Futures Tumble On Abysmal European Data, Euro Stocks Turn Red For 2014; German 2Y Bunds Negative

With everyone focused on China as the source of next systemic risk, most forgot or simply chose to ignore Europe, which through Draghi's verbal magic was said to be "fixed." Or at least everyone hoped that the rigged European bond market would preserve the "recovery" illusion a little longer giving the world some more time to reform pretend it is doing something to fix it. Turns out that was a mistake, confirmed earlier not only by the plunge in German Factory Orders which cratered -4.3%, down from 7.7% and below the 1.1% revised, and UK Industrial production which missed expectations of a 0.6% boost, rising only 0.3%, but most importantly Italy's Q2 GDP shocker, which as we reported earlier, dropped for the second consecutive quarter sending the country officially into recession. As a result, European stock markets, Stoxx600, has joined the DJIA in the red for the year while Germany's 2 Year Bund just went negative on aggressive risk aversion, the first time since 2012.

Adding insult to injury was the previously reported Termination Fee Tuesday, which was replaced Merger Monday, when two mega M&A deals, 21st Century Fox for Time Warner and Sprint for T-Mobile were both called off, signalling that the M&A bubble is also officially over. Finally, ongoing escalation with Russia assures that the only continent set to feel the full brunt of Obama's "costs" is... Europe, something with the Dax has clearly figured out by now. Oh yeah, and there is the whole Ebola going global thing.

All of the above means that the Great Unrotation is fully on and with equity futures tumbling yet again, all the money is going into the safety of the Fed-hated 10 Year, which at last check was yielding below 2.45%, and just above 2014 lows.

Looking at overnight markets, equities are trading lower across the board as the carryover of Russia/Ukraine tensions and a weak day for broader EM spills over into Asian markets. Asian bourses are down between one-third to half a percent with losses led by the Nikkei (-1.0%). Asian EM local currency bonds are generally around 2-3bp higher in yield and Asian USD credit is edging wider today. EURUSD is down 0.1% overnight at 1.336 ahead of Thursday’s ECB and is poised to close lower for the 12th time in the last 15 days.

Stocks traded lower since the get-go in Europe, with the German DAX index under particular selling pressure where Deutsche Telekom (-3%) shares came under pressure in reaction to reports that Sprint is to drop its T Mobile- US bid. At the same time, Hannover Re (-3.5&) shares tumbled after the company missed on net income and operating profit metrics. In terms of US earnings, focus today will be on Time Warner, Mondelez, Viacom and Prudential Financial.

On today's US docket we have the US trade balance expected later today and Q2 earning season continues with Time Warner, Mondelez, Viacom and Prudential Financial

Market Wrap

S&P 500 futures down 0.3% to 1906
Stoxx 600 down 1.3% to 327.95
US 10Yr yield down 4bps to 2.44%
German 10Yr yield down 2bps to 1.14%
MSCI Asia Pacific down 0.4% to 146.2
Gold spot up 0.1% to $1290.7/oz

Bulletin Headline Summary from Bloomberg and RanSquawk

Europe’s Stoxx600 erases YTD gains as Italy returns to recession
M&A picture deteriorates as Sprint/T-Mobile and 21st Century Fox/Time Warner deal collapse
Treasuries gain, led by long-end, with 10Y yield at lowest since May amid escalating tensions in Ukraine, and bund yields fall to record low on weak European data.
Poland said the risk of Russia invading Ukraine has increased in the “last dozen hours or so” after Putin increased the number of troops on his country’s western border
Italy returned to recession in the 2Q, with its economy shrinking 0.2%, while German factory orders dropped 3.2% in June; both reports worse than forecast in separate Bloomberg surveys; data come on eve on ECB’s August meeting
Negotiators are seeking a lasting solution to the Gaza conflict at talks in Cairo, as Israel withdrew troops on the first day of a 72-hour cease-fire that has held so far
Obama said Africa’s fast-growing economies represent a great opportunity for U.S. companies to expand their investments if governments curb corruption and human rights abuses
Obama says U.S. corporations that adopt foreign addresses to avoid taxes are unpatriotic. His own administration helped one $20b American company -- Delphi Automotive-- do just that
Statist strongmen such as Putin and China’s Yi are challenging U.S.-style capitalism as the tidy 20th century separation between rival economic blocs has been replaced with a confounding web of cross-border ties
An insider attack against international and Afghan forces in Kabul that killed a U.S. general has renewed questions about the Obama administration’s exit strategy from Afghanistan and the country’s security
Most international airlines flying to West Africa in the grip of the deadly Ebola outbreak are counting on stepped-up passenger screening as they continue serving the region
Sovereign yields mostly lower. Euro Stoxx Banks -2.7%. Asian and European equities slide, U.S. stock futures lower. WTI crude higher, gold unchanged, copper falls
US trade balance expected later today and Q2 earning season continues
with Time Warner, Mondelez, Viacom and Prudential Financial

