Sell in May But Do Not Go Away…

During the different meetings last month, the various Central Banks, the Fed, Bank of Japan, People Bank of China, and the ECB left rates and policies unchanged as expected.

While the tone was quite optimistic on both sides of the Atlantic, Chairman Powell remained dovish and said the “time is not yet” to talk about tapering. Regarding inflation, Powell emphasized again that the Fed’s focus is on actual numbers and not on forecasts, and even if higher this year, the inflationary pressure should only be transitory.

However, last week Treasury Secretary Yellen shook the markets when she said that rising rates would be a necessary tool against an overheating economy. At the end of the day, the decision-maker regarding the rates is the Fed, but since Powell and Yellen are close, we may legitimately ask ourselves if they do not start questioning the inflation’s “temporary” nature.

During its meeting, the ECB said it would expect to lower bond purchases by the end of the year if vaccine rollout is improving and new variants do not represent a threat to the reopening.

In addition, the European Union plans to launch a Recovery Fund in June, under which it will issue a total of 800 billion EUR within five years, in order to support the post COVID economy.

The Central Banks in China, the US, and Europe are planning or checking a potential launch of a digital currency of their own – a move which may counter the original purpose of the cryptocurrency, a non-regulated coin.

Biden seems decided to finance his plans with tax hikes

In the US, President Biden seems decided to finance his plans with tax hikes: his $2.25 trillion infrastructure plan should be financed with an up to 28% corporate tax hike. He announced a $1.8 trillion children and families plan that should be financed with a tax increase as well. In addition, he proposed a capital gains tax hike from 20% to a 39.6% maximum rate for households making more than $1 million per year.

Of course, with a narrow majority in Congress, such increases will likely be compromised, but still, the tone is set, tax hikes will happen for corporates and for investors. An interesting and historical fact though: US markets tend to perform better in years of tax increases than during years of tax reduction. Food for thought…

On the vaccination side, Biden missed his target of 60% for the end of April. Nevertheless, even with 45% of Americans have received their first dose, restrictions are being eased all over the country. The new target is for 70% of Americans to get vaccinated by July 4th. In Europe, the vaccine rollout accelerated and as of today, 25% of Europeans have received their first jab. Israel is still a world leader with more than 62% of the population vaccinated.

April saw also the kickoff of the earnings season for Q1: so far 87% of the S&P 500 have reported, with 87% beating estimates. US major banks and giant techs reported extraordinarily strong numbers with good guidance, but little or no change was observed in their stock prices.

In the meantime, in China, regulators are focused on giant tech companies, and in this framework, Alibaba was fined $2.8 billion for breaking anti-monopoly laws, the largest amount ever imposed on a company. However, to put things in perspective, it represents only 2.5% of the forecasted revenue of the company for 2021 and the company accepted and complied with the charge without complaint. But for now, big Chinese stocks are under pressure mainly for that reason.

Virtual Climate Summit and the clean energy sector

Finally, a world leaders’ virtual summit on climate took place last month, organized by President Biden, hosting heads of states as well as philanthropists and activists on this matter. They all committed to efforts of lowering carbon emissions. This commitment has supported temporarily the clean energy sector. However, this sector is now suffering again, because of supply chain issues, despite actual good numbers.

Like automakers, renewable energy companies are being hit by the global chip shortage and by the cost of transport which has more than doubled this year. All that weighs particularly on solar energy companies that are in a period of development and investment.

From our side, as volatility and yields stabilize, and market movements on good news are contained, we tend to think that the recovery is now priced in and not much upside is left, at least in the short term. In this context, any bad news could have a strong and unexpected impact. However, for the midterm, two factors are incredibly supportive of the equity markets: first, the huge increase in dividend rates, even to above the pre-COVID levels, and secondly, the huge inflows into equity ETFs.

Indeed, inflows for the first quarter were the largest ever and more than three times the inflows during Q1 2020. If this trend continues, we could reach a total of $1 trillion cash brought to US equity ETFs by the end of the year, more than twice the actual record set in 2017. These facts tell us that there is plenty of money around and it mostly goes to one place, and one place only.

As always, risk management combined with rigorous sector and geographical diversification will remain key factors for investment performance.

You are more than welcome to contact us to discuss our investment views or financial markets generally.

For a look at all of today’s economic events, check out our economic calendar.

The Dollar and the Fed

This was also true in dealing with the Great Financial Crisis. The divergence then and now had shaped the investment climate.

On a per-capita basis, the pandemic struck the US harder than in most other high-income countries, and some see the wide disparity of income and wealth as a contributing factor. In any event, the vaccine rollout has been quite good by international standards. This, coupled with vigorous policy support, economic activity has exploded.

A growing chorus of economists has argued that the Fed ought to target nominal GDP. Two percent inflation, which the Fed targets at 2% (now on an average basis, but no term for the average has been declared) and three percent real growth, has been an elusive but desired goal. In nominal terms, the US economy grew by more than 10% annualized in Q1, and it appears well above that here in Q2. In fact, after the disappointing employment report, the Atlanta Fed’s GDP tracker sees Q2 real GDP at 11% annualized, down from 13.6% prior to the employment report. The NY Fed’s tracker slipped to 5.1% last week from 5.3%.

Many high-income countries contracted in Q1 but are recovering, and positive growth is likely going forward. The acceleration of the US economy is still quicker, meaning that the divergence may extend a bit longer. However, the real takeaway from recent news and developments is that the divergence meme is ending. In fact, models of data surprises show the US faltering and Europe improving and can only be underscored by the nonfarm payroll report. In addition, the vaccine rollout in other high-income countries is accelerating, and Europe’s seven-day average has surpassed the US. Partly, this is a function of catching up after a slow start. However, there is another issue that is unfolding. A significant minority appear reluctant to take the vaccine.

As we have come to appreciate, herd immunity does not require everyone is vaccinated. The greater the contagion, the greater the percentage of people needed to have immunity. It is possible that some areas, and even states, may fall shy of the coverage that doctors and scientists say is required to achieve herd immunity. In the US, the vaccines are still regarded as for emergency purposes only, making it difficult for public authorities to force the issue. Making the vaccines not just for emergencies could make it easier to impose greater social ostracization on those who refuse a vaccine. While the modern libertarian spirit may be the force behind attempts to decentralize finance, the public health crisis seems to push in the opposite direction.

We have anticipated that the divergence meme morphs into its opposite, namely convergence. However, another divergence is opening and one in which the US is the laggard. The Federal Reserve’s leadership says it too soon to even talk about talking about adjusting the open spigot of monetary policy by slowing the pace of bond purchases from the current $120 bln a month pace. Canada has also begun the process of tapering. Last week, Norway’s central bank reaffirmed its intention to raise rates before the end of this year. The Bank of England said it would slow its weekly bond purchases and look to complete them this year.

There will be a vigorous debate next month at the ECB about the pace of its bond purchases. Several of the more hawkish members apparently want to slow from the stepped-up pace agreed to in March. New staff forecasts at the meeting will likely revise up their growth forecasts and take into account the spillover of the significant US fiscal stimulus. The Reserve Bank of Australia may also be in line ahead of the US to adjust its policies. In July, it will decide whether to extend its yield-curve control to the November 2024 bond and about a new bond-buying program.

With the strong fiscal support, the pent-up demand, the vaccine, the re-opening, the Fed’s stance seems to stretch credulity. While April’s employment data were terribly disappointing, and the 146k downward revision in March’s estimate shows recovery in the labor market is not a powerful as it had appeared. Cleaning the weekly initial jobless claims from fraudulent filings may have exaggerated the decline in filings, but it also exaggerated the increase. Weekly initial jobless claims fell below 500k at the end of April for the first time since March 2020. The four-week was 866k at the end of January.

Unlike the downside of a business cycle, the problem might not be on the demand side of the labor market but the supply side. Without schools and daycare fully open, many who might be taking new positions or returning to old positions cannot. Others may still be reluctant due to the virus and availability and confidence in public transportation. Like the Chamber of Commerce, some called for the end of the federal government’s $300 weekly supplement unemployment compensation to address what anecdotal reports suggest is a labor shortage.

After the Great Financial Crisis, it took five years for the unemployment rate to fall below 6%. It stood at 6.1% last month after falling to 6% in March. It has more than halved from last year’s peak. After the Great Financial Crisis, it took six years from the peak in unemployment to be reduced by half. The underemployment rate fell to 10.4% from 10.7% in March. In the GFC, it peaked in 2009 and was not under 10% until late 2015.

