Recovering US Equities Puts Floor Under Europe after Asia Tanks

After the dramatic fall in US equities, Asian equities followed
The MSCI Asia Pacific Index fell 3.4% following Monday’s
slide of 1.7%.   European bourses gapped lower and spent most of the
morning moving higher, though large gaps remain.  At its worst, the Dow
Jones Stoxx 600 was off about 3.3%, and at the time of this writing, it is half
as much.  US equities initially extended yesterday’s losses, but the
S&P 500 has turned higher in the European morning in very volatile

The US 10-year note yield fell nearly 14 bp yesterday.  Asian
and European bond yields have fallen today. Australia’s 10-year yield is off 11
bp to 2.82%, while core bond yields in Europe are off four-five basis points and
the peripheral yields are off two-three basis points.  US Treasuries
yields have stabilized about two basis points above yesterday’s close near

Just like portfolio insurance has been cited in many narratives for
aggravating the 1987 equity market crash, so are volatility-linked strategies
and products being a factor in the current meltdown. 
These products
allowed investors to be short volatility in expectations of continued
calm.  It has been a virtual cash register.  Two such exchange traded
products failed yesterday.  

Yet it is important the price action in perspective. As dramatic as
it is, the major bourses have given up last month’s gain and a little be
more.  The record point drop in the Dow Jones Industrials leaves if off 1.5%
for the year.  The S&P 500 is off less than 1% coming into today.
  Italy’s FTSE Milan is the only G7 equity market still up on the year
(~2.9%).  If one was concerned that equity valuations were elevated, the
recent drop may have simply skimmed off some froth.  

The news stream is relatively light today and the implications of the
equity drop is being mulled by investors. 
The initial reaction seems
to be two-fold.  One if the broad de-risking, and the second is the
economic implications.  The idea is that the sharp decline in equities
will impact consumer sentiment and undermine the wealth impact.   
Given the strength of the US, EMU and Japanese economic momentum, it may take
more than giving back a few weeks’ worth of gains to pose a serious challenge. 
Moreover, there is no urgency for central banks.  The Fed does not meet
for a little more than a month, and the ECB’s course is set via 30 bln a month
in asset purchases through September.  The BOJ’s Kuroda argued against any
near-term rate increase, arguing inflation is simply too low.  

To the extent that investors can shift their attention from the equity
drama, Germany is center stage today. 
First, after a series of work
stoppages, IG Metall struck a deal with employers.   It is a complicated
deal with one off payments and covering 27 months.  The headline of a 4.3%
wage deal over 27 months, seems to downplay the wage increase, which is
something like 3.7% for 2018 and a little more (~4.0% in 2019).  The deal
also includes greater flexibility in terms of hours– a right to reduce the
workweek to 28 hours for two years, with the option to return to full-time
later.  One issue is whether the deal can be used as a boilerplate for
other industries that facing negotiations this year, including chemical,
construction, rail, and telecom workers.  

Second, German factory orders jumped 3.8% in December, a gain of more
than five-times the median forecast in the Bloomberg survey. 
November series was revised to show a 0.1% decline instead of a 0.4% fall. 
Big ticket items drove the increase, and capital equipment orders from EMU
members jumped 18.5%.  Domestic orders rose a still-healthy 0.7%. 

Third, talks between the Merkel’s CDU/CSU and the SPD are in overtime,
but officials seem optimistic that a deal can still be struck that would avoid
a minority government and new elections.
The latest polls warn that the SPD
may have slipped below 20% public support.  The SPD members get a final
say on whatever agreement may be struck, but the threat of new elections seems
to be a poison chalice.    

Separately, we not that today is the last day to submit candidates for
the vice president of the ECB.  Ireland has submitted its central banker
Lane as a candidate. 
Spain’s de Guindos was thought to be the
front-runner, and apparently did not compete for Eurogroup head to position for
the ECB post.  Many ECB officials seemed uneasy about a finance minister
and one without a deep economic background to be in such a senior position at
the ECB.    De Guindos has not been formally nominated, and the
Socialists have indicated they will not support his candidacy.  This
leaves Spain, with a minority government, in a difficult position. 

The Reserve Bank of Australia met earlier today.  It was the
first of three major central banks to meet this week (RBNZ and BOE meetings
still to come).  There were no surprises.  The cash rate was left
unchanged at 1.5%.  The statement seemed upbeat on growth and encouraging
on labor market developments, but was caution on housing and

In North America, the equity markets are the key focus, while both Canada
and the US report December trade figures.
  We know from the initial
release of Q4 17 US GDP, that net exports were a significant drag.  The
December trade balance is expected to have widened to $52.1 bln from $50.5 in
November.  While a widening of the trade deficit is likely to irk some US
Administration officials, we argue that the narrowing of the energy balance
means that the non-oil balance is deteriorating faster than appreciated. 
The average shortfall in 2017 through November was $46.7 bln.  Canada’s
trade’s trade deficit is expected to be little changed from November C$2.5 bln
deficit.  The average deficit in the first 11 months was C$1.9 bln.

Separately, Canada reported the IVEY PMI for January, and it will be
compared to December’s 60.4 reading.
  The Fed’s Bullard speaks on the
US economy and monetary policy today, while another seven Fed officials speak
before the end of the week. 


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