A couple of ugly events sapped investor confidence this week. One will never go away and has left a scar: Brazil’s shellacking by Germany on home soil at the World Cup tournament. The other occurred in Europe, managing temporarily to freak out global markets, as participants collectively experienced a eurozone crisis flashback. Portugal’s largest bank, Banco Espirito Santo (BES), saw its shares suspended from trading on Thursday after a wealth management affiliate delayed payments on debt and Moody’s Investor Service downgraded the firm. The knock-on effect began a global equity and periphery bond rout and a mini-break from risk trading.
The capital market managed to push the yield on Portugal’s 10-year note back to +4%, the highest since early April, while two Spanish banks were forced to suspend bond sales. Anything affecting one eurozone periphery member basically affects all nowadays — the yields on other peripheral members sovereign bonds also blew out, reminding all of the darkest days of the euro debt crisis. Throw into the mix some weak industrial data from France and Italy and you have an investor, who may not be wholly tuned in, fearing déjà vu.
Risk versus Yield?
Fear not, this week’s reaction to the events surrounding BES should serve to remind investors that risk versus return should be as an important consideration as “yield and carry.” What has transpired in Europe is being treated as a flash in the pan. So far, euro debt concerns have had a marginal effect on Australasian credit spreads overnight, as investors continue to focus on buying new issues. Even the European bourses are in the green as we head stateside.
This bout of volatility has at least woken the market up from its deep slumber (and it’s not even considered the summer doldrums yet). If investors consider looking at FX, bond, and equity implied volatility, one will notice that we are still some distance from trading in a contagion/systemic risk environment. Portugal’s BES is a reminder for eurozone authorities what work remains to be done to wholly convince the global investor of the health of their financial system. Remember, the European Central Bank has a backstop: very long-term refinancing operations, aka VLTROs.
Expect Market Quietude Today
A positive start for the main European bourses and a small selloff in core government bonds is proof of an easing of yesterday’s risk-aversion setup. The FX market is reacting with a small unwinding of the common safety trades, which see JPY (¥101.30) and USD trade a tad weaker versus the 18-member single unit (€1.3615) and the commodity currencies (CAD $1.0635 and AUD$0.9400).
The EUR has been pushed reluctantly higher as traders continue to pare their risk-averse bets. A 10-bps narrowing for 10-year German to Portuguese bond spreads was the first signal for the market to consider covering some of its EUR shorts. However, ultra-low option volumes continue to dominate FX thinking (moves are nearly non-existent). With little data of note to spur on traders, the market should expect very little chance of any significant (or any) moves away from €1.3600 today.
Is U.K. Growth Under Threat?
There are not many data points for investors to sink their teeth into on Friday. The only one of note is the U.K. Office for Budget Responsibility’s Fiscal Sustainability Report. Until recently, Britain’s second-quarter gross domestic product growth looked to be on course to match the +0.8% print of the first quarter; however, many are suggesting that this may be in doubt now, especially after this morning’s construction releases. U.K. data headlines reveal that construction output actually fell -1.1% in May. Despite being a volatile report, add today’s results to U.K.’s industrial production falling -0.7%, manufacturing output down -1.3%, and a widening trade deficit and one gets the sense that Bank of England (BoE) Governor Mark Carney and company may be losing the Midas Touch. The BoE will have to look to the U.K.’s dominant service sector for much needed support, as well as an uptick in June’s construction output and industrial production. The pound has seen a quick unwinding of the pre-data buying that pushed it up to a fresh day high (£1.7151). Until something does happen, sub-£1.7085 is still considered as key support.
Canadian Employment Data Takes Center Stage
There is little of note to spur on the various asset classes as we close out the week. Nevertheless, Canada will try to do its part with the release of its June employment report. The market’s forecast is for a headline print of +20k and an unemployment rate of +7%. The consensus view is that a strong report will threaten the $1.0600 option barrier in play (current $1.0635). Stronger numbers should give the impetus to blow through last week’s six-month low ($1.0620). The dollar’s pre-figure resistance remains at $1.0654 (Asia high) and $1.0676.
Are EUR and Sterling Risks Climbing?