The April retail sales and industrial production reports will shed light on the meaning of the disappointing employment data. Does it signal a slowing of the US economy? Did the fiscal buzz wear off, as some are suggesting? The strong, strong auto sales hint at a healthy retail sales report, but the employment data seemed to have spooked some economists who reduced their forecasts. March’s record US trade deficit showed businesses anticipating strong consumer demand. Manufacturing employment fell by 18k instead of rising by 54k as the median forecast in Bloomberg’s survey had it, and some revised down their forecasts for manufacturing output/industrial production.

The other target is inflation. Next week the April CPI and PPI will be released. Whether price pressures prove temporary, reasonable people may differ, but what seems to be clear is that threat of deflation has all but disappeared. The year-over-year CPI rate stood at 2.6% in March and is expected to have jumped to 3.6% in April. This is partly the base effect, as the last April’s decline drops out of the 12-month comparison.

The average monthly increase of CPI in Q1 was a little more than 0.4%. This is picking up the impact of the supply chain issues and shortages. The median forecast in Bloomberg’s survey was for a 0.2% increase in April. Over the last 10 years (120 months), US CPI has averaged a 1.7% increase and 2.3% over the past 30 years (360 months). The similar core rate averages are 1.9% and 2.3%. The averages capture the broad trend of lessening price pressures and how closely they track each other on a medium and long-term basis.

Producer prices jumped 1% in March for a 4.2% year-over-year rate. Bloomberg’s survey’s median forecast is for the monthly rate to slow to 0.2%, but the year-over-year rate to accelerate to 5.8%. A little more than a third of the year-over-year increase stems from food and energy, which, if stripped out, should around a 3.7% year-over-year pace in April. This means that the cost of inputs, including packaging and transportation costs, are rising. As a result, one of three things, or more frequently it seems, a combination takes place, costs passed on to the consumer, narrow profit margins are accepted, perhaps to maintain market share or productivity increases.

The point, again, is that the threat of deflation has been exorcised. The first debate is not about removing monetary stimulus. It is about slowing the amount of new accommodation by reducing the bond purchases. In Japan, quantitative easing via Rinban operations before the Great Financial Crisis was the norm, but in the US, the purchase of long-term assets is about triage, but now the patient has had a large fiscal and medical vaccine, and some extra monetary vitamins, and is beginning to run. Therapy is still needed, but triage, less so.

While the Fed’s leadership is reluctant to signal that it may begin considering reducing the pace of its bond purchases, the Treasury will auction $126 bln of coupons in next week’s quarterly refunding. The primary dealer system obligates the necessary buying. However, the auctions can be sloppy–low bid cover, a large tail, an immediate post-auction decline in yield, as we have experienced with the sale of the seven-year note earlier this year.

Given the size of the budget and current account deficits, the US has to offer a combination of higher interest rates or a weaker dollar. The Federal Reserve is blocking the former and is willing to accept the latter. Among the high-income countries, the US 10-year note has performed best over the past month. The yield has fallen by almost 10 bp, while European yields have risen 10-27 bp.

In addition to the signals from the 10-year, look at what has happened to the December 2022 Eurodollar futures contract. The implied yield trended higher in Q1 and peaked in early April around 53 bp (cash is around 16 bp), almost 35 bp higher than it had begun the year. The dollar generally trended higher in Q1. Since early April, the yield has trended lower and took another big step down after the employment disappointment. The implied yield traded near 37 bp before the weekend, essentially unwinding this year’s increase. The dollar has been tracking the yield lower.

Tapering is not tightening, but the market knows, and the Fed knows that the market knows that tapering is the first step toward tightening. The Fed may not want to signal tapering because it does not want markets to run with it and tighten financial conditions prematurely. Fed officials appreciate arguably, if not better than Wall Street, that there is no free lunch; there are trade-offs. The disequilibrium will be addressed by either higher interest rates or a lower dollar, or a combination.

This article was written by Marc Chandler, MarctoMarket.

For a look at all of today’s economic events, check out our economic calendar.

Israel and South Korea to Sign Free Trade Pact

The deal is meant to bolster bilateral trade by cutting out customs duties and offering safety nets on investments. Bilateral trade reached about $2.4 billion in 2020, about two thirds of it goods and services imported into Israel, the ministry said.

The deal will be signed this week in Seoul during a visit by Israel’s foreign affairs and economy ministers.

More than 95% of Israeli exports to South Korea will be customs-free, the ministry said. Israel is working on similar deals with China, Vietnam and India, it added.

(Reporting by Ari Rabinovitch; Editing by Andrew Cawthorne)

Gold Price During Hyperinflation

Let’s start by defining hyperinflation…

“Hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.” (source)

In addition, hyperinflation is described as “an extreme case of monetary devaluation that is so rapid and out of control that the normal concepts of value and prices are meaningless.”

The latter description is much more characteristic of the potential threat that most people envision when they invoke the term hyperinflation.

Before answering that, let’s look at what happened to the prices of bread and fuel.

The lady pictured above is stuffing German marks into her wood burning stove. Such action was cheaper since the paper currency would burn longer than the amount of firewood they could afford to buy with the worthless ‘money’.


During a period of stabilization for approximately six months during 1920, 1400 German marks was equal to 1 oz. gold. Three years earlier the ratio was 100 marks to 1 oz. gold.

However, a fourteen-fold increase in the ratio of marks to gold was nothing compared to what was about to happen.

“By July 1922, the German Mark fell to 300 marks for $1; in November it was at 9,000 to $1; by January 1923 it was at 49,000 to $1; by July 1923, it was at 1,100,000 to $1. It reached 2.5 trillion marks to $1 in mid-November 1923, varying from city to city.” (source)

Using the ratio of 1 trillion marks to the US dollar in July 1923, the equivalent price for one ounce of gold was 20 TRILLION German marks!


Germany (Weimar Republic) had rejected gold convertibility and abandoned the gold standard prior to the end of World War I. Since their obligations to pay reparations resulting from their activities during the war required them to remit funds in hard currencies, they continued to ramp up the presses.

Any plans to borrow money had been abandoned earlier. They printed whatever marks were needed in order to buy other currencies which they could use to pay their obligations, and hopefully chase away the inflationary effects of their efforts.

Here is another example of how those effects translated in real life…

“A student at Freiburg University ordered a cup of coffee at a cafe. The price on the menu was 5,000 Marks. He had two cups. When the bill came, it was for 14,000 Marks. “If you want to save money,” he was told, “and you want two cups of coffee, you should order them both at the same time.”

If we use a price of 5 cents per cup of coffee in US dollars, then the ratio at that time was 140,000 marks to $1. Even though the worst was yet to come, this still represents a 27,900 percent increase in the price of a cup of coffee from five years earlier.

At one point in 1923, the price for one loaf of bread was more than 200 billion marks.


Some (not just a few) people today think that the higher the gold price goes, the richer they will be. That is not the case.

One ounce of gold in 1920 was the equivalent 1400 German marks. Three years later, that same ounce of gold was priced at the equivalent of 20,000,000,000,000 German marks.

If you were prescient enough to secure to yourself one ounce of gold before the fun started, you could have become a multi-trillionaire almost overnight. Great!

Now, how will you spend your money? Better get something to eat first before tackling a plan for your finances. You could buy a loaf of bread for two hundred billion marks and a cup of coffee for fifty billion marks.

If you buy the loaf directly from the baker, you might score a free cup of coffee. Nobody even knows what price to charge for a cup of coffee anyway, and the baker desperately needs to sell that bread. He is only inclined to make that offer if he is paid in gold, though.

You decide to buy five loaves since you don’t know how much bread will cost next week. You give the baker 1/20th oz of gold which is the equivalent of one trillion marks ( 5 loaves x 200 billion marks = 1 trillion marks). You and your friends enjoy drinking the five free cups of coffee and you break bread with them.

You are not as jovial as you were before your purchase, though. You know that you are not as rich, either. Doing some quick math, you realize that if you spend 1/20th oz gold every day, you will be a pauper again in three weeks.

What you could buy with your gold after its price went up did not make you rich. The value of your gold is the same as it was three years earlier. The price for the bread and coffee is the same as it was just a few years earlier: 1/20th oz of gold.


If you own gold and are betting on a much higher gold price because you expect hyperinflation anytime soon, don’t expect to be any richer than you are now. The higher price for gold will only compensate you for the loss in purchasing power of the US dollar

(also see Gold’s Singular Role)

Kelsey Williams is the author of two books: Gold’s Singular Role  and  Gold’s Singular Role

Inflation Knock-knock-knockin’ On Golden Door

“Knock, knock, knockin’ on heaven’s door”, so sing Bob Dylan and Guns N’ Roses. Now, inflation is knocking on the golden door. According to the BLS , the U.S. CPI inflation rate recorded a monthly jump of 0.6% in March, while soaring 2.6% on an annual basis. And the core inflation has also accelerated. So, inflation has significantly surpassed the Fed’s target of 2% , as one can see in the chart below.

