With much of Europe coming back from Whit Monday holiday, the much more liquid market focused on the latest news in the easing US-China trade war and this morning’s announcement by Beijing to cut import duties on autos to 15%, with the resulting risk-on mood sending U.S. equity futures push back to yesterday’s session highs, while Asian and European stocks were mixed.
Broader European stocks were mixed, and turned modestly negative, driven by declines in the health care sector and utilities after both were downgraded by Deutsche Bank, pushing the Stoxx Europe 600 Index down 0.1% to session low, erasing earlier gains with 11 of 19 industry groups declining. Earlier, Deutsche Bank downgraded Europe’s energy sector on risks in oil price development in coming months, and also cut utility stocks as further upside to sector’s price relative implied by PMI forecast only marginal. Meanwhile, the European bank sector outperformed as the bund/BTP spread snapped 11bps tighter (see below), while European automakers gapped higher on China’s tariff cut.
After hitting a 5 month high on Monday, the USD continued to weaken across the G-10 space forming a distorted head and shoulders topping formation, even as rangebound 10Y yields rose to session highs of 3.078%.
The second consecutive slide in the USD, at least for now, meant some breathing space for Emerging Markets, which have been crushed over the past month, while the month-long slide in EM local-currency government bonds has widened the yield spread they offer over their developed-market counterparts: “What we see is attractive real yields in the emerging markets, coupled with a good underlying fundamental growth,” said Richard Lawrence, SVP at Brandywine Global. However, it remains to be seen if the recent dollar weakness will translate into an EM buying spree. For now, the EM FX screen is mostly green with the exception of Turkey (thanks Mark Cudmore).
Meanwhile, in Developed Markets, the euro rose a second day as shorts trimmed exposure amid a rebound in Italian bonds while the Dollar Index retreated after it failed to rise Monday above a strong technical resistance level; EURUSD gained as much as 0.3% to touch 1.1830 high, versus 1.1757 day low, although for now it remains in sell-the-rally mode as sizable offers extend all way to 1.1850, a Europe-based trader told Bloomberg.
The pound looked to erase its Monday drop as comments from Bank of England officials during a testimony in front of lawmakers struck a more hawkish tone than investors were positioned for. More notably, Bloomberg notes that as soon as London stepped in, there was a familiar leveraged bid for the dollar that sent its major peers to fresh day lows. However, the market reversed course as Italian bonds rallied after yields touched the highest in more than a year on Monday.
Elsewhere in global macro, GBPUSD rose as much as 0.5% to touch 1.3492 day high, after BOE’s Gertjan Vlieghe, a dove, said he sees one or two rate hikes a year for the next three amid evidence that a tight labor market is boosting wage growth. At the same time, the USDJPY steadied around 111.00 vs day-low of 110.84 as Treasury yields rose; pair snapped its 6-day advance despite comments from BOJ Governor Kuroda the central bank won’t exit its current monetary policy before 2% inflation is reached. In Africa, the USDZAR was heavily offered as EMFX remains highly reactive to USD moves.
In the biggest news out of Europe, one day after a plunge in Italian bonds following the formation of the new 5-star/League government, BTPs bounced, retracing some of Monday’s panicky leg wider versus Germany as markets became somewhat more orderly as Germans returned from holiday. Italy 10-year yield dropped as much as 10bps, after touching 2.40% on Monday, while BTP yields were lower across the curve by 4-8bps.
Italy’s gain was Germany’s loss as Bunds were under sharp pressure, dragging Treasuries and gilts lower, as EGB spreads erased most of the latest spillover move; Bund spreads vs Spain and France also tightened, by 7bps and 3bps, respectively. Monday’s move was the first clear sign of spillover impacting these spreads and has promptly retracted.
