Stocks In Holding Pattern Following Blow-Off Top, Oblivious Of Fed's Warning Of "Stretched" Valuations

Following the first of two Janet Yellen testimonies to Congress, the market read between the lines of what the Fed Chairman said when she hinted that "the Fed needs confidence on recovery and inflation before beginning to raise rates" and realized that the case of a June rate hike is suddenly far less realistic than previously expected, as a result not only did we see another blowoff top in stocks to fresh all time highs, a move which sent the USD lower, has pushed the median EV/EBITDA multiple to the mid 11x (!) range and the forward PE to just shy of 18x ironically coming on a day when the Fed itself warned about "stretched" equity valuations, and led to brisk buying of global Treasurys across the board, pushing the 10 Year in the US back under 2%, and due to the global convergence trade (because if the Fed returns to QE, it will be forced to buy up Treasuries not just in the US but around the globe, since net issuance including CBs globally is now negative) and leading to today's German 5 Year bond auction pricing at a negative yield for the first time ever.

Then again since the breadth of the "market" is now defined by just 5 stocks which are responsible for the parabolic move in the Nasdaq in the past two months, talking about a market is no longer meaningful, and any attempts to forecast what a central-bank dominated market will do are now more futile than ever. One thing that will surely impact stocks again, will be Yellen's second day of testimony, this time before the Senate, where her prepared remarks will be the same, however where she is now expected to be forced with more aggressive questions than the generic fluff the members of the House lobbed at her yesterday, with the possible exception of Elizabeth Warren's demands for a "Yes or No" answer on whether Citigroup runs Fed policy now by drafting swaps push out laws.

So, to keep it easy, here is what has already happened: European equities reside in negative territory across the board albeit modestly so, with things pretty light in Europe so far this morning. On a sector specific basis, energy names lead the way lower in a continuation of yesterday’s move despite oil prices holding their own this morning. Price action nonetheless has been more defined across fixed income products with core paper continuing to rally in the wake of comments from Fed Chair Yellen whose remarks were perceived as more dovish than markets were expecting, leading to markets now pricing in a 66% probability of a FFR hike in Oct. From a UK perspective, Gilts have been outperforming in early trade as UK paper plays catch up with US and GE paper which rallied after the UK close yesterday.

Asian equity markets initially traded mostly higher after taking the lead from another record Wall Street close for the DJIA and S&P 500. However, Nikkei 225 (-0.1%) was unable to hold on to its earlier advance after fluctuating between losses and gains, amid a strengthening JPY. Shanghai Comp (-1%) and Hang Seng (-0.1%) traded lower after a mixed Chinese February HSBC Flash Mfg. PMI which rose to a 4-month high (50.1 vs. Exp. 49.5 (Prev. 49.7), although export orders fell by the most since Jun’13. JGBs gained 29 ticks, lifted by spill-over buying in USTs yesterday’s and the BoJ buying a total of JPY 1.18trl worth of government debt from the market.

Despite the upside for Gilts, GBP actually outperforms in the FX market this morning as policy divergence takes precedence given the dovish outcome of Yellen's speech compared to more hawkish commentary from the BoE of late. More specifically, BoE's Forbes yesterday said that gradual increases in interest rates should support the economy in the UK adding that low inflation present at the moment will fade quickly while BoE's Weale said that the BoE may have to lift rates before the time frame which markets are currently expecting. Elsewhere, given the move lower in US yields, USD has continued to trail its major counterparts, much to the benefit of EUR with EUR/USD making a technical break above yesterday’s highs while EUR/GBP manages to remain resilient to the broad-based GBP strength. Finally, CAD has managed to hold onto its gains against the Greenback in the wake of those less dovish than expected comments from BoC’s Poloz, which has resulted in markets scaling back their expectations for action by the central bank next week.

