The global liquidation wave started with Bernanke's statement yesterday, which was interpreted far more hawkishly than any of his previous public appearances, even though the Fed had been warning for months about the taper (even if meant sacrificing what little credibility Hilsenrath had following his latest "blog" article). Still, markets were shocked, shocked.
Then it moved to Japan, where for the first time in months, the USDJPY and the Nikkei diverged, and despite the strong dollar, the Nikkei slumped 1.74%. Then, China was swept under, following the weakest HSBC flash manufacturing PMI print even as the PBOC continued to not help a liquidity-starved banking sector, leading to the overnight repo rate briefly touching on an unprecedented 25%, and locking up the entire interbank market, sending the Shanghai Composite down nearly 3% as China is on its way to going red for the year.
Then, India got hit, with the rupee plunging to a record low against the dollar and the bond market briefly being halted limit down.
Then moving to Europe, market after market opened and promptly slid deep into the red, despite a services and mfg PMI which both beat expectations modestly (48.6 vs 47.5 exp., 48.9 vs 48.1 exp) while German manufacturing weakened. This didn't matter to either stocks or bond markets, as peripheral bond yields promptly soared as the unwind of the carry trade is facing complacent bond fund managers in the face. And of course, the selling has now shifted to the US-premarket session where equity futures have seen better days. In short: a bloodbath.
In fact, no fundamental news at all mattered for a market that is now in liquidation panic mode, selling equities, bonds and commodities across the board: the 10 Year Treasury hitting 2.45% moments ago will not help with the impression that things are spiralling out of control, and the only sell off that is helping the Fed's cause is that of gold which tumbled to two year lows under $1300, driven by a scramble for dollars.
Of course, what the market is forgetting is that just like in Japan a month ago, the volatility that will emerge from Bernanke's hawkish stance will lead to a sell off, which in turn will force the Fed to promptly undo any taper talk, and even promptlier lead to speculation when the untaper will hit. Which is to be expected in a market in which over 50% of the gains since 2009 are on the back of the $12 trillion in global central bank liquidity.
Either way, the plunge protection team will have its hands full this morning to put a halt to the equity sell off. We wish them luck.
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A different summary of overnight's action from RanSquawk:
Stocks and bonds under pressure in Europe as markets re-price Fed QE tapering expectations. The price action was dominated by bond vigilantes this morning, with stocks also in free-fall mode as market participants reacted to the release of less than impressive macroeconomic data in China, but also digested the statement and more importantly comments by the governor Bernanke who suggested that tapering could begin this year. The belly of the treasury curve bore the brunt of the sell-off, while credit spreads blew out overnight in Asia and in Europe this morning as the USD rallied and the index looks set to make a test on the 1000MA level at 82.18. The USD was also supported by worsening liquidity conditions in the Chinese interbank market, where the 7-day repo rate soared. Heading into the North American open, stocks are seen lower across the board, with basic materials and financials seen as the worst performing sectors, while health care stocks outperformed given the flight to quality sentiment.
Going forward, market participants will await the release of the latest weekly jobs data, as well as the Philadelphia Fed survey.
