Believe it or not, the main driver of risk overnight had nothing to do with Iraq, with the global economy or even with hopes for more liquidity, and everything to do with a largely meaningless component of Japan's future tax policy, namely whether or not Abe (who at this pace of soaring imported inflation and plunging wages won't have to worry much about 2015 as he won't be PM then) should cut the corporate tax rate in 2015. As Bloomberg reported [33], Abe, speaking to reporters in Tokyo today after a meeting with Finance Minister Taro Aso and Economy Minister Akira Amari, said the plan would bring the rate under 30 percent in a few years. He said alternative revenue will be secured for the move, which requires approval from the Diet.
The following sentence demonstrates vividly the clusterfuck Japan and its contradictory policies have become: "A lower levy is the centerpiece of Abe’s latest initiative to boost growth, now the main focus with the Bank of Japan keeping its policy unchanged. Failure to find extra funds to offset the blow to revenue risks worsening the world’s largest debt burden." So cut taxes to boost revenues, got it? Even the Japanese are starting to laugh at their Imodium-full Keynesian idol:
“Cutting corporate tax is a move in the right direction but it won’t necessarily trigger economic growth,” said Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo. “It is absolutely necessary to secure alternative tax revenue as the government’s finances are deteriorating.”
Idiocy aside, this corporate tax debate activated the USDJPY 102.000 tractor beam and after dropping as low as 101.60 during the US session, the pair rose as high as 102.9, dragging US equity futures and Asian stocks with it.
And just in case this particular piece of absolutely irrelevant for global markets data was insufficient to push stocks higher, Japan also continued, for the nth time, to disclose that it would force its pension fund to sell JGBs and buy high beta stocks. This helped the Nikkei, and also added to the USDJPY thrust (because apparently this was not priced in the first few hundred times it was revealed) and also was seen as sufficiently offseting the soaring geopolitical risk in Ukraine and, of course, Iraq, where things are getting from bad to worse.
Because when a mutant butterfly flaps its wings in Fukushima, global stocks rise.
However, the Asian bounce appears short lived: as Europe woke up, sentiment remained driven by the recent escalation of geopolitical tensions in Iraq, which in turn resulted in stocks trading lower since the get-go. In terms of stock specific movers, UK home-builders were under particular selling pressure in reaction to the UK Chancellor Osborne's move to give the BoE powers to cap mortgage lending ratios and also hawkish comments by BoE's Carney. Oh yeah, Goldman's BOE head warned that the UK may raise rates sooner than expected [34]. Don't hold your breath on this particular instance of busted forward guidance either.
Crude continues to surge on concerns the Iraq situation will deteriorate even further. As DB reported overnight, if ISIL is able to make southward progress towards Baghdad this will heighten instability in the country and possibly threaten the smooth operation of existing refineries and oilfields. Of most concern would be any detrimental impact on investment in new capacity. From a global oil perspective our commodities team expect the latest events in Iraq will sustain strong fundamentals for Brent crude oil. DB concludes that we may be witnessing the start of a more divergent supply picture between Brent on the one hand and WTI on the other.
Turning to the day ahead on this Friday the 13th, S&P is due to release their rating updates for South Africa shortly after we go to print and the general consensus is that it could become more negative in their stance on the sovereign. S&P rates South Africa at BBB with a negative outlook, so any downward ratings action could take the sovereign to the edge of investment grade territory. The 10yr local currency bond has increased 40bp in yield in the last few weeks partly in anticipation of this. A number of Euroarea countries report their final May CPI. The Univ of Michigan confidence and US PPI data will also be released.
Finally, remember: TGIF it's no POMO Friday (for all of June and beyond).
Market Wrap
European shares fall, close to intraday lows, with the travel & leisure and autos sectors underperforming and oil & gas, utilities outperforming. The U.K.
and Italian markets are the worst-performing larger bourses, the Dutch the best. The euro is little changed against the dollar.
French 10yr bond yields fall; German yields decline. Commodities gain, with natural gas, zinc underperforming and corn outperforming. U.S. Michigan confidence, PPI due later.
- S&P 500 futures down 0.1% to 1920.5
- Stoxx 600 down 0.8% to 345.1
- US 10Yr yield down 1bps to 2.59%
- German 10Yr yield down 3bps to 1.36%
- MSCI Asia Pacific down 0.2% to 144.1
- Gold spot little changed at $1273.4/oz
EUROPE
- 2 out of 19 Stoxx 600 sectors rise; oil & gas, utilities outperform, travel & leisure, autos underperform
- 11% of Stoxx 600 members gain, 88.2% decline
- Eurostoxx 50 -0.8%, FTSE 100 -1.1%, CAC 40 -0.9%, DAX -1%, IBEX -0.7%, FTSEMIB -1.1%, SMI -0.8%
ASIA
- Asian stocks fall with the Shanghai Composite outperforming and the Sensex underperforming.
