Overnight Sentiment: Celebrating Spain's Non-Junk Status
With little official macro news overnight, the market has focused on yesterday's after hours positive surprise which was Moody's confirmation that nothing major is allowed to happen to Europe until after the US election, namely Spain's downgrade to junk. Sure enough, despite expectations to the contrary, and reality screaming, Moody's decided to keep Spain at Baa3, on the verge of junk, with a warning that if there is any hiccup in the country's private market debt access, a multi-notch downgrade would follow. All the headline scanning algos however saw 'Spain is IG' and never looked back. The result is a slide in Spanish bond yields to multi-month lows on the confluence of two absolutely paradoxical events: Moody's saying Spain is fine if it can fund itself, and the ECB saying it is there to rescue the country when the time when it can fund itself runs out. Naturally, under this confluence of events, Spain will be even less likely to request a bailout, which will require an even more forceful shock when the time finally comes for reality to reassert itself, to get Rajoy to smell the morning napalm. Until then however, the musical chairs continues, and in the scramble for yield Spanish bonds are suddenly attractive, at least until they aren't.
To summarize: European stocks are little changed although Spanish shares rise. Spain 10-yr bond yields fall to the lowest level in more than 6 months. S&P futures are now higher on the trading session, driven by correlation engines as the euro is up vs the dollar, despite major disappointments by IBM and Intel. In other news Germany formally shut down the debt redemption fund proposal, ending one more rescue avenue for when the recent baseless euphoria ends, even as Spanish La Vanguardia reports that Germany is pressuring Italy to request European aid alongside Spain so that the government of Prime Minister Mario Monti doesn’t reap the benefit of lower borrowing costs without being tied to tougher economic reforms. Needless to say, Italy is said to resist the proposal: after all in Europe one just wants the upside from being bailed out, as opposed to actually being bailed out...
FX recap via SocGen:
EUR/USD 1.3041-1.3124 overnight range. Big two-day move puts spot above 1.3100 with overnight Spain ratings confirmation supporting positive momentum. Resistance 1.3147, then 1.3172 the Sep 17 high. 1mth RR jump to -0.2725.
USD/JPY 78.62-78.92 overnight range. The six -day rally comes to an end as spot slips back below 78.75, the 100d ma. Japanese cabinet meeting awaited later today to confirm stimulus bill. EUR/JPY resistance 103.86.
GBP/USD 1.6109-1.6138 overnight range. Up with risk appetite overnight, resistance situated at 1.6138. Trailing EUR/USD means that EUR/GBP is squeezing above 0.8100. The MPC minutes and labour market data in focus this morning.
AUD/USD 1.0263-1.0324 overnight range. Back above 1.0300 on Spain news and broad Asian equity market gains overnight. Difficult to be very bullish given dovish RBA stance. Resistance runs at 1.0345, the 200d ma. Focus on stocks.
What else is on the outlook:
We were warned by Germany late yesterday not to ‘over-interpret' the statement with regard to making a credit line available to Spain, but speculation (and hope) of progress in the margin of the EU Council summit tomorrow is of such nature that smallest hint of negotiations advancing can be infectious for the broader market. Better macro data (US NAHB homebuilding at a six year high, capacity use up) and more bullish investor optimism explain the resilience in risk assets that now has the Eurostoxx targeting the September high (256.9) on the dawn of the latest EU leader gathering. The move in EUR/USD risk reversals compared to a year ago is staggering (see chart vs US/EU macro surprise index) and underlines how the backdrop has improved and EUR angst has receded in particular since the summer. The conciliatory tone of German officials with respect to Spain and Greece in particular demonstrates how, in the short-term at least, the thought of (more) flexible lending terms but without mentioning the words ‘debt mutualisation' is making confidence stick. The question is whether this time the EUR can hold on to its gains or we revert to type where post Summit blues last year set the scene for a big 12 figure drop in EUR/USD between late October and mid December.
No EU first-tier data or events are scheduled today except for the German 2y auction. In the UK we get the latest MPC minutes and labour market data. The minutes of the October meeting will be key to finalise expectations for the November meeting and whether further QE is possible. A drop in annual CPI to 2.2% in September suggests more asset purchases could be on the way though we will reserve our final judgement until after the first release of Q3 GDP next week.
