S&P's downgrades of a number of EU sovereigns appears to have had limited impact so far on risk appetite, which remains healthy on the surface. But beneath the surface signs of strain are increasingly evident.
EU focus
The key focus this week is the aftermath of the downgrade Friday by the S&P bond ratings agency of multiple EU countries, including Spain, Portugal and Italy by two notches, and importantly, the downgrade of two of the triple-AAA countries, Austria and France, by a notch. See our Chief Economist Steen Jakobsen's exhaustive run-down of the implications in his chronicle from this weekend. The most important direct fall-out from the downgrades is on the status of the EFSF, as only a shrinking minority of its sponsors are now AAA.
The other hot potato issue for the week is the Greek PSI deal, where talks have fallen apart and various scenarios are on the table - the market continues to express the opinion that Greek debt is only worth about 20 cents on the dollar while the PSI deal is for only a 50 percent haircut. The risk is that Greece renegs on the deal and imposes new harsher terms that effectively constitute a default, which might in turn trigger an exit from the Euro Zone because the “troika” (ECB, EC and IMF) refuses to advance any further bailout money. That would also have important implications for the ECB balance sheet and any contagion worries (Portugal the next in line) could deepen those worries.
EU bond auctions
So far today, the fall-out from the S&P downgrades has been minimal in terms of bond yields across Europe, but the ECB is doubtless intervening to keep a lid on things again. The auction calendar this week is fairly light (shorter term bills from France, Spain and Belgium on Mon-Tue) until Wednesday, when we have an auction of German 2-year debt and then on Thursday, the key day on the auction calendar, when Spain will be auctioning debt from 4- to 10-years and France will be auctioning a wide range of maturities, from 2 yeard up to almost 30 years.
Technical and Intermarket indicators - rising worry evident amid complacency
Intermarket technicals are inconclusive - bond yields are easing back to the bottom of the medium term range - pointing to continued safe haven seeking and expectations for low growth. But asset markets appear rather complacent and are perhaps warming up for the next round of expected liquidity from the Fed in the form of QE3 and possibly looking for another wave of stimulus from China. We noted very complacent investor surveys last week and some divergence in the VIX, both of which continued this week. The new development over the last week has been signs of increased worry in the likes of Emerging Market bond spreads and Junk bond spreads.
Equities
Looking ahead toward the end of this week for a heavier dose of "real economy" earnings reports from the likes of IBM and other US tech giants, though better indications on corporate earnings and outlooks are up next week. JP Morgan set the tone for weak bank earnings last week, with its major rivals reporting this week.
FX
Euro very weak, but is trade getting crowded? Aussie is getting odd safe haven behavior (considering its historically very pro-cyclical behavior) as a solid AAA sovereign in a world of increasingly ugly sovereign balance sheets elsewhere. But how would the Aussie fare in the event of a 8-10% correction in the S&P500? USDJPY and EURJPY at painful levels once again for Japan - will they intervene again soon?
Economic Calendar this week - highlights only
Today
- Markets in the US are closed for the Martin Luther King, Jr. holiday.
- Chinese Q4 GDP, Dec. Retail Sales and Dec. Industrial Production data set for release tonight, with some risk of a downside risk in GDP, depending on how transparent China would like to make its current economic plight. Bloomberg expectations are running at 8.7% YoY
- UK Dec. CPI - is inflation finally decelerating in the UK and thus encouraging next round of QE?
- Germany Jan. ZEW - currently as low as lowest during financial crisis - interesting thing being that ZEW bottomed in July of 2008, therefore somewhat predictive
- US Jan. Empire Manufacturing - manufacturing surveys for January very interesting for the US as we wonder to what degree
- Canada - Bank of Canada rate - expectations very flat. The Canadian economy appears relatively healthy, though a housing bubble demise awaits and employment data has been souring for some time. There's hardly anything for the bank to get hawkish about.
- US Dec PPI and Industrial Production - US core inflation data needs to fade again soon if the Fed is to indulge in yet another round of money printing
- Australia Dec. employment report - Aussie's star has been burning bright of late - could another bad employment report introduce at least a temporary setback?
- US Jan. Philly Fed - ditto for Empire survey above
- US Dec. Housing Start and Building Permits - resilience of late noted, but it's a long slog to normalization
- US Weekly Jobless Claims - a bit worry that last week's ugly print came at a time of year when firings are especially heavy - let's see if it was an aberration or a worry new trend in claims (even confirmation that the downtrend in claims has halted is bad news)
- UK Dec. Retail Sales - will heavy retailer discounting mean a shortfall like in the US?
- Canada CPI - high end of the range of late, but the BoC wants to turn a blind eye.
- Don't forget that the Chinese New Year comes early this year (Jan 23) and that much of Asia will be more or less off-line from late this week through to the week after next.
- Next week also features the next FOMC meeting, where we are likely to get more transparency on the FOMC members' thoughts on the trajectory of monetary policy.
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