- Global equities continue to rally on eurozone optimism.
- Short-dated Spanish and Italian bonds continue to perform strongly.
- Bernanke argues that economic indicators might paint too rosy a picture.
The positive market sentiment that started on Friday when financial markets changed their view on the ECB stance and the employment report surprised on the upside continued yesterday and the S&P 500 index was sent to a three-month high at 1,394, gaining 0.2% after jumping 2% on Friday.
The rally in short-dated Italian and Spanish bonds also continued yesterday. The Spanish 2-year yield dropped 44bp to 3.37% and Italian 2-years dropped 7bp to 3.0%. The rally in peripheral debt gained momentum as it became clear that Merkel and her government back the plan announced by ECB President Draghi last week. According to Bloomberg German government spokesman Streiter said that Germany has “no doubt” that the ECB is acting within its mandate.
However, Draghi’s big master plan can still derail. Especially, it seems that the political climate between Italy and Germany has worsened after Italian Prime Minister Monti in an interview with Der Spiegel yesterday said that Bundestag control over EU debt policies threatens to bring about “disintegration” of the EU project. The comments have evoked furious reactions from German politicians. In our view one of the biggest concerns for financial markets at the moment is a political deadlock meaning that neither Italy nor Spain would ask for help.
Even though the rally in equities continued yesterday, US Treasuries managed to perform after two days of decline. The yield on the 10-year note fell slightly and is this morning trading at 1.56%. Treasuries were supported by comments from Fed Chairman Bernanke. He said that indicators of strength in the US economy may fail to measure the struggles faced by individuals, indicating in our view that despite the slightly stronger labour market report on Friday the market should be prepared for further stimulus at the September FOMC meeting.
After some initial sell-off in both NOK and SEK yesterday, both EUR/NOK and
EUR/SEK have once again edged lower overnight. In our view it reflects that both currencies are supported by the positive risk sentiment and that the initial fears of safehaven unwinds in both currencies were unfounded. We continue to see EUR/NOK and EUR/SEK trading close to current levels despite the eurozone optimism.
Global Daily
Focus today: Market attention will continue to centre on when Spain could ask for assistance and details on how ECB could intervene. This is likely to continue over the coming weeks. The political leaders in Spain are now slowly preparing the public and the political community internally for a reversal of this issue and it could take weeks or maybe more than a month before Draghi’s vision matures. How long will depend both on market developments and signals from Frankfurt on the details of the expected ECB support.
The most interesting release today will also come from Southern Europe where Italy will release its flash Q2 GDP reading. Consensus expectation among analysts is a drop of 0.8% q/q, unchanged from Q1. We expect a substantial drop but see upside risk relative to the very negative consensus view.
German factory orders could attract some attention as well and Bernanke will be speaking on financial education in the US session. Any comments on how he has digested Friday’s payrolls could have market impact as analysts remain divided on the likelihood of further QE in September.
Fixed income markets: Despite the ongoing positive risk sentiment yesterday, there are few signs that safe-haven bonds are getting further hit. The Bund gained back some of the losses from Friday’s sell-off and long Treasuries yields declined marginally. There are no major events scheduled for today. Hence, the markets are expected to trade more or less sideways. Focus will remain on the short end of the Italian and Spanish bond curves, which continued to perform yesterday. In the fixed income markets the US treasury is printing USD32bn 3yr notes. There is no bond supply out of Europe.
FX markets: In the FX market the euro continues to be well supported as Spanish and Italian borrowing costs are being driven lower. We believe that EUR/USD has further upside, not least given the many short euro positions in place. In Asia JPY remains well supported despite financial optimism with USD/JPY trading at 78.25 this morning. Analysts no longer expect additional monetary easing from the BoJ when the monetary policy meeting starts tomorrow. AUD is also well supported with USD/AUD at the highest level since March this year as the RBA left the policy rate unchanged at 3.5% this morning.
Scandi Daily
Norway: Industrial and manufacturing production numbers are not expected to attract much attention but they could give us an idea whether Norway - contrary to Sweden - has been affected by the drop in activity in the eurozone. Also note that Industrial production numbers might be somewhat affected by the oil strike in Norway that came into effect on 24 June.
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