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Easing Bond Rout Stabilizes Global Markets, But Surging Dollar Keeps Traders On Edge

Courtesy of ZeroHedge. View original post here.

Following yesterday’s rate spike-driven market rout, S&P futures have steadied alongside European stocks as global markets stabilized thanks to an easing in the bond selloff, leading to speculation that the worst may be over. 

US equity futures were all roughly unchanged on Wednesday morning as Europe’s Stoxx 600 Index drifted, pressured by the latest political chaos out of Italy, while Asian stocks dipped slightly, with Japan’s Nikkei and Hong Kong’s Hang Seng declining while Australia’s AX rose 0.2% and Korean stocks were little changed, despite North Korea’s unexpected threat to scuttle the peace process.

The big story, however, was the stabilization in US Treasurys, which after suffering a spectacular drop on Tuesday, some some modest buying, with the yield on the 10Y dipping to 3.06%, once again close to the critical 3.05% level.

10-year Treasury yields will move in a 3%-3.5% range for the rest of the year as the Federal Reserve continues raising interest rates, said Robert Mead, co-head of Asia-Pacific at PIMCO: “We do think this hiking cycle is quite well advanced,” he says, “Nothing is pound-the-table cheap,” but rising yields mean investors can gradually reduce their underweight bond positions, Mead said.

Yesterday’s slump in Treasurys led to a surge in Treasury vol, with the MOVE bond volatility index surging the most since the February volocaust.

And while the pressure on US Treasurys eased, Italian bonds slumped and the country’s stocks underperformed as populist parties set to fomr Italy’s new government discussed a potential €250BN debt write-down from the ECB as noted earlier. As a result, Italian 10Y bonds sold off aggressively from the open, widening spread to bunds by 10bps.

Italy’s FTSE MIB also underperformed core European equity markets, led by the bank sector -2.5%. Concerns about Italy also sent the EUR under pressure, with the EUR/USD sliding to session lows below 1.18.

That said, looking at the dollar, there is the possibility that we are merely in the eye of the hurricane, as the recent catalyst behind the entire market move, the dollar, rose a fourth day, helped by Euro weakness and ongoing EM fears. Once again it was the Turkish Lira TRY led EMFX lower in continuation of recent collapse.

For now, however, markets welcome today’s relative stability especially after the latest uncertainty about the U.S.-North Korea summit, which has resurfaced just as violence flares in Gaza, the IMF warns on the threat protectionism poses to global growth, Italy stands on the brink of a euro-skeptic government, and US rates are rising in anticipation of more Fed rate hikes, in the process crushing US consumer loan demand.

Meanwhile, that “other” major risk refuses to go away: while emerging-market equities steadied following Tuesday’s plunge and Argentina’s recent rout, the resumption in the dollar spike pushed developing currencies lower and the lira weakened again. The Thai baht, South Korean won and Indonesian rupiah led Asian declines. The Malaysian ringgit fell for a sixth day after overseas investors pulled out a net $376 million from stocks over Monday and Tuesday in the wake of last week’s election.

Expected data include mortgage applications, housing starts, and industrial production. Cisco, Macy’s, and Take-Two are reporting earnings

Market Snapshot

  • STOXX Europe 600 up 0.1% to 392.80
  • MXAP down 0.1% to 174.51
  • MXAPJ down 0.03% to 569.34
  • Nikkei down 0.4% to 22,717.23
  • Topix down 0.3% to 1,800.35
  • Hang Seng Index down 0.1% to 31,110.20
  • Shanghai Composite down 0.7% to 3,169.57
  • Sensex down 0.3% to 35,430.00
  • Australia S&P/ASX 200 up 0.2% to 6,106.96
  • Kospi up 0.05% to 2,459.82
  • German 10Y yield fell 1.2 bps to 0.633%
  • Euro down 0.02% to $1.1836
  • Italian 10Y yield rose 2.5 bps to 1.697%
  • Spanish 10Y yield rose 1.2 bps to 1.371%