In the commodity complex, both spot gold and silver remain in the green with the weaker USD aiding prices. Elsewhere, Copper saw a mild decline overnight, while iron ore prices were also weaker as the largest buyer China saw a subdued return to the market following the week-long Lunar New Year holiday. Despite the reprieve for precious metals markets, the energy complex has failed to capitalise from the move following last night’s API inventory report showed a smaller than previous build in stockpiles (W/W +8900k vs. Prev. +14300k) but a build nonetheless.

In summary: European shares fall with autos and banks underperforming and utilities, travel & leisure outperforming. The Swiss and Italian markets are the worst-performing larger bourses, Germany’s is the best. The euro is stronger against the dollar. Japanese 10yr bond yields fall; German yields decline Germany seels 5 years debt at a negative yield for the first time ever.  Commodities decline, with WTI crude, copper underperforming and silver outperforming. U.S. mortgage applications, new home sales, mortgage delinquencies, mortgage foreclosures,  due later.

Taking a look at the day’s calendar, it’s quiet in the Euro-area this morning with just French consumer confidence for France due. Draghi speaking this afternoon in European parliament however will most likely attract attention. Over in the US we’ve got new home sales data to look forward whilst Yellen is also due to speak again, this time to the House Financial Services Committee. Historically the second day's testimony is a repeat affair with less likelihood of market moving themes given the prior day's discussion.

Market Wrap:

  • S&P 500 futures down 0.1% to 2111.4
  • Stoxx 600 down 0.2% to 386.5; Eurostoxx 50 -0.2%, FTSE 100 -0.3%, CAC 40 -0.2%, DAX -0%, IBEX -0.3%, FTSEMIB -0.5%, SMI -0.6%
  • US 10Yr yield down 2bps to 1.96%
  • German 10Yr yield down 3bps to 0.34%
  • Gold spot up 0.6% to $1207.6/oz
  • MSCI Asia Pacific up 0.6% to 146.3
  • Nikkei 225 down 0.1%, Hang Seng up 0.1%, Kospi up 0.7%, Shanghai Composite down 0.6%, ASX up 0.3%, Sensex up 0%
  • Euro up 0.23% to $1.1366
  • Dollar Index down 0.28% to 94.23
  • Italian 10Yr yield down 1bps to 1.45%
  • Spanish 10Yr yield down 0bps to 1.38%
  • French 10Yr yield down 3bps to 0.62%
  • S&P GSCI Index down 0.1% to 409.6
  • Brent Futures up 0.1% to $58.7/bbl, WTI Futures down 0.4% to $49.1/bbl
  • LME 3m Copper down 0.4% to $5760/MT
  • LME 3m Nickel up 0.3% to $14400/MT
  • Wheat futures up 0.1% to 504.5 USd/bu

Bulletin Headline Summary from Bloomberg and RanSquawk

  • European equities trade in a relatively tentative manner while fixed income products continue to climb following Fed Yellen’s testimony yesterday
  • USD weakness has helped lift its major counterparts, notably GBP which has been provided a further boost by policy divergence plays
  • Looking ahead, today sees the release of US new home sales, DoE inventories and comments from Fed’s Yellen and ECB President Draghi. Note Yellen’s testimony today will likely be a reiteration of yesterday’s
  • Treasuries gain, 10Y yield below 2% in extension of rally spurred by Yellen comment that Fed needs confidence on recovery and inflation before beginning to raise rates; auctions continue with $13b 2Y FRN, $35b 5Y; WI 1.465% vs. 1.288% in Jan.
  • Germany sold 5Y notes at a negative yield for the first time, Irish 10Y yields fell below 1% and rates on Italian and Spanish debt touched all time lows before ECB begins QE next week
  • While the Greek government was praised for coming up with a workable package of measures including maintaining state-asset sales and collecting more tax, the EC, ECB and IMF all warned that action speaks louder than words
  • HSBC/Markit’s preliminary China PMI was at 50.1 in Feb., exceeding the median estimate of 49.5 in a Bloomberg survey and up from January’s 49.7
  • China is preparing measures to counter a housing market slump and will roll them out if the economy needs support, people with knowledge of the matter said
  • RBS will outline plans Thursday to reduce the number of countries in which it operates by two-thirds to 13, a person with knowledge of the matter said
  • Ukraine said fighting in its easternmost regions has subsided, though a “full truce” still hasn’t taken effect
  • Obama yesterday vetoed the Keystone XL pipeline bill because it interfered with a review being led by the State Department, though he hasn’t decided whether to approve a permit for the pipeline, White House spokesman Josh Earnest said Tuesday
  • Chicago mayor Rahm Emmanuel was forced into a runoff election in a clear sign of discord in the third-largest city, where $20b in unfunded pension liabilities threaten insolvency and citizens are plagued by persistent violence
  • Sovereign 10Y yields lower. Asian stocks mixed, European stocks decline; U.S. equity-index futures fall. Crude and gold higher, copper declines