Still as Bloomberg’s Heather Burke notes, “Italy’s troubles aren’t all over: credit default swaps have blown out and small caps may continue to face greater pressure. Plus, investors are worried that mini-BOTs could succeed at addressing Italy’s slow growth, undermining the euro project.“
There is little on the calendar today, with the only expected data the Richmond Fed Manufacturing Survey at 10am ET. AutoZone, Eaton Vance, TJX, and Intuit are among companies reporting earnings. Attention will be focused on the ongoing trade talks, the South Korean president’s visit to D.C., and oil’s continued climb amid a new wave of U.S. sanctions on Venezuela
Market Snapshot
- S&P 500 futures up 0.2% to 2,737.75
- Brent futures up 0.4% to $79.50/bbl
- Gold spot up 0.1% to $1,293.91
- U.S. Dollar Index down 0.3% to 93.38
- STOXX Europe 600 up 0.07% to 396.16
- MXAP up 0.1% to 174.45
- MXAPJ up 0.2% to 569.13
- Nikkei down 0.2% to 22,960.34
- Topix down 0.2% to 1,809.57
- Hang Seng Index up 0.6% to 31,234.35
- Shanghai Composite up 0.02% to 3,214.35
- Sensex up 0.1% to 34,663.51
- Australia S&P/ASX 200 down 0.7% to 6,041.87
- Kospi up 0.2% to 2,465.57
- German 10Y yield rose 4.2 bps to 0.565%
- Euro up 0.2% to $1.1811
- Italian 10Y yield rose 15.9 bps to 2.127%
- Spanish 10Y yield fell 7.2 bps to 1.436%
Top Overnight News from Bloomberg
- China confirms it is cutting import taxes on autos to 15% from 25%
- WSJ: U.S. and China have agreed outline on a deal to settle dispute over ZTE, according to people familiar
- Dodd-Frank: House Repubicans to vote on Senate compromise as early as today; broader set of House-passed rollbacks will get a vote later this year
- Fed’s Kashkari: yield curve could invert by end of year; paying close attention to long-end of UST curve
- BOE’s Vlieghe: sees one or two 25bps rate hikes a year for the next three years
- President Donald Trump retreated from imposing tariffs on billions of dollars worth of Chinese goods because of White House discord over trade strategy and concern about harming negotiations with North Korea, according to people briefed on the administration’s deliberations
- Britain could be facing another vote in 2018 as Prime Minister Theresa May may be unable to find a way to navigate between those in her party who want Britain to leave the EU’s customs union and the majority in Parliament that wants the opposite
- French President Emmanuel Macron’s trip to Russia this week once threatened to split France from its European allies. Now it’s part of a wider European effort to tie President Vladimir Putin to the Iran nuclear accord
- The Italian government’s borrowing costs have surged to inauspicious territory as the nation is getting punished in the bond market over the incoming populist government coalition. Novice Prime Minister may face rival puppet-masters
- Foreign Secretary Boris Johnson has urged Theresa May not to contemplate calling another early election, after reports that members of parliament are preparing for a snap vote later this year due to Brexit turmoil
- Turkey is paying more than Senegal on its debt, even though it has a higher credit rating and its economy is 60 times bigger
- Fed’s Minneapolis President Kashkari says U.S. job creation despite lack of evidence that inflation is picking up is an argument for allowing the economy to continue to grow. Philadelphia Fed President Patrick Harker says “in general, on average, the economy is just clicking along just fine”
- Confidence about the economic strength of Poland, Hungary and the Czech Republic had helped mute the pain of dollar gains that battered their developing peers. But on Monday, Italy’s plans to embark on a populist fiscal path landed them among the biggest currency decliners in emerging markets
Top Asian News
- Singapore Bourse Sued by India Exchange in Futures Dispute
- Hyundai Motor Caves in to Elliott, Scraps $8.8 Billion Deal
- Hyflux Is Said to Weigh Court Protection for Creditor Talks
- Sony to Buy Out EMI Music Publishing for About $2 Billion
- Indonesia’s Stock Rout Claims Another Victim: The IPO Market
- Erdogan Imperils Turkey Rating as Bonds Sink Below Senegal’s
Top European News
- Deutsche Bank Unit Sells $600 Million Seadrill Claim in Days
- Italy Bonds Rise as Yields Retreat From the Highest Since 2017
- French Telecom Regulator Says He’s More Open to Mergers
- Could Britain Have an Election in 2018? It’s Not Impossible
Looking at the day ahead, in the US the only release scheduled is the May Richmond Fed PMI. Politics should play a greater role with the next round of Brexit negotiations beginning in Brussels, and South Korean President Moon Jae-in due to visit Washington to meet President Trump, in part to discuss whether next month’s US / North Korea summit is still going ahead.
