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Deutsche Bank Early Morning Reid – July 31, 2018

Welcome to the final day of July. We will include our usual monthly asset performance review in tomorrow’s EMR but with the exception of the European peripheral complex July is shaping up to be a positive month for most risk assets largely helped by expectations of some form of ECB intervention in the coming days. Indeed these policy hopes have continued to build and has helped European risk assets higher over the last 24 hours. The latest optimism was fuelled further by the joint statement from Geithner and Schaeuble after a meeting at the Island of Sylt yesterday as they acknowledged the comments last week by European leaders to take whatever steps needed to safeguard the euro area stability.

Whilst we didn’t think there is much news in the finance ministers’ joint statement it was probably perceived by the market as further political backing of the bold statements from last week. On the back of these it was another day of outperformance in Italian and Spanish equities with both bourses adding +2.80% and +2.78% respectively on the day. Whilst still lower than where it started at the
beginning of the month they have rallied about 13-14% off their recent lows in less than a week which also marks the best four-day rally since 3 November 2008. Peripheral bonds also extended their rally with the 10-year Spanish yield down 13bp yesterday to 6.613%. The 10-year yield is 100bp off the recent closing highs of 7.621% last week and the 2s/10s Spanish curve has also steepened 65bp over
the same period. In Italy the 10-year yield rallied off its pre-auction highs of 6.06% yesterday but still closed +7bp higher on the day at 6.027%. Italy’s auction was just short of the maximum target (EU5.48bn v 5.50bn across 2015-2022 maturities) although it paid a lower yield for the 10-year than last month’s auction.

Interestingly amid some hopes of ECB’s intervention in the peripheral bond market, insiders say bold action is probably at least five weeks away though some more clues may come when the ECB reveals its rate decision on Thursday (Reuters). The article noted that several other pieces have to fall into place before the ECB will act decisively and these include a request for assistance from Spain
(which Madrid is still resisting) a decision by eurozone leaders to let their bailout fund buy bonds at auction, and a German court ruling on the legality of the euro zone’s permanent rescue fund (due on 12 September). The article also noted that some colleagues on the ECB’s Governing Council were surprised by Draghi’s “do whatever it takes” comments last Thursday. The market will need explicit policy actions from the authorities this week to back up all the pro-euro commentary we’ve heard since the middle of last week.

Moving on to the US, the S&P 500 (-0.05%) was little changed overnight although as it consolidated after a +3.6% rally in the two days prior. The very disappointing Dallas Fed Manufacturing survey (-13.2 v +2.0 expected) didn’t help as the market prepare itself for today’s Chicago PMI which is expected to ease slightly, to 52.5 in July from 52.9 in June. This would be an important print today ahead of tomorrow’s ISM manufacturing. In other markets it was a quiet day for US credit which saw the CDX IG close 1bp wider at 106.25bp on relatively low volumes.

Asian equities are mostly higher overnight despite the softer US lead. The KOSPI (+1.8%) is the outperformer overnight despite a weaker IP data (-0.4% v +0.1% mom expected). Taiwan also posted weaker-than-expected GDP for Q2 (-0.16% v +0.50%) which is also the first negative print since September 2009. Elsewhere across the region, the Nikkei and Hang Seng are up +0.6% and +0.8% as we go
to print. The Shanghai Composite (-0.07%) is the underperformer overnight as the index trades at the lowest since 3 March 2009 on growth concerns despite China’s plans to boost railway investments for the second time in a month.

Turning our attention to the day ahead today marks the first of the two day FOMC meeting this week. On the data front we have retail data from Germany, France and Spain; unemployment data from Germany and inflation report for the Eurozone. The EFSF will sell
up to EU1.5bn of 2015 bonds today. In the US, today also brings personal income and spending stats for the month of June on top of the important Chicago PMI reading as mentioned above.

Colin Tan, CFA
Research Analyst

Jim Reid
Strategist

Deutsche Bank