Tue, 14 Aug 2018 04:32 IST
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Deutsche Bank Early Morning Reid – August 8, 2018

Yesterday proved to be another good day for risk assets with equities trending higher once again amid the summer lull. Flows were generally light but that certainly didn’t stop the S&P 500 (+0.51%) from closing above 1400 for the first time since the 2nd of May. US jobs openings in June were the highest in four years but the market also digested Fed Rosengren’s calls for an open-ended bond
buying programme published in the WSJ yesterday. It’s difficult to pinpoint if QE hopes were the main market driver but we can’t help to think that the case for a further large scale QE would have been a lot easier to build if the S&P 500 was much lower as opposed to being just 1.3% away from its post-crisis highs now. As DB’s Peter Hooper noted last week it will probably take a further deterioration
in the economic outlook for the Fed to do more QE. Credit was a clear underperformer yesterday with spreads generally consolidating flat to moderately wider. The UST 10-year yield rose 6bp to close at a one-month high of 1.628% probably in response to a better risk tone.

The positive risk tone is largely extending into the Asian session overnight but Chinese equities are lagging again. Gains were led by the Nikkei (+1.5%) and the KOSPI (+1.3%) whilst the Hang Seng and the Shanghai Composite are both about -0.1% lower. Copper (-0.5%) and Brent (-0.3%) are down for the first time since last Friday.

S&P was active overnight placing Greece’s CCC/C foreign and local currency credit ratings to Negative (from Stable). The action reflects the possibility of a downgrade if Greece fails to secure the next disbursement of the EU/IMF program. S&P expects part of the EU3.1bn principal payment due on the 20 August to the Eurosystem to be funded by T-bills issuance on top of other reserves. S&P said an estimated EU3bn in cash remains in the Hellenic Financial Stability Fund, while the state-owned Deposit and Loans Fund holds approximately EU1-2bn in Green Funds dedicated to environmental projects. Under S&P’s criteria, nonpayment on Eurosystem obligation would not constitute a default as the Eurosystem is not a commercial creditor.

The agency overnight also placed ratings of Banco Popular Espanol, Bankia, Banco Financiero y de Ahorro, and Ibercaja on CreditWatch Negative reflecting the uncertainty over how the recapitalisations (if it were to happen) and associated restructuring plans could affect the bank’s credit profiles.

Back to yesterday it was another session of equity outperformance in Europe with the CAC, IBEX and FTSEMIB closing +1.52%, +2.23% and +2.19% respectively. In an interview posted on the Luxembourg government’s website Juncker said that a Greek exit from the euro would be “manageable” but not desirable. This helped drive the EUR/USD off the intraday highs which was soon followed by an
afternoon turnaround in Spanish bonds. The 10yr Spanish bond yield closed 12bp higher at 6.86%, or 17bp off the day’s lows. This had a minimal impact on Spanish equities though as the IBEX went on to close near the day’s highs of 7211 – a level not seen since the middle of April.

More on Spanish news reports yesterday noted that the government will not seek for a eurozone bailout if more conditions than those already agreed for bank recaps are attached. The FT said that PM Monti is under pressure from domestic politicians/economists to give an EU bailout a pass. Renato Brunetta, an aspiring finance minister, is reported to be working on the initiative that would aim to
reduce Italy’s EU2tn of debt by some EU400bn over the next five years.

He declined to reveal details but confirmed it centered on setting up a Triple A-rated private fund that would use non-strategic public assets allocated by the government as backing to issue bonds. He said “We can do it on our own; Italy is a rich country, with a high savings propensity”. On the micro front Standard Chartered’s money laundering allegation has driven its shares over 22% lower and its 5yr senior CDS more than 35bp wider this week.

Looking to the day ahead, notable economic data points are German and French trade numbers as well as German industrial production are the main European releases. The BOE’s latest quarterly inflation report will also be followed. According to Bloomberg consensus the central bank will probably downgrade its GDP outlook today. It will be a quiet day in the US again with nonfarm productivity, unit labour costs and mortgage applications the only updates. In terms of bond auctions, Germany will tap EUR4bn in 10yr notes, and the US will sell $24bn of 10-year bond.

Colin Tan, CFA
Research Analyst

Jim Reid

Deutsche Bank