US Event Calendar
- 10am: Richmond Fed Manufact. Index, est. 10, prior -3
DB’s Jim Reid concludes the overnight wrap
It’s certainly been a 24 hours of split trading with the split depending on whether your assets were more sensitive to hopes of a more positive outcome in the global trade war spat or more sensitive to a worsening Italian risk situation. Indeed Italian debt had what can only be called a “mini-shocker” yesterday after increased speculation about the so called issuance of “mini-BOTs” and warnings from Fitch on their debt path. However neither story was new news and the sell-off just seemed to be a building up of the pressure of these and other related issues over recent days.
2y yields underperformed (+16.8bps) versus 10yr (+15.7bps) and 30y yields (+10.9bps). Remarkably 2y yields are up 59.4bps since May 3rd and now the highest since July 2015. Over the same period 2y Bunds are -3.9bps lower for comparison. The 2y BTP/Bund spread is now at 88.1bps and approaching the 2017 high of 99bps. This was as low as 22bps back in February. 10 year Italian yields (2.371%) are now within a couple of basis points from their highest level since November 2014.
Overnight DB’s Clemente De Lucia and Mark Wall have published an update putting the current Italian risk in some perspective. They note that relative to 2011-2012 Italy has achieved some fundamental improvements. In particular 1) a move from current account deficit to surplus and 2) the terming out of debt. They also note that the Five Star-League final programme for government does not directly question Italy’s membership of the single currency. However, the proposed fiscal and structural policies, including the mini-BOT, are a challenge to EU rules and the Brussels orthodoxy. This means policy clash and uncertainty. If fully implemented, our economists think that Italy’s debt trajectory will no longer be downward sloping. So much depends on the new administration’s policy choices and their ability to pursue them due to the constraints from the President, the constitution, the parliamentary process and of course the markets and the EU. So lots of moving parts. In the report they note that the 2019 Budget is not due to be presented to Parliament until September 20th so plenty of time for markets to go through their whole range of emotions over Italian risk. See the note for more details.
Following on, Italy’s League Party leader Mr Salvini noted in a Facebook video that “we’ve swallowed too many yes sirs” and that Italy must have the freedom to say “no” to Paris, Berlin and Brussels. He added that “…enough is enough, cuts can kill, austerity can kill….and European limits can kill”. Elsewhere, Mr Salvini has confirmed that he has proposed Florence University law professor Giuseppe Conte to be Italy’s new Premier, while President Mattarella is expected to meet the Senate and Lower house speakers today to discuss next steps.
In equities yesterday, Italy’s FTSE MIB (-1.52%) looked as if it materially underperformed peers, but most of this was due to it being a big ex-dividend day for the index. After adjusting for the 20 companies that have gone ex-div, the underlying index change was closer to -0.3%. Nonetheless, the 5y senior CDS for Italian banks did widened 6-8bps vs. iTraxx Senior Financials at +3.8bp. Elsewhere, the Stoxx 600 (+0.30%) and US bourses (S&P +0.74%; Dow +1.21%; Nasdaq +0.54%) were all higher as trade tensions eased following US Secretary Mnuchin’s comments around putting the trade war and tariffs on hold. The S&P closed at a 9 week high with all sectors up and gains led by the industrials and telco. sectors.