US Econ Data

7:00am: MBA Mortgage Applications, Aug. 1 (prior -2.2%)
8:30am: Trade Balance, June, est. -$44.8b (prior -$44.4b) Supply
8:30am: U.S. to announce plans for quarterly refunding auction of 3Y/10Y notes, 30Y bonds
11:00am: Fed to purchase $1.4b-$1.7b notes in 2018-2019 sector

FIXED INCOME

Looming supply failed to weigh on Bunds this morning, which instead traded higher on the back of lower stocks, uncertainty surrounding the looming risk events, as well as the ongoing stand-off between Russia and Ukraine. The bid tone was also supported by the release of weaker than expected German Factory Orders and EU based retail PMIs. Unlike yesterday, weak macro picture was also evident over in the UK, with Gilts gaining upside traction following the release of worse than expected UK Manufacturing and Industrial Production reports.

EQUITIES

The release of much weaker than expected UK Manufacturing and Industrial Production reports saw GBP/USD reverse yesterday's Service PMI inspired gains and slip below the key 100DMA line. This in turn meant that in spite of the apparent risk off sentiment, EUR/USD traded steady, as EUR/GBP consolidated above the 21DMA line.

COMMODITIES

WTI crude futures currently trade in positive territory, underpinned by the API crude inventory report yesterday, as speculators now await the DoE Inventories expected later today at 1530BST/0930CDT. After initial strength through the European morning on safe haven bids and improving Asian demand gold has come off best session levels, yet remains in up heading into the North American cross-over.

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DB's Jim Reid concludes the overnight recap

There continues to be a lot of chatter about US high yield outflows but the daily flow data from the high yield ETF sector indicate there are some initial signs that outflows are abating. Taking a look at iShares iBoxx High Yield ETF, Tuesday’s flows were flat (i.e. neither positive or negative). This follows the inflow of $129m recorded on Monday, which was the first inflow since July 7th. Similarly, the SPDR Barclays HY ETF recorded an inflow of +$20m yesterday, which was the first inflow in more than a week. Despite the early signs of slowing outflows, we note that these two large ETFs remain under selling pressure with their price-to-NAV ratios still in negative territory (versus historical average premiums of between +0.15% to +0.20%). This last point is worth monitoring as ETF outflows are typically associated with negative premiums.

Coming back to Tuesday, it was day when it seemed that strong US data was working against the weight of geopolitical headlines. Indeed, 10yr UST yields finished flat on the day at 2.48%, after initially selling off on the strength of the non-manufacturing ISM but rallying back on the Russian headlines. Meanwhile, the S&P500 (-0.97%) took both the data and geopolitical headlines negatively to notch up its lowest close since May. In terms of the Russian news, much of the focus was on President Putin who suggested that his government prepare retaliatory measures against Western economic sanctions imposed on Russia (Reuters). However Putin added a caveat that any new moves “must be done extremely carefully to support (Russian) producers and avoid harming consumers”. Russia's Vedomosti newspaper reported yesterday that the government was considering a partial or total ban on overflights of Siberia by European airlines, which use the route to shorten trips from Europe to Asia. In recent days, Russian regulators have banned shipments of some European fruits and vegetables (WSJ). Perhaps of more immediate concern were the warnings from Ukrainian and Polish officials yesterday that Russia was renewing a buildup of troops on the Russian side of the border with eastern Ukraine. The Polish foreign minister suggested that “this is the sort of thing one does to exert pressure or to invade”. Markets seemed to connect this with Russia’s move to call an emergency UN security council meeting to discuss the humanitarian situation in Ukraine. At the meeting which was held late on Tuesday NY time, Moscow suggested sending convoys with Russian humanitarian aid supplies to Donetsk and Lugansk, as well as to Ukraine's other cities with a high number of displaced people.

