Peripheral stock indices underperformed in early trade, with banks under considerable selling pressure amid renewed tensions in credit markets. Wave after wave of poor data from the European PMIs and the German IFOs placed shares under further pressure and talk of macro names selling EUR/USD weighed on the pair. As a result, in the fixed income space, the German 2/5 spread traded at levels not seen since December 2008. However as the session progressed, stocks staged a decent recovery, which coincided with unconfirmed market talk of an asset reallocation trade, together with talk of Asian real money accounts buying French OATs, which in turn prompted sharp tightening in FR/GE 10y bond yield spread. This also supported EUR/USD, which after coming close to making a test on the 1.2500 barrier is now trading little changed. In other news, the ONS reported that the UK economy shrank by 0.3% in the first three months of the year, more than previously thought. The downward revision was due to a bigger contraction in construction output than previously estimated. Despite this, FTSE in the cash has persisted, and is the strongest performing index in Europe today.
Following the morning in Europe, a generally risk-off tone is observed, with stock futures sitting just above session lows and the German Schatz auction resulting in record low yields. Some of the risk-averse moves were noted following unconfirmed market talk that a troubled Dutch housing association may be pressed towards bankruptcy, however this seems to be linked towards an article concerning the Dutch central bank probing into the sale of derivatives to the housing group Vestia. Nonetheless, the long end of the Dutch curve remains well-bid and European 10-yr government bond yield spreads are seen generally wider across the board. Releases from the UK have come under particular focus; the BoE minutes showed an alongside-expectations vote of 8-1 to keep QE on hold. With some analysts estimating more of a lean towards further asset purchases, the initial reaction was strength in the GBP currency, but countering this effect was the parallel release of UK retail sales, with the monthly reading showing the sharpest decline since January 2010. Additionally, it was noted that several members of the board saw further QE as a finely balanced decision, placing GBP/USD back on a downward trajectory and briefly below 1.5700. Elsewhere in foreign exchange, current sentiment is reflected in EUR/USD, printing multi-month lows earlier in the session of 1.2615, with the USD index at 20-month highs which in turn has weighed on commodities.
With only new home sales (which we actually report as opposed to NAR goalseeked marketing materials) to hit the docket in the US, the only newsflow that matters again will be that coming out of Europe, which is holding an informal summit. As BofA reminds us, the summit was originally set up to discuss growth. Now, it is there for Grexit damage control. Today's discussions will focus on the use of existing tools for supporting short-term growth. Spain and Greece are likely to be on the agenda as well. On Greece, although discussions should focus on the pros and cons of a Greek exit, we believe there will be no communiqué other than to mention that Greece should stay in the euro area and implement the programme. On Spain, discussions will likely focus on the banking sector. The discussion will likely be around using the EFSF (or its successor ESM) directly to fund the banking sector, a step Germany opposed in the past. Overall, we do not expect many decisions from the summit. Rather, we expect a communiqué about what was officially discussed, and a date for a later rendezvous. In other words, "investors are likely to be let down by today's summit" (that was BofA's assessment). Also let down, were markets in the overnight session when the BOJ, contrary to some expectations, left its QE program unchanged. As usual keep an eye on headlines: record EUR interest means violent short covering squeezes if the algos sense a hint of optimism in any red flashing text (if only briefly, as the long-term outlook for the situation is quite hopeless).
It was all going to plan until that early angst from Egan-Jones Spain downgrade was increased by L-Pap's 'sky-is-falling' Greek exit plans comments. Treasuries had leaked higher in yield and recoupled with stocks (after the divergence yesterday) but the USD (driven by EUR deterioration) was pushing higher (diverging from its recent correlation). This was dragging commodities lower but gently as stocks (especially financials) continued their dead-cat impressions. Even Facebook showed signs that the deluge of reality was coming off its shoulders. By the European close, stocks had pulled unhealthily high relative to risk-assets in general (once again) and credit was lagging a little. The Spain downgrade news stalled the EUR which began to slide - as did Gold and Silver along with USD strength - but Treasuries kept on limping higher in yield and tracking stocks, Then in the last hour of the day the L-Pap headlines - along with an increasing sense of deceleration (we saw heavy volume come in just after the European close - suggesting covering of the heavy volume up from the bounce lows yesterday) - and all the momo names started to lag with AAPL losing steam (more schadenfreude there after our comments yesterday) and then financials stumbled off their exuberant highs (though JPM managed a very good gain of over 4.5% still - as IG9 compressed for the first time in a few weeks). S&P 500 e-mini futures (ES) managed only a small loss but all the positive momentum was lost and large average trade size pressure came in at the close as it tried to get up to VWAP. VIX gained 0.5vols to close back above 22.5% and the term structure bear-steepened a little more. Yesterday's credit-led strength faded today, as skews normalized, with HYG losses and a renewed fear of the ETFs and indices leaking into the real bond market soon once again. Clusterbook is trading $30.80 after-hours with over 101mm shares traded!
