First Euroarea Deflation Since Lehman Sends Futures Higher; Brent Tumbles Below $50 Then Rebounds

Things in risk land started off badly this morning, with the worst start to a year ever was set to worsen when European equities came under early selling pressure following news of German unemployment falling to record low, offset by a record high Italian jobless rate, with declining oil prices still the predominant theme as Brent crude briefly touched its lowest level since May 2009, this consequently saw the German 10yr yield print a fresh record low in a continuation of the move seen yesterday. However, after breaking USD 50.00 Brent prices have seen an aggressive bounce which has seen European equities move into positive territory with the energy names helping lift the sector which is now outperforming its peers. As a result fixed income futures have pared a large majority of the move higher at the EU open. But the punchline came several hours ago courtesy of Eurostat, when it was revealed that December was the first deflationary month for the Eurozone since the depths of the financial crisis more than five years ago, when prices dropped by -0.2% below the -0.1% expectation, and sharply lower than the 0.3% increase in November, driven by a collapse in Energy prices.

And to think it was just October when this exchange with an ECB member took place, as part of the Eurozone's annual stress test farce:

My question would be on how credible these tests are. Looking at the adverse scenario, you haven't even included deflation. You have not included an interruption in gas imports to Europe. You have not included full-on sanctions on Russia. So please elaborate and convince us.


Constâncio: The scenario for the stress test was published earlier in the year, so some of the things you mentioned would not have been considered. But indeed, what was considered is a severe shock being the growth of other countries. If you look to the scenario, you see that for the US, there is also a big deceleration of growth which is part of the scenario and also for other countries that are the markets of the euro area. So that is embedded in those assumptions of indeed a big drop in external demand directed to the euro area. That's the first point.


The scenario of deflation is not there because indeed we don't consider that deflation is going to happen.

Two months later, it happened.

And while its happening once again crushed the ECB's credibility, the "good news", and the reason stocks took off the moment deflation hit, is that algos are desperately hoping this finally unleashes Eurozone QE, perhaps as soon as three weeks from now when the ECB is said to be discussing three different options. This is taking place despite not only Merkel advisor Lars Feld warning ECB will "damage its reputation" if it announces QE plans before the Greek election but Merkel ally Michael Fuchs repeating that Grexit is no longer a systemic threat, and warning that launching QE now would crush any impetus for further reforms. He is right, but algos don't care. At least not for now, and as a result futures are sharply higher on both sides of the Atlantic.


The USD-index (+0.17%) is marginally stronger ahead of today’s FOMC minutes with market participants expecting the Fed to clarify their ‘patient’ rhetoric from December’s FOMC rate decision. This helped USD/JPY stage a minor recovery overnight, with the pair breaking above the 119.00 handle however trade has been range-bound since the European open. With the resurgence in energy prices, commodity currencies including the NOK, RUB and CAD have strengthened slightly against the USD granting the currencies some reprieve after the selloff yesterday.


Oil initially continued its downward trend as Brent crude briefly broke below USD 50.00 for the first time since May 2009 and WTI crude broke below USD 47.00 with the downside attributed to the overnight comments from UAE Oil Minister asserting that market oversupply may last months or years and depends on non-OPEC output growth. However, this move has retraced with the Brent and WTI crude currently trading in positive territory. The precious metal markets, Gold has pulled off yesterday’s 3 week highs where the safe-haven bid was lifted amid weakness in global equity markets after a continued slump in crude and disappointing data from EU and US. Looking ahead, todays DoE Crude Inventories could provide some downside for oil prices as analyst expectations show a build of 700K.

Market Wrap: European shares remain higher with the oil & gas and autos sectors outperforming and financial services, tech underperforming. Brent crude fell below $50 a barrel earlier. German unemployment drops to record low, Italian rises to record high. Greek 10-yr bond yield climbs above 10% for first time since Sept. 2013. At least 11 people killed in Paris offices of satirical magazine Charlie Hebdo. The Spanish and Italian markets are the best-performing larger bourses, Swedish the worst. The euro is weaker against the dollar. Commodities decline, with silver, zinc underperforming and natural gas outperforming. U.S. trade balance, mortgage applications, ADP employment change due later.

