Data And Politics Drive Markets

News that Ukraine and Russia have agreed on a cease-fire in east Ukraine was greeted enthusiastically by investors even though what this means for what Putin has called "Novorossiya" is not immediately clear. Recall that Russian forces still occupy part of Georgia taken in 2008. That Putin can agree to a cease fire also seems to contradict his claims that the insurgency was independent of Moscow. Moreover, that the agreement was struck on the eve of the NATO meeting may also not be coincidental, and is consistent with Putin's ability to keep the US and Europe off-balance.

Russian stocks advanced sharply. Reports suggest that ETFs investing in Russia have seen significant inflows in recent weeks. Russian bonds have rallied strongly, with the benchmark 10-Year yield off 23 bp to 9.54%. Central and Eastern European assets have also rallied.

Even with questions over the political development, the euro had traded up to a 3-day high near $1.3155 despite the disappointing service PMI. While the euro may probe a bit higher, we expect tomorrow's ECB meeting will limit gains to the $1.3170 area. For the euro area as a whole, the services PMI slipped to 53.1 from 53.5 flash and 54.2 in July. Germany, France and Italy were disappointing. Germany came in at 54.9 down from 56.7 in July and 56.4 flash. The French flash had reported improvement to 51.1 from 50.4, but the final report today put it back at 50.3.

Italy's service PMI was simply dismal. It fell back below the 50 boom/bust level for the first time since March to stand at 49.8. The consensus was for 52.0 after 52.8 in July. The forward looking "new business " component slumped to 49.7 from 53.2.

The divergence between Italy and Spain continues to widen. Spain's service PMI was the positive surprise from the euro area. Its PMI was reported at 58.1. The consensus expected 55.1 after 56.4 in July. It is the highest reading since December 2006. This will intensify the debate over the key to Spain's economic success compared with Italy. Some will talk about labor market reforms, for which investors sensitive. However, other arguments emphasis the strengthening of the banking system, with the help of ESM funds.

The UK also provided a pleasant surprise. However, rising anxiety over the Scottish referendum may have limited the positive response by sterling, which gained less than half a cent after falling to a seven-month low in Asia near $1.6445. There was also a muted reaction by the short-sterling futures strip, though the data would seem to strengthen the conviction of a rate hike in Q1 2015, which has been our base case.

CIPS/PMI rose to 60.5 from 59.1 in July. The consensus anticipated a decline to 58.5. The composite PMI rose to 59.3 form 58.6, and this is the highest reading since last November. Separately, the BRC shop price deflator showed a 1.6% decline on a year-over-year basis in August. Prices had fallen 1.9% in the year through July. This is a favorable backdrop from the two-day MPC meeting that begins today. The Shadow MPC voted 6-3 in favor of a hike with one member advocating a 50 bp immediate hike. Needless to say, the real MPC will not follow the call. That said, two dissents, as last month, seem likely. A third is possible and would likely elicit a market response.

China offered a pleasant surprise as well. The official non-manufacturing PMI edged higher to 54.4 from 54.2, while the HSBC measure rose to 54.1 from 50.0. The HSBC Composite rose to 52.8 from 51.6 and is the highest since March 2013.

Australia's Q2 GDP rose 0.5% quarter-over-quarter and 3.1% year-over-year. This was slightly better than expected, but softer sequentially.

The well telegraphed reshuffling of the Japanese cabinet was announced. From investors' point of view, the appointment of Shiozaki, the health minister to oversee the Government Pension Investment Fund (GPIF) is important as it solidifies Prime Minister's Abe's drive for it to investment in riskier assets, which appears to have already begun. The key economic posts were unchanged as anticipated.

However, the appointment of Tanigaki as Secretary-General of the LDP is potentially significant. He had been instrumental in striking the deal with the DPJ government that left to the retail sales tax hike. His appointment would seem to favor the implementation of the next hike (from 8% to 10%), which we had thought the risks of were diminishing. The cabinet reshuffle also increased the number of women. Of note, Obuchi, who is a potential future PM candidate (her father was a PM) will oversee the troubled and controversial nuclear industry.

We make three points about the North American session. First, the strength of the US ISM and construction spending largely offset the the unexpected weakness in personal consumption expenditures reported last week. This leaves Q3 GDP tracking a little better than 3%, according to the Atlanta Fe's GDPNow calculus.

Second, US data today features July factory orders, which like durable goods orders that have already been reported, will be lifted by the surge in Boeing orders, and the Fed's Beige Book ahead of the Sept 16-17 FOMC meeting. It is likely to be upbeat with little sign that either wage or price acceleration. The US will also report auto sales, and a modest gain from last month is expected. A combination of easy credit and aging vehicles will extend the streak that goes back to March of 16+ mln unit annualized pace.

Third, the Bank of Canada meeting concludes. There is no press briefing of Monetary Policy Review. The new information will likely be minimal. The Bank of Canada has all but jettisoned forward guidance. It is in a wait-and-see mode. While growth has improved, the central bank would likely to see exports pick up more of the slack Canada, like the US, reports the August jobs data at the end of the week. We generally expect the Canadian dollar to outperform on a cross basis against the euro and yen.