Top Overnight News from Bloomberg

  • The leader of Italy’s anti-migrant League Matteo Salvini said talks with the anti-establishment Five Star Movement on a populist government have entered their final lap. Italian bonds slumped, driving benchmark yields to a two-month high amid the view that populist parties would seek a debt write-off involving billions of euros
  • North Korea threatened to walk away from its meeting with President Trump next month if the U.S. made a “one-sided demand” for the regime to surrender its nuclear weapons. Earlier Wednesday, North Korea abruptly canceled talks with South Korea
  • Turkish central-bank governor to meet President Erdogan, NTV reports; central bank says it will take “necessary steps”
  • The U.S. 10-year yield rose as high as 3.093% on Tuesday, climbing the most in three months to surpass the intraday peak from Jan. 2, 2014. Traders are now looking at the 3.2% area, which would match the highs seen in mid-2011, just before S&P Global Ratings downgraded the U.S.
  • The European Union set out to identify “practical solutions” for salvaging the Iran nuclear accord within weeks, as the bloc strives to contain the fallout from President Donald Trump’s decision to pull the plug from the landmark deal.
  • U.K. Prime Minister Theresa May will publish a detailed plan for the country’s post-Brexit relationship with Europe next month, setting a deadline for her warring Cabinet to agree on a common stance. The policy document, known as a white paper, will be released in June, according to a government official; The upper house of the U.K. Parliament will seek to inflict a final defeat on May’s flagship piece of Brexit legislation on Wednesday
  • The Trump administration is delivering the World Trade Organization “three hard blows” that could destroy the body’s ability to regulate global commerce, China’s ambassador to the Geneva-based body said
  • Federal Reserve Bank of San Francisco President John Williams said he’s “very positive” about the economic outlook and reiterated that three to four interest-rate increases this year was appropriate

Top Asian News

  • China’s Holdings of U.S. Treasuries Rise to Five-Month High
  • Japan’s Two-Year Growth Streak Snapped as Economy Contracts
  • Thailand Doesn’t Feel Pressure to Join Global Tightening
  • Elliott Wins Allies in Blocking Hyundai Motor’s Restructure Plan
  • Didi Shakes Up Car Pooling Safety After Passenger Murdered

Top European News

  • Fatal Tesla Crash in Switzerland Probed by Ticino Prosecutors
  • Goldman Gets Flashback to Yukos as Russia’s Recovery Falters
  • Repsol Said to End Hunt for Oil Growth in Clean Energy Tilt
  • The Worst Day Since 2011 Leaves Pandora A/S Investors in Shock
  • Merkel Calls for Euro Reform as ECB Policy Won’t Last Forever

Looking at the day ahead, this morning the early focus will be in Germany where the final April CPI revisions are due to be made, although no change from the -0.1% mom flash estimate is expected. Shortly after that we have the broader April CPI report for the Euro area which is expected to confirm the seasonally-impacted +0.7% yoy core reading. Over in the US the main focus is likely to be on the April industrial production print (+0.6% mom expected) along with capacity utilization.  April housing starts and building permits data is also due. Away from the data the BoE’s Sarah John is scheduled to speak in a few hours’ time in Liverpool at a conference I spoke at yesterday (I’m not sure my comments got any attention), before an ECB conference this afternoon in Frankfurt has President Draghi giving the welcome address, along with comments from officials Coeure and Praet. Over at the Fed, Bostic is due to give an economic update at 1.30pm BST and Bullard is scheduled to speak to media at 10.30pm BST.

