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Overnight Nikkei Crash Drags Risk Lower
While there was little macro news to report overnight, the most notable development was yet another USDJPY-driven crash in the Nikkei 225 which plunged by a whopping 576 points, or 4%, to 13825, while the Yen soared to under 96.80 in the longest series of gains since mid-June before recouping some of the losses on pre-US open program trading. The reason attributed for the move were reports that Japan would adhere to pledge to cut its deficit which is the last thing the market wanted to hear, as it realizes that boundless QE is only possible in a context of near-infinite deficit spending. The index, which has now become a volatility joke and woe to anyone whose "wealth effect" is linked to its stability, pushed not only China's Shanghai composite lower by 0.7% but led to losses across the board and as of this moment is seen dragging US equity futures lower for the third day in a row.
Furthermore as already noted, the forward guidance announcement by the BOE being riddled with so many exclusion loopholes and footnotes, and carrying an emphasis on inflation, did not help the market get the sense of a definitive BOE backstop if and when the Fed has to pull out.
There is little on the US docket today, with consumer credit due out at 3pm, while the Fed's Pianalto speaks on monetary policy in Cleveland at 1:40 pm. Expect even more hawkish tones and tapering warnings now that we are just a month away from the all important September FOMC meeting.
Market Re-Cap via RanSquawk
Heading into the North American open, stocks in Europe are seen lower across the board, after the negative tone which dominated the session overnight in Asia following reports that Japan will adhere to pledge to cut deficit carried over into the European session. However, the initial bid tone by Bunds and Gilts ahead of the release of the Quarterly Inflation Report by the BoE was not sustained and both are now trading lower after the BoE refrained from overlooking inflation while also linking interest rates to unemployment with a 7% threshold. The fact that the Bank refrained from overlooking inflation and instead reiterated its commitment to price stability contained the short-end of the curve. At the same time, while Carney stated exactly what will prevent the MPC from following through with its forward guidance pledge, there was no mention of rate hikes even if forward guidance was to end earlier than initially envisaged.
There was little in terms of EU related commentary, Bundesbank’s auction of 0.25% 2018s was well covered, while the latest German Industrial Production data also surprised to the upside. Going forward, market participants will get to digest the release of the weekly DoE data and the US Treasury will sell USD 24bln in 10y notes.
Asian Headlines
Japan will adhere to an international pledge to halve its primary deficit by FY 2015, according to a draft medium-term fiscal plan. According to the report, reaching the target would entail lowering the primary deficit by JPY 8trl at the national level and to accomplish this, the government will consider shrinking a JPY 1trl bracket for regional stimulus, under the draft plan.
PBOC is said to plan a new unit to invest FX reserves. According to reports, the PBOC governor is assigning the SAFE division head to lead a small team conducting a feasibility study and that a new unit would be responsible for the bulk of the management of China's USD 3.5trl in FX reserves.
EU & UK Headlines
BoE links interest rate to unemployment with 7% threshold, forecasts unemployment above 7% until at least Q3 2016.
The guidance linking Bank Rate and asset sales to the unemployment threshold would cease to hold if any of the following three ‘knockouts’ were breached:
- The Bank also noted that guidance won’t hold if CPI seen 0.5% over 2% in 18-24 months.
- Medium-term inflation expectations no longer remain sufficiently well anchored
- Guidance won’t hold if the FPC sees financial stability threat.
The fact that the Bank refrained from overlooking inflation and instead reiterated its commitment to price stability contained the short-end of the curve. At the same time, while Carney stated exactly what will prevent the MPC from following through with its forward guidance pledge, there was no mention of rate hikes even forward guidance was to end earlier than initially envisaged.
German Industrial Production SA (Jun) M/M 2.4% vs. Exp. 0.3% (Prev. -1.0%, Rev. -0.8%)
German Industrial Production WDA (Jun) Y/Y 2.0% vs. Exp. -0.3% (Prev. -1.0%, Rev. -1.2%)
US Headlines
US President Barack Obama has outlined his plan to completely overhaul the mortgage business by winding down the government-backed Fannie Mae and Freddie Mac bodies and replacing them with a system in which the private sector is responsible for mortgage defaults.