We have not been shy to point out the potential (and now proven) flaws in the Euro experiment (here, here, and here for example) over the past year or so but UBS reminds us that while most people remain fixated on the absence of a fiscal transfer union in so large a monetary union (to offset incidents of inappropriate monetary policy) as Eurobonds and Federalism come back to the fore; it is the second flaw - the absence of an integrated banking system (backed implicitly by a credible lender of last resort) - that should be getting front-page headlines. As Niall Ferguson noted at Zeitgeist this morning, "Structural reforms will work but will not work this week" and in the meantime, TARGET2 balances grow out of control and the longer the 'problem' remains, the worse it becomes leaving an implicit infinitely supported firewall as the only interim solution. While most who foresaw the Euro as implicitly leading to federalism were right, it seems the link to a German dominance (of ECB rulings and general fiscal and monetary decisions) has been the ultimate outcome. While an integrated banking system would do nothing to change the relative competitiveness or growth issues that plague Europe, the 'essential' internal capital flows would be sustained. Is this sort of integration a realistic prospect? The politics is not especially propitious.
UK CPI this morning came in weaker than expected at 3.0% Y/Y in April, weighed by a fall in air fares, alcohol, clothes and sea transport, according to the ONS. The release saw aggressive selling of GBP in the currency market and has underpinned the rise in gilt futures. Alongside the 26th month low in UK CPI the IMF also issued their latest assessment on the UK economy and said further policy easing is required and that the Bank could cut its interest rate from the current 0.5% level. In other market moving news a Greek government source said that Greek banks are to receive a EUR 18bln recapitalisation down payment this Friday which initially saw the EUR and stock futures rally, however, the move was short lived as it became clear that the payment is scheduled as part of the bailout programme for Greece. Elsewhere, Fitch made a surprise announcement and downgraded the Japanese sovereign rating by two notches to A+, outlook negative. The move means Fitch has the lowest rating for Japan of the three main rating agencies so we remain vigilant for any comments from S&P and Moody’s today.
Forget The "Bazookas": Here Come The "Tomahawks" And "Howitzers" - An R-Rated Walk Thru The Greek EndgameSubmitted by Tyler Durden on 05/21/2012 17:01 -0400
"So lets "run" through the mechanics of a Greek bank run. ... The end is of course ECB printing, Eurobonds and every developed market central bank dumping massive liquidity into the global financial markets as systemic risks rise - QE, LTROs, Currency swaps, and every funding facility under the sun come into play. The path to this end game will be bumpy, but make no mistake, the developed market central banks will dump so much fiat on the system to cover the losses, that risk free real rates will plummet to levels so negative that anyone left holding cash or cash equivalents will see massive destruction of real wealth. We may have to push risk assets a bit lower from here, but the global central banks will be firing howitzers and tomahawks very shortly, not bazookas!"
At the beginning of the week, European equities are seen modestly higher in the major indices with underperformance noted in the peripheral markets. Markets have sought some solace in the G8 summit over the weekend, with leaders agreeing that the optimal scenario would be Greece remaining within the European Monetary Union, and have furtively agreed that further measures may be necessary to return Europe to growth. The disagreements, however, continue to rollover as leaders fail to commit to a specific growth strategy. The tentative risk sentiment is reflected in the fixed income markets, with the German Bund remaining in negative territory for much of the session and 10yr government bond yield spread between the periphery and the German benchmark tighter on the session. Touted bids by domestic accounts helped support BTPs (Italian paper), especially in the short end of the curve, where the spread between the German equivalent is trading tighter by around 3bps. From Tokyo, comments from Fed’s Lockhart have drawn attention, who commented that with the downside risks emerging from the Eurozone, it would be unwise to take QE3 off the table.
In continuing with the 2011 deja vu theme which has become the norm at this point, nearly half way into 2012, the key overnight events driving sentiment and futures higher (if not the EURUSD which despite a record number of shorts appears to have once again decoupled with the US stock market), were a statement following the latest G-8 summit (penned in the brief time when the world leaders were not watching soccer) that Greece should stay in the Eurozone (as opposed to?), and yet another promise from China's Wen Jiabao that the world's fastest growing economy would focus on growth (what a truly radical shift in policy for the country which needs GDP growth over 8% just to avoid riots and civil unrest). And in continuing with the "summit" theme so well exhausted back in 2011, and mocked by David Einhorn (see below), let's recall that there is yet another summit on May 22, this time where the European heads of state will sit down and also decide that, shockingly, they want Greece in Europe, in response to which stocks will surge, then be very confused just why they surged, and promptly tumble. Sadly, by now we have seen it all since 2012 continues to be a carbon copy replica of last year. We can only hope the powers that be infuse at least some originality before we are forced to start recycling headlines from the summer of 2011. In the meantime, futures are green, especially since Dennis Lockhart unleashed the QE bomb hours ago in Tokyo, saying that more easing should not be ruled out amid European risks. Wink wink.
