The central bank "reason" goal-seeked for today's US overnight ramp - because it sure wasn't fundamentals with both German exports (-2.4%, Exp. +0.1%) and Industrial Production (-1.0%, Exp. -0.5%) missing - was the weekend Spiegel story that despite the unanimous decision by the ECB last week to keep rates unchanged, ECB chief economist Peter Praet and Mario Draghi himself had insisted on a 25 bps rate cut. They were, however, stopped by seven council members from the northern euro states, including Weidmann, Knot and Asmussen. As a result, Draghi was steamrolled in the final vote. Yet somehow this is bullish for risk, pushing equity futures higher and peripheral debt spreads lower, even as the EURUSD has drifted higher.
Of course, one can't have an even more dovish ECB as a risk on catalyst alongside a rising Euro, but who cares about news, fundamentals, or logic at this point. All that matters is that US futures are higher, which was especially needed following yet another rout in the Shanghai Composite which dropped 2.44% back under 2,000 following news that China's Finance Ministry has told central government agencies to cut expenditures by 5% this year, and a 1.4% drop in the PenNikkeiStock225 on a weaker USDJPY. Remember: all is well in the global economy (whose forecast is about to be cut by the IMF) if the US is generating a record number of part-time jobs.
In other completely expected news, the status quo in both Portugal and Greece appears to have been preserved, with an agreement to preserve the Portuguese ruling coalition emerging after Prime Minister Pedro Passos Coelho said Paulo Portas, leader of the CDS party, will become vice premier as part of an agreement to hold the coalition together. Greek Finance Minister Yannis Stournaras said the government probably will reach a deal with international creditors before today’s Eurogroup meeting.
With little on today's docket, and abysmal volumes guaranteed, expect the BTFD algo to continue churning along in the face of all adversity. After all, Larry "Mr Burns" Summers, who now is said to "be interested in taking over for Bernanke", will soon have its back.
Another very weak earnings season kicks off today (keep an eye out on the guidance cuts) with Alcoa, but in a centrally-planned world, who cares about earnings also?
Main overnight news in bulletin format via Bloomberg:
- Treasury yields holding near highest levels since 2011 after Friday’s better than forecast U.S. jobs report bolstered expectations for Fed trimming asset purchases; Goldman, JPM now expect taper to start in September.
- German/U.S. 10Y spread at widest since 2006 after ECB provided forward guidance at last week’s meeting, with Draghi saying policy will “remain accommodative for as long as necessary”
- China’s money-market cash squeeze is likely to reduce credit growth this year by 750b yuan ($122b), an amount equivalent to the size of Vietnam’s economy, according to a Bloomberg News survey
- Euro-area finance ministers will probably approve the latest disbursement of bailout aid to Greece when they meet in Brussels later today, an EU official said
- German industrial production fell 1% in May, more than forecast; exports also declined and factory orders dropped for a second month
- Japan investors sold a record JPY2.96t of overseas bonds and notes in June, the Ministry of Finance said today; sales of U.S. debt, which included JPY2.998t yen in net sales of U.S. sovereigns, were most on record in data going back to 2005
- Supporters of deposed Egyptian President Mohamed Mursi clashed with the military today outside a main security installation, in violence that authorities said killed at least 42 people
- BofAML Corporate Master Index OAS narrows 2bps to 164bps; $1.3b priced last week. Markit IG steady at 86bps, YTD range 69bps-98bps. High Yield Master II OAS narrows to 504bps from 515bps; no deals priced last week. CDX High Yield at 103.09 from 102.87 Friday
- Sovereign yields mixed, with EU peripherals falling. Nikkei falls 1.4%, Shanghai Composite falls most in two weeks as Goldman cuts earnings forecasts for mining companies. Europe equity indexes gain. U.S. index futures higher. WTI crude lower, gold and copper gain
- Spanish 10-yr yield down 2bps to 4.63%
- Italian 10-yr yield down 4bps to 4.39%
- U.K. 10-yr yield unchanged at 2.49%
- German 10-yr yield unchanged at 1.72%
- Bund future up 0.02% to 141.69
- BTP future up 0.28% to 110.93
- EUR/USD up 0.13% to $1.2846
- Dollar Index down 0.05% to 84.41
