Plan QE For The Hilsenrath Morning After

Overnight risk continues to ignore all newsflow (today the economic reporting finally picks up with advance retail sales due at 8:30 am as expectations for a second modest decline in a row of -0.3%) and is focused entirely on what the consensus decides to make of the Hilsenrath piece, even as the difficulty level was raised a notch following another late Sunday Hilsenrath piece, which puts more variable into the "tapering" equation, and whose focus is whether Bernanke will be replaced by Janet Yellen, Geithner or Summers, or anyone. With all three classified as permadoves, one does scratch their head how the market can be confused: worst case Fed tapers by $10/20 billion per month, market tumbles, then Bernanke's replacement or Ben himself ploughs on even more aggressively with QE. QED.

As noted, overnight data was sparse with Chinese industrial production picking up 9.3% in April, from 8.9%, but just below consensus of 9.4%. Elsewhere, the consumption story was also less encouraging than suggested by retail sales growth, which ticked up by 0.2ppt to 12.8% yoy (Cons. 12.8%) in April. As SocGen explains, first of all, inflation helped. The real rate, according to the National Bureau of Statistics, moved up by just 0.1ppt to 11.8% yoy. Second, the best performing segment was jewellery sales, which had more to do with savings rather than consumption. Following a sharp decline in the gold price, Chinese households' purchase of jewellery surged 72% yoy in April, substantially faster than the 17.7% yoy in Q1. This gold rush contributed nearly 2ppt to the headline in April, up from about 1ppt in March.

Data out of Japan has become a total farce, with the various authorities making up numbers with a great flair than reality was misrepresented during the Fukushima catastrophe: how anyone can have a bearing on consumption, trade, or anything for that matter at a time of such epic flux is simply ludicrous and yet that's precisely what the local Keynesian acolytes are doing. No wonder, what they have practically achieved is a broken bond market, and a collapse in the currency, which if anything translates into a surge in local energy prices when priced in Yen. As for the stickiness of core-inflation, we'll just see about that. The only notable news about the island nation is that for the second time in a row, the G-7 refused to criticize Japan about its currency debasement using the same illogical platitudes. Of course, the G-7 will say nothing as long as a plunging Yen leads to rising stock markets around the world. Once that ends, lots and lots of deferred "criticism" will be unleashed.

In Europe, we got more of the same as ECB's Visco said if the economy needs further help the ECB will cut the deposit rate to negative territory. Nothing new, but surprising that the jawboning continues. The EUR tumbled to 1.295 on the headline but has since regained all

The rest of the overnight highlights in easy to digest, bulletin fashion courtesy of Bloomberg's daybook.

  • Treasuries reversed overnight declines, 10Y yield at 1.892%, as USD/JPY retreats below 102 level
  • Japan’s Obuchi said the government is watching bond yields carefully, 10Y yield touched highest since Feb. 6 overnight
  • Wall Street’s biggest bond dealers are starting to forecast that the U.S. Treasury will reduce the size of its debt auctions in coming months for the first time in three years as government revenue soars
  • G-7 finance chiefs indicated they will tolerate a sliding yen for now as they intensified their focus on Japan’s recovery strategy
  • European policy makers expressed a willingness to consider new ways to revive their ailing economy as they confronted fresh U.S. pressure to take action
  • The improving U.S. housing market and declining unemployment won’t ignite the nation’s economy unless companies start spending, Citigroup CEO Michael Corbat said in Bloomberg interview
  • Yellen, Geithner, Summers seen as Fed chair contenders, WSJ reported; Bernanke may accept another term
  • Fed plans to cut amount of bond purchases in careful steps, changing buying level based on confidence in employment market, inflation, WSJ reports, citing unidentified officials
  • At least two congressional committees plan to hold hearings on the U.S. Internal Revenue Service’s admission that it targeted for special attention groups promoting limited government
  • China’s industrial production rose 9.3% Y/y in April vs est. +9.4%; fixed-asset investment increased 20.6% YTD through April vs est. 21.0%; retail sales climbed 12.8% Y/y in April, matching median forecast of economists
  • Yuan declines for second day, down 0.08% to 6.1468 per dollar, after central bank lowers fixing by 0.09% to 6.2072
  • China may widen yuan trading band soon, most likely to 2%: Shanghai Securities News cites unidentified “people in the industry”
  • Sovereign yields mixed; Japanese yields rise, peripheral spreads widen over Germany. Nikkei +1.2%, Shanghai -0.22%. European stocks and U.S. stock-index futures lower; WTI crude falls for third day, as OPEC boosted output to highest level in 5 mos.; gold, metals lower

SocGen's take on the key macro events and notable FX levels

A wild end to last week across asset markets caused by a surge in the USD prompted a battering of the safe haven currencies, JPY and CHF, and caused gold and other commodities to surrender a chunky portion of the gains registered in April. The repatriation from emerging market currencies added to the USD bid, and with central banks set to keep the monetary taps open, the trend is not over. UST 10y yields are up nearly 30bp this month and even following a lurch above 1.90%, EUR/USD does not look oversold below 1.2996. Nor does the violation of the trend channel in cable at 1.5355 augur well for sterling which looks set for further downside, even though GBP remains an attractive proposition vs currencies like the AUD ahead of this week's Inflation Report from the BoE.

