Obama's Latest Russian Sanctions Send Global Stocks Reeling

Slowly but surely, all those cans that many hoped were kicked indefinitely into the future, are coming back home to roost. The biggest impact on global risk overnight have been undoubtedly the expanded Russian sanctions announced by Obama yesterday, which have sent the Russian Micex index reeling to six week lows (as it does initially after every sanction announcement, only for the BTFDers to appear promptly thereafter), with the biggest hits saved for the named companies such as Rosneft -5.6%, Novatek -5.1%, and others Alrosa -5.7%, VTB Bank -4.3%, Sberbank -3.4% and so on. Then promptly risk off mood spilled over into broader Europe and at last check the Stoxx600 was down 0.8%, with Bund futures soaring to record highs especially following news (from the Ukraine side) that a Russian warplane attacked a Ukrainian fighter jet. Not helping matters is the end of the dead cat bounce in Portugal where after soaring by 20% yesterday on hopes of a fresh capital infusion, Espirito Santo has once again crashed, dropping as much as 11%, driven lower following downgrades by both S&P and Moodys, as well as the realization that someone was pulling everyone's legs with the rumor of an equity stake sale.

Heading into the North American open, stocks in Europe are seen broadly lower, weighed on by concerns surrounding the implications that fresh round of sanctions on Russia will have on banks exposed to Eastern Europe. In terms of stock specific movers, SAP (+4.16%) bucked the trend following earnings pre-market, while Fiat (+3.68%) shares rose following reports in Manager Magazin that VW (-2.09%) and Fiat owners are exploring possible takeover deal. 3 out of 19 Stoxx 600 sectors rise; tech, media outperform, telcos, utilities underperform. 27.3% of Stoxx 600 members gain, 70.5% decline. Eurostoxx 50 -0.7%, FTSE 100 -0.4%, CAC 40 -0.6%, DAX -0.4%, IBEX -0.8%, FTSEMIB -1%, SMI -0.5%. The Italian and Spanish markets are the worst-performing larger bourses, the U.K. the best. The euro is little changed against the dollar.

Then there is China where since the government decided to resume injecting debt, it now has to face the consequences of a monster credit bubble. And sure enough, overnight a construction company (Huatong Road & Bridge) warned that it may default on RMB400m (or US$65m) of bonds that mature on July 23rd. This would make it just the second Chinese company to default in the domestic bond market after Shanghai Chaori Solar who defaulted in March, and the first to default on both principal and interest payments (Chaori failed to meet coupon payments). Paradoxically this does show that maybe the government is continuing to impose discipline in the nascent domestic bond market which makes little sense considering latest monetary figures show the government has resumed fanning the credit bubble flames on its own. The news has had little impact on the Chinese USD credit market so far.

Looking at the day ahead, the St Louis Fed’s James Bullard will be speaking on monetary policy today (scheduled for around 6:30pm London). Although Bullard is not an FOMC voter this year, he is usually middle-of-the-road on the hawk/dove scale but his comments have gotten noticeably more hawkish in recent months. In recent months Bullard has warned that inflation may overshoot 2% in 2015 and has played down the importance of Q1’s soft GDP growth numbers. Something to watch for today. On the earnings front, Morgan Stanley reports Q2 results before the NY opening bell and Google reports after-market. The US mega banks and tech companies have set a pretty good start to the Q2 reporting season so far (relative to expectations), so it will be interesting to see if this trend can continue. Highlights on the data docket include Euroarea CPI, US housing starts, jobless claims and the Philly Fed survey.

Market Wrap

S&P 500 futures down 0.4% to 1967.2
Stoxx 600 down 0.5% to 341.2
US 10Yr yield down 2bps to 2.5%
German 10Yr yield down 3bps to 1.17%
MSCI Asia Pacific little changed at 147.2
Gold spot up 0.3% to $1303/oz

ASIA

Flight to quality theme dominated the session overnight, as market participants reacted to Obama approving additional sanctions on Russia and also after Chinese builder Huatong Road & Bridge Group warned of a possible bond default, which would make it the first borrower to default in China's bond market.

FIXED INCOME

Risk averse sentiment stemming from another round of sanctions on Russia saw Bunds trade higher since the open, however peripheral bond yield spreads gradually recovered initial widening bias. This tightening is in part an unintended by-product of sanctions, which will likely encourage further inflows into EU paper at the expense of US. In terms of macroeconomic data releases, the final CPI reading came in line with expectations, while ECB's Hansson said that ECB asset purchases are not imminent or needed now.

EQUITIES

Flight to quality flows saw USD/JPY trade lower overnight in Asia and in Europe this morning. Consequent USD weakness, together with likely inflows into EU related assets by Russia companies, seeking to reduce the impact that sanctions will have on operations supported EUR.

COMMODITIES

Safe-haven related flows saw gold reclaim USD 1,300 level, while palladium prices rose to 13-year highs after Russian and Ukrainian geo-political concerns became the focal point, as the US imposed more further-reaching sanctions on Russia, the world largest producer of the metal.

