Month: June 2018

The eye of the hurricane may have passed over Italy and the winds are again starting to pick up speed, because shortly after Morgan Stanley laid out what a worse case scenario for Rome could look like (ugly, read here), Italian bonds started selling off again, with 2Y yields rising to session highs following Italian premier Conte’s inaugural speech in which the populist premier spooked markets by reiterating that the new populist government will pursue a radical policy program, and highlighting legislative priorities that will be extremely costly – including the right to universal income, minimum wage, overhauling the healthcare system, prioritizing social rights, and so on – all without saying just how these will be paid for (spoiler alert: much more debt).

Conte also said that a new flat tax would be introduced, even if no timeframe has been provided, and there was no mention of avoiding the hike in sales taxes which is currently planned for 2019, or canceling the “Fornero” pension reform.

Amusingly, in the speech Conte also said that he plans on reducing public debt, although in light of the surge in spending which will not be financed with increased revenue, it is not clear how that can be achieved. As Bloomberg economist Stephanie Flanders notes “Italy cannot convincingly cut its public debt as a share of GDP without reasonable growth in nominal GDP (real growth plus inflation). Even the more optimistic forecasts do not point to nominal GDP growing much faster than 2.5% in the foreseeable future. By contrast, the average cost of its public debt is 3.1%.”

A much more important chart is the following from Morgan Stanley showing what would happen to Italy’s debt/GDP if interest rates rose even modestly from their artificially low levels.

As a result of Italy politely reminding the world that nothing has changed since the start of last week when the world woke up to the reality of a populist government in Europe’s 3rd largest economy, Italian 2Y yields have spiked….

… with the move starting to seep across the Atlantic, sending the dollar to sessions highs…

… and 10Y yields back to lows.

Via Reuters, here are the key excerpts from Conte’s speech (link to full speech here), highlights ours:

INTRODUCTION

“Today we come before you to ask for your trust not only in a government team, but also in a project for the change of Italy.”

“I do not think this is simple novelty. The truth is that we have brought with us radical change, of which we are proud.”

“I take on this task with humility, but also with determination, with the awareness of my limits, but also with passion.”

“The political forces that make up this government have been accused of being ‘populist’ and ‘anti-system’ … If ‘populism’ means the ruling class listens to the needs of the people … (and) if ‘anti-system’ means to aim to introduce a new system, which removes old privileges and encrusted power, well these political forces deserve both these epithets.”

EUROPE AND PUBLIC FINANCES

“We want to reduce the public debt, but we want to do it by increasing our wealth, not with austerity that, in recent years, has helped to make it (public debt) grow.”

“Italian public debt is fully sustainable today. However, its reduction must be pursued, but with a view to economic growth. Fiscal and public spending policy should be geared towards the pursuit of the objectives set for stable and sustainable growth.

“In Europe, these issues will be strongly pushed forward with the aim of changing its governance, a change already at the centre of reflection and discussion in all EU member states.

“We are optimistic about the outcome of these discussions and confident of our negotiating power, because we are facing a situation in which Italy’s interests … coincide with the general interests of Europe, with the aim of preventing its possible decline. Europe is our home.”

PENSIONS AND CITIZEN’S WAGE

“The government’s goal is to provide income support for families most affected by socio-economic hardship. The support … will be conditional on vocational training and job reintegration. We propose, in a first phase, to strengthen the employment centres.”

“We will also take action to help pensioners who do not have enough income to live in a dignified manner.”

“We need to cut the pensions and annuities of parliamentarians, regional councillors and employees of constitutional bodies … The so-called ‘golden pensions’ are another example of unjustified privilege that must be opposed. We will intervene on pensions that exceed 5,000 euros per month when the sum has not been covered by the contributions paid.”

TAXES

“Our tax burden, combined with an excessive amount of bureaucracy, has a negative effect on the relationship between taxpayers and the state, and on the competitiveness of our country.”

“The goal is the ‘flat tax’, which is a reform with fixed tax brackets and a system of deductions that guarantees the progressiveness of the levy in full harmony with the principles of the constitution. This is the only way to bring about a drastic reduction in tax evasion, which will have benefits in terms of greater tax savings, greater consumer spending and investments, and increasing the tax base.”

IMMIGRATION

“We will end the immigration business, which has grown out of all proportion under the cloak of fake solidarity.”

“We will forcefully seek the overcoming of the Dublin Regulations in order to obtain the effective respect of the principle of equal distribution of the responsibility to set up an automatic system of obligatory re-distribution of asylum seekers.”

“We are not and will never be racists. We want procedures that determine refugee status to be certain and speedy, in order to effectively guarantee their (refugee) rights.”

FOREIGN POLICY

“First of all, we intend to reaffirm our convinced membership of NATO, with the United States of America as a privileged ally.”

“We will support opening up to Russia … We will push for a review of the sanctions system, starting with those that risk humiliating Russian civil society.”

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Just weeks after the US Department of Homeland Security introduced a new policy that allowed ICE agents to separate children and adults crossing the border, NBC News is reporting that the rapidly rising number of minors being housed at the border is forcing DHS to scramble to find new accommodations as the administration continues to separate migrant children from their parents.

In May, President Trump introduced his “zero-tolerance” policy, saying that parents and migrant children would be separated at the border. The Department of Homeland Security then inflamed the situation by revealing that it had lost track of some 1,500 children. Since then, demands for more oversight at DHS have intensified.

As of Sunday, 300 of 550 children currently in custody at US border stations had spent more than 72 hours there, having reached the time limit for temporary detention. These stations often lack the resources necessary to house children, including bedding and other resources.

Almost half of these children are younger than 12, meaning they’re classified as “tender age children.” Given the inadequacy of their temporary accommodations, DHS scouts are searching for more space where these children can be comfortably housed for the interim period until they’ve been placed in permanent accommodations.

As NBC notes, the “overstays” at border stations are a result of a backlog at U.S. Health and Human Services (HHS), which is the agency responsible for sheltering migrant children longer term and matching them with relatives or foster parents in the U.S. The agency’s Administration for Children and Families has 11,200 unaccompanied children in its care and takes 45 days on average to place a child with a sponsor.

