:
- Market relief did not last long – European bond spreads are widening again.
- Yesterday’s Italian bond auction did not fail, but the yield was high.
- US stocks closed with an almost 1% loss and Asian markets were lower overnight.
- EUR/USD has fallen to 1.36 and we still see risks to the downside.
- Focus today is on European Q3 GDP, UK CPI and US retail sales.
Markets Overnight
The market relief in response to the formation of technocrat governments in Italy and Greece did not last long. Yesterday’s Italian 5-year bond auction did not fail, but Italy did have to pay a yield of 6.29% - the highest since 1997 and up from 5.32% at the last auction in October. Even though most analysts welcome the new governments, 10-year spreads to Germany widened yesterday across the board; to 488bp (Italy), 427bp (Spain) and 163bp (France). As an illustration of the declining credit perception of Europe, note that Indonesia yesterday sold USD1bn of 2018 bonds at around 4% - more than 2ppt lower than Italy.
The rising debt risk premium in Europe saw risk assets fall once again and markets continue to look very vulnerable. US stock markets closed with small losses – the S&P500 index was down 0.96% - and most Asian stock indices have fallen overnight. Brent oil has fallen almost three dollars to trade around USD112 per barrel and US Treasuries are posting big long-end gains.
The euro has also corrected lower again to trade around 1.36 against the dollar and we continue to see risks skewed to the downside. Not only is the euro depreciating in response to widening sovereign spreads, but it is also at risk from narrowing rate spreads, as the market prices in more aggressive rate cuts from the ECB. Industrial production data published yesterday showed a significant drop in September and while the fast deterioration of economic conditions in the eurozone is not expected to show up fully in today’s Q3 GDP release, the eurozone has almost certainly entered a recession. Hence, risks are for further downside in the key euro crosses; EUR/USD, EUR/JPY and EUR/GBP.
Russian GDP missed the consensus expectation, but nonetheless showed accelerated growth in Q3 with a y/y increase of 4.8%. Growth is thus clearly picking up towards the end of the year from the sluggish 3.7% growth in H1 11. Global market jitters have only had a marginal effect on Russia’s real economy and as long as the oil price remains high, and Russia is not faced with a renewed credit crunch, we expect the good growth performance to continue.
Global Daily:
Focus today: With renewed upward pressure yesterday on Italian and now also increasingly Spanish bond yields, focus will continue to be on any signs of more aggressive government bond purchases by ECB. However, the financial markets will have to digest a lot of economic data today. In Europe attention will be on the release of Q3 GDP for the euro area starting with France and Germany early this morning. The Q3 numbers are unlikely to be horrible for the euro area as a whole because the current weakness will not be evident until Q4. In the UK CPI data for October will be released today and we expect them to show that inflation in the UK has probably peaked. We expect CPI inflation to decline to 5.0% y/y and the annual pace to slow going into 2012 when the VAT effect drops out of the data. In the US focus will be on retail sales, which we expect to have slowed in October but to still show an upward trend. In the US the regional Empire manufacturing survey for November will also be released today.
Fixed income markets: German and Danish bond yields declined yesterday as market pressures in the Southern European bond markets did not ease off, as was widely expected following the events in Italy during the weekend. A softening in ECB’s rhetoric over the past few days may also have been a factor. Today focus will be on the flow of economic data out of the eurozone and the US. Over the past months the two areas have been diverging with an emerging recovery in the US and a deeper downturn in Europe. We continue to think that there is a good case for underweighting US bonds relative to German and Danish bonds, as the ECB will continue to ease monetary policy.
FX markets: EUR/USD corrected lower yesterday in response to re-widening European bond spreads. Until the ECB accelerates its bond purchases significantly and drives down the widening spreads, we continue to see downside risks to the euro. Strong technical support in EUR/USD is not found until below 1.34 – but given the still cheap JPY, we see a more attractive risk/reward from EUR/JPY short positions than from EUR/USD ones. Support is found at 104.74, 104.01, and 103.86.
Scandi Daily
There are no key data releases out of Scandinavia today.