Overnight Levitation Is Back On Hopes Of Draghi Hopium Salvage

Crashing Australian and a miss in South Korean PMIs, following days of weak Japanese data, and a divergence in the official and HSBC Chinese manufacturing indicators to a 15 month high (HSBC PMI sliding to 11 month low) was just the bad news Asian market needed to break out higher from the recent range and thanks to the return of overnight USDJPY levitation as well as a modest reverse repo liquidity injection by the PBOC overnight, not only did the Nikkei and Shanghai rise 3% and 1.8% respectively, but US futures are right back to where they were before yesterday's dramatic turnaround in the market following a strongly dovish FOMC statement and just shy of the 1700 once more. As for Europe, while there a smattering of noise following the release of final PMIs which did not change the preliminary picture much (Spain 49.8, vs 50.6 exp; Italy 50.4 vs 49.8 exp; France 49.7 vs 49.8 exp; Germany 50.7 vs 50.3 exp) it is all up to the ECB today to preserve the myth of a European improvement coupled with a EUR currency at or near multi-month highs.

Look toward the ECB's press conference today at 8:30 am when it will be Draghi's turn to pick up the dovish baton from Bernanke who failed to inspire market hopium yesterday, and after the EURUSD soared yesterday, it will be the USDEUR's turn to surge when the ECB does all it can to regain some currency, and thus trade, competitiveness. More importantly, with lending to private institutions in Europe at record lows, one wonders just how much longer Europe can fools most of the people some of the time that its economy is "improving" when its primary lifeblood - credit - continues to decline.

A visual breakdown of the latest European mfg PMIs via Reuters. This is quite reminiscent of the last such pick up in a credit-starved Europe in early 2012 just before it resumed its downward slide once again.

A complete overnight market recap courtesy of RanSquawk

• Stocks and bonds remained bid throughout the session this morning, as market participants scaled back their expectations of higher policy rates following somewhat dovish FOMC statement.
• Market participants await monetary policy announcements by the BoE at 1200BST (0600CDT) and then the ECB at 1245BST (0745CDT).
• UK Manufacturing PMI (Jul) M/M 54.6 vs. Exp. 52.8 (Prev. 52.5, Rev. 52.9); highest since March 2011.

Market Re-Cap

Stocks and bonds traded higher in Europe this morning, as prospects of lower interest rates following somewhat dovish FOMC decision late yesterday resulted in bull flattening of money market curves and consequent credit spread tightening. Better than expected earnings from Lloyds and SocGen also buoyed investor sentiment, which in turn saw financials outperform on the sector breakdown. The positive sentiment was also evident in Asia, where equities benefited from yet another liquidity injection by the PBOC, which saw the 1y swap rate fall to a 1-month low. The move is the clearest indication yet that the central bank will become more proactive in managing liquidity and prevent a similar run on banks as observed in June should economic conditions deteriorate further.

Interest rate differential flows saw USD/JPY edge higher overnight and in Europe this morning, which in turn saw the pair top the 100DMA line located at 98.51. Elsewhere, firmer USD, as well as the release of much better than expected UK Manufacturing PMI (highest since March 2011) weighed on EUR/USD, while GBP/USD managed to edged back into positive territory. However this failed to prop up the 1y/1y GBP forward rate, which ahead of the MPC decision is trading at its lowest level since late May. Going forward, market participants will get to digest monetary policy announcements by the BoE, the ECB and also the release of the latest ISM Manufacturing report.

Asian Headlines

Chinese Manufacturing PMI (Jul) M/M 50.3 vs. Exp. 49.8 (Prev. 50.1).
Chinese HSBC Manufacturing PMI (Jul F) M/M 47.7 vs. Exp. 47.7 (Prev. 48.2); 11 month low

China State Council said China's potential growth rate has fallen to 7%-8% range and that it can't allow growth to slow to an unreasonable level.

