With China on holiday for the week, overnight sessions remain quiet: at this moment, S&P 500 futures are little changed as European stocks fall for first day in seven, on yesterday's concern that the ECB is moving toward tightening monetary policy; Asian indices rose slightly for third day. WTI climbs to $49.40, the highest since June 30 after yesterday's surprisingly large API crude draw report.

Following yesterday's Bloomberg report that an informal consensus was building in the European Central Bank that quantitative easing will need to be tapered once a decision is taken to end the program, the Stoxx Europe 600 Index dropped for the first time in seven days and the MSCI Emerging Markets Index halted a two-day rally, despite a prompt denial by the ECB itself. Spanish and Italian bonds extended a selloff in euro-area debt markets, while Treasuries held a three-day drop after Federal Reserve officials talked up the chance of a U.S. interest-rate increase in 2016.

Spain’s 10-year bond yield climbed six basis points to 1.04 percent as traders digested the potential for an ECB taper. Italian yields rose seven basis points to 1.38 percent, a day after the nation sold 50-year bonds for the first time. Benchmark German 10-year bond yields increased three basis points to minus 0.02 percent. The yield Treasury 10-year notes rose one basis point to 1.70 percent, after climbing six basis points on Tuesday. Following hawkish comments from Fed officials, the odds of an interest rate increase this year have risen to 61 percent, up about 11 percentage points from last week, though futures indicate only a 21 percent chance of a move coming when the next meeting concludes on Nov. 2.

While the ECB's intentions remain unclear, the report triggered a flashback of the BOJ's recent intention to implement a "reverse Operation Twist", which lead to a mini Taper Tantrum around the globe and a sharp drop in early September as central banks have left markets vulnerable to a selloff as central banks in Europe and Japan show signs of wanting to dial back their unprecedented stimulus and the case for a U.S. interest-rate increase builds. As a reminder, when the Fed indicated it was reducing asset purchases in 2013, it sparked a so-called taper tantrum leading to a surge in bond yields.

Ultimately, as we first suggested, it may be nothing more than a trial balloon: “The central bank may be trying to test the market, see how it reacts to this sort of news and lift some of the pressure we’ve had on the banking sector,” said William Hobbs, head of investment strategy at Barclays Plc’s wealth-management unit in London. “They may have come to the realization that monetary policy isn’t helping the banking sector, which may ultimately make it counter-productive.”

“The most important thing on investors’ minds are still central banks,” said Christian Zogg, head of equity and fixed income at LLB Asset Management in Vaduz, Liechtenstein. His firm manages the equivalent of about $10 billion. “While a normalization of interest rates would probably give more confidence to market participants in the longer run, it’s clear that a change of central bank policies will add uncertainty and shake the market a little.”

Perhaps it is expectations that the bond curve will steepen that helped financial stocks push against today's modest selling: while the Stoxx Europe 600 Index fell as much as 0.9% in early trading, a gauge of banks in the index eked out a gain of 0.1%. Yield-sensitive industries including telecommunications, utilities and real estate were among the biggest decliners on the Stoxx 600. The number of shares changing hands was about 23 percent higher than the 30-day average.Tesco Plc helped limit losses among retailers, jumping 11 percent after reporting first-half profit that beat analysts’ estimates. Delta Lloyd NV rallied 29 percent after NN Group offered to buy the company for 2.4 billion euros ($2.7 billion) in cash to boost scale in the pensions and insurance sectors. NN Group slid 1.8 percent.

The MSCI Emerging Markets Index fell 0.3 percent following a 1.3 percent advance over the previous two days. Shares in Asia led losses, with the Philippines and Indonesia dropping more than 0.9 percent. The Hang Seng China Enterprises Index of Chinese companies listed in Hong Kong rose for a third day, advancing 0.6 percent. The Hang Seng Index added 0.4 percent, with trading volumes 26 percent less than the 30-day average amid a week-long holiday in mainland China.

S&P 500 futures were little changed after U.S. stocks fell 0.5% on Tuesday.

