Let’s start the week with a bit from Bloomberg’s Richard Breslow who documents the continuation of the reflation trade and (correctly) maps out the critical test facing sovereign yields.
There’s lots of supply coming online ahead of the FOMC call and we can likely divine quite a bit from the auctions. Here’s Breslow’s take:
This is a really important week for Treasuries. And therefore for global sovereigns as well. Whether you look at economic numbers, technicals, sentiment or expected policies, there’s very little to suggest that yields are ready to stop attempting to push higher. Sticker shock may be the only thing to hold things in check, but it sure feels that traders are getting more and more comfortable with these new levels.
There are a lot, lot more people talking 3% for 10s than 2%. No one would have believed that possible back in July. Isn’t it curious how “global headwinds” just fell out of the conversation when it ceased to help describe the price actioWith the whole Treasury curve pushing against support, how this week’s compressed, yet full, schedule of auctions is received in the lead-up to the FOMC is key. Was this last leg of rather impressive bear-steepening part set-up for the sales or a renewed bout of bearishness? Ding, ding, ding: watch 2.50% in 10s
Whether these yields encourage foreign indirects should be key. Are central banks hunting for yield or raising cash to manage their currencies?
Consider how markets are taking new news. Curves steepened smartly on Draghi last week. The Japanese 5s/30s yield curve widened another 7bps today following reports that next year’s expected record issuance was going to put a lot more emphasis on the long end as, surprise, surprise, people are getting fed up buying negative yields
Bond bulls have been keeping their powder dry, to say the least. Levels have been broken ad seriatim
And lest we forget, oil gapped higher this morning on the Saudi output news. WTI is doing its best to prove it can sustain above $50. Nothing deflationary in that. Fascinatingly, it is actually trying to fill the gap left behind from July 2015, which was the last time we were trading at these very levels
If Treasury yields continue higher, it’s going to force the FOMC’s hand at the margin. Just what should those dot plots show? Chair Yellen will have an interesting task, acknowledging the change in bond-market reality without being the cause of it
And the visual (again) for anyone who missed it:
Also, here’s Deutsche Bank’s Jim Reid with his daily market summary (you can read this elsewhere but not this early):
It seems rather apt that in 2016, those of us in the UK last night voted a Finnish lady and resident as the runner-up in the X-Factor TV singing competition. Perhaps globalisation and even the UK’s relationship with Europe is not dead after all! Is it too much though to think this could herald the odd vote for the UK in next year’s Eurovision Song Contest to return the favour? Moving swiftly on so as to gloss over the fact that I watch the X-Factor, outside of Bronte’s second birthday today (what an impact my first dog has had on me), the main event this week is of course the likely 2nd US rate hike (Wednesday) in this cycle 10 and a half years on from the last hike in the previous cycle. On our rough calculations we’ve seen over 670 rate cuts globally since the GFC but not much more than a handful of hikes. So this is a pretty monumental event. Yellen’s words will be the most closely watched part of the day but it would be a surprise if she deviated too far from her remarks to Congress back on November 17th with perhaps the key message being that it was too early for her to judge the impact of President-elect Trump’s potential fiscal plans. With little additional info to add on this since the testimony she’s unlikely to rock the boat. Whether other members feel the same will be unveiled in the dots. So keep an eye out for that. We’ll preview in full on Wednesday. There’s a fair amount of US data alongside the FOMC this week. Given the ECB meeting last week and the recent run up in oil we’ll be particularly interested in CPI on Thursday. The reason we mention the ECB and oil is that the discussion within DB research last week was how crucial oil has been to the ECB’s policy in recent years (the hike in 2011 and negative rates and QE more recently) and how we may have to watch it in 2017 for any signs that the taper announced last week looks set to go much further in 2018. Obviously the opposite could also happen but the news over the weekend that non-OPEC countries have joined in with production cuts makes things interesting. Indeed the latest update is that Russia along with 10 other non-OPEC members have agreed to a production cut of 558k barrels per day. That’s in conjunction with the 1.2m barrels per day reduction agreed upon by OPEC members at the Vienna meeting on November 30th. That’s not all as Bloomberg is also reporting that Saudi Arabia is supposedly signalling that it might be ready to cut output more than it had initially suggested at that meeting. Saudi’s Oil Minister was reported as saying that ‘effective January 1st we’re going to cut and cut substantially to be below the level that we have committed to on November 30th’. Unsurprisingly the news of a now coordinated agreement has seen Oil rally again this morning. WTI is currently +4.76% as we type and around $54/bbl (and the highest since July 2015) while Brent is up a similar amount and trading above $56/bbl. While energy stocks are generally outperforming in Asia this morning its still been a much more mixed start to the week. The Nikkei (+0.52%) is leading the way and in the process has bounced back into positive territory for the year, although it has pared back much stronger gains at the open. The ASX (+0.14%) is also slightly higher while the Kospi is flat. The Hang Seng (-1.12%) and Shanghai Comp (-2.03%) have weakened however with property names in particular under pressure after the president of one of the largest Chinese property companies painted a bleak view about the prospects for real estate sales in the year ahead. Some weakness in the insurance sector is also weighing. The other big story for markets at the moment is Italy. More specifically, its Italy’s banking system that’s in the spotlight after being under pressure again on Friday following the news that the ECB had rejected a timeline extension for a proposed recap in the sector. Reports this morning suggest that a planned capital raising is to still go ahead in the next couple of days following a meeting yesterday. The FTSE Italia Banks index was down -2.25% on Friday (versus the FTSE MIB at -0.73%) while sub spreads on 3 of the nation’s banks were 9bps to 18bps wider. Still, Italian Banks closed over +12% higher last week while the simple average of the 4 Italian banks in the sub financial index rallied 36bps (versus a 12bp rally for the wider index). We’ve also since had the news that Foreign Minister Paolo Gentiloni has been appointed as the new PM and given a mandate to form a new government. According to newswires, this will allow current Finance Minister, Carlos Padoan, to stay in his current role and manage the banking sector troubles. So this should be another big focus for markets this week. For more on the subject, on Friday, DB’s Marco Stringa (Economics), Paola Sabbione (Bank Equity) and Michal Jezek (Credit) published a joint piece “Italy: Options to address the bank problem”. They focus on two key short-term priorities for Italy: 1) a new electoral law and 2) a solution to the bank problem. On 1), they argue that while it may be controversial (higher risk of 5SM in power in the short term), it may be more beneficial in the medium term for Italy to have a strong majoritarian electoral system in both Houses. That would give rise to stable governments capable of reforms which are necessary for Italy to grow out of its debt. 2) They discuss the size of the NPL overhang in the Italian banking sector and argue that the most efficient solution, if purely private efforts fail, would be a public backstop greater than the size of the problem. They also discuss the option of a possible ESM involvement, as reported by some media last week, explaining that it is very unlikely at this point.
