Futures Levitate Because Any Re-escalation Is Simply Pent Up De-escalation

A quick reminder of how geopolitics governs markets: on Friday, the market plunged 0.005% over fears Ukraine and Russia may be about to go at it all out after a fake report Ukraine shelled a Russian military convoy. On Monday, the same "market" soared just under 1% as the news that had caused the "crash" was refuted. That has been the dominant rinse, repeat theme for the past month and will continue to be well after Yellen's Friday speech at Jackson Hole (although one does wonder why she is not speaking on Wednesday when the symposium begins). Not surprisingly, with only modest re-escalation news overnight (that Russia is preparing further retaliatory sanctions against the West), which is simply "pent up de-escalation" in the eyes of Keynesian algos, futures are again up a solid 0.2% and rising, and the way the rampy USDJPY is being manipulated before its pre-market blast off, we may well see the S&P hit 1980, if not a new all time high before 9:30am, let alone during today's cash session. In any event, whatever you do, don't you dare suggest that algos should care one bit about Ferguson and its implications for US society.

Taking a closer look at the geopolitical stories, as DB summarizes, no bad news is certainly viewed as good news for now. Following the four-way diplomatic talks in Berlin on Sunday, Russian Foreign Minister Sergei Lavrov yesterday told the press that the talks have failed to produce positive results in establishing a ceasefire and (starting) a political process. According to Reuters, Lavrov accused Ukraine for changing their demands over what it would take to establish a truce between government troops and pro-Russian insurgents. The good news though is that some progress was made on allowing the delivery of Russian humanitarian aid to eastern Ukraine. Lavrov said that “all questions” regarding the humanitarian convoy had been removed and agreement had been reached with Ukraine and the International Committee of the Red Cross (ICRC). Bloomberg news overnight said that the ICRC expects to work out the details of a safe-passage plan for the convoy into Ukraine “soon”. The four-way talk is expected to resume again sometime this week but we don’t have specific timing on that yet. Despite the ongoing volatility, it is interesting to see the strong performance in Russian equities over the past week. The MICEX index has rallied every single day for the past 7 trading sessions and is currently about 7% off its early August lows. One wonders which Russian oligarchs are selling into the latest liftathon.

European equity markets trade strongly, with the benchmark DAX outperforming as Bayer (+2.0%) benefit from a UBS upgrade and ThyssenKrupp (+1.8%) gain on a bullish outlook provided by the CEO. Nonetheless, the materials sector underperforms as BHP Billiton (-4.0%) trade poorly after their earnings update. BHP Billiton are to spin-off coal, nickel, aluminium, manganese and silver assets into a new Australian and South African listed company. Nonetheless, BHP Billiton failed to disclose a new share buyback and their financial metrics remained weaker.

Looking ahead, inflation readings from the UK and the US will be the notable releases to watch. We will also get July housing starts and building permits from the US today, which are both expected to rebound strongly after a disappointing month in June. We might be back to geopolitical watch mode again today as we build up towards Jackson Hole this Friday.

