Markets On Edge As All Eyes Turn To Spain And Rajoy’s No-Confidence Vote

A good summary of overnight events comes from UBS’ chief economist Paul Donovan who writes:

We are not back to normal, but markets have reacquainted themselves with what normal might look like. Italian bond yields fell and the euro recovered yesterday. A consensus is forming that there will not be elections in Italy until September at the earliest. Italian President Mattarella is waiting to see if the two anti-parties can in fact form a coalition.

Meanwhile, with European and Asian stocks all higher – if only for the duration of the Italian waiting game – helped by the jump in Italian bonds and plunging yields, all eyes more to Spain, with the Socialists getting close to lining up the support they need to oust Prime Minister Mariano Rajoy in a no-confidence vote.

As Bloomberg notes, lawmakers are due to vote on the no-confidence motion Friday and people close to the negotiations were signaling late Wednesday that Socialist leader Pedro Sanchez – who already has the backing of the anti-establishment group Podemos and Esquerra Republicana, one of two Catalan separatist groups and just needs the other Catalan party, PdeCat, and the Basque Nationalists to clinch it – is likely to get the support he needs to replace Rajoy as prime minister, who on Thrusday was starting to sound a little forlorn: “I know how these votes work, but you should at least be clear in your minds what you’re doing,” Rajoy, who will soon be unemployed, told lawmakers.

Incidentally, a poll published by El Confidencial, found that Ciudadanos remains in top spot with 28.6% of votes, followed by the Socialists who requested today’s no-confidence vote in 2nd with 20.6%, Podemos is third with 19.7% and the ruling PP is in fourth with 19.7%.

One additional note on the ongoing Italian drama, where should the Cottarelli government fail, Savona could be considered for Foreign minister in a League/5SM government, Angelo Ciocca a possible pick for finance minister, the local press reported. Italy’s League and Brothers of Italy are however quoted to join forces at the potential upcoming elections, 5SM are also open to a Brothers of Italy coalition. This is amid Italy League leader Salvini cancelling all his rallies today to return to Rome. 5SM’s Di Maio and League’s Salvini may meet today for government talks; according to an official. Should the talks between 5SM and League fail, Cottarelli could be sworn in as early as today.

Meanwhile, with European markets generally well in the green, one outlier has emerged: Germany’s DAX, which is lower on the day pressured by the stronger euro, which was boosted by the fastest European inflation in more than year…

… as well as President Trump’s threat to impose tariffs on European steel and aluminum imports as soon as tomorrow, driving Europe to prepare for a “trade brawl”, with sentiment especially shaky among the auto sector.

Incidentally, Deutsche Bank’s Jim Reid had an apt comment on Europe’s rising inflation at a time when the Italian crisis sent German bond yields sharply lower:

The most delicious irony about the last 48 hours is that a day after Italy drove German yields back down towards rock bottom levels, along comes a way above consensus German inflation print (2.2% YoY vs 1.8% expected) yesterday. We wrote a quick note on this last night and showed that the gap between German inflation and 2yr and 10yr Bund yields are both within a whisker of record levels with data stretching back to the 1950s. German yields are totally detached from German economic fundamentals.

That said, everyone was euphoric: “The likelihood of new elections in Italy has risen materially and outcomes could be binary while ECB is running out of bullets. We see further downside to our EUR and higher European equity risk premium should spreads widen further,” BofAML analysts wrote.

As such today’s market tension will be one between the relief rally from the lack of further bad news out of Italy (for now) offset by the threat of the Spanish political overhaul and Europe’s response to Trump’s tariffs.

Earlier in the session, Asian stocks posted their first sgain in three days with the MSCI Asia Pacific index rising 0.8%, while Australian and Japanese government bonds were little changed, and the yen was modestly stronger on month-end flows. Chinese stocks rallied after a surprising uptick in factory PMI, while the yuan rose as PBOC strengthens CNY fixing first time in six days even as it injected nearly 200 billion yuan in the financial system with a daily reverse repo.

