While the skeleton crew of market participants are still digesting yesterday's uber-dovish, "forward guidance" conversion by the BOE and ECB, driven in response to the Fed's increasingly tight (at least relatively) monetary policy, they now have month's biggest economic and market catalyst to look forward to. In a day which promises to be rife with illiquidity as the bulk of US market participants are within 100 feet of a sandy beach, we are about to get the number that will shape the market's mood for the next month: will the Fed's tapering planes be strengthened in response to strong NFP, or not. As Deutsche accurately points out, the curveball to throw in is that June-August numbers have tended to be seasonally weak over the whole period we have data (back 70+ years) and again over the last 10 years. Today's number is therefore going to be fascinating. A number between 150-200k is unlikely to change anyone’s opinion on the Fed whereas a number below might start to build a case for a taper delay. Above 200k and the September taper momentum will build. Such a high number (especially in a weak seasonal period) is unlikely to be great for markets but the ECB/BoE might have cushioned some of the hawkish blow for now. For the record the market is expecting 165k on payrolls and 7.5% (DB same) for unemployment. A full NFP preview post is coming shortly.
So while the NFP will dominate the news, earlier today we got the latest LTRO repayment news from Europe, where we learned that on 10 July 2013 a whopping EUR 0.00 billion will be repaid under the first LTRO, and EUR 2.1 billion in the second by 8 counterparties. So promises of easing with one hand, while banks continue to voluntarily remove liquidity from the market with the other? We got some additional bad news out of Europe when German factory orders tumbled -1.3% in May on expectations of a +1.2% increase, but the ECB's dovishness is already to be expected. Perhaps the most curious European news of the day came from the Cyprus government which believes that ECB Executive Board Member Joerg Asmussen threatened Cyprus with stopping financial aid, Die Welt reported, without saying where it obtained the information. Asmussen threat came after Cyprus asked repeatedly for softening of agreed-on reforms, Welt reports. The reason is that Cyprus wants more liquidity support for Bank of Cyprus, among others concessions. Keep an eye on that alongside the deteriorating situation in Portugal.
Key markets summary:
- S&P 500 futures up 0.9% to 1623.9
- Stoxx 600 down 0% to 292.1
- US 10Yr yield up 4bps to 2.54%
- German 10Yr yield up 1bps to 1.66%
- MSCI Asia Pacific up 1.1% to 132.1
- Gold spot down 1.2% to $1234.9/oz
More on the key overnight news in bulletin format from Bloomberg:
- Treasuries fall before report forecast to show U.S. added 165k jobs in June with unemployment rate falling to 7.5% from 7.6%.
- EUR and GBP fall vs USD after BoE’s Carney and ECB’s Draghi each indicated they will keep interest rates low for longer than investors expect
- BoE said recent increase in rates was “not warranted by recent developments in the domestic economy”; Draghi said ECB was injecting a “downward bias in interest rates for the foreseeable future”
- Fed policy makers are ready to start tapering bond purchases in September after Bernanke shocked markets by announcing a conditional timetable, said former Fed Governor Laurence Meyer
- German factory orders declined 1.3% in May vs expectations for 1.2% gain; April revised to -2.2%
- China suspended the release of industry-specific data from a monthly survey of manufacturing purchasing managers, with an official saying there’s limited time to analyze the large volume of responses
- Japanese investors sold JPY10.6t of foreign debt in the first half of 2013, the most since at least 2001, according to Ministry of Finance data
- Egypt’s Muslim Brotherhood called for nationwide protests in the first major trial of strength with the military- appointed government after the ouster of Islamist Mohamed Mursi as president
- Sovereign yields mixed. Nikkei gains 2.1%, leading Asian markets higher; Europe equity indexes mixed after yesterday’s rally. U.S. index futures higher. WTI crude,gold and copper lower
WHAT TO WATCH:
- 8:30am: Change in Nonfarm Payrolls, June., est. 165k (prior 175k)
- Change in Private Payrolls, June, est. 175k (prior 178k)
- Change in Manufacturing Payrolls, June., est. 0k (prior -8k)
- Unemployment Rate, June, est. 7.5% (prior 7.6%)
- Average Hourly Earning M/m, June, est. 0.2% (prior 0.0%)
- Average Hourly Earning Y/y, June, est. 1.9% (prior 2%)
- Average Weekly Hours, June, est. 34.5 (prior 34.5)
- Change in Household Employment, June (prior 319k)
- Underemployment Rate (U6), June (prior 13.8%) Central Banks
