Tue, 14 Aug 2018 04:32 IST
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Deutsche Bank Early Morning Reid – August 6, 2018

Well I’m totally exhausted this morning after an extremely tiring weekend lying on the sofa watching an amazing two days of the Olympics. I couldn’t get any tickets but my fiancé went to the Greco-Roman Wrestling last night!! Hope she hasn’t
picked up any moves.

A spectacular weekend followed a manic few days in financial markets and we have now moved to a week of anniversaries with Thursday seeing the 5 year anniversary of the seminal moment where BNP Paribas froze withdrawals from 3 funds due to the sub-prime crisis, and yesterday marking the one year anniversary of the US being downgraded from AAA by S&P. We think the crisis started with the collapse of the ABX market in February 2007 but many will feel that this week marks the 5 year anniversary of the Global Financial Crisis. Whatever your start date its fair to say that its impact continues to reverberate and is likely to do so for
many years to come.

However last week likely marked the beginnings of the next round of serious intervention in Europe. We discussed on Friday that had Draghi’s London speech 10 days ago not taken place then the ECB meeting last week would have been seen as a welcome development. We also argued that with the ECB opening the door to bond buying then Thursday’s meeting has reduced (but not eliminated) the
tail-risk for the remainder of 2018.

It’s fair to say that many sources of volatility and risk remain over the next couple of months but if we can get to a stage where the ECB aggressively buys bonds then it will give Europe more time to try to find a growth miracle. For us the ECB has always been the only organization that has a chance of easing the European Sovereign crisis and it seems they will soon be more active again. However this
crisis is a long, long way from being over and execution risks aside they have only bought time. In the end it still might be beyond all parties involved to find a longterm solution but the events of the last 10 days indicate that there’s every chance they are going to use more ammunition first.

The ball is now in Spain and Italy’s court given that Draghi indicated that ECB support would be available as soon as these two potential recipients trigger some kind of official European support programme. While the near-term tail risks of a Spanish bond market implosion should be reduced there are still execution risks given the eventful couple of months ahead of us. The German Constitutional Court ESM approval, the Dutch election, and the Troika report on Greece are just some of the main events in September that may still be a source of market volatility.

But for now the market is clearly encouraged by ECB’s guidance as bearish bets continue to be pared back. The Nikkei and the Hang Seng have started the week +1.7% and +2.0% respectively as we type. Credit spreads are tighter in Asia with the IG CDS index -8bp on the day following a strong 5bp rally in the CDX IG on Friday. The strong risk tone overnight is also benefiting from the better-thanexpected payrolls report on Friday. Headline non-farm and private payrolls rose +163k and +172k in July although June’s payrolls were revised lower. The market was expecting +100k and +110k for July.

The unemployment rate nudged a smidgen higher to 8.3% (from 8.2%). We also saw a stronger-than-expected ISM non-manufacturing index (52.6 v 52.1) in July even though the employment component (49.3) dipped below 50 for the first time since December last year. The S&P 500 (+1.90%) rose for the first time in a week on Friday while the UST 10yr yield rose nearly 9% to close at a four-week high.

Back to Europe the ekathimerini has reported that a 3 hour meeting between Greek and Troika officials ended on Sunday with the IMF envoy saying there had been great progress in finalising a package of EU11.5bn in budget cuts for 2019 and 2014. Given how well the
meeting apparently went the report suggests that the Troika will take a break and be back in Athens in early September. The package will be developed over the coming weeks and finalise early next month in time for a Eurogroup summit on 3rd September. The article also said that there are no concerns about a EU3.2bn bond held by the ECB that expires on 20th August, noting that Mr Juncker has said a solution will be found to cover the bond.

Previewing the week ahead we have the usual post-payrolls lull as far as dataflow is concerned. Trade data from Germany and France (Wed), US, UK and Italy (Thurs) and China (Fri) will probably be the main theme this week. That aside, Italy’s Q2 GDP (Tues), German
factory orders (Tues), and German inflation (Fri) are also notable releases. Italy’s GDP is expected to post its fourth consecutive quarterly contraction. China’s monthly data dump on Friday will be the key release in Asia with headline inflation expected to fall to a 30-month low of 1.7% in July from 2.2% last month.

Jim Reid
Strategist

Colin Tan, CFA
Research Analyst