* * *

DB's Jim Reid wraps up the overnight event recap

A positive Wednesday session for risk has lost some momentum this morning following a couple of after-market earnings disappointments (Yum Brands, Sandisk) and news of further US sanctions on Russian firms. On the latter, the White House announced late yesterday that it was imposing sanctions on a number of Russian energy, defense and banking groups. The companies that are sanctioned include Rosneft (who accounts for 4% of the world’s crude and 8% of Russia’s GDP according to Reuters), Novatek (no 2 gas producer), two banks and eight defense firms. The sanctions would not freeze the Russian firms' assets nor prohibit most transactions with them, but will prevent the sanctioned companies from accessing US equity or debt markets for new financing with a maturity beyond 90 days. It’s unclear to what degree that this will squeeze funding for these corporates, though media reports suggest that the energy and banking groups are significantly dependent on USD funding (Reuters).

We’ll get a firmer picture on the extent this will affect sentiment in EM when Europe opens, but as we type Asian EM is trading with a slightly softer tone. There are small losses in Asian equities led by China (HSCEI -0.4%) as well as a number of EM FX bellwethers such as KRW (-0.15%) and INR (-0.1%). In China, following yesterday’s GDP print of 7.5%, the State Council has reiterated today that the government will meet its economic growth goals and pledged to further promote targeted stimulus measures in the railway, urban infrastructure and irrigation sectors. This has benefited specific names such as China Railway Construction (+0.5%) but the rest of Chinese equity market is lagging this morning (SHCOMP -0.9%). The IDR (+0.3%) is firmer, perhaps buoyed by comments from the leading Presidential candidate Jokowi suggesting that he will work more closely with Indonesia’s central bank to curb IDR volatility.

Coming back to China, a construction company (Huatong Road & Bridge) has warned that it may default on RMB400m (or US$65m) of bonds that mature on July 23rd. This would make it just the second Chinese company to default in the domestic bond market after Shanghai Chaori Solar who defaulted in March, and the first to default on both principal and interest payments (Chaori failed to meet coupon payments). Though the news is unlikely to shake markets which have become accustomed to credit issues in China, it does show perhaps that the government is continuing to impose discipline in the nascent domestic bond market - despite the stronger-than-expected June money and credit aggregates data. The news has had little impact on the Chinese USD credit market.

The S&P500 (+0.42%) climbed closer to the 2000 mark yesterday, while the Dow (+0.45%) hit a record high, buoyed by M&A activity (Fox and Time Warner) and US data (NAHB housing, benign PPI). Yesterday saw Intel (+9.3%) stock rise strongly in reaction to its after-market earnings from the day before, which dragged along with it related companies such as Microsoft (+3.8%). In terms of earnings, Wednesday was a relatively mixed day with the likes of eBay and Bank of America beating consensus estimates but disappointing in the details. Bank of America stock fell 1.9%, with markets probably spooked by the high amount of litigation charges of around $4bn or more than $0.20 per share. EPS ex litigation of $0.40 was above the $0.29 consensus estimate, but the EPS was just $0.19 once litigation costs were taken into account. Other details of the BofA result provided better comfort with FICC trading revenues up 5% on the year, which is the best result we’ve seen thus far from the US banks. NIMs were relatively solid at around 2.26%.

We’re a little more than one week into the US earnings season and so far around 49 companies have reported representing around 15% of the index market cap. The current tally has seen around 80% of companies beat consensus estimates on earnings, and around 71% do the same in terms of revenues. Both figures are above recent averages though it’s still clearly early days in the Q2 reporting season.

In Europe, the Periphery led a fairly strong session and this was sparked by a Portuguese newspaper report saying that Banco Espirito Santo's new CEO had convinced private-sector investors to inject EUR2bn into the bank. However it wasn’t clear yesterday exactly who these investors were. This follows comments from the Bank of Portugal late on Tuesday that there are certainly shareholders interested in participating in a capital increase, should the bank require it. BES’ LT2 debt rallied more than 10pts at one point yesterday, the biggest intraday jump on record, despite talk that subordinated bondholders may be required to participate in the bank’s recapitalisation (Bloomberg). The European iTraxx senior financials (-3.625bp) and subordinated financials (-5bp) indices both rallied substantially yesterday, Stoxx600 financial stocks strengthened 1.77% (vs a 1.27% gain in the Stoxx600) and BES stock itself rallied 19.74%.

In treasuries, the curve continued to flatten, though this was more driven by a rally in the long-end than any hawkish carryover from Yellen’s Tuesday Senate comments. There was nothing substantially new in Yellen’s House Committee testimony, which carried a very similar message overall to her comments at the Senate Banking Committee. Indeed, Ms Yellen’s prepared remarks were exactly the same on both days, and perhaps the main bit of new information from yesterday’s Q&A was that the Fed is continuing to discuss the framework for policy normalisation. Yellen said more details will be given on this topic later this year. In other bits of the Q&A, the Fedchair responded to a Republican proposal tying rate increases to a mathematical formula, for example the Taylor rule, saying that it’s “utterly necessary for us to provide more monetary policy accommodation that those simple rules would have suggested”. On the topic of markets, the Fedchair classified the threats to financial stability as at a “moderate, not high level”. The WSJ interviewed the Chicago Fed’s Charles Evans yesterday who reiterated Yellen’s comment that the employment picture was improving faster than anticipated, but he continued to advocate for rates to remain low into 2015 and early 2016 because inflation remained low.