Today we enter an important two or three days for Europe with a stretch of data that may determine whether the ECB can find the justification to aggressively act at next week’s meeting. First we have today’s flash PMIs in Europe overall and in Germany and France specifically. Although we won’t see any early signs from the periphery we should get an idea of where the momentum is from the numbers. Then tomorrow and Wednesday we see the ECB lending survey and region-wide M3 numbers.
If the numbers are bad then maybe there would be an excuse to activate LTRO III and/or ease collateral rules. It could be justified on the basis that the monetary policy transition mechanism wasn’t working properly. Even if they don’t act the market might start to price in the expectation of it if this week’s data is bad. For us we think the hurdle for the ECB to act next week is high. Earlier in the year they suggested that LTROs were temporary measures and that it was up to Governments to fix the structural problems. With the ESM available will the ECB not see that as the first port of call for any country in need of funding assistance? Difficult to tell although Draghi
yesterday told the Le Monde that “we are very open and we do not have any taboos”.
Whoever intervenes, the price action yesterday suggested that something needs to happen soon. Spanish 10yr bond yields hit an intraday high of 7.56% and the IBEX and FTSE MIB fell as much as 5.4% and 5.2% at one point yesterday with the IBEX being down around 11% over a business day and a half. Facing a free falling market we then saw a combination of short selling ban announcements and headlines that the “EU can find solutions to avoid Greece’s funding problems in August”. This certainly seemed to help markets find a bottom yesterday. The IBEX (-1.10%) and FTSEMIB (-2.76%) closed well off their lows although core euro markets finished the day at the lows with the DAX and CAC down -3.18% and -2.89% respectively. Perhaps shorts rolled into markets where there was no ban.
Whilst Spanish yields were off their intraday highs, 10 year bonds rose 23bp and again closed at a fresh euro-era high of 7.50%. More worryingly were the moves at the front end. The 2yr spiked 77bps to a new high of 6.53% and the 2s/10s curve has compressed dramatically to just 97bp from 217bp a week ago. For the record later during the day LCH Clearnet announced a margin hike on Spanish and Italian government bonds.
These eurozone concerns are clearly not being helped by Moody’s action on core Europe overnight. The rating agency overnight revised its outlook on the Aaa rated Germany, Luxembourg and Netherlands to Negative on rising uncertainty about the crisis. Whilst this brings Moody’s rating/outlook on Luxembourg and Netherlands in line with S&P, Germany is still AAA/Stable by S&P.
Asian markets are taking the news relatively well overnight. Main equity indices are moderately lower across the board but markets have stabilised. The Nikkei and the Shanghai Composite are about 0.3-0.4% lower although this has been enough to send Chinese markets back to levels last seen in March 2009 when financial markets were in meltdown mode. Elsewhere the Hang Seng is still closed following a severe Typhoon in HK overnight. In terms of data, China’s HSBC Flash Manufacturing PMI came in at 49.5 in July, a bit stronger than the 48.2 reading last month but below the important 50 mark. Also overnight Geithner said US is working with Europe quietly behind the scenes – whatever that means.
The announcements yesterday brings back memories of the short selling ban announced in France, Spain, Italy, Belgium and Greece at the height of the market volatility in August last year. Whether such a strategy has made a difference in the past is questionable. The ban last year saw the Stoxx600 immediately gain +3.7% but we then gave back around 6% in the five days following. Looking further back, the unilateral ban from Germany’s BaFin on naked short-selling on selected financials and sovereigns on 19th May 2010 created enough uncertainty to see the S&P 500 and the Stoxx600 close -0.51% and -3.02% on the day before slipping another -4.2% and
-2.5% in the 5 days following. During the depths of the 2008 crisis the co-ordinated short-selling ban that was announced by the FSA and the SEC during the depths of the crisis saw the S&P 500 and Stoxx600 rally +4.0% and +8.3% on the first day of the ban but of course that did not fail to prevent both benchmarks from losing another 28% for the remainder of 2008. Markets may have fallen too fast too quickly since Friday and a ban may offer some near term respite but we can’t help thinking that it is a band-aid solution that does not resolve the fundamental problem that we are currently facing. The increasing frequency of short selling bans also supports our view that we are increasingly moving away from a free market as authorities’ intervention plays an increasing role in investment decisions.
Moving onto today, in terms of expectations on the flash PMIs the market is expecting a flat outcome in the manufacturing and services reading. German manufacturing PMI is expected at 45.1 up from 45.0 in June and French manufacturing PMI is expected to inch 0.3pts higher to 45.5 in July. For the eurozone manufacturing PMI the market expectations are at 45.1 versus 45.0 in June. Services PMI is expected to be down a touch in France to 47.5 (from 47.9), and virtually flat in Germany (at 50.0) and the eurozone (47.1). In other data we also have the French business confidence today. The Troika will also resume their Greek review in Athens today. On the other side of the pond, Markit’s US PMI Preliminary could be interesting. Markets are looking for a small drop to 52.0 in July from 52.5 in June but remember the official ISM dipped below 50 last month. We also get the Richmond fed manufacturing and house price index.
Colin Tan, CFA
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