Good morning!

Much has been said lately about the unusually low volatility that took hold of the markets and a possible unsustainable complacency among investors, with Fed being the latest institution to express concern in this regard in the latest FOMC minutes published. Against this background, we saw some corrections in many risky assets, particularly eqities and peripheral bonds. Portuguese 10 year bonds posted a 21 bps increase in yields, Greek government securities retreated by a comparable degree and closed well above 6% (6.17%) while the Spanish and Italian notes were somehow more resilient losing around 6 bps. To add to the uneasiness, the head of the IMF’s Spain mission reiterated calls for an increase in revenues to match the government’s recent tax cuts.

The non-core government bonds sold off after the events relating to Grupo Espirito Santo apparently left investors wondering if the carry trades induced by the current ECB monetary policy can overrule the still weak fundamentals of these countries. As a reminder, after the decisions taken in June by ECB it became apparent that getting cheap funding from the Central Bank and investing in interest earning assets such as sovereigns remains possible, which should result in lower peripheral yields. As such, this recent retreat in PIIGS bond prices is likely to prove just a short term correction as technicals will probably carry more weight than fundamentals which have been known to be only slowly, if at all, improving. Indeed, as we are writing, the European stocks are slightly in the positive territory.

Banks were among the worst performing stock in Europe, dropping by 2.12% versus a change of 1.64% in Eurostoxx 600. Banco Espirito Santo saw a sharp drop in equity and bond prices after investors grew worried about possible repercussions following distress at Espirito Santo Financial Group SA, which owns 25% of the bank’s shares; this is despite assurances coming from Bank of Portugal earlier this month. Meanwhile, Banco Espirito Santo disclosed yesterday said it has exposure of EUR1.18 billion Grupo Espirito Santo, while its capital buffer is EUR2.1 billion; the bank said it is waiting for more information to assess any potential losses.

The evidence of higher risk aversion was however more broad-based as the volatility index (VIX) edged as high as 13 while the US 10 year treasury yield briefly fell below 2.5% and closed lower than a day earlier. Also, EURUSD advanced to 1.365 during the first part of the day but then retreated substantially. Emerging markets also took a toll, although Indonesian stocks performed well given the unofficial results of the elections. In India, the recent rally is threatened by the disappointment relating to the new Government’s budget decisions. More specifically, the finance minister surprised markets by keeping the fiscal deficit target unchanged at 4.1% of GDP and failing to reduce subsidies which will likely be inflated by the rising oil prices.

Maybe a more tangible evidence of how investors currently judge peripherals’ attractiveness will be brought about by the Italian auctions due to take place today (i.e. up to EU3b 1.15% 2017 bonds, EU2.5b, 2.15% 2021 bonds, EU2b 3.5% 2030 bonds). Yesterday Greece placed a three-year note at 3.5%, higher than the analysts were forecasting; also, the amount raised was EUR1.5 billion although last week officials said they will be targeting EUR3 billion.

US equities were also negative but the movements were more measured here after the weekly unemployment claims data added to the previous week’s evidence that labour market conditions are improving; also, wholesale inventories data confirmed analysts’ expectations for a positive change, supporting expectations for a rebound in growth in Q2. The Asian markets in turn were supported by signals that property markets are supported by local governments; that is, according to Bloomberg, Jinan has become the latest city to remove home purchase limits.

On the data front, today’s calendar includes the final inflation figures for Germany and Spain as well as the Spanish industrial production.

Have a nice day!