Red Dawn

This morning market participants turn on their trading terminals to see an unfamiliar shade of green: red.

Following yesterday's blow out in US bond yields, which have continued to leak wider and are now at 2.20% after touching 2.23%,  the overnight Japanese trading session was relatively tame, with the 10Y JGB closing just modestly wider at 0.93%, following the market stabilization due to a substantial JPY1 trillion JOMO operation which also meant barely any change to the NKY225, while the USDJPY slipped in overnight trading below the 102 support line and was trading in the mid 101s as of this moment, pulling all risk classes lower with it. There was no immediate catalyst for the sharp slide around 3am Eastern, although there was the usual plethora of weak economic data.

The IMF cut its China 2013 and 2014 growth forecasts to 7.75%, from 8% and 8.2%, validated by news that nearly half of China's 80 major steel producers reported losses in April and that Chinese import iron ore prices fell below $120/tonne for the first time this year. In Japan, as we expected, following the BOJ's meeting with bond market participants, it found they wanted more frequent bond operations, a la the US daily POMO, and asked the BOJ to buy more 1-5Y notes, with the suggestion of smaller overall POMO operations, also as expected would happen now that the BOJ is merely a surrogate copycat of all the Fed does.

In Europe, German May unemployment rose 21K on expectations of a 5K rise, Spanish April retail sales posted yet another negative print at -4.9% if a little better than expected, even though Eurozone M3 rose by 3.2% on expectations of a 2.9% increase. In the UK, May retail sales fell the most in 16 months CBI said; with the gauge of annual sales growth -11 vs -1 in April, est. +3

The biggest news of the night was a report by German Welt saying that Mario Draghi has lost the support of the ECB executive board on the issue of ABS purchases as a pathway to stimulate credit growth, with Mersch, Asmussen and Weidmann all voting against an ABS-purchase program. There also is more discord on the issue of negative deposit rates, an idea which may now be scrapped following Merkel's announcement yesterday that her reelection campaign would run on the message of a strong Euro: all EUR bullish developments, and thus Eurozone economy negative.

Key overnight highlights bulletized via Bloomberg:

  • Treasuries lower, 10Y yield at 2.195%, highest since April 2012, JPY strengthens; Treasury sells $35b 5Y debt, WI yield 1.08%, 5Y yield crossed 1% yesterday.
  • BoJ met with 56 bond market participants, said participants wanted more frequent bond operations and asked central bank to buy more 1Y-5Y notes; suggested smaller amounts of purchases at every operation
  • BoJ to release bond operation plan from June for tomorrow
  • OECD expects global growth to accelerate in 2014, with both the U.S. and Japan to outpace euro area growth
  • U.S. GDP +1.9% in 2013, +2.8% in 2014; Japan +1.6%  in 2013, +1.4% in 2014; euro area -0.6% in 2013, +1.1% in 2014
  • SNB may have to raise rates to cool housing market: OECD
  • Euro area private sector loans in April fell 0.9% from a year ago after a decline of 0.7% in March, ECB said, contracting for 12th straight month
  • German unemployment rose 21k to 2.96m, for 4th monthly rise; est. +5k
  • U.K. May retail sales fell the most in 16 mos., CBI said; with gauge of annual sales growth -11 vs -1 in April, est. +3
  • IMF cuts its growth outlook for China to around 7.75% this year and next from its April forecast of 8% this year and 8.2% next year; urged government to undertake “decisive” policy changes to put economy on more sustainable path
  • Sovereign yields higher across the board, tracking U.S. yields. Asian stocks mixed, Nikkei +0.10%, European stocks lower across the board. U.S. stock index futures lower. WTI crude, metals lower; gold higher

Main catalysts via SocGen:

The 2.23% print on US 10y cash and 2.41% on 10y swaps overnight have capped a 60bp move this month alone and are enough to send a shiver down the spine of any seasoned bond market veteran. A much bigger than anticipated increase in consumer confidence in May and an improvement in the employment sub-component to a six-month high nailed the case for yields to extend their winning streak to a fifth successive week. It is likely to be an uncomfortable ride between now and the next FOMC meeting at the end of June, and hopes of a reprieve on 7 June (payrolls day) may prove in vain. With US yield differentials setting the tone in FX, the drop in USD/JPY risk reversals (bid for USD puts) is an anomaly waiting to be corrected. UST/JGB 2y spreads widened overnigght to 16bp, the highest since early April.

Swedish Q1 GDP and the Bank of Canada rate decision will bring some distraction from the US today. German unemployment and CPI data should keep additional ECB stimulus on ice. Inflation is forecast to have edged up to 1.3% vs 1.2%, marking only the first rise since December. EU M3 data are also due and though a rise in the annual rate is forecast, lending figures to households and NFCs in particular are expected to reaffirm the weak underlying demand for credit as indicated by the ECB’s own quarterly lending survey. A number of ECB council members took to the speakers’ circuit yesterday and the conclusion we make is that there is no consensus about negative deposit rates. No speakers are scheduled today. The EU will make its annual formal recommendation on budget policy. The FT reports this morning that budget deficit deadlines will be extended for France, Spain and the Netherlands and that it will lift the ‘intensive fiscal monitoring’ of Italy. The postponement of the deficit deadline has been coming since the early spring and the last G7 meeting stepped up calls to concentrate less on austerity and more on growth.