  • S&P 500 futures up 0.7% to 2008.1
  • Stoxx 600 up 1.1% to 335.3
  • US 10Yr yield up 4bps to 1.98%
  • German 10Yr yield up 2bps to 0.47%
  • MSCI Asia Pacific down 0.1% to 134.9
  • Gold spot down 0.5% to $1212.6/oz
  • Euro down 0.46% to $1.1835
  • Dollar Index up 0.52% to 91.97
  • Italian 10Yr yield down 1bps to 1.86%
  • Spanish 10Yr yield up 1bps to 1.66%
  • French 10Yr yield up 2bps to 0.75%
  • S&P GSCI Index down 0.2% to 397.3
  • Brent Futures down 0.4% to $50.9/bbl, WTI Futures up 0.3% to $48.1/bbl
  • LME 3m Copper down 0.5% to $6116.5/MT
  • LME 3m Nickel up 0.4% to $15325/MT
  • Wheat futures up 0% to 592 USd/bu

Bulletin Headline Summary from RanSquawk and Bloomberg

  • European Equities now reside in positive territory after a bounce back in Energy prices despite Brent breaking below USD 50.00 in early European trade
  • The USD-index remains firmer ahead of today FOMC Minutes where market participants expect the Fed to clarify the ‘patient’ rhetoric following December’s Rate decision.
  • Treasuries decline for first time this year as European stocks rise and Brent crude gains after earlier dropping below $50/bbl for first time since May 2009.
  • 30Y yield yesterday declined as much as 12.9bps to 2.470%, within 3bps of its July 2012 record low; it is lower by 22bps over past 3 days; 10Y yield fell as much as 14.7bps to 1.885%, within 3bps of its low during Oct. 15 market cataclysm
  • Euro area consumer prices fell 0.2% in December, dropping below zero for the first time in more than two years and bolstering the case for more ECB stimulus
  • German government preparing for a possible exit of Greece from the euro, sees risk of bank collapse in event of possible election of left-wing Syriza, Bild reports, citing unidentified government officials
  • Any political turmoil in Greece following this month’s election is no longer a threat to the wider stability of the euro area, said Michael Fuchs, a senior lawmaker from  Merkel’s party
  • ECB to damage reputation if it announces plan to buy sovereign bonds which includes Greek debt before elections in that country this month, Frankfurter Allgemeine Zeitung cites Lars Feld, economic adviser to German Chancellor Angela Merkel, as saying in interview
  • Greek 10Y bond yields rose above 10% for the first time in 15 months
  • Italy’s jobless rate increased to 13.4% in Nov. from a revised 13.3% the previous month, while separate data showed the euro-region rate at 11.5%
  • Reports contrast with data from Germany showing unemployment fell to a record low in Dec.
  • Germany’s Merkel will offer U.K. PM Cameron a compromise on immigration, pledging support for welfare curbs so long as Europe’s freedom-of-movement rights are not called into question
  • Sovereign yields mixed. Asian stocks mixed, with Nikkei little changed, Shanghai +0.7%. European stocks and U.S. equity-index futures gain. Brent crude, WTI higher;  gold and copper lower

US Event Calendar

  • 7:00am: MBA Mortgage Applications, Jan. 2
  • 8:15am: ADP Employment Change, Dec., est. 225k (prior 208k)
  • 8:30am: Trade Balance, Nov., est. -$42b (prior -$43.4b) Central Banks
  • 2:00pm: Fed to release minutes from Dec. 16-17 FOMC meeting
  • 6:30pm: Fed’s Evans speaks in Chicago

DB's Jim Reid concludes the overnight recap

Markets have started 2015 nearly as chaotically as my skiing. Most major equity markets are down 2-5%, Crossover is 22bp wider, WTI has traded below $50 for the first time since April 2009, the US Energy HY sector is 44bps wider, 5yr Bund yields have gone sub-zero for the first time in history, 10yr US yields have rallied 23bps (now 1.94%) and 30 year USTs are at 2.50% - 6bps off their all time lows. Given this is my first day back in 2015 it’s a good point to remind readers of the views in our outlook entitled "Plate Spinning". For European credit we're resting a lot of our hopes on what we expect to be fairly aggressive broad based asset purchases from the ECB. However we don't think this occurs until March and we still think Q1 will be problematic for markets due to uncertainty over the timing and scale of the above, the Greece election, periodic fears over imminent Fed hikes, and due to the overhang in US credit due to the energy sector stresses. If central banks didn't exist we would be very bearish as we still think we're a long way off repairing the global financial system. However they do exist and 2015 will likely see the highest global QE since 2011. So a lot rests on the ECB acting as we think they will but the BoJ will also help. Elsewhere China will likely keep policy loose and we can't help think that the Fed will struggle to raise rates in 2015. So central banks will continue to keep spinning plates until either a policy error occurs or until politics prevents them. 2015 may see some near misses on this front but ultimately central banks will likely win out in a volatile year, especially in the first few months.

Although markets recovered some of the earlier intraday losses, the S&P 500 (-0.89%) fell for the 5th day in a row and the worst 3-day start to a year since 2008. Once again oil markets are dominating headlines with further tumbles in WTI (-4.22%) and Brent (-3.78%) to $47.93/bbl and $51.10/bbl respectively. Having tested the $50 level on Monday, WTI crashed through $50 and closed below $48 for the first time since 2009. Energy stocks extended declines with the component closing 1.31% lower, although financials were the notable underperformer with the sector -1.53% at the close.