More from NBC:

“It would be highly inappropriate and even unsafe to hold children for extended periods in these short-term border facilities because they often lack the adequate medical and nutritional resources for these young people,” said Greg Chen, director of government relations for the American Immigration Lawyers Association. “It would place these children at risk of harm if they are housed with adults without the proper privacy that children should have.”

[…]

The overstays at border stations are a result of a backlog at U.S. Health and Human Services (HHS), the agency responsible for sheltering migrant children longer term and matching them with relatives or foster parents in the U.S. The agency’s Administration for Children and Families has 11,200 unaccompanied children in its care and takes 45 days on average to place a child with a sponsor, according to a spokesperson.

HHS officials will soon tour military installations near the border in Texas as they search for more space to house children while they wait for placement. The officials will tour Dyess Air Force Base, Goodfellow Air Force Base, and Fort Bliss, the spokesperson said.

“HHS will make the determination if they will use any of the three sites for UAC (unaccompanied alien children) operations,” the spokesperson said.

To be sure, military bases have been used to house migrant children in the past – including during the Obama administration, although Obama-era officials who spoke with NBC predictably said they only housed children at military bases as a “last resort.”

“What’s happening now is a broad indication of a total lack of planning or forethought for the policy they enacted,” said Peter Boogaard, a former DHS and White House official in the Obama administration who is now a spokesman for the immigration reform group FW.us. “They didn’t think this through at all — what it would mean for kids, for their parents and for the operational challenges.”

“Instead of having Border Patrol agents at the border, you have them taking care of kids at border stations.”

In another policy decision that could make it more difficult for the administration to place children with relatives, the Trump administration recently started requiring the Department of Health and Human Services to fingerprint people claiming to be parents of unaccompanied children, a move the previous administration said would delay children from being reunited with their families and scare undocumented parents away from coming forward.

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The Mexican peso tumbled on Tuesday after Mexico announced that in retaliation to Trump’s import tariffs on steel and aluminum, it would impose a 20% tariff on U.S. pork imports.The greenback was trading at 20.25 pesos per dollar, up 0.9% on the day and at its highest levels since February 2017.

Last week Mexico said the retaliatory tariffs would apply to pork legs and shoulders from U.S. suppliers, which account for about 90% of the country’s $1.07 billion annual imports of the cuts.  Mexico’s overall pork imports in 2017 totaled about 840,000 tonnes, of which pork legs and shoulders amounted for nearly 650,000 tonnes.

“It’s a 20 percent (tariff) on legs and shoulders, fresh and frozen … with bones and without bones,” said Heriberto Hernandez, president of Mexico’s leading pork producers association OPORPA, quoted by Reuters.

The Mexican government has not yet given details of the level of the tariff and did not immediately respond to a request for a comment about the tariff or the meeting. Hernandez said he supported the Mexican government’s decision and does not expect it to cause pork prices in Mexico to rise because “there are many alternatives” to U.S. suppliers.

Industry officials pointed to Canada as a possible substitute pork supplier that has tariff-free access to Mexico thanks to NAFTA, or the European Union, which recently concluded a revised trade pact with Mexico that allows tariff-free pork imports but does include other restrictions like volume quotas.

Mexico’s foreign ministry previously blasted the U.S. tariffs as “unjustified, unilateral measures” and warned that even more tariffs are on the table:

“The government of Mexico responds, responds with equivalent measures for diverse products, such as flat steel, lamps, legs and pork trowels, sausages and food preparations, apples, grapes, cranberries, and various cheeses among others, up to a comparable amount to the level of disruption,” stated Mexican Foreign Minister Luis Videgaray.

For now, however, the government of Mexico has more inflation to look forward to. Victor Manuel Ochoa, chief executive of top Mexican pork producer Granjas Carroll, said he would support a temporary import deal for Brazilian pork legs if Mexico goes ahead with the tariffs on U.S. imports. He said prices in Mexico will likely rise as a result of the tariffs on U.S. pork. “We think they’d rise around 15 or 16 percent, and I think that could reduce consumption which worries me,” Ochoa said.

Granjas Carroll is a joint venture of ECOM Agroindustrial Corporation, a major commodity trader, and China’s WH Group. “It would be very difficult for Mexican pork prices to stay the same,” Ochoa added, if imported U.S. pork prices spike as a result of the tariffs.

Meanwhile, it now appears that ongoing NAFTA negotiations will not find a solution during this Congress, and will likely extend beyond the US midterm elections. Trump’s decision to launch the steel and aluminum tariffs tanked talks with Mexico and Canada to rework NAFTA, while sellside strategists have said the latest moves by Mexico might prompt Trump to pull out of NAFTA, resulting in the Peso’s plunge.

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While global markets remain largely a sea of green, ignoring the threat of a trade war between the US and the rest of the world which remains a non-event for now (for reasons discussed overnight), the move higher has been more muted overnight, and even as European and Asian stocks extended Monday’s gains and U.S. futures pointed to a higher open, some familiar risks have re-emerged.

Europe’s Stoxx 600 Index advanced for a third day, if off its highs, led by tech companies and automakers. Looking at sectors, Telecoms are underperforming while IT names outperform. In terms of stock specifics, RBS (-3.6%) is hit after the UK government decided to sell a 7.7% stake in the company worth around GBP 2.6bln following the bank bailout during the crisis.

Following some early outperformance, Italy’s FTSE MIB slumped into the red as Italian PM Conte delivered his inaugural speech before Senate (ahead of a confidence vote later today which is expected to pass) in which the new prime minister re-asserted that the Five Star-League government will follow a radical policy program, noting that citizens have a right to universal income and minimum wage, proposals which are set to blow out Italy’s budget and public debt. It is therefore not surprising that Italian bond yields spiked to session highs as Conte spoke.

Here are the highlights so far from Conte’s inaugural speech:

• This is a project for the change of Italy.
• I take up this responsibility with humility and determination … I am motivated by nothing but a spirit of service … like a lawyer representing all of Italy’s people.
• This is not a simple novelty. The truth is that we have brought a radical change, of which we are proud.
• We will put an end to the immigration “business” which has grown out of control under the guise of solidarity.
• We want to reduce public debt by increasing the wealth of our economy, not through austerity.
• We intend to preliminarily restate our convinced membership of our country of NATO, with the United States of America as a privilege partner.
• The elimination of the gap in growth between Italy and the European Union is our objective, which must be followed in a framework of financial stability and the trust of markets.
• This government intends to act with determination (against political privileges). The struggle against the privileges and waste is not a merely symbolic question.
• Italian public debt is fully sustainable today. However, its reduction must be pursued, but with a view to economic growth. Fiscal and public spending policy should be geared towards the pursuit of the objectives set for stable and sustainable growth. In Europe, these issues will be strongly pushed forward with the aim of change of its governance, a change already at the centre of reflection and discussion in all EU member states.

