Markets Mark Time Ahead of Tomorrow

Tomorrow may be the most important day of the quarter for investors. 
The ECB meets.  The UK goes to the polls.  Former FBI Comey
testifies.  Ahead of these significant events, the global capital markets
are mostly quiet, with some pockets of activity.  

The US dollar is narrowly mixed.  The Australian dollar is the
strongest currency today, gaining nearly 0.7%  against the dollar to edge
through last month’s high on the back of news that the economy expanded 0.3%
rather than contract as some feared after Tuesday’s poor trade

The Aussie looks constructive from a technical perspective, and the
relatively high interest rates may be
more salient given the pullback in US rates.
  However, while a
contraction was avoided, Australia’s
economy is not firing on all cylinders.  Growth was flattered by an
accumulation of inventories in mining (largest build in five years). 
Consumption was halved in Q1 from Q4 16,
and that consumption that did take place
appears to have been financed in part by a draw down in savings, which at 4.7%,
is the lowest in nine years.  And even then, the much of the consumption
was taken up by “dwelling services,”
like rent, food, and

The yen remains bid.  The US dollar’s losses have been extended as the JPY109 level is
approached.  US yields stabilized
after the four basis point decline yesterday.    Bloomberg cited
its story that cited unnamed sources saying that, after a recent divestment,
China was ready to invest in US Treasuries again, as a reason for yesterday’s
rally.  We are skeptical of the narrative, but the truth is that China’s
reserves have begun rising again and as they do, there will be a natural demand
for Treasuries.  

Indeed earlier today, China reported that its reserves rose for a fourth
consecutive month in April. 
The $24 bln increase was more than some
economists expected, and the largest monthly increase since April 2014.
   They stand at $3.053 trillion, having bottomed in January a little
below $3 trillion.    Valuation adjustments, helped by the
euro’s appreciation, complemented by the capital controls likely

There are two European stories that are attracting interest. 
First, German factory orders fell sharply in April.  Factory orders fell
2.1% rather than 0.3% as the Bloomberg median survey forecast indicated. 
There was little offset by the revision in March to 1.1% from 1.0%. 
Weakness was especially evident in orders for investment goods from outside the
euro area.  Tomorrow Germany reports April industrial output, and after
the disappointing orders data, there is some risk that April output is weaker
than expected (~0.5%).  

Before leaving Germany, note the Constitutional Court ruling that strikes
down the nuclear fuel tax has seen German utility companies rally while the DAX
is little changed,
  An index of
utility companies is up 4.3%, ostensibly in
the judgment.  

The other European story is in Spain.  Banco Popular, which as
we discussed earlier this week, was under pressure and once the Single
Resolution Board was informed that it
would likely fail, it marked the end.  Heavy losses were inflicted on
shareholders and subordinated bond holders  (~3.3 bln euros).  The
AT1 (Alternative Tier 1) securities collapsed.  The bank was sold to Santander for a euro. 
Santander announced a seven bln euro
rights offering, which some analysts think is more than is needed for Popular and is raising extra capital.  It
shares are off around 3%.   

There is an extra layer of importance.  It is the first (major)
action taken by the Single Resolution
Board that was established 2 1/2 years
ago.   After wiping out shareholders,
additional Tier 1 debt, and conversion of Tier 2 bonds into equities, it did
not have to take stronger measures.  If needed, it has the authority to
take over the institution and/or force
senior creditors to take a hit.  

These events in Spain may help inform the discussion of Italy’s troubled
  One important difference is that some of the Italian bank
bonds were sold to directly to retail investors.  It seemed a good idea at
the time, broaden the investment base, but some of the bonds were sold as having little risk.  There is
a precedent to compensate such investors
after the resolution process.   In any event, Italian bank shares are
snapping a two-day decline today.  

Separately, we note that Spanish industrial output was softer than
It rose 0.1% in April.  The median forecast was for a
0.4% increase.  The year-over-year rate edged up to 0.7% from a revised
0.6% (initially 0.4%).  

The euro is trading quietly,
keeping to the range seen over the past two sessions. 
It runs into
offers in front of $1.1285, perhaps as some defend the $1.13 level where large
options have been struck.  Dips
below $1.1250 seem to draw bids.   Ahead of tomorrow’s ECB meeting, the
market is fairly calm with the euro near seven-month highs.  

The US Department of Energy reports the oil and gas inventories, and late
in the session, consumer credit will be reported.
Former FBI Director Comey testifies tomorrow, but media reports appear to steal some of the potential thunder.  In
particular, if the FBI thought the President was obstructing justice his behavior
would have been different.  Therefore, there will be no such claim.  This, in turn, warns investors that the
tomorrow’s testimony may have been over-hyped and that the distraction from the
economic agenda, at least now, may not be as significant as feared.  


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