- Fed deadline for U.S. bank stress test results
DB has much more on the overnight events as well as what to expect today:
The BoE and the ECB (more details below) made a great effort yesterday to stress that they are nowhere near as hawkish as the Fed - t least on a relative basis. Before we get excited it’s worth noting that the Fed are still injecting $85bn a month of liquidity into markets whereas the BoE and ECB are currently on hold with regards unconventional policy. In fact the ECB balance sheet has been slowly shrinking this year. Nevertheless that the ECB broke with 14 years of protocol to give any guidance on future rate policy is a notable step. The BoE by issuing a statement suggesting that the recent rise in yields was not consistent with the weak recovery and low inflation was also significant. They also hinted in their statement that they may be more specific on their commitments to keep rates low for longer at their August meeting. So Carney is making his mark and I'm glad I got my Euros before the meeting. Sterling fell 0.7% and 1.4% against the Euro and Dollar yesterday and the Euro was down 0.7% against the Dollar.
Given the Fed's recent statement and yesterday's news, the sensible trade seems to be long Euro/UK rates vs US and to be long the Dollar against the Euro and Sterling. Indeed our rates and fx strategists have been in favour of this bias in their recent notes. While we would agree with this in the near-term we can't help but think that the Fed will become more dovish as the year progresses and that such trades have a shelf-life of weeks not several months. This won't be an overnight change from the Fed but will evolve with the data and from market signals. Ever since the financial crisis started we've been of the opinion that once money printing started it would be very difficult to reverse the process and that balance sheets around the world will eventually be a decent size bigger than they are even today and that unconventional policy will probably last well into the second half of the decade across many parts of the globe. Whether it’s the right thing to do is irrelevant but with very low nominal growth and with very high and still growing total debt, such an outcome seems inevitable to us. A 1-handle on 10 year Treasuries again at some point before year-end wouldn't surprise us even if there's volatility first.
Especially as in the near-term the Fed are minded to start tapering in September and until persuaded otherwise will likely do so even if we think this is an unnecessary risk to take given the fragile global economy. However their actions will depend on numbers like today's payroll/unemployment print. The curveball to throw in is that June-August numbers have tended to be seasonally weak over the whole period we have data (back 70+ years) and again over the last 10 years. Today's number is therefore going to be fascinating. A number between 150-200k is unlikely to change anyone’s opinion on the Fed whereas a number below might start to build a case for a taper delay. Above 200k and the September taper momentum will build. Such a high number (especially in a weak seasonal period) is unlikely to be great for markets but the ECB/BoE might have cushioned some of the hawkish blow for now. For the record the market is expecting 165k (DB at 145k) on payrolls and 7.5% (DB same) for unemployment. We should note however, that recent market estimates in the last 24 hours have been in the 175k to 180k range.
Turning to Asia, yesterday’s positive reaction to Draghi’s “lower for longer” rate guidance has largely carried through to Asian markets. As we type, the Hang Seng, Nikkei and Shanghai Comp are all sitting on gains of 1.5%, 1.6% and 0.3% respectively with banking stocks generally outperforming across the region. The S&P 500 futures is trading relatively flat this morning at 1624 after adding a percent yesterday in European trading - including a 0.5% gain after Draghi’s press conference started. In credit markets, the Asia and Australian IG indices are both trading 3-4bp firmer but overall liquidity with many participants content to take a wait-and-see approach ahead of tonight’s NFP. Chinese interbank rates continue to ease (7-day repo rate down -2.36% today to 3.8%) after reports that the PBoC had injected funds into a select number of banks to ease liquidity (Bloomberg). Staying in China, in a sign of the stresses in the shipbuilding sector, shares in Rongsheng Heavy which at one stage was the world’s 6th largest shipyard, are down 14% overnight after it reported that many shipowners have delayed, renegotiated or defaulted on payments to builders and that it is actively seeking financial support from the government.
