Saturday, 21 July 2018

IFR Comment: Carney and Draghi rally remains in place ahead of payrolls

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Nonfarm Friday dawned bright, clear and warm in London. And there has been a nice warm glow hovering over the financial markets since yesterday afternoon. It all makes Wednesday’s Portugal inspired sell-off seem a very long time ago.

The reason for that rally yesterday afternoon was the dovish stance of the central banks in Europe.

First we got Carney’s debut at the Bank of England, when the new governor revealed he was not going to take any of the usual nonsense from the short sterling market and promptly told those speculators that have been betting on a rate hike next year that they were categorically wrong.

And in what could be seen as a co-ordinated move, Draghi changed a 14yr habit of the ECB not committing on rates and gave the market forward guidance that rates would stay at the same levels or go lower for a prolonged period of time.

Cue a move to buy everything again. Core and peripheral yields dropped, short sterling and Euribor roared, equities rose, and credit tightened.

And that baton was taken up overnight in Asia. The Nikkei closed up 291 points at 14,309, and is very much in the process of reversing some of the disastrous losses seen since the end of May. The Hang Seng ended the session up 386 points at 20,854 and the Shanghai Composite finished up 0.3%.

That in turn led to a tighter start for synthetic European credit markets. The iTraxx Main began the session 1.5bp tighter at 110.5bp, having been as wide as 121bp on Wednesday morning as Portugal capitulated. The Crossover was 4bp tighter at 442bp, having been out at 480bp a couple of days ago.

As the morning has progressed, it has been very quiet – as to be expected ahead of the big number in the US later – but there has been no appreciable pullback. Thus by 0900GMT according to Tradeweb, the Main is at 110bp with the Crossover at 440bp.

It has been a bright start to the session in peripheral markets too, continuing the good work started by Draghi yesterday afternoon.

In Portugal, news that PM Coelho has found a formula to maintain government stability, allied to the fact that Portas is committed to finding a way for the CDS to support the government, has further calmed nerves.

Portuguese 10yr yields are a further 30bp lower this morning at 6.85% having had a peek at the 8% level on Wednesday for the first time since November last year. Perhaps more encouraging, though, is that the curve has stabilised, with 2s/10s 10bp steeper having flattened by nearly 100bp before Draghi took to the lectern yesterday. It should be reiterated, though, that liquidity remains shocking.

During the press conference, Draghi also stated that the OMT is ready to be active and conditions are known. That gave some further impetus to second tier peripheral yields, which will have been somewhat of a relief after a somewhat lacklustre 5yr auction from the Spanish Tesoro yesterday morning.

And that tightening continued on the open this morning on the back of some decent domestic buying. Spanish 10yr yields were 7bp tighter at 4.55%, having been at 4.78% after the auction. As the morning has progressed, though, some of those gains have been pared, with yields back at 4.58%.

That price action has been replicated in Italy. 10yr yields opened 6bp tighter at 4.34%, having been at 4.57% after the Spanish results yesterday. They are now back at 4.37%.

Sovereign protection markets are once again closely tracking the cash moves. Portuguese 5yr CDS is 18bp tighter at 460bp having been over 500bp on Wednesday. The cost of protection on Spain is 5bp tighter at 277bp, while Italian 5yr CDS is also 5bp tighter at 277bp.

The financial sector is keeping pace with broader credit so far this morning. The Senior Financials index is 3bp tighter at 159.5bp, having been at 170bp before Draghi spoke yesterday afternoon, with the spread to the Main still at the key 50bp level. The Subordinated is 5bp tighter at 244bp.

As you would expect on a Friday morning - and particularly this Friday morning - senior cash markets are quiet. There is, however, a bit of short covering coming in from retail accounts on the e-trading platforms, where offers are being sporadically lifted. That has led to a modicum of spread tightening, but nothing to get carried away with.

Right, get your lunchtime sandwiches early and strap yourself in for another hugely anticipated BLS Employment report in the US.

The change in Nonfarm Payrolls is expected at 165k, and any major deviation will lead to a knee-jerk reaction. The key to longer term direction from a QE tapering point of view, however, lies in the unemployment rate. Expectations are for the rate to be rounded down to 7.5%, which could lead to a reversal of the fortunes of the previous 24 hours. Should the rate remain elevated at 7.6%, we could see a good old-fashioned Friday squeeze.

Either way, with many of our US cousins taking the opportunity for a long holiday weekend, it is likely to be whippy in lower liquidity conditions.



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