Also overnight, China Mofcom said China is not willing to see an escalation in trade tensions with US, while it added that the measures against China are against WTO rules and that China reserves the right to respond with countermeasures. In other news, China Mofcom said that China will release a new negative list on foreign investment by June 30th at the latest, which will include measures to relax or drop restrictions on sectors including energy, resources and transportation.

Amid political and trade turbulence, the next focus for traders may well be the U.S. jobs report on Friday, the last one before the Federal Reserve meets next month, when it’s expected to lift interest rates for the seventh time since the end of 2015. Morgan Stanley Chief Executive Officer James Gorman said the Fed is unlikely to be dissuaded from pursuing its path of monetary tightening as a result of recent volatility in financial markets.

In macro, the euro enjoyed support from the crosses and rose for a second day versus the dollar as Italian bond yields continued to decline. The common currency stayed around the day’s high of 1.1724 after flash euro-zone  inflation data beat the highest estimate while the yen reversed earlier gains as London came to the market. The pound gained for the second day, rising beyond 1.33 against the dollar, benefiting from an improvement in euro- area investor sentiment. US 10Y Treasury yields were modestly higher, rising about 1 basis point, to 2.8731%.

In overnight central banks news, Jonathan Haskel has been nominated to the BoE’s MPC by the Treasury replacing hawkish McCafferty. SNB’s Zurbrugg says current monetary policy takes into account of fragility in FX markets.

In geopolitical developments, President Trump is to impose metal tariffs on Canada, Mexico and EU, according to reports in Washington Post. US Commerce Secretary Ross says that US steel and aluminium tariffs on EU are to be announced before markets open or after markets close today; adding that US does not want a trade war. Trump has also told French President Macron that he would block German premium cars from entering the US market.

In commodities, Brent (-0.6%) and WTI (-0.4%) gradually extended losses on the day following the latest API crude inventory printing a surprise build in headline crude stockpiles. Elsewhere, Gold (+0.2%) trades marginally higher as it tracks the greenback following the uneventful Asia-Pac session. Meanwhile,  base metals (with the exception of copper) were boosted by a strong Chinese manufacturing PMI reading with Shanghai nickel soaring to fresh three-year highs and London zinc higher by 0.8%. On the trade front, US Secretary Wilbur Ross said that US steel and aluminium tariffs on EU will be announced as early as today, before US markets open or after markets close.

Expected data include jobless claims and personal income. Costco, Dollar General, VMware, Workday, and Lululemon are among companies reporting earnings.

Bulletin Headline Summary from RanSquawk

• BTPs recovering as tensions calm in Italy, with talks set to resume later in the day; EZ CPI provides no shocks
• Focus set on Spanish no-confidence debate, as Cuidadanos ahead in polls and PP collapses to 4th
• Looking ahead, highlights include, US personal consumption and PCE price index, Chicago PMI, Canadian GDP and DoEs

Market Snapshot

• S&P 500 futures little changed at 2,723.75
• STOXX Europe 600 up 0.2% to 386.23
• MXAP up 0.9% to 172.10
• MXAPJ up 1% to 562.53
• Nikkei up 0.8% to 22,201.82
• Topix up 0.7% to 1,747.45
• Hang Seng Index up 1.4% to 30,468.56
• Shanghai Composite up 1.8% to 3,095.47
• Sensex up 0.5% to 35,074.00
• Australia S&P/ASX 200 up 0.5% to 6,011.88
• Kospi up 0.6% to 2,423.01
• German 10Y yield rose 3.1 bps to 0.403%
• Euro up 0.4% to $1.1714
• Italian 10Y yield fell 24.5 bps to 2.646%
• Spanish 10Y yield fell 3.4 bps to 1.499%
• Brent futures down 0.4% to $77.19/bbl
• Gold spot up 0.2% to $1,304.06
• U.S. Dollar Index down 0.3% to 93.83