US Event calendar

  • 7:00am: MBA Mortgage Applications, Feb. 20 (prior -13.2%)
  • 10:00am: New Home Sales, Jan., est. 470k (prior 481k)
  • New Home Sales m/m, Jan., est. -2.3% (prior 11.6%)

Central Banks

  • 10:00am: Yellen testifies to House committee
  • 10:00am and 11:30am: ECB’s Draghi at European Parliament in
  • 11:30am: U.S. to sell $13b 2Y FRN
  • 1:00pm: U.S. to sell $35b 5Y notes


DB's Jim Reid concludes the overnight recap

It took a lot of skill for Mrs Yellen to ensure that both the hawks and doves in the market could claim victory after her testimony yesterday. We think it was slightly dovish due to her inflation comments but others we respect think it more hawkish. Indeed the hawks would point towards the upbeat tone surrounding the labour market as well as the overall more positive economic outlook in the US. In addition the text around forward guidance would be of most interest to the hawks. Specifically Yellen commented that should economic conditions improve as anticipated, the Fed will consider an increase in the target rate on a meeting by meeting basis but would beforehand alter the forward guidance provided to markets. Yellen went on to say that ‘it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee’s judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting’. So the hawks would point towards there being sufficient evidence and a case to be made that we could see the ‘patience’ language dropped and possibly as soon as the March meeting, which in turn means June is in play.

On the other hand, the doves would argue that Yellen’s comments were more aimed at gaining the necessary flexibility to react rather than being tied to any particular time frame. Clearly a large part of the focus will be on the data and the doves would argue that on the whole macro prints generally have been unsupportive for a rate move. The lack of wage growth is clearly a concern and one which is holding back labour market data on balance. Also Yellen’s comments that ‘before raising rates, we will want to feel confident that the recovery will continue and that inflation is moving up over time’ puts some emphasis on the need to see clarity of the recovery in inflation prior to a hike. So it all might rest on inflation and interestingly tomorrow sees a strong possibility that we might see a negative headline YoY CPI print. Given Yellen also said they're looking at all measures of inflation then maybe we need to see this start to recover over the months ahead before the FOMC pull the trigger.

So all in all a fairly balanced tone from Yellen, with a case to be made that it neither favours the hawks nor the doves and instead leaves the Fed in a position of flexibility with no particular bias either way as of right now. If you think inflation is going to pick up soon then maybe you can read it hawkishly. If you think low inflation is here for a while longer then you're a dove! In terms of the market reaction, the S&P 500 recorded a fresh record high after closing +0.28% whilst the Dow added +0.51% to also mark a fresh record high. There were sharper moves in Treasuries however as yields rallied across the board. Indeed 3y (-6.5bps), 5y (-8.5bps), 10y (-7.7bps) and 30y (-6.5bps) yields all closed tighter. In fact 10y yields actually widened 4bps immediately following the speech, before then rallying into the close and perhaps supporting those on the dovish side. Given the shift down in the yield curve, the moves suggested a more dovish speech than expected. There were similar moves in the Dollar as the DXY bounced as much as +0.4% intraday before paring those gains to finish down 0.1%.