US Event Calendar

  • 7am: MBA Mortgage Applications, prior -0.4%
  • 8:30am: Fed’s Bostic to Give Economic Update

  • 8:30am: Housing Starts, est. 1.31m, prior 1.32m; Housing Starts MoM, est. -0.68%, prior 1.9%

    • Building Permits, est. 1.35m, prior 1.35m; Building Permits MoM, est. -2.1%, prior 2.5%
  • 9:15am: Industrial Production MoM, est. 0.6%, prior 0.5%; Manufacturing (SIC) Production, est. 0.5%, prior 0.1%
  • 10am: Mortgage Delinquencies, prior 5.17%; MBA Mortgage Foreclosures, prior 1.19%
  • 5:30pm: Fed’s Bullard Speaks to Media

DB’s Jim Reid concludes the overnight wrap

Given that 10 year US Treasuries hit their highest level for seven years (+7.0bps to 3.073% and 3.093% at the intra-day highs) yesterday I can’t help but wonder where they would be today if we hadn’t had the softer than expected US average hourly earnings and CPI data over the last two weeks and also if there wasn’t such a large short base out there. Probably breaking well through 3.25% I’d imagine. Don’t panic bond bulls though as whenever we remind readers of our note from early this year entitled “Why yields and rates are rising and why they’ll continue to?” bonds immediately rally.

One of the significant things about yesterday’s move was that 10yr USTs crossed the intraday taper-tantrum high of 3.052% from the start of 2014 and this morning are holding around 3.061%. After failing to hold above 3% numerous times, could this mean that they’ve finally crossed the Rubicon? It’s also worth noting that 30y yields were +6.6bps higher yesterday at 3.201%, while the 2s30s curve steepened +4.1bps. For comparisons sake, back in 2011 when 10 year yields were last at these levels 2yr yields were around 0.4% and 30yr yields were around 4.3% so today’s level are a testament to how much flattening the curve has still seen in recent years as 10yrs have returned to the same level. For reference 10yr Bunds were around 3% back then so that continues to be one of the most crazy global financial markets. They did climb 3.3bps to 0.641% yesterday as most core European 10yr yields climbed 2-3bps with Gilts (+4.6bp) the regional under-performer perhaps on the back of firm wages (see below).

A hat-tip to DB’s Alan Ruskin who pointed out that not only does the US have the highest 2y, 5y and 10y yields in all of the G10, but its 5y yield is now higher than any available 10y yield in other G10 countries. Even the US 3y yield (2.737%) is higher than all G10 countries’ 10y yields except Australia’s 10y (2.869%).

As for what triggered yesterday’s move, yield rises, dollar strength and risk off all really started to get going after the solid but not necessarily spectacular US retail sales report and also similarly solid data from the manufacturing sector (more on both of that below). Again what would have happened had retail sales been a bumper report? Elsewhere 10y US Breakevens also nudged up a couple of basis points and are back to YTD highs and near 4 year highs while the USD index rallied +0.68% and also to a new year-to-date high. The market-implied probability of 4 Fed rate hikes (or a further 3) also broke above 40%. Bear in mind that this was as low as 18% back in April.

The combination of that bond sell-off and a stronger USD was a perfect cocktail for weakness across riskier assets though. As has been the trend lately, this was most pertinent in EM, especially early in the US session immediately after US retail sales, higher yields and a stronger dollar. However a 50bps rally from the highs for the session actually left 10yr Argentina debt 23bp tighter on the day after the market drew some confidence from getting a bond auction away and the complex came off its worst levels for the session. Bonds were generally still weak as Brazilian 10yr notes were 12bps higher.

It was a similar weaker story for EM FX with currencies in Colombia, South Africa, Turkey, Chile and Poland all falling 1-2%. Turkey continuing its recent weakness as President Erdogan suggested that he’ll take more control of monetary policy if he won an election next month. In fact if there’s one asset class where the ‘sell in May and go  away’ phrase holds true this year its EM currencies. The woes in Argentina are well known and the Peso has depreciated a remarkable -13.33% so far in May despite a +4.09% rally yesterday, while the Turkish Lira is down -8.11%, Mexican Peso -4.45%, Brazilian Real -3.78%, Polish Zloty -3.33% and Hungarian Forint -2.95%. Indeed it’s been difficult to hide although the Russian Ruble can take some comfort for being up +1.36% in May – making it the only EM currency to buck the trend.

