- Risk appetite returns after the initial disappointment over the ECB meeting as investors now conclude that ECB action will occur, the timing is just unknown.
- Slightly stronger labour market than expected but not strong enough to change the outlook for more Fed stimulus at the September FOMC.
Markets Overnight
On Friday afternoon the non-farm payrolls beat expectations rising to 163,000 versus expectations of 100,000. However, the unemployment rate measured in the Household survey edged higher to 8.3% from earlier 8.2%, which gave the report a more mixed impression and the report was certainly not strong enough to change our view that the Fed will deliver more stimulus at the September meeting, see Flash Comment US: Mixed employment report, 3 August. Note also that Italian central bank governor Visco over the weekend indicated that ECB will cut rates if the economy continues to slow down.
Beside the non-farm payrolls report, all attention Friday night and over the weekend has been on how to understand Thursday’s message from the ECB and on whether Spain and Italy would officially request for aid. The market reaction on Friday that pushed the Euro Stocks 500 index close to 5% higher, EUR/USD above 1.24 and secured a drop in Italian and Spanish 2-year yields of 63bp and 87bp respectively, provided the answer.
Investors now clearly conclude – and we agree – that ECB President Mario Draghi indeed made a smart move on Thursday and that ECB action will occur but the timing is still unclear. As we write in Government Bond Weekly, 3 August, the ECB addressed many of the issues that trouble investors, among others that it will have to deal with the seniority issue. We actually believe that especially short-dated Italian government bonds can rally further even after the latest 100bp rally.
One of the issues the market will focus on is when Spain and subsequently Italy will make the official request for aid. During the weekend Spain’s Minister of Economy Guindos said in an ABC newspaper that Spain will wait until the details of the ECB' bond buying proposal have been set out before it decides whether a formal request for help will be made.
We might therefore be in for a couple of weeks of uncertainly, which could derail current market optimism but remember that Spain has already made commitments in the so-called Memorandum of Understanding so there will most likely be few additional requirements for intervention in the Spanish bond market. Italy could prove more difficult and of course Bundesbank reservations are well known.
The positive market reaction in the European market was carried over to the US with the three major indices closing between 1.7% and 2.0% higher. In Asia markets are also 1-2% higher. EUR/USD has been more or less stable overnight after the rally on Friday. Scandi currencies weakened slightly on Friday as safe-haven money might dry out a bit going forward but the moves has been muted underlining that positive growth and higher yields are still supporting both NOK and SEK.
Global Daily
Focus today: As there are no important economic releases in the calendar today the markets are likely to focus on comments from ECB members and European politicians in view of the debt crisis and the ECB meeting last week.
Fixed income markets: Market sentiment turned 180 degrees on Friday, when Spanish prime minister Rajoy cautiously eased his stance against requesting EFSF aid. Against this backdrop the short end of Italy and Spain performed significantly, which also initiated a global risk rally. Consequently Bunds took back the gains of Thursday and even lost some further ground. At 143 the Bund is now trading at the lowest level in a month. There are no big events today, so markets will probably spend the day consolidating Friday’s big moves.
FX markets: EUR/USD rallied strongly on Friday and the cross was pushed above 1.24 for the first time since the beginning of July after trading below 1.2150 initially after the ECB meeting. The move partly reflects hopes that the ECB will now act much more aggressively – albeit timing being uncertain - and the many short speculative euro positions being in place.
The so-called CFTC data that were released Friday night showed that the market was indeed very short the euro going into the ECB meeting, although the number of so-called net-short positions had been trimmed slightly. Disagreement and concerns whether Spain will actually ask for help and German reservations still have the potential to derail current market optimism, but it seems that a lot of downside risks to EUR/USD have now been taken out of the market. Furthermore, it should be remembered that the euro crisis is certainly not the only potential driver of EUR/USD over the next couple of months.
The latest FOMC meeting made it clear that the Fed is moving towards further easing, probably in the form of quantitative easing (QE3). We expect Fed easing at the September meeting and we know from the first two rounds of quantitative easing in the US that it actually has a negative impact on the dollar when the Fed starts the printer – or rather, the effect often happens ahead of the official announcement.
EUR/GBP was also pushed higher on Friday and the cross has continued higher overnight currently trading at 0.7936. Sterling might very well continue to suffer this week. This week’s main event will be the Inflation report on Wednesday. We look for a soft report paving the way for a rate cut in November. The BoE will most likely revise growth forecasts lower and dampen the optimistic tone struck in the previous Inflation Report from May.
Scandi Daily
Denmark: Forced sales and bankruptcies numbers will be published today.
Sweden: Service production numbers are not expected to attract much attention. Note that we have changed our forecast for policy rates in Sweden after the strong numbers published the past two weeks. The numbers support the view of the ‘hawkish’ Riksbank majority. Hence, the probability that the Riksbank majority will soften up and decide to cut rates in September now appears to be very small. Surely, SEK is steaming ahead and it will certainly be discussed both how much it might pull down the inflation outlook and its potential impact on exporters and foreign trade.
But for now, you hear few complaints from the industry and the trade balance has been very strong in the past quarter. Hence, we adjust our repo rate forecast: we assume that the Riksbank's next cut will not be before December instead of previously expected in September and that it will be followed by a further cut in February. An unchanged policy rate in September should further support SEK, albeit some safe-haven flows might work in the other direction. For more on the outlook for the Swedish market see Reading the Markets Sweden, 3 August.
Norway: No major data releases today.
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