- MSCI Asia Pacific down 0.2% to 144.1
- Nikkei 225 up 0.8%, Hang Seng up 0.6%, Kospi down 1%, Shanghai Composite up 0.9%, ASX down 0.4%, Sensex down 1.4%
- 3 out of 10 sectors rise with energy, telcos outperforming and materials, tech underperforming
Bulletin headline summary from Bloomberg and RanSquawk
- Elevated risk premiums related to an escalation of geopolitical tensions in Iraq dominated the sentiment in Europe this morning.
- Hawkish comments by Carney resulted in the Short-Sterling curve bear steepening and supported GBP across the board
- Treasury curve flattened overnight after 10Y and 30Y yields closed Thursday below their 50-DMAs; 30Y auction yesterday was awarded at 3.444%, a 2.7bps stop- through.
- BoE governor Carney said rising U.K. mortgage debt may threaten Britain’s recovery as he signaled interest rates might start to rise earlier than anticipated
- The pound reached the strongest level in 19 months against the euro, gained versus all but one of its 31 major peers
- The European Commission is ready to side with Denmark in agreeing to more lenient rules in the treatment of covered bonds than recommended under Basel III
- President Obama won’t rule out using airstrikes to help Iraq’s government beat back Islamist militants
- Oil led commodities to a nine-month high on concern that turmoil in Iraq will disrupt supplies
- In response to rising default rates on subprime U.S. auto loans, bond investors are deciding the best thing to do is pile into securities backed by the debt
- Georges Chodron de Courcel’s resignation after more than 40 years at BNP Paribas SA won’t soften U.S. demands for a guilty plea and a $10b penalty for sanctions violations, according to a person familiar with the matter
- Sovereign yields mixed. EU peripheral spreads mostly higher. Asian equities rise; European equity markets, U.S. stock futures drop. WTI crude rises, gold steady, copper higher
US Event Calendar
- 8:30am: PPI Final Demand, May, est. 0.1% (prior 0.6%)
- PPI Ex Food and Energy, May, est. 0.1% (prior 0.5%)
- PPI Final Demand y/y, May, est. 2.4% (prior 2.1%)
- PPI Ex Food and Energy y/y, May, est. 2.3% (prior 1.9%)
- 9:55am: UMich Confidence, June, est. 83 (prior 81.9)
ASIAN HEADLINES
Despite the negative close over on Wall Street, the sentiment was short-lived during the overnight session in Asia, with stocks reversing earlier losses and moving higher following supportive comments by PBoC sources, also resulting in the Hang Seng (+0.65%) and Shanghai Comp (+0.92%) outperforming its peers. At the same time, the Nikkei 225 (+%) benefited from reports that Japanese PM Abe is to announce corporate tax cut policy, together with comments by GPIF'S Yonezawa who said he sees cutting JGB allocation to 30-50% from the current 60%.
PBoC sources said that CNY may not see more depreciation in H2 of 2014 and wants FX rate to maintain monetary stability. (MNI) Of note the CNY is heading for its biggest weekly rally in almost 3yrs.
In terms of Chinese data: Chinese Retail Sales (May) Y/Y 12.5% vs. Exp. 12.1% (Prev. 11.9%), Industrial Production (May) Y/Y 8.8% vs. Exp. 8.8% (Prev. 8.7%)
FIXED INCOME
Hawkish comments by Carney yesterday resulted in the Short-Sterling curve bear steepening as market participants re-assess projected interest rate path expectations, while the GE/UK 10y spread widening to levels not seen since December 1996. However losses by Gilts were gradually reversed, supported by safe-haven related flow which saw Bunds close initial gap lower and move into firm positive territory.
EQUITIES
Sentiment remained driven by the recent escalation of geopolitical tensions in Iraq, which in turn resulted in stocks trading lower since the get-go. In terms of stock specific movers, UK home-builders were under particular selling pressure in reaction to the UK Chancellor Osborne's move to give the BoE powers to cap mortgage lending ratios and also hawkish comments by BoE's Carney.
As a reminder, Intel (INTC) shares surged 6% after the closing bell yesterday and the company raised Q2 and FY revenue and gross margin expectations.