US MBA Mortgage Applications (Aug 2) W/W 0.2% (Prev. -3.7%)
Equities
Stocks opened lower in Europe, as the negative sentiment which saw the Nikkei 225 index settle lower by 4% carried over and supported flows into defensive equity sectors. As a result, health care related stocks outperformed, closely followed by utilities.
FX
Reports which suggested that Japan will adhere to an international pledge to halve its primary deficit by FY 2015 which in turn weighed on the domestic benchmark stock index also resulted in broad based JPY strength, with the major USD/JPY pair down around 80pips as a result.
The initial surge lower by GBP/USD following the release of the latest Quarterly Inflation Report was not sustained and instead the pair reversed course as market participants focused on comments regarding inflation and a number of caveats which would mean that BoE would have to abolish using forward guidance. The Bank also noted that guidance won’t hold if CPI seen 0.5% over 2% in 18-24 months.
Commodities
China net gold imports from Hong Kong fell 4.8% due to the government curbing the use of bullion in the financing deals. According to the report, mainland buyers bought 101 tons after deducting flows from China into Hong Kong, compared with 106 tons in the previous month. Inbound shipments including scrap declined to 113 tons from the 127 tons in the previous month.
NDRC Centre for Urban Development deputy director Qiao Runling said China's urbanization shouldn't be seen as a new CNY 4trl stimulus plan and that the core idea is reform. In other news, the NDRC pledged to continue implementing macro-policies that will boost employment.
API US Crude Oil Inventories (Aug 6) W/W -3700K vs. Prev. -740K
- Cushing Crude Inventory (Aug 6) W/W -2200K vs. Prev. -1900K
- Gasoline Inventories (Aug 6) W/W -971K vs. Prev. 1800K
- Distillate Inventory (Aug 6) W/W +1500K vs. Prev. -497K
Iraq’s crude oil production reached 3.250 million barrels per day (bpd) at the beginning of August, compared to 2.942 million bpd a year earlier. Iraq expects total production to increase by 400,000 bpd by the end of the year with Shell-operated RDSa.L Majnoon field starting up in October, according to oil ministry spokesman Jihad.
Egypt’s presidency is expected to announce that foreign mediation efforts to end the political crisis have failed according to a state-run newspaper.
Overnight news bulletin from Bloomberg:
- Treasuries steady before U.S. sells $24b new 10Y in second of week’s three quarterly refunding auctions; yield 2.65% in WI trading; July’s reopening of May 2023 drew 2.67%, highest since July 2011.
- 3Y notes sold yesterday drew 0.631%, stopping through 1pm WI level, with highest indirects since August 2011 and lowest primary dealer award since November 2011
- Bank of England’s Mark Carney for the first time linked policy to unemployment, saying that the MPC “stands ready to undertake further asset purchases” while unemployment rate remains above 7% and that GDP won’t reach pre-crisis peak until a year from now
- Bank of Japan starts two-day policy meeting today; will expand its record easing by June next year as inflation remains distant from its 2% target, according to a Bloomberg survey
- Nikkei fell 4% overnight as JPY gained through 97.50 level, reaching seven-week high vs USD
- German industrial production rose 2.4% in June, more than forecast
- Obama in a speech yesterday for the first time endorsed an approach to remake the housing finance system as Fannie Mae and Freddie Mac are wound down
- Sovereign yields mostly lower. Nikkei -4%, leading Asian stocks lower, as JPY gains through 97.50 level. European stocks, U.S. equity-index futures decline. WTI crude little changed, copper, gold fall
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Finally, and in line with tradition, we conclude with Jim Reid's recap of overnight events:
Central banks remain the focus for markets this week. Today, we have the Bank of England inflation report and Carney press conference, which we discuss further below. Yesterday we had the seemingly hawkish tones from the usually dovish Evans and Lockhart of the Fed. Tomorrow, it’s the BoJ’s turn to take the spotlight but markets are generally expecting no change in policy from them.
