US Stocks were lifted on Wednesday by a rally in tech shares as concerns eased about a potential global trade war. While the Nasdaq and Small Caps rallied +0.7% to a fresh record, the Dow barely stayed green, exacerbating a divergence witnessed since the saber rattling on the trade front intensified. Biotech, fangs all rallied while the rest of the tape including European stocks were left lagging behind. Most EM currencies and stocks rallied yesterday for a change, supported by Argentina and Brazil gaining “emerging” status from MSCI which will integrate them in benchmarks. Treasury yields rose and Oil jumped. Russia reportedly sold $47.4bn of Treasuries in April, more than any other major foreign holder of the US securities, despite growing reserves. Russia remained with $48.7bn, down from $176 billion in 2010. At the same time, Russia’s gold reserves increased by 1% to $80.5 billion. In May, the central bank said. China remained the largest foreign owner of Treasuries (with $1.18 trillion) in April but also reported a slight drop (of $5.8bn) in holdings, as China’s appetite for U.S. government debt diminished amid growing trade tensions, Bloomberg reported. 

This is to say that China also possesses the nuclear option of using the capital account as part of retaliatory measures against D. Trump’s anti trade policy which most likely it will not use, however. Japan also reduced its holdings as expensive hedging costs continued to sour them on U.S. debt. For buyers in Japan who use swaps to protect from currency risk, the yield on 10-year Treasuries is now a mere 0.38%, compared to 2.92% available for owning US 10-year notes unhedged. This currency hedged yield of 38bps is similar to owning JGB’s or Bunds. We are making this point and presenting this simple math calculation to say that it fits in with the Fed’s intention, reiterated yesterday by Fed Chair Powell at an ECB Central Bank event in Portugal to keep raising rates (while others promised to leave them unchanged). In our view, the Fed wishes as much to keep normalising interest rates in the face of a resilient economy than to keep the conditions necessary to keep attracting foreign investors into US treasuries, so as to be able to fund ballooning US financial needs and crowd out international investors into US debt at the expense of other local markets. By delaying the normalisation of interest rates, the ECB could be painting itself against the wall. Not only are investors likely to give up hedging dollar risk, which would force a devaluation of the euro but Europe won’t necessarily reap the benefit of a lower euro, at least not for boosting exports to the US (!) considering the trade barriers D. Trump will erect to prevent this from happening. (As for developing ties elsewhere including with Russia or Iran, Europe is largely prevented to do so... by the US). Not only is the ECB unduly penalising pension funds and savers with an unnecessary financial repression but negative rates are not really helping local stock markets anymore which are decoupling from US equity markets which now suck out international investors to the detriment of EM and European capital markets. With this policy, the ECB renders the ownership of local bond markets unattractive to investors. Extreme accommodation in our view has outlasted its usefulness and has started working in reverse to the full benefit of the US. Not only are the ECB and the BoJ failing to normalize interest rates which means that they will have limited to no ammunition when the next recession strikes (for the moment the ECB line of defense is to discard the danger of recession because it is not there) but their policy now contributes to attrition investors out of European, Japanese (and EM!) capital markets as flows of funds data suggest.

If the fear is a stock market crash, a few billions euros purchased in major European equity futures (at the same time as taking rates off negative territory), should do the trick, just like it did on the S&P 500 at critical moments without anyone complaining too much... Many central banks are in the stock market for policy making purposes. Why not also the ECB instead of buying all Bunds issuance … At the moment it is a win-win for D. Trump’s policies. Having said that, M. Draghi’s sharp intellect and tact was in full display yesterday. When Fed Chair Powell and the panel were asked two ‘batch’ questions, one concerning forward guidance (the Fed plans to drop it while the ECB will keep it) and another one concerning the potential economic impact of trade barriers and as Powell showed a second of hesitation to answer the question regarding US policy, M. Draghi swiftly and delicately offered to answer the question on trade barriers, suggesting Powell to answer the question on forward guidance... This was a nice illustration of wit and style. Talking of which… D. Trump backpedaled and signed an executive order to keep immigrant families together as the political pressure (including from his wife) left him with no choice. This reversed his earlier insistence that only Congress could end his policy of separating children from parents. 

Global markets are weaker this morning in Europe as risk aversion resurfaced following Daimler guiding lower on trade war fears. Dollar strength also returned. 

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