EU & UK Headlines

Eurozone Manufacturing PMI (Jul) M/M 50.3 vs. exp. 50.1 (Prev. 50.1)
German Manufacturing PMI (Jul) M/M 50.7 vs. Exp. 50.3 (Prev. 50.3) - Highest since January 2012.
French Manufacturing PMI (Jul) M/M 49.7 vs. Exp. 49.8 (Prev. 49.8)
Italian Manufacturing PMI (Jul) M/M 50.4 vs. Exp. 49.8 (Prev. 49.1) - Expanded for first time since July 2011.

Spanish bond auction results: sells EUR 3.22bln vs. Exp. EUR 2-3bln. Relatively small auction size (roughly 10k Sep-Bund contracts), as well as around 23bps yield pick up offered by 10/18 vs. 07/18 bond, proved supportive of demand.

- Sells EUR 0.951bln in 3.30% 2016, b/c 3.3 (Prev. 2.57) and avg. yield 2.636% (Prev. 2.768%), tail 2.0bps (Prev. 2.6bps)
- Sells EUR 2.27bln in 3.75% 2018, b/c 1.7 (Prev. 2.1) and avg. yield 3.561% (Prev. 3.735%), tail 2.8bps (Prev. 3.3bps)

UK Manufacturing PMI (Jul) M/M 54.6 vs. Exp. 52.8 (Prev. 52.5, Rev. 52.9); highest since March 2011.

ECB's Draghi, in letter to member of European parliament, says ECB monetary policy will support recovery, which is expected to start in H2 2013

US Headlines

WSJ’s Hilsenrath noted that the description of growth as modest appears to be a slight downgrade from the "moderate" growth Fed officials had been seeing in the economy. It is the first time in at least three years that the

Fed has used the term "modest" to describe the economy in its formal policy statement. The Fed's comment about higher mortgage rates is also a new expression of concern in the statement.

Equities

Stocks and bonds traded higher in Europe this morning, as prospects of lower interest rates following somewhat dovish FOMC decision late yesterday resulted in bull flattening of money market curves and consequent credit spread tightening. Better than expected earnings from Lloyds and SocGen also buoyed investor sentiment, which in turn saw financials outperform on the sector breakdown.

FX

Interest rate differential flows saw USD/JPY edge higher overnight and in Europe this morning, which in turn saw the pair top the 100DMA line located at 98.51. Elsewhere, firmer USD, as well as the release of much better than expected UK Manufacturing PMI (highest since March 2011) weighed on EUR/USD, while GBP/USD managed to edged back into positive territory. However this failed to prop up the 1y/1y GBP forward rate, which ahead of the MPC decision is trading at its lowest level since late May.

Commodities

China may cut almost half of the nation's total 970mln tonnes of steel capacity to remove overcapacity, according to unidentified sources.
US Mint's American Eagle gold bullion coin fell to 50,500 ounces in July from. 57,000 ounces in June, whilst silver bullion coin sales rose to 4.41mln ounces in July from 3.28mln ounces in June.
US House passed bill on tighter Iran sanctions, which will slash Iran's oil exports by another 1mln bbls per day within a year.

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The full overnight event recap from DB's Jim Reid

Before we review what we perceive to be on balance a dovish FOMC last night, August has started already as seen in the latest Chinese PMIs. The official Chinese manufacturing PMI for July printed at 50.3 which is a 0.2pt improvement on June’s reading and is higher than expectations of 49.8. The HSBC manufacturing PMI, whose final reading of 47.7 was also released overnight, fell 0.5pts from last month’s reading. Over the last couple of months, a divergence has opened up between the official manufacturing PMI and the HSBC manufacturing PMI. The gap between the two surveys is now 2.6pts versus 1.9pts in June, 1.6pts in May and 0.2pts in April. The 2.6pt gap is the largest in at least 12 months and will probably make it even more difficult to get a read on the trends in economic activity (although we note the sampling and methodological differences between the surveys). This also comes after Bloomberg reported earlier this month that the Chinese government will suspend the release of industry-specific activity indices from its monthly PMI report.