The Bank of Canada introduced the language of supporting considerable monetary policy stimulus in place for a ‘period of time’ two meetings ago and will not be making plans to change tactics today at what is governor Carney’s last meeting in charge as governor before he departs for the BoE. USD/CAD traded at a 1.0421 high in Asia and short-term prospects are intact for a first weekly close above 1.04 since June last year. Bulls now target 1.0447/50. USD/SEK firmed back over 6.71 and a successful break of 6.7168, the 14 December high, would open the door to 6.80. A 0.3% increase in qoq GDP would mark a return to positive growth after a flat Q4 12, but disappointing confidence surveys last week suggest a return to the top of the G10 currency table is not imminent for the SEK.

And a full overnight recap via DB's Jim Reid as usual:

Yesterday’s sharp selloff in US treasuries has been extended overnight with the 10yr benchmark up 4bp at 2.2% in Asian trading, coming after Tuesday’s +16bp move to 2.17%. Meanwhile in Japan, 10yr JGB yields are up 4bp as they edge closer to the 1% mark (0.93% as we type). Kuroda’s speech at a BoJ conference this morning had little effect on markets with the Governor’s key message being that no financial system is perfect in the face of global  uncertainty. In other BoJ-related headlines, there were some interesting comments PM Abe’s economic adviser, Koichi Hamada, who was quoted as saying that Korea “shouldn’t blame” the Japanese central bank if Korean growth slows due a weaker yen, but instead “they should demand the Korean central bank have a proper monetary policy”. Hamada also urged Kuroda to ease monetary policy further should it be needed.

The news comes as PM Abe unveiled a 5yr plan that details a number of structural reforms to achieve growth, but the issue of corporate tax rate cuts is reportedly undecided at this stage. Attention now shifts to the BoJ’s meeting with JGB-market participants later today (8am London time) which may provide more detail on the central bank’s upcoming market operations. As we type, USDJPY is down to  101.56 while the Nikkei is barely higher.

Elsewhere in Asia, equity markets are trading with a positive tone led by gains on the KOSPI (+0.9%), ASX200 (++0.16%) and Shanghai Composite (+0.4%). The Hang Seng (-0.7%) is underperforming the broader region weighed by property developers amid concern that home sales are slowing in Hong Kong. Asian credit markets opened 2-3bp weaker as the rise in rates dampens demand for longer duration EM credit. In China, DB and the IMF have both revised the country’s growth forecasts downwards in the last 24 hours. The IMF cut its 2013 and 2014 growth forecasts to 7.75%, versus previous estimates of 8% and 8.2% in 2013 and 2014 respectively. DB's economist Jun Ma revised down his Q2 GDP forecast to 7.7% yoy from 7.9%, the 2013's full-year GDP growth forecast to 7.9% from 8.2% and his 2014 GDP growth forecast to 8.8% from 8.9%. Jun writes that the changes reflect a delay in growth recovery due to slower-than-expected transmission of total social financing into real economic growth and the short-term impact of anti-corruption measures. Overnight, the head of China’s Iron and Steel Association said that the price of steel and iron ore may below the 2012 lows. Indeed, Chinese import iron ore prices fell below $120/tonne for the first time this year on Tuesday, which is weighing on the Australian dollar (0.5% lower this morning at a fresh YTD low of 0.956).

More on yesterday’s UST selloff which saw the 10yr yield close at its highest level since April 2012. The 16bp rise in yields was the highest one day rise in 19 months. This brings the cumulative rise in yields to 50bp since the beginning of this month - spurring the return of “Great Rotation” talk. The majority of yesterdays move came after the release of the Conference Board’s US consumer confidence data which printed at a post-GFC high of 76.2 (vs 71.2 expected). There were also reports of technical selling after stops were triggered around the 2.08% to 2.10% level.

Yesterday’s 2yr tnote auction didn’t help either after it recorded its lowest bid-to-cover ratio (3.04x) since February 2011. The weakness wasn’t confined to US rates with 10yr yields in the UK (+5bp), Germany (+4bp) and French (+4bp) rising yesterday, while Spanish (-4bp) and Italian (-2bp) yields firmed. Outside of rates, equities had a solid day with the Stoxx600 (+1.3%) having its best day in more than a month. The index has climbed for 12 consecutive months, its longest winning streak since 1997 – and its YTD gain of 10% is its best start to a year since 1998 (Bloomberg). Across the Atlantic, the S&P500 initially traded as high as +1.4% but pared gains later in the session to close up 0.7% after some late-session concerns about Fed tapering. The Dow Jones had another strong Tuesday (+0.7%) which CNBC notes is the 20th consecutive positive Tuesday close, extending the longest Tuesday streak in Dow Jones history. The second longest streak was in 1927 when the Dow recorded 15 consecutive positive Tuesdays. Among the only risk assets to underperform were gold (-1%), silver (-1.5%) and US credit (CDX IG +0.5bp) – unsurprising given the talk about Fed tapering yesterday.

Turning to the day ahead, we have German inflation and unemployment data, Eurozone monetary data and the latest Italian business confidence reading. The European Commission will be releasing its economic policy recommendations for all 27 EU members today. Newswires are suggesting that the Commission may ease budget targets for France, Spain and the Netherlands. The Bank of Canada makes their policy announcement later today. In terms of the US, the focus will be on today’s 5yr treasury auction and the Boston Fed’s Rosengren (FOMC voter) will be speaking towards the end of the US session.