Europe Continues To Deteriorate Leading To Fresh Record Bund Highs; All Eyes On Draghi

Tyler Durden's picture

There were some minor fireworks in the overnight session following the worst Australian unemployment data in 12 years reported previously (and which sent the AUD crashing), most notably news that the Japanese Pension Fund would throw more pensioner money away by boosting the allocation to domestic stocks from 12% to 20%, while reducing holdings of JGBs from 60% to 40%. This in turn sent the USDJPY soaring (ironically, following yesterday's mini flash crash) if only briefly before it retraced much of the gains, even as the tortured pension asset reallocation news now appears to be entirely priced in. It may be all downhill from here for Japanese stocks.

It was certainly downhill for Europe where after ugly German factory orders yesterday, it was the turn of Europe's growth dynamo to report just as ugly Industrial Production which missed expectations of a 1.2% print rising only 0.3%. The release subsequently pushed Bunds above the 149.00 handle to record highs, with the German 2yr yield pressing below 0% for the first time since May 2013. Geopolitical risk remains at the forefront as Ukraine Special Forces press pro-Russian separatists further back even as trade wars between Russia and Europe now appear set to hurt Europe far more than the Kremlin.

Elsewhere, peripheral debt markets have seen a continuation of their widening since Italy yesterday unexpectedly entered into recession, although Spanish paper has seen a modest recovery following a strong 6yr and 10yr auction which has subsequently seen Bunds come off their highs , while French bonds have been supported by talk of domestic accounts buying French 2yr and 3yr bonds.  It wasn't only Germany: after Italy entered a shocking triple-dip recession yesterday, today Spain too saw its industrial output sputter rising only 0.8% on expectations of a 2.7% rise. However, thanks to broken, centrally-planned markets that only served to send its bond yields to fresh record lows now that it is seen, incorrectly, for the time being as a foil to the Italian recession, when all it really is is a hodge-podge of fabricated economic data serving clear propaganda and which laughably includes drugs and prostitution estimates.

Nonetheless, asset classes have not seen major moves yet, as today's main event is the ECB announcement due out in less than an hour. Consensus expects Draghi to do nothing, however with fresh cyclical lows in European inflation prints, and an economy which is clearly rolling over from Germany to the periphery, the ex-Goldmanite just may surprise watchers.

Equities are trading mostly lower with the exception of the FTSE MIB and Swiss SMI as participants hold their breath ahead of today’s BoE and ECB rate decisions. The FTSE MIB has stabilised since yesterday’s GDP-inspired losses, while the SMI has been supported by Nestle after they announced a CHF 8bln share buyback. The DAX has been seen lower since the open, weighed on by Beiersdorf and Munich Re after their pre-market earnings releases. However, Commerzbank have provided the index with some support after its Q2 profit more than doubled.

Looking ahead, attention now turns towards the BoE and ECB rate decisions, where both banks are expected to keep rates on hold. Initial jobless claims and the monthly consumer credit report are the main highlights on the US data docket.

Market Wrap

  • S&P 500 futures up 0.1% to 1918.6
  • Stoxx 600 down 0.2% to 328.6
  • US 10Yr yield down 1bps to 2.46%
  • German 10Yr yield down 1bps to 1.09%
  • MSCI Asia Pacific down 0.2% to 146
  • Gold spot little changed at $1305/oz