Elsewhere overnight, the EUR (-0.1%) and GBP (-0.2%) are losing further ground against the USD but some of the losses have been pared this morning. US treasuries have reopened a touch weaker across the board with the 10yr yield up 2bp this morning at 2.52% versus Wednesday’s close of 2.50%. This is contrast to European rates which yesterday fell almost universally across the core and periphery markets on the back of Draghi’s rate guidance. Ten year German, Italian and Spanish bond yields fell 1bp, 10bp and 13bp. Indeed the yield differential between 10yr USTs and Bunds has widened to 0.87% which is the widest level in more than 2 years. Portuguese yields fell by 16bp to 7.05%, helped by signs that the PM and CDS party had reached an agreement to hold the coalition together.
Returning to the ECB’s comment yesterday, DB’s Moec and Wall described Draghi’s forward guidance as the best way to reconcile i) the split between improving real economy data and stubbornly weak credit figures; ii) pressure on intra-Eurozone spreads partly triggered by Fed communication on tapering; iii) perturbations in the forward money market rates under pressure from early LTRO repayments. Stating that the Council expects "the key ECB interest rates to remain at present or lower levels for an extended period of time" addresses ii) and iii). Meanwhile, the message to the money market is strong: negative deposit rates, which had been seemingly downplayed last month, are back on the table. Draghi insisted several times that "all key rates" could be lower. For now, DB maintain their call for unchanged policy rates until 2015, as the latest communication makes an implicit easing bias more explicit but does not reveal a substantially different view.
Looking at today’s calendar, ahead of the payrolls print, we have a number of European data releases including Spanish industrial output, German factory orders and the French trade balance for the month of May. But all eyes will on US payrolls which will likely set the tone for markets in the days and weeks to come.
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The introduction of forward guidance on interest rates by the ECB, and the likelihood that the BoE will formally do the same in August after hinting as much yesterday, lifted risk sentiment and caused the EUR to drop 0.7% and GBP 1.3% vs the USD. The jury will be out on recent moves in rates and FX until after the release of US non-farm payrolls data today, as investors gauge the probability of Fed tapering after the summer. A number below 150k or above 200k is probably needed to push the market out of the comfort zone. UST yields will lead FX and equities.
The ‘heavy lifting' is now supposedly being done by the ECB and BoE in terms of keeping policy accommodation intact but whether in 12 months time this will be sufficient enough to fill the void left by a Fed exiting QE is difficult to say. Moreover, although the announcements yesterday by the ECB and BoE put both central banks on exactly the same footing as the Fed where short-term rates are concerned, remember the Fed is still adding liquidity to the tune of $85bn a month. So in actual fact most of the lifting is still being done by the Fed (and BoJ), not this side of the Atlantic in the eurozone or Britain, even though the long end of the yield curve would tell you otherwise. US/EU and US/UK 10y spreads widened a couple of bps yesterday ie the gap between borrowing/funding costs for the UK and EU cheapened relative to the US. The Eurostoxx-50 and FTSE-100 indices have now returned to pre-FOMC levels, but whether the 6% rally since 24 June is a dead cat bounce or forms the base for a summer rally will partially be answered by the US labour market report at 14:30 CET.
Labour market anecdotes from the US ISM surveys for this month were conflicting in that services employment gained and manufacturing fell, but our economists calculate the composite ISM employment gauge rose by almost four points to a four-month high. With ADP and ISM composite anecdotes at the highest level since February (payrolls +332k), the bar for a positive surprise today would appear to be quite low. A number between 150k and 200k will not shift the needle with respect to the timing of Fed tapering (we still think September). On a number above 225k, the Street may talk up the possibility of Fed tapering immediately on 31 July by $10bn to $25bn.