It was shaping up to be another bloodbathed session, with the futures down 10 points around the time Shanghai started crashing for the second night in a row, and threatening to take out key SPX support levels, when the previously noted rumor of an imminent PBOC liquidity injection appeared ex machina and sent the Shanghai composite soaring by 5% to barely unchanged, but more importantly for the all important US wealth effect, the Emini moved nearly 20 points higher from the overnight lows triggering momentum ignition algos that had no idea why they are buying only knowing others are buying. The rumor was promptly squashed when the PBOC did indeed take the mic, but contrary to expectations, announced that liquidity was quite "ample" and no new measures were forthcoming. However, by then the upward momentum was all that mattered and the fact that the underlying catalyst was a lie, was promptly forgotten. End result: futures now at the highs for absolutely no reason.
That this rumor emerged just as Korea’s President Park asked ministers to "help stabilize financial markets", is probably a simple coincidence. Elsewhere, in Europe, both Spain and Italy sold short-term debt, however at soaring rates. Spain sold 3 and 9 month bills (EUR3 billion in total), at an average yield of 0.869% and 1.441%. The last time these came to market a month ago, they yielded 0.331% and 0.789%. Sorry Spanish pension fund. Meanwhile in Italy, the Zero Coupon two year bond sold at 2.403%, over double the yield from May 28 when the same issue priced at a tiny 1.113%. So much for the carry trade.
Today's economic calendar is quite full with durable goods orders, FHFA/Case-Shiller house prices, new home sales and the Conference board’s consumer confidence survey, however now that good economic news is once again bad news for the market, the bulls will be praying for wild, major misses in all categories. More importantly, there is a 2yr US note auction scheduled today which will show how the most recent repricing of the bond market has impacted short rates. Speaking of which, at least for now the bond market fireworks seen yesterday are missing, and following last night's words of caution by Dick Fisher to the "feral hogs" aka indiscriminate bond sellers, the 10 Year is trading higher at a "stable" 2.52%
DB's Jim Reid recaps what the overnight session looked like, at least until the arrival of the Chinese hence rejected rumor.
The rocky start to the week for markets looks set to continue today. Indeed, after initially seeing some stability in early trading (probably helped by the rally in US treasuries late yesterday), Asian stocks are once again trading lower across the board led by a 4% drop in the Shanghai Composite. In terms of Chinese banks, there has been little to report in the past 24 hours following the PBoC’s statement yesterday but domestic news agency Caixin did write that liquidity in Chinese banks is expected to ease this week and that excess reserve levels will increase into the month-end, citing an unidentified PBoC official. Sentiment in Chinese banks remains soft though, with interbank funding rates still at elevated levels and relatively unchanged on yesterday's fixes. Falls in Chinese stocks are being led by domestic brokers (-7.8%), natural resources (-5%) and insurance (-5%) while Chinese banks are down about 2%. Elsewhere in Asia, the Hang Seng (-1.4%), KOSPI (-1%) and ASX200 (-0.3%) have reversed earlier gains and S&P futures are trading 4pts lower (-0.25%) as we type. We’re also seeing a fairly sharp intraday turnaround in Asian credit with the IG index initially trading 9bp tighter, before gapping out to trade unchanged on the day as we go to print.
In Japan, the Nikkei (-2%) is also seeing losses despite some seemingly dovish comments from the deputy governor of the BoJ yesterday. Kikuo Iwata said that the BoJ still has policy options and remains ready to act if price expectations experience long-term declines. He balanced out the comments by saying that central bank will not be reacting to short term market movements, particularly because it has not harmed the real economy. He also said that if the central bank were to boost asset purchases in the future he would favour government bonds over risky assets, given the large size of the JGB market. Dollar yen is 0.2% lower this morning at 97.6 and 10yr JGB yields are at 0.87%.
While we’re on the subject of yields, its worth reiterating our comments last week about how important US yields are when most of the world is still levering (in other words, issuing more debt relative to economic activity) and hasn't started the deleveraging process yet. From a markets standpoint, the problem we face is that the US tends to set the price of debt everywhere. Indeed treasury yields tend to be the first building block for the price of all assets globally and any increase in yields will likely expose some of the weaker entities. Most of the recent focus has been on EM but Europe's periphery are also being negatively impacted by the Fed.