The broadly risk-off tone continued to support a strong bid for Treasuries. Indeed, having traded as low as 1.885% intraday, yields on the 10y benchmark closed 9bps lower at 1.94% and below 2% for the first time since May 2013. As mentioned, 30y yields continue to fall (-9.6bps) leading to a further compression in the 2y30y spread (187bps). The rally in fixed income was supported by softer data out yesterday. In terms of the prints, the December non-manufacturing ISM (56.2 vs. 58.0 expected) was perhaps the most disappointing with the figure the lowest since June although it’s worth highlighting that the 57.4 average for Q4 was the highest on record. Elsewhere the final print of the services PMI for December came in a tad under consensus (53.3 vs. 53.7) whilst November factory orders remained weak (-0.7% vs. -0.5% expected). Elsewhere, news-flow was relatively limited. A report in the Nikkei Asian Review was perhaps of most interest with the article quoting ex-Fed Vice-Chairman Donald Kohn stating that a June rate rise seems most likely. US Dollar strength continues with the DXY finishing +0.13% and now 1.4% up in 2015.

Recapping the price action in Europe yesterday, the Stoxx 600 closed 0.71% lower at the close of play – not helped by a 1.3% decline in the last hour of trading as the aforementioned oil market decline dragged equity indices with it. Credit fared little better with Crossover finishing 8.5bps wider. In reality it was a fairly volatile day with European equities largely trading with little obvious direction. This was perhaps a result of what were generally mixed PMI prints for the region. Just recapping, the final December services PMI reading for the Euro-area printed modestly softer than expectations (51.4 vs. 51.7 expected), although regionally both Germany (52.1 vs. 51.4 expected) and France (50.6 vs. 49.8 expected) surprised to the upside. Elsewhere, preliminary services PMI readings for the UK (55.8 vs. 58.5 expected) and Italy (49.4 vs. 51.7) disappointed, however data for Spain (54.3 vs. 53.4 expected) offset this somewhat. The combination of weak data and prospects of the impending ECB QE drove core European bond yields lower across the board. 10y Bunds in particular extending their record lows to close 7.1bps tighter at 0.446%. Bunds are now around 150bp tighter than Treasuries and the spread differential has not been this wide since 1989. Interestingly DB's George Saravelos pointed out that the power of ECB QE is also influenced by the total amount of risk-free securities which a central bank removes from the market. Compared to all other QE programs, the demand-supply dynamics of Europe's risk-free bond market are incredibly tight. From a flow perspective Germany will have close to flat net issuance in 2015 compared to more than $1.5trio UST issuance during Fed QE1 and around 400bn USD of JGB issuance during BoJ QQE1.

Elsewhere, Inflation expectations as measured by the EUR 5y5y swap continue to drop, with the index falling 6.25bps to 1.5675% - extending the lows. The Euro weakened, dropping 0.36% versus the Dollar to $1.189 and is now down 5% from the December highs.

Greek equity markets were closed yesterday however bond markets were open and it was a case of further widening with Greek 3y yields another +58bps wider to 14.06%. In fact peripheral debt struggled across the board with 10y benchmark yields in Spain (+3.5bps), Italy (+2.4bps) and Portugal (+5.3bps) all wider. George Saravelos also noted that we should get fresh opinion polls in Greece at the end of the week, although his baseline remains for SYRIZA or a SYRIZA-small party coalition.

Before we look at today’s calendar, following the weaker day for risk assets yesterday Asian equities appear to be shrugging off yesterday’s moves with most major bourses trading in the green. The Nikkei (+0.12%), Hang Seng (+0.03%) and Kospi (+0.15%) are all firmer although the Shanghai Comp (-0.74%) is weaker. Macro drivers aside Asian credit investors are watching the ongoing developments of Chinese property developer Kaisa very closely. Following the selective default of a bank loan last week all eyes are now on the company's c.US$26m coupon payment on its 2020 bond tomorrow (8 Jan). Kaisa's 2018 bonds were last quoted in the mid-30s. Away from Kaisa the news that Malaysia's 1MDB has failed to repay a RM2bn loan is also an eye-catching event that has driven Malaysian sovereign CDS nearly 30bps since the news broke. Credit markets in Asia and Australia have been on the back foot since the start of the year with Asia iTraxx and Aus iTraxx indices about 15bp and 7bp wider thus far to date.

Looking at the calendar for today, the December ADP employment report in the US this afternoon will be seen as a precursor to payrolls on Friday. For what it’s worth, market consensus is for a +225k print, up from 208k in November. Elsewhere in the US we get the trade balance data for November and finally the release of the FOMC minutes from the December meeting – and as Colin and Craig mentioned on Monday we will be keeping an eye on any language regarding clues to a potential ‘lift-off’ in rates. Before all this in Europe we kick the morning off with retail sales in Germany. This is followed up with the CPI print for the Euro-area which will of course be a key focus following the weaker print in Germany. Unemployment data for the Euro-area as well as regionally in Germany rounds off the key releases.