Bulletin Headline Summary

European equities take confidence from the strong Wall Street close, however T-notes erase overnight weakness on weak UK CPI and reports of the Kremlin preparing further retaliatory sanctions against the West in the event of stricter controls on Russian trade
Markets await any further clarity on the Russian aid convoy’s safe passage into eastern Ukraine after Ukraine/Russia tensions ebbed lower yesterday on a series of negotiations held between the countries counterparties
Treasuries gain amid rally in core euro-zone bonds on U.K. inflation data, expectations for dovish Yellen at Fed’s Jackson Hole conference; German 10Y holds below 1.00% level.
U.K. inflation fell to 1.6% in July from 1.9% in June, more than forecast, giving Bank of England room to keep its key interest rate at a record low; GBP fell to four-month low vs USD
Pimco has been buying some of the higher-rated high-yield bonds dumped by speculative-grade debt managers amid the recent exodus from funds
Fed Chair Yellen is likely to avoid taking more hawkish stance at this week’s Jackson Hole symposium, based on published research
The Fed now owns almost a third of MBS outstanding. One rarely discussed consequence: Money managers are being pushed to add more of the securities than they otherwise might because the benchmark debt indexes that they’re judged against fail to exclude the Fed’s sizable holdings, according to Citigroup Inc. analysts
Australia’s central bank said the nation’s economic outlook remains uncertain because of the conflicting forces at play and reiterated that interest rates are set to remain on hold
A former Rabobank Groep senior trader pleaded guilty in New York to conspiring to manipulate a benchmark interest rate tied to trillions of dollars of securities to benefit his trading positions, the U.S. said
The biggest overhaul to the $19t credit derivatives market in more than a decade will seek to solve flaws that have stopped some contracts paying out as buyers anticipated
The Red Cross is close to working out the details of a safe- passage plan for a Russian aid convoy intended for war-torn southeastern Ukraine, while four-way talks on a halt to the fighting reached an impasse in Berlin.
Obama said the U.S. will continue “limited” airstrikes against Islamic State militants, which have stopped their advance on the city of Erbil and helped Iraqi and Kurdish forces recapture a key dam at Mosul
Police fired stun grenades and tear gas at protesters in a St. Louis suburb rocked by violence after police shot and killed an unarmed black teen 10 days ago
Obama is dispatching Attorney General Eric Holder to the St. Louis suburb in a show of commitment to an aggressive inquiry into the shooting of an unarmed black teenager by a local police officer
Orphans whose families were killed by Ebola are becoming a tragic legacy of the deadly outbreak in West Africa, say relief organizations struggling to care for the children who may themselves be infected
Sovereign yields mostly lower. Euro Stoxx Banks +0.6%. Asian and European equities higher, U.S. stock futures gain. WTI crude, gold and copper higher
US CPI expected to decline further, keeping the focus on Fed chair Yellen’s appearance at Jackson Hole this Friday

Market Wrap

S&P 500 futures up 0.2% to 1971.3
Stoxx 600 up 0.5% to 335.2
US 10Yr yield down 1bps to 2.39%
German 10Yr yield down 1bps to 1.01%
MSCI Asia Pacific up 0.7% to 149
Gold spot up 0.1% to $1299.9/oz

US Economic Docket

8:30 am: CPI m/m, July, est. 0.1% (prior 0.3%)
- CPI Ex-Food and Energy m/m, July, est. 0.2% (prior 0.1%)
- CPI y/y, July, est. 2% (prior 2.1%)
- CPI Ex-Food and Energy y/y, July, est. 1.9% (prior 1.9%)
- CPI Core Index SA, July, est. 238.520 (prior 238.083)
- CPI Index NSA, July, est 238.316 (prior 238.343)
8:30am: Housing Starts, July, est. 966k (prior 893k)
- Housing Starts m/m, July, est. 8.1% (prior -9.3%)
- Building Permits, July, est. 1m (prior 963k, revised 973k)
- Building Permits m/m, July, est. 2.8% (prior -4.2%, revised -3.2%)
11:00am: Fed to purchase $250m-$350m notes in 2024-2031 sector
11:30am: U.S. to sell $50b 4W bills, $25b 52W bills

ASIAN HEADLINES

The Nikkei 225 (+0.9%) closed at 2-week highs on a strong Wall Street close, with the Hang Seng (+0.2%) having opened above the 25,000 level for the first time since 2008.

FIXED INCOME

Bund futures opened relatively unchanged, despite JGBs falling overnight as the market made way for 20yr supply from the Ministry of Finance, but found some support at the lows of 149.82 as a Kremlin spokesman warned that Russia were preparing retaliatory sanctions against the West if they continue their aggressive and destructive policy toward Russia. Nonetheless, the bid-tone was relatively short-lived as the Finnish PM stated the EU are unlikely to embark on further sanctions last week. Gilt futures sharply outperform, pressing the UK 10yr yield to 2.385% after UK CPI fell below expectations (1.6% vs. Exp. 1.8%) as the drop in apparel prices weighed.

EQUITIES

GBP/USD fell below the 200DMA at 1.6674 and hit April 2014 lows on the lower-than-expected CPI, heightening speculation that the Bank of England will be forced to remain dovish in the near-term in order to prop up inflationary expectations. Elsewhere, the USD-index trades positively, pressing EUR/USD toward touted options rolling off at 1.3350 (just under USD 1bln) at today’s 10am (1500BST) NY cut.

NZD declined sharply against all of its counterparts after New Zealand PPI fell by the most in 7 quarters and as the New Zealand Treasury announced a cut to its growth forecasts. Elsewhere, AUD firmed following the release of the RBA August 5th meeting minutes, where the central bank refrained from aggressive jawboning of the currency and instead highlighted noticeable easing in financial conditions, hence lowering expectations of further easing.