A rare moment of optimism from David Rosenberg: "I've said it once and I'll say it again. And believe me, this is no intent to wrap myself up in stars and stripes. But there is a strong possibility that I see a flicker of light come November. The U.S. has great demographics with over 80 million millennials that will power the next bull market in housing, likely three years from now. After an unprecedented two straight years of a decline in the stock of vehicles on the road, we do have pent-up demand for autos. I coined the term "manufacturing renaissance" back when I toiled for Mother Merrill and this is happening on the back of sharply improved cost competitiveness. Oil production and mining services are booming. Cheap natural gas is a boon to many industries. A boom in Chinese travel to the U.S. has triggered a secular growth phase in the tourism and leisure industry. The trend towards frugality has opened up doors for do-it-yourselfers, private labels and discounting stores.... Few folks saw it at the time. But it's worth remembering, especially now as we face this latest round of economic weakness and market turbulence. It is exactly in periods of distress that the best buying opportunities are borne...and believe it or not, when new disruptive technologies are formed to power the next sustainable bull market and economic expansion. Something tells me that we are just one recession and one last leg down in the market away from crossing over the other side of the mountain. And believe me, nobody is in a bigger hurry to get there, than yours truly. At the risk of perhaps getting too far ahead of myself, but you may end up calling me a perma-bull (at that stage, I must warn you, folks like Jim Paulsen will have thrown in the towel)."
The big banks are getting restless. Nowhere is this more evident than in the latest just released letter from Citi's European Credit Strategy, literally a letter to Europe's trio of leading politicians, which follows hot on the heels of yet another recent Citigroup missive from Willem Buiter, which was largely ignored in the noise, yet which made it all too clear that when all else fails, it is the Chairman's sworn duty to paradrop money. Because if anyone, it is the banks that know that if things aren't fixed (they aren't), it is up to the central banks to do something to prevent the vigilantes from forcing the politicians hands, as they did in the summer and fall of 2011 (which will not provide a long-term fix, but at least allow bankers to hope that the next collapse won't take place before bonus season). As Citi says, "Until the gravity of the situation is made clear, until the self-reinforcing mechanisms that already seem to be in motion are understood, we don't see how the solutions, the answers, and the certainty that market craves can be brought to the table." Which simply means that things are about to get much, much worse as it will be up to the markets to bring the world to the edge of collapse once again, just so Europe, with the help of the Fed of course, once again is forced to get over the political bickering and prop up risk assets, in yet another iteration of "this time it's different", even though it isn't. Sure enough: "Our impression is that markets will need to act as the proverbial 'attack dog', forcing the issue on the political agenda. We can't escape the sense that it is probably politically easier to let the markets run loose for the time being to make it apparent that further intervention is needed. But 1000bp on Crossover is much closer than you imagine." In other words, Citi just gave the green light for the bottom to fall from the market just so Europe's increasingly impotent political elite does something, anything. Look for many more banks to sign off on the same letter.
In an interview with Louis James, John Hathaway discusses the US's economic outlook and why he's delighted by the current bearish sentiment toward gold. "I think we're at the end of a correction that resulted from the peak last summer. It was overcooked, kind of hyperventilated hysteria over the debt-ceiling talks, the rating downgrade of the US sovereign debt, and I think basically the stocks and the metal had been working off that boiled down to what we now have is a simmer. I think we are at a position where there's not a lot of downside, and I would not be surprised by revisiting the previous highs of $1,900 and maybe even new highs over $2,000 this year."
There's a big, fat "I told you so" coming down the pike.
With a lack of European data, markets have remained focused on the macroeconomic issues throughout the morning. European equities have seen mixed trade this morning, starting off sharply lower following Moody’s downgrade of 16 Spanish banks late last night. Equities have been observed on a relatively upwards trend as market talk of asset reallocation into stocks from fixed-income has somewhat buoyed sentiment, however this remains unconfirmed. The news that Spanish banks are pressing regulators to reinstate a short-selling ban on domestic banking stocks has also helped keep negative sentiment towards Spanish financials at bay, with Bankia dramatically reversing recent trends and seen higher by around 25% at the midpoint of the session...The chief of the Australia and New Zealand Banking Group has said volatile conditions in global markets have caused the wholesale funding market for Australian banks to freeze, a further sign that the European turmoil is taking its toll on global markets.
European cash equities are in the red across the board at the midway point, as the bourses fail to reverse the trend of the past few sessions. With data points very light today, participants continue to focus on the macroeconomic themes as speculation regarding a Greek exit maintains focus. A medium-term maturity Spanish bond auction slightly eased fears, selling to the top of the indicative range, however the appearance of solid demand was countered somewhat by limited supply and sharply higher yields across all three lines. Following the auction results, EUR/USD saw some modest support and the Bund exhibited slight weakness, but this was short-lived as the macroeconomic concerns took over once more. Unexpectedly, the 3-month Euribor rate fixing came in with its first increase since December last year, prompting some selling pressure on the Euribor strip. This move was retraced as it was rumoured that one bank had not submitted a rate due to the Ascension Day market holiday across certain European markets, prompting the incline.