85 – the New 100
U.S. markets have taken a back seat to the Euro QE trade that has pushed many of the extreme and somewhat unbelievable valuations that have emerged since the start of the year. Under the auspices of continued monetary divergence, with the Fed seemingly set to raise rates within the next 6-months, while the ECB, BOJ and almost every other central bank going in the opposite direction, we have seen sovereign yields fall to once unimaginable levels. Having spent the better part of our career watching Japanese yields collapse under the distortive influences of fiscal and monetary policies, we will admit to watching in disbelief as 10y bunds traded through 20 bps, if only momentarily. Negative yields are now out to 7-years on the bund curve, turning the concept of buy and hold on its head. In many ways, the Euro has become the litmus test as to how far investors are willing to take the divergence trade. The start of ECB QE, which will essentially buy all EGB issuance over the next 18-months, has also had the effect of devaluing the Euro by 12% this year. After a relatively calm February, the start of the central bank reporting cycle is highlighting the extreme measures being embarked by the monetary authorities. With the Euro falling over 5% this month alone, we have had heightened volatility as big figure moves are become fairly common. Not be left out, the strategy community has completely capitulated on Euro parity, with $0.85 per euro the new parity. While it’s hard to argue that fundamentals and policy actions will continue to exert downward pressure on the common currency, the speed of the moves on seemingly old news give us pause for concern. Regular readers of our musings have heard us express concerns when consensus becomes too concentrated in an investment thesis. We sense that the Euro parity trade is in this camp given the recent acceleration towards this objective as strategist fight to move their estimates lower. This certainly doesn’t mean that we won’t see the target being hit, but rather are more concerned over what happens after we get close to those levels. We have seen bounces on NASDAQ 5,000 and the 1.68% 10 year earlier this year, as investors seemingly wanted to get to those levels and abandoned the trade one they got there. Given the slight improvements in recent Euro data, we suspect that the volatility both lower and higher will remain with us, until fundamentals provide more granularity.