Top Overnight News from Bloomberg

• President Trump plans to announce as soon as Thursday the imposition of tariffs on steel and aluminum imports from Canada, Mexico, and EU, the Washington Post reports, citing three unidentified people familiar with the plan
• Italian President Sergio Mattarella is ready to appoint a new premier, but he’s still waiting on a signal from the populists who denounced him as an enemy of democracy.
• A top North Korean official met Secretary of State Mike Pompeo for dinner in New York on Thursday night, the highest-level talks between the two countries on American soil in 18 years as the Trump administration works to prepare for a summit in Singapore with the isolated regime. Here’s where things stand on the Trump-Kim summit
• China’s official factory gauge rose more than estimated as export orders accelerated, signaling that the expansion continues to be driven by global trade
• The Socialists, Spain’s biggest opposition party, are close to lining up the support they need to oust Prime Minister Mariano Rajoy in a no- confidence vote Friday, according to people briefed on the talks
• JPMorgan Chase & Co. won the title of world’s largest currency trader by market share, ending Citigroup Inc.’s four- year run at the top, according to a Euromoney Institutional Investor Plc survey that featured a new methodology. XTX Markets, a computerized trading firm, placed third, with 7.4 percent
• Humming factories lifted China’s official manufacturing gauge above economist estimates in May, following an acceleration of industrial production in April. Even so, gauges of demand across property, investment and consumption indicate weakness is in store
• The Swiss economy started the year with faster-than- expected growth, helped by consumers and investment spending
• As all Asian emerging-market currencies but one head for a losing month, consistency in central bank policy may have been an element that dictated their fortunes
• Europe’s biggest debt collector, Intrum AB, says it doesn’t see the political turmoil in Italy hurting its business

Asian markets traded positive across the board as the regional bourses follow suit from the rebound seen in their global counterparts after political fears surrounding Italy subsided, while participants also digested strong Chinese PMI data. ASX 200 (+0.4%) was led higher by the energy sector following similar outperformance on Wall St after source reports suggested OPEC and Non-OPEC are not yet ready to fully lift controls and that any adjustment in oil output will be gradual, while Nikkei 225 (+0.8%) was also positive but with gains initially contained after a pullback in USD/JPY and miss on Industrial Production data. Elsewhere, Hang Seng (+0.8%) and Shanghai Comp. (+1.4%) conformed to the positivity with outperformance in mainland China after better than expected Chinese Official Manufacturing and Non-Manufacturing PMIs in which the former data release printed an 8-month high. In addition, officials also did their part to help out with China to further cut import tariffs for consumer goods and will announce a new negative list which would ease investment restrictions on certain sectors, while the PBoC conducted a substantial daily net liquidity injection of CNY 180bln. Finally, 10yr JGBs were lacklustre amid a similar subdued performance in T-Notes, due to a broad recovery in risk sentiment and after weaker demand in today’s 2yr JGB auction. China Mofcom said China is not willing to see an escalation in trade tensions with US, while it added that the measures against China are against WTO rules and that China reserves the right to respond with countermeasures. In other news, China Mofcom said that China will release a new negative list on foreign investment by June 30th at the latest, which will include measures to relax or drop restrictions on sectors including energy, resources and  transportation

Top Asian News

• BOJ Bond Buying Back Under Scrutiny as Japan’s Yield Halves
• Alibaba-Backed WeWork Rival Is Said to Seek New Funding Round
• India’s Growth Rebound Collides With Emerging Market Chaos
• India’s Central Bank Needs Better Rupee Policy, Modi’s Aide Says

European stocks (Euro Stoxx 50 +0.3%) are largely tracking higher as the tension surrounding Italian politics cools further. The underperforming bourse is the DAX (-0.4%) which is being weighed upon by a possible US import ban on German autos. Large index constituents Daimler (-1.0%), Volkswagen (-1.9%) and BMW (-0.5%) all negative on the day. Spanish banks are seeing positivity as the no confidence vote debate in Spain begins (Santander +1.2% and Banco Bilbao +1.4%), with expectations set on the ousting of Spanish PM Rajoy. Firstgroup collapsing to the bottom of the Stoxx 600 (-14.5%) after the resignation of their CEO

Top European News

• Italy’s Conte Says Euro Exit Never Raised in Talks: Corriere
• Italian Woes Fail to Deter Czech Businesses Embracing Euro
• Euro-Area Inflation Accelerates to Fastest in More Than a Year