Nevertheless, the better than expected official PMI, and some more supportive comments from China’s State Council, is driving a small bounce in Chinese growth related assets overnight. China’s CDS is quoted 1bp tighter at around 115bp while the Hang Seng (+0.6%) and Hang Seng China Enterprise indices are both seeing decent gains (+0.4%). The main overnight laggard is the ASX200 (-0.05%) which is weighed by banks after media reports of a new tax on Australian bank deposits which may be announced on Friday. The Nikkei (+1.6%) is reversing some of the past week’s underperformance underpinned by a 0.5% rise in dollar yen (98.3 as we type).

Coming back to yesterday’s events, it was fair to say that it was rollercoaster ride for markets which saw 10yr UST yields trade as high as 2.70% (+10bp) after the release of the ADP employment (200k vs 180k expected) and US Q2 GDP report (more on this below). From there, USTs came tracking back in, spurred by the FOMC’s statement that included a few important changes on last month. Those changes were interpreted as being on the dovish-side judging by the 9bp rally in UST yields in the minutes following the FOMC’s statement. The first of the changes included a reference to rising mortgage rates, perhaps suggesting some concern amongst Fed policymakers that this could slow the improvement in the housing market. The second nuance was a comment saying “the Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance”. While the Fed has acknowledged for some time that inflation is running at below its 2% objective, the reference to “risks to economic performance” was seen as a dovish addition to this month’s statement. But this was balanced somewhat by the FOMC’s statement immediately following that inflation “will move back toward its objective over the medium term”. Thirdly, there was only one dissent this month compared to two in June. This was likely due to the second point above—heightened concerns about low inflation assuaged St. Louis President Bullard’s concerns, which led him to dissent last month. The S&P500 again failed to break through the 1700 mark, falling short at 1698 in the hour following the FOMC statement, before fading to close unchanged at 1686. S&P futures are trading 0.4% firmer this morning as we go to print.

Yesterday's GDP report was pretty much in line with consensus net of revisions over the last 2 quarters (Q2: 1.7%, Q1: 1.1%). The longer-term historical re-stating increased GDP as expected though time but not dramatically. Again we'll bore you with what we think is an interesting observations on nominal US GDP. Q2 saw YoY growth of 2.9% with Q1 revised down to 3.1%. These last two quarters are as low as anything seen at the depths of the recessions between the early 1960s and those prior to the  2009 slump. For example in the recessions of 2001, 1991, 1982, 1980, 1974 and 1970, the low point for nominal GDP growth was 2.4%, 2.8%, 3.1%, 7.1%, 8.3% and 4.8%. So nominal activity really is low at the moment and one can't help thinking that if there was a nominal GDP target (not an outlandish idea) the Fed would now be increasing QE not moving towards tapering. However there isn't such a target and we'll see whether nominal GDP can hold up when tapering comes through.

With the FOMC behind us, the attention will shift to today’s ECB and BoE policy meetings. A Bloomberg poll shows that all but one economist are expecting no change in refi/deposit rates by the ECB. For the record, DB expect President Draghi will steer a steady course and will not bring in changes in guidance or non-standard policies (LTROs, collateral, OMT, etc). In the UK, the Bank of England minutes from Carney’s first policy meeting in July revealed that some MPC members had thought “there was merit in pursuing a mixed strategy with regards to the different policy instruments at the committee’s disposal”. The general expectation is that Carney will propose some form of “forward guidance”, similar to the policy he initiated at the Bank of Canada. This comes after the MPC surprised last month with the statement that "the implied rise in the expected future path of the Bank Rate was not warranted by the recent developments in the domestic economy" which came several days into Mr Caney’s tenure and could’ve been seen as an early step towards formal forward guidance.

Looking at the day ahead, the Euroarea PMIs will garner most of the attention. The consensus estimates for Spain and Italy are 50.6 and 49.7 respectively. The BoE comes later in the day, followed shortly thereafter by the ECB. As usual, the more interesting part of the ECB policy meeting will come from Draghi’s press conference which begins 45 minutes after the ECB’s formal   announcement. In the US, the focus will be on the ISM as well as jobless claims. Earnings announcements by Procter & Gamble, Exxon Mobil, BMW and Royal Dutch Shell also have the potential to be market moving.