Overnight Futures Ramp Right On Schedule
At this point it has gotten painfully tedious, and the one phrase to describe trading is - Same Pattern Different Day. With equity futures closing decidedly weak on earnings reality after US market close, the slowly, steady overnight ramp seen every single day for the past month has returned as always, this time on yet another largely expected German confidence indicator beat (following the just as irrationally exuberant ZEW some time ago, and yesterday's far better than expected PMI), this time the IFO Business Climate, which printed at 104.2, on expectations of 103 and up from 102.4. This was driven by both the current assessment rising from 107.1 to 108 and the Expectations rising from 97.9 to 100.5. Naturally, all confidence indicators will be skewed in a way to prevent the market from doubting for a second that Germany may actually succumb to the same recession that has gripped all other European countries (which Germany is an inch away from after its negative Q4 GDP). In other words: there is hope. As for reality, UK Q4 GDP came in at -0.3% on expectations of a far lower drop to -0.1%, and down from the olympics-boosted 0.9% in Q3. The UK certainly can't wait for Mark Carney to come and show them how cable devaluation is really done, cause this time it will be different, if only it wasn't different for everyone else.
But the most anticipated news of the day was the previously reported LTRO repayment, which came in far "stronger" than expected. Initially this was taken as positive as it means the ECB's balance sheet will shrink at a time when everyone else is engaging in open balance sheet busting FX warfare, even if in reality this is a deflationary outcome leading to even more appreciation for the EURUSD, and even more pain for both the European trade and current account balance. As Deutsche Bank explained, "the market will likely continue to have some focus on the fact that the ECB balance sheet is likely to be steadily shrinking for a period at a time when the Fed is effectively increasing its by $85bn/month and where Japan is seen by many to be set to notably increase its interventions. So while the repayments are not a big deal in themselves the contrast between the ECB and many other central banks means that the Euro is probably biased to appreciate for the foreseeable future. This might provide an unwelcome headwind for growth in Europe later in the year." And, naturally, a few hours before the LTRO announcement, none other than Italy's Monti said that a strong EUR could harm exports, something we already showed for Spain.
More from Deutsche Bank:
Today is the day the ECB unofficially starts to exit from unconventional monetary policy as Euro-area banks now have the option to repay some of the 1 trillion Euros of LTRO money afforded to them last year. Banks can now hand back money with one week's notice, and today at 11am London time is the first announcement of what they have initially done. It’s likely that any repayment will be biased towards stronger banks and as such there's no real immediate systemic risk from this story. However the market will likely continue to have some focus on the fact that the ECB balance sheet is likely to be steadily shrinking for a period at a time when the Fed is effectively increasing its by $85bn/month and where Japan is seen by many to be set to notably increase its interventions. So while the repayments are not a big deal in themselves the contrast between the ECB and many other central banks means that the Euro is probably biased to appreciate for the foreseeable future. This might provide an unwelcome headwind for growth in Europe later in the year. Despite the promise of the OMT, Europe is in danger as being seen as the least active in the near-term in the currency war skirmishes that are focusing investors minds at the moment. Maybe actions elsewhere and a higher Euro will eventually lead to the ECB balance sheet expanding again after some market stress but this is further down the road.
While on European matters, Draghi is expected to speak at Davos today at 930am London time so it'll be interesting to hear if he continues to give off an air of increased confidence and whether he discusses the currency at all. Data wise Europe had a mixed day yesterday but the US was strong. In terms of the flash PMIs, Germany (48.8 vs 47.0 expected for Manufacturing, and 55.3 vs 52.0 for Services) was strong but weakness in France (42.9 vs 44.9 expected for Manufacturing, and 43.6 vs 45.5 expected for Services) was notable. The overall European number beat expectations but Germany played a large part in this. Our European economists think that these numbers are consistent with a flat Italian and Spanish composite reading when the data comes out next Friday. The Flash Markit US PMI number was very strong (56.1 vs 53.0). This release is still in its infancy with little track record but if it’s close to being consistent with the official ISM then US markets are not mis-priced at current levels. Indeed in our ISM/S&P 500 simple regression model, at current levels US equities are broadly pricing in an ISM of 54.7. The last ISM was at 50.7 though so the flash PMI is well ahead for now and a bit of caution is required. In Europe the market is much more ahead of the economy as our simple model suggests that equities are broadly pricing in a French, German and Euro-area PMI of 54.5, 56 and 54, respectively (against yesterday’s flash manufacturing numbers of 42.9, 48.8 and 47.5). This is all quite sweeping but in general the US economy is showing signs that it might be living up to some of the faith the equity market has recently shown in it whereas Europe still has a long way to go.
As we said in the 2013 outlook, liquidity and the benefit of the doubt will likely dominate in Q1 and market should generally be in decent shape. However we do need to see Europe show more consistent and broad growth for European markets not to have a set-back in Q2. The jury is still out on this and a steadily increasing Euro won't help.
Moving on to the market, yesterday saw the S&P 500 breach the symbolic 1500 mark for the first time since 2007 before chatter of a Financial Transactions Tax helped reverse all of those earlier gains. US data flow was generally positive supported by a larger-than-expected drop in initial jobless claims (330k v 355k) and the stronger preliminary PMI as mentioned above. Although we should note that the regional manufacturing surveys from the Kansas Fed yesterday (-2 vs +1) and the Richmond Fed on Tuesday (-12 v +5) were both disappointing.
The S&P 500 finished the day virtually unchanged with the NASDAQ (-0.74%) being a standout underperformer amongst major indices as sentiment for Tech stocks softened on the back of Apple’s results.
Turning to Asia and overnight markets are mixed. The Nikkei (+2.5%) is leading the pack as the continued fall in consumer prices probably added further easing optimism. Core CPI fell - 0.6% yoy in December which is a touch more than expected (-0.5% yoy).
The JPY fell to 90.5 against the Dollar and is now 2.7% off the intra-week highs. Elsewhere the Hang Seng (- 0.3%) and the KOSPI (-1.1%) are both lower with the latter particularly being impacted by the renewed weakness in JPY.
In other news EU’s Olli Rehn said that he is unsure that the Euro is overvalued now but would not want to see a currency war of competitive devaluations which would have a negative effect on the Euro. On the peripheral countries, Rehn said there are several options under consideration to help Dublin and Lisbon return to markets including possibly extending the maturity of bailout loans or providing a new precautionary credit line.
In terms of today, Germany’s IFO survey and UK GDP for the fourth quarter will be the data highlights in Europe. The New home sales report is the only major release in the US. So all eyes will be on the ECB’s LTRO prepayment announcement and Draghi’s speech at Davos today.