The Bank of England releases its quarterly inflation report at 10:30am London time today but all eyes will be on comments from Mark Carney who will give his first press conference since taking office. Carney is widely tipped to announce some form of forward guidance alongside the inflation report but what form this guidance takes remains uncertain. DB expects “loose-form” guidance from the Bank, rather than an explicit time or data-based “precommitment”.
Coming back to the Fedspeak yesterday, on the face of it the comments from the Chicago Fed President were relatively hawkish for the dovish-leaning Charles Evans (who also happens to be a FOMC member). He commented that the Fed “is quite likely” to slow down its asset purchase program “starting later this year”. Evans added that “we’re not far” from having sufficient evidence of accelerating growth and he “would not rule out a September tapering”. Evans forecast that the Fed would be able to stop QE in mid-2014. Balancing those comments, he said rates could stay low even after the jobless rate falls below 6.5% and that inflation remains below target. So on balance, his comments were relatively hawkish on the topic of QE but were more accommodative on the rates side. Earlier in the day, the Atlanta Fed’s Lockhart mentioned that tapering could begin in September. Lockhart also said tapering could begin in October’s FOMC and that there was no reason why Bernanke couldn’t call a press conference for that month’s meeting. Overall, the comments had little effect on treasuries however, with 10yr yields closing virtually unchanged at 2.64% (+1bp).
The hawkish Fed tones perhaps had a greater effect on gold prices, which continue to fare poorly this morning. Indeed, Tuesday’s 1.5% drop has been followed by another 0.3% fall overnight. So far this week, the precious metal is down 3%, bringing it back below $1300/oz and at three week lows. Gold mining stocks such as Newmont (-6.5%), Barrick (-4.5%) and Anglogold Ashanti (-4.7%) were heavily hit while gold mining bonds also underperformed on the back of the gold price decline.
The US trade data did little to allay further fears of tapering. The June trade balance made a surprising improvement, falling to -$34.2B from -$44.1B previously and versus the -$43.5B expected by the market. DB’s US economists note that this was driven by a 2.2% increase in exports to an alltime high of $191.2B (vs. $187.1B previously) and a -2.5% decline in imports to $225.4B (vs. $231.2B previously)—the average in H1 was $228.5B. The trade revisions imply roughly an additional $32B of output in Q2 relative to what the BEA had previously assumed. As a result, real GDP growth in Q2 is likely to be significantly stronger (+2.5%) than what was first reported (+1.7%). The revised growth figure is more consistent with the healthy employment gains over the past several months. DB’s Joe LaVorgna writes that the growth profile over the prior three quarters is now (+0.1% in Q4 2012, +1.1% in Q1 2013 and probably +2.5% in Q2 2013).
Turning to this morning’s Asian markets, equities are trading with a weaker tone, taking their lead from the S&P500’s -0.6% performance yesterday. S&P500 futures are currently 1691 or -0.2%. The Nikkei is the main laggard at - 2.9% weighed by a -0.45% drop in USDJPY. Chinese equities are outperforming this morning (Shanghai Comp +0.4%) led by Chinese property developers. There have been reports that the government may loosen restrictions on share sales and IPOs from Chinese property developers to ease financing burdens for the sector. A number of Chinese developers have announced equity raisings this week and the stocks of some property developers are up 5%+ this morning. Outside of equities, Asian EM credit is a touch wider this morning and the AUD is marginally weaker against the USD following a mixed Australian housing finance report.
Staying in China but focusing on the longer horizon, DB’s Jun Ma has published an interesting note attempting to quantify the impact of the country relaxing its one-child policy, as some media reports have suggested in recent days. From late this year or early next year the government might implement the “dandu" policy on a national basis. The policy is currently being trialled in a select number of rural locations, and would allow a couple to have two children if either the husband or the wife has no siblings. Jun says that press reports also indicate that a more ambitious plan to allow all couples in China to have two children could be implemented after 2015. Assuming such a twostep reform, Jun estimates that will have very little impact on economic growth in the coming 16 years, but could boost annual GDP growth by 0.2ppts during 2030-50.
The highlight today will be the BoE’s inflation report and potential forward guidance. In terms of data, German industrial production, French trade, US consumer credit and US mortgage applications are the main focus. The Fed’s Pianalto will be speaking today.
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