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Atlantic Spread

29 April 2019 by jbchevrel

As political risks don’t seem to be driving the market as much as they did earlier this year (Brexit and other € elections), the focus is seemingly increasing on the US-EU trade after the EC was given the mandate to negotiate tariff cuts on industrial goods. Both the US and the EU are considering tariffs ($11bn and $20bn resp), in connection to a WTO dispute concerning US subsidies to Boeing. A meeting between negotiators has not been fixed yet. It is not clear whether the benefits of a trade deal would be equivalent for both parties, and one might (correctly or not) think that if the US is able to strike a deal with China (widely expected now, Mnuchin adding to the point today), it might look easier with the EU. That said, the tough points of that nego may well be US farm products, where US demands for a comprehensive access have been rejected by the EU. Another factor can be central banks. While the ECB’s line isn’t seen moving in the short term, more focus is likely to build on the Fed, with FOMC this Wednesday. While US Q1 GDP beat is partly one-off (inventories, trade), the economy there is undoubtedly still running above potential as of Q1. A month ago, noise had it that the Fed could cut rates to counter a potential recession, and that rhetoric seems to be shifting, as it becomes evident that the economy is still running above potential. Thus, some members, as Chicago Fed President Evans, seem potentially sympathetic to a cut even if activity pace sustains, if core inflation remains significantly below the 2% target. Evans mentioned 1.5% as a guidance. Such a move could see US IG credit outperform € IG credit, everything else being equal. Again, the fact that we are now pricing 60% of a cut by the end of this year might look counter-intuitive for anyone who’d have been trapped in a block of ice over the past seven months (gardening?), as SPX/Nasdaq are hitting new record highs, and financials conditions indices are back pretty much where we were at the end of SEP (Bloomberg FCI back to +1 GS FCI back to 99.3).