In currencies the most notable move remained the slide in the pound which touched a fresh five-year low versus the euro, staying weaker even as a report showed the services industry grew more than economists forecast last month, in another sign of the economy’s resilience following the June vote to leave the European Union. Sterling was 0.2 percent weaker at 88.23 pence per euro. The British currency has tumbled against all of its major counterparts this week after Prime Minister Theresa May signaled the U.K. is prepared to surrender membership of Europe’s single market

Crude oil continued to rise, up as much as 1.8 percent to $49.57 a barrel in New York, the highest since June 30. Inventories dropped by 7.6 million barrels last week, API reported, before official data on Wednesday that’s forecast to show stockpiles increased. The rise continued even as Goldman's Jeff Currie said on BBG TV that the market looks very oversupplied in 2017, noting that production is increasing in low-cost players like Russia and a “Wall of supply” is coming from international oil companies. Another risk is a “detente” in troubled oil-producing countries like Nigeria, Libya also swelling supply. For now, however, the fundamentals once again don't matter as the momentum CTAs remain in control, this time to the upside.

Among economic data scheduled for Wednesday, the focus will be on the ADP Research Institute’s employment figures, services and manufacturing reports, as well as orders for durable goods.

Richmond Fed chief Jeffrey Lacker may argue for the second time this week in favor of an interest-rate rise when he speaks Wednesday. Fed Bank of Chicago President Charles Evans said borrowing costs could be raised as early as November and his counterparts for Richmond and Cleveland spoke over the last two days in favor of a hike.

Market Snapshot

• S&P 500 futures up less than 0.1% to 2145
• Stoxx 600 down 0.7% to 344
• FTSE 100 down 0.3% to 7052
• DAX down 0.6% to 10554
• German 10Yr yield up less than 1bp to -0.05%
• Italian 10Yr yield up 2bps to 1.33%
• Spanish 10Yr yield up 2bps to 0.99%
• S&P GSCI Index up 0.8% to 370.4
• MSCI Asia Pacific up less than 0.1% to 141
• US 10-yr yield down less than 1bp to 1.68%
• Dollar Index down 0.19% to 95.98
• WTI Crude futures up 1.4% to $49.39
• Brent Futures up 1.4% to $51.58
• Gold spot up 0.3% to $1,272
• Silver spot up 0.8% to $17.95

Global News Highlights

• Japan’s Sompo Agrees to Buy Endurance Specialty for $6.3b: Insurer will pay $93/share in cash for Endurance, or 43% premium to Monday’s close.
• Twitter (TWTR) to Field Offers This Week; CRM Among Bidders: WSJ: Salesforce CEO Marc Benioff said to see TWTR as “unpolished jewel.”; Early Twitter Investor Sacca Says He’s Been Selling Shares: “I don’t own as many as I used to because I’m not an idiot, but I own more than I should because I’m an idiot,” Chris Sacca said in an interview Tuesday on Bloomberg TV.
• BlackRock (BLK) Cuts Prices on ETFs Anticipating Greater Passive Shift: iShares lineup will feature lower expense ratios on 15 stock, bond funds aimed at buy-and-hold investors.
• Team Health Jumps on Report of Private Equity Firm Talks: WSJ reported yesterday that co. in talks with Blackstone, Bain Capital.
• Constellation Brands Buys High West Distillery for ~$160m: WSJ: STZ beat out several other bidders including Pernod Ricard, LVMH Moet Hennessy.
• Caesars Updates Reorganization Plan With Bondholder Settlement: Lawyer tells bankruptcy judge that co. believes each class of creditors will vote in favor of plan.
• Pence Succeeds in Debate Without Really Trying to Defend Trump: 48% of voters who watched said Pence won debate, 42% said Kaine won: CNN poll.
• McDonald’s (MCD) Moving to Sustainable Coffee in Latest Menu Change: Last year, 37% of McDonald’s coffee was purchased from certified sustainable sources.
• Dow Jones’s ‘Financial News’ Said Planning to Cut Some Staff: Cuts could amount to ~10% of staff.

Looking at regional markets, Asia stocks traded mixed following the weak lead from Wall Street where Fed rate hike concerns and unsubstantiated reports of the ECB near a consensus on tapering QE pressured sentiment. ASX 200 (-0.6%) was dragged by miners after declines across the metals complex which saw gold prices slump over USD 43/oz to its lowest levels since the Brexit vote. Nikkei 225 (+0.5%) outperformed on a weaker JPY after USD/JPY tested 103.00 to the upside. Hang Seng (+0.4%) saw choppy trade amid a lack of drivers with China away from market. 10yr JGBs were flat despite the positive risk tone seen in Japanese stocks, with bonds supported by the BoJ in the market for JPY 1.2tIn of government debt.