With USD/JPY racing through stops and taking out options barriers in quick succession, the US swaps curve has steepened hard on further PRDC note hedging (these are dual currency notes popular in Japan that pay out foreign coupons in the domestic currency; as the JPY weakens, the coupon rises). Having closed above 2.00% for the first time in four weeks, US 10y swaps look destined for a return to the March highs of 2.17%. Bond bulls will be braced for a strong US retail sales report this afternoon, but whether a soft number is enough to temper bearish momentum remains to be seen. If the squeeze in USD/JPY continues, swaps are likely to follow. To what extent the equity market can absorb the correction in bond markets and rising mortgage rates is difficult to predict, but as we set out earlier in the year, with the US housing market on a solid footing, a gradual unwind in long bonds from QE is unlikely to cause a major setback in risk.

The way in which bunds and EU swaps underperformed the US on Friday (higher rates) is unnerving and puzzling at the same time given the gulf in performance between US and eurozone economies. It is a testimony however to how asset classes correlate in times of stress. Remarkably, peripheral bonds held their ground and spreads over bunds compressed even further as the grab for yield continues. Italian bonds have rallied immensely over the last couple of weeks, and how much appetite there is for BTPs even at the current compressed yield levels will emerge from today's BTP auction. Peripheral yields are no longer driving the EUR, so the auction results should not be a major factor, especially with US retail sales following closely behind. ECB data last week showed its balance sheet has shrunk to EUR2.608trn, the lowest level since December 2011. But relative differences in size between ECB and Fed balance sheets have equally become irrelevant for EUR/USD.

Jim Reid from DB recaps the majority of overnight events

After last week’s lull, the data calendar picks up again this week with a number of important pulse-readings on the real economy. The data flow kicks off with retail  sales in the US today where the market is expecting the second straight month-on-month contraction in April (-0.3% estimate vs -0.4% previous). It will be a fairly full week of data in the US with the NY Fed releasing its Q1 household debt report on Tuesday followed by the Empire manufacturing report on Wednesday. Also on Wednesday, the April industrial production (-0.2% vs. +0.4%) print is due. On Thursday, April’s CPI is scheduled where the consensus is expecting the first back-to-back decrease in consumer prices (-0.3% estimated vs -0.2% expected) since 2008, driven by declining energy prices. Thursday’s housing starts, permits and the Philly Fed reading for May round out the week’s US data flow.

In Europe, the initial focus will be on the two-day Eurogroup/ECOFIN meeting beginning today. In terms of data, Tuesday’s ZEW Survey and Euroarea industrial production, Wednesday’s flash Q1 GDP estimates and Thursday’s Euroarea CPI are the main data updates. The UK sees both employment data and the BoE’s inflation report on Wednesday. In Asia, China’s industrial production and retail sales data are due as we go to print this morning. Highlights on the Japanese weekly calendar include machine tools order (Tues) and Q1 preliminary GDP and industrial production (Thurs).

On the micro side although US earnings season is drawing to a close, the Japanese annual reporting season will be important to keep an eye on this week in light of the Abe-inspired 70%+ rise in the Nikkei since Q3 last year. A number of major Japanese banking and corporate groups will be providing earnings./outlook updates this week which will provide an update on how monetary policies have impacted the economy. In the US, Cisco (Wed) and Walmart (Thurs) are amongst the last companies reporting.

Returning to markets, the yen continues to be in focus after briefly trading above 102 during the Asian session this morning before meeting resistance. Over the weekend, G7 finance ministers and central bankers reaffirmed their February commitment to “not target exchange rates”, according to UK Chancellor Osborne. Though a communiqué was not released, German Finance Minister Schaeuble said after the meeting that "we had a very intense discussion about Japan with our Japanese colleagues." Other topics discussed included the scope for slower austerity in Europe and potential asset purchases by the ECB. Draghi did say that there wasn’t a call for the ECB to take further steps to ease policy, playing down suggestions that the ECB was considering a program similar to the Bank of England's Funding for Lending Scheme (Reuters).

On a separate but related note, the Dollar index continues its recent strength (+0.2% overnight), helped by a much-anticipated Hilsenrath WSJ article on the potential for a winding down in the Fed’ QE program. While containing little additional information, especially on the timing of the wind down, the article mentioned that Fed officials have mapped out a strategy to eventually slow asset purchases in “potentially halting steps”, varying their rates of purchases as confidence about the job markets and inflation evolves. The WSJ writes that officials are focusing on clarifying the strategy so markets don't overreact about their next moves.

In other overnight markets, Asian equities have started the week on a softer footing with most major indices trading in the red ahead of today’s industrial production and retail sales numbers from China. The Nikkei is outperforming (+1.2%) on the back of the continued yen depreciation. Elsewhere the Aussie dollar is trading 0.5% weaker against the USD, and is poised to close weaker against the greenback for the sixth straight session.

Returning briefly to last Friday, there were a few jitters in credit markets on Friday after news that the Manchester-based mutual Co-Operative Bank was downgraded six notches by Moodys to Ba3 from A3. Moody’s flagged a potential capital shortfall arising from further substantial losses on the bank’s real-estate exposures. Co-Op's subordinated bonds reportedly sold off more than 20 points on Friday, which briefly affected sentiment in other financials. The bank said that it does not need government support and Bloomberg is reporting that it will sell large parts of its business to bolster capital ratios. As of 30 June 2012, the bank’s market share among UK monetary financial institutions was 0.68%, based on total consolidated assets of £48bn, according to Moody’s. Despite the jitters, credit markets had another solid week. Indeed, Reuters reported that 25 US high yield deals totalling USD11.185bn priced last week and the majority were reportedly some three to four times oversubscribed with most generally performing on the break.

So stand by for a busier data week. Will we see the fundamentals start to catch-up with the very supportive technicals or will it confirm the widening divergence between the two.


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