Furthermore, as Bloomberg’s Heather Burker points out, “Italy’s CDS remains elevated, and above their five-year average despite a pullback from last week’s peak (which was within striking distance of the July 2013 high).”

The spread between Italy’s CDS and that of emerging markets, as highlighted by colleague Natasha Doff last week, still shows investors are paying more to hedge against a default in the euro-area nation than for a basket of 14 developing countries — a dynamic that hasn’t persisted since the height of the euro crisis in 2012

Elsewhere, there was more bad economic news for Europe this morning, when the Markit PMI dropped to a fresh 18 month low of 54.1 from 55.1 in Apr, although it is still above the 50-mark separating growth from contraction.

Earlier, Asian equity markets traded indecisive after the momentum faded from Wall St, where all majors extended on gains and the Nasdaq Comp. posted a record close. ASX 200 (-0.5%) was negative with the index weighed by the energy sector after oil prices slipped to below USD 65.00/bbl and with Retail Food Group the worst performer in the index after it flagged a statutory net loss due to termination payments. Elsewhere, Nikkei 225 (+0.3%) remained afloat following the recent currency weakness, while Shanghai Comp. (+0.7%) and Hang Seng (+0.3%) were choppy as participants mulled over a mild liquidity drain as well as inconclusive Chinese Caixin Services and Composite PMI data which were unchanged from the prior month.

U.S. futures also turned higher following the S&P 500’s highest finish since mid-March, on the back of more records by tech stocks, as the S&P 500 gradually morphs into the FAAMG 5.

Treasury yields slipped for the first time in five days, while those of Italian bonds seemed ready to resume their push higher (as Morgan Stanley warned overnight) and were poised for the first increase since they blew up a week ago.

In overnight FX trading, the dollar meandered without a direction and was largely unchanged against Group-of-10 peers, with the the Bloomberg Dollar Spot Index paring modest earlier gains as traders adjusted positions before the G7 summit this week (which will be attended by Trump) and policy decisions by the Fed and the ECB.

The pound rose to a session high in the wake of a strong U.K. services PMI that exceeded expectations, and as the economy continued its modest recovery from the snow disruption of the first quarter. Australia’s dollar fell from a six-week high as the current-account deficit widened more than economists’ forecast, dampening the optimism toward GDP data due tomorrow, and the central bank kept interest rates on hold. The yen touched the lowest in more than a week before recovering to trade little changed as investors were reluctant to sell beyond 110 on caution of heavy positioning before a slew of events including the FOMC meeting next week. Overnight, BoJ member Wakatabe said they are still distant from the 2% inflation target and thus too early to talk about specific exit strategies.

Just after midnight EDT, Australia’s RBA announced that it kept its cash rate at 1.50%, as expected by all economists; the RBA said that its policy is consistent with sustainable economic growth and reaching inflation target. Low level of rates continues to support economy. Inflation and wage growth likely to remain low for a while. Expect pick up in domestic growth this year and next, global economy has strengthened. Strengthening currency would result in slower pick up of growth and inflation.

Earlier this morning, Bloomberg reported that Trump had explicitly requested that Saudi Arabia/OPEC boost oil production by 1MMb/d, offsetting the Iranian export drop; the news promptly sent Brent and WTI to session lows.  Trump’s request comes ahead of US mid-terms later this year, which has recently seen US President Trump try to talk down the price of oil via OPEC with US retail gasoline prices at 3 year highs.

Looking ahead traders are eyeing the OPEC+ meeting on June 22nd. Energy ministers did initially signal a rise in output to offset supply disruptions from Iranian and Venezuelan sanctions but then switched rhetoric at the unofficial OPEC+ meeting over the weekend. An official restriction ease is still anyone’s guess. Meanwhile, participants await the latest stockpile count with API inventories due after-hours.

Elsewhere, in the metals complex, the yellow metal takes a breather with little price change following three consecutive days in the red. Dalian iron ore futures rise despite record stockpiles after reports Tangshan (China’s number 1 steelmaking city) is to shut 226 mining companies. Furthermore, copper rose for a fourth consecutive session to its highest in almost six weeks as the red metal is underpinned by potential supply disruptions amid wage talks at the world’s largest mine.

In overnight geopolitical news, Iran nuclear official Kamalvandi said Tehran will inform the UN atomic agency regarding beginning of capacity increase for uranium gas production. Iran has begun work on infrastructure for advanced centrifuges at the Natanz facility, as according to the Iranian atomic energy organization, these activities will be within the framework of the nuclear agreement.

It’s a relatively quiet day, with data includingJOLTS job openings and the final May PMIs. HD Supply, Navistar, Guidewire, and YY Inc are among companies reporting earnings.

Bulletin Headline Summary from RanSquawk

• Cable saw a significant jump in the wake of UK PMI data that exceeded expectations
• Reports suggest that the US has asked OPEC to raise output by 1mln BPD
• Looking ahead, highlights include, US ISM non-manufacturing, APIs, and ECB’s Weidmann

Market Snapshot

• S&P 500 futures up 0.2% to 2,749.50
• STOXX Europe 600 up 0.2% to 388.77
• MXAP up 0.02% to 174.57
• MXAPJ up 0.09% to 573.11
• Nikkei up 0.3% to 22,539.54
• Topix up 0.02% to 1,774.96
• Hang Seng Index up 0.3% to 31,093.45
• Shanghai Composite up 0.7% to 3,114.21
• Sensex down 0.4% to 34,860.09
• Australia S&P/ASX 200 down 0.5% to 5,994.88
• Kospi up 0.3% to 2,453.76
• German 10Y yield fell 0.5 bps to 0.413%
• Euro up 0.1% to $1.1713
• Italian 10Y yield fell 14.9 bps to 2.273%
• Spanish 10Y yield rose 1.8 bps to 1.348%
• Brent futures down 0.1% to $75.21/bbl
• Gold spot little changed at $1,292.46
• U.S. Dollar Index down 0.2% to 93.90

