Global Daily – Temporary Dutch election relief

by: Kim Liu , Maritza Cabezas , Nick Kounis

Euro Government Bonds: Optimism after Dutch elections is short lived – The Dutch elections have been seen as a bellwether of European populism after the surprise election of President Trump and the Brexit vote. The main risk for the EU, the eurozone bond market and Dutch bonds was a higher than expected shock vote for the populist Freedom party of Mr Wilders. However, this did not occur as the Liberal Party of Mr Rutte won by a wide margin and it will probably lead a centrist government. This means that a Nexit can be ruled out. The market interpreted the benign election outcome as investor friendly and pro-Europe. Directly after the first exit polls of the Dutch elections, the market therefore priced in a lower likelihood of an euro breakup scenario as the euro appreciated (albeit slightly) and the bund future indicated a yield increase. In a quick reaction on the exit polls, we judged that the loss in the bund future could mark a reversal of the flight to quality in safe haven German bonds. This would mean that a relief rally could be expected in Dutch and French bonds. At the same time, we argued that such a rally would be short lived given the upcoming elections in France. Today, the bond market opened favourably with country yield spreads tightening for virtually every country compared to German bonds. Especially Dutch and French bonds outperformed. However, during the day, most of the gains slipped, as the optimism ebbed away. Although there is not a single reason which explains the reversal we judge that investors may have rethought their sanguine stance. Investors likely judge that that there are still obstacles ahead, such as  weak fundamentals in some countries (Italy) as well as political risk (France). (Kim Liu)

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US Macro: President Trump’s budget blueprint meets campaign promises – The Office of Management and Budget presented a Federal budget blueprint today. This budget proposal basically provides details on discretionary spending. These are the spending items that are subject to annual review. Discretionary spending is about a third of total spending and was 6.3% of GDP in 2016. This proposal does not contain any information about tax cuts and other revenues. The budget blueprint shows that President Trump has translated some of his election promises into policies. The focus is on increasing military and security spending and improving infrastructure. In this proposal, defense spending increases by USD 54 bn. There is also additional spending for security at the borders and enforcement of immigration, but this is a small increase. At the same time, the budget’s objective is to remain neutral, that is increasing spending without increasing the deficit. To offset the extra spending, the budget includes large reductions in spending for International Development Aid. This blueprint is a first step in the budget process. Traditionally it is presented in February. The next step is for Congress to produce its own budget plan taking into account the President’s proposal. The target date for this is 15 April. Cutting development aid could cause some tensions among certain Republicans, but we don’t expect a major impasse. A more detailed budget proposal should be presented before mid-May. This is expected to include the tax overhaul and economic and fiscal projections for the coming decade. The Administration is targeting August to conclude the budget process. Given the delay it is questionable if this deadline will be met. (Maritza Cabezas)

UK Macro: MPC dissenter triggers rate hike fears – The BoE left the Bank Rate unchanged at 0.25% at its meeting on Thursday. However, financial markets interpreted the announcement as being hawkish, with sterling strengthening significantly. This reflected that the vote was not unanimous, with Kristin Forbes voting instead for a rate hike. In addition, the MPC minutes revealed that some members might be close to joining her, and required only ‘relatively little further upside news’ to do so. This reflects the view that while inflation has spiked, there is not sufficient evidence yet that the economy is cooling. This combination seems to have made more MPC members concerned about upside risks to inflation over the medium term. Nevertheless, we do not think it is a majority view yet and the MPC’s joint commentary on inflation is still relatively sanguine. The Committee notes that ‘the projected overshoot (of inflation) entirely reflects the expected effects of the drop in sterling.  Pay growth has remained subdued, while measures of inflation expectations remain at levels broadly consistent with the achievement of the inflation target’. Overall, we continue to think that the BoE will keep interest rates on hold in the coming months, given the relatively transient nature of inflation driven by exchange-rate weakness. Though risks of a more hawkish stance are building. (Nick Kounis)