Top Asian News

• Kuroda Fails to Convince Investors Policy Means What He Says: BoJ governor’s new stimulus plan ‘is essentially tapering’: Sumitomo Mitsui.
• Shenzhen Qianhai Said to Near $1b Purchase of ACR Capital: Deal may be announced as soon as today.
• Asia’s Best Bond Rally Boosted as Morgan Stanley Sees More Cuts: Morgan Stanley forecasts inflation lower than RBI expectations.
• After War and Tumult, the Palestine Stock Market Joins the World: Palestine Exchange gets included in FTSE Russell index.
• Chinese Buyers Returning to Hong Kong Housing, Wheelock Says: Mass-market sales to mainlanders have doubled y/y.
• Billionaire Riady Family Said to Seek United Engineers Stake: OCBC and Great Eastern reviewing options for stakes in co.

In Europe, with the first opportunity to react to yesterday's source reports from the ECB which suggested the prospect of tapering the central banks QE program next year, European equities trade lower across the board (Eurostoxx 50 -0.6%). The FTSE 100 (-0.4%) yet again outperforms relative to its counterparts (albeit in negative territory) with GBP remaining gripped by Brexit-uncertainty, alongside this the FTSE has also been supported by the surge in Tesco (+7%) following strong interim results. In credit market, Eurozone bond yields are a touch firmer amid the circulation of ECB source reports, as such Bunds broke below 165.00 while the belly of the curve have seen some notable outperformance. In terms of this morning's supply, Bunds were relatively unfazed by the latest 10yr auction which drew a respectable b/c of 1.4, which was somewhat of a relief compared to the previously uncovered auction of this line.

Top European News

• Delta Lloyd Rises Most Ever After Receiving $2.7b Bid From NN: Co. said it has received a “conditional, unsolicited” offer and its boards are studying it.
• Euro-Area Expansion Loses Momentum as Uncertainty Saps Growth: Manufacturing, services PMI slid to 52.6 in Sept. vs 52.9 in Aug.: IHS Markit.
• Tesco Surges as Lewis Seeks to Restore Margins Amid Revival: U.K. grocer aims to widen margins to as much as 4% by 2020.
• ZF Drops Haldex Takeover Bid After Investors Spurn Lower Offer: ZF Friedrichshafen dropping SEK5.3b offer to buy Haldex after failing to achieve 50% acceptance.
• Norway Stimulus Seen Fading as Economy Survives Oil Calamity: Govt will pitch stimulus substantially below 1.1pp push it provided this year, according to Svenska Handelsbanken, DNB economists.
• Sweden Bets Expanding Economy Will Soak Up Ericsson Job Cuts: Co.’s Ericsson’s plan to eliminate 3,000 jobs in Sweden is “heartbreaking,” it comes at a time when economy is “strong”: Enterprise Minister Mikael Damberg.

In FX, the pound touched a fresh five-year low versus the euro, staying weaker even as a report showed the services industry grew more than economists forecast last month, in another sign of the economy’s resilience following the June vote to leave the European Union. Sterling was 0.2 percent weaker at 88.23 pence per euro. The British currency has tumbled against all of its major counterparts this week after Prime Minister Theresa May signaled the U.K. is prepared to surrender membership of Europe’s single market. May is due to speak again on Wednesday at the conclusion of her Conservative Party’s annual conference. The Bloomberg Dollar Spot Index was little changed, after gaining 0.6 percent in the last session. The yen fluctuated following a 1.2 percent drop versus the greenback on Tuesday. New Zealand’s dollar sank to a seven-week low after global dairy prices fell. Average prices for whole milk powder, the nation’s chief farm export, fell 3.8 percent at Tuesday’s GlobalDairyTrade auction.