Another report worth drawing readers’ attention to is an update from DB’s Chief China Economist, Zhiwei Zhang, over the weekend. Zhiwei noted that the Politburo of the Communist Party held a meeting on December 9th discussing the economic policies in 2017. The press release showed that the policy stance will remain broadly unchanged, with a focus on the stability of growth. At the same time progress on reforms will likely be slow. All of this was in line with Zhiwei’s expectations and he maintains his 6.5% China growth forecast in 2017. Before we look at the week ahead, a quick recap of how we closed out Friday. Despite that leg lower for Italian banks that we highlighted at the top post the ECB story, it was on the whole another positive session which capped a strong week for risk assets. The Stoxx 600 closed up +0.97% to finish the week +4.72% which is the strongest weekly performance for the index since January 2015. In the US the S&P 500 (+0.59%) rallied for a sixth session in a row to turn in a +3.08% return for the week. All four major bourses struck new record highs in the process too with the Santa Claus rally in full flight. Credit indices were much the same. CDX IG finished 2bps tighter on Friday and 6bps tighter over the week while the iTraxx Main index was 1bp tighter on Friday and 5bps tighter over the 5 days. Despite financials having a weaker day (Senior and Sub +1bps and +5bps respectively) on Friday with the Italy news they still ended 6bps and 12bps tighter respectively during the week. Meanwhile it was a much more mixed performance across rates. 10y Treasury yields finished 6bps higher on Friday at 2.468% which is the highest closing yield now since June last year. 10y Bund yields on the other hand finished a couple of basis points lower at 0.360% while 2y yields dived another 2.1bps lower to -0.771% and the lowest yield recorded. As far as the data was concerned, in the US the first estimate of the University of Michigan consumer sentiment print rose 4.2pts in December to 98.0 (vs. 94.5 expected). That is the highest reading since January 2015 and was supported by a boost from both the current conditions (+4.8pts to 112.1) and expectations (+3.7pts to 88.9) components. Clearly President-elect Trump’s proposed policies having a clear positive impact on sentiment and it’ll be interesting to see if this is a one off honeymoon impact or we get some moderation in the next revision. Meanwhile, inflation expectations did soften with both 1y and 5-10y expectations easing one-tenth to 2.3% and 2.5% respectively. Elsewhere, there was no change to the final wholesale inventories reading of -0.4% mom in October. In Europe we received the latest trade data in Germany where the surplus shrunk slightly in October owing to a +1.3% mom uptick in imports which more than offset the more modest +0.5% mom rise in exports. In France industrial production was unexpectedly weak in October (-0.2% mom vs. +0.6% expected) and which had the effect of lowering the YoY rate to -1.8% from -1.1%. Finally in the UK the trade deficit was reported as shrinking thanks to a sharp bounce back in exports. Over to the week ahead now. It’s a quiet start to the week today. There’s no notable data to highlight in Europe while the sole release in the US is the November monthly budget statement. Tuesday morning kicks off in China where we’ll get the November industrial production, retail sales and fixed asset investment data. In Europe we’ll get final November CPI revisions in Germany, last month’s inflation report for the UK, Euro area employment data for Q3 and the ZEW survey in Germany. In the US the import price index reading for last month will be out. Japan gets things going on Wednesday where all eyes will be on the Q4 Tankan survey. There are a few notable reports in Europe including the final November CPI report in France, the latest employment report in the UK and also retail sales data for the Euro area. It’s busy in the US on Wednesday. We’ll get November retail sales data, PPI, industrial and manufacturing production, business inventories and then of course later in the evening concluding with the FOMC rate decision and also the updated Fed dot plots. Thursday is PMI day where we’ll get the flash December manufacturing, services and composite readings in Europe. Thereafter, UK retail sales data for last month will be released before we turn over to the BoE policy meeting outcome just after midday. In the US it’s another important day for data with the November CPI report being the focus. Also due out is empire manufacturing, initial jobless claims, Philly Fed survey, flash manufacturing PMI and NAHB housing market index. We close the week out in Europe on Friday with the final revisions to the November CPI report for the Euro area, along with various confidence indicators in France and CBI trends orders data for the UK. In the US we’ll get housing starts and buildings permits data. Away from the data the Fedspeak this week comes on Friday when Lacker is due to speak in the evening. Fed Chair Yellen will of course also be hosting a press conference following the FOMC outcome on Wednesday. Other potentially interesting events include a meeting of EU leaders on Thursday to discuss migration issues and the Brexit process and a meeting between Japan PM Abe and Russia President Putin the same day.