Bulletin Headline Summary from RanSquawk and Bloomberg

  • Despite printing further record highs following weak German IP data and geopolitical concerns, Bunds pullback from these levels following a successful Spanish bond auction and profit-taking.
  • European equities trade mostly lower (Euro Stoxx 50 -0.30%), with the DAX the underperformer following weak earnings from Beiersdorf and Munich Re.
  • Treasuries 5Y and longer gain, curves flattening; 2Y yields hold below 0.459% 50-DMA. Bank of England rate decision due at 7am ET, with ECB at 7:45am and Draghi press conference at 8:30am.
  • ECB expected to keep rates on hold, refrain from any new policy measures even as evidence is building that the conflict in Ukraine and EU sanctions against Russia are undermining a euro-area recovery that Draghi already describes as weak
  • Russia slapped import bans on an array of food goods from the U.S. and Europe, striking back at sanctions over the conflict in Ukraine, where at least three people were killed overnight as separatist fighting rages on
  • The small companies that dominate China’s private market for high-yield bonds face rising default risks as their debt obligations soar to a record and economic growth slows to the lowest in more than two decades
  • A reluctance among some Chinese developers to sell units at prices lower than they could fetch just months ago threatens to cause a swelling in  properties; this would would extend a slide in construction that’s already put a drag on the world’s second-largest economy
  • Australia’s jobless rate jumped to a 12-year high in July, surpassing the U.S. level for the first time since 2007 and sending the local currency tumbling
  • Bank of America is nearing a $16b-$17b record settlement with the U.S. Justice Department to end probes into sales of MBS that fueled the financial crisis, according to a person familiar with the matter
  • Liberian President Ellen Johnson-Sirleaf declared a 90-day state of emergency over Ebola as West African nations struggle to control an outbreak of the virus that has left at least 932 people dead
  • Activists say Obama should have focused on discussing human rights with the more than 40 heads of state including Paul Kagame of Rwanda and Teodoro Obiang of Equatorial Guinea who attended the U.S.-Africa Business Forum, rather than promoting investment
  • Clergymen in northwestern Iraq say Islamic State militants have overrun a cluster of Christian villages alongside the country’s semi-autonomous Kurdish region, sending civilians and Kurdish fighters fleeing from the area: AP
  • Thousands of people from Iraq’s Yezidi religious group are stranded in northern mountains, according to the United Nations Children’s Fund, as they sought to escape execution and rape by Islamist militants
  • Sovereign yields lower, with German 2Y yield below zero. Euro Stoxx Banks little changed. Asian stocks mostly lower, with Japanese stocks higher, Shanghai -1.3%. European equities mixed, U.S. stock futures gain. WTI crude and gold lower, copper gains
  • Looking ahead, attention now turns towards the BoE and ECB rate decisions, where both banks are expected to keep rates on hold.

US Event Calendar

  • 7:00am: Bank of England seen holding bank rate at 0.50%
  • 7:45am: ECB seen holding main refinancing rate at 0.15%
  • 8:30am: ECB’s Draghi holds news conference
  • 8:30am: Initial Jobless Claims, Aug. 2, est. 304k (prior 302k)
  • Continuing Claims, July 26, est. 2.512m (prior 2.539m)
  • 9:45am: Bloomberg Consumer Comfort, Aug. 3
  • 3:00pm: Consumer Credit, June, est. $18.650b (prior $19.602b)
  • 9:30pm: Reserve Bank of Australia issues monetary policy statement
  • 11:00am POMO: Fed to purchase $2.05b-$2.5b notes in 2021-2024 sector

ASIA

The Nikkei 225 (+0.5%) erased the overnight weakness as sources suggested the Japanese pension fund (GPIF) is planning to boost its Japanese stock allocation to over 20% from 12% currently. Elsewhere, the Shanghai Composite (-1.3%) printed its longest streak of losses since the period ending June 19.

FIXED INCOME

Fixed income products have once again taken centre-stage with Bunds extending on yesterday’s gains following a particularly weak German industrial production release. The release subsequently pushed Bunds above the 149.00 handle to record highs, with the German 2yr yield pressing below 0% for the first time since May 2013. Geopolitical risk remains at the forefront as Ukraine Special Forces press pro-Russian separatists further back. Elsewhere, peripheral debt markets have seen a continuation of their widening since Italy yesterday unexpectedly entered into recession, although Spanish paper has seen a modest recovery following a strong 6yr and 10yr auction which has subsequently seen Bunds come off their highs , while French bonds have been supported by talk of domestic accounts buying French 2yr and 3yr bonds.

EQUITIES

Equities are trading mostly lower with the exception of the FTSE MIB and Swiss SMI as participants hold their breath ahead of today’s BoE and ECB rate decisions. The FTSE MIB has stabilised since yesterday’s GDP-inspired losses, while the SMI has been supported by Nestle after they announced a CHF 8bln share buyback. The DAX has been seen lower since the open, weighed on by Beiersdorf and Munich Re after their pre-market earnings releases. However, Commerzbank have provided the index with some support after its Q2 profit more than doubled.

FX

In FX, AUD is the notable underperformer after the Australian unemployment rate hit a 12-year high at 6.4% vs. Exp. 6.0% while Employment Change fell by 300 vs. expectations of a gain of 13,200. This saw AUD/USD fall just shy of a point, the most in a month, breaking below the 0.9300. USD/JPY is trading higher after sources suggested the Japanese pension fund (GPIF) is planning to boost its Japanese stock allocation to over 20% from 12% currently.