In FX, the Greenback is weaker across the board again, and partly due to gains in rival currencies, but also as simmering tit-for-tat tariff threats have resurfaced hot on the heels of yesterday’s mainly sub-forecast US data. Hence, the index has pulled back further from 2018 peaks just above 95.000 to 93.710, while EMs continue their recovery or at least consolidate off all time/multi-year lows. EUR: Back to best G10 performer on more stronger than expected Eurozone inflation data (French, Italian and the pan print), and another downturn in investor concerns regarding the political stalemate in Rome. The single currency has cleared another big figure at 1.1700 and its 10 DMA (1.1690) on the way up to a circa 1.1725 peak, but may now get bogged down by hefty option expiries spanning 1.1700-50. CAD/CHF: Both around 0.2-0.25% up vs the Usd, with the Loonie extending post-BoC gains to 1.2835 and now looking for Canadian GDP data to back up the Central Bank’s more upbeat economic assessment. The Franc has climbed a bit further vs the Usd to around 0.9870, but like Sterling has not kept pace with the Eur after latest SNB comments underlining that the current monetary policy stance is apt for choppy currency market conditions. Note, not much net response to a Swiss retail sales beat or a mixed GDP release. JPY:  Still stuck in a narrow band vs the Usd just under 109.00, after much weaker than anticipated Japanese IP data and amidst more decent option interest between 108.90-109.00 (1.1 bn).

Commodities are trading mixed today with Brent (-0.6%) and WTI (-0.4%) gradually extending losses on the day following the latest API crude inventory printing a surprise build in headline crude stockpiles. Note we will see the release of the weekly DoE’s today due to the US Memorial Day on Monday. Elsewhere, Gold (+0.2%) trades marginally higher as it tracks the greenback following the uneventful Asia-Pac session. Meanwhile, base metals (with the exception of copper) were boosted by a strong Chinese manufacturing PMI reading with Shanghai nickel soaring to fresh three-year highs and London zinc higher by 0.8%. On the trade front, US Secretary Wilbur Ross said that US steel and aluminium tariffs on EU will be announced as early as today, before US markets open or after markets close.

Looking at the day ahead, we’ll get April personal income and spending reports, weekly initial jobless claims, May Chicago PMI and April pending home sales data. In the morning the Fed’s Bullard will speak in Tokyo again, while in the evening the Fed’s Bostic is due to speak. G7 finance ministers and central bankers are also due to gather in Whistler with the topic of the conference being “Investing in Growth that Works for Everyone”. Good luck with that!!

US Event Calendar

• 8:30am: Personal Income, est. 0.3%, prior 0.3%; Personal Spending, est. 0.4%, prior 0.4%
• PCE Core MoM, est. 0.1%, prior 0.2%; PCE Core YoY, est. 1.8%, prior 1.9%
• 8:30am: Initial Jobless Claims, est. 228,000, prior 234,000; Continuing Claims, est. 1.73m, prior 1.74m
• 9:45am: Chicago Purchasing Manager, est. 58.3, prior 57.6;
• 9:45am: Bloomberg Consumer Comfort, prior 55.2
• 10am: Pending Home Sales MoM, est. 0.4%, prior 0.4%; Pending Home Sales NSA YoY, prior -4.4%
• 12:30pm: Fed’s Bostic Speaks in Moderated Q&A in Orlando
• 1pm: Fed’s Brainard Speaks on Economic and Monetary Policy Outlook
• 8:30pm: Fed’s Kaplan Speaks in Dallas

DB’s Jim Reid concludes the overnight wrap

The most delicious irony about the last 48 hours is that a day after Italy drove German yields back down towards rock bottom levels, along comes a way above consensus German inflation print (2.2% YoY vs 1.8% expected) yesterday. We wrote a quick note on this last night and showed that the gap between German inflation and 2yr and 10yr Bund yields are both within a whisker of record levels with data stretching back to the 1950s. German yields are totally detached from German economic fundamentals.

Whether Italian yields are totally detached from fundamentals in the near-term is at the mercy of their politicians and yesterday was a better day on that front as we’ll see below. However the longer-term stresses have lingered for years and will likely continue for many more to come. On that, yesterday we also published a ‘best of’ note of all the Italy related charts we’ve published in our annual Long Term Asset Return Studies over the last few years. We regularly return to Italy in this note due to how remarkable some of the long-term charts look for this country. See the link here.

