Europe In Turmoil: Spreads Explode On Portulitical Crisis; Egypt Ultimatum Nears
And just like that things are going bump in the night once more. First, as previously reported, the $100+ WTI surge continues on fears over how the Egyptian coup will unfold, now that Mursi has a few short hours left until his army-given ultimatum runs out. But it is Europe where things are crashing fast and furious, with the EURUSD tumbling to under 1.2925 overnight and stocks sliding on renewed political risk, with particular underperformance observed over in Portugal, closely followed by its Iberian neighbor Spain, amid concerns that developments in Portugal, where according to some media reports all CDS-PP ministers will resign forcing early elections, will undermine country's ability to continue implementing the agreed bailout measures. As a result, Portuguese bond yields have spiked higher and the 10y bond yield spread are wider by over a whopping 100bps as austerity's "poster child" has rapidly become Europe's forgotten "dunce." The portu-litical crisis has finally arrived.
Secretary of State for Treasury Maria Luis Albuquerque replaced Vitor Gaspar at the Ministry of Finance. That prompted Paulo Portas, who leads the smaller CDS party in the coalition government, to quit, saying the new minister would offer “mere continuity” of the country’s deficit-cutting plans.
“It sounds the alarm bell of austerity fatigue,” said David Schnautz, a strategist at Commerzbank AG in New York. “This domestic noise is definitely negative.”
Portugal’s 10-year bond yield jumped to 8 percent earlier today, the highest level since Nov. 27, and was hovering at 7.65 percent as of 11:10 a.m. London time. The nation pays an average 3.2 percent for loans it received as part of the aid package.
Prime Minister Pedro Passos Coelho is battling rising unemployment and a deepening recession as he cuts spending and increases taxes to meet terms of a 78 billion-euro ($101 billion) rescue plan monitored by the European Union, the International Monetary Fund and the European Central Bank, known as the Troika. Coelho announced measures on May 3 intended to generate savings of about 4.8 billion euros through 2015 that include reducing the number of state workers.
The contagion effect has quickly spread to other bond markets and both Italian and Spanish 10% spreads were seen wider by over 10bps. Financials underperformed on the sector breakdown, as fears of potential liquidity squeeze, together with the latest ratings action by S&P who cut Barclays, Deutsche Bank and Credit Suisse rating to A- from A, saw credit spreads widen. iTraxx crossover and sub fin indices widened by over 15bps, while the Eurodollar curve steepened on prospect of higher borrowing costs. In terms of macroeconomic releases this morning, the latest round of Eurozone Services PMIs had little impact on the price action, however the release of much better than expected UK Services PMIs saw GBP/USD break above 1.5200 level. Finally, a weaker than expected Eurozone Service PMI print (48.3, Exp. 48.6, last 48.6, once again driven by a weaker Germany) has certainly not helped matters.
If nothing else, at least Draghi's unused (and non-existent) OMT bazooka will soon have to be used. We will see just how effective it will be.
Looking elsewhere, the army in Egypt has given a deadline of around 1530 London time on Wednesday for the crisis to be dealt with; otherwise the so-called road map will be put forward by the army which included the outline for new presidential elections, the suspension of the new constitution and the dissolution of parliament. However, an Egypt military source denied local media reports on a political road map and instead suggested that next step will be to invite political, social and economic figures to talks on vision of the road map.
A quick summary of the European damage:
- Portugal 10Y yield up 89bps to 7.61%, was up 130bps at 8.023% earlier
- Spanish 10Y yield up 14bps to 4.76%
- Italian 10Y yield up 7bps to 4.51%
- U.K. 10Y yield down 4bps to 2.34%
- German 10Y yield down 6bps to 1.64%
- Bund future up 0.53% to 142.44
- BTP future down 0.88% to 109.77
- EUR/USD down 0.13% to $1.2962
- Dollar Index down 0.15% to 83.42
- Sterling spot up 0.62% to 1.525
- 1Y euro cross currency basis swap down 1bp to -18bps
- Stoxx 600 down 1.21% to 283.67
DB's Jim Reid has the full overnight rundown
The last 12-24 hours have turned into a bit of a round-the-globe Sovereign watch with Brazil, Egypt and Portugal all being highly newsworthy. Starting with Brazil, the BOVESPA (-4.2%) suffered its biggest one-day loss since September 2011, reaching its lowest level since April 2009, after the country reported weaker than expected industrial output data. Industrial production fell 2% mom (vs -1.1% expected) which is the worst result for the month of May since 1995 when industrial output contracted by 11%. As with other EM equities, the BOVESPA had a rough June. The index recorded 7 trading days with falls greater than 2% during the month, which is exactly half the number seen in the whole of 2012. Amongst the individual stock moves yesterday, there were material declines in market
heavyweights including Vale (-3.4%) and Petrobras (-4.8%) which both fell through their 52-week lows. On the credit side, Brazil’s 5yr CDS widened by about 9bp to 195bp. Conditions have also been challenging for Brazil's corporate funding markets with no Brazilian company able to price an international bond since May 15th according to Bloomberg data.