And remember that this is what the official data shows, which rather underestimates the true inflation. This is because of several issues, including hedonic quality adjustments, shifts in the composition of the consumer baskets and methodological changes. It is enough to say that the rate of inflation calculated by the John Williams’ Shadow Government Statistics that uses methodology from the 1980s is over 10% right now.

There are some controversies about this alternate data, but I would like to focus on something else. The CPI doesn’t include houses (or other assets) into the consumer baskets, as they are treated as investments. The index only takes rents into account. But homeowners don’t pay rents, so for them, the cost of shelter, which accounts for about one-fourth of the overall CPI, is the implicit rent that owner-occupants would have to pay if they were renting their homes. And this component rose just 2 percent in March, while the Case-Shiller Home Price Index, which measures the actual house prices, soared more than 11% in January (the latest available data). According to Wolf Street , if we had replaced the owners’ equivalent rent of primary residence with the Case-Shiller Index, the CPI would have jumped 5.1 instead of 2.6%. The chart below shows the difference between these two measures.

Hence, inflation has come, and even the official data – which can underestimate the level of inflation that ordinary people deal with in their daily lives – confirms this. If you’ve been buying food lately, you know what I mean. Now, the question is whether this inflation will be temporary or more lasting.

Powell , his colleagues and the pundits claim that higher inflation will only be a temporary phenomenon caused by the base effect. The story goes like this: the CPI plunged in March 2020, which created a lower base for today’s annual inflation rate. There is, of course, a grain of truth here. But let’s take a look at the chart below. It shows the CPI, with both March 2020 (red line) and February 2020 (green line) as a base. As you can see, in the latter case the index jumped 2.3%. Yes, lower, but not significantly lower than 2.6% when compared to March 2020. So, the Fed shouldn’t blame the base effects for accelerating inflation (and funny thing: have you heard the pundits talking about the base effect when they were talking about vigorous GDP recovery?).

Instead, central bankers should blame themselves and their insane monetary policy . After all, as the chart below shows, the Fed’s balance sheet has soared $3.4 trillion (or 81%), while the broad money supply (measured by M2) has increased more than $4 trillion (or 26%) from February to date.

They could also blame reckless fiscal policy . Growing government spending, enabled by a rising pile of debts monetized indirectly by the Fed, has headed for Main Street. This, combined with a jump in the broad money supply, is the key change compared to the Great Recession when almost all stimuli flowed into Wall Street and big corporations. Sure, some people use the received money to increase savings and repay debts. But with the reopening economy, some of the pent-up demand will be realized. Actually, many Americans have already started spending free time traveling like crazy after being locked in homes for so long.

And this is very important: consumers are therefore more eager to accept higher prices. It shouldn’t be surprising given all the checks they got and how hungry for normal life they are. As I reported last month , companies are reporting rising prices of commodities and inputs (partially because of the supply disruptions too), but so far their power to pass the producer price inflation to consumers has been limited. However, this is changing . The April report IHS Markit U.S. Services PMI observes that

Rates of input cost and output charge inflation reached fresh record peaks, as firms sought to pass on steep rises in input prices to clients (…) A number of companies also stated that stronger client demand allowed a greater proportion of the hike in costs to be passed through. The resulting rate of charge inflation was the quickest on record.

All these reasons suggest that higher inflation could be more lasting than most of the so-called experts believe (although the officially reported inflation doesn’t have to show it). This is good news for the yellow metal . Higher inflation implies lower real interest rates and stronger demand for gold as an inflation hedge . What is important here is that we have more inflationary pressure in the pipeline exactly at the time when the Fed has become more tolerant of inflation. So, the combination of higher inflation with a passive central bank position sounds bullish for gold . The key issue here is whether the markets believe that the Fed will allow for higher inflation. So far, they have been skeptical, so the expectations of interest rates hikes accumulated and the bond yields rallied. But it seems that the Fed has managed to convince the markets that it’s even more incompetent than it is widely believed. If the distrust in the Fed strengthens, gold should return to its upward trajectory from the last year.

Thank you for reading today’s free analysis. We hope you enjoyed it. If so, we would like to invite you to sign up for our free gold newsletter . Once you sign up, you’ll also get 7-day no-obligation trial of all our premium gold services, including our Gold & Silver Trading Alerts. Sign up today!

For a look at all of today’s economic events, check out our economic calendar.

Arkadiusz Sieron, PhD
Sunshine Profits: Effective Investment through Diligence & Care.


U.S. Service Sector Slows Modestly in April: ISM Survey

The Institute for Supply Management (ISM) said on Wednesday its non-manufacturing activity index fell to a reading of 62.7 last month from 63.7 in March, which was the highest on record.

A reading above 50 indicates growth in the services sector, which accounts for more than two-thirds of U.S. economic activity. Economists polled by Reuters had forecast the index rising to 64.3 in April.

The findings mirrored the ISM’s manufacturing survey published on Monday showing bottlenecks in the supply chain constraining factory activity in April. The economy is experiencing a boom in demand, thanks to the White House’s massive $1.9 trillion pandemic relief package and the expansion of the COVID-19 vaccination program to all adult Americans.

Federal Reserve Chair Jerome Powell said last week the U.S. central bank expected the bottlenecks would be resolved as workers and businesses adapted, adding “we think of them as not calling for a change in monetary policy.” The Fed has slashed its benchmark interest rate to near zero and is pumping money into the economy through bond purchases.

Inventories at businesses were drawn down in the first quarter as consumer spending soared. The economy grew at a 6.4% annualized rate in the January-March quarter after expanding at a 4.3% pace in the fourth quarter.

Most economists expect double-digit GDP growth this quarter, which would position the economy for growth of at least 7%, which would be the fastest since 1984. The economy contracted 3.5% in 2020, its worst performance in 74 years.

Demand for services could surge in the coming months as vaccinated Americans go on vacations and visit theaters, among other activities. Many states, including New York, New Jersey and Connecticut are lifting most of their coronavirus capacity restrictions on businesses.

The ISM survey’s measure of new orders for the services industry dropped to 63.2 in April from an all-time high of 67.2 in March. Backlogs of uncompleted work increased strongly, underscoring the impact of the supply constraints.

Inventories contracted and businesses boosted imports. They continued to pay more for inputs. The survey’s measure of prices paid by services industries rose to 76.8, the highest reading since July 2008, from 74.0 in March.

Its measure of services industry employment rose to 58.8 from 57.2 in March. That strengthens expectations for another month of blockbuster job growth in April. According to a Reuters survey of economists, nonfarm payrolls likely increased by 978,000 jobs last month after rising by 916,000 in March.

The Labor Department will publish April’s employment report on Friday.

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama)

Wall Street Worries About Interest Rates – What Does It Mean for SP500?

Fundamental Analysis

Treasury Secretary Janet Yellen taking a somewhat opposing stance to Fed Chair Jerome Powell. In case you missed the headline, Yellen is saying we might need a modest rise in interest rates to blunt some of the government spendings we are seeing hit the street.

Later in the day, Dallas Fed President Robert Kaplan reiterated the need for the Fed to begin a conversation about scaling back its bond-buying in an interview with MarketWatch. Kaplan says that’s largely because he has greater confidence in the economy than he had a few months ago, but noted a “fog” around labor market participation rates that will take a while to clear.

Kaplan also noted that the Fed could remain “highly accommodative” without keeping rates pegged at zero. According to his assessment of the economy, Kaplan anticipates the Fed raising rates sometime in 2022, which is ahead of the timeline forecast by most Fed officials who don’t see the benchmark being lifted until 2023.

The moral of the story, talk that the economy could “overheat” and push interest rates higher seems to be a bit more worrisome now on Wall Street. I don’t think this anything most of us didn’t see coming, but the question of how the Fed reduces liquidity and tapers is still the big question?

If the Fed can nail the dismount then no harm no foul, but if you believe the market is currently “priced to perfection” then there is absolutely no room for Fed error.

Some of the bigger and more experienced investors won’t even like the thought of being this high up if the Fed is going to start unwinding.

A growing number of Wall Street traders expect the Fed’s June 15-16 policy meeting could begin outlining plans for such moves.

Economic data

Investors today are anxious to see ADP’s Employment Report for April which is expected to show around +850,000 jobs added. ADP’s numbers can vary widely from the official Labor Department numbers, which are due out on Friday and expected to show close to +1 million jobs were added during April.

