ECB Stress Test Fails To Inspire Confidence Again As Euro Stocks Slide After Early Rally; Monte Paschi Crashes

It started off so well: the day after the ECB said that despite a gargantuan €879 billion in bad loans, of which €136 billion were previously undisclosed, only 25 European banks had failed its stress test and had to raised capital, 17 of which had already remedied their capital deficiency confirming that absolutely nothing would change (conveniently the ECB reported that private sector loan issuance declined once again by 1.2% Y/Y), Europe started off with a bang as stocks across the Atlantic jumped, which in turn pushed US equity futures to fresh multi-week highs putting the early October market drubbing well into the rear view mirror. Then things turned sour.

Whether as a result of the re-election of incumbent Brazilian president Dilma Russeff, which is expected to lead to a greater than 10% plunge in the Bovespa when it opens later, or the latest disappointment out of Germany, when the October IFO confidence declined again from 104.5 to 103.2, or because "failing" Italian bank Monte Paschi was not only repeatedly halted after crashing 20% but which saw yet another "transitory" short-selling ban by the Italian regulator, and the mood in Europe suddenly turned quite sour, which in turn dragged both the EURUSD and the USDJPY lower, and with it US equity futures which at last check were red.

So here is where we are now in the markets: European shares fluctuate, currently down having just touched session lows with the travel & leisure and food & beverage sectors outperforming and banks, autos underperforming. Banks index falls having risen earlier on results of ECB stress tests yesterday. Brazilian stocks fall after Rousseff wins election. The Dutch and Swiss markets are the best-performing larger bourses, Italian the worst. The euro is stronger against the dollar. Irish 10yr bond yields fall; Spanish yields decline. Commodities decline, with nickel, corn underperforming and natural gas outperforming. U.S. Dallas Fed index, pending home sales, Markit U.S. composite PMI, Markit U.S. services PMI due later.

And while today attention turns towards the US pending home sales release and a host of tier 1 US earnings including Merck at 1100GMT and Twitter after-market, the biggest event by far takes place at 11:00 am when the Fed monetizes some $0.85 - $1.05 billion in 2036-2044 bonds, after which POMO, and QE3, are officially over!

Market wrap

  • S&P 500 futures down 0.1% to 1959.1
  • Stoxx 600 down 0.5% to 327.3
  • US 10Yr yield down 1bps to 2.27%
  • German 10Yr yield down 0bps to 0.89%
  • MSCI Asia Pacific up 0.6% to 138.4
  • Gold spot down 0% to $1230.5/oz

Bulletin Headline Summary from Bloomberg and RanSquawk

  • European equities pare their initial gains as participant’s book profits and a disappointing German IFO survey returns focus back towards the dreary outlook for the Eurozone economy
  • EUR/USD trades higher albeit off its best levels alongside the turnaround in Eurozone sentiment with large expires at 1.2680-90 (2.25bln) and 1.2700 (1.3bln) also said to be anchoring price action
  • Looking ahead, attention turns towards the US pending home sales release and a host of tier 1 US earnings including Merck at 1100GMT and Twitter after-market.
  • Treasuries decline amid expectations Fed will end bond-buying program at two-day meeting starting tomorrow; week’s auction cycle also begins tomorrow with $29b 2Y notes.
  • Fed to buy $850m to $1.05b in 2036-2044 sector today, last purchase scheduled for October
  • Ifo institute’s index of German business confidence fell to 103.2 in October from 104.7 in September, lowest since December 2012 and below 104.5 median estimate in Bloomberg survey
  • Twenty-five banks including Italy’s Banca Monte dei Paschi di Siena SpA failed a stress test led by the ECB, which said almost half of them must act to raise more capital
  • Most of the lenders that failed have been let off for good behavior; only eight banks out of the 25 found with shortfall haven’t already plugged capital gaps or satisfied the ECB with plans to shrink
  • China’s economic growth will slow to 7.2% in 4Q as domestic demand weakens, said Song Guoqing, an academic member of the People’s Bank of China monetary policy advisory committee
  • Pro-European parties are set to control Ukraine’s parliament and form a coalition government after trouncing the Russian- leaning political forces popular in the nation’s war-torn east
  • The Obama administration is concerned that required quarantines of health workers returning from West Africa to New York and New Jersey may have unintended consequences and is preparing new directives, a senior administration official said
  • ETFs tracking Brazilian shares slid as President Dilma Rousseff’s re-election damped speculation for a change in policies that wiped out $553b of stock market value and left the economy in recession
  • Sovereign yields mostly higher. Asian stocks mixed, with Nikkei higher, Shanghai lower; European stocks mostly lower, U.S. equity-index futures decline. Brent  crude falls 0.2%; copper, gold little changed

US Event Calendar

  • 9:45am: Markit US Services PMI, Oct. preliminary, 57.8 (prior 58.9); Markit US Composite PMI, Oct. preliminary (prior 59)
  • 10:00am: Pending Home Sales m/m, Sept., est. 1% (prior -1%)
  • Pending Home Sales y/y, Sept., est. 2.2% (prior -4.1%)
  • 10:30am: Dallas Fed Manufacturing Activity, Oct., est. 11 (prior 10.8)
  • Last Ever POMO: 11:00am: Fed to buy $0.85 - $1.05 billion in bonds due 02/15/2036 - 08/15/2044