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A bulletin recap of all the news highlights via Bloomberg
- Treasuries extend yesterday’s losses after Bernanke indicated Fed is prepared to begin phasing out its easing, with tapering of $85b in monthly bond buying later this year, halt purchases around mid-2014
- 5Y yields surged as much as 22bps yesterday, most since Jan. 1962; 5Y-30Y yields all at highest levels since August 2011
- Unwind tactical UST 5Y longs on more hawkish Fed, JPM says
- China’s benchmark money-market rates climbed to records as the central bank refrained from using reverse-repurchase agreements to address a cash crunch
- China’s manufacturing is shrinking at a faster pace this month, adding to stresses in the economy and financial system
- Investors are pulling money from emerging markets at the fastest pace in two years as slowing economic growth and the prospect of less global stimulus sink stocks, bonds and currencies from India to Brazil
- Swiss National Bank President Thomas Jordan pledged to defend the Swiss currency ceiling “with utmost determination” after the central bank underlined the measure’s importance in protecting the economy
- Norges Bank signaled interest rates may be cut later this year as inflation is slowing more than projected amid weakening economic growth in western Europe’s largest oil producer
- JGBs are set for the worst quarterly performance in a decade as the central bank’s unprecedented buying of the debt crowds out investors and increases volatility
- MSCI Pacific Index dropped 4.2%, most in two years
- Five U.K. banks including Barclays, RBS and Lloyds must find GBP13.4b ($21 billion) to plug a GBP27.1b capital shortfall by the end of the year, the Bank of England said
- Sovereign yields surge. Nikkei falls 1.7%; Asian, European equity markets and U.S. index futures uniformly lower. WTI crude falls, copper and gold plunge
SocGen highlights the main macro events:
The dust is settling on the FOMC announcement of yesterday evening and realistically speaking, today's packed data and event calendar should not be too influential we suspect. Central bank decisions in Norway and Switzerland are likely to stick to the ‘low for longer' mantra on interest rates in contrast to the US where the Fed yesterday took another step towards normalisation and the weaning of excess liquidity. Don't fight the Fed: tapering may start later this year and asset purchases may cease altogether in mid 2014 if the economy (read labour market) follows the Fed's projected path (jobless rate forecast lowered for 2013 and 2014; more insight from SG economics here). The back up in UST 10y yields carried on overnight, further inflating US/G10 and US/EM rate differentials and supporting the USD across the board. The outflow of bonds into cash is set to continue. EM currencies predictably took a severe hit but the AUD is competing for the crown of worst performer. A break of 0.9216 in AUD/USD opens up a return to the Jun-10 low of 0.8067.
Turning to the SNB, annual CPI inflation in Switzerland has averaged 0.55% so far in Q2 which means that it is not following the official central bank forecast. In March, the SNB put out a Q2 forecast of -0.4% which would only be reached on a leap from -0.4% in May to -0.1% in June. Unlikely. And with the EUR/CHF and the trade-weighted franc having surrendered all of the gains since the March meeting, the case for another downward revision to the inflation forecast is a foregone conclusion. Look for the SNB to reiterate that it will enforce the minimum EUR/CHF 1.20 rate with the utmost determination. But as the normalisation in US rates gathers momentum in the second half and the eurozone turns the corner, the erosion of the franc's safe haven status is anticipated to continue. The 3.4% retracement from the 1.2650 high was reminiscent of the move in January and February, but the correlation of EUR long-term rates with the US should soon cause the uptrend to reverse. This should lead participants to pay up for EUR/CHF vol and narrow the gap with EUR/JPY vol.
In the eurozone, the preliminary manufacturing and services PMIs from Germany and France will draw close attention. A narrowing in the difference between the PMIs of both countries started to materialise in late spring and, though a gap of 3pts and 5pts respectively in manufacturing and in services continues to exist, confirmation today of the mild improvement from the lows and a cheapening in EUR/USD will keep a lid on expectations of further ECB easing. Where the Spanish and French auctions are concerned, we look for good demand in 5y and 8y Bonos and see more value in 2y vs 5y OATs.
In the US today, we will get weekly initial claims and the Philly Fed survey. In the UK, a 1.0% gain in May retail sales is forecast to reverse two successive months of decline.
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And finally, Jim Reid from DB wraps it all together:
If the Fed’s new revised economic forecasts are correct then over the medium term there is not much to worry about them being more hawkish than expected last night. However, will their expectation that tapering will start before the end of 2013 and bond purchases be totally removed by mid-2014 actually cause a global risk sell-off that means these forecasts end up being too optimistic? If so, then the pace of tapering will end up being slower than the scenario painted last night by Bernanke. But for now there’s little doubt that this was a hawkish FOMC as the Fed showed little desire to squeeze the tapering genie back into the bottle. Investors have been given warning that liquidity and carry sensitive trades are dangerous if the summer sees stronger data.
