It’s pretty fair to say the open on both the European bond and equity markets is going to be a lively affair, with Italy taking centre stage again. There has been a reaction already in Italian yields, with the ten-year selling off 32 basis points (bp) from a low of 4.17% into the close. While the MIB found sellers (with the index coming off over 700 points at one stage), we are now calling the index down over 400 points, although there has been signs of cautious buying throughout the day.
The ranges seen yesterday in the currency market were simply staggering, and thus we have seen an explosion in option volatility, with EUR/JPY moving in a mere 664-pip range, while USD/JPY a more modest 389-pip range. Even EUR/GBP saw massive range expansion, although just missed out on a key outside day reversal. Clearly this was a market that simply wasn’t prepared or positioned for a hung parliament, and traders are now asking if this blanket sell-off represents something more substantial for the EUR. It seems the worst fears of the market have been realised and while the centre-left will narrowly take the lower house, the expected coalition of Pier Luigi Bersani and Mario Monti was a whole sixteen seats shy of the majority needed to gain control of the upper house. Thus, we simply don’t know the state of play with Italian politics, and markets find sellers in times of instability. The President will take centre stage now and either form a ‘grand coalition’, although this seems unlikely. It has been speculated that Mr Bersani may look to team up with Beppe Grillo’s Five Star movement (again unlikely), or ultimately fresh elections will be called down the track.
This is a story of anti-austerity and one where most hadn’t expected the anti-austerity / anti-European parties to do anywhere near as well as they have. The Italian voter has spoken out and this has thrown up political instability as perhaps the number one issue facing Europe in 2013.
Interestingly, the Italian treasury will still push ahead with its planned sale of €6.5 billion in five- and ten-year bonds on Wednesday, but one gets the sense they will be paying higher yields than previous auctions. It will be interesting to see how bond traders treat BTPs’ on open today, with some comparing what we are seeing now to the political issues in Greece in May and June 2012 when it failed to form a coalition and EUR/USD hit a low of 1.2288. Keep an eye on EUR/CHF as there may be traders who are compelled back into the safety of Switzerland’s current account surplus of 12.1% of GDP and low government debt (under 50% of GDP).
There has been some recovery in risk though, and certainly this has been evident with EUR/JPY and USD/JPY moving over 100 pips from the lows. The Nikkei and ASX 200 have also found modest buyers, which is certainly positive, however more conservative traders will probably hold off and see how traders act tonight in Europe and the US. Certainly it look like dark days as it stands for the open, and perhaps this will be magnified by margin calls, but any strong buying of dips could spur life into tomorrow’s Asian open. We are still sceptical as there are simply too many questions around Italy that need to be answered.
China has been the shining light and has probably had an influence on the Nikkei, along with margin accounts who were happy to get into USD/JPY sub 91. The A-shares have gained 1.3%, while the Shanghai a more modest 0.4%.
So, upcoming trade is likely to be pretty hectic and could really be the catalyst the bears have needed, given most US commentators have been running with the line ‘the S&P 500 needs to correct 5%’. Our flows have predominantly been on the short side, and 69% of all open positions on the S&P have been short, although it’s interesting to see that 78% of opening orders on the MIB have been on the long side and probably see the 400 sell-off as overdone. It could be down to Ben Bernanke to set the market straight, although it is going to take something substantial to lift European spirits given the uncertainty.
Gold looks interesting and while some will look to get back into bunds, gilts and the CHF, the combination of ‘risk off’ and the prospect of Ben Bernanke setting the record straight with regards to Fed policy could see the metal re-claim the $1600 level. Recall that the Fed Chairman has been pretty transparent with the markets for his terms on withdrawing stimulus from the market and has suggested he wants to see a ‘substantial improvement’ in the labor market, or a substantial increase in inflation. None of this is occurring and we feel he will want to keep the market in check after getting pretty hawkish after the recent minutes. Perhaps there’s been a few who have been thinking along these lines today in Asia, with Australian gold stocks seeing strong gains, albeit short-covering to a larger extent.
US data will be announced around the same time that the Fed Chairman speaks, with US consumer confidence, new homes sales and the Richmond Fed manufacturing index being announced. Currency traders will be keen to hear the minutes from the Riksbank given the recent strength in the SEK.
China tightening – a bears den:
The Shanghai Composite sank 4.9% this week. Markets increasingly fear a government imposed tightening cycle in China. Recall that Chinese officials were in the process of attempting to cool an overheated economy and a national housing Bubble before the “European” crisis last year risked unwieldy downturns. Officials cautiously retreated from measured “tightening” and, as Bubbles tend to do in the face of timid policymaking, the Chinese economic, Credit and Housing market Bubbles sprung right back. Housing transactions have surged, price inflation has accelerated and Credit growth has gone from amazing to utterly astounding. Reports put total January system lending (“social financing”) at an incredible $400bn. There is the distinct possibility that the Chinese Credit boom has reached the point of being, literally, out of control.
Importantly, global “risk on” – with attendant liquidity and “hot money” bonanzas – has worked to reenergize China’s historic Bubble. The bullish consensus view holds that Chinese leaders have their economy and Credit system well under control. Yet each passing year of Bubble excess – certainly exacerbated by global liquidity oversupply and timid domestic policy – ensures that myriad imbalances become more deeply embedded in financial and economic structures.
There were indications this week that Chinese authorities are again moving to tighten housing finance (see “China Bubble Watch” below). On the one hand, the consensus view holds that the Chinese will approach tightening gingerly. And, at this point, global markets seem rather numb to Chinese tightening risks. On the other hand, with Credit Bubble infrastructure and psychology now deeply embedded, authorities will need to inflict some real pain (break inflationary psychology) if they are indeed determined to see results.
I would argue that a new Chinese tightening cycle would come with huge uncertainties and major unappreciated risks. Indeed, it could mark a significant inflection point for Chinese Credit, the imbalanced Chinese economy and global economies and markets more generally. It is worth noting that tin and nickel prices were down 7% this week, with silver, platinum and copper all down more than 5%.
A lot has transpired in China over the past year. The Chinese people – and the world more generally – have become much more aware of China’s endemic corruption problem. Widespread toxic air (and water) pollution has also been recognized as a consequence of a runaway Chinese boom. Other more typical Credit inflation consequences – notably asset Bubbles, widening wealth disparities and economic imbalances – have also become more pressing. Moreover, inflation continues to quietly impart pain upon the large population of impoverished Chinese. The new Chinese government faces daunting financial, economic, environmental and social challenges. The global love affair with money printing (QE) doesn’t today seem to work in their best interest.
When I ponder a future bursting of the Chinese Bubble, I fret China’s relationship with Japan. For now, however, we’ll focus on the yen and Japanese stocks and bonds. The hedge funds have placed big bearish bets on Japan’s currency, while yen weakness has fueled heightened speculation in Japanese equities and, likely, global “risk on” “carry trades” more generally. Markets this week seemed to indicate that a yen rally might endanger an increasingly vulnerable global “risk on” market backdrop. And if “risk on” is viewed as susceptible, yen weakness might not be such a sure one-way bet.
Ta TM
A few things to check tomorrow thanks to this post
Ping An bank forbidding branches approving property loans
http://www.reuters.com/article/2013/02/26/china-property-loans-idUSL4N0BQ40L20130226