JGBs traded up 4 ticks at 146.50 underpinned by the BoJ who unexpectedly increased their purchasing operation in the 10yr-25yr sector by JPY 10bln. Asian equity markets kicked-off the week mostly higher with the exception of Hk and Chinese bourses, weighed on by reports of a delay in the HK-Shanghai cross border trading link. Consequently, the Shanghai Comp traded down 0.5% while the Hang Seng index trades lower by 0.7%. The Nikkei 225 traded up 0.6%, supported by improved risk appetite from Friday’s positive Wall Street close and news that most European banks passed the ECB/EBA stress tests.


European equities traded in the green from the get-go as participants digested the ECB stress test results with outperformance in the periphery as despite the disappointing findings for Banca Carige/Monte Paschi, the stress tests painted a better than expected picture for Spain and Italy. The main takeaway from the release was that the EUR 25bln capital hole was towards the lower end of analyst expectations and when capital raising exercises that are already underway are taken into account, this figure falls to EUR 9.5bln. Elsewhere, Commerzbank were one of the major outperformers in Europe (up as much as 9%) after any potential concerns regarding the German lender were alleviated.

However, following the open, participants then began to book profits with attention returning back to the current outlook for the Eurozone economy. This sentiment was further buoyed by the German IFO survey which was expected to reveal a 6th consecutive monthly decline, an outcome which was confirmed by the release (Business Climate 103.2 vs. Exp. 104.5). This subsequently saw European equities move into the red, with notable underperformance in the periphery, with Banca Monte dei Paschi (-17%) who initially failed to set an opening price, weighing on the FTSE MIB. This investor caution subsequently saw a flight to quality with Bunds then moving into relatively neutral territory, with the European spreads against the German benchmark unwinding their initial tightness.


In FX markets, EUR/USD is currently trading with modest gains after coming off its highs in-line with the turnaround in European equities, with large option expires in EUR/USD at 1.2680-90 and 1.2700 said to be anchoring the pair’s price action. Furthermore, sentiment for EUR was also buoyed by the disappointing IFO release, with IFO economist Wohlrabe saying he sees no growth in Q4 for Germany. Elsewhere, USD-index (-0.15%) remains on the back foot after breaking below support seen at Friday's lows, spurring leveraged hedge funds to reduce JPY short positions and in-turn send USD/JPY back below the 108.00

Brazilian President Dilma Rousseff was re-elected by a narrow margin, after securing 51.6% of the valid votes cast, having fought off a strong challenge by pro-business challenger Aécio Neves who finished with 48.5%. (Guardian)


Heading into the North American open, WTI and Brent crude futures trade in the red, with further negative sentiment stemming from Goldman Sachs cutting their forecasts for Brent and WTI prices for 2015. GS also said OPEC was losing its pricing power as US shale output increases and forecast Brent to avg. USD 85/bbl (Prev. USD 100/bbl), and WTI USD 75/bbl (Prev. USD 90/bbl). Elsewhere, precious metals trade with little overall direction with markets looking ahead to the prospect of the Fed ending QE at their meeting on Wednesday.

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DB's Jim Reid concludes the overnight recap

In terms of nail biting events this week, the FOMC probably doesn't look as likely to be a cliff hanger that it perhaps looked 10 days ago when markets were spiralling lower and the ECB comprehensive assessment (stress tests) was broadly in line with expectations although most people's first reactions have generally been positive towards the exercise. Before we preview the FOMC, lets review some of the key details of the stress test results released yesterday. 25 of the 130 euro-area banks covered in the assessment ‘failed’ with a total gross capital shortfall amounting to €24.6bn as of the end of 2013. However if we take into account for capital already raised this year, the actual capital shortfall amounts to just €9.5bn. The capital needs are concentrated in a few countries (Italy, Greece, Austria, Portugal and Ireland) with these five countries accounting for EUR8.9bn of the above net EUR9.5bn. Overall the results are largely in line with DB economists’ expectations of €8-25bn. As they pointed out, it is also worth noting that the aggregate capital shortfall is fairly small relative to either the total CET1 capital of banks included in the stress test (nearly EUR1trillion) or euro-area GDP (nearly EUR10trillion). The banks included in this exercise have raised over EUR200bn between 2008 and 2013 and an additional EUR57bn has also been raised in the first 9 months of 2014.

One of the key things to look out for was how the market would perceive the credibility of the tests after earlier worries that the tests would largely be a wash. Most reports have been favourable of this front with some citing the Bank of Italy's reaction that the tests were harsh on Italian banks as evidence that it wasn't too easy to pass. However an early criticism has already come from the President of Germany’s IFO Institute, Hans-Werner Sinn who was quoted in Bloomberg overnight saying that the exercise lost credibility given the lack of a deflation stress scenario and that ‚with its assumptions, the ECB has set an inflationary scenario on average for the euro area so that not too many banks would fall under the red line?. Perhaps the ECB feel that they have the ability to avert deflation and therefore didn't stress this as aggressively as other variables. The implied adverse inflation rates put through the stress test looks to be 1.0% in 2014, 0.6% in 2015 and 0.3% in 2016 - not particularly stressful, especially in light of recent numbers. However notwithstanding this DB’s economists and equity strategists believe the latest stress test is more credible than previous exercises in the past and most reports over the weekend expect a positive performance today from European financials.