Top Overnight News from Bloomberg

• President Donald Trump plans to meet Tuesday with Senate Republicans concerned about restrictions he’s weighing on Chinese investments in the U.S., two people familiar with the matter said
• While Trump has sown confusion and frustration among fellow political leaders, economists at most Wall Street banks are barely changing their forecasts for solid global growth this year as they estimate only modest fallout from a skirmish over commerce
• Germany is ready to challenge any attempt by Italy’s populist government to flout European Union regulations or seek special treatment from the bloc
• Italian Premier Giuseppe Conte’s maiden speech to Parliament Tuesday will be the first public test of his ability to navigate between the contrasting demands of the populist leaders who got him appointed
• When a group of London hedge-fund managers gathered last month for a quarterly working dinner hosted by corporate-intelligence firm Third Bridge, the discussion struck a tone they hadn’t heard in years. This time guests were asked to suggest bonds likely to fall in value
• Teamwork is the new way at Pimco, and that’s evident right at the top. Whereas Gross once ran the show, Ivascyn and Roman embrace their shared responsibilities
• Investors holding Ukrainian debt are approaching a crucial moment as the country counted among the shakiest emerging markets prepares for a vote that can alleviate a swirling political crisis — or tip the nation deeper into turmoil

Asian equity markets traded indecisive after the momentum somewhat petered out from Wall St, where all majors extended on gains and the Nasdaq Comp. posted a record close. ASX 200 (-0.5%) was negative with the index weighed by the energy sector after oil prices briefly slipped to below USD 65.00/bbl and with Retail Food Group the worst performer in the index after it flagged a statutory net loss due to termination payments. Elsewhere, Nikkei 225 (+0.3%) remained afloat following the recent currency weakness, while Shanghai Comp. (+0.7%) and Hang Seng (+0.3%) were choppy as participants mulled over a mild liquidity drain as well as inconclusive Chinese Caixin Services and Composite PMI data which were unchanged from the prior month. Finally, 10yr JGBs were flat amid similar quiet trade in T-notes and the indecisiveness in the region, while the10yr JGB auction failed to provide a catalyst as the results were mixed which added to the sombre tone.

Top Asian News

• Krishnan Is Said to Mull Buyout of $1.9 Billion Pay-TV Operator
• Dubai Buyout Firm Abraaj Says Close to Debt Standstill Pact
• Giant Waste-Spewing Mine Turns to Battleground in Indonesia
• TPG Enters Private Equity Secondaries With Asia-Focused NewQuest

European bourses are trading mostly in the green (Eurostoxx 50 +0.5%) with the exception of the SMI 20 and FTSE 100. The UK index is feeling pressure from the strengthening GBP following an above consensus UK Services PMI, adding to the slew of recent PMI beats. The FTSE MIB is outperforming its peers while Italian PM Conte is to speak before Senate and go through a confidence vote later today, where the chance of a rejection is almost non-existent following the limbo-state Italy has been in for months. Looking at sectors, Telecoms are underperforming while IT names outperform. In terms of stock specifics, RBS (-3.6%) is hit after the UK government decided to sell a 7.7% stake in the company worth around GBP 2.6bln following the bank bailout during the crisis.

Top European News

• U.K. Services Growth Quickens Amid Subdued Economic Rebound
• Waning Italy Political Risk Can Prop Up the Euro Only So Much
• Elliott, CRC Are Said to Bid for Banco BPM’s $6 Billion Loans
• German, French Services Cool as Euro Area Growth Loses Steam

In FX, the USD has seen relatively quiet trade overall, but the index has inched back to the 94.000 handle as the Greenback claws back losses vs G10 counterparts and/or rival currencies lose some of their recent momentum. A raft of Eurozone PMIs are not providing much impetus, but the US slate is busy and could prompt more in the way of price action as Treasury yields sit off late May/very early June lows. GBP: The Pound has leapt to the top of the pile in wake of another UK PMI beat that has lifted the composite reading to its best ytd level and prompted survey compiler Markit to predict Q2 GDP growth of 0.3-0.4% q/q (vs just 0.1% in Q1). Cable has duly extended gains above 1.3300 towards 1.3400, while Eur/Gbp has retreated from almost 0.8800 to sub-0.8750. CHF/EUR/JPY:  All keeping tabs with big figure levels vs the Usd with the Franc not straying too far from 0.9900, Eur/Usd pivoting 1.1700 and Usd/Jpy still capped around 110.00. For the single currency especially, a band of option expiries spanning 1.1675-1.1750 and totalling 5 bn looks set to keep the pair rangebound barring any other significant driver. EM: The Peso is a notable laggard with Usd/Mxn back over 20.000 after Mexico upped the trade war ante vs the US buy proposing a 20% tax on pork, while raising objections via the WTO in response to the US tariffs on steel and aluminium

In Commodities, oil is negative on the day with WTI down 0.2% and Brent down 1.2% as traders focus on the US reportedly asking OPEC for a 1mln BPD oil output increase, as according to sources. In an immediate move WTI moved from USD 64.94 to USD 64.78. This comes ahead of US mid-terms later this year, which has recently seen US President Trump try to talk down the price of oil via OPEC with US retail gasoline prices at 3 year highs.

Looking ahead traders are eyeing the OPEC+ meeting on June 22nd. Energy ministers did initially signal a rise in output to offset supply disruptions from Iranian and Venezuelan sanctions but then switched rhetoric at the unofficial OPEC+ meeting over the weekend. An official restriction ease is still anyone’s guess. Meanwhile, participants await the latest stockpile count with API inventories due after-hours.

Elsewhere, in the metals complex, the yellow metal takes a breather with little price change following three consecutive days in the red. Dalian iron ore futures rise despite record stockpiles after reports Tangshan (China’s number 1 steelmaking city) is to shut 226 mining companies. Furthermore, copper rose for a fourth consecutive session to its highest in almost six weeks as the red metal is underpinned by potential supply disruptions amid wage talks at the world’s largest mine.

