While trading during US hours is all about the Cliff On/Cliff Off debate, the rest of the world is simple: the overnight session begins (and largely ends) with whether or not China has done another reverse repo (if yes, then PBOC will not lower rates, and inject unsterilized billions into the market) and whether the Shanghai Composite is up or down. Last night, after jumping by 3% the session before, it was down 0.13% to 2029. Was this it for the great Chinese "bottom?" Japan may or may not figure in the equations, although with the 10 Year future just hitting a record overnight, it is amusing to see how the bond complex is indicating record deflation just in time for the market to anticipate a surge in inflation. Ah, the joys of frontrunning central planning's monetization of government bonds. And then we move on to Europe, which is a whole new level of basket case-ness...
So what happened in Europe? Plenty, it seems.
First, we had a move wider on peripheral notes following a fresh round of concerns, this time driven by a NYT piece which recaps all the now generic exchange logic first presented here in January-March during the time of the second Greek bailout-cum-cramdown, that the Greek "selective default"-inducing debt buyback may, after all, fail as various exchange classes hold out for better terms than the proposed exchanges, and in doing so, scuttle the entire third Greek bailout. Logically, all it would take is for a blocking stake of bondholders to organize, and to demand a higher tender price than the 30-40 cents proposed. Of course, the higher the price, the more meaningless the exchange, as a par take out would mean swapping par debt for par debt, and no net deleveraging for Greece. And with Greece already having boosted the exchange price on one occasion, funds and banks feel empowered to demand even more concessions: perhaps to the point where collective action clauses have to be invoked one more time in the English-law governed bond complex. However, no matter the nuances, if more than a third of holdouts emerge, expect to see Greek bonds tumble, not rise, on fears the entire ad hoc designed rescue package may fail, only this time hedge funds get the blame for Greece getting kicked out of the Eurozone.
Next, confirming that Spanish bonds are now a "Sell", was the release by Goldman two hours ago that its #4 Top Trade for 2013 is to go "Long Spanish Sovereign Bonds," specifically 5 Years, at a current yield of 4.30%, a target of 3.50% and a stop loss of 5.50%. Always the best contrarian indicator, this means that Goldman is now fiercely selling SPGBs (more on this later). Sure enough the Spanish bond complex is materially wider for the second day in a row, and will likely continue dumping.
Then we got a variety of European economic data, the most notable of which was Eurozone Q3 GDP which, as expected, declined by 0.1%. It is a recession after all. We also got Greek unemployment, but we won't spoil the ending - that too will be disclosed in a subsequent post. Completing the data picture was German factory orders which snapped the recent trend of uber-weakness out of Germany, and spiked by 3.9% M/M in October on expectations of a 1.0% rise, up from the previous drop of -2.3%.
Shortly, we get the ECB's benchmark rate announcement which will almost certainly remain unchanged at 0.75%.
But the most notable event so far was a vote of confidence for Mario Monti's "growth package" in the upper house, which passed however with the majority of the lawmakers in the Berlusconi political party not taking place. This followed the statement of PDL head Maurizioo Gasparri who said that the party will move to a position of "abstention" which is now threatening the survival of the government, and which has led to various unfounded rumors that Monti may in fact resign. While these are completely baseless, the return of political infighting to Italy is certainly something to be concerned about, as the technocratic leadership of yet another ex-Goldmanite may be coming to an end, and chaos may well be returning. Naturally, should Berlusconi somehow indeed manage a return to power in Italy, all BTP bets are off.
End result: EURUSD dropping fast int he past hour on this Italian news, and was at 1.3064 at last check.
What to expect from the ECB later, and will a rate cut paradoxically result in an even higher EUR? SocGen chimes in:
Will the ECB meeting fuel or halt this uptrend? The ECB likely will have to cut its growth projections. Nevertheless, although the scenario cannot be fully excluded, a rate cut appears unlikely: potential negative effects (i.e. additional money market outflows) would outweigh the advantages, in our view. As for unconventional measures, Mr Draghi is expected to reiterate that everyone will have to face up to their responsibilities. The ECB is ready to launch OMT; however, Spain will have to request this aide. Regarding the market impact, confirmation by the ECB of its commitment to contend with the European sovereign crisis in its entirety may be enough to underpin the EUR/USD today.
A status quo by the BoE would be a non-event for the GBP. Investors will thus be looking to the United States where employment data (Challenger survey and initial claims) will be published ahead of the NFP report to be released tomorrow. This will be a determining factor ahead of the FOMC next week.
The end of the week will thus be rich in events likely to confirm or halt current market trends. Nevertheless, the ECB would have to cut rates today or the US employment report release solid figures on Friday to radically reverse the strengthening trend of the EUR/USD and pull 10Y EUR and US swap rates out of their current lethargic state.