In commodities, crude oil rose as much as 1.8 percent to $49.57 a barrel in New York, the highest since June 30. Inventories dropped by 7.6 million barrels last week, the American Petroleum Institute was said to report, before official data on Wednesday that’s forecast to show stockpiles increased. A deal between major producers could trim output by 1.2 million barrels a day and boost prices by as much as $15 a barrel, according to Venezuela’s oil minister.Gold for immediate delivery rose 0.4 percent, after a 3.3 percent plunge in the last session that marked its steepest slide in a year. Industrial metals declined in London, with copper, nickel and lead declining for a third day. “It does appear that the market is a bit jittery over prospects for a global exit from central bank stimulus,” said Ric Spooner, a chief market analyst at CMC Markets in Sydney. “For metals there’s a concern that the main impact would be a stronger dollar” as most commodities are priced in the currency, he said. Natural gas for same-day delivery rose 12 percent in London after gaining 29 percent on Tuesday as a cold snap is expected to boost demand for the heating fuel.

Looking at the day ahead a big focus will be on the release of the remaining global PMI’s today where we’ll get confirmation of the final September services and composite readings for the likes of the Euro area and the US, along with a first look at the data for the periphery in Europe and also the UK. In the US, there will be plenty of focus on the ADP employment change reading for September ahead of Friday’s payrolls print. Market expectation is for a 165k reading. The other big release this afternoon is the ISM non-manufacturing print for September. The market is expecting an increase to 53.0 from 51.4 and there should also be a close watch on the employment component for the series after the data retreated to 50.7 in August. Also due out this afternoon will be August factory orders (-0.2% mom expected) and the August trade balance (little change expected). Away from the data we’ve got the Fed’s Kashkari due to speak followed by Lacker again this evening. The BoE’s Broadbent is also due to speak this morning in London. UK PM Theresa May also wraps up the Conservative Party conference with a keynote speech at lunchtime.

* * *

Bulletin headline summary from RanSquawk and Bloomberg

• EU equities trade lower across the board as European participants react to yesterday's ECB source comments
• The FTSE 100 (-0.4%) yet again outperforms relative to its counterparts (albeit in negative territory) with GBP remaining gripped by Brexit-uncertainty
• Looking ahead, highlights include US ADP Employment Change, US Factory orders, ISM non-manufacturing and DOE's
• Euro-area economy loses momentum as uncertainty saps growth
• BOE’s Broadbent says Brexit may delay investment, impact to take time; adds that pound decline since vote has been “relatively orderly”
• U.K. September services PMI falls to 52.6 vs 52.9 prior; median estimate 52.2
• Kuroda fails to convince investors policy means what he says
• RBNZ’s McDermott says monetary policy challenges “large as ever”; adds RBNZ framework aims to reduce uncertainty

US Event Summary

• 7:00am: MBA Mortgage Applications, Sept. 30, no est. (prior -0.7%)
• 8:15am: ADP Employment Change, Sept., est. 165k (prior 177k)
• 8:30am: Trade Balance, Aug., est. -$39.2b (prior -$39.5b)
• 9:45am: Markit U.S. Services PMI, Sept. F, est. 51.9 (prior 51.9)
  • Markit U.S. Composite PMI, Sept. F, no est. (prior 52)
• 10:00am: ISM Non-Manufacturing Composite, Sept., est. 53 (prior 51.4)
• 10:00am: Factory Orders, Aug., est. -0.2% (prior 1.9%)
  • Factory Orders Ex-Transportation, Aug., no est. (prior 0.2%)
  • Durable Goods Orders, Aug. F, est. 0% (prior 0%)
  • Durables Ex-Transportation, Aug. F, no est. (prior -0.4%)
  • Capital Goods Orders Non-defense Excluding Aircraft, Aug. F, no est. (prior 0.6%)
  • Cap Goods Ship Non-defense Excluding Aircraft, Aug. F, no est. (prior -0.4%)

Central Bank Speakers

• 9:30am: Fed’s Kashkari speaks in Minneapolis
• 5:00pm: Fed’s Lacker speaks in Huntington, W.Va.