COMMODITIES

In the metals complex, spot gold has pared some of yesterday’s gains after taking out stops on the bottom end of the Asian overnight range, however has found support at the 23.6% fib from yesterday's high. While WTI crude futures have dipped below yesterday’s lows seen at USD 96.69, with the next level of support seen at USD 96.43 (April’s low).

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DB's Jim Reid concludes the overnight event summary

When you have a structurally weak global recovery it does leave you much more vulnerable to shocks. The US saw this earlier this year with the abnormal cold spell pushing Q1 GDP into negative territory and in Europe the evidence is building that Russian sanctions are starting to hit the economy this side of the pond. Yesterday in market terms the US came to the rescue somewhat after a very weak open in Europe due to these data concerns. We had disappointing German factory orders (-3.2% v +0.9% expected m/m) and an unexpected negative Italian GDP print (-0.2% qoq v +0.1% qoq expected) which set the tone but both the S&P 500 and the CDX IG were mostly flat on the day despite opening lower/wider on concerns about the escalating geopolitical events in Russia and the economic impact (more below). Given this data it wasn’t surprising to see much of the European weakness being periphery-led. Italian and Spanish equity markets were down -2.7% and -1.0% respectively. Italian and Spanish 10yr bond spreads to Bunds also widened by 13bp and 10bp, respectively.

Turning to geopolitics (NBC), there is some sense that events are escalating in Russia with NATO yesterday firing a warning shot that Russia has amassed around 20,000 troops on Ukraine’s border. NATO expressed concerns that Moscow could use a humanitarian or peacekeeping mission as an excuse for an invasion and described the conflict as being fuelled by Russia. Echoing similar sentiments, Polish PM Donald Tusk yesterday also said that the threat of a direct intervention by Russia has risen over the last couple of days. The Ruble lost 0.4% against the USD, taking the currency back to levels last seen in mid-March. On the equity side, the MICEX lost 1.7% and it was again the country's financial institutions which came under significant pressure, including names like Sberbank (-3.6%).

Clearly the ongoing crisis in Ukraine will be important to monitor in the coming days/weeks but the price action in EM was actually fairly firm yesterday. They found some support during the NY session with the Latam sovereign CDS closing modestly tighter (and off the opening wides) on the day. Asian sovereign CDS spreads are also moving tighter with China, Malaysia and Vietnam 1-2bp tighter overnight. On the cash side of things, Indo sovereigns are a touch lower overnight despite a very solid tone for US Treasuries on safe haven flows (UST 10yr now 2.465%). The usual correlation between US rates and EM bonds have somewhat decoupled over the past day or so but our EM strategists’ view is that with valuations at supportive levels and the macro backdrop relatively benign, they don’t think a protracted selloff looks likely at this stage. Rather they see much of the recent sell off being technical in nature due to poor summer liquidity and exacerbated by a number of idiosyncratic events such as those in Russia.

The resilience in EM bonds are not being carried through into the equity markets overnight with key Asian bourses lower across the board. The Shanghai Comp, Hang Seng, Nikkei, and the KOSPI are all about 0.5% lower. Chinese equities are down for the third straight day. There might be some profit taking here given the sharp rally we’ve seen last month.

Looking at the day ahead, today’s calendar will be largely dominated by the ECB and BoE meetings. Our European economists think that neither the growth nor the inflation picture means the ECB is in the clear — but they do have room to pause and reflect. The medium-term outlook is still sufficiently weak for the ECB to maintain its conditional dovish stance. They expect the ECB to repeat the message that should the 5 June announcements and in particular the TLTRO not have the desired effect of stimulating lending, growth and inflation, the Council is prepared to implement an ABS purchasing scheme. The success or otherwise of the TLTRO will take time to assess. Aside from that, Draghi might comment on Euro area HICP inflation (which hit a new cycle low in July), the impact of Russian sanctions and the recent developments in the Portuguese banking sector. In terms of the BoE, the Street and DB do not expect a change in policy at this meeting, but the occasion of the latest Inflation Report (and the BoE’s new forecasts) could prompt one or more members into voting a quarter-point rise.

Aside from central bank meetings Germany and Spain will print industrial production for June. Initial jobless claims and the monthly consumer credit report are the main highlights on the US data docket.