European Rumblings Return As ECB Integrity Questioned

As we warned here first, and as the sellside crew finally caught on, while the key macro event this week is the US presidential election, the one most "under the radar" catalyst will take place in Greece (currently on strike for the next 48 hours, or, "as usual") on Wednesday, when a vote to pass the latest round of Troika mandated austerity (too bad there is no vote to cut corruption and to actually collect taxes) takes place even as the government coalition has now torn, and there is a high probability the ruling coalition may not have the required majority to pass the vote, which would send Greece into limbo, and move up right back from the naive concept of Grimbo and right back into Grexit. Which is why the market's attention is slowly shifting to Europe once more, and perhaps not at the best time, as news out of the old continent was anything but good: Spain's October jobless claims rose by 128,242, higher than the estimated 110,000 and the biggest jump in 9 months, bringing the total number of unemployed to 4,833,521, a rise of 2.7%, according to official statistics released Monday. This means broad Spanish unemployment is now well above 25%.  In the UK, the Services PMI plunged from 52.2 to 50.6, which was the lowest print in nearly two years or since December 2010, and proved that the Olympics-driven bump of the past few months is not only over, but the vicious snapback has begun.

Finally, the European bond space is getting whacked with the Italian 10 Year above 5% for the first time in weeks and SPGBs spiking not only on the heavy Spanish backlog which sees the country naively issuing a new 5 year bond as well as a 3 and 20 year tap but also as yesterday's story that the ECB was willfully not haircutting Spanish collateral refuses to go away (now at the WSJ), which if not refuted will crush ECB credibility, "Beeeleeeveee Us." One wouldn't be very surprised to see Spain pull any/all of these auctions if conditions deteriorated sufficiently, due to "market conditions."

The immediate result of all this is the EURUSD dropping to under 1.28 overnight, the lowest print in nearly 2 months, and the German 2 year bond under 0.00% also for the first time in 2 months, as once again nothing appears to have been "fixed" in Europe, and the time to come up with yet another creative moment of can kicking is upon us.

A quick key event recap from Bloomberg's Daybook:

  • Treasuries gain, led by 10- and 30-yr debt, as global stocks and EUR/USD decline; Greece’s Samaras struggling to secure political support for measures to assure the country’s financial lifeline.
  • In the U.S., focus on tomorrow’s presidential election and looming fiscal cliff; Treasury’s quarterly refunding also begins tomorrow with $32b 3-yr notes, followed by $24b 10-yrs, $16b 30-yrs
  • New York-area residents head into their first full week of commuting since superstorm Sandy crippled the biggest U.S. mass-transit network, even as a new storm threatens a fresh set of disruptions to daily routines
  • German bonds gain, pushing 2-yr yields below zero for the first time in two months; Spanish yields rise
  • Spain may tap its pension reserve fund, depending on the performance of tax revenue, says Tomas Burgos, deputy minister for social security.
  • China’s stocks fell for the first time in five days amid conflicting data on the nation’s services industry and before a Communist Party leadership congress and U.S. presidential elections this week
  • BofAML Corporate Master Index OAS steady at 150bps, near YTD low 146bps reached last month, as $25.75b priced in the wake of Sandy last week. Markit IG at 98bps, YTD low 83bps. High Yield Master II OAS narrows to 554bps as $3.8b priced last week; Markit HY at 512bps; YTD low 445bps

Key events today:

  • ISM Non-Manufacturing, Oct. est. 54.5 (prior 55.1) Supply
  • 11:00am: Fed to buy $1.75b-$2.25b debt due 2/15/36-8/15/42
  • 11:30am: U.S. Treasury to sell 3-mo, 6-mo bills Central Banks
  • G20 finance ministers, central bankers meet in Mexico
  • 8:00pm: Fed’s William speaks in California

What to look forward to from SocGen:

What if trends in US economic indicators led to a change in how the dollar reacts to shifts in risk sentiment? Market players have spent much of this year attempting to assess risk sentiment in line with what they had anticipated would be a sharp slowdown in US economic growth, and, in turn, how much QE the Fed could implement: QE3, QE3.5 etc... Any disappointment on US economic indicators fueled expectations of further quantitive easing and was perceived as prompting investors to change to risk-on mode on risky assets (liquidity injections to support the global economy) but weighed on the dollar (owing to the size of the Fed's balance sheet).


