Sea Of Red

In the brief but tempestuous fight between Abe and the "deflation monster", the latter is now victoriously romping through an irradiated Tokyo, if last night's epic (ongoing) collapse in the Nikkei is any indication: down 6.4%, crushing anyone who listened to Goldman's "buy Nikkei" recommendation which has now been stopped out at a major loss in three days, and now well in bear-market territory, it would appear that a neurotic Mrs. Watanabe is finally with done with daytrading the Pennikkeistock market, and demands Shirakawa's deflationary, triumphal return to finally clam the market. Only this time the Japan's selling tsunami is finally starting to spill, if not to the US just yet (it will) then certainly to Asia, where the Shanghai Composite which was down 2.7%, and is once again well down for the year, and virtually all other Asian stock markets. Except for Pakistan - the Karachi Stock Exchange is an island of stability in the Asian sea of red.

... As is Italy.

RanSquawk summarizes it best: broad based risk off sentiment was observed in Europe this morning, after the Nikkei 225 index over in Japan officially moved into bear market territory and officials at the World Bank slashed global and China's growth forecasts. As a result, the positive correlation between the Nikkei 225 index and USD/JPY saw the major pair decline over 200pips to trade at levels not seen since early April. However, even though the spot rate remained under pressure, the implied vols surged to 2y high which indicates that the sell-off may now be viewed as a buying opportunity. Technically, major support level is seen at 93.57 which is the 38.2% retracement of the September to May rally.

Looking elsewhere, Italian Treasury successfully tapped markets this morning and sold just shy of €5 billion planned in BTPs. Still, the risk off sentiment ensured that peripheral bond yield spreads with respect to the benchmark German Bund remained wider. Going forward, market participants will get to digest the release of the latest Retail Sales report, as well as the weekly jobs data.

SocGen's macro update confirms more of the same:

Risk aversion is back today, as investors turn concerned about the Fed exit and the success of the Abenomics. JPY and CHF are the best performers on the FX, while USD and EM currencies are hardly hit.

Will US retail sales reassure today? Consensus is for a 0.4% increase. A positive economic surprise could revive selling pressure on 10Y Treasuries. However, 2.23% must be fully cleared to catch a glimpse of 2.40% and see dollar buying rekindle.

As far as EUR/USD is concerned, we continue to think that the EUR/USD's current upside will not last. Should global risk aversion continue, the USD would have to benefit at the end of the day: the BoJ and the SNB will not accept that the JPY and the CHF recover their safe haven status.

Moreover turning to the EUR, the ECB's surplus liquidity reserves have been falling on a regular basis for a while now, and European banks have continued to reimburse the two 3-year LTROs: to date, they have reimbursed 40% of the amounts borrowed. This may have contributed to the EUR's current resilience of late. Indeed, the reduction in surplus liquidity has mechanically hardened monetary conditions.

Nevertheless, while this likely will hinder the ECB in its ultra-accommodative monetary policy, the ECB does have room for manoeuvre. Although President Draghi last week indicated that no urgent action was needed, which is also underpinning the EUR, but he stated that the bank has several instruments at its disposal and that they are easy to implement. In short, the ECB is still considering using them. SG economists project that the ECB will go ahead with new accommodative monetary measures by the end of 2013: they expect a further 25bp decline in the repo rate and do not exclude more non conventional measures.

* * *

All the bulletin points that's fit to print, courtesy of Bloomberg's DayBook:

  • Treasuries gain as Nikkei slides into bear market territory, leading global stocks lower, as JPY strengthens past 94; Japanese investors were net sellers of foreign bonds for a fourth week.
  • Emerging markets from Brazil to India took steps to stem an outflow of capital as concern mounts that developed nations are approaching the beginning of the end unprecedented liquidity
  • More than $2.5t has been erased from the value of global equities since Bernanke said May 22 that the Fed could scale back QE should the job market show “sustainable improvement”; the BoJ left its stimulus unchanged at June 11 meeting
  • Reserve Bank of New Zealand left its official cash rate at  2.5%, said kiwi remains overvalued; Bank of Korea left its benchmark rate unchanged at 2.5%
  • BoJ’s Kuroda said Japan’s real economy is recovering steadily, signaled confidence markets would recover
  • The World Bank cut its global growth forecast for this year after emerging markets from China to Brazil slowed more than projected, while budget cuts and slumping investor confidence deepened Europe’s contraction
  • Canada and the U.K. are seeking to galvanize an austerity alliance within the G-8 amid mounting pressure to ease up on the spending-cut strategy
  • Treasury 30Y bonds to be sold today yield 3.335% in WI trading; stopout yield at that level would be highest since March 2012; 10Y notes sold yesterday awarded at 2.209%, highest since Oct. 2011, tailing 1pm level by 0.1bps-0.2bps; 2.53 bid-to-cover lowest since Aug. while indirects surged
  • Sovereign yields mostly lower. Asian and European stock markets, U.S. equity index futures slide, WTI crude, metals lower

