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What have we been up to


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Inflation – check. Negative real interest – check.

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The second biggest countdown after New Year’s Eve in Europe has ended with a bang – nowhere more so than on the Iberian Peninsula. Spanish diplomacy probably scored its biggest cheer in a decade when the EU, in answering Britain’s Article 50 letter, singled out Gibraltar as a place where any post-Brexit trade agreement would apply unless Britain came to a direct agreement with Spain on their 200+ year-old dispute over the 6.8 Km2 stretch of land. The poor Gibraltarians (who voted 96% to stay in the EU), are caught between the Rock and a hard place.

There are only 723 days to go before the EU and UK revert to using something akin to WTO trade rules to exchange goods and insult letters. For the latter, diplomats and institutional representatives may decide to use Chatham House rules at some point, and that may be for the best. Over the next two years there will have to be some real, down to earth negotiation: on the exit bill, for example, and particularly on access to the European market. Harsh framing and threats are subsiding to more civil tones, but bear in mind that any pick-up of the former may feed volatility to the markets again.

Financial markets showed a little uneasiness on the day, but even on close examination one would not have thought that anything mind-blowing had happened. The biggest change has been on the rates side, where swap rates have dropped by some 10bp across curves and countries. Most interestingly, the EUR interest rate swap five-year vs three-month Euribor is again close to 0% (actually 0.02%), quite a drop from its high of 0.20% on 10 March. This means the Euribor forward curve projects – again - negative borrowing rates until April 2020: three full years. Perfect timing to consider hedging floating rates to fixed, but please mind the Euribor floor if you have that in your debt facilities.

Other financial markets stumbled upon the big news, but kept going undeterred. Equity indices are up another few percentage points. This is probably sensible, if you consider that the real yield on investment-grade bonds remains negative. Speaking of investment-grade bonds, various ratings agencies downgraded South African government bonds to junk, ultimately aligning them with Russia and Brazil in the BRICS bad boys’ bond market. This followed Zuma’s very controversial decision to fire Finance Minister Pravin Gordhan. Meanwhile, the Rand has depreciated around 10% against USD in the space of a week, showing a real market move from a real emerging market currency. For the record, the currency rating is not junk yet, but the outlook is negative and the junk status close enough. Time for some hedging top-ups if you budgeted ZAR in November and missed the window of opportunity; volatility will remain high in coming months.

Inflation figures are set to be a thorn in the ECB’s side. Consumers, particularly in money-savvy and poorer countries, care about headline inflation; oil and food costs matter for their expenses and may hit their purchasing power hard. EU year-on-year HCPI inflation dropped in March from 2.0%, when it triggered a variety of hawkish comments, to 1.5%. That said, it is the ‘core’ measure of inflation, which excludes volatile, mostly exogenous oil and food prices, that the ECB cares about in its price stability effort. As the latter is not showing signs of moving higher (indeed it fell from 0.9% to 0.7% in March), it is unlikely that any hike will happen for another quarter or two - or possibly longer. The dynamics of the two measures will matter in adjusting market expectations regarding whether (and when) rates in Europe will move upwards. Similarly, ECB meetings’ minutes and Q&A sessions will deserve close attention, as they have the capacity to trigger quick adjustments in market expectations. Eurostat releases March CPI figures on 19 April, one week ahead of the next ECB monetary policy meeting on the 27th of the month.

Currency markets around the euro have remained stable. EUR-USD, EUR-CHF and EUR-GBP are all trading around last month’s averages, at 1.0680, 1.0700 and 0.8600 respectively. The only cross that showed some directionality has been EUR-JPY, trading lower at 118.00, following JPY strength against the USD



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