US Equities continued their downtrend on Tuesday

by KBC Market Research Desk

Sunrise Headlines

US Equities continued their downtrend on Tuesday as some better than expected economic data failed ease concerns about the European government debt crisis. This morning, most Asian shares gains some ground, while Chinese stocks lose some ground.

Chinese factories increased production in November, but a big jump in input prices pointed to more inflationary pressure in the pipeline and a need for monetary tightening. The official Chinese manufacturing PMI rose to a seven-month high of 55.2 in November.
ECB President Jean Claude Trichet left open the possibility of the bank significantly expanding its government bond purchases and warned markets not to underestimate Europe's determination to resolve the escalating euro zone crisis, the FT reports on its website.
US Fed Chairman Ben Bernanke warned on Tuesday that a long period of high unemployment could exact a steep social cost as he defended the central bank's policy of easy money.
Prolonged economic weakness may keep Japan in deflation longer than the Bank of Japan's current forecast, a member of the policy board said this morning, offering the bleakest view to date by a central bank policy maker.
Standard & Poor's warned on Tuesday it could cut Portugal's credit rating if the country's growth prospects weaken further or if private creditors become subordinated to public creditors in a possible financial aid programme.
Australia's economy grew at the slowest pace in almost two years last quarter as the booming mining sector hit an air pocket while consumers were cowed by higher interest rates. GDP slowed to 0.2% Q/Q from 1.1% Q/Q. The Australian dollar weakened slightly on the data.
German retail sales rose by 2.3% M/M in October, surpassing economists' forecasts and pointing to a broad and sustained recovery in Europe's largest economy.
Today, the eco calendar contains the UK and euro zone manufacturing PMI's, the US manufacturing ISM and ADP employment report.
Markets

Today, the eco calendar contains a few interesting items as the manufacturing ISM and ADP employment report in the US and the UK and euro zone (final) manufacturing PMI's. Besides that, the Fed will release its Beige Book, some Fed and BoE officials are taking the word and Germany (Bobl) and Portugal (T-Bills) will tap the market.
In November, the US manufacturing ISM is forecasted to show a slight decline (from 56.9 to 56.5) after a significant increase in October. Regional indicators showed however wild swings, which makes it difficult to accurately estimate last month's development in the manufacturing ISM. Nevertheless, we believe that upward surprises outweighed the negative ones and believe therefore that the risks might be on the upside of expectations. The ADP employment report is forecasted to show a 72 000 increase in private employment, significantly up from last month's 43 000 increase. Recently, the correlation with the official BLS report weakened significantly. In the euro zone, the final figure of euro zone manufacturing PMI is forecasted to confirm the first outcome, which showed an increase from 54.6 to 55.5, as the improvement was confirmed by the German Ifo and European Commission confidence indicators. More interesting might be the national data which are expected to show a significant disparity between the core-EMU and weaker peripheral countries. In the UK, manufacturing PMI is expected to show a marginal decline in November (from 54.9 to 54.7) after remarkable upward surprise in October.
On Tuesday, increased tensions on peripheral Europe once again dominated the trading session. From the start of the session peripheral bonds were hammered. The remarks made by the Central Bank of Portugal that the country's banks could face an "intolerable risk" if Portugal failed to consolidate its public finances immediately weighed on the markets. This gave investors yet another reason to believe that the question for Portugal won't be IF they would also ask for a EU/IMF bailout but WHEN they will do so. Also the euro and most of the equities went down. Investors found their way back to the safe German Bund, which gained ground yesterday and tested at the end of the session the 128.08 resistance level. These safe haven flows made the German yield decrease all over the curve with the longer end outperforming. In a daily perspective, German yield dropped 5.7 (2-year) to 11.9 (30-year) bps. In the US bond markets, yields ended practically flat.
Peripheral yield spreads versus the German bund skyrocketed for the second day straight, taking the Irish (+19bps), Spanish (+16bps) and Italian (+12bps) spreads at the end of the session to euro lifetime highs of respectively 669bps, 430 bps and 200bps. The German/Belgian yield spread increased by 21bps and the Belgian 10-year yield reached the 4% level. A level not seen since Jun2009. Intraday also the German/Portuguese yield spread suffered as well but at the end of the day it only increased by 3bps. During the afternoon there were rumours that the ECB was buying Portuguese government bonds. Overnight, S&P rating agency placed the "A-" long-term and "A-2" short term foreign and local sovereign credit ratings on the Republic of Portugal on creditwatch with negative implications. "The creditwatch placement reflects our view of increased risks to the government's creditworthiness". PM Socrates denied over day that his country needs to seek an international bailout. "First of all there are no pressures (to seek a bailout). This is not true." "We don't need any help. We will do all we can ourselves." Today, a T-bill auction takes place. Rising borrowing costs would be another blow for Portugal.
ECB president Trichet spoke to the European parliament yesterday evening. He indicated that there was a possibility for the ECB to significantly increase its bond buying program again in order to calm the European sovereign debt crisis. On Thursday, the ECB holds it monthly meeting. It will be interestingly to see if they will further cut back non-conventional liquidity measures given the recent peripheral developments.
The ECB allotted €179.7B of liquidity at its one-week MRO tender versus a maturing €177.1B or a net amount of €2.6B added. The number of bidding banks decreased slightly to 163 from 165 at the previous tender.
Today, the German treasury taps the on the run 5-year Bobl (1.75% Oct2015) for the last time for an amount of €5B. This year's average bid cover was 1.55 and on average 19.47% was set aside for secondary market operations. This auction is supposed to be decent although we remain cautious as the demand for last week's Bund auction was poor. The Portuguese treasury holds a €500M T-bill auction (Nov2011). Given the untenable tensions in the periphery and recent poorly received auctions, the Portuguese are expected to pay an extremely high price for their debt. The same goes for the Spanish treasury, which taps the market tomorrow with the 3-year Bono (2.5% Oct2013) for an amount of €1.75-2.75B. This is lower than the originally planned €3-4B as the Spanish Finance minister on Friday already said that Spain will issue less debt in the remaining auctions as the finance needs for the year are already covered.
Regarding trading today, yesterday's remarks by ECB president Trichet that the bond buying programme can be significantly expanded might be a trigger to ease tensions. Today's eco data are also interesting. Strong PMI's might return some (temporary) calm to the markets. However, the possibility remains that the focus will be on the peripheral bond markets and the growing European sovereign debt crisis once again. Will Spain, Italy and Belgium succeed to find their composure after the battering they got on Monday and Tuesday? And will the German bund profit again from safe haven bids as it did yesterday?
The fear for a further spreading of the EMU souvereign crisis was still the most important driver for currency trading on Tuesday. Early in Asia, it looked there would be room for the euro sell-off to take a breather after the recent steep losses. However, European traders didn't join this view. The euro was again heavily sold from the open of the European markets. We didn't see any specific headline that triggered this new sell-off. However, as usual in this kind of context, there were plenty of rumours. We don't intend to give an in extenso summary of the rumours or small headlines that swirled. We just retain a few of them. On the financial news wires there was speculation on a potential downgrade of France (later dismissed by the French Budget Minister). At the same time there was also a lot of market chatter on a report from the Bank Portugal as it indicated that Portuguese banks remained strongly dependant on ECB funding. Spreads of the peripherals remained under upward pressure and EUR/USD dropped below the psychological level of 1.30. The eco data in Europe (German labour market data, Flash CPI and unemployment) were too close to expectations and therefore were not relevant for currency trading. EUR/USD touched a minor new low early in US dealings at around 1.2970. From there some consolidation kicked in. The US eco data were mixed, with the CS house prices coming out weaker than expected. On the other hand, the consumer confidence and the Chicago PMI were above market consensus. However, they got hardly any attention from currency traders. The focus then turned the hearing of ECB's Trichet before the committee on Economic and Monetary affairs from the European Parliament. The ECB President brought no new info on Monetary Policy just two days ahead of the policy meeting. He made some standard comments on the developments on the global currency markets. Excess volatility and disorderly movements in exchange rates were said to have adverse implications for economic and financial stability. He said also that the currencies of several excess countries were not sufficiently flexible. The ECB President made also quite some remarks on economic governance. His basic message was that recent measures went in the right direction but that (much) more had to be done. The comments of the ECB President left no noticeable traces on the EUR/USD graphs. Nevertheless, later in US trading, the pair continued to hover sideways but still within striking distance of the recent lows.