These trends now appear to be reversing: at present, fears on the extent of the US economic slowdown are starting to ease, reassuring investors and suggesting that the Fed may not have to go so far on QE: therefore, risk-on mode is becoming positive for the dollar. It is true that we will have to wait for confirmation of this situation but it could lead to a lower EUR/USD and could send the USD/JPY higher.


Of course, developments in Europe will also have to be taken into account. This is a busy week in Europe, with the head of the EFSF/ESM to speak today, followed by Angela Merkel before the European Parliament on Wednesday, a meeting with the Eurogroup on the EU budget on Thursday and Friday, and the Greek Parliament's vote on the new austerity measures imposed by the Troika during the week. And, let's not forget that everyone is also still waiting for Spain to officially request help. All of these developments are likely to unsettle the EUR/USD. Last Friday, the parity came close to the key support at 1.2835 (200dma): keep a close eye on this threshold.

And the complete recent event summary from Deutsche Bank:

Politically it’s going to be a week that’s almost impossible to top. Not only do we have the US elections tomorrow, we also have China’s 18th National Party congress beginning on Thursday which is expected to set the stage for a once-in-adecade transition of leadership to Xi Jinping and Li Keqiang as President and Premier respectively. The two countries alone account for around a third of the world’s economic output, leaving the rest of us in the other 200 or so sovereign states to fight for the scraps of the remaining two-thirds of activity.

Before we preview the big week ahead and update our latest earnings table we thought we would outline a few thoughts into year-end now we are well into the home straight for 2012.

The first thing to say is that the seasonals at this time of year are good. November through to early the following year often sees outsized performance. So for markets to be weak this time of year you tend to need a big negative event. So what are the things to watch that might derail the seasonals? Europe has clearly been a great source of negative events over the last three years but we can’t help thinking that if we have an issue into YE the only place it’s likely to come from within Europe is Greece. With the ECB ready to act, and with the market seemingly not pressing Spain into an immediate request for aid, it seems that this can be put off into 2013 if necessary. We still think there may be genuine concerns over solvency in Europe in 2013 but this isn’t going to happen soon. On Greece, the parliament vote on the latest Troika plans this week with DB’s George Saravelos suggesting that there’s an 80% chance of it passing. Clearly the 20% outcome wouldn’t be good and even a passing still leaves a difficult winter ahead. So we need to watch this as a potential risk.

The more likely source of volatility and pullbacks comes from the US and we’ll know much more about the probability of this over the next 48 hours post the election. Clearly every pundit has given his predictions on the scenarios, so we’re not going to be left out.

The worst-case market scenario is likely to be a narrow Obama victory where a bruised Republican party have enough power and frustration to cause large fiscal cliff tensions. It may never arise but surely the market would factor in some risk even if it’s not immediate. A clear victory for Obama would probably reduce but not eliminate this risk. A Romney win would likely be market positive initially with the risk being that the market turns its attention to what it means for Fed accommodation. We think Romney would eventually have to be pragmatic and keep the Fed similar to what it is today but again the market might worry first. Basically the market reaction to the election depends on what it means for the fiscal cliff and the Fed. Without an extraordinary past 3 years of the highest peacetime budget deficits on record and without dramatic and unique balance sheet expansion from the Fed, the US could have easily sunk into depression and indeed would be in recession now. So the party politics don’t really matter particularly, it’s all about the future fiscal and monetary policy that ensues that counts.

Markets will like the scenario that allows for higher government spending and more money printing for now and will put to the back of their mind the longer-term consequences. Ahead of the important week, the US saw a slow reversal on Friday with the S&P500 closing 0.94% lower, despite opening +0.4% higher following a better-than-expected employment report. Sentiment was probably weighed by US election uncertainty, as a number of news outlets warned that a photo finish could mean that it may take weeks to determine a winner.