In terms of the day ahead, we’ll also get April retail sales data for the Euro area, and April JOLTS and the May ISM non-manufacturing prints in the US. Elsewhere, the Brussels Economic Forum is due to begin with Juncker and Moscovici due to speak, while the BoE’s Cunliffe and ECB’s Weidmann speak this morning at separate events. Meanwhile, Italy’s confidence vote in the Senate will be today with the vote in the Lower House still yet to be announced.

US Event Calendar

• 9:45am: Markit US Services PMI, est. 55.7, prior 55.7
• 9:45am: Markit US Composite PMI, prior 55.7
• 10am: JOLTS Job Openings, est. 6,350, prior 6,550
• 10am: ISM Non-Manf. Composite, est. 57.6, prior 56.8

DB’s Jim Reid concludes the overnight wrap

Well it hasn’t taken long for Italy, and to a lesser extent Spain, to already feel a bit like yesterday’s news. While in all honesty it hasn’t been the most exciting last 24 hours in markets – which is probably welcome following last week – it does seem like the attention is firmly back on the US versus the ROW trade war tit for tat. Aside from the odd Trump tweet or two yesterday and China announcing on Sunday that it’s prepared to backtrack on some its recent commitments in negotiations should Trump pursue tariffs on the country, there were no real developments and instead all eyes appear to be on this Friday and Saturday’s G7 meeting in Quebec and whether or not it will be a united G7 meeting or more a G6+1. But with the calendar reasonably sparse over the next few days it appears that markets are also keeping a close eye on whether or not Trump will be backed far enough into a corner to make him stand down on his threats.

Markets for now seem to be trading as though a worst-case scenario will be avoided with the S&P 500 last night rising +0.45% and Dow +0.72%. The Nasdaq also rose +0.69% and to a new record high although still remains slightly below the intraday highs from mid-March. European markets were in a similarly jovial mood with the Stoxx 600 (+0.31%), DAX (+0.37%) and CAC (+0.14%) all up modestly. The IBEX (+1.22%) was the bigger mover post the positive political developments in Spain although the FTSE MIB (-0.45%) did struggle a bit. Treasury yields finished the day +4.0bps higher while Bunds and OATs were +3.6bps and +2.1bps higher respectively. Meanwhile BTPs continue to recoup some of the recent damage done with 2y and 10y yields ending yesterday -28.3bps and -14.1bps lower. That means 2y BTP yields have now rallied 205bps from the intraday highs of last Tuesday and the spread to similar maturity Bunds and Bonos are now at 138bps and 96bps respectively compared to the intra-day wides of 361bps and 292bps.

On a related note there was a bit made about the latest ECB bond buying numbers yesterday with the data showing a decent slowdown in net purchases of BTPs in May to 16.5%. That is below the implied capital key level of 17.5% and also the roughly 18-19% monthly purchases in 2018 through to April. On the flip side Bund purchases were much higher in May with the ECB stating that this was due to Bund reinvestments being carried over from April, and likewise a timing impact of BTP reinvestments in Italy which lowered net purchases. Indeed gross purchases of BTPs were actually higher but it’s noteworthy that the ECB made the point of addressing the purchases data directly which is something the ECB very rarely does. No doubt this shows how hypertensive the bond market is at present.

Taking a quick look at our screens this morning, overnight in Asia markets are  broadly mixed although moves have been relatively muted. The Nikkei (+0.08%), Hang Seng (+0.16%) and Shanghai Comp (+0.23%) have posted small gains while the Kospi (-0.09%) and ASX (-0.30%) are slightly in the red. Meanwhile, the White House confirmed last night that the US/North Korea leaders’ summit will take place at 9am Singapore time on June 12th, but US sanctions will remain “unless NK denuclearized”. Elsewhere, ahead of the remaining global PMIs today, China’s May Caixin services and composite PMIs were both steady month on month and in line with expectations at 52.3 and 52.9 respectively, while Japan’s May Nikkei composite PMI fell 1.4pts to 51.7 due to a 1.5pt fall in the services reading to 51.0.

Moving on. The improved mood in Europe in particular yesterday may have also in part been due to comments from German Chancellor Merkel over the weekend and then in another interview in Berlin yesterday. Indeed, Merkel appeared to be closing the gap with French President Macron over ESM reform. In the interview, Merkel seemingly gave her approval of support for two new crisis tools which would reduce contagion risk. While some of the other aspects of Eurozone reform appeared a bit vague, crucially, the interview was seen as finally providing a bit of clarity that Merkel is willing to and ready to talk about reforms.  This all comes before the eagerly anticipated EU Leaders Summit on the 28th and 29th this month which is looking like a pivotal couple of days for markets.

Away from politics and in light of it being a fairly quiet last 24 hours for newsflow we thought we’d revisit Friday’s manufacturing PMIs and update our charts showing the data regressed against the YoY change in equity markets over the last 20 years. A good starting place for last month is Italy given the big selloff for the FTSE MIB into month end. Indeed the index is now up only +6% over the last 12 months (compared to +17% at the end of April) and despite the PMI deteriorating further, the implied level now is broadly fair compared to it being 8% expensive as at the end of April. For the rest of Europe however the same story largely holds. The Stoxx is still 17% cheap (unchanged from April), the DAX 22% cheap (versus 23% previously) and CAC 11% cheap (versus 8% previously).

Spain’s IBEX is 22% cheap and also in line with where it was at April. For the UK the FTSE 100 is 6% cheap (compared to 4% cheap at April) while in Asia the Nikkei (1% cheap) and Shanghai Comp (16% cheap) are also broadly the same. In the US, despite the manufacturing ISM rising well over 1pt in May a higher S&P 500 means that the performance gap continues to hover around the 10% cheap level. Check the PDF for the tables and charts where we’ve also included the data in USD terms.

Back to yesterday, the economic data didn’t move the dial a huge amount although the Sentix investor confidence reading for the Eurozone did at least show the impact of the Italy woes from last month after the reading tumbled 9.9pts in June to 9.3 (vs. 18.5 expected) and the lowest since October 2016. More eye catching though was the expectations component which slumped over 11pts to -13.3 and the lowest since the depths of the Eurozone crisis in 2012. In the US the data was mostly flat to slightly softer. Headline April factory orders fell more than expected to -0.8% mom (vs. -0.5% expected), while the final readings for core durable goods and capital orders were confirmed at +0.9% mom and +1.0% mom respectively (unchanged versus flash estimates).