* * *

DB's Jim Reid as usual concludes the overnight wrap

It has become increasingly clear to us over the last few months that 2016 will go down as the year where monetary policy alone ran out of road in its current form. The last hoorah in the current regime. Ever since the ECB and BoJ cut rates into negative territory and drove long end yields much lower through aggressive QE, monetary policy has started to have adverse impacts on certain parts of the economy - the financial and insurance sector in particular. Prior to this, although aggressive monetary policy wasn't doing much to help the economy it did have a near universally positive impact on asset prices. Obviously the BoJ have recently made their first tentative steps towards changing emphasis and the surprise story late yesterday from Bloomberg about the ECB possibly tapering before QE is currently schedule to end in March 2017 is possibly the first hint of the ECB trying to do the same thing.

The Bloomberg story was fairly vague and did suggest that the ECB could alternatively still extend QE further so quite a range of outcomes possible. Indeed the article quotes ‘central-bank officials’ rather than governing council members and also had that big caveat saying that ‘they didn’t exclude that QE could still be extended past the current end-date of March 2017 at the full pace of 80bn Euros a month’. Obviously we've got no idea whether this story is the ECB's way of testing the ground for such a policy or whether it is a way of the anti-QE brigade within the ECB trying to influence policy. It could be neither but still, there is no smoke without fire and it seemed a credible enough article to at least take seriously.

Our big issue is that it's all very laudable trying to wean the market off such aggressive monetary policy but if you don't have a replacement in place it could easily lead to higher real yields and risks of weaker activity. Ultimately if the likes of the BoJ and the ECB decide to taper it may hasten the day governments are forced to spend (and/or reform) more which is probably what the global economy needs if you accept that it's too late in the super cycle for the preferable outcome of creative destruction. However for there to be a passing of the baton between monetary and fiscal you probably need the baton to be dropped first by central banks and then picked up after a downturn by more highly motivated politicians than those of today due to them being landed with a crisis. So the BoJ and perhaps the ECB actions might increase the risk of a recession but this in turn might increase the chances of governments getting involved. We still think central banks will be forced to buy government bonds for several years to come but the QE of the future will likely be more in response to additional government spending rather than an isolated independent act of extreme monetary policy as it has been to date.

The biggest impact market-wise from the ECB story yesterday was in rates. The story broke late in the European session so there wasn’t a huge amount of time to react but we did still see 10y Bund yields spike up nearly 4bps or so (the most in nearly a month) to -0.058% in the last 30 minutes of the day. European yields were generally 3-5bps higher with the story actually coming as Italy joined the 50y bond club after issuing €5bn of bonds at a yield of 2.85%, attracting a staggering €18bn of orders in the process. Meanwhile the Treasury curve also steepened up yesterday with 2y, 10y and 30y yields up +3.0bps, +6.4bps and +7.0bps respectively. This morning in Asia we’ve seen long dated 30y JGB yields move up nearly 4bps, while 10y benchmark bonds across the rest of Asia-Pacific are 3-7bps higher generally.
So while rates markets were quick to scramble as the article broke, the big question, assuming that there is some credibility to the report, is timing. Currently, markets are not pricing in a tapering as early as March 2017 and as a reminder Ben Bernanke first talked about potential tapering by the Fed nearly 18 months prior to it being achieved in 2014. In that time the 10y Treasury yield went from 1.629% to a shade over 3.000%.

Away from the ECB story and the subsequent rates selloff, one of the other big movers in markets yesterday was once again Sterling which tumbled -0.89% versus the US Dollar to $1.273 and to the lowest since 1985. It also broke below 1.14 versus the Euro (-0.82%) which is the lowest since October 2011. As the Conservative Party conference rumbles on ‘hard’ Brexit concerns have only intensified with the vast majority of politician comments pointing toward a bumpy road ahead. This has completely overshadowed any positive data and case in point yesterday where the UK construction PMI rebounded 3.1pts last month to 52.3 (vs. 49.0 expected) and to the highest since March. At the same time, the IMF also revised up its 2016 (by 0.1%) growth forecast for the UK to 1.8% which would make it the fastest growing economy in the G7. The agency did however cut its 2017 UK forecast to 1.1% from 1.3%. The collapse in Sterling has however, along with the robust data, made for a strong rally in UK equities. Yesterday, the FTSE 100 (+1.30%), FTSE 250 (+0.87%) and FTSE 350 (+1.23%) all reached simultaneous record highs on the same day for the first time since 1999.

