Overnight Sentiment Pricing In A Favorable Italian Election Outcome

Following last night's very disappointing China HSBC PMI numbers, one would think that the traditional EURUSD, and thus ES, overnight ramp would be missing or at least delayed, especially ahead of a very possible risk off day such as Italian election day. One would be wrong. Because some time after midnight eastern, in what can only be seen as a celebration of Argo's choice as a best picture, the EURUSD resumed its upward ramp on absolutely no news, pushing the pair higher by nearly 100 pips in a smooth diagonal line, and dragging US futures up with it as usual. The catalyst apparently is that with Italian exit polls mere hours away (due out at 2pm GMT), market talk is that Berlusconi's resurgent chances have been hobbled due to a low turnout in the pro-Berlusconi northern states (recall that Lombardia is the key state for the elections) following a quick read of a Reuters recap article. What is ignored is that the referenced Reuters article also notes the "surge in protests votes being cast" in the first day of voting, which means less votes on an absolute and relative basis for Bersani and Monti, even if Berlusconi ends up getting less of the Northern vote.

Of course, nobody actually has any clue what the exit polls look like. In fact, with a hung parliament a distinct possibility even assuming a Bersani-Monti coalition, both Goldman and JPM have said a 50-100 pip widening across the Italian curve is possible should a Hung Parliament develop (for more read here). But for now hope dominates and is both squeezing the shorts and causing yet another algorithmic stop hunt in FX, and thus every other asset class. Don't be surprised all of overnight's gains, and much more to be wiped out minutes after 9 am eastern when the first Italian exit polls emerge.

Other overnight news were relatively spares and already covered previously. A quick summary from Bloomberg:

  • Abe is also likely to tap Kikuo Iwata, an academic who has urged a ramping up in Japan’s monetary base to end deflation, and Hiroshi Nakaso, a senior BOJ official, as deputy governors according to one government official and a ruling coalition executive
  • Voting stations in Italy close at 3pm local time, after which initial estimates shortly thereafter; a resurgent Silvio Berlusconi and former comedian Beppe Grillo have promised to roll back Monti’s austerity if elected
  • U.K. Chancellor of the Exchequer George Osborne said he won’t bow to opposition calls to change economic policy after the decision by Moody’s Investors Service to strip the U.K. of its Aaa status
  • Nicos Anastasiades defeated opponent Stavros Malas by the biggest margin in 30 years to become Cyprus’s seventh president and begin the process  of steering the country away from economic ruin
  • With four days until the start of sequestration, there is little indication that Obama and congressional Republicans will reach an agreement this week
  • Week’s $99b of 2Y, 5Y, 7Y note auctions begin today with $35b 2Y; yield 0.264% in WI trading, drew 0.288% in Jan.
  • Nikkei rises 2.4%; European stocks rise, U.S. equity-index futures lower. Italian and Spanish bonds slightly higher. Energy, precious metals increase

And while the most important news of the day will come out of Italy today, here is what else is on today's docket:

  • 8:30am: Chicago Fed Nat Activity Index, Jan (prior 0.02)
  • 10:30am: Dallas Fed Manf. Activity, Feb. (prior 5.5) Fed
  • 7:00pm: Fed’s Lockhart speaks on economy in Knoxville,Tennessee

A quick look where markets stand:

  • Spanish 10Y yield down 2bps to 5.13%
  • Italian 10Y yield down 4bps to 4.41%
  • U.K. 10Y yield up 0bps to 2.11%
  • German 10Y yield up 1bps to 1.58%
  • Bund future down 0.06% to 143.53
  • BTP future up 0.29% to 112.14
  • EUR/USD up 0.49% to $1.3258
  • Dollar Index down 0.24% to 81.28
  • Sterling spot down 0.12% to 1.5145
  • 1Y euro cross currency basis swap up 1bps to -21bps
  • Stoxx 600 up 0.38% to 289.67

Finally, the comprehensive overnight recap from DB's Jim Reid:

It’s fair to say that Sterling, Gilts and the Italian elections will get most of the spotlight today. We'll discuss the latest available info on Italy a little later but just to highlight that DB's Marco Stringa will host a conference call at 4pm London time today, 2 hours after the ballot boxes close and the first exit polls are released. Details of the call are at the bottom of today's EMR.

Back to Sterling, the currency has weakened further on the downgrade to now trade at 1.5122 and 1.1467 against the Dollar and Euro, respectively. Whilst certainly off the lows of 1.5073 and 1.1398 in the overnight session in Asia, the pound is nonetheless still –0.8% and -0.9% weaker against the Dollar and Euro, respectively since Moodys' action. However its worth noting that of the G8, only Germany and Canada now have a AAA/Aaa rating so others have shown before that losing top status needn't in itself cause any notable funding issues or sizable yield changes. However as we've said before the UK is going to be a great laboratory for the rest of the world as to whether financial repression (of which central bank buying and regulation are the key weapons) can continue to keep yields below the rate of inflation. Even before the most recent fall of sterling the BoE were forecasting another 3 years of above target inflation which would extend the record to 37 out of 40 quarters over 10 years if the forecasts are proved right. With this track record and forecast there is very little justifiable reason for buying Gilts at these yields unless you believe that someone is going to buy them off you at a higher price. Financial repression and/or another flight to quality bid at some point could ensure this occurs but it’s getting a more difficult sell. The BoE already own around 30% of the Gilt market and they may need to continue to be the marginal buyer going forward to retain the status quo. So Sterling and UK yields are going to be a fascinating macro test case for the rest of the world over the next few weeks and months.