Before we wrap up, a quick mention that yesterday DB’s Luke Templeman published a thematic note called “Wall Street’s dislocation gauge”. Luke notes that since the financial crisis, companies have experienced great variation in their profitability, yet stock returns have been remarkably similar. Yet, a reversal of this trend is finally in full swing. Investors can now buy stocks that benefit from the reattachment of RoE and market prices, and sell those that are hurt. Indeed Luke highlights that ‘reattachment’ stocks have returned 37% since the inflection point in mid-2016 (when bond yields began to rise), one-third more than the market’s return. The report identifies 74 stocks that can benefit from further normalisation and a further 76 that could be hurt. See the link for more here.

In addition to that, Michal in our team published the report “ECB CSPP Flows Picking Up but Still Below Q1”. It provides an update on the latest CSPP purchases, their breakdown into primary and secondary, and their relative weight in the  ECB QE programme. It also estimates the ECB’s average allocation of primary deals and analyses the relative pricing of CSPP-eligible and ineligible securities during the Italy-driven sell-off. You can download the full report here.

Finally, in terms of the day ahead, as noted earlier the final May services and composite PMIs in Europe and the US are due today. Outside of that we’ll also get April retail sales data for the Euro area, and April JOLTS and the May ISM non-manufacturing prints in the US. Elsewhere, the Brussels Economic Forum is due to begin with Juncker and Moscovici due to speak, while the BoE’s Cunliffe and ECB’s Weidmann speak this morning at separate events. Meanwhile, Italy’s confidence vote in the Senate will be today with the vote in the Lower House still yet to be announced.

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It all started on April 20, when having tweeted at and about virtually everything else, President Trump realized that surging oil and gasoline prices are wreaking havoc on his economic agenda and eating away at the benefits from his tax cuts, and so he made it clear when he lashed out on twitter against OPEC which he said was “at it again. With record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!”

Looks like OPEC is at it again. With record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!

— Donald J. Trump (@realDonaldTrump) April 20, 2018

The result was instant, sending the price of oil sharply lower….

… and effectively capping the price oil, which is now at the level when Trump made his warning.

Since then Trump’s stance has only hardened, and because the US president has become an especially good friend with the ruling Saudi regime, there has been a dramatic reversal within OPEC, whose next meeting is now expected to see the cartel and Russia modestly boost oil production to comply with Trump’s demand.

But by how much?

This morning Bloomberg reported the answer, when it said that the Trump administration has quietly asked Saudi Arabia and other OPEC producers to increase oil production by about 1 million barrels a day, or – not surprisingly – just enough to offset expected Iran oil export declines as a result of Trump’s renewed embargo on Tehran.

The rare request came after U.S. retail gasoline prices surged to their highest in more than three years and President Donald Trump publicly complained about OPEC policy and rising oil prices on Twitter. It also follows Washington’s decision to reimpose sanctions on Iran’s crude exports that had previously displaced about 1 million barrels a day from global markets.

As Bloomberg adds, while U.S. lawmakers have habitually criticized the Organization of Petroleum Exporting Countries at times of high oil prices, and the government has on occasion encouraged the cartel to pump more, it’s unusual for Washington to ask for a specific output hike, although not that unusual when one considers just how much effort Trump has put into becoming a BFF with the Saudi rulers. Also, Bloomberg notes that it was not clear precisely how the request was communicated.

The disclosure of the American request emerged over the weekend, when some Arab oil ministers discussed oil production in Kuwait City. The meeting was followed by a statement which pledged to “ensure stable oil supplies are made available in a timely manner to meet growing demand and offset declines in some parts of the world.” And, as reported at the time, Saudi Arabia and Russia last month proposed a gradual production increase, although other members of the group have yet to agree.

While the White House refused to comment on any specific conversations with Saudi Arabia, a spokesman told Bloomberg that “we welcome any market-based action that increases energy access and fosters a healthy global economy.”

Treasury Secretary Steven Mnuchin hinted last month that Washington had “various conversations with various parties about different parties that would be willing to increase oil supply to offset” the impact of U.S. sanctions on Iranian oil output. Only four countries among OPEC and its allies hold enough spare production capacity to offset that impact: Saudi Arabia, Russia, the United Arab Emirates and Kuwait.

A formal revision to the cartel’s oil output is expected to be proposed in 2 weeks when OPEC and its allies will meet in Vienna on June 22 and 23 to discuss their production policy for the second half of the year. Saudi Oil Minister Khalid Al-Falih last month said the kingdom shared the “anxiety” of consuming nations about high oil prices and added that OPEC and its allies were “likely” to boost output, undoing nearly 2 years of “progress” following the Vienna oil output deal which cut 1.6 mmb/d from world production in an attempt to eliminate the record inventory overhang, and nearly doubling the price of oil from $45/barrell to $80.

As Bloomberg concludes, the most recent comments by Trump and the request for extra oil are among the most forceful U.S. intervention in OPEC affairs since Bill Richardson, the energy secretary during the second administration of Bill Clinton, phoned the Saudi minister in the middle of an OPEC meeting in 2000 asking for a production increase.

The intervention enraged other members of the cartel, exacerbating a schism between Saudi Arabia and Iran. This time around, it appears that Trump’s peculiar brand of diplomacy may have achieved its goal without angering anyone.

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After an exciting weekend of comments from U.S. Defense Secretary James Mattis and Chinese People’s Liberation Army Lieutenant General He Lei at the IISS Shangri-La Dialogue, a civilian and military defense summit in Singapore, it appears the United States had to have the last word.

On Sunday, two U.S. officials told Reuters that the Pentagon is considering increased naval war drills in the South China Sea near China’s heavily disputed militarized islands. The officials, who are working jointly with Asian diplomats — declined to comment about the Pentagon’s progress in finalizing the plan for the new drills.

Such a move could further increase geopolitical tensions in one of the world’s most volatile regions.

Officials explained to Reuters that the naval drills could involve more extensive patrols, ones involving a large number of warships or operations including closer surveillance of the Chinese military bases on the islands, which now includes anti-ship cruise missiles, radar-jamming equipment, and strategic bombers.

U.S. officials said they are not doing this alone. They are aligning international allies and strategic partners to increase “naval deployments through the vital trade route as China strengthens its military capabilities on both the Paracel and Spratly islands.”