Before we work out where we are on Italy it’s worth making a couple of additional points on German inflation. HICP at 2.2% YoY was the joint highest print since April 2012 so it’s wrong to say there is no inflation is Europe especially as Spanish HICP climbed back above 2% YoY yesterday (1.7% expected). Although much of the increase was energy related it wasn’t all from commodities. Today we see the same for France, Italy and the Euro area, so some eyes should be diverted in that direction. It’s easy to miss in this ongoing Italian saga.

Anyway onto Italy. The news-flow calmed yesterday and culminated in the President providing more time for the Five-Star and League parties to try to form a government. Meanwhile the PM designate Cottarelli also said possibilities had emerged “for the birth of a political government” (rather than a technocrats led government). Further, the 5Star leader Di Maio noted the 5SM and League Party never sought Euro exit and that he was willing to find a new finance minister who was “the same level of the excellent Professor Savona”. Conversely, the League leader Salvini didn’t seem to be that supportive as he said “either the government is the one proposed or there is no government” and in terms of “Di Maio’s overture? We’re not at the market (for a new deal)” while he hoped for elections “as soon as possible, but not at the end of July”. Elsewhere, the Italian government sold €3.6bn of 5 and 10y bonds yesterday and although the demand was mixed the fact that markets absorbed them seemed to help sentiment.

Following on, markets yesterday went into a partial but significant reversal of Tuesday’s sell off, as Italian bonds snapped back, equities firmed and safe haven core bonds sold off. In government bonds, the yields on 2y and 10y Italian BTPs dropped -110bp and -27bp respectively, albeit still up 73bp and 21bp from Monday. Meanwhile, core 10y bond yields rose 4-11bp (UST +7.4bp; Gilts +6bp) with Bunds leading the losses following its above market CPI print (+11bp). Notably, the 10y spread between BTPs and Bunds dropped 38bp yesterday to 251bp while the 5y sovereign CDS on Italy also narrowed -15bp to 254bp.

Elsewhere, European and US equities both rebounded given the risk on tone. Key European bourses rebounded 0.3%-1% (Stoxx 600 +0.27%; DAX +0.93%; FTSE +0.75%) while the Italian market jumped +2.09% to now be only modestly lower than Monday’s close (-0.6%). The S&P rallied +1.27%, which now makes it 34 days in 2018 when the index has moved by at least 1% up or down (just under a third of all sessions). This compares to 2017 which only had 8 such occasions when this happened (3% of all trading days). Within the S&P, all sectors were up with gains led by the energy (+3.1%), financials and the health care sector. The former was boosted by a stronger oil price as WTI oil was up for the first time in 6 days (+2.2% to $68.21/bbl), in part as Reuters reported that OPEC plans to stick with its output cuts until the end of 2018 while further adjustments to offset any supply shortage would be gradual.

This morning in Asia, markets are rebounding after the positive European/ US leads. Across the region, the Nikkei (+0.82%), Kospi (+0.48%), Hang Seng (+0.76%) and Shanghai Comp. (+1.38%) are up modestly. Datawise, China’s May manufacturing and non-manufacturing PMIs both nudged up mom and were above expectations at 51.9 (vs. 51.4 expected) and 54.9 (vs. 54.8 expected) respectively. Elsewhere, the prep work for a potential US / North Korea leaders’ summit have moved a step closer as a top North Korean official (Kim Yong Chol) arrived at NY yesterday for two days of talks with the Secretary of State Pompeo.

Now recapping other markets performance from yesterday. The US dollar index fell for first time in four days (-0.79%) while the Euro regained +1.08% as Italian fears eased. Elsewhere, precious metals advanced modestly following the dollar’s weakness (Gold +0.20%; Silver +0.86%) and other base metals were mixed (Copper -0.12%; Zinc +1.48%; Aluminium +0.03%).