Over in government bonds, yields on UST 10y were little changed (+0.4bp) while Gilts (-2.5bp) and Bunds (-5.6bp) seemed to benefit from the flight to safety effect, particularly for Bunds which rallied despite Germany’s markets being off on holiday yesterday. In FX, the US dollar index firmed marginally (+0.04%) while the Euro pared back losses to close up for the first time in six days (+0.16%). Elsewhere, WTI oil rose 1.35% to $72.24/bbl ahead of IEA talks with major oil producers on collapsing Venezuelan output.
This morning in Asia, markets are broadly lower with the Nikkei (-0.07%), Shanghai Comp. (-0.41%) and ASX 200 (-0.84%) all down while the Hang Seng and Kospi are closed for holidays. In Japan, BOJ’s Kuroda told the Parliament that “we’ll patiently pursue powerful monetary easing to achieve 2% inflation” and that we’ll “guide monetary policy taking into account its side effects such as its impact on financial institutions”. Over in China, the State Council is planning to scrap all limits on how many children a family can have, potentially as early as 4Q18. Notably, Bloomberg noted that the number of births in China rose c8% in 2016 after the government shifted the policy from one child to two in 2015, but then births fell 3.5% in 2017. Finally, a group of Western and Chinese journalists are arriving in North Korea today to witness the closure of its nuclear test site.
Now turning to the three Fed speakers on rates and the yield curve. Mr Bostic (a voter this year) noted “I think we have two more” rate hikes this year, but added this could change depending on what happens on the economy. On inflation, he reiterated that “I won’t be surprised to see a modest overshoot of our long run target” of 2%. Elsewhere, he noted that “I’m less concerned about (the yield curve) in the sense that we do have a say in that” and it is “very present in all our minds” that there is a correlation between inverted curves and economic downturns. On rates for this year, Mr Harker (a non-voter) “could back a third move (in addition to the March rate hike)…if prices picked up”, although he is not “seeing rapid acceleration in inflation”. Further, he added that we’re on a gradual, prudent path and “let’s go to neutral (rates first) and see how things play out, I would prefer to not be contracting the economy”. On inflation, he noted that it will go somewhere above 2%, but “could even go as high as 2.5%”. Finally, Mr Kashkari (a non-voter) reiterated his dovish views on rates and noted that “we should shift only to a neutral policy stance and not move too quickly, until we see more evidence that wages are climbing…” Elsewhere, he noted that “we could flatten the yield curve by the end of the year” and that it “really depends what happens to the long end of the curve……(and so) that’s something I’m going to be paying close attention to”. He added that “gives us some information where neutral (rate) is, but this is part art and part science”.
Moving onto some trade rhetoric from the US side. President Trump’s economic advisor Mr Kudlow noted that “I’ve heard privately in the discussions…that the Chinese are in fact very willing to open the door to a lot more financial services”, with options such as China allowing US financial firms to set up asset management companies to help tackle China’s bad debt issues. Looking ahead, Secretary of Commerce Ross will return to Beijing for more talks soon. Turning to NAFTA, Secretary Mnuchin noted that “there are still some very significant, open issues” and “we’ll see where we get to over the next few weeks”, although he added that all three countries are “still trying to get a new deal done”.
Before we take a look at today’s calendar, we wrap up with the data releases from yesterday. In the US, the April Chicago Fed national activity index was slightly above market at 0.34 (vs. 0.3 expected), although the prior reading was also upwardly revised by 0.22pt. In the UK, the May Rightmove house price index was up 1.1% yoy (vs. 1.6% previous).
Looking at the day ahead, the April public finances data and May CBI selling prices in the UK are the only prints due in the European session, while in the US the only release scheduled is the May Richmond Fed PMI. Politics should play a greater role with the next round of Brexit negotiations beginning in Brussels, and South Korean President Moon Jae-in due to visit Washington to meet President Trump, in part to discuss whether next month’s US / North Korea summit is still going ahead.
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