“What we have seen in the last few weeks is just the start, significantly more is being planned,” said one Western diplomat, referring to a freedom of navigation patrol late last month that used two U.S. ships for the first time.

“There is a real sense more needs to be done.”

While the Pentagon does not directly comment on future classified operations, there is a reason to believe that more naval drills are set to intensify in the second half of 2018. Last month, we reported that the U.S. Navy conducted its “freedom of navigation” patrols near the islands to demonstrate the right to sail through the international waters, even as President Donald Trump asked Beijing for cooperation on North Korea.

Even though the naval operation had been planned for many months in advance, this was the first time where two U.S. warships used the “freedom of navigation” card to sail miles from the heavily disputed islands.

In response to Beijing’s recent militarization of its islands, the Pentagon withdrew an invitation for the People’s Liberation Army Navy (PLAN) to participate in a massive multinational naval exercise off Hawaii’s coast this summer.

During the IISS Shangri-La Dialogue summit on Saturday, Mattis blasted Beijing for the militarization of artificial islands in the South China Sea and warned there could be “much larger consequences” in the near term. He said China’s militarization in the region was now a “reality” but that Beijing would face unspecified consequences.

Last month, China conducted military drills over – and on – heavily disputed islands in the South China Sea, as the People’s Liberation Army Air Force (PLAAF) for the first time landed several strategic bombers on the islands, triggering concern from Vietnam and the Philippines.

Chinese bombers including the H-6K conduct takeoff and landing training on an island reef at a southern sea area pic.twitter.com/ASY9tGhfAU

— People’s Daily,China (@PDChina) May 18, 2018

At the IISS Shangri-La Dialogue, Senior Col. Zhao Xiaozhou, of the People’s Liberation Army’s, hinted in a question to Mattis that the U.S. Navy’s recent freedom of navigation around the islands could be defined as militarization.

“Mattis’ speech was negative,” Zhao said in an interview afterward.

“If China’s islands and reefs are continuously threatened by activities under the name of so-called freedom of navigation, China will eventually station troops on these reefs.”

Speaking to reporters at the Singapore conference, Lieutenant General He Lei defended Beijing’s military build-up in the South China Sea, blasting the “irresponsible comments” made by Mattis, who on Saturday accused Beijing of threatening its neighbors in the heavily disputed waters and warned China of “consequences” if it continues weaponizing the South China Sea.

“It is China’s sovereign and legal right for China to place our army and military weapons there. We see any other country that tries to make noise about this as interfering in our internal affairs,” He said.

Singapore-based military strategist Tim Huxley told Reuters while increased international pressure might slow China’s militarization efforts, however, the momentum will be hard to stop.

“China has created a new reality down there, and it is not going to be rolled back,” Huxley said.

“They are not doing this to poke America or their neighbors in the eye but they are almost certainly doing this to serve their long-term strategic objectives, whether that is projecting their military power or securing energy supplies.”

The amount of insight from Mattis and General He Lei at the IISS Shangri-La Dialogue this past weekend has provided us with the understanding that tensions in the South China Sea are about to significantly flare up in the second half of 2018 and beyond. Nevertheless, the clues from Reuters about their conversation with U.S. officials familiar with the situation confirms that one of the world’s most volatile areas could soon be much closer to war than we thought.

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Authored by Tom Luongo,

The latest twist of the Nordstream 2 Saga is the U.S. is now threatening to sanction the European companies acting as Gazprom’s financier’s for the pipeline.  This threat has been there since President Trump signed the sanctions bill spearheaded by a dying John McCain last summer.

But, don’t let appearances fool you.  Trump wasn’t reluctant about signing that bill.  He welcomed it.  He went to the Three Seas Summit with “European Energy Security” on his lips and trade tariffs/barriers in his heart.

He knew where this would lead.  And so did we.  The recent report from RT linked above reveals just how desperate the U.S. is to stopping Nordstream 2, and, frankly, it’s pathetic.

“Everything is on the table. The administration is taking a whole-of-government approach to stopping the Nord Stream project,” the source said, as cited by the media.

Last summer, Congress approved the so-called Countering America’s Adversaries Through Sanctions Act (CAATSA). The legislation allows the White House to introduce punitive measures against the participants of the energy project, investing over $5 million in those enterprises.

“We have been clear that firms working in the Russian energy export pipeline sector are engaging in a line of business that carries sanctions risk,” a State Department spokeswoman told the media.

Trump and his increasingly erratic foreign policy inner circle continue to up the stakes for European companies and countries that do not go along with his plans to remake the world in his image.

Nordstream, along with Turkish Stream and potentially a revived Southstream into Bulgaria represent an existential threat to U.S. control over European politics and its economy.

Losing Face

So, it’s no wonder why the U.S. is taking such a hard-line approach to Nordstream 2.

But even if sanctions against companies like Royal Dutch Shell, OMV, Uniper, Engie and Germany’s Wintershall, the investors in Nordstream 2, pressure them to call their loans to Gazprom, if that’s even possible without significant losses, that won’t stop the pipeline from being built.

Because, it’s not like Russia doesn’t have the resources to reroute to Gazprom and offer ruble-denominated loans to cover any pull-out.  It does.

Moreover, all legal challenges to the pipeline have failed.  Permits have been issued.  Oil prices are high so Russian government coffers are in good shape.  Russian banks are carrying just 1.3% non-performing loans on their books and the Bank of Russia is, slowly, lowering interest rates.

So, at this point, you have to wonder what the point is of continuing the charade that Nordstream 2 can be stopped?

To my mind, the biggest issue is one of saving face at this point.  The U.S. has invested so much political capital in stopping Nordstream 2, losing out and watching it get built is a monument to its lost influence in Europe.

Remember, Trump went, practically hat in hand, and tried to bribe German Chancellor Angela Merkel to stop Nordstream 2 last month when she was in Washington to get him to not leave the JCPOA.

Neither budged.  Trump wants Merkel to spend 3% of GDP on NATO.  She moved it up to 1.5%.  He slapped steel and aluminum tariffs on.  He’s mulling banning German luxury car imports.  Bullies bully because they are weak.

Merkel visited Putin twice and resurrected an EU law that punishes companies for bending to foreign government demands.

But, as I’ve been saying for over a year now, Europe is staring a sovereign debt crisis in the face.  Merkel’s position as Chancellor in Germany is weak and could collapse by the end of Trump’s first term.