- Sterling spot up 0.07% to 1.49
- 1-yr euro cross currency basis swap down 1bp to -17bps
- Stoxx 600 up 1.4% to 292.36
DB summarizes the key events from the weekend:
The after-effects of Friday’s above-consensus US payrolls, and the pricing in of potential Fed tapering, continue to be felt across markets on Monday morning. Although 10yr UST yields are a touch firmer overnight at 2.70% (-5bp), Asian equities are weaker and other EM asset classes such as credit and currencies are under pressure. In equities, most Asian bourses are 1%-2% lower across the board paced by the Hang Seng (-1.9%) and KOSPI (-1.0%) while higher beta equity markets such as Indonesia (-2.6%) and Philippines (-2.6%) are underperforming. In China, the Shanghai Composite (-1.7%) is also lower following news that China's Finance Ministry has told central government agencies to cut expenditures by 5% this year, a move the official Xinhua news agency said was part of an austerity campaign launched by the country's new leaders. A ministry circular ordered spending cuts in a range of areas, including the building and renovation of government offices, meetings, domestic and overseas trips, vehicles and official receptions, Xinhua reported on Sunday (Reuters). The Nikkei is outperforming in relative terms (-0.2% as we type) helped by the yen’s weakening against the USD (-1.2%) following last Friday’s payrolls. Asian credit markets are about 5-10bp wider weighed by Friday’s move in treasuries, albeit amidst low volumes. In the currency space, USD strength remains a core theme (dollar index +0.15% as we type) with the Australian dollar 0.25% weaker against the USD this morning.
Coming back to Friday’s payroll print, while the headline number came at +195k, which was significantly better than consensus estimates of +165k, it’s also worth noting the +70k in upward revisions to the last two months’ results. This had the result of pushing the YTD average monthly gain to +202k. DB’s US economists highlight that this is substantially better than the 94k (initially reported) trend that had prevailed last September at the time of QE3, and therefore the latest labor news keeps the Fed on track to begin tapering at the upcoming September 17-18 FOMC meeting in their view. The unemployment rate remained unchanged at 7.6% with the +302k gain in private household employment dampened by a -204k decline in government employment, likely due to the sequester. The labor force participation rate also ticked up one-tenth to 63.5%.
In terms of the market reaction to payrolls last Friday, perhaps the most notable move was in treasuries where the 10yr yield added 24bp with the market expectations of QE tapering seemingly brought forward. US yields are now at their highest level in 3 years. In basis point terms, Friday saw the largest upward move in 10yr yields since the 2008-2009 financial crisis. Also reaching a 3 year high was the USD index (+1.5%) while EURUSD lost 0.66%. Interestingly, the S&P500 shrugged off the higher rates, recovering from the early lows to post a 1% gain on the day. Gains in equities were led by banks (+2.1%) while real estate stocks underperformed (-0.16%) – the latter probably due to the prospect of higher rates. EM equities were less resilient however with Mexico’s IPC (-1.4%), Argentina’s MERVAL (-1.1%) and Brazil’s IBOVESPA (-1.2%) all down by more than a percent. In the fixed income space, US 10yr breakevens added 4bp and are now 15bp higher than their June lows of 1.92%. The CDX IG index widened about 4bp following the payrolls print to close about 1bp wider on the day.
Turning to the week ahead, the highlight of this week’s event calendar is likely to be the minutes from the June 18-19th FOMC meeting which will be published on Wednesday. Although the June FOMC meeting was held before the release of the latest round of payroll data, the meeting did conclude with Fed saying that “the downside risks to the outlook for the economy and the labor market as having diminished since the fall” which was followed up by Bernanke suggesting QE tapering could begin later this year. Later on Wednesday, Bernanke will be speaking on the topic “The First 100 Years of the Federal Reserve: The Policy Record, Lessons Learned, and Prospects for the future” which will be followed by Q&A. The Fed's Plosser and Bullard will be speaking at Jackson Hole, Wyoming. Note that this event is separate to the Fed’s annual marquee summit hosted by the Kansas City Fed which is currently scheduled for August.