Markets have reacted with a slightly positive bias overnight with most Asian equity bourses in the green as we type. The Nikkei, the KOSPI, and the ASX 200 are +0.8%, +0.3% and +0.8%, respectively. The S&P 500 Futures are also marginally higher (+0.09%) whilst the EUR is now 1.2705 against the Dollar (up from 1.2671 last Friday). The Hang Seng is down though on concerns that the HK-Shanghai Stock Connect programme will be delayed. Credit spreads are also tighter in Asia although in reality some of that also reflects a solid US session on Friday. The Asia and Australia iTraxx indices are around 3bp and 2bp tighter, respectively. Treasuries are a little softer with the 10yr yield around nearly 2bps higher at 2.29%.

Moving our focus to emerging markets the latest from Brazil’s weekend elections is that Dilma Rousseff has been re-elected following victory over rival Aecio Neves by just an incredibly marrow margin of around 3ppt - supposedly the tightest margin in an election race since at least 1945. Given Friday's market action reflected a Neves turnaround (CDS: -10bp; BRL: +1.5%; Jan-21: -30bp), our EM strategists expect the market to move in the opposite direction today. With the re-election of President Rousseff, our EM colleagues also think that the market will immediately focus on to a possible announcement on the president’s new economic team, especially the finance minister appointment, although it is far from clear how long it would take her to make the announcement (the longer it takes, the more jittery markets will be). Indeed a Brazilian stock ETF plunged by nearly 8% overnight in Tokyo on what is supposedly its biggest decline in 3 years.

Previewing the FOMC meeting this week, we won't have a press conference this time round when the 2 day meeting ends on Wednesday. Joe Lavorgna expects little changes in the committee's assessment of the economy and as indicated at the September meeting the Fed will likely conclude its asset purchase program and will continue to reinvest maturing securities on its balance sheet. Importantly he expects the Fed to maintain the current forward guidance on the fed funds rate by keeping the 'considerable time' language in the meeting statement. Whilst we won't hear from Yellen at the FOMC press briefing, she will speak in Washington on Thursday on Diversity in the Economics Profession but as she will be speaking from her prepared remarks with no Q&A we can perhaps expect less fireworks from that. In terms of other Fed speakers, San Francisco Fed President Williams will be giving a keynote speech to the South African Reserve Bank's 5th biennial conference on Friday although the event seems to be closed to the media.

Besides the FOMC and looking at the other data/events for rest of the week we kick off today with September's pending home sales, the Dallas Fed  Manufacturing Survey and a round off of the Markit Services/Composite PMIs. Euro M3 data for September is also due today alongside the German IFO survey for October. On Tuesday durable goods orders will be the key release in the US along with the Richmond Fed survey and the Case-Shiller home price index. The durable goods headline is expected to get a boost from Boeing aircraft orders (+1.5% v -18.4% last month) although this is an extremely volatile series. Our US economists expect ex-transportation orders to improve as well. Wednesday's main event will be the FOMC statement although we also have the ECB's Bank Lending Survey (Q3) from the other side of the pond. Thursday's highlights will include the first reading of the US Q3 real GDP from the BEA, the usual weekly jobless claims, as well as CPI readings from both Spain and Germany. As for the US Q3 GDP, market consensus is currently looking for +3.0% growth for Q3, down from 4.6% in Q2. Data aside we also note that Bank of Spain's Governor Linde will speak in Madrid on Thursday as part of a debate on the role of central banks in the euro region. Friday will see the release of US personal income and spending stats but the focus will likely be on the latest Chicago PMI ahead of next week's ISM report. Friday's core PCE inflation data will also be interesting in light of the recent declines in breakeven inflation rates. Speaking of which we also  have the Euro area inflation report for October due on Friday.

If that wasn't enough company analysts will be busy covering the 160 S&P 500 earnings reports this week with European earnings also picking up with 85 Stoxx600 results due over the same period. Pfizer, Facebook, Exxon Mobile and Berkshire Hathaway are just some of the big US names this week whilst in Europe we do have the major financials such as UBS, BBVA, Barclays, BNP Paribas, and RBS lined up. Before we wrap up for today we'll quickly take a look at how US and European companies are faring in Q3 relative to street estimates. In the US we have seen a total of 188 companies reported so far and as it has been the case for many years quarterly earnings beat:miss ratios (79%:20%, 1% in line) are performing much better than sales beat:miss ratios (60%:40%). Both look decent relative to recent quarters though. The beat/miss ratios between earnings and sales are more balanced in Europe with about 62% and 61% of those reported so far coming above analysts’ EPS and revenue estimates, respectively. Our usual earnings tracker table updated in today's PDF.