For EUR/GBP, trading developed more or less in line with the trading pattern seen for EUR/USD. The UK GFK consumer confidence came out weaker than expected, but the euro side of the story prevailed. So EUR/GBP was hammered early in European trade. Remarkable, cable also continued to outperform EUR/USD later in the session, even as the decline in EUR/USD slowed at that time. So, EUR/GBP extended its slide also after the close of the European markets. The pair reached a new correction low at around 0.8335 overnight.

Thursday evening apparently marked the tipping point in USD/JPY trading. Recently, the US currency rivalled with the yen for the status of preferred save haven currency. Of late, the US currency also got some support from higher US bond yields. However, as global uncertainty continued to mount, the rise in US bond yields slowed. In addition, the recent flaring up of risk aversion, showed that the yen was still the most important funding currency for carry trades. Coincident unwinding of carry trades in several cross rates (AYD/JPY, EUR/JPY, CAD/JPY……) finally pulled the trigger for a comeback of the yen against the dollar, too. The pair returned win the consolidation barrier which is/was marked by the 84.00 mark.

Looking forward to today's price action , the calendar of eco data is quite interesting. The final reading of the EMU PMI's will probably bring no big surprise. However, markets will keep a close eye on the details of the peripheral countries. In the US, the calendar is interesting, too as it contains the ADP labour market report and the ISM for the manufacturing sector. Recent economic evidence from the US wasn't that bad and this might be confirmed by today's data. Already for quite some time we indicated that the combination of reasonably strong US eco data and additional support from the Fed after the decision on QE-2 might become dollar supportive short-term. The dollar recently indeed regained ground, but this was obviously for other reasons. So, it will be interesting to see whether US eco data will be able to turn the market focus away from the souvereign debt crisis in the Europe. Even if this would be the case, the question is what this would mean for EUR/USD trading. Recently, dollar-strength was in the first place a risk aversion trade, rather than a positive call on the US economy. So, the jury is still out what would be the reaction in EUR/USD if this week's US data would be able to improve global risk sentiment for the better. Of course at this stage, this is nothing more than hypothetical thinking. Until further notice, the focus of markets remains on the EU sovereign crisis.

So, for now we don't see any reason to try to catch the falling knife of the single currency. Most euro cross rates including EUR/USD and EUR/GBP are heavily oversold, but we don't row against the tide as long as there is no trigger from the fundamental side or a clear technical signal that the pressure on the euro is abating, we assume to trend to remain south. 1.2588 is still the next high profile target on the charts (24 August low).
This morning, the Nationwide House prices in the UK came out at -0.3%M/M and 0.4% Y/Y. This was close to expectations. However, sterling is ceding some ground against the euro this morning. This should in the first place be considered as a retracement of yesterday's sharp decline in EUR/GBP. In a longer term perspective, we are not convinced on the need of a further big recovery of sterling against the eurfo from the current levels. However, as long as the negative headlines from Europe keeping coming in, we also don't row against the tide in this cross rate. The PMI of the manufacturing sector in the UK is interesting, but we expect the impact of release only to be of intraday importance.