What Has Happened So Far

Once again: The FOMC minutes had nothing to do with overnight's events, especially since both Ben Bernanke and Bill Dudley made it very clear previously that for any tapering to occur (and which is supposedly bullish according to David Tepper, who may finally be done selling to momentum chasers) if ever, the economy would have to be be stronger (which is of course a paradox because it is the Fed's QE that is making the economy weaker). If anything, the minutes reminded us that there is a mutiny in the FOMC with finally someone having the guts to say on the record that Bernanke is blowing a bubble - something never seen before on the official FOMC record. And after all, the Nikkei opened way up, not down. It was only after the realization of what soaring bond yields mean for, wait for it, stocks (despite central planner promises that it is soaring bond yields that are a good thing - turns out, they aren't) that the sell-off really started. That, and of course copper, and the end of the Chinese Copper Financing Deals arrangement that has been China's illicit cross-asset rehypothecation scheme for years (more shortly). So in a nutshell, here is what has transpired so far, courtesy of Bloomberg.

  • Treasuries higher as global stock markets fell on concerns over rising interest rates in wake of Bernanke’s testimony yday and evidence that China’s economy may be slowing.
  • Japan’s Topix index fell almost 7%, the most since the aftermath of the March 2011 tsunami and nuclear disaster; financial firms slid amid rising bond yields
  • 10Y JGB yields erased earlier losses as stocks fell  after yields touched 1%, the highest in a year
  • UST domestic trading volumes were highest in 5yrs yday, FTN’s Jim Vogel wrote. 10Y yield rose as high as 2.062%, highest since March 14; TY traded 3m contracts yday, busiest day for 1st contract on record, according to Bloomberg data to 1982
  • Economy Minister Amari said there’s no reason to be concerned over stock market decline, economic recovery on track
  • China’s HSBC flash manufacturing PMI stood at 49.6 for May, contracting for 1st time in 7 mos. and adding to signs of slowing economic growth in 2Q
  • Bond buying should respond to economic data, Fed’s Bullard said in speech in London; Fed should “continue with the present quantitative easing program, adjusting the rate of purchases appropriately in view of incoming data on both real economic performance and inflation”
  • The euro area’s manufacturing PMI for May rose to 47.8, services to 47.5; composite index at 47.7, est. 47.2; Germany’s manufacturing PMI 49.8
  • U.K. GDP +0.3% in 1Q, confirming initial estimate, on inventories, consumer spending; exports declined sharply in quarter
  • Surge in Japanese bond yields since early April would push up Prime Minister Abe’s budget bill by about $3 billion, a possibility that’s prompting central bank Governor Haruhiko Kuroda to pledge more focus on curbing debt-market swings * Deutsche Bank AG, continental Europe’s biggest bank, said some investors are probably underestimating the ramifications of the European debt crisis and a political stalemate over the U.S. debt ceiling
  • Bond investors don’t perceive the six biggest U.S. banks as “too big to fail,” according to a report from one of those lenders, Goldman Sachs
  • U.S. bankers and insurers are trying to use trade deals, which can trump existing legislation, to weaken parts of the Dodd-Frank Act designed to prevent a repeat of the 2008 financial crisis
  • China will tighten rules on bond sales by polluters, local government financing vehicles with higher debt levels and companies in industries with overcapacity as the  government seeks to redirect the economy
  • BofAML Corporate Master Index OAS steady at 141bps, tight for year, as $14.05b priced. Markit IG at 71.6bps, YTD low 69bps. High Yield Master II OAS tightened  to 427bps from 435bps; $1.59b priced yesterday. CDX High Yield fell to 106.63 from 107.13
  • Sovereign yields mixed; euro-area peripheral yields higher; core G-4 yields lower. Asian stocks fell across the board; European stocks, U.S. stock-index futures lower. WTI crude, metals lower, gold gains 1.4%

And SocGen's recap:

The 7.3% collapse in the Nikkei and the sharp intra-day volatility yesterday in bonds and currencies shows the formidable task facing the Fed (and other central banks) as they prepare to take the first steps of ending the policy of extreme accommodation. A tapering of asset purchases is by no means a tightening in policy, but the wild reaction to the faintest indication that the Fed is preparing to start dialling back, possibly as soon as September, demonstrates how tricky it will be for policymakers to wean markets off liquidity without causing a tremor. However, Bernanke in his prepared remarks could not have been clearer yesterday: he is in no hurry to change monetary policy. While he acknowledged afterwards that the pace of asset purchases may slow over the next few meetings, the Fed Chairman was unequivocal that so far, economic indicators and fiscal considerations do not yet make that an option. The job market's recovery does not yet make it an option. He clearly does not want a change in monetary policy to push up interest rates and endanger the real estate market's recovery. Today, we will be watching the initial claims and new home sales data.

In the short term, pro-risk strategies are likely to be favoured still but the days of remorseless gains may well be numbered for stocks after the drubbing for the Nikkei. A possible change of tack by the Fed and a simultaneous weakening in China will spur further profit taking, ending a blistering rally. USD/JPY hit 103.45 yesterday but the subsequent pull back overnight shows the JPY still has its admirers when risk goes in reverse.

The EUR/USD trend is more muddied. In the euro zone, the manufacturing and services PMI indices announced today will give us some more information on the outlook for activity in Q2, but the focus will be on the speech by ECB president Draghi. We are hoping that the string of unpleasant surprises will slow, giving some modest support to EUR/USD. Support runs at 1.2797 and 1.2775. The trend in US 10-year bond yields should dictate the path as illustrated in our chart.

Across the Channel, will the downward pressure on EUR/GBP resume as UK growth outpaces that of the euro zone, or will EUR/GBP get caught up in the woes affecting other EUR exchange rates? We still prefer fading short-term gains.