COMMODITIES

Brent and WTI crude futures trade higher after yesterday’s Libya, Ukraine and Iraqi-inspired sell-off, but WTI is still far from testing the week’s best levels at USD 95.33 as the market makes way for the ongoing resumption of Libyan exports – another tanker is set to load crude at the Es Sider oil port on the Libyan coast in due course. Precious and industrial metals prices trade relatively muted, with gold awaiting the upcoming US CPI figures, with falling inflation in the US expected to keep the onus on Yellen’s Jackson Hole appearance later this week.

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DB's Jim Reid Concludes the overnight recap

Geopolitics continues to be front and centre of mind at the moment. Indeed markets were off to a positive start to the week given the lack of negative geopolitical surprises over the past 24 hours. We’ll recap some of the key stories below but for now markets are seeing a decent follow through in the Asian session overnight. Main bourses in Japan, Korea, and Australia are up +0.8%, +0.9%, +0.5%, respectively as we type. Asian cash credits are also performing well given the absence of new supply. The Asia iTraxx IG index is wrapped around 101bp, down from the wides of 112bps two Fridays ago. Treasuries have lost some of the safe-haven bid with the 10s now at around 2.39% (9bps off its recent intraday lows) as we go to print.

Taking a closer look at the geopolitical stories, no bad news is certainly viewed as good news for now. Following the four-way diplomatic talks in Berlin on Sunday, Russian Foreign Minister Sergei Lavrov yesterday told the press that the talks have failed to produce positive results in establishing a ceasefire and (starting) a political process. According to Reuters, Lavrov accused Ukraine for changing their demands over what it would take to establish a truce between government troops and pro-Russian insurgents. The good news though is that some progress was made on allowing the delivery of Russian humanitarian aid to eastern Ukraine. Lavrov said that “all questions” regarding the humanitarian convoy had been removed and agreement had been reached with Ukraine and the International Committee of the Red Cross (ICRC). Bloomberg news overnight said that the ICRC expects to work out the details of a safe-passage plan for the convoy into Ukraine “soon”. The four-way talk is expected to resume again sometime this week but we don’t have specific timing on that yet. Despite the ongoing volatility, it is interesting to see the strong performance in Russian equities over the past week. The MICEX index has rallied every single day for the past 7 trading sessions and is currently about 7% off its early August lows.

Away from Russia, the reclamation of the strategic Mosul Dam by the Iraqi and Kurdish forces (aided by US airstrikes) was seen as a key progress in the fight against the ISIS militants. The fear was that ISIS could use the dam to cut off power and water supplies to millions of Iraqis who lived downstream and a destruction of the dam could also flood the capital city of Baghdad. Moving slightly westwards, markets were probably relieved to learnt that the Gaze truce has been extended for an extra day at the request of Egypt. The extension came just minutes before the 5-day cease fire deadline was set to expire at midnight local time on Monday. According to the WSJ, there were no indications on whether both sides have narrowed their differences which does raise the question of what an extra 24 hours would do to help. Indeed both sides have failed to make a compromise, with Israel demanding the demilitarization of the territory while Hamas demanding an end of the economic blockade of the Gaza strip.

Back to markets, the sharp outperformance in European equities was hardly surprising as they had some catch up to do. The Stoxx600 closed up +1.18% with the DAX and CAC leading the way, up +1.68% and +1.35% respectively. On the other side of the pond the S&P 500 gained around +0.8% while the VIX dropped to its lowest in about 3 weeks. US markets were also supported by M&A news and a better-than-expected NAHB Housing Market index (55 v 53 expected) print for August. Dollar General Corp yesterday announced a takeover offer of US$9bn for Family Dollar stores stating that the deal will generate US$550-600m in cost synergies three years after completion. The S&P 500 Homebuilding sub index also rallied nearly 2% on the day helped by the positive housing data.

In fixed income markets, Credit also performed well with European Main and Xover 5bps and 16bps tighter and the US CDX IG and HY 2bps and 9bps tighter, respectively. The 10yr bund yield unwound some of its recent gains, closing 6bp higher at 1.014%. Gilts also gave back virtually all of its Friday’s gains with the 10-year yields up 10bps to 2.43% after Carney’s weekend interview with the Sunday Times. The BoE Governor noted that an expectation of recovery in earnings may be enough to push the MPC toward policy tightening and the bank doesn’t need to wait for an actual increase in wages before raising rates. The policy divergence amongst key central banks also makes this Jackson Hole an interesting one to watch, particularly given the representation from the BoE, the ECB and the BoJ at the symposium.