Finally, DB's Jim Reid with the usual recap of all other major and non-major overnight events:

A bleak month for Japanese equities has just become bleaker with large declines seen in the Nikkei and TOPIX overnight. The overnight declines have been broad based with all but one constituent in the Nikkei trading lower. By sector, declines have been led by Retail, Automakers and Consumer Finance stocks. At the same time, dollar yen has broken through the 95 level to a 2-month low of 94.5. Since hitting 103.2 in mid-May, the yen has strengthened by more than 8% against the USD. Overnight flow data from the Japanese Ministry of Finance showed continued selling of foreign assets by Japanese investors for a fourth straight week. Domestic money managers sold a net JPY387bn yen of foreign debt and a net JPY222bn of foreign equities for the week ended June 7th. On a slightly better note, JGBs are firmer across the curve with 10yr yields having their best day in more than two months (-8bp as we type). Having played down the recent volatility in Japanese markets, the BoJ said that Governor Kuroda will meet with PM Abe later today to discuss recent moves in the yen and stock markets. It is unknown at this stage if there will be an official statement following the meeting.

Elsewhere in Asia, the temporary respite in emerging markets has been rather short-lived. The Asian IG credit index is currently marked 12bp wider at 153bp and sovereign CDS such as China and Korea are marked about 8-9bp wider. Meanwhile in Asian equities, the Hang Seng (-2.6%) and KOSPI (-1.0%) are both nursing losses, partly in concert with the declines seen in Japanese equities. Mainland Chinese equities are down 2-3% in their first trading session since last Friday and are in part reacting to the weaker-than-expected trade numbers which were released last weekend. In currencies, the Indian Rupee is 0.7% weaker against the USD, despite news that the RBI had intervened in the FX market in recent days to support the currency after it record lows against the dollar on Tuesday.

Returning to yesterday, a strong start to the European trading session failed to carry through to the market close (Stoxx600 -0.36%). Some of yesterday’s late selloff was attributed to talk of a “no confidence” vote in Greece. Greece’s government came under some pressure from junior coalition members in the Pasok and Democratic Left parties following public anger over the sudden closure of the Hellenic Broadcasting Corporation (ERT) on Tuesday night. According to Reuters, ERT had a combined audience share of 13%. PM Samaras described the closure as a necessary process before a relaunch of the broadcaster in a slimmed-down form later this year. A number of Greek labour unions have planned a protest in the Greek capital today to voice out against the closure. Greece's ASE Index fell 3.2% after the country became the first developed nation cut to emerging-market status by MSCI Inc. In other changes announced by MSCI, Qatar and the United Arab Emirates were raised to emerging markets, while Morocco was cut to a frontier market.

Across the Atlantic, we had an interesting day where we saw weakness in both equities and fixed income. Indeed, the S&P500 closed 0.8% weaker, while 10yr USTs added 4bp to close at 14mth highs. Some of the weakness in USTs came after soft demand at a 10yr treasury auction where the bid-to-cover of 2.53x was the lowest in 10 months. There was also data showing that outflows from US long-term mutual funds were $11.5bn for the week ending June 5th, of which US bond funds saw outflows of $10.93bn. The last time fund outflows reached a similar figure was in early October 2012. Indeed, bond fund flows remain highly topical given the recent move in rates and follows findings last week that investors had pulled a record $12.53bn from bond funds tracked by EPFR Global for the week ended Wednesday June 5th. In other markets, the dollar index (-0.3%) continued its decline from YTD peaks and credit markets finished weaker (CDX IG +2bp) amidst the move higher in rates.

Turning to the day ahead, US retail sales, business inventories and initial jobless claims are likely to be the main focus of a sparsely populated data docket. In terms of retail sales, DB is forecasting gains of +0.3% across both the headline and ex-auto sales. It’s also worth watching today’s 30yr UST auction following yesterday’s lacklustre 10yr sale.


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