Wednesday, May 30, 2018

Capital Markets: "Italian Reprieve, Euro Bounces, Trade Tensions Rise"

From Marc to Market:
After what a 15-sigma event yesterday in the Italian bond market, a reprieve today has seen the euro recover a cent from yesterday's lows. While the political situation in Italy is worrisome, many observers suspect that the new banking rules exacerbated the illiquidity that explains outsized moves. Italy's 10-year bond yield is off nearly 20 bp today, and the two-year yield is off almost 90 bp. Italian stocks have also stabilized, gaining about 0.5% near midday. IWith the highest coupons in several years, Italy's bond auction was well received in terms of bid-to-cover ratios.

To be sure the political situation remains unresolved. It seems that the Five Star Movement is more willing to find a solution short of elections, but the League is taking more strident tones. Perhaps the strategy is rational and not driven by personalities. The latest SWG poll covering May23-May28 showed the League with 27.5% support, up from around 17% in the March election. M5S, on the other hand, has seen its support slip to 29.5% from nearly 33% in March. Weekly tracking polls concur that the League is the only party that has gained support since the election.

Outside of Italy, and Spain, which holds a confidence vote at the end of the week, the other notable development has been heightened trade tensions. Pressure was going to mount in any event, ahead of the June 1 expiration of the exemptions from the US steel and aluminum tariffs. While Europe has been lobbying hard for a permanent exemption, it does not seem likely. NAFTA negotiations are ongoing, and it is not clear what the Trump Administration will do for Canada and Mexico. However, adding to this the Administration indicated that it is moving forward with the tariff on $50 bln of Chinese imports to retaliate for intellectual property right violations.

Reportedly, a list of specific products will be released in around two weeks. New curbs may be announced on sensitive technology as well, ahead of the next round of talks that are to begin in a few days. New restrictions on Chinese investment in the US and enhanced export controls are thought to be ready by the end of next month.

Recall that when the US first announced the actions on intellectual property, China threatened to retaliate. That is when Trump countered with a threat of tariffs on another $100 bln of Chinese goods. This time there did not seem to be an immediate response.

Economic data released today may have helped soothe investors' nerves. Both Japan and Germany reported considerably stronger retail sales than the market expected. In Japan, April retail sales rose 1.4%. The median forecast was for a 0.5% increase after a 0.7% decline in March. German retail sales rose 2.3% in April. It is the largest increase since October 2016. The median forecast was for a 0.5% increase. The March decline was shaved to 0.4% from -0.6%.

Separately, Germany reported a strong employment report. Unemployment fell by 11k in May, which nearly matches the three-month average. Unemployment fell by an average of almost 22k a month in 2017. The unemployment rate unexpectedly edged down to 5.2% from 5.3%. Germany states also reported preliminary May CPI figures and the national report will be released shortly....