the best performing global indices today, up some 0.5%. The FTSE MIB is also approaching a key resistance level at 20,000, which also corresponds with the 50% retracement level of the index’s February to March decline. The boost to the ECB’s bond-buying programme could be the tonic that the Italian stock market needed, and with the European Commission’s announcement of grants and pooled loans that will help Italy the most, we believe that the Italian index is poised to potentially breach this level and continue its recovery. The FTSE MIB has lagged behind Germany’s Dax index, which has recovered nearly 70% of its February to March losses. After a very strong rally in recent weeks, investors may look to cheaper indices to play catch up, and the FTSE MIB is well-placed to benefit from greater investor interest in the short and medium term. Thus, as long as there isn’t a spike in the infection rate, then we could see the FTSE MIB outperform the Dax in the coming days and weeks.
What next for the FTSE?
Elsewhere, the FTSE 100 is taking a breather after it approached the 50% retracement level of its February to March decline. This is to be expected at such an important technical level. Below we take a look at the future drivers of the FTSE 100:
· The oil price: a lot is hinging on the Opec + meeting, which is expected to go ahead this week, although the date of the meeting is still unclear. Reports suggest that the meeting will lead to a month-long extension to production cuts, with rogue Opec members, such as Nigeria and Iraq, also pressured into cutting their production levels after failing to do so in April. If this meeting happens, and if the extension to the production cut is announced, then we may see Brent crude finally breach the $40 per barrel level. Combined with the - so far - successful reopening of many global economies, this news should also boost BP and Shell, two big players in the FTSE 100. If their share prices can recover, then this could help to lift the overall index in the coming weeks.
· Economic data:The economic data has surprised to the upside for May, which has led many FTSE 100 investors to believe that April could have been the nadir for the UK economy. However, the fate of the FTSE 100 and 250 is likely to be closely linked to the unemployment rate. We will have to wait until the middle of the month to see how the labour market performed for May. However, the key data to watch for is for June, to see if employment picked up as the lockdown was eased, and in August, once the government’s furlough scheme starts to wind down. If we see better than expected employment data in the UK then this has the potential to be a powerful driver of the FTSE 100 and 250 in the coming months.
· Winners and losers:at this stage of the market recovery, it is worth looking at which companies are rising and which are falling to see if there is a pattern. During a sell off riskier companies tend to decline in value, while safer companies rally, the opposite is sometimes true in a recovery. Some traders may be concerned that Whitbread, the pub and hotel company, is down more than 4% today when it was a top performer yesterday. However, the fact that Ocado and BT, two winners from the pandemic, are also falling, suggests to me that this is a bout of temporary profit taking rather than cold feet from investors that the rally will run out steam. Airlines and banks are some of the biggest winners on the FTSE 100 today, which also suggests that risk appetite remains strong.
· Threat level:ultimately global markets will recover for as long as the coronavirus stays away. For now, infection rates around the world look like they are declining, and this is helping risk appetite to recover. Likewise, the easing of lockdown restrictions seems to be successful, with economies adjusting well to the new normal. We expect this to continue, thus we believe that global stock markets should continue to recover. However, we would suggest that investors be aware of the news, as any reports of more outbreaks of Covid-19 could see the recovery rally thwarted and traders heading for the exits at the same time.
Overall, this has been a week where investors have cheered central banks and the cheap money that they have poured into the global economy. This is sustaining global risk appetite even though there remains some uncertainty around jobs markets and social upheaval continues in the US.