Looking more closely at the US data, the non-manufacturing ISM printed at 58.7, higher than the median estimate of 56.5 and significantly exceeding even the highest analyst estimate of 57.5. It was also the highest headline print since 2005. The new orders component increased to the highest level since August 2005 and has increased every month this year, the longest such stretch since records began in 1997 according to Bloomberg. There was further positive data for the US growth bulls in the form of June factory orders, which printed at +1.1%, higher than estimates of +0.6%.

The strong US data (and resulting rate hike concerns), fears of Russian military escalation in Ukraine and yesterday’s Chinese services PMI shocker proved a tough combination for the EM complex. The CDX EM index was quoted 12bp wider at 290bp at the close and the MSCI EM equity index lost 0.58%. The weakness in EM seemed to gather momentum as the US session wore on and LATAM EMFX bellwethers such as MXN (-0.7%) and BRL (-1%) finished the day near the lows against the USD. The fall in the BRL seemed to be exacerbated by comments from BCB president that Brazilian inflation will slow towards the official target if interest rates are maintained, suggesting a lower probability of rate hikes ahead.

On the M&A front there were a number of withdrawn or cancelled takeover bids in the last 24 hours which stand in contrast to all the recent flow of merger and acquisition headlines. After the US closing bell, 21st Century Fox withdrew its unsolicited takeover offer of $75bn for Time Warner Inc. The chairman of Fox said he’s backing down after Time Warner’s board refused to engage in talks and Fox’s stock price declined 11% since the offer became public. Fox instead authorized a $6 billion repurchase of its Class A shares (Bloomberg). The other major M&A talking point also came after the US close – the WSJ reported that Sprint Corp has ended talks to acquire T-Mobile US Inc, which would’ve created a US rival to Verizon. Japan’s Softbank Corp, who controls Sprint, is down 3.7% this morning in Japanese trading and that is partly explaining the underperformance of the Nikkei this morning.

Coming back to the credit space, the UK’s Financial Conduct Authority announced yesterday that it will restrict the sale of Contingent Convertible bonds (CoCos) to retail investors for a period of 12 months. The FCA will publish a consultation paper on a set of permanent rules for CoCos in September. This comes after the European Securities and Markets Authority issued a statement in late July warning that bondholders may not be fully appreciative of the risks that bank CoCo instruments entail, such as call risks, subordination and the risk of write-offs. ESMA said that “investing in CoCos requires a sophisticated level of financial literacy and a high risk appetite....these may not be appropriate for retail investors”. The WSJ notes that there may be a high degree of complacency amongst CoCo investors - a poll of over 150 investors showed that 90% of respondents thought they understood CoCos better than other market participants, citing an RBS survey. CoCos have underperformed recently on the back of the EMSA’s comments. In addition to that, recent reports that the instruments have been removed from some credit indices have led to further pressure on technicals. The newsflow from BES has probably exacerbated the move as well. According to the Journal over $100bn of CoCos have been issued already - in an environment of supportive ECB policy and low rates, investors have been happy to take on (or overlook as some would suggest) the structural risks in exchange for higher yields from bank CoCos.

Looking at the day ahead, the European calendar will be dominated by German factory orders, Italian and UK industrial production for the month of June and Italy Q2 GDP. On the latter, Bloomberg median consensus is for the Italian economy to register a +0.1% QoQ and YoY growth number. If correct, this would be the first positive YoY number since 2011. Following that there is the release of the US June trade balance (consensus -$44.8bn) and the usual weekly mortgage applications.