Europe Stabilizes After Asia Melts

After a meltdown in Asia, the global capital markets are stabilizing in Europe.   The US S&P managed to recoup about half of its losses before the close yesterday, but this gave not comfort to Japanese investors.  The yen's strength and ongoing concerns about banks' exposure to energy companies took the down 5.4% and pushed the 10-year JGB yield into negative territory for the first time.

The Dow Jones Stoxx 600 is off 0.25% near midday in London.  Telecoms and consumer staples are firm, but materials and financials are the largest drags.  This plays on the bank-energy theme as well as more concern about European banks.  In particular, the contingent convertible bonds, which emerged as a part of the effort to strengthen bank balance sheets, are being "battle-tested".  The new  Bank Recovery and Resolution Directive (BRRD) which exposure fixed income investors to a greater risk of being bailed-in, may also be a source of anxiety.

European bond yields are higher.  Italian and Spanish bonds are nearly flat while core bond yields are 3-4 bp higher.  Although Portugal appears to have struck a compromise with the EC over this year's budget, and in some ways, as austere if not more than the previous center-right government.  The 50 bp increase in 10-year yields over the past five sessions, three times the increase that Spain, which is still trying to cobble together a government, is not a vote of confidence.  Indeed, many suspect Portugal will be required to have a mid-course correction, i.e., more fiscal action when if slower growth risks a deficit overshoot.

Oil is trading 1-2% higher even though the IEA reported that Saudi Arabia boosted oil output in January by 70k barrels to 10.2 mln bpd, and Iraqi output hit a new record high.  It increased production by 50k barrels to 4.35 mln bpd.   The US Department of Energy updates its short-term energy outlook and tomorrow reports the weekly inventory figures.  The Bloomberg consensus calls for a 3.1 mln barrel build of crude stocks.  This follows a 7.8 mln barrel build the previous week.

The economic data has been largely limited to industrial output and trade figures.  Both were disappointing.  The slightly larger than expected decline in December factory orders reported last week gave little sign of the poor industrial output figures.  Industrial production was expected to have risen by 0.5%.  Instead, it fell by 1.2%.  While the figure was dragged lower by the 3% decline in energy output, which was a function of the weather, consumer and capital goods output also fell. 

Separately, German reported a slight decline in its trade balance to 18.8 bln euros from 20.5 bln.  However, this masked a 1.6% decline in exports.  The consensus expected a 0.5% increase.  Imports also fell 1.6%, three times what the market anticipated.  The 25.6 bln euro current account surplus puts the Q4 average at 24.3 bln compared with 21.0 bln average in Q3, despite the trade balance, was little changed in the quarter.     German Q4 GDP figures are due before the weekend.  The economy ended 2015 on a soft note. 

The US calendar is light.  The JOLTS report on the labor market and wholesale inventories are the main features but are not typically market-moving releases even in the best of times.  Yellen’s testimony before the House Financial Panel tomorrow is awaited for fresh insight into what the Federal Reserve makes recent market developments, which seem more significant than the real sector data.  After a poor Q4 GDP, the Atlanta Fed GDPNow is tracking a little more than 2% growth in Q1 16.   While the tightening of financial conditions has become an important focus,  we note that dollar’s trade-weighted measure has fallen over the past week.