The ISM Services Index for April is also due today. The gauge hit a new pandemic high as well as an all-time record high in March.

Wall Street will be paying particular attention to the employment and price components, which rose to pandemic highs last month as well.

Services activity accounts for about 75% of U.S. GDP so what’s happening in the sector has broad implications for the overall economy. Earnings will likely be the main focus today with several big names reporting, including Allstate, Barrick Gold, Cerner, Etsy, General Motors, GoDaddy, Hilton Worldwide, HubSpot, MetLife, Paypal, Redfin, Rocket Companies, Scotts MiracleGro, Twilio, Uber, Volkswagen. And Wynn Resorts.

SP500 technical analysis

Yesterday’s breakout levels played very well. For today, the neutral zone is 4131 – 4195.5. Middle-strength level within this zone – 4163.25, weak levels – 4179.25, 4147.

In case of a bullish breakout above 4195.5, look for weak level 4211.5 and middle-strength level – 4228. A bearish breakout below 4131 will target for 4115 – weak level and in extension 4098 – middle-strength level. Based on the intraday cycles, there are more chances for trading within the neutral zone today.

Important Note! For qualified breakout entry breakout level should turn into support/resistance. Don’t enter the trades without this price action confirmation.

For a look at all of today’s economic events, check out our economic calendar.

Italy’s Debt: ECB Creates Room for Budget Expansion but Fiscal Space Still has Limits – Interview

An interview with Giacomo Barisone, head of sovereign and public sector ratings at Scope Ratings, about Italy’s sovereign debt dynamics.

Italy (rated BBB+/Negative Outlook by Scope) needs the public investment and structural economic reforms proposed by Draghi to increase near- and long-term growth, but the part financed by national resources comes at cost of wider budget deficits. Can Italy easily take on this new debt?

According to the government’s current debt projections, public debt increases to around 160% of GDP this year from 156% in 2020 before declining, under a constructive scenario to 135.5% of GDP by 2032, near the 134.6% level of 2019. We consider this government scenario optimistic – and instead expect Italy’s debt ratio to remain on a structurally increasing trajectory longer term.

However, the goalposts for interpreting public debt sustainability are shifting. A general government debt ratio of 160% or 180% of GDP in the euro area does mean something different today from what it might have 10 years ago. In 2010, such a debt ratio would surely have resulted in lost market confidence and materially exacerbated Italy’s debt crisis. What has changed are the actions of the European Central Bank, anchoring ultra-low sovereign borrowing rates today, and doing so with scale and flexibility.

Has this monetary-policy shift benefitted countries such as Italy especially?

Yes, it has – the innovation during this crisis has been the flexibility of ECB purchases across jurisdictions, time and asset classes. The central bank has stabilised especially financing conditions of member states with greater propensity for market stress such as Italy by not strictly purchasing assets proportionally to a country’s population & economic size during this crisis. In the process, nearly 30% of Italian general government debt has shifted to the joint Eurosystem balance sheet. As sovereign ratings are assigned on debt due to be paid to the private sector, shifting debt to the official sector balance sheet is credit positive, curtailing the outstanding segment of rated debt owned by the private sector.

The ECB programmes have also given an extended window of opportunity for Italy as well as other sovereign borrowers to improve their debt profile. In addition to changes in the ownership of Italy’s sovereign debt, the weighted average interest cost of outstanding debt has declined to 2% this year from 4% in 2012. We anticipate further declines with Italy refinancing its maturing debt at 10-year BTP rates of (only) 0.9%. The average life of Italian debt has also increased to seven years due to the actions of the Italian Treasury, taking advantage of the flatter yield curve. This supports greater resilience against a higher stock of debt.

So, given ECB support and still favourable rates conditions, how much fiscal space does Italy have?

Even with greater tolerance for increased debt given ECB intervention, Italy’s fiscal space in 2021 still has bounds. True, it is the accommodative monetary policy that is creating fiscal space, and the ECB – as a credible, reserve-currency central bank – does have flexibility with its balance sheet to create further fiscal space for euro area member countries. Yet the ECB’s room for manoeuvre is not without its own checks and balances. The central bank has an inflation mandate, and overly assertive action could result in higher inflation. The central bank’s actions also exacerbate pre-existing financial-system imbalances and could bring more substantive depreciation of the euro especially after this crisis if such balance-sheet expansion were pursued asymmetrically rather than in aggregate during crisis across all major central banks.

Such depreciation would undermine the euro’s growing global reserve-currency status. As the ECB plans exit strategies from the crisis – scaling back pandemic programmes – it is unclear how conventional QE via the Public Sector Purchase Programme, with associated issuer and issue limits, may constrain monetary space after the crisis, or whether such self-imposed QE limits may be further adjusted. There are also legal constraints on the ECB – and thus on the sovereigns relying on the ECB to extend fiscal space.

As Italy does not have an independent monetary policy, any Italy-specific crisis, such as one akin to the 2018 crisis, may not necessarily result in the same scale of ECB intervention as we are currently seeing when all euro area countries face an aggregate shock.

How does Scope weigh up the need for Draghi to kick start the economy with these concerns?

The 25pp increase in Italy’s debt-to-GDP ratio since the start of the crisis is a key credit concern. At the same time, there is no public debt level that by itself implies a lowering in the rating from the current BBB+ investment-grade assignment. Changes in ECB policy and progress toward closer European fiscal union, via ECB policies as well as via forthcoming EU joint-debt issuance, have offset to an extent pressure on the ratings. Nevertheless, Italy’s fiscal space has limits and a higher debt stock increases the sovereign’s vulnerabilities after this crisis is over under conditions of any market reappraisal of sovereign risk or withdrawal of monetary accommodation in the future. The Draghi government should keep fiscal sustainability in mind even as it rightly makes growth-enhancing policies the main priority.

Despite the ECB and EU support, what are the longer-term risks to Italy’s ratings?

Risks to Italy’s longer-term credit outlook are several. They include: (i) lower long-run output due to prolongation of lockdowns and permanent structural damage to economic potential stemming from Covid-19 impairment; (ii) implementation risks surrounding recovery funds and pro-growth structural reform, in recognising Italy’s record of low absorption rates of EU funds and recurrent changes in government interrupting reform momentum; and (iii) the risk of crystallisation of high contingent liabilities on the country’s balance sheet from stress in the private sector.

Italy has sharply increased public guarantee schemes amounting to 13% of GDP, which have been extended until end-2021. If the private sector were to require further extraordinary support in the form of bailout monies, this could push up public debt beyond existing expectations, which could result in downward pressure on ratings.

For a look at all of today’s economic events, check out our economic calendar.

Giacomo Barisone is Managing Director of Sovereign and Public Sector ratings at Scope Ratings GmbH. Dennis Shen, Director at Scope, contributed to writing this interview.

India Central Bank Gives Small Borrowers Debt Relief as COVID-19 Cases Spike

By Swati Bhat and Nupur Anand

The moratorium will be available to individuals and small and medium enterprises that did not restructure their loans in 2020 and were classified as standard accounts till March 2021, Reserve Bank of India Governor Shaktikanta Das said in a virtual address.

“Small businesses and financial entities at the grassroot level are bearing the biggest brunt of the second wave of infections,” Das said, as he announced several measures to enhance liquidity and boost lending to various needy sectors.

The fresh round of moratoriums will be applicable for borrowers with a maximum total exposure of 250 million rupees ($3.39 million), Das said.

During the last financial year, the RBI had introduced a one-time restructuring plan for small borrowers and corporates allowing banks to extend the repayment period for up to two years.

Businesses in India have been hit hard by the new round of lockdowns over the past month to curb the spread of the virus just as many were inching back to normalcy from the nationwide lockdown last year.

The RBI also announced a special on-tap liquidity window of up to 500 billion rupees for banks to lend to the health care sector with tenors up to three years at the repo rate and will be available until March 31, 2022.

The central bank said banks will need to maintain a COVID loan book under the scheme and will also get a 40 basis point higher return over the reverse repo rate on surplus funds parked with the central bank, to the extent of disbursed loans.

In order to incentivise banks, RBI has allowed lenders to classify these as priority sector loans (PSL) which provide additional benefits.

India recorded 382,315 new infections over the last 24 hours to reach a total of 20.67 million, while deaths rose by a record 3,780 to 226,188, health ministry data showed. Experts say actual numbers could be five to 10 times higher.

Among other measures, the RBI announced a special 3-year long-term repo operation of 100 billion rupees for small finance banks (SFB), saying lending by SFBs to microfinance institutions can be classified as priority sector and also allowed banks to maintain lower reserves for advances made to small borrowers.