Meanwhile, the broader equity complex also sold-off in tow yesterday. The S&P 500 finished last night -0.68% and the Dow -0.78% – the latter snapping a run of 8 consecutive positive daily returns. Europe also wiped out early gains with the Stoxx 600 just in positive territory after a late rally to end +0.05% with most other continental bourses either side of the flat line. WTI Oil initially soared +1.60% before retail sales, then slumped a couple of percent late US morning time before closing around unchanged, seemingly being held back by the Dollar move. Interestingly Gold (-1.75%) also sold-off despite the broader risk-off tone, so there didn’t appear to be anywhere to hide.

This morning in Asia markets have also had to contend with the latest North Korea developments which broke last night. North Korea’s vice foreign minister, Kim Kye Gwan, has called the US demands to surrender its nuclear weapons “one-sided” and also as driving North Korea “into a corner”. Subsequently, Kim Kye Gwan said that North Korea will be forced to reconsider proceeding to a possible summit with President Trump next month. In fairness markets haven’t appeared to be greatly worried by the comments with the Kospi in particular up +0.05%. The Nikkei (-0.15%) and Shanghai Comp (-0.28%) are only modestly in the red too. Meanwhile bond markets in Asia have followed the lead from the US yesterday. Yields in the antipodeans are up +5bps while yields in the likes of Malaysia and Indonesia are between +4bps and +5bps higher too. In line with EM weakness yesterday, Asia FX is also softer with the Thai Bhat (-0.47%) and Indonesian Rupiah (-0.40%) leading losses.

Back to yesterday, given the packed schedule, economic data was always likely to be a factor for markets. In the US the April retail sales report was seen as fairly solid when taking into account the upward revisions to prior months. Of particular significance was the control group component which rose +0.4% mom and in line with expectations, albeit with March and February data both revised up a tenth which could be taken as a positive for potential upward revisions to Q1 growth. Meanwhile the May Empire Manufacturing print came in at 20.1 (vs. 15.0 expected) which was an increase of 4.3pts. The prices paid components again confirmed other surveys this year and rose to the highest level in several years.

In Europe there were no final surprises from the second revision to Q1 GDP for the Euro area at +0.4% qoq and +2.5% yoy, however Germany was a slight downside surprise at +0.3% qoq (vs. +0.4% expected). Our economists do however expect growth to rebound in Q2 to +0.5% qoq and have a 2018 forecast of +2.0% yoy.

Where there was some good news however was in the UK where the March earnings numbers came in fairly solid. As expected, weekly earnings ex bonuses rose a tenth to +2.9% yoy, implying a pickup in the run rate again. The unemployment rate also held steady at 4.2% while Q1 employment rose a healthy 197k (vs. 125k expected). So that data should comfort the BoE somewhat. Sterling was actually weaker yesterday (-0.40%) albeit more due to the broad Dollar strength.

Staying with the UK, it was announced yesterday that PM May will publish a Brexit white paper next month ahead of the EU Summit on June 28th, representing something of a key milestone for May’s cabinet to come to a unified stance with the customs union debate likely to be the focus. So another potentially important Brexit date to be aware of.

In terms of the day ahead, this morning the early focus will be in Germany where the final April CPI revisions are due to be made, although no change from the -0.1% mom flash estimate is expected. Shortly after that we have the broader April CPI report for the Euro area which is expected to confirm the seasonally-impacted +0.7% yoy core reading. Over in the US the main focus is likely to be on the April industrial production print (+0.6% mom expected) along with capacity utilization.  April housing starts and building permits data is also due. Away from the data the BoE’s Sarah John is scheduled to speak in a few hours’ time in Liverpool at a conference I spoke at yesterday (I’m not sure my comments got any attention), before an ECB conference this afternoon in Frankfurt has President Draghi giving the welcome address, along with comments from officials Coeure and Praet. Over at the Fed, Bostic is due to give an economic update at 1.30pm BST and Bullard is scheduled to speak to media at 10.30pm BST.


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