Since the lows on May 2nd, 10 year Spanish and Italian have both added more than 100bp, including a 20bp move higher yesterday. On a year-to-date basis, Spanish yields are now basically unchanged (5.12%) and Italian yields are 34bp higher (4.83%).
The market tone in Asia this morning follows a fairly volatile session yesterday that saw 10yr UST yields oscillate in a 15bp range. Indeed 10yr yields briefly broke through the 2.60% mark to an intraday high of 2.66% at the mid-point of the US session, which also roughly coincided with the wides in credit and the lows in equities. From there, yields rallied by more than 12bp helped by comments from the Minneapolis Fed’s Kocherlakota and the Dallas Fed’s Fisher. Kocherlakota, a non-voter, held a conference call with news reporters to clarify what he saw as a “mis-perception” by markets that the Fed had become more hawkish. He told reporters that he "was concerned about the strong reaction….to the committee's communication" and that the FOMC could clarify future communiations by laying out thresholds to reduce QE. These thresholds include an unemployment rate falling under 7.0%, provided the outlook for inflation remains below 2.5%.
Kocherlakota added that the current rise in yields was not a cause for concern. Those sentiments were echoed by Dallas Fed President Richard Fisher, also a non voter, who said that he thought markets overreacted to the latest policy meeting, and emphasised that all the Fed had announced last week was that it would begin tapering when conditions were firmer. As for yields, he was concerned about a significant spike in yields but added that a gradual rise over time would not be worrying. Elsewhere US equities also had a fairly volatile day, bottoming at -1.8% before erasing most of those losses, and then fading again towards the close (-1.2%).
Turning to the day ahead, amid the market volatility we also have a fairly full US data docket including durable goods orders, FHFA/Case-Shiller house prices, new home sales and the Conference board’s consumer confidence survey. There is a 2yr US note auction scheduled today.
* * *
SocGen's FX outlook of key events is below:
The meltdown in bond markets continued apace yesterday with most still pointing the blame at the post-FOMC dynamics which are giving rise to a reshuffling of portfolios. The de facto safe haven escape route out of stocks, metals and bonds has simply been shut down, as expectations of Fed tapering have pushed yields up at a rate not seen since January 2009. The aversion to stocks - the S&P has lost over 1% in three of the last four sessions - lifted the VIX volatility index above 20% last week to a six-month high, and though Fed voter Dudley (followed by non-voters Fisher and Kocherlakota overnight) tried to soothe markets with his comments (in the margin of the BIS meeting at the weekend), investors continue to rush for the exit contemplating where an exit from stimulus will leave yields over 6-12month timeframe. ‘Market conditions will be considered when making monetary policy' as Dudley stated, expected rhetoric from a dove, but so far this has not brought a pause in the selling.
Meanwhile, funds-tracking company, EPFR, reports that global investors pulled out over $3bn from emerging market equity funds over the past week alone, with China, Brazil, Russia and South Africa in particular seeing outflows accumulating. Inflows into Japan show that most investors still believe that Japanese stocks offer value over the long run, and are happy to see through the short-term ‘noise'. The Nikkei is down 18% from the May high, but it has outperformed US indices since the FOMC last week. The outlook for a weaker JPY should continue to bolster demand and help Japan outperform, with the BoJ's own easing programme firmly in place.
The focus today will be on the bond markets again. Supply from the US, but also Italy and the Netherlands, is due and auction statistics will be watched carefully in the wake of yesterday's sell-off in eurozone core, semi-core and periphery. Do participants hold off and wait to buy at even higher yields? In FX, the NOK and SEK were beaten and bruised badly again yesterday, but the selling may have further to go as USD/NOK flirts with 6.15 and USD/SEK tests 6.80. Data today includes US consumer confidence. ECB president Draghi is slated to speak and the BoE's King will testify for the last time on the Inflation Report to Parliament.