On a vaguely related theme, on Friday I contributed a piece to our Rates and Credit weekly looking at the historic impact of yields on credit spreads. The inspiration for the piece was hearing repeatedly that one of the main concerns for 2013 is that credit spreads could widen due to Government yields rising. However the results of the piece suggest there is little evidence that higher yields typically lead to wider credit spreads using historical data from the US back to 1919. In fact through history the opposite tends to happen as higher yields usually reflect better economic conditions and visa-versa. The word of caution is that this cycle is very different to anything seen through history and that there is evidence in the note that those countries seeing yields rise due to sovereign concerns do tend to see wider spreads.
Nevertheless if higher government yields are not due to repayment concerns then we don't think rising yields will be a negative drag on spreads in 2013.

Continuing on the rates theme, in the latest edition of Global Economic Perspectives, DB’s Peter Hooper argues that assuming the recent firmness of payroll employment growth persists, he expects the Fed to downshift and eventually end its asset purchases during H2 2103. The conclusion is that a sharp backup in Treasury yields will results as these events unfold.

In terms of the latest in the Italian elections, the first day of voting has seen some 54% of voters cast their ballots, a sharp fall on the 62.5% seen at the same stage in the last election in 2008, according to Reuters who cite interior ministry data. The same article also describes the “surge in protests votes being cast” in the first day of voting. The UK Telegraph wrote that heavy snowfall in the north, high winds further south and volcanic activity in Sicily could lower voter turnout, particularly amongst indecisive voters and the elderly, "who are considered to be the most faithful to the traditional parties." Less likely to stay at home will be supporters of comedian Mr Grillo, who are seen as younger and more determined to make their vote count (UK Telegraph).

Turning to the broader overnight session, the Nikkei (+1.9%) is leading the pack higher in what is generally a firm night for risk in Asia. Clarity around the next BoJ governor has promoted further JPY weakness overnight. The JPY reached a near 3-year low of 94.77 although it has pared back those losses to 94.18 as we type. Various news outlets have reported that Japan’s PM Abe will nominate Haruhiko Kuroda as the next BoJ's Governor.

Kuroda, the President of the Asian Development Bank, is thought to be an advocate of aggressive monetary easing. In addition press reports suggest Abe will also likely ask Iwata as Deputy Governor. The current administration still needs approval from opposition parties but the Mainichi newspaper today reported that the DPJ has signalled that it wouldn’t oppose Kuroda. Markets seem to be also fairly relaxed with the disappointing Chinese PMI print overnight. The HSBC flash manufacturing reading came at 50.4 versus a market consensus of 52.2 and a previous reading of 52.3. The exports subindex reversed January’s gain and is now back below 50 at 49.8. Asian cash credit spreads are firmer along with the broader positive tone in markets.

Looking at today’s calendar, the obvious focus will be on the outcome of the Italian elections. Ahead of the polls closing though, the Italian Treasury will be testing investor appetite with the issuance of 2021 and 2026 inflation linked bonds as well as zero coupon 2014 bonds. Jens Weidmann speaks at an in event Paris on the topic of “Fiscal and Monetary Policy: Dancing Too Close”. So we have quite a bit going on but thankfully it will be a relatively quiet day in terms of data with no major releases in Europe and US today.

Turning to the rest of the week’s calendar, if we manage to get through the Italian elections we will then have the looming US spending sequester, Bernanke’s congressional testimony and the potential nomination of the BoJ governor to look out for in what is a busy week of
macro event risk.

In Europe, Italy will auction another EUR7bn of bonds on Wednesday including a new benchmark 10yr bond. On the same day, the ECB has said that 356 banks will repay a combined EUR61bn in LTRO II loans (down from EUR130bn initially expected in a Reuters poll) at their first opportunity. Data releases include Euroarea business/consumer confidence; Euroarea money/credit supply and UK Q4 GDP revisions on Wednesday; and German employment/inflation data on Thursday. Euro area flash inflation, January unemployment, February PMIs for Spain and Italy are scheduled for Friday. Reporting wise we have 108 Stoxx600 companies this week including some of the big UK banks.

In the US, congress returns on Monday after a week-long recess ahead of spending sequesters which take effect on Friday March 1st, unless Democrats and Republicans agree to a deal beforehand. Ben Bernanke delivers his semiannual testimony on monetary policy to the Senate Banking Committee on Tuesday followed by an appearance before the House Financial Services Committee on Wednesday. It will be heavy week of data with Tuesday's consumer confidence, new home sales and consumer confidence, Wednesday's durable goods and pending homes sales, Thursday's US Q4  GDP 2nd estimate and jobless claims; and Friday's consumer spending and the ISM. The US Treasury will auction $35bn in 2yr notes on Monday; $35bn in 5yr notes on Tuesday and $29bn 7yr notes on Wednesday.

In Japan, PM Shinzo Abe intends to nominate the new BoJ governor and two deputy governors this week. Japanese data releases include industrial production on Thursday and spending/CPI/jobless/capex on Friday. In China, the final HSBC and official readings PMIs for February are scheduled on Friday.


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