Moving onto trade. The Washington Post has cited unnamed sources that the Trump administration plans to announce 25% tariffs on imported steel / aluminium on the EU if negotiations were not satisfactory ahead of tomorrows’ deadline.  Meanwhile after yesterday’s announcement that the US will implement 25% tariffs on $50bn worth of Chinese imports shortly after 15th June, our US and China economists have updated their views on the potential impacts.  Notably, DB’s Zhiwei Zhang pointed out that the persistent trade tension likely makes China cautious in dealing with its domestic economic problems. In particular, the government seems reluctant to crack down further on the booming property market in some cities while the new rule on wealth management businesses has been revised with a longer grace period into 2020. Overall, he believes economic momentum likely remains stable, with potential upside risk to property and infrastructure investments over the next few months.

Over in Spain, the no confidence vote on PM Rajoy proposed by the Socialists Party (2nd largest opposition) is scheduled for tomorrow. Unnamed sources told Bloomberg that the Socialists are close to achieving sufficient votes, although other parties such as the PNV (the Basque Nationalists) and Catalan separatists have not made a firm decision yet.

Back onto Italy, Nick Burns in my team published a note showing that HY Italian issuers are the largest contributor (across non-financials and financials) to the EUR HY index. Nick also looks at how HY Italian names have performed against the non-Italian names recently as well as trying to put the moves in the context of the relative performance we saw around the European sovereign crisis. Of particular interest is that many Italian HY bonds now trade in line or at lower yields than Italian government bonds. In the near-term this might reverse through falling government bond yields. But if that’s not the case then some of those Italian HY names will start to look expensive on a relative basis.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the May ADP employment change number was below market at 178k (vs. 190k expected) and the prior month’s reading was downwardly revised by 41k. There was some talk within the report about companies struggling to hire as we increasingly hit labour shortages. The second reading on Q1 GDP was revised down by 0.1ppt to 2.2% qoq. In the details, consumption (-0.1ppt), inventories (-0.3ppt) and residential investment (-2ppt) were revised down while non-residential fixed investment was revised up 3.1ppt.

DB’s Alan Ruskin noted these revisions were on net modestly positive for underlying growth momentum, as less inventory build and stronger capex should support growth momentum in the coming quarters. As evidence of this, final sales to domestic purchasers was revised up 0.3ppt. The 1Q Core PCE was also revised 0.2ppt lower to 2.3% qoq. Elsewhere, the April wholesale inventories was flat mom (vs. 0.5% expected) while the April advance goods trade deficit was narrower than expected (-$68.2bln vs. -$71bln expected).

The latest Fed Beige book noted that: i) more than half of the Districts reported a pickup in industrial activity and a third of the Districts classified manufacturing activity as “strong”, ii) labour market conditions have “remained tight across the country” but in aggregate, wage increases were still described as “modest in most Districts”, while iii) on inflation “some Districts noted that their retail contacts were more able to pass along price increases to their customers than in the recent past”

In Germany, the May unemployment rate edged down 0.1ppt mom to a fresh record low of 5.2% (vs. 5.3% expected) while the April retail sales rebounded more than expected after four consecutive months of decline to +2.3% mom (vs. 0.5% expected). Moving along, the Euro zone’s May economic confidence was 112.5 (vs. 112 expected) while  the final reading for the consumer confidence index was unrevised at 0.2. Over in France, the 1Q GDP was revised 0.1ppt lower to 0.2% qoq, leading to an annual growth of 2.2% yoy. Meanwhile, consumer spending for April was quite weak, falling 1.5% mom to be up 0.2% yoy (1.8% expected).

Looking at the day ahead, inflation data should be the big focus today with the May CPI report for the Euro area (core CPI of 1% yoy expected) and the April PCE report in the US both due (core PCE of 1.8% yoy expected). Away from that, May CPI for France and Italy and April money and credit aggregates data in the UK are all due this morning. In the US we’ll also get April personal income and spending reports, weekly initial jobless claims, May Chicago PMI and April pending home sales data. In the morning the Fed’s Bullard will speak in Tokyo again, while in the evening the Fed’s Bostic is due to speak. G7 finance ministers and central bankers are also due to gather in Whistler with the topic of the conference being “Investing in Growth that Works for Everyone”. Good luck with that!!

 

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