February 6, 2018 / 8:37 AM / 19 days ago

Daily Briefing: EU expansion - a signal of intent

LONDON (Reuters) - By formally encouraging the membership ambitions of six Balkan states today, the European Union will today signal its strategic intent to keep growing despite Brexit and other challenges to its future.

The post-Cold War enlargement of the bloc was seen as testimony to its soft-power attraction but the strategy has since run into problems: the badly managed migration of eastern European workers to Britain was a contributory factor in the Brexit vote; there are still questions over whether rule of law in Romania and Bulgaria is up to EU standards; and Turkey’s accession bid has ground to a damaging halt.

Many obstacles stand in the way of today’s hopefuls - Serbia, Bosnia, Albania, Macedonia, Montenegro and Kosovo - and only optimists would bank on a new enlargement wave by the 2025 target date. But as is so often the case for the EU, especially as Russia and others show interest in the region, what counts is the direction of travel.

Germany's politicians still haven't quite concluded a new grand coalition deal in Berlin but already there is grumbling among Angela Merkel's conservatives that she has sold out on Europe. Yesterday SPD leader Martin Schulz was happy enough with the side deal on euro zone reform that he hailed the "end of austerity" in Europe; Merkel's allies fear that means Germany will in future be picking up the bill for profligate states in the south.

Both interpretations could prove overdone - the full details of the accord will have to be examined carefully when the overall coalition deal is struck. The current expectation is that it could happen later today.

Trips to Corsica are always tricky for French presidents and Emmanuel Macron's visit to the Mediterranean island today is no exception. This is no Catalonia (the local Corsican economy in any case would not be strong enough to stand by itself) but there is a marked upsurge in nationalist sentiment and Corsican leaders will want their demands for a special autonomy status taken seriously. Like other leaders before him, Macron will have to juggle that with the firm message that the restive island must accept French rule of law as sovereign.

MARKETS

Since last autumn, investors had been betting on the goldilocks economy - solid economic expansion, improving corporate earnings and stable inflation. But the tide seems to have changed
A man walks past electronic boards showing the Nikkei average and Dow Jones Industrial Average outside a brokerage in Tokyo, Japan, February 6, 2018. REUTERS/Toru Hanai

Boom! From one set of records to another in two weeks. What seemed like an overdue pullback has intensified into a frenzied selloff and the milestones are being clocked off by the hour.

The biggest intra-day points drop on the Dow Jones Industrial Average in history at one point; a wipeout of all the MSCI World index’s year-to-date stock market gains in just seven sessions; the biggest one-day fall in the S&P500 in more than six years; a surge in the Vix volatility index – Wall St’s ‘fear gauge’ – to its highest since August 2015; and a cumulative loss of world equity market capitalisation from late January’s peak of more than $4 trillion.

While the trigger for this reversal may have been last week’s U.S. wage inflation scare, this overnight plunge has little to do with economic fundamentals and everything to do with market dynamics. After an historically long period of extremely low volatility on global equity markets, the bottle seems to have been uncorked.

The combination of an unwinding of highly leveraged bets on super low volatility persisting, via exchange-traded products based on ‘inverse VIX’ positioning, and computer-driven selling has supercharged the selloff – the extent of which may not have surprised many wary of correction, even if the speed is alarming. Some of those inverse Vix products lost as much as 80 percent overnight and many may now be redeemed. The fallout from this sort of stress will keep markets turbulent for a period at least.

After the main U.S. stock indexes eventually closed down more than 4 percent late Monday, the selling has inevitably rippled across Asia. Japan’s Nikkei, which fell more than 7 percent at one point, ended 4.7 percent lower. Shanghai lost more than 3 percent and HK more 4than 4 percent. South Korea’s Kospi outperformed with a relatively contained drop of 1.5 percent.

Price action is clearly driven by technical factors, tied to a brutal awakening of stock volatility. We are undoubtedly in uncharted waters

European stock futures are down more than 3 percent and S&P futures are pointing to a further loss later of up to 1 percent. Even though rising bond yields were the driver of the equity reversal last week, the violence of the overnight stock market plunge has pulled benchmark bond yields back lower too, and there was a peak-to-trough drop in U.S. Treasury yields over the past 24 hours of more than 24 basis points.

From a high of 2.885 percent, the 10-year bond plunged as low as 2.6480 percent but has settled around 2.74 percent first thing. Money markets have also shifted to rethink central bank policy trajectories, with only two Federal Reserve interest rate rises now priced for this year where there were three yesterday.

Currency markets have been relatively stable through all this, with the dollar index flat first thing after rising on Monday on the equity market stress. Euro/dollar is firmer at just under $1.24.

Bitcoin and the cryptocurrencies continue to get whacked, with Bitcoin down another 10 percent or so and testing levels below $6,000 overnight. It's now lost up to 70 percent from December's peaks. Brent crude is down as low as $67.

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