“The smaller entities like micro finance institutions also benefit from the current package, which will bring some relief to them too which is one of the worst affected sectors as of now,” said Joseph Thomas, head of research at Emkay Wealth Management.

The RBI also relaxed overdraft guidelines for state governments and said banks can utilise their countercyclical provisioning buffers held by them as of Dec. 31, 2020 to make provisions for non-performing assets with prior board approval.

Last year, the central bank declared a moratorium for a total of six months for all borrowers.

($1 = 73.8 Indian rupees)

(Additional reporting by Abhirup Roy; Editing by Jacqueline Wong)

U.S. Manufacturing Sector Slows in April amid Supply Challenges

By Lucia Mutikani

The Institute for Supply Management (ISM) said on Monday its index of national factory activity fell to a reading of 60.7 last month after surging to 64.7 in March, which was the highest level since December 1983.

A reading above 50 indicates expansion in manufacturing, which accounts for 11.9% of the U.S. economy. Economists polled by Reuters had forecast the index edging up to 65 in April.

The White House’s massive $1.9 trillion pandemic relief package and the expansion of the COVID-19 vaccination program to all adult Americans has led to a boom in demand. But the pent-up demand is pushing against supply constraints as the pandemic, now in its second year, has disrupted labor supply, leading to shortages that are boosting prices of inputs.

That has been most evident in the automobile industry, where a global semiconductor chip shortage has forced cuts in production. Ford Motor Co said last week the scarcity of chips slashed production in half in its second quarter.

Technology companies are also feeling the heat. Apple warned last week that the chip shortage could dent iPads and Mac sales by several billion dollars.

Demand for goods like motor vehicles and electronics has surged during the pandemic as Americans shunned public transportation and millions worked from home and took classes remotely. Robust consumer spending helped to lift gross domestic product growth at a 6.4% annualized rate in the first quarter.

Most economists expect double-digit GDP growth this quarter, which would position the economy to achieve growth of at least 7%, which would be the fastest since 1984. The economy contracted 3.5% in 2020, its worst performance in 74 years.

The ISM survey’s measure of prices paid by manufacturers rose last month to the highest reading since July 2008.

The survey’s forward-looking new orders sub-index dropped to 64.3 after racing to 68.0 in March, which was the highest reading since January 2004.

Backlogs of uncompleted work increased last month as did export orders. Manufacturers started drawing down on inventories last month to meet demand. Business warehouses are almost bare, which should keep manufacturers busy and scrambling for resources for a while.

The survey’s manufacturing employment gauge fell to 55.1 after shooting up to 59.6 in March, which was the highest reading since February 2018. The index was well below the 61.5 forecast in a poll of economists, with the slowdown in hiring probably due to a scarcity of workers. Companies across many industries are struggling to find workers, even as employment is 8.4 million jobs below its peak in February 2020.

Federal Reserve Chair Jerome Powell last week acknowledged the worker shortage saying “one big factor would be schools aren’t open yet, so there’s still people who are at home taking care of their children, and would like to be back in the workforce, but can’t be yet.”

The worker shortage could hurt expectations for another month of blockbuster job growth in April. According to an early Reuters survey of economists, nonfarm payrolls likely increased by 950,000 jobs last month after rising by 916,000 in March.

The government is due to publish April’s employment report on Friday.

(Reporting By Lucia Mutikani; Editing by Chizu Nomiyama)

ECB Can Start Phasing Out Emergency Stimulus when Vaccinations Pick Up – de Guindos

The ECB will next meet on June 10 and conservative policymakers are already calling for a cut in bond purchases, while others, particularly from the bloc’s south, are arguing for continued patience in clawing back support.

“If by speeding up the vaccination campaign, we manage to have vaccinated 70% of Europe’s adult population by the summer and the economy starts to pick up speed, we may also start to think about phasing out the emergency mode on the monetary policy side,” de Guindos told la Repubblica.

“The normalisation of monetary policy should go hand in hand with the normalisation of the economy,” he said in the newspaper interview.

Less than 30% of the bloc’s population have received their first COVID-19 jabs so far. Experts say that getting 70% of people fully vaccinated is unlikely before the end of July, with the end of August seen as a more realistic deadline.

But de Guindos also cautioned against keeping central bank stimulus lingering too long, warning the side effects could be as damaging as removing support too early.

“Prolonging emergency measures for too long may run the risk of moral hazard as well as the zombification of parts of the European economy,” he said.

Much of Europe’s services sector is now kept afloat by government subsidies and de Guindos called on governments to remove that support only gradually, even if it places a burden on budgets and pushes debt levels even higher.

“It will be crucial that these measures are withdrawn gradually and with a great deal of prudence after the crisis. Otherwise we run the risk of choking the recovery,” he said.

(Reporting by Balazs Koranyi; Editing by Peter Cooney)

MMT: Medieval Monetary Theory

We’ve certainly not heard much about it in mainstream economics or investment publications. But I do think it’s gaining traction.

In my view, MMT is a very big deal because of its massive implications to our economic future. And so, I think it’s worthwhile having at least a basic understanding of the concept.

In fact, if you’re reading this, odds are good you’ve at least heard of MMT and you may have some idea of what it’s about. If that’s the case, you probably understand better than most the importance of investing in hard assets that can’t be inflated at the whim of central planners.

And right now, the two most undervalued hard assets remain gold and silver.

Roots of MMT

Some say, and I agree, we don’t live in a true free-market society. In many ways, that’s been especially so since the U.S. central bank, the Federal Reserve, was established in 1913. I could certainly go into a whole long discussion about the Fed and its roles and mandates, but that’s a topic worthy of its own essay.

MMT was first introduced by American economist Warren Mosler in the early 1990s. It has gained a lot of traction in recent years, championed in particular by Stephanie Kelton, economics professor at SUNY Stony Brook. Kelton authored the book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. Kelton was also an advisor to Bernie Sanders’s 2016 presidential campaign, and a former Chief Economist on the U.S. Senate Budget Committee (Democratic Staff).

For the purposes of understanding MMT, suffice it to say that because the Fed sets interest rates, we don’t have a free market in one of the most basic and pervasive aspects of our lives: money. Actually, a better word is currency, because money is supposed to have intrinsic value. And today’s fiat dollars only have value because central banks issue them and government decrees say we have to accept them.

So, if interest rates are set by a central authority, the central bank, then the market for currency is not free, as they are deciding at what rates currency is to be loaned out.

Interest rates are essentially the “price” to borrow money or currency. In a free market, that price should be set between the lender and the borrower. In fact, rates set by central banks are used as the barometer for banks and businesses to establish contracts and make economic projections. So, you can see how this makes its way through the economy and skews nearly every aspect of our lives. That’s why I feel that we don’t live in a free market, and haven’t for a long time. Anyways, back to MMT.

MMT is the idea that federal spending is not limited by revenues: printing money is a tool to be used to help a country deal with its economic issues, and that it will not automatically trigger inflation or currency devaluation. Proponents believe governments who print and spend their own currency should not be limited in their spending to avoid deficits and a growing debt. They say deficits and debt don’t matter unless they begin generating inflation.

Not the Real World

It needs to be pointed out here that this is a departure from the way the rest of the world works. A company or an individual cannot operate on that basis. Firstly, they don’t print their own money and so they don’t have that luxury. They also cannot borrow to infinity because at some point creditors will force them into bankruptcy.

That exact scenario can’t happen with a country, because MMT says it can just keep printing its currency to pay for spending and to pay interest on debts. But in fact, it’s a vicious circle in which the public eventually loses confidence.

If you look back throughout history, fiat currencies have all failed eventually, with the typical “world reserve currency” lasting about 100 years on average.

Looking at the above chart, and if history repeats or at least rhymes, then the current reserve currency, the US fiat dollar, has already overstayed its welcome.

We don’t need to look too far to see concrete examples of this. In the late 1990s to mid-2000s, Zimbabwe printed endless Zimbabwean dollars to pay its bills. Eventually, they ended up with 100 trillion-dollar banknotes. Their currency became so worthless, no one wanted it. Something similar has been happening in Venezuela, which is dealing with hyperinflation to the tune of over 10,000% per year thanks to a badly mismanaged economy rife with price controls. Nearly 80% of Venezuelans can’t afford basic food, while 95% of households live in poverty.

It won’t surprise you to know that MMT says that a nation’s currency has value because the state has issued it, and because only that currency is accepted to pay taxes. That makes earning the currency of that nation necessary to pay those taxes. In effect, the currency has value because of government decree, and not because the free market has accepted it as having value.