A more comprehensive summary via Deutsche Bank:
S&P 500 Futures (-0.09%) turned negative after the debate which was predictable but something that might be a little short-sighted. Bernanke and QE are more likely to survive with Obama than with Romney. Nevertheless, major Asian bourses are still higher across the board though with the Hang Seng (+0.96%), ASX200 (+0.87%) and the Nikkei (+1.41%) all higher. The EURUSD cross jumped 0.5% following the Moody’s press release, adding to yesterday’s 0.8% gain, now trading just under the 1.31 mark. In the credit space, Asian and Australian IG indices are trading 4bp and 7bp tighter respectively overnight, with cash bond spreads generally marked 5-10bp tighter.
This all followed another positive day for markets yesterday. The Dow and the S&P 500 added +0.95% and 1.03% on the day to close just 0.4% and 0.7% below their post QE3 highs.
The market saw broad based gains across most sectors but the strength was mostly concentrated in cyclicals. Better US earnings certainly helped. Indeed the market was encouraged by pre-market earnings beats from Goldman Sachs, State Street and Johnson & Johnson yesterday. Coca-Cola finished the day lower (-0.6%) after falling short of the market’s top line estimates. Indeed revenue beats are a lot lower than earnings beats so far in the current reporting season. Of the companies reported to date the beat:miss ratio is around 52%:48% for revenues versus 84%:16% for EPS. Intel and IBM both reported better earnings after the close but the latter fell short on revenue estimates. Elsewhere Apple rose +2.4% yesterday after it issued invitations to an October 23rd event which prompted chatter that it will unveil a mini-version of its iPad. I must somehow try to resist.
US data was overall a bit more mixed. Industrial production was up 0.4%mom (vs +0.2% expected), an improvement on the prior month’s print which was revised down two-tenths to - 1.4%. September CPI came in higher than expected 0.6% (vs 0.5%) because of a 4.5% increase in energy prices, much of which was due to higher gasoline prices (+7.0%). The core CPI was reported at 0.1% which kept the year-over-year rate unchanged at +2.0%. Meanwhile,the October NAHB housing market index was up by a point in the month to 41. This brings the series to the highest level since June 2006(42) as US housing data continues to improve.
The Stoxx 600, IBEX and FTSEMIB rose +1.32%, +3.41% and +2.53% respectively after German coalition members Michael Meister and Norbert Barthle from Merkel’s Christian Democrats, indicated that Germany was open to Spain applying for a precautionary credit line (PCCL) from the ESM. However, Barthle later played down the comments saying that they were "over-interpreted" by markets, and that he was only making a general point about a PCCL being one of a number of options available (Reuters). Indeed, the Dow Jones reported overnight that Rajoy had phoned Merkel to assure her “not to believe everything you hear” about Spain requesting a credit line.
These comments came after the FT report yesterday suggesting that Spain was preparing to request EU support in the form of a PCCL that would trigger the ECB’s OMT programme but would not need to be funded by the ESM. DB's Gilles Moec noted that although what the FT describes is accurate, crucially it does not discuss the details of the MoU’s conditionality which is key for the success of EU support. Conditionality will have to be flexible enough - in particular on the deficit targets - to be credible and keep the market ready to believe that the outcome of the quarterly conditionality reviews will allow the ECB to continue to intervene, but at the same time tough enough to address doubts about writing a “blank cheque”. Spanish 10yr bond yields finished about 9bps off the intraday lows to finish the day virtually unchanged at 5.81% although the front end outperformed (2yr yields were -7bps on the day) probably reflecting a greater probability of ECB intervention in shorter-dated bonds.
Looking at the day ahead, the key data points in the US are housing starts and building permits with the market expecting 775k (which would be the highest since late 2008) and 810k respectively. BofNY, BofA and PepsiCo are among the companies reporting in the US morning, while Amex and eBay report later. It will be relatively quiet on the datafront in the Eurozone.
Elsewhere Monti is scheduled to meet the Cypriot President in Rome this afternoon. Portugal will sell some bills today while Germany will auction EU5bn in two-year notes. Finally, Merkel will be hosting the Swedish Prime Minister for talks on the EU and the topic of last nights remarkable 4-4 draw between the nations will surely be discussed, especially as Germany were 4-0 up! However at least they got a game, unlike England. Strange times!