In spite of a pretty poor US retail sales report and fresh record yield lows in many countries, yesterday felt fairly quiet and devoid of any desire to factor in the implications of a Q2 GDP in US that now might struggle to eclipse 1%. Indeed even the IMF’s growth outlook cuts and warning of a looming risk to the recovery failed to attract much focus. Perhaps we’re waiting for Bernanke Part 1 today and
for more news on Spain’s bailout terms on Friday. Indeed as we’ll see below Asia and S&P futures are rallying this morning on fresh QE hopes.
Indeed Bernanke’s testimony comes at an interesting time with many US economists slashing their Q2 numbers. DB’s Joe Lavorgna has made his second downgrade within the space of a week after retail sales (-0.5% v +0.2% expected). His Q2 Real GDP forecast has been cut by another 0.4% to +1.0% which follows on from the full percentage point cut last Wednesday. Regular readers will be aware that this US cycle is now pretty much approaching average length through history and we can’t help thinking that without a significant policy response it will be tough to avoid a recession over the coming year. A lot rests in the fairly constrained hands of Bernanke, Congress and the Senate.
So with 10 year US yields briefly trading through their all time (220-years history in our data) closing lows yesterday there was little signs of panic in equities ahead of Bernanke. The S&P 500 traded sideways below the flat line for most of the day to eventually finish -0.23% lower. The data weakness/QE hopes saw the Dollar Index fall -0.3% as the Euro pounding pauses. So all eyes on Bernanke’s comments today and while we would be surprised if the Chairman isn’t his usual dovish self, he’s unlike to unveil anything new today. Nevertheless markets will pay close attention to his outlook commentary and any possible discussions of easing options and “new tools” that the Fed may have. His speech starts at 3pm London and there will be a Q&A session to follow. All in all the data weakness is leading to a fair amount of flight to quality flows and to notable reappraisal of the front end of interest rate curves. There are now 20 countries that we have found that have sub- 1% 2-year government bond yields of which 6 of those are actually negative – (all in Europe, being Swiss, Denmark, Germany, Austria, Netherlands and Finland). Whatever happened to zero percent mattresses? They’ve been overlooked in these countries above.
Over to European equities, it was a weaker session with the underperformance in Spain being a notable theme. The IBEX (-1.99%) leading the market lower as Spanish banks fell on news that the ESM launch date maybe delayed by Germany’s constitutional court. The court said that it needs eight weeks (to Sept 12th) to determine whether to uphold an interim order which challenges the legality of the ESM and fiscal compact. This is certainly taking longer than expected as our economists had originally expected this to be completed by end of July. In other news, according to Bloomberg, Spain’s Target 2 liabilities has spiked to more than EU370bn and now represents more than half of Germany’s outstanding claims.
Spain’s 10yr bond yields rose 15bp to 6.817% yesterday but with German yields falling 3bps the spread is moving back towards its 2012 highs (16bps away). In fact Italian 10yr spreads closed at their 2012 highs (at 488bp).
The WSJ article that we discussed yesterday around the ECB debating their stance on senior bank bond haircuts, and Merkel’s comments that the Spanish banking loans will be backed by the Government both also weighed negatively on sentiment. The ECB declined to comment on the WSJ story above but it certainly didn’t help Financial spreads as the senior and sub index moved around 7-8bp wider on the day.
Turning to the overnight session the risk tone is quite a bit better with Asian equities higher across the board ahead of Bernanke’s event later. Indeed Gold (+0.36%) is moderately higher and the Dollar Index (-0.16%) continues to fall to an 8-day low. The Shanghai Composite is up +0.5% overnight on news that the government will increase railway infrastructure investment after having reached a 3-year low yesterday. In credit the Japan iTraxx is 2bp wider on the back of some single name weakness. We are also seeing some selling in China HY industrials today on earnings concern. In other overnight stories, Moody’s as expected followed up its downgrade of the Italian sovereign rating last week by cutting 13 Italian banks by one to two notches.
In terms of today, Inflation and IP prints are the notable data releases in the US today. It will be a relatively quieter day in Europe but Germany’s ZEW survey tends to create a buzz around its release (time 10am London). On the earnings front we have a number of corporate heavyweights reporting including Johnson &Johnson, Intel and Coca-Cola. Goldman Sach’s Q2 earnings will also be keenly watched after the recent above-consensus numbers from JPM and Citigroup. But macro will likely again be a main driver today with all eyes on Mr Bernanke!
*** A reminder of our latest Credit Weekly where we will look at potential relative value in European HY, specifically focusing on possible opportunities within the capital structure (essentially secured vs. unsecured bonds). The idea of this note is not to take any directional views on either the market as a whole or on individual names but instead to highlight where potential dislocations exist based on our analysis of the entire universe. We have looked at comparisons based purely on overall spreads as well as spread per turn of leverage and shown that there appears to be a fairly strong relationship between secured and unsecured bonds through the universe. We have identified the names we think have notably deviated from the relationships formed in this analysis and could provide potential trading opportunities.
Colin Tan, CFA
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