Bourses in the UK outperformed their European counterparts although the Stoxx 600 did still manage to rebound +0.84%. Interest rate sensitive sector like REITS and utilities took another hit in the US however though as bond yields climbed and that was enough to weigh on the S&P 500 (-0.50%) for the second day in a row. The strongest day for the US Dollar in over two weeks did little to help stem losses. This morning bourses in Asia are off to another relatively mixed start. A seventh successive weaker day for the Yen has helped the Nikkei (+0.57%) and Topix (+0.62%) to gain, while the Hang Seng is also +0.46%. The gains in Japan have come despite a 1.4pt drop in the services PMI to 48.2. Meanwhile the Kospi is little changed and ASX (-0.47%) is currently in the red. As a reminder markets in China are closed for Golden Week.

The Chicago Fed President Evans was also vocal overnight after speaking at an event in New Zealand. A non-voter this year, Evans said that ‘I would not be surprised, and if the data continue to roll as they have, I would be fine with increasing the funds rate once by the end of the year’. In terms of timing, Evans said it would ‘most likely be December’ but at the same time didn’t rule out a move before that next month.

Moving on. The ECB released its latest CSPP numbers yesterday which included the monthly primary/secondary splits. They settled €1.854bn purchases last week implying an average daily run rate of €371mn and very close to the €372mn average since the program started. This follows several strong weeks in September where it was clear the ECB must have been increasing their primary involvement. This was confirmed yesterday as September saw 19.8% of their €9.801bn monthly aggregate bought at new issue. As of the end of August they had only achieved 6.5% this way.

On this note, this morning we have just published the report "ECB CSPP Primary-Market Picks and IG Cash & CDS Strategy Update". Firstly, it provides an analysis of the ECB's primary market purchases of corporate bonds, including estimates of the amount of eligible bonds issued so far, the ECB's apparent picks and pans, and the average percentage of new deals it has been allocated. Secondly, it provides an update of our IG credit strategy where we overweight financial senior credit. We have been cautious about the equity of European banks but fundamentally constructive about their credit. At this point, we have a contrarian bias and see value in tilting risk allocation to this sector. In cash, we think senior unsecured bank bonds could tighten some 10bp relative to non-financials. In the CDS space, we like the long iTraxx Fin. Snr. vs. short iTraxx Main compression trade. See your emails shortly before this or contact Michal.Jezek@db.com for a copy if not.

Before we look at today’s calendar, it felt a bit like a day of records being broken in markets yesterday and not to be outdone, Gold (-3.26%) had a day to forget after dropping by the most since December 2013 and back below $1300/oz for the first time since June. Silver (-5.38%) and Platinum (-2.12%) were also down sharply and it was hard to really attribute the move to anything other than a bit of profit taking given the rally this year and after hawkish Fedspeak from Lacker yesterday which follows a similar tone to Mester on Monday. This has subsequently resulted in December tightening odds creeping up to 61% from 54% this time last week. Lacker – a hawkish but non-voting member this year – said that he would have dissented at the September meeting in favour of a hike and that ‘while inflation pressures may seem a distant and theoretical concern right now, prudent pre-emptive action can help us avoid the hard-to-predict emergence of a situation that requires more drastic action after the fact’.

Looking at the day ahead a big focus will be on the release of the remaining global PMI’s today where we’ll get confirmation of the final September services and composite readings for the likes of the Euro area and the US, along with a first look at the data for the periphery in Europe and also the UK. Also due out this morning is the August retail sales numbers for the Euro area (expected to decline modestly). This afternoon across the pond there will be plenty of focus on the ADP employment change reading for September ahead of Friday’s payrolls print. Market expectation is for a 165k reading while our US economists have pencilled in a 140k forecast. The other big release this afternoon is the ISM non-manufacturing print for September. The market is expecting an increase to 53.0 from 51.4 and there should also be a close watch on the employment component for the series after the data retreated to 50.7 in August. Also due out this afternoon will be August factory orders (-0.2% mom expected) and the August trade balance (little change expected). Away from the data we’ve got the Fed’s Kashkari due to speak at 2.30pm BST followed by Lacker again this evening (10pm BST). The BoE’s Broadbent is also due to speak this morning in London. UK PM Theresa May also wraps up the Conservative Party conference with a keynote speech at lunchtime.