Overnight Summary: Euphoria Fading, Reality Setting In
After hitting overnight highs of 1.2670, the EURUSD has wiped out nearly all of its gains following the Spanish "bailout", and was last trading just +40 pips higher compared to the Friday close. Same thing with Spanish bonds: these reacted favorably initially, but slowly the bondholder realization that they just got primed has settled in, and with sovereign CDS still a questionable hedge courtesy of ISDA, the only real hedge is selling, and have now drifted wider on the day, as have Italian bonds following a Bloomberg piece which notes the patently obvious: Italy Moves Into Debt-Crisis Crosshairs After Spain. Expect US stocks, always last to get the memo, to realize that Europe has not only faded the entire move, but is now appreciating it for what it is: a confirmation of failure.
Below is a full summary of the catalysts driving the overnight action.
As the Wall Street Journal reminds us, "Greek Election Poses The Next Major Threat." We believe investors should remain defensive as there are still plenty of things that can go wrong in the Euro area. The upcoming Greek elections on June 17 pose the biggest near term risk. For more take a look at: What if Greece Exits The Euro?
The markets are reacting positively to Spain's request for external help in recapping its banking sector. Most Asian equity markets finished sharply higher with the Hang Seng leading the pact up 2.4%. The Japanese Nikkei rose 2.0%, the Korean Kospi finished 1.7% higher and the Shanghai Composite finished 1.1% higher. The only regional market that we cover that finished lower was the Indian Sensex down 0.3%.
In Europe, equities are up 1.4% in the aggregate. The region's blue chips are outperforming up 1.9%. At home, futures are also pointing to a strong open. The S&P 500 is set to open 0.7% higher.
In bondland, Treasuries were selling off overnight due to the risk on atmosphere - the 10-year yield was as high as 1.72% at one point - but as the day progress yields have been falling. The 10-year is now only trading at 1.66%. In Europe, Spain's 10-year yields are flat at 6.18% while Italy's 10-year is up 6bp to 5.81%. German bunds are 3bp higher at 1.36% and UK gilts are 3bp higher at 1.65%.
The risk on trading is causing the dollar to weaken with the DXY index down 0.5%. Commodities are mixed; WTI crude is 89 cents higher at $84.98 while gold is down $3.38 an ounce to $1,589.93.
The key takeaway from China's May data is that unless there is a significant rebound in June, there is downside risk to second quarter GDP. Consensus estimates for second quarter growth is 7.9% yoy - that is above our in house estimate of 7.6% yoy, the lowest estimate on the street. We expect that other houses on the street will mark down their growth estimates over the next couple of weeks. Currently our Chinese economist is sticking with his current growth rate forecast for the second quarter but notes there is a slight downside risk to his below consensus estimate as well.
Our Chinese economist, Ting Lu, lowered his inflation forecast for 2012 to 3.2% yoy from 3.5%. A large part of that is due to our commodities team taking down their estimates of crude prices. Our commodity team has recently revised down forecast of Brent and WTI crude oil spot price to US$106 and $97/bbl respectively in 2H12 (from US$116 and $107/bbl previously). Ting expects that China's central bank will cut both their deposit and lending rates by 25bp once more this year.
Also on the policy front, Ting expects the government to start or speed up more projects and to make project financing easier via cutting RRR/ interest rates, approving more enterprises bonds and lifting more lending restrictions. However, without a Greek exit from the Euro area, he expects the size of the overall stimulus could be relatively small (slightly below 1% of GDP).
Over the weekend, Spain announced that it will present a formal request for financial assistance to restructure its financial sector. The Eurogroup said it is ready to lend up to €100 billion to cleanup and recap Spanish banks. The final amount and details of the program would be released after knowing the results of the two independent audits due June 21. Our Euro area team views this as a positive step.
This week's data highlights include the inflation trifecta of CPI, PPI and the import price index. We expect core CPI, released on Thursday, to come in at 0.2% MoM and 2.2% YoY - close enough to the Fed's 2.0% target. Look out also for retail sales on Wednesday: the report is likely to be weak, undermined by a contraction in gasoline sales and soft auto and chain store sales.