This week also marks the start of the US Q2 reporting season. Our US equity strategist, David Bianco, expects top-line growth to be uninspiring with ongoing weakness in manufacturing, business spending and trade. But he expects 2Q EPS growth of 3% year-on-year, with some upside risk, helped by share buybacks and a slight improvement in margins. As usual, industrial bellwether Alcoa will kick off proceedings when it reports after the market close today. As it currently stands, analysts are expecting EPS and revenues of $0.06 and 5.788bn respectively, but these expectations have been revised down sharply overly the past several weeks. On Friday, JP Morgan and Wells Fargo will be amongst the first major banks to report.
In Europe, Draghi speaks at the quarterly Economic and Monetary Affairs Committee hearing today. The two-day Eurogroup/ECOFIN meeting begins today to consider the latest tranche of financial aid for Greece (EUR8.1bn, of which EUR1.8bn is due to be signed off by the IMF Board by the end of July). DB’s economists believe that the best case outcome is a total completion of these outstanding issues and the Eurogroup agrees to disburse the tranche immediately. More likely, however, is a conditional agreement to disburse in monthly mini-tranches on the basis of milestones over the subsequent three months determined by the outstanding policy gaps. This 'muddle through' we expect will be enough to assuage IMF concerns about sufficient funding.
The economic data calendar looks relatively sparse on both sides of the Atlantic. In the US, the focus will be on PPI and the July preliminary UofMichigan consumer sentiment survey both of which are scheduled for Friday. In Europe, May industrial production numbers for Germany (Monday), France, Italy (Wednesday) and the EMU (Friday) are the major data releases.
In Asia, China reports June inflation readings on Tuesday followed by trade data on Wednesday. Of some interest will be the money and bank loan data for the month of June which may provide some indication as to whether last month’s interbank liquidity squeeze has affected wider lending activity. In Japan, the BoJ begins its 2-day policy meeting on Wednesday. Trade balance (Mon), machine tool orders (Tues) and industrial production (Fri) are the main Japanese data releases. Koichi Hamada, monetary policy adviser to PM Abe, speaks at an economic forum on Thursday.
SocGen goes over the main FX macro highlights for the day
The differentiation between US, EU and UK central bank policies crystallised last week and its impact on the FX and rates markets was laid bare on Friday after a strong US payrolls report lifted UST yields and the USD, but added to selling pressure on commodities. The US/EU 10y swap spread moved to within breathing distance of 100bp, the highest since 2007, and US/UK 10y swaps to 35bp, the highest since 2006. The introduction of forward guidance by the ECB, and likely in a more formal format by the BoE in August, is still in its infancy compared to that of the Fed where preparations for stimulus exit will now be difficult to play down, even by the more dovish FOMC members. The sharp nature of recent moves suggests that an overshoot of the UST10 to 3.00% cannot be ruled out in the short term. After the 175k payrolls print on 7 June, 10y yields reached a high of 2.29%, a 22bp increase over three days. The next FOMC meeting is scheduled at the end of this month, but although Friday's data was solid, it will not prompt the Fed to start tapering soon. Bernanke's semi-annual testimony on 17 July is the next signpost and should clarify that policy won't be altered until after the summer. However, the bond market is still adjusting to this new reality and the Fed has to ensure that the policy transition happens smoothly.
The NOK was the hardest hit currency in the G10 (and EM) universe last week, followed by the ZAR, GBP and TRY. On a PPP basis (OECD), the NOK and the CHF are among the most overvalued currencies in the G10 space and will be subject to further depreciation as long as the normalisation in US yields continues to draw liquidity out of safe havens and commodity-linked exchange rates. Low for longer remains the mantra among most G10 central banks including the Scandis and Switzerland. The Fed is on the same wavelength for the Fed funds rate but, as we saw last week, pricing in tapering is accompanied by a shift higher in the front end of the US money market curve also. The moves have been less marked compared to the long end, but Fed fund futures currently price in 0.415% by December 2014. Chairman Bernanke may wish to correct expectations during his Congress testimony in two weeks.
The spotlight today will be predominantly on the Eurogroup meeting (decision on Greece), and ECB president Draghi's quarterly testimony to the EP and speeches by council members Weidmann and Coeure. A reiteration of the ‘forward guidance' means the ST selling in EUR/USD may not be over until we reach 1.2750.