Moving to Portugal, there were signs of austerity fatigue amongst the ruling coalition government after Prime Minister Coelho lost two key ministers in as many days. The resignation of Finance Minister Vitor Gaspar was promptly followed by that of the foreign minister Paulo Portas who is also head of the smaller CDS party in the coalition. Portas reportedly disagreed with the PM’s decision to name Secretary of State for Treasury Maria Luis Albuquerque as a replacement for the FM, saying it would mean a continuation of the policies
deepening the country’s recession (Bloomberg). PM Coelho said he didn’t accept the resignation request and hasn’t asked the President to dismiss Portas due to the minister’s importance in the coalition. Portas did not say whether he would take his junior party out of the government — a step which would leave the government without a parliamentary majority. Portuguese bond yields added 33bp yesterday to 6.72% and are now up more than 140bp since the May lows. The PSI equity index finished 1.3% weaker. Elsewhere in the periphery, Greek 10yr yields jumped by 15bp after it was reported that the troika had given a 3-day ultimatum to the government to reassure international lenders that it can deliver on conditions attached to its bailout programme. The report was later denied by a spokesperson from the European Commission (Ekathimerini).
Speaking of ultimatums, President Mursi appeared on television yesterday to reject an ultimatum from the Egyptian military that he share power with his political opponents or face a military solution. In response, the Egyptian army said it was ready to sacrifice “blood…and its people” which has helped send WTI crude (+2.3% this morning) above the $100/bbl mark. At least one anti-Mursi TV station put up a clock counting down to the end of the military's ultimatum, putting it at 4 p.m. today (or 1400 GMT), though a countdown clock posted online by Mursi opponents put the deadline one hour later. The military did not give a precise hour (Associated Press). WTI has gained 17% since its low in mid-April, more than double an 8% gain in Brent crude over the same period. It will be interesting to see whether this shows up in US inflation numbers in the next few months and whether it impacts growth.
Overnight, Asian stocks are trading with a negative tone taking the lead from the S&P500 which faded into the close for the third consecutive day. Losses are being led by a -1.9% and 1.5% decline in the Hang Seng and Shanghai Composite respectively with the main laggards being Chinese banks and real estate developers. China’s official services PMI came in 0.4pts weaker than last month (53.9 vs 54.3) while the HSBC services PMI was a touch stronger (51.3 vs 51.2). On the fixed income side, Asian credit is trading about 9bp wider this morning but 10yr UST yield remain in a tight range (unchanged at 2.47% as we type). The AUDUSD is down 0.4% after disappointing Australian retail sales data (0.1% vs 0.3%) and comments from the RBA governor that the central bank will do what it reasonably can to assist the transition from a resource-led economy. S&P’s downgrade of several major European investment banking groups is also dampening overnight sentiment.
Looking at today’s calendar, Euroarea service PMIs, the US non-manufacturing ISM and ADP employment report are the three key highlights on the data docket. The last two will provide the final employment-related data points ahead of the looming payroll print on Friday. Specifically on the ADP, DB’s US economists view the ADP as the single best predictor of monthly changes in payrolls. Over the last 12 months, the average error between the difference in private payrolls and ADP has been -14k, which is quite small since the standard error on private payrolls is about 75k per month. US weekly jobless claims have been brought forward to today due to Independence Day holidays tomorrow. So these are going to be important numbers for markets. A reminder that US bond and equity markets will be shutting early today ahead of Independence Day tomorrow.
* * *
SocGen recaps the FX macro highlights
There were further gains in periphery debt prices yesterday resulting in lower yields in moves that were accompanied by broad based JPY selling and a the ascent over130.50 in EUR/JPY. It is tempting to interpolate a return of Japanese investor flows into eurozone debt two days before the ECB casts its verdict on monetary policy and before Spanish benchmark supply, but the co-movement of yields and the currency pair have been no coincidence and suggest Japanese flows may have flipped from the relentless repatriation from overseas in the spring. The 4.7% bounce in EUR/JPY from the June lows should not realistically be challenged by a dovish ECB (if that's how the press conference turns out tomorrow). The correlation of the currency pair with the US/EU 10y swap spread is only 0.41 and short JPY positions are considerably less heavy than they were six weeks ago. Option structures and flows aside, only a disappointing US payrolls report on Friday would give investors a reason to book profits. Meanwhile, Greece continues to bubble in the background as a EUR negative but the EC yesterday denied it has set the country a three-day deadline to reassure lenders if can deliver on the bailout terms. It was announced that the Eurogroup will make a decision next Monday whether or not to disburse the next EUR6.3bn bailout tranche to help cover the repayment of EUR2.17bn worth of government debt on 20 August.
A trio of key US labour market data will take precedence today over pretty much everything else. Initial claims, ADP and the ISM non-manufacturing services survey are due before US markets shut for Independence Day tomorrow. We got an inkling yesterday of the direction the market is willing to push the USD, irrespective of the fact that US yields continue to trade remarkably well in the face of Friday's upbeat employment expectations. Today's ADP and ISM releases may prove whether the calm is deceptive and the pivoting around 2.50% in cash yields and 2.70% in swaps is merely a testimony of investors playing for time before Friday and a function of reduced trading volume.
The Riksbank is expected to keep its benchmark rate on hold at 1.00% today. The bank issued a lower repo rate forecast last April and is likely to reiterate this view today without making meaningful changes to the underlying forecasts. Increases in the repo rate are not expected until the second half of 2014. For EUR/SEK, quite a bit rides on the ECB tomorrow and the UST reaction to payrolls tomorrow, but with the mean reversion move from 8.90 nearly over, SEK bears may be tempted to reload long EUR/SEK (and USD/SEK).