Proponents of MMT see the treasury and central bank as one. They argue the central bank is there to print whatever the government needs, while the treasury’s role is to collect taxes and allocate funds to various departments which spend it according to their budgets. Anything needed beyond what’s collected in taxes is simply printed into existence to make up the shortfall.

One thing to keep in mind is that central banks only control short-term rates. For the most part, long-term rates are determined by the market. And that’s where inflation fears will often show up first. That’s likely what we’ve been witnessing over the last several months in U.S. long-term Treasuries, whose yields have risen dramatically. In effect, the market is saying those bonds are now worthless, which pushes up their yields, as it senses higher inflation on the horizon.

MMT advocates say even if people lose confidence in their currency, they can’t simply abandon it as they need it to pay their taxes. But if the government can print all it needs, why even bother to collect taxes? MMT thinking says that if inflation shows up, the government can then increase taxes to cool things off, making them a necessary part of the equation.

Though these days central banks have certainly lost a lot of the public’s confidence, the little that remains is partly from the “perceived” independence they have from the central government. MMT would do away with that, and markets would likely quickly lose confidence in the central bank. As a result, inflation expectations would probably soar, and interest rates would follow.

A good example of this is what just happened in Turkey. President Erdogan replaced the central bank governor two days after he hiked interest rates to curb inflation (running at 16%) and the weakening currency. Erdogan has been repeatedly calling for lower interest rates. After replacing the central bank governor, the lira plunged to record lows. Simply put, the market lost confidence… quickly.

MMT supporters also say the bond market is not required to finance the government’s budget. But government bond markets are so big, the interest rates on those bonds provide market signals as to whether money growth is too fast or too slow, and whether inflation is too high or too low. As well, the interest rates on those bonds help set interest rates for business loans and mortgages. So, in today’s markets, they certainly serve several functions.

Gold and Silver: Enemies of MMT

There’s another consideration too. Gresham’s Law tells us that bad money drives out good. Some of you may remember or at least know that, prior to 1965, quarters and dimes in the U.S. contained 90% silver. The treasury did away with those because silver had become too valuable. Naturally, those coins disappeared from circulation as people hoarded, keeping them for their silver content.

While there’s no silver in our currency today, that doesn’t mean people aren’t aware that dollars are being rapidly debased. We only need to look at record high real estate prices, stock markets, and cryptocurrencies to see that people are anxious to trade dollars for assets that have value they feel can protect them from inflation.

And it’s why we’ve seen commodities, gold, and silver rise dramatically in the past year. It’s also why we’ve seen shortages, delivery delays, and huge premiums on coins and bullion bars at precious metals dealers. People are catching on, and they are trading their fiat currency for things of inherent value.

The way I see it, MMT is going to be popular with future governments as they come to see the potential of limitless spending on all their favorite pet projects. The masses, despite little understanding, will come to accept MMT as a great new economic paradigm that will allow them to get all the “goodies” that governments will be happy to provide, in return for votes.

In the end, it’s important for you to know MMT will only exacerbate and accelerate the overspending problems we have today. So now that you hopefully understand MMT a bit better, and how it’s supposed to work, you can see it with a more critical eye.

I call it Medieval Monetary Theory because there’s nothing new about it. Currencies have been massively debased for millennia; each time leading to detrimental outcomes.

In the Gold Resource Investor newsletter, I provide my outlook on which resource stocks offer the best prospects as this bull market progresses. I recently added a low-risk, deep value gold royalty company to the portfolio which I believe has exceptional potential to outperform its peers in the next 12 months.

Now’s the time to prepare for MMT’s inevitable effect of driving precious metals and commodities much, much higher.

Euro Zone Sentiment Surges in April Ending COVID Recession

By Jan Strupczewski

The European Commission’s monthly sentiment survey for the 19 countries sharing the euro on Thursday showed optimism rising to 110.3 points in April from 100.9 in March, beating consensus estimates in a Reuters poll of a 102.2 reading.

“The services sector now also in expansion mode. We can now declare the Covid-19 recession over. Inflation expectations also continue to increase,” ING bank economist Peter Vanden Houte wrote in a note to clients.

The mood became much more upbeat in industry, rising to 10.7 points from 2.1 in March, far exceeding consensus expectations of an increase to 4.0. In services, the euro zone’s biggest sector responsible for more than two thirds of gross domestic product, the reading went up to 2.1 points from -9.6 in March, also far above expectations.

Consumer optimism rose to -8.1 from -10.8, in line with an initial estimate published last week, and in retail trade to -3.1 from -12.2.

The optimism translated into manufacturing industry’s selling price expectations rising to 24.1 points in April from 17.5 in March, coming very close to the highest reading since 2000, which was 25.5 points in March 2011.

Consumers also began to expect higher inflation over the next 12 months, with the reading going up to 19.6 in April from 18.6 in March, moving above the average reading since 2000.

“The big question is how temporary these price increases will be,” Vanden Houte said.

“Will they disappear once some of the supply chains problems are resolved? With strong demand to be expected in the second half of the year and a further inventory build-up in the offing, we doubt that price tensions will disappear quickly,” he said.

He said that while it was too early to expect a price-wage spiral, if there is a strong recovery in the coming months as suggested by the April sentiment data, the European Central Bank may become less inclined to keep up its bond buying scheme.

“The chances of the Pandemic Emergency Purchase Programme being lengthened after March 2022 are getting slimmer by the day and the central bank could even suggest that it will not fully spend the current envelope,” he said.

(Reporting by Jan Strupczewski; editing by Philip Blenkinsop and Toby Chopra)

Italy: Fiscal Prudence Requires Attention Even as Draghi Investment Plan Critical to Reviving Growth

The Italian government presented earlier this month the fiscal plan and economic strategies for 2021 and beyond under the Economic and Financial Document (DEF). This week, the government of Prime Minister Mario Draghi outlines historic plans to put to prudent usage EUR 191.5bn of EU loans and grants – including spending on critical areas such as the green transition, digitalisation and infrastructure, targeting Italy’s less-developed southern regions – alongside around EUR 70bn of other national and EU resources and associated structural reform.

The government puts growth this year at 4.5%, rising to 4.8% in 2022, before falling back to 2.6% in 2023, 1.8% in 2024, and averaging 1.1% a year at the end of the decade under a scenario that incorporates the full effects of Next Generation EU (NGEU) funding from which Italy is the most significant EU beneficiary.

Sustained growth of above 1% per year seems optimistic

The sustained growth of well above 1% per year after Covid-19 does seem very optimistic – even with the positive economic support from the NGEU and associated government investment. Looking back over the last decade, economic growth averaged only 0.3% in the decade before the coronavirus crisis.

Our estimate of Italy’s potential growth of 0.7% is similar to a government estimate of 0.8-0.9% medium-run growth under government scenarios of incomplete implementation of NGEU. Italy’s realised economic growth has fallen short of comparatively modest potential growth estimates in the years pre-pandemic – constraining a higher estimate at this stage for future growth potential. Next, the scale of the growth impetus of this historic post-Covid-19 investment programme is unclear at this stage and will rest on how effectively implementation proceeds.

Italy is unlikely to reverse debt ratios by such a scale as to reach pre-crisis levels

The government expects economic impetus as well via an additional EUR 40bn (2.4% of 2020 GDP) fiscal package after the earlier EUR 32bn “DL Sostegni” support sleeve.

Italy’s budget deficit will widen at minimum short term: the government’s estimate in 2021 is 11.8% of GDP – above an earlier 7% government estimate as well as above Scope’s December forecast of 9% for this year – before shrinking to 5.9% of GDP next year and to the 3% Maastricht limit by 2025. Under government projections, public debt rises to around 160% of GDP in 2021 from 156% in 2020 before declining, under a scenario of “full NGEU effects”, to 135.5% of GDP by 2032, close to the 134.8% level before the crisis.

In our view, Italy is unlikely to reverse debt ratios by such a scale as to reach pre-crisis levels. The risk to budget deficits is, furthermore, skewed to the upside – as many households and businesses may require extended support and growth expectations might prove optimistic. While we are similarly of the view concerning the appropriateness of governments spending counter-cyclically during crisis, the issue, during a present early recovery, will be in deciding when and for which sectors government support will be pulled back to allow markets to again function and re-allocate resources more effectively, as well as when to allow select insolvencies.

Fewer restraints preventing higher sovereign borrowing

In view of ongoing transitions in fiscal orthodoxy in favour of pro-growth policies, the checks and balances pre-crisis that restrained the scale of spending have been eased exiting this crisis. Market disciplining powers against high spending and government excess are also likely to remain suppressed for a prolonged phase as ECB intervention has put in place an implicit put option, likely holding more durable signalling effects even after central bank purchasing begins to be wound back – restricting market willingness to sell off past boundaries.

