Tue, 31 Jul 2018 10:51 IST
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Deutsche Bank Early Morning Reid – July 27, 2018

What a week we have coming up. The highlights being Usain Bolt here in London, Ben Bernanke in Washington and Mario Draghi in Frankfurt. The first of these three may set the hearts fluttering most but everyone in the world’s wallet will be very influenced by the latter two. After yesterday’s surprise comments, Mario Draghi will take centre-stage this week. Over the next few days he now has more ability to influence Gold than any Olympic athlete!

So by now we’ve all probably heard that Draghi said that “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The more interesting quote was the one about sovereign risk premia when he said “To the extent that the size of these sovereign premia hampers the functioning of the monetary policy transmission channel, they come within our mandate.” One would have to say that having made such explicit comments, it’s no surprise that the market aggressively started to price in significant intervention.

Indeed peripheral spreads rallied sharply yesterday with the 2yr and 10yr Spanish yields down -74bp and -45bp on the day to 5.68% and 6.93%. In Italy the 2yr and 10yr BTP yields also eased by -88bp and -39bp yesterday to 3.43% and 6.06%. The IBEX and FTSE MIB rallied +6.06% and +5.62% yesterday; with the former posting its best one-day performance since May 2010. In aggregate since Nowotny remarks a day earlier Spanish and Italian 10-year yields are now 82bp and 65bp lower than where they were just before Nowotny commented on the ESM banking license on Wednesday. Likewise Italian and Spanish equities are also looking to close the week on a positive note after having rallied 7-8% off their lows of the week.

So what do we think? Our view at the start of the week was that the market would likely start to price in some kind of intervention from the Fed/ECB ahead of next week’s summit even if they actually didn’t deliver. If you take the media quoted parts of Draghi’s speech from yesterday at face value then it would seem odd now for Draghi not to deliver something major next Thursday. However I would urge all readers to digest the full transcript of his speech as it probably doesn’t sound quite so cut and dry when you read it in full.

I suspect the ECB will do something next week, but in reading the speech in full I wouldn’t have high confidence that there is about to be a game-changing decision.

It’s not obvious to me that the speech should be interpreted that way. However I would stress that predicting next Thursday’s moves is nigh on impossible. Suffice to say that the nature of markets are that hope has come back into the room and may continue to stay for a few days and therefore anything other than a major announcement could be a sharp disappointment to a market desperate to pounce on both this week’s out-of-nowhere remarks from Nowotny and Draghi.

On to markets, the Draghi-led rally carried on into the US session to see the S&P 500 finish +1.65% higher despite some softer US data and mixed earnings. The headline durable goods orders rose by more than expected (+1.6% v +0.3%) but this was really driven by
aircraft orders. Core durable orders were down -1.4% (vs market estimates of +0.1%). Initial claims fell by a sharp 35k in the latest week but the data is usually distorted by auto retooling around this time of the year. Pending home sales also disappointed as it
unexpectedly fell by -1.4% MoM in June. At the micro level we saw 73% of the companies reporting yesterday beat EPS estimates but sales revenue performance remains on the soft side with more than 60% missing.

In terms of overnight markets, Asian equities are following the positive lead with the Nikkei, Hang Seng and KOSPI all up over 1% as we type. Chinese equities are underperforming (Shanghai Composite is flat), perhaps reacting to the latest data showing that Chinese
Industrial Profits are down -2.2% yoy, the third straight month of declines. EUR/USD is trading in a narrow band following yesterday’s post-Draghi rally but is still around 2% off its Tuesday’s lows. Asian credit is also stronger this morning with the Aussie iTraxx and Asia IG indices around 9bps and 5bps tighter respectively. Facebook’s debut post market result was disappointing. The company reported a second quarter loss (-8cps) against analyst estimates of a profit of 11cps. FB’s shares were down 10% in extended trading and are now about 37% below its IPO price.

In terms of today we have Spanish unemployment, French consumer confidence and Italian business confidence out in Europe. The main data focus will probably be the initial Q2 GDP report in the US. The market is looking for a +1.4% QoQ annualised print today down from 1.9% in Q1. In the upside down world we inhabit, a very weak number could see markets rally on easing hopes ahead of next week’s FOMC.

Finally, wherever you are in the world hopefully you’ll enjoy tonight’s opening ceremony here in London. I’ll be attending the cycling road race tomorrow somewhere in Surrey so keep an eye out for me on telly.

Jim Reid
Strategist

Colin Tan, CFA
Research Analyst

Deutsche Bank