Overnight Summary: All Eyes On The Central Printer
While this and that may have happened overnight, the only thing that matters today is what the FOMC presents to a market which has now priced in well over 100% of a new easing round. Except little movement until Bernanke speaks, and with that removes any doubt that i) the Fed, like the ECB, are both political creations comprised of unelected academics, and ii) the entire modern capitalist world is nothing but a Pavlovian creation that responds only to promises of liquidity injections. Luckily, if nothing else, this will once and for all shut up anyone who claims that the market reflects the economy, it doesn't; that a "virtuous economic cycle" is possible under the new centrally planned normal, it isn't, and that the US economy is recovering 4 years after Lehman collapsed. It never did, and without $14 trillion in central bank liquidity injections over the same period, the world, as represented by the S&P, would be in a mindblowing depression, which it will still get back to once the surge in hard asset inflation offsets any incremental liquidity provided by the central planning academics as Citi warned yesterday.
As to the "this and that" here is a summary of key events from DB's Jim Reid:
Briefly recapping the events of yesterday, in what German Chancellor Angela Merkel described as a “good day for Germany and a good day for Europe”. The German Constitutional Court dismissed six constitutional complaints against the ratification of the ESM and the fiscal compact. However the court did impose a EU190bn cap on Germany's liability which cannot be increased without German legislative approval. In addition, the German court explicitly ruled out the ESM borrowing from the ECB. Following the ruling, a German ministry spokesperson said that the German government will move to sign the ESM into German law "within the next few weeks" and EU President Juncker said that he will convene an inaugural ESM meeting on October 8th in Luxembourg.
Across the border in the Netherlands, Bloomberg is reporting that PM Mark Rutte’s Liberal Party has taken 41 out of the 150 seats in the lower house (up from 31 in the outgoing parliament). They narrowly edged out the Labour Party who won 39 seats (up from 30). D66 rose to 12 from 10, the Christian Democrats lost eight seats to 13, while the anti-euro Freedom Party lost nine seats to 15. According to Reuters, the most likely scenario at this stage is a left-right coalition between the two centrist parties in the 150-seat lower house, which would be a positive development for markets.
The reaction from markets was broadly supportive. The S&P500 closed up 0.2% with seven out of ten sectors trading up. The Stoxx 600 index rallied 1.5% on the news of the ESM ruling, but faded into the close to finish 0.3% higher on the day. Notably, the Stoxx 600 closed at levels last seen in July 2011. Italy's MIB (+1.2%) and Spain's IBEX (+0.8%) outperformed yesterday. Spanish 10-yr yields rallied 8bps, while Italian 10yr BTPS were 5bp lower. Italian 10yr BTP yields closed just above the 5% mark. EURUSD rallied 0.9% after the German court's ruling, finishing 0.35% higher on the day, a four-month peak.
Credit markets have virtually unwound all the volatility that picked up beginning last summer post the US rating downgrade and European sovereign issues. Yesterday, the Xover (490bp) and Subordinated Financials (320bp) indices closed at the lowest levels since late July 2011; while iTraxx Main (124.5bp) and Senior Financials (198bp) indices closed at the lowest levels since March 2012. Staying in credit, it was a busy day for USD new credit issues yesterday. The day saw the market absorb $4.8bn in new paper bringing week to date supply to just over $30bn.
In other European headlines, the European Commission unveiled its proposals for Eurozone bank regulations and ultimately, a banking union. The core aspects of the proposal include a single rulebook in the form of capital requirements, harmonized deposit protection schemes, and a single European recovery and resolution framework. The ECB will be tasked with ultimate responsibility of the financial stability of banks, while national supervisors will play a role in implementation and day-to-day monitoring. German Finance Minister Schauble reiterated his doubts that the ECB has the capacity to supervise all 6000 banks in the Eurozone. In his State of the Union speech, European Commission's President Barroso said that the EU needs to move towards a federation of nation states and will publish plans to deepen the economic and monetary union later this year.
Greece's finance minister Stournaras said talks with the Troika are continuing with around half of the targeted EU11.5bn in budget cuts signed off (ekathmerini). Newswires are reporting that the next Greece aid tranche will be decided on at the EU summit on October 18th. Stournaras and the Troika will fly to Cyprus today to provide an update to the Eurogroup.
According to Bloomberg, Greece has identified 40 uninhabited islands that could be leased for as long as 50 years to reduce debt. In Spain, PM Rajoy said that a full sovereign bailout is not needed and he will monitor bond yields in coming days to determine the appropriate course of action. Finally, China’s envoy to the EU said that the country will step up its cooperation with the EFSF through investment in the bailout fund’s bonds and will also reach out to the ESM.
Moving to overnight markets, Asian markets are trading with a mixed tone led by the Nikkei (+0.4%) and Hang Seng (+0.2%). Chinese equities are underperforming (Shanghai Composite -0.2%) despite new government measures announced yesterday to provide tax and fiscal support to exporters. State-owned Xinhua news agency said in a commentary that “massive stimulus” measures would be “detrimental” to sustainable growth which is likely weighing on sentiment. Korean equities are also underperforming following the Bank of Korea’s surprising decision to leave rates unchanged at 3%. Asian credit is weaker overnight, with the IG index 3bp wider as we type.
Looking at the day ahead, aside from the FOMC meeting and Bernanke’s press conference, we get the usual Thursday US jobless claims in addition to the August PPI print and monthly budget statement. While in Europe, Italian CPI and Greek unemployment will be the main data releases. But all eyes will be on the Chairman today.
Finally, some thoughts from Reid on the world's now admitted addiction to liquidity:
Firstly I think its still fair to say that the financial world remains addicted to liquidity and can't prosper without it. Whether that be periodic Chinese stimulus or hints thereof, hope of fresh action from the Fed, the ECBs LTROs and now the new OMT facility. To be fair to the authorities they have so far come good in the market's hours of need. We've long been of the opinion that the Fed would do QE, QE2, QE3, QE4 etc etc so whilst the timing is debatable the end game seems more certain to us. As for timing its strange that one volatile jobs report can tip the balance of market probabilities in favour of 100s of extra billions of future dollar liquidity injections but that seems to be where consensus is after last Friday.
DB's view has also tipped slightly in favour of at least announcing another QE program today on top of an extension of the initial rate hike projection to 2015 or even further into the future. Verbal easing is widely expected but DB’s Peter Hooper thinks whether or not we get another dose of QE is a more finely balanced call to make. There are a number of options if fresh QE was announced. As Peter highlights, the Fed may repeat its past practice and announce a fixed amount of bonds to be purchased over a specific period (say another $600bn over next 12 months) focusing on USTs or MBS. The other choice is to announce an adjustable and open ended programme which the Fed could start with a smaller amount of purchases per month but keep its options open to buy more if economic and financial conditions took a turn for the worse or do less if things improved.
This seems to be the more likely to us as it continues to satisfy the market’s appetite for more liquidity going whilst retaining some flexibility and ammunition. So all eyes on the announcement at 12:30pm and Bernanke’s press conference at 2:15pm (NY time).
Indeed, the only thing that matters now, as we first said well over 3 years ago, is what the Fed does.