On the topic of earnings, our usual reporting season review table can be found below. Activity will slowly wind down from here with over 350 S&P 500 companies having reported so far. The weak revenue trend has been well documented in previous EMRs with just 40% beating analysts’ estimates. Indeed the number of revenue upside surprises is at the lowest since Q1 2009. EPS performance remains solid with a beat:miss ratio of 71%:27% (2% in line). In Europe, we are seeing slightly more than half of the firms (53%) that have reported so far beating analysts’ EPS forecasts with the beat:miss ratio for sales at 50%:50%. So not a great European season so far.

Turning to Asia, equities are trading with a weaker tone as the weak US close on Friday feeds into overnight markets. Losses are led by the Nikkei (-0.51%) and Hang Seng (0.40%). Over the weekend, China published its official non-manufacturing PMI, which came in at 55.5 rebounding from last month’s 53.7 reading (a 19-month low). Conversely, HSBC’s services PMI overnight printed at 53.5, down from last month’s 54.3.

The Japanese electronics sector continues to receive focus overnight following Fitch’s 6-notch downgrade of Sharp’s rating on Friday to B-. The rating remains on Rating Watch Negative. Friday also saw S&P cut Panasonic by two notches to BBB/Stable after a 1H loss and the agency’s expectations of a slow recovery. Panasonic 5yr CDS closed 15bps tighter on Friday but still 185bp wider over the past month. On the other hand, Sharp 5yr CDS is already pricing in an extremely high probability of a credit event. Sharp CDS has risen by around 13 upfront points in the past month and is indicated at 69.5pts (mid) upfront. This implies a market implied cumulative default probability of 97% over the next 5 years if we assume a 20% recovery rate or a 5-year default probability of 82% if we assume zero recovery rate.

Returning to the week’s key political developments, it has been well documented that the US election result will boil down to a handful of results in key swing states. On that note, the New York Times wrote over the weekend that of the 22 polls of swing states published Friday, Obama led in 19 polls, and two showed a tie. Mitt Romney led in just one of the surveys, a Mason-Dixon poll of Florida. The article concludes that “for Romney to win, state polls must be statistically biased”.

Staying with politics, China’s National Party congress will this week introduce the new members of the 7-seat Politburo Standing Committee, along with the new President and Premier. On this front, the South China Morning Post wrote last Friday that the new make-up of the Politburo will be “packed with conservatives”, potentially reducing hopes of bold economic and political reforms from the next generation of China’s leaders.

Elsewhere in key events this week we have the ECB and BoE meetings on Thursday. The market expects no major policy changes on both fronts. Our European economists expect the ECB to be patient with the next rate cut likely to come in 1Q13. The RBA is meeting tomorrow though economists and the market are expecting a potential rate cut to be a much more of a touch and go decision. DB’s Australian economists see a 25bp rate cut as marginally more likely than not.

It will relatively quiet week for data in both the US and Europe. In the US, Joe Lavorgna points out that much of the near term data will now be overlooked because it was compiled before the storm. Subsequent weeks will provide more useful guidance with respect to industrial impairment. Nonetheless, the ISM non-manufacturing PMI (DB: 57) report will be today’s highlight. This will be followed by  Wednesday’s consumer credit (DB: +9.0B), Thursday’s trade balance (DB:-45B) and jobless claims, Friday’s wholesale inventories (DB: +0.5%) and the preliminary UofM confidence survey. In the Eurozone, key data include Eurozone services PMIs and German factory orders on Tuesday and Eurozone retail sales, Spanish industrial output and German IP on Wednesday. We also get German and French trade data on Thursday; followed by German CPI and French and Italian IP on Friday. Also worth looking out for is the EU Commission’s autumn forecasts for 2012-14 GDP, deficits, inflation and employment on Wednesday. In China, October IP, CPI and retail trade numbers are due on Friday while trade data and bank lending numbers are due over the coming weekend.

So good luck in what will be a fascinating week.


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