So where do we go from here? Well, the Fed have just made the market even more sensitive to data than it was previously and the volatility surrounding each key data print will likely multiply. We now think this will be a difficult few weeks for risk, especially if the data is on the stronger side. If you wanted to be more sanguine you would highlight the fact that they remain data dependent and no stimulus reduction has been announced yet. The removal still requires another few weeks of improving data. It might now need data to disappoint over the summer
for risk to perform.
As we wrote yesterday, the last two quarters have seen the lowest US nominal GDP since Q1 in 2010 – some 13 quarters ago now. This has recently been a weakening nominal recovery and one that even at its peak was still very weak relative to history. Clearly the Fed has emphasized many times the difference between the end of asset purchases and a policy rate hike but investors may perceive the latest signalling as the beginning of a ‘tightening’ journey. If that’s the case we note that the Fed has never hiked rates in the past when nominal GDP is growing below 3.5% (3.4% in Q1 2013). Furthermore, for the Fed to be tightening while nominal GDP has been weakening is also a rare occasion. The last time we saw this was in 1979/80 when nominal GDP fell from 14.6% in Q1 1979 to 10.6% in Q1 1980 whilst the Fed Funds rate rose from 10% to 20% during the same time on sharp inflationary concerns. What’s also unusual is that yesterday’s ‘tightening’ came as the Fed lowered their projections for core inflation to 1.2-1.3% from 1.5-1.6% for year-end 2013 although they noted that there are transitory influences, and acknowledged that inflation over the medium term will likely run at or below its 2% objective. So they are hoping by the time the tapering is underway nominal GDP will be edging back up but it will still be a low nominal growth environment to be withdrawing stimulus.
So what was the market reaction last night and this morning? Starting with last night, the S&P500 managed to limit its losses initially following the FOMC’s statement, as markets digested the Fed’s comment about “diminished” downside risks to the economic outlook. But the sell-off gathered steam as Bernanke started his press conference and his talk of tapering and the ending of QE next year. The S&P500 closed at a session low of -1.39% and now stands about 2.4% below its May all-time high. By sector, the higher yielding telco (-2.7%), utilities (-2.25%) and consumer goods (-1.8%) industry stocks were the underperformers. In fixed income, 10yr UST yields jumped 17bp to close at a 16-month high of 2.33%. The belly of the treasury curve bore the brunt of the sell-off. Yesterday’s rise in 10yr yields was also the largest one-day increase in basis point terms since October 2011. Indeed, 10yr yields were last seen at these levels March 2012. But we have to go back to mid-2011 to find a time when 10yr yields traded consistently above 2.30%. On the inflation front, US 10yr breakeven rates fell 3bp to their lowest level in a one year (2.04%) while in DM credit, the IG20 widened sharply post-FOMC to close 7bp wider. The EM complex remains under enormous pressure with the MSCI EM Latam equities index down 3.5% last night with Latam sovereign CDS anywhere between 16-30bp wider on the day. The US dollar (dollar index +1%) was perhaps one of the few assets to see strength yesterday.
The risk-off sentiment has continued in Asia with equities and credit markets all weaker as we type, but some markets have managed to stabilise towards the second half of the session. The disappointing Chinese HSBC Flash Manufacturing PMI (48.3 v 49.1 expected) and the worsening liquidity conditions in the Chinese interbank market are unlikely to improve sentiment today. On the latter point, China’s 7-day repo rate rose by 374bps overnight to a record 12%. The Shanghai Composite (-0.7%) is down for the second consecutive day and the benchmark has fallen 13 out of the last 15 trading sessions. Asia credit spreads are also markedly wider overnight with the Asia iTraxx IG about 22bp wider at one point.