And now, a more comprehensive recap from DB's Jim Reid as usual
With just 19 days to go until Xmas, it appears that some of us will need to change our holiday schedules. US House Majority leader Eric Cantor together with the House Minority Whip Steny Hoyer announced that the House of Representatives will not formally adjourn for the year “until a credible solution to the fiscal cliff has been found” (Washington Post). The House was originally scheduled to adjourn on Dec 14th, but it looks like lawmakers are preparing to spend the holiday period in DC in anticipation of an 11th hour negotiation.
On a more positive note, we got some tentative signs yesterday that Democrats and Republicans are willing to compromise to reach a deal. According to the WSJ and Washington Post, one option being considered involves setting the top tax rate above 35% but below the 39.6% that was in effect during the Clinton administration. Another plan being floated involves Republicans giving in on tax rates for top income earners now, and negotiating reductions in Social Security and Medicare spending early next year when the debt ceiling needs to be raised.
Bloomberg wrote that a few dozen Republicans have signed a letter calling for the exploration of “all options” on taxes and spending in a potential signal that some party members are ready to bargain. Perhaps the threat of having to convene through the holiday period is enough to spur a compromise?
Moving to the markets, it was an interesting day of contrasts yesterday. We saw the S&P500 swing between gains and losses of -0.6% and +0.6% on the whim of those in Washington, to eventually close with a modest gain (+0.16%). Citigroup posted its largest one-day gain in more than a year (+6.33%) following the announcement of cost reductions. Meanwhile Apple lost an almost-equal but opposite percentage (-6.43%) in its largest one-day fall in four years and shedding the equivalent of the Dow Chemical Company in market capitalisation terms in a single day ($35bn). Elsewhere the VIX fell to a 3-day low (16.46) while USTs continued to rally with 10yr yields breaking through the 1.600% level for the first time since mid-November to settle at 1.587%.
US dataflow was mixed. The November non-manufacturing ISM rose +0.5 points to 54.7 (vs 53.5 expected) mainly reflecting a pick-up in business activity (61.2 vs. 55.4). DB's Joe Lavorgna points out however that the employment subcomponent, which is arguably the most important piece of information within the survey fell 4.6 points to 50.3 - the lowest level since July (49.3). The ADP employment report showed that hiring fell to +118k (vs +125k expected and +157k the previous month).
Turning to overnight markets, risk assets are generally lacking firm direction this morning as most Asian equity indices sway between gains and losses. The Shanghai Composite (-0.55%) is once again underperforming the broader moves in the region despite the impressive 2.9% gain yesterday. The Nikkei is the clear outperformer (+0.73%) on the back of the USDJPY’s performance yesterday (+0.7%), and helped by the latest poll from the Nikkei newspaper suggesting the opposition LDP will sweep more than half of the lower house’s 480 seats in the next election. 10yr JGB yields are down a further 2bp overnight, and are currently trading at 9yr lows of 0.701% despite the opposition’s pledge to target 2% inflation.
The KOSPI (+0.1%) is poised to finish with a small gain, while the Hang Seng (-0.13%) and ASX200 (-0.25%) are in the red as we type. In credit markets, the Australian and Asian IG indices are trading relatively flat to yesterday’s close.
In other headlines, the ECB’s Joerg Asmussen conceded that European officials can no longer meet their pledge to complete the framework for an EU-wide banking union by the end of the year despite finance ministers planning to resume discussions next Wednesday – although we suspect that such an outcome was expected by many. The FT wrote that the UK’s AAA rating from Fitch is “under threat” following the rating agency’s statement that weaker growth will make it impossible to hit the government’s target to have falling public sector debt by 2015-16. Fitch wrote that “missing the target weakens the credibility of the UK's fiscal framework, which is one of the factors supporting the (AAA) rating".
Staying on the subject of rating changes, S&P downgraded Greece’s rating to SD (Selective Default) from CCC overnight, saying that the buyback constitutes “what we consider to be a distressed debt restructuring”. It’s unlikely to be market moving given Greece has been downgraded to SD before back in February following the PSI announcement. S&P did say that Greece will likely return the to CCC once the buyback is completed.
Looking at the day ahead, the focus will be on the ECB and BoE meetings with market consensus expecting no major changes in policy from either central bank. Draghi’s postmeeting press conference is scheduled for 1:30pm London time where our European economists expect the ECB President to maintain a relatively dovish tone. In terms of data, Eurozone Q3 GDP, German factory orders and France’s unemployment report are the main data points. In the US, US jobless claims will be the key event to watch ahead of Friday’s payrolls.