Within such conditions of curtailed guardrails restricting sovereign balance sheet expansion, we have touched on in the past that projections of the government, the IMF and other forecasting organisations for a swift, sustainable decline in Italian public debt ratios starting from 2021 might be optimistic. Instead, we expect the Italian debt ratio to remain on an upward trajectory longer term – looking through the cycle. In this respect, general government debt might reach meaningfully higher levels beyond 160% of GDP.

Italy may not need to reverse public debt to pre-crisis levels

But, at the same time, Italy may not need to reverse public debt to pre-crisis levels.

Italy can sustain somewhat higher debt ratios at prevailing BBB+ credit rating levels than it could pre-crisis. This is partly because of the extraordinary European monetary and fiscal support but as well because of improvements in the profile of Italy’s government debt.

The weighted average cost of outstanding debt has fallen from 4% as of 2012 to an estimated 2% this year. With a 10-year BTP yield of only 0.8%, this weighted average cost of outstanding debt will continue declining. The Italian Treasury has lengthened the average life of debt to 7 years from 6.7 as of August last year.

Even if Italy’s current 160% debt ratio does not automatically signal crisis as this would have 10 years ago, there are nevertheless limits to how much debt Italy can ultimately hold within a monetary union in which the Italian sovereign does not have an independent monetary policy.

In the end, monetary space creates fiscal space

In the end, monetary space creates fiscal space – and how much fiscal space Italy has, as an example, to spend counter-cyclically in a future crisis even with higher levels of debt – depends on market confidence in the efficacy of Italian government policies, which might presently be high, but also on how much support the ECB is willing to give Italy and other euro area member states and the associated constraints the ECB itself faces in being able to provide continued scale in such support.

At this stage, we believe that even with high public debt, Italy has the fiscal space in a next crisis partly in view of the capacity for the ECB to ensure accommodative market conditions. But this, in and of itself, does not mean governments can ignore longer-run fiscal sustainability challenges.

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Giulia Branz, Associate Analyst at Scope Ratings, contributed to writing this commentary.

Capitalizing on IPO Mania: Will Stripe’s IPO Become The Biggest of All-Time?

Boosted by huge demand for technology and sustainability stocks, as well as a frenzied rush from blank-check SPAC companies, the volume of IPOs in the US doubled to 494 – raising a collective $174 billion. Now, with the news of payments giants Stripe intending to go public, we may see the biggest initial public offering yet.

According to FactSet, high profile IPOs from Snowflake, Airbnb and Rocket Companies were well received by investors, contributing to 150% year-on-year growth for money raised through offerings.

However, one company that’s seemingly been at the centre of speculation throughout 2020 without pulling the trigger on an IPO was Stripe. In August last year, Stripe sparked a furore when the company announced that it had recruited CFO Dhivya Suryadevara from General Motors to assume the same role at the startup. At the time, it was anticipated that the company was in the final stages of preparing to go public. But instead, the company opted to raise an additional $600 million in new equity from private investors at a seismic valuation of $95 billion.

At a valuation of $95bn, Stripe has become the most valuable US startup, pushing past huge industry players like Elon Musk’s SpaceX and grocery delivery service Instacart. However, the latest fundraising effort could lead the company to the biggest IPO ever.

Entering The IPO Frenzy

Stripe’s push towards an IPO comes at a time when a global IPO frenzy is in full swing. At the end of Q1 in 2021, global dealmaking stood at $1.4 trillion thanks to blank-check SPACs and newfound excitement for tech initial public offerings.

These figures represent a 103% increase in the same period last year, and a faster start to a year in over two decades – according to preliminary data from Dealogic. There’s no sign of the furore simmering down, either.

One of the key reasons behind such astronomical figures stems from the boom in special-purpose acquisition companies (SPACs), which offer private companies a faster route into public markets. SPACs have helped to push equity capital market fees up by almost 340% compared to the same period in 2020 to a total of $13.1 billion – more than double the revenues in any first quarter over the past 20 years.

(Image: Financial Times)

As the data above shows, IPO proceeds already soared to levels that haven’t been seen since the financial crisis of 2008 by the end of last year. Driven largely by unprecedented volumes of SPACs entering the market, more businesses feel emboldened to embrace the huge boom in IPO popularity.

Will Stripe Become the World’s Biggest IPO?

So, will Stripe use the current investment landscape to launch the biggest IPO ever? There are a few things to consider before we can gain a clearer idea of just how seismic the company’s arrival on the New York Stock Exchange will be. Firstly, it’s important to note that these metrics are largely determined by total deal size, rather than the company’s market capitalization. The current biggest IPO belongs to that of Saudi Aramco, which raised $29.4 billion through a home-country listing. Meanwhile, the biggest US-based initial public offering was the 2014 debut of Alibaba, which ultimately raised a total of $25 billion.

Weighing in with a $95 billion valuation means that Stripe has the potential for a huge IPO, but it remains to be seen that the company will beat the aforementioned records at its current valuation. Companies typically avoid releasing too many shares during an IPO as they can pursue follow-on offerings for insiders once the lockup period is over – which tends to be around 90 to 180 days after the initial public offering date.

Although holding the record for the largest IPO will no doubt hold plenty of appeal for the company, it’s unlikely that Stripe would willingly sell almost one-third of its shares for the sake of beating the existing stock market record – but this doesn’t mean that the company should be discounted. Stripe appears to be investing on a global scale and is producing results that have captured the imagination of institutional investors that have been willing to pay way over the odds for admission just one year on from the company’s last fundraising effort. With palpable excitement for both Stripe and the IPO market as a whole, all bets are off when it comes to anticipating the sheer scale of the upcoming floatation.

Buying Stripe’s IPO

With speculation rife about the ultimate size of Stripe’s IPO, many retail investors will likely find the notion of investing in the payments company a tantalizing one to say the least. However, the process of investing in initial public offerings can be tricky for individuals to buy into. This is because many companies choose to sell their shares to institutional investors who are capable of buying huge volumes of their IPO in one single transaction.

Maxim Manturov, Head of Investment Research at Freedom Finance Europe, says that: “Historically, institutional investors get around 90% of all shares, with only around 10% left for retail trades. This is where allocation comes from: when the demand is high, the broker will have to reduce order amounts so as to at least partially fill all of them. The allocation ratio, meanwhile, depends on the investor trading activity and volume.”

That said, there’s still a way for the general public to participate in IPOs – there’re online brokers that allow retail investors to take part in IPOs. However, there’s generally a vetting process to go through and a financial threshold to meet.

However, retail investors can still get in on the action when trading eventually begins on the New York Stock Exchange. In an IPO landscape that’s filled with huge levels of investor confidence, we may yet see Stripe’s initial public offering break plenty of records upon its arrival.

German, French Ministers Back U.S. on 21% Minimum Corporate Tax Rate

“I, personally, have nothing against the U.S. proposal,” Germany’s Olaf Scholz was quoted as saying. “If that is the result of negotiations, we would also be agreed,” France’s Bruno Le Maire said, according to Zeit.

U.S. Treasury Secretary Janet Yellen said this month she was working with G20 countries to agree on a global corporate minimum tax rate, and put forward a figure of 21%.

A rate of 12.5% for multinationals had been under discussion for new rules being negotiated at the Organisation for Economic Cooperation and Development.

Scholz and Le Maire are holding talks on Tuesday and, among other issues, are due to discuss tapping money from the European Recovery Fund.

(Reporting by Madeline ChambersEditing by Riham Alkousaa and John Stonestreet)

U.S. Core Capital Goods Orders Rise Less than Expected

Orders for non-defense capital goods excluding aircraft, a closely watched proxy for business spending plans, increased 0.9% last month, the Commerce Department said on Monday. These so-called core capital goods orders fell 0.8% in February after bitterly cold temperatures gripped large parts of the country.

Economists polled by Reuters had forecast core capital goods orders increasing 1.5% in March.

(Reporting by Lucia Mutikani; Editing by Edmund Blair)

German Business Morale Improves Less Than Expected in April – Ifo

The Ifo institute said its business climate index edged up to 96.8 from 96.6 in March. A Reuters poll of analysts had pointed to a bigger increase to 97.8.

“Both the third wave of infections and bottlenecks in intermediate products are impeding Germany’s economic recovery,” Ifo President Clemens Fuest said in a statement.

Companies raised their assessment of the current business situation once again, but they were less optimistic about the coming six months, the survey showed.

