Euro area solidarity still missing

Emily Nicol
Chris Scicluna

Overview:
After Wall Street extended its rally to a third day yesterday (the S&P500 closed up 6.4%), most Asian stock markets ended the week with further gains. Once again, Japan’s markets led the way, with the Topix rallying to close up 4.3% on the day and 13.7% compared to last Friday’s close. But far more modest gains were chalked up in most other regional markets (e.g. China’s CSI300 was up just 0.3%). Aussie stocks followed three days of gains with a drop of more than 5% in the main index after the government announced that it would quarantine anyone arriving in the country by air. And US futures have fallen as have European equities at the opening, with the Stoxx Europe 600 currently down more than 2%.

Of course, the expectation that the US House of Representatives will back the US $2trn emergency relief bill later today was already fully priced in. But in Japan, where PM Abe today refrained from calling a national emergency and the budget for the coming fiscal year was finally adopted by the Diet, the focus has also shifted to options for the new stimulus package slated for adoption next month. Direct payments of at least ¥200k per eligible household seem likely to take centre-stage alongside other spending incentives and support for businesses including tax deferrals. But the overall size of the package, likely to reach several percentage points of GDP, remains unclear, with the ¥30trn (6% of GDP) figure mooted by some MPs only a very rough ballpark figure.

In the bond markets, meanwhile, JGB yields followed domestic stocks higher, e.g. with 10Y yields back above zero percent. But with sentiment softening in other major markets, yields on USTs fell back again (10Y yields down about 6bps to 0.78%). And after EU leaders last night reached a stalemate in terms of how best to respond to the Covid-19 crisis, most euro govvies have made further gains too, e.g. yields on 10Y Bunds are down about 6bps to -0.43%. The exceptions are BTPs (10Y yields up almost 10bps so far to 1.30%) and GGBs (10Y yields up a couple of bps to 1.50%) after yesterday’s extraordinary rallies saw yields on longer-dated BTPs fall about 30bps and those on equivalent maturity GGBs fall more than 70bps.

Of course, EU leaders remain split into two camps. Macron, Conte, Sanchez and like-minded leaders continue to argue that the common external shock of Covid-19 merits the large-scale issuance of common longer-dated ‘coronabonds’. But Merkel and her sidekicks still insist that the ESM’s €410bn lending capacity, perhaps via a new facility, should suffice to allow member states to fund their new support packages. Euro area finance ministers have been given two weeks to find a solution, but leaders have given them little guidance. And if the euro area can’t find the solidarity to issue common bonds in the current circumstances, it’s hard to see it ever doing so. In the meantime, however, Italy’s government continues to prepare a further stimulus package of at least €25bn, with the support of the ECB’s PEPP at least allowing it to plan its biggest auctions of BTPs and CCTs so far this year for next Tuesday.

Economic data

Japan:
Against the backdrop of the sharp drop in oil prices over the past month (down almost 50% in yen terms over the past month), the overnight release of Tokyo’s inflation figures surprisingly showed that headline inflation moved sideways in March, admittedly at just 0.4%Y/Y. And when adjusting for the consumption tax hike and government education policies, headline inflation was only just in positive territory (0.1%Y/Y).

The higher-than-expected outturn in part reflected fresh food inflation, up 2.1ppts to 1.6%Y/Y. So, when excluding such items, the BoJ’s forecast measure of core inflation fell for the third consecutive month to 0.4%Y/Y (0.1%Y/Y on an adjusted basis), the lowest reading since the summer of 2017. Perhaps surprisingly given the tighter visitor restrictions, cancellation of sporting and cultural events and closure of major tourist attractions, prices of recreational services increased in March (up 1.2%Y/Y) with a bounce back in prices of package tours.

But given the sharp retrenchment in demand, further upwards pressure from this source seems highly unlikely going forward. And with the oil price set to remain a significant drag on inflation for the foreseeable future, spare capacity in the economy set to increase sharply, Rakuten’s mobile phone charge war set to kick in on 8 April, and free education policies to be extended from next week, we see a significant probability that nationwide inflation will slip back into negative territory at the start of Q2.

Euro area:
Despite the escalating coronavirus outbreak across the euro area’s second largest member state, which has seen the number of confirmed cases rise above 29,000 and fatalities reach almost 1,700, today’s French INSEE consumer survey suggested that household sentiment has been little impacted. In particular, the headline confidence index fell just 1pt to 103, still well above the long-run average. But the survey was largely conducted before the pandemic intensified and tighter restrictions came into force this month. And the detail of the report did imply rising concerns about the near-term outlook. For example, the survey’s future economic outlook indicator fell 10pts to a fifteen-month low and concerns about future unemployment rose to the highest for eleven months. As such, the share of households assessing it to be an appropriate time to make major purchases fell to its lowest for a year to a level below the long-run average. And with the country now on lockdown, this seems bound to deteriorate very significantly further next month.

With Italy worst hit by Covid-19, with the number of fatalities almost double that reported in any other member state, and having been under much stricter trading and freedom of movement restrictions for a longer period, today’s business and consumer surveys seem bound to be highly depressed, with the headline indices likely to report the steepest declines on record and quite possibly to levels below that seen during the Global Financial Crisis.

US:
While the House of Representatives is set to ensure swift passage of the $2trn government support package, data-wise today will bring the revised University of Michigan’s consumer sentiment survey for March. The preliminary release showed the headline confidence index dropping 5pts to 95.9, a five-month low. But with the Covid-19 crisis having escalated in the US over recent weeks, we would expect a notable downwards revision to both the headline and expectations components. Today will also bring personal income and spending figures for February, including the closely-watched deflators. The core PCE deflator is expected to rise 0.1ppt on both monthly and annual rates to 0.2%M/M and 1.7%Y/Y.

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