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DB's Jim Reid concludes the overnight recap
Asian equities are trading firmly lower overnight but there has been a rally off the lows in Japanese equities after Japan’s Jiji news reported that PM Abe will announce a corporate tax cut and other reform as early as today. The Nikkei (+0.2% on the day) has rallied 0.7% off the early lows and dollar-yen is up 0.23% as we type. Outside of Japan, the escalating conflict in Iraq is continuing to weigh on markets today, and Brent has added another 0.4%, consolidating its gains of 2.8% yesterday. Looking at our screens this morning, equity laggards are the KOSPI (-1.3%) while the Hang Seng (+0.56%) is outperforming and in the process has clawed its way back to positive territory on a YTD basis. The BoJ kept policy unchanged as expected. Also announced overnight, Fitch has revised South Africa’s rating outlook to negative from stable and affirmed its BBB rating. ZAR is 0.2% weaker today.
Yesterday was another weaker day for risk and we saw 10yr treasury yields hit an intraday low of 2.573%, before closing 4.5bp lower on the day at 2.595%. The S&P 500 finished at -0.71%, near the day’s lows, taking the index to its pre-ECB levels. It was a fairly choppy session, but the combination of weaker than expected US retail sales, conflict in Iraq and a strong 30yr auction combined to drag UST yields lower. However the gains in USTs were partially reversed late in the day after BoE governor Carney surprised with some hawkish remarks at the annual Mansion House dinner. GBPEUR spiked by 0.65% to 1.249 after Carney warned that the first BoE rate hike “could happen sooner than markets currently expect”. This came as a surprise to many, having come less than a year since Governor Carney issued his lower-for-longer forward guidance. Perhaps due to fears that the Fed could follow in Carney’s footsteps, the front end of the treasury curve reacted sharply to Carney’s comments. Dec15 Eurodollars reversed almost all the day’s gains in the final minutes of trading and they have sold off another 5bp this morning.
Outside of equities, iron ore fell to a 21-month low of $91.5/t (-2.1%) and gold added 1%. After the US closing bell, Intel announced an increase in its Q2 and FY revenue guidance on the back of stronger than expected demand for business PCs. Intel stock was up 5% in after-market trading and that helped
S&P500 futures come off the lows. Earlier in the day, the bid for treasuries was boosted by a fairly strong 30 year auction where the bid-to-cover ratio rose to 2.69x from a 2.45x average over the prior four auctions. The BTC ratio was the highest in 16 months. The selloff in equities began at the start of the US session, partly in reaction to the retail sales data. Indeed, retail stocks (-1.45%) were amongst the worst performers yesterday. In terms of the data itself, US retail sales for May grew +0.3% (vs. +0.6% expected) with similar weakness across the ex auto (0.1% vs 0.4% expected) and ex auto and gas (0.0% vs 0.4% expected) categories. Some of this was partly offset by 0.4% upward revisions to the prior month’s numbers. In the details, weakness was concentrated in food and beverage stores (-0.1% vs. +0.1% prev), clothing and accessories (-0.6% vs. +1.2%) and department stores (-1.4% vs. +1.9%). US Jobless claims were slightly softer in the first week of June, as initial claims rose 4k to 317k (vs 312k previous). Speaking of data, DB’s Joe Lavorgna has lowered his forecast for Q1 US GDP growth to - 1.5% (compared to -1.0% previously) following new information from the Quarterly Services Survey.
Also dragging treasury yields lower were the developments in Iraq. Reports suggested that ISIL was targeting the Baiji refinery in Iraq and that supply may be disrupted by the Ceyhan-Kirkuk pipeline. The White House says that the oil refinery remains in control of the Iraqi government and that it was not considering sending in ground troops. Kurdish forces have apparently taken control of the city of Kirkuk and reports suggest that ISIL could begin preparations to advance of Baghdad (Bloomberg). In terms of the impact on oil markets, DB’s commodities team thinks that given the conflict has been confined to the north of the country, it does not yet pose a significant threat to the country’s oil production since the northern region represents only a small proportion of total Iraqi oil production. If ISIL is able to make southward progress towards Baghdad this will heighten instability in the country and possibly threaten the smooth operation of existing refineries and oilfields. Of most concern would be any detrimental impact on investment in new capacity. From a global oil perspective our commodities team expect the latest events in Iraq will sustain strong fundamentals for Brent crude oil. We may therefore be witnessing the start of a more divergent supply picture between Brent on the one hand and WTI on the other.
Before we turn to the day ahead, just a note that our strategists have just published their latest Emerging Market monthly where they argue that the EM complex will enjoy a summer reprieve. They argue that the The ECB has also delivered significant additional liquidity, which will support credit and carry even if the boost to the real economy is modest. EM will benefit as this provides further time for recoveries to take root, especially where low inflation provides room for additional accommodation. The team also tone down their bullish tone of the recent months on less appealing valuations, but stop short of turning negative EM assets. EMFX has little intrinsic value in their view, but they maintain selective longs where we see stronger fundamentals such as in Korea, Malaysia, and the Philippines in Asia, and in Colombia, Peru, and Mexico in LatAm.