Fundamental Analysis

Euro Outperforms Despite Spain Triggering art 155

Typography
  • European equities lose up to 1%, copying a sudden slide in the Hang Seng Index at the end of Asian trading. Comments by PBOC governor Zhou on a "Minsky moment" are to blame. US stock markets opened losses between 0.3% and 0.6%, with the Nasdaq underperforming.
  • The Spanish government has promised to begin the process of taking direct control over Catalonia after the region's president Carles Puigdemont declined to renounce claims to independence.
  • China will fend off risks from excessive optimism that could lead to a "Minsky Moment", central bank governor Zhou Xiaochuan said, adding that corporate debt levels are relatively high and household debt is rising too quickly. A Minsky Moment is a sudden collapse of asset prices after a long period of growth, sparked by debt or FX pressures.
  • UK retail sales fell more than forecast in September, leaving growth in the third quarter at its weakest in four years. Sales dropped 0.8% from August, far more than the 0.1% estimated. Over the third quarter, annual growth slowed to 1.5%, the worst performance since October 2013, according to the ONS.
  • The number of Americans filing for unemployment benefits fell to its lowest level in more than 44 years last week (222k), pointing to a rebound in job growth after a hurricane-related decline in employment in September. The Philly Fed business outlook unexpectedly rose from 23.8 to 27.9.
  • New Zealand First party backed Labour to form a government after 12 days of talks following inconclusive elections. The new PM will be Jacinda Ardern, who became Labour leader in July. NZ First argues the kiwi is overvalued and wants to change the RBNZ's inflation mandate to a system in which it can directly control the currency. NZD/USD crashed from 0.7150 towards 0.70.
  • President Donald Trump's drive to overhaul the US tax code headed for a pivotal moment, with Senate Republicans poised to approve a budget measure that would help them pass tax legislation without Democratic support.
  • Austria's likely next chancellor assured EU leaders of his support for the EU, allaying concerns that his country would become a dissonant voice in the bloc with the far right expected to enter its government.

Rates

Risk aversion with US outperformance

Global core bonds gained ground today in a risk-off environment. US Treasuries surprisingly outperformed German Bunds. A sudden drop of Hong Kong shares at the end of Asian trading initiated a disappointing European stock market opening and triggered first safe haven flows. Equity investors took a scare from comments of PBOC governor Zhou who warned for a Minsky moment (see headlines) in Chinese assets. Developments in Spain caused a second bout of risk aversion, even if it was short-lived (Bund completely retraced the move). Catalan President Puigdemont refused to renounce his claim on independence, forcing Madrid to proceed with activating article 155 which would strip Catalunya from its autonomy. Spanish parliament is expected to vote on the issue on Monday. The Spanish asset underperformance was rapidly undone, in line with previous days. Investors clearly think that the Spanish-Catalan stand-off won't spiral out of control. US eco data printed very strong with historically low jobless claims and a strong Philly Fed Business outlook, but couldn't change the tide on the US Treasury market.

At the time of writing, US yields decline by 2.4 bps (2-yr) to 3.8 bps (10-yr). Changes on the German yield curve are limited between -0.6 bps (2-yr) and -0.1 bp (30-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany are close to unchanged with Greece underperforming (+5 bps) and Portugal outperforming (-5 bps).

The French treasury tapped two on the run OAT's (€1.8B 0% May2021 & €2.57B 0% Mar2023) and an off the run OAT (€2.63B 1.75% Nov2024) for a combined €7bn, the maximum amount on offer. Demand was good with a 2.07 auction bid cover. The Spanish debt agency sold three on the run bonds (€1.81B 0.05% Jan2021, €1.02B 1.45% Oct2027 & €0.74B 2.9% Oct2046) and one off the run Obligacion (€0.97B 4.65% Jul2025). The combined amount raised, €4.53B, was in the middle of the €4-5B target range with a 1.52 auction bid cover. Given today's escalation in the Spanish constitutional crisis, the result could have been much worse.

Currencies

Euro outperforms despite Spain triggering art 155

All eyes were on Spain today. EUR/USD spiked lower as the Spanish government stated the process of suspending the regional powers of the Catalan government. However, the euro decline was almost immediately reversed. EUR/USD even moved in positive territory. A tentative global risk-off sentiment caused US Treasuries to outperform German bunds; reducing the interest rate differential in favour of the euro. EUR/USD trades in the 1.1835 area. USD/JPY dropped to the mid 112 area.

Overnight, the Chinese Q3 GDP was in line with expectations. The composition was OK. Even so, Chinese data were insufficient to enhance the Asian risk rally. Most regional indices showed modest losses. Japan outperformed on overall yen weakness. At the end of the session, shares in Hong Kong even fell off a cliff, closing the day with a loss of 1.92%. USD/JPY tried to regain the 113 barrier overnight, but the risk-off correction pushed the pair back below the big figure. EUR/USD was little affected by the Asian equity swings. The pair hovered in the low 1.18 area.

European equities opened little changed, but volatility from Asia and uncertainty ahead of the Catalan deadline triggered caution among European (equity) investors. Catalan president Puidgemont refused to withdraw the Catalan independence claim. As a result, Spanish PM Rajoy started the procedure to suspend the power for the regional authority, invoking article 155 of the Spanish constitution. EUR/USD spiked to the 1.1770 area on the announcement of the start of this procedure. However, the euro decline was very short-lived. EUR/USD soon returned to the 1.18 area and even moved in positive territory. The euro already showed resilience to the Spanish political uncertainty of late. Other factors were also at play. Global risk sentiment , but Spain wasn't the only factor to blame. US equity futures nosedived (fall-out from Hong Kong?). Remarkably, despite the Spanish uncertainty, interest rate differentials moved in favour of the euro rather than the dollar as US Treasuries outperformed German bonds. EUR/USD stayed well above the 1.18 barrier. In the same move, USD/JPY dropped to mid-112 area.

The US jobless claims and the Philly Fed business outlook were both very strong. Claims even dropped to the lowest level since 1973. However, the reports didn't help the dollar. The key question for global trading was whether or not US stocks would join a broader risk-off correction. US equities opened with modest losses of 0.3% to 0.6%. EUR/USD stabilizes in the 1.1835 area. USD/JPY is changing hands in the 112.55 area. Dollar sentiment remains fragile. Despite Spain, the US currency looks at least as vulnerable to global uncertainty than the euro.

Poor UK retail sales cause additional sterling selling

UK retail sales fell 0.8% M/M in September, reversing a rise of 0.9% the previous month. The September decline brings third quarter growth to 1.5% Y/Y, the slowest level since Q2 2013. The ONS said that the rising cost of goods eroded Britton's spending power. Today's retail sales suggest that there is little room for the BoE to raise its policy rate beyond a sole rate hike in November. The prospect of little additional interest rate support triggered further sterling selling. EUR/GBP spiked to the 0.8990 area and remained close to that level for the remainder of the session. Cable set a minor low for this week (1.3135 area), but further losses were blocked as the dollar came also under pressure. At the EU summit in Brussels, UK PM May will ask the other EU leaders to proceed talks on the future relationship between the EU and the UK. The EU might give some encouraging words, but it is unlikely that they will make big unilateral concessions. In this context, sterling might remain the defensive.

Author: KBC BankWebsite: https://www.kbc.be/dealingroom
KBC Bank
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