Third Wave of Opposition

It is possible that Gazprom could run afoul of the EU’s Third Energy Package over the part of the pipeline that crosses Germany’s territorial waters if its European financiers pull out thanks to Trump’s sanctions threats. But, even then, the worries over that are about tariff structure of delivered gas, not about ownership.

A deal can be worked out once the pipeline begins shipping gas, around the same time that a new deal with Ukraine’s Naftogaz will be needed.  Those two issues are linked but very solvable.

The Third Energy Package is why Southstream was originally canceled because the EU included a clause demanding the pipeline’s owner and operator be unbundled. This means that Gazprom gets to build the pipeline but can only own 50% of it.

The U.S. put heavy pressure on the Bulgarian government to stop it as well, which ultimately cost them their jobs.

Nordstream 2 was designed to be a joint venture between Gazprom (50% ownership) and a 10% stake by the five companies I listed above.  Poland nixed the JV in January of 2016, prompting the current arrangement with those five companies loaning their stake to Nordstream 2, a wholly owned subsidiary of Gazprom, to build the pipeline.

The terms aren’t as good this way, but it was the only way to get the pipeline off the ground.  By having these companies from core EU countries invested, Nordstream 2 was a brilliant piece of political maneuvering, which would always lead us to the current situation.

Reality Strikes Back

Trump is fighting against the economic tide with his opposition to Nordstream 2.  He won’t be able to stop Turkish Stream from bringing gas into Eastern Europe, the very countries he’s trying to bolster with his opposition to Nordstream.

It is Poland and the Baltics who stand to lose the most over Nordstream 2.  The Neocons that infest Trump’s cabinet are still convinced they can pressure Russia into a mistake in Ukraine, dumping billions into a sinking ship to goad Putin into invading on behalf of the separatists in the Donbass.

He hasn’t done it yet in nearly four years, it isn’t likely to happen now, especially with UAF desertions rising catastrophically, no matter how many anti-tank guns we ‘sell’ them or hospitals they bomb.

They still dream of putting missile ‘defense’ systems on Russia’s border to intimidate Putin into submission.  They are, to paraphrase Darth Vader, as clumsy as they are stupid.

But, with the Russia inching closer to putting its hyper-sonic weapons into the field and Europe vulnerable financially and politically, this is the last chance they have to stop Eurasian integration and continue the Empire.

Trump is threatening people he has transitory leverage over in the EU.  Nordstream 2 is a path to EU independence, not slavery to Russia.  The EU’s politics are not controlled by Russian imperatives.  So, all talk of “European Energy Security” is complete nonsense.

This is about maintaining the post-WWII institutional control the U.S. and the U.K. have had for the past three generations.  But, the rest of the world has had it.  Europeans have had it with their leaders doing Washington’s and Wall St.’s bidding.

This is where the populism is coming from.  And if Merkel wants to last out her full term she has to stand up to Trump over Nordstream 2, back the companies she’s supposed to protect from foreign influence and come up with a better way.

The rest of the world is ready to switch to euros and yuan to settle their trade.  Iran, China and Russia are inviting Trump to act like he is.  They want him to burn bridges, make unreasonable demands and transparently push policies against his allies’ best interests.

It makes it easier for them to break down the barriers to new relationships.  To end frozen conflicts like a divided Korea, an intractable Iran/Israel divide and a Russian/Japanese state of war.

If he pushes the world into a full-on trade war the subsequent debt deflation (beginning now) will not be controllable the way it was in previous iterations of strong dollar ‘diplomacy.’  And it may provide the perfect opportunity for Europe to find out just who its friends truly are.

*  *  *

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The situation surrounding Italy “must have become serious” for The European Union, because it appears EU Commission President Jean-Claude Juncker is lying once again.

Juncker who in 2011, in the depths of the EU crisis, admitted “when it becomes serious, you have to lie” said this weekend that, while he had been tempted to intervene during the recent political impasse in Italy, he was determined not to feed the populist narrative: that the EU is meddling in domestic affairs.

As Giuseppe Conte was sworn in as Italian prime minister on Friday – after a last-ditch coalition deal between the two parties ended months of political deadlock and narrowly averted the need for a snap election in the eurozone’s third-largest economy – Juncker proclaimed:

 “By keeping out of it, I’m not helping. By getting involved, I’m not helping. I am caught between a rock and a hard place.”

Throwing the new government in Rome an olive branch, saying that Brussels and “German-speaking countries” must not repeat the error made during the Greek crisis by reading stern lectures to the Italian people.

In an interview with German news service RedaktionsNetzwerk, Juncker admitted to “concern” about the recent developments in Italy, but insisted that the recent turmoil in the financial markets in response to the new government had been “irrational” and should not be seen as a guide to how the political story will unfold in Rome.

“I think very highly of President Mattarella, but I have not spoken to him during this crisis. I have not interfered, although I have been tempted to,” Juncker said.

“I do not want to feed the accusations spread by the populists that we are sitting in Brussels meddling in Italy’s affairs. I am certain the Italians have a keen sense of what is good for their country. They will sort it out.”

Juncker offered a more placatory tone, suggesting that Brussels and Berlin had learned the lessons of the Greek crisis. He also denied that the eurozone was set on a course for another economic downturn:

“The Italians cannot really complain about austerity measures from Brussels. However, I do not now want to lecture Rome. We must treat Italy with respect. Too many lectures were given to Greece in the past, in particular from German-speaking countries. This dealt a blow to the dignity of the Greek people. The same thing must not be allowed to happen to Italy.”

Juncker said that the financial markets’ reaction was “irrational”:

“People should not draw political conclusions from every fluctuation in the stock market. Investors have been wrong on so many occasions.”

But, as The Guardian reports, the commission president had flirted with danger on Thursday by suggesting that the EU should not be blamed for the state of Italy’s poorer regions, where there needed to be “more work” and “less corruption”. Rather than blaming the EU, there needed to be more “seriousness” within the country about tackling its economic and social problems, he said.

Does J-C really expect us to believe he is going to just leave the Italians well enough alone to their ‘democracy’ and they ‘sovereign’ decisions? We already know The ECB screwed Italy over – so what is Brussels’ evil plot to pressure Conte et al. back to the heart of darkness?

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