Meanwhile, turning over to the latest in the Greek saga, yesterday we learned that the Eurozone had approved the latest reform proposals from the Greek government. Whilst a step in the right direction, as we’ve previously mentioned the key will be the actual substance behind the proposals for which the current government has an end-April deadline to act by. In the mean time, yesterday we also heard echoes of caution from various European officials yesterday with the IMF’s Lagarde in particular saying that the list is ‘not very specific’ and didn’t portray ‘clear assurances’. A statement issued by the Eurogroup meanwhile said that ‘we call on the Greek authorities to further develop and broaden the list of reform measures’.

We’ve already heard of some potential tension in SYRIZA itself so it’ll be interesting to see how things progress as Tsipras and Varoufakis start talks internally, but clearly there is still much for Greece to do. It’s also not entirely clear how Greece will fund itself through the month of March with suggestions that they will run out of cash shortly after the end of this month (Bloomberg). This could in effect force Greece to agree on things much earlier than the end-April deadline or we could see an increase in the T-Bill issuance cap. Some near term attention will now also turn to Greek banks where Bloomberg reported that the ECB would be unlikely to wait until at least its next policy meeting on March 5th before making a decision on restoring the collateral waiver and allowing Greek banks direct funding.

Equity markets in Europe firmed with the approval news though. Having traded relatively subdued for most of the morning, the bulk of the gains came shortly following the headlines with the Stoxx 600 (+0.56%), DAX (+0.67%) and CAC (+0.50%) all finishing higher. The Stoxx 600 in fact closed higher for the 6th consecutive day and extended its 7y highs. The index is now +13% through 2015 already whilst the DAX and CAC have similar year-to-date returns. On the other hand and despite reaching record highs, the S&P 500 is +2.8% through 2015 so far. Elsewhere, Greek equities (+9.8%) were a notable outperformer yesterday with banks (+17%) leading the way. 3y and 10y yields for Greece meanwhile rallied 221bps and 55bps on the better sentiment. Peripheral 10y yields meanwhile were 2-4bps tighter and the Euro closed relatively unchanged at $1.134 – although in reality bounced around with Greek headlines and Yellen’s comments.

Away from Greece and Yellen yesterday, it was actually a fairly busy day data wise. In Europe Germany reported no change to their final Q4 GDP reading of +1.6% yoy. Our European colleagues have however raised their growth target for Germany in 2015 to 2.0% from 1.4% previously. They note that the upgraded forecast reflects the stronger carry over effect from the Q4 reading. The team has also raised their Q1 2015 forecast to +0.5% qoq from +0.3% qoq previously. Elsewhere the final January CPI print for the Euro-area was confirmed at -0.6% for the headline and +0.6% for the core. French manufacturing confidence (99 vs. 99 expected) meanwhile was in line with consensus however business confidence (94 vs. 95) was a touch below expectations. Over in the US, the S&P/Case Shiller home price index came in higher than consensus (+4.46% vs. 4.30% expected) whilst the services PMI bounced 2.8pts to 57.0 (vs. 54.5 expected) for February. Elsewhere, the consumer confidence print for February disappointed, falling 7.4pts to 96.8 and backing up recent falls in other confidence indicators. Finally there was also softness in manufacturing with the Richmond Fed manufacturing index for February falling 6pts to 0 – the lowest reading since March last year.

In terms of the trading this morning in Asia, bourses are largely following the US lead and trading firmer as we type. The Kospi (+0.69%), ASX (+0.30%) and Hang Seng (+0.36%) in particular are all trading stronger. Meanwhile equity markets in China - having reopened after a break for the New Year holiday- are softer despite a better than expected manufacturing PMI reading (50.1 vs. 49.5 expected). The Shanghai composite is -0.12% as we got to print.

Taking a look at the day’s calendar, it’s quiet in the Euro-area this morning with just French consumer confidence for France due. Draghi speaking this afternoon in European parliament however will most likely attract attention. Over in the US this afternoon, we’ve got new home sales data to look forward whilst Yellen is also due to speak again, this time to the House Financial Services Committee. Historically the second day's testimony is a repeat affair with less likelihood of market moving themes given the prior day's discussion.