Risk assets are not quite (yet) back to the ‘melt-up' of May but equity markets are trading in a confident mood after Bernanke caused sentiment to flip from glass ‘half empty' to ‘half full'. China Q2 GDP data did not derail price action as equity futures anticipate a positive start of the week. The semi-annual testimony of the Fed Chairman is typically a seminal event on the market calendar but do we dare say that the one coming up this week is a non-event following last week's message on policy accommodation? The VIX index dropped 7 points over the last three weeks of which 2 points alone came last Thursday and Friday as stocks roared to new highs and shrugged off the candid observation on the Chinese economy by finance minister Lou Jiwei. If a 6.5% growth rate is tolerable in the future, there is little doubt that commodities and the AUD have further to fall. Chinese GDP slowed from 7.7% to 7.5% according to data released overnight and prospects for the second half don't look much brighter after evidence of slowing credit growth. Data on Friday showed declines of narrow money from 11.3% yoy to 9.1% in May, with broad money growth slowing to 14% yoy. Non-bank credit and new foreign currency bank lending also weakened.
Much deep though has been put into the Chinese data released overnight, which of course is an exercise in futility: the "data" (which was inferred perfectly vs PMI data as shown below) reflects simply what the Politburo wants it to reflects and serve financial policy, not anything actually happening in the real world. Still that it did not tumble any lower has been taken as a good sign that despite the imminent massive deleveraging about to hit China (unless the PBOC folds), China is proceeding on a golidlocks path of reform without crushing its markets and starving liquidity, or at least this is what is being telegraphed. Of course, when it comes to the bottom line, the one thing to know is that power generation in the first half rose 4.4%, which the economy grew "7.6%." Still, despite the slowdown, the number was agreeable to all, as confirmed by the 1% closing print in the SHCOMP.
The data from China carried over into Europe, whose stocks traded higher this morning, as market participants breathed a sigh of relief following the inline reading and also welcomed comments from PBOC's Zhou who said that China is to continue to lower the RRR for medium and small banks. Given the absence of market participants in Japan due to market holiday meant that traders in Europe were able to capitalise on the muted USD/JPY price action, which saw the pair cross the 100.00 level for the first time in three days. Consequent USD strength weighed on both EUR/USD and GBP/USD since the European open.
Despite the risk on sentiment, Portuguese stocks have underperformed their peers this morning, with financials under particular selling pressure. Press reports over the weekend indicated that the opposition leader Alfredo Perez Rubalcaba called for the immediate resignation of Spanish PM Rajoy and warned that his refusal to stand down was causing incalculable damage to the country. His call was echoed by other opposition leaders. As a result, Portuguese PSI-20 index traded lower by almost 1% and the Portuguese biggest lender Banif was nursing losses close to 12%. The contagion effect meant that the IBEX-35 index in Spain also traded lower, with financials under pressure amid the potential freeze in liquidity should conditions deteriorate further in Portugal.
In Europe, stocks were led higher by financials and tech sectors, with Commerzbank up over 3% following reports that Germany met with UBS to discuss selling the government's stake in the bank. At the same time, defensive stocks such as healthcare underperformed, which meant that the SMI index over in Switzerland lagged its EU peers. Going forward, market participants will get to digest the release of the advanced retail sales report and the Empire Manufacturing for the month of July.
Looking at today's macro highlights SocGen reminds us that US retail sales data for June will kick off a busy week for global markets but the semi-annual testimony on the economy by Fed Chairman Bernanke on Wednesday towers high above all the other events. It is a quiet week for eurozone data but as Friday's sell-off in Portugal benchmark bonds shows, EU officials may be scrambling to restore and prevent negative contagion from spreading. The ripple effects from surging PGB yields across the curve have so far been contained and the EUR has not responded which shows the market is interpreting the jitters as an isolated event. However, the fact is that Portugal is not eligible to access to the OMT and so a second bailout is going to be increasingly discounted which means the trend of higher yields may prove irreversible. The 2y and 5y maturities already breached the early July highs on Friday and it may be only a matter of time before the 10y returns above 8.107%.
US retail sales are the focus today and our forecast of a 1.2% mom gain is well ahead of the 0.7% consensus (0.9% ex autos and gas vs 0.5% consensus). We have also pencilled in a rise for Empire manufacturing to 8.5 vs 7.84 previously.
Finally, one last glance at Chinese GDP "data" which lst SocGen scratching its head:
There are several puzzling details to us. First, the year-to-date contribution of gross capital formation rebounded strongly to 4.1ppt from 2.3ppt in Q1 and also a touch higher than the 4ppt in Q2 2012, which nearly offset the 1ppt decline in the contribution from net exports (0.1ppt ytd). Second, nominal GDP growth decelerated much more sharply from 9.6% in Q1 to 8%, as the deflator increased just 0.5% yoy (1.7% yoy in Q1). We find this deflator somewhat too low given the monthly inflation data published over the quarter. In comparison, Q4 2009 had much lower CPI, similar PPI, lower export price inflation and higher import price inflation, but yet the GDP deflator was significantly higher at 1.4% yoy.
Following data releases, when asked by the media if 7% is the minimum tolerable growth for Beijing, the spokesperson of the National Statistic Bureau replied that there is not any fixed number. We view this as yet another signal that the new leaders’ tough love stance will not be easily swayed, at least not by this latest set of data. We continue to see limited chance of any significant monetary easing or infrastructure stimulus from Beijing in the near term, and so economic growth is expected to step down further in H2.