The business climate in manufacturing improved further to reach its highest level in nearly three years, with industrial companies reporting full order books and humming factories.

“The demand situation is still very good,” Fuest said.

But their business outlook was less optimistic as 45 percent of companies reported bottlenecks in intermediate products, the highest value since 1991, the institute said.

The Ifo figures were broadly in line with the PMI survey from last week that showed factories continued to churn out goods at a near-record pace in April while activity in the services sector remained sluggish.

The government is expected to raise its 2021 GDP growth forecast on Tuesday after Economy Minister Peter Altmaier hinted earlier this month that Berlin was mulling an upward revision to the 3% estimate it presented in January.

(Reporting by Michael Nienaber, editing by Thomas Escritt)

France’s Stability Programme: Sizeable Fiscal Support Followed by Gradual Expenditure Containment

France’s Stability Programme for 2021-27 highlights the government’s priority to support a strong post-Covid-19 recovery, close the output gap by 2024 and boost potential growth via fiscal support focused on greening the economy as well as on social cohesion and industrial sector competitiveness. Given already high shares of tax revenues in GDP, the government decided against tax hikes under the Programme to cover the Covid-19 bill, relying instead on gradual expenditure containment from 2022 onwards.

Following sizeable recovery spending reflected in nearly a 10% increase in real spending between 2019 and this year, post-crisis fiscal consolidation is expected to be jump started by a fiscal cut of 3.3% of GDP in 2022 as emergency support measures are tapered, and gradually phased in via containment of public outlays afterwards.

Specifically, the government aims at limiting annual growth of real public expenditures to 0.7% between 2022 and 2027. This is lower than the average growth rates of 2007-12 and 2012-17 periods of 1.4% and 1.0%, respectively, and also below projected real output growth.

Streamlining and digitalising public services

The government will continue to pursue streamlining and digitalisation of public services as outlined under the “Action Publique 2022” and focus on efficient public spending that favours more inclusive and green growth. In addition, the government plans to reform public finance governance by implementing a multi-year spending rule that limits general government expenditure growth. This can be exceeded only during times of crisis and after close parliamentary scrutiny.

A gradual consolidation approach concentrating on the expenditure side is appropriate

The government’s plan to gradually reduce the fiscal deficit via expenditure-based consolidation is appropriate since this tends to be more effective than revenue-based plans. This will help place the economy on a sound post-crisis recovery path. Any premature rapid consolidation would likely hold adverse implications for growth and could weigh upon longer-term debt sustainability. However, this gradual approach to consolidating the budget will come at the cost of materially weaker fiscal fundamentals at a minimum over the medium term.

France’s projected primary fiscal balances are weaker than those of most other euro area countries, albeit similar to or stronger than those of Scope’s other AA-rated sovereigns such as Belgium, Czech Republic, the United Kingdom or the United States.

The budget deficit is expected to remain elevated

The French budget deficit is expected to stay elevated, at 4.6% of GDP on average, over the next seven years and is forecast to fall to below the 3% of GDP Maastricht threshold only by 2027. This includes the fiscal impact of France’s EUR 100bn recovery plan, on top of a gradual withdrawal of support measures implemented to address Covid-19. Similarly, the public debt ratio will stabilise at 118% of GDP only in 2024-26 and start declining by 2027 absent a substantive economic shock in the interim years.

While France’s debt level and trajectory are similar to those of other Scope AA rated sovereign borrowers (other than that of the Czech Republic with its notably lower debt stock), the government debt burden leaves the economy vulnerable to an abrupt rise in interest rates, should investor appetite suddenly deteriorate. Similarly, the reduced fiscal space limits room for counter-cyclical fiscal measures in the event of another large adverse shock.

While low funding costs support fiscal fundamentals, a more decisive fiscal consolidation is needed

The weakening in fiscal fundamentals is likely to be mitigated partially by low funding costs available to the government as French interest payments relative to revenues are expected to continue falling over the coming years. It is clear that further structural reforms are needed to raise growth potential and start a more decisive fiscal consolidation over the longer term that would place the debt-to-GDP ratio onto a durably declining path.

This may prove difficult given the Emmanuel Macron government’s waning public and political support. After strong popular opposition to some of the government reforms, opinion polls show a narrowing victory margin for Macron versus favoured contender, Marine Le Pen, raising the prospect of a leadership change after 2022 elections.

For a look at all of today’s economic events, check out our economic calendar.

Zuzana Schwidrowski is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Thibault Vasse, Analyst at Scope Ratings, contributed to writing this commentary.

Will a Fiscal Revolution Raise Gold to the Throne?

We live in turbulent times. The pandemic is still raging and will most likely have lost lasting effects on our society. But a revolution is also happening right before our eyes. And I don’t mean another storming of the U.S. Capitol or the clash of individual investors with big fish on Wall Street. I have in mind something less spectacular but potentially more influential: a macroeconomic revolution.

I refer here to the growing acceptance of easy fiscal policy . In the aftermath of the Great Recession , the central banks adopted an aggressive monetary policy , slashing interest rates to almost zero and introducing quantitative easing . It has become a new norm since then.

But fiscal policy was another kettle of fish. Although almost nobody cared about balanced government budgets, people at least pretended to worry about overly large fiscal deficits and an overly quick accumulation of public debt . For example, while Obama wanted $1.8 trillion in fiscal stimulus in a response to the global financial crisis of 2007-09, Congress passed a package of about $800 billion, as Republicans opposed larger spending. But in March 2020, Congress passed the CARES act worth about $2 trillion (and additional significant stimulus in December 2020), with the full support of Republicans.

Even Germany – the country famous for its fiscal conservatism – ran a fiscal deficit in 2020 and – what’s more – agreed to issue bonds jointly with other EU countries, although it was previously a taboo. The International Monetary Fund (IMF), another bastion of economic orthodoxy, which advocated for austerity and balanced budgets for years, gave up during the epidemic and started to call for more fiscal stimulus to fight the economic crisis .

And this fiscal revolution is already seen in data. As the chart below shows, the U.S. fiscal deficit has increased from 4.6 percent of GDP in 2019 (which was already at an elevated level) to 15 percent of GDP in 2020, the highest level in the post-war era.

According to the IMF’s Fiscal Monitor Update from January 2021 , fiscal deficits amounted to 13.3 percent of GDP , on average, in advanced economies, in 2021, a spike from 3.3 percent seen in 2019. As a consequence, the gross global debt approached 98 percent in 2020 and it’s projected to reach 99.5 percent of the world’s GDP by the end of this year.

What is important to note here is that government support wasn’t limited mainly to the financial institutions and big companies (such as automakers), as was the case in 2009, but it was distributed more widely. There was a huge direct money transfer to Main Street, including checks for practically all citizens. This is important for two reasons.

First, money flowing into the economy through nonfinancial institutions and people’s accounts may be more inflationary. This is because money doesn’t stay in the financial market where it mainly raises asset prices, but it’s more likely to be spent on consumer goods, boosting the CPI inflation rate . Higher officially reported inflation (and relatively lower asset prices) should support gold , which is seen by investors as an inflation hedge .

Second, the direct cash transfer to the people creates a dangerous precedent. From now, each time the economy falls into crisis, people will demand checks. It means that fiscal responses would have to be increasingly larger to meet the inflated expectations of the public. It also implies that we are approaching a universal basic income, with its mammoth fiscal costs and all related negative economic and social consequences.

Summing up, we live in revolutionary times. The old paradigm that “central banks are the only game in town” has been replaced by the idea that fiscal policy should be more aggressively used. Maintaining balanced budgets is also a dead concept – who would care about deficits when interest rates are so low?

However, assigning a greater role to fiscal policy in achieving macroeconomic goals increases the risk of higher inflation and macroeconomic instability, as politicians tend to be pro-cyclical and reckless. After all, the economic orthodoxy that monetary policy is better suited to achieve macroeconomic stability didn’t come out from nowhere, but from awful experiences of the fiscal follies of the past. I’m not a fan of central bankers, but they are at least less short-sighted than politicians who think mainly about how to win the next election and stay in power.

Hence, the growing acceptance of easy fiscal policy should be positive for gold prices , especially considering that it will be accompanied by an accommodative monetary policy. Such a policy mix should increase the public debt and inflation, which could support gold prices. The caveat is that investors have so far welcomed more stimulus flowing from both the Fed and the Treasury. But this “go big” approach of Powell and Yellen increases the longer-term risk for the economy, which could materialize – similar to the pandemic – sooner than anyone thought.

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For a look at all of today’s economic events, check out our economic calendar.

Arkadiusz Sieron, PhD
Sunshine Profits: Effective Investment through Diligence & Care.