What to expect next week ?

What do I expect as being important next week: 7 points at least
Markit and ISM indices in the manufacturing sector (June 3)
German Industrial Orders for April (June 6)
US employment for May (June 7)
Euro Area inflation rate for May (June 4)
 ECB meeting (June 6)
Trade war (no specific date)
Inversion of the US yield curve
The document is available here What to expect Next Week June 3 – June 7 2019

Inversion of the US yield curve now points to lackluster projections

Investors have been keeping an eye on the US yield curve since the fall of 2018, as they wonder about a potential inversion and the effects this would have. This is a major issue as inversion of the yield curve is always a flag for economic recession in the US. We can try to convince ourselves that this time will be different … but in vain.

The first step is to look at the trend on the yield curve, and our chart provides daily data since 1983. We can see a clear pattern of yield curve inversion followed by recession with a 12-18 month lag. Each recession is resolutely heralded by an inverted yield curve.

We can take our analysis of US interest rate structures further by looking at the chart opposite.
I have looked at the various interest rates since 1983 – from Fed funds through to the 30-year rate, including the 1-year, 2-year, 5-year and the 10-year of course – and we can see compression as a result of rising Fed funds rates before each recession. Before each recession the Fed’s key rate moves above the others; although the current period does not yet show this configuration as the 30-year rate is still above the Fed funds rate. 

We can see very different situations for the US yield curve over the period from 2018.
A flatter yield curve in the fall of 2018 reflected a swift rise in the 2-year rate to price in expected future Fed moves, and the 10-year rate moved above 3%.
Expected inversion in the curve would then come from a swift hike in the central bank’s rates to curb the risks of excessive nominal growth, as reflected by a rise in the 10-year rate.
The situation changed in mid-November with long-term rates falling. Plunging oil prices changed inflation projections, restricting the 10-year rate’s ability to rise further. 

Since the start of 2019, recovering oil prices – currently at the average price witnessed in 2018 – have not had a major impact on interest rate trends. However, concerns on growth have stepped up a pace and this can be seen in the decline in 10-year real rates. These uncertainties and risks on growth are the result of the China-US battle of wills and these tensions jeopardize future economic growth. The 10-year rate has been below the Fed funds rate since May 7, and this inversion can be seen right across all maturities up to 10 years, although not yet for the 30-year rate, which is falling swiftly but has not yet hit the traditional recession-heralding configuration. The current 30-year rate is 2.75, and around 25 bp remain for it to move into recession-indicating territory. 

The yield curve has reflected the same inversion trend since the fall, but for two different reasons. Initially it embodied strong projections on economic growth, while the Fed endeavored to contain these to avoid the emergence of excessive imbalances. Today it points to lackluster projections from investors, regardless of the Fed’s policies. 
It is easy to envisage the Fed’s role in solving this conundrum: it could cut back its key rate. Yet if we look at the minutes of the last meeting, members of the monetary policy committee are not yet entirely convinced that this is required.
Recessionary risk increases as investor projections deteriorate and everyone sits tight to wait it out. But this is when action is required, although the president does not seem to be persuaded that this type of move is needed.

European elections: changes but no revolution

Elections for the European Parliament mobilized more in the May 26 poll. The participation rate is at 50.8%, the highest since 1994. For France also this change is strong with a participation of 50.1%, the highest since 1994.

We can see on the graph the change of pace This mobilization has been observed in most European countries.

Only 8 countries have a participation rate which is down compared to the 2014 elections. We note the very strong increase in participation in Central Europe.

In Poland, Hungary and Romania, this rate had never been so high.
In other words, the European question has rather mobilized in all European countries.

This vote has also resulted in greater diversity and this may be a consequence of this increased participation.
The conservative party (EPP) is no longer so dominant and the social democrats can no longer make an alliance with them for a broad coalition. The counterpart of this weakness of the parties that traditionally dominated the Parliament, is the circa forty seats won by the liberal centrists, the circa thirty won by the greens and the twentieth gleaned by the nationalist parties and extreme right. The radical left, however, loses about fifteen seats.
The question that was important on the eve of these elections was the balancing point between those who want to make the evolution of Europe within the existing rules and those who want to use rules when they fit them. The parliament remains very oriented towards the respect of the rules. The nationalist and far-right parties will represent just under 180 seats out of 751 and will not participate in any coalition.
There has not been a tidal wave towards nationalism and that is why the financial markets do not experience any ups and downs. Salvini’s victory in Italy was long overdue, so it’s no surprise, just like Orban’s victory in Hungary.
There may, however, be local stories like in Greece where the Democratic Party has supplanted Prime Minister Tsipras’ s party while legislative elections will be held soon.
On this point, moreover, the impact of the elections to the European Parliament is still very small at the national level. Each time we imagine strong changes but this vote remains European with little impact on national policies.
It will nevertheless be interesting to look at the British situation closely since if Farage wins the elections, pro-brexit are not the majority. That’s why the situation across the Channel will become complex after May’s resignation on June 7th. It will be necessary to find a new political balance to designate a prime minister who will negotiate the Brexit and that will be necessarily very complex (see here (in French) on the resignation of Theresa May)

The question now is that of the election of the European Commission.
There is a double change here. The first is that the grand coalition will not take place. There will necessarily be greens and liberal centrists. The balance will be different from that observed for a long time.
The other point is that the German candidate is no longer as strong as expected because of the low score of the CDU / CSU in Germany (but also maybe because of the Selmayrgate that weakens Germany within the Commission). Angela Merkel will not necessarily have the capacity to impose Manfred Weber. The game will be played between this German candidate, Michel Barnier, Frans Timmermans and Margrethe Vestager.
For the Euro zone, the choice of the President of the European Commission can not be neutral because in a few weeks, the new president of the ECB, will be named. A few months ago, Angela Merkel said she did not support Jens Weidmann at the head of the ECB preferring the Commission’s presidency to that of the central bank. If Manfred Weber is not the future president, then the Weidmann card could be played. This is already an attitude we have seen for some time. The candidacy of the President of the Bundesbank is once again on newspapers’ front page.
I do not think it would be a positive for the Euro Area if he replaced Draghi’ after his departure. He does not have a cooperative attitude within the countries of the zone. He was opposed to the OMT, hostile to a policy that was too accommodating (which may not have been enough) and to a possible fiscal stimulus in the event of a negative shock to activity. To the German influence on fiscal austerity it is not necessary to add monetary austerity if we want the Euro zone to continue functioning.

This arbitration will be important and that’s what will excite us in the coming weeks.