Good Morning,

Markets took a breather Friday, and to some extent yesterday too, after what had been a painful week for most asset classes, primarily High Yield Credit and Equity markets, as a series of back-to-back negative sessions triggered core European government bond yields to reach lows and a subsequent sharp widening of peripheral eurozone bond spreads. Investor’s major concerns, perhaps the reason behind this sell-off, has been the suspicion that the global economy seems to be losing momentum at a time when some central banks were indicating that the interest rate normalisation phase was/is just about to commence. The fulcrum of these somewhat exacerbated moves has been the eurozone, mainly on the back of the heightened vulnerability of the economy to possible external shock, coupled with limited willingness by central governments to take any form of policy reaction.

Investors’ expectations of a gradual economic recovery in the region during the second half of 2014 have faded following declines in the leading indicators and as well as industrial production. Sentiment (and consequently economic activity) has been dragged lower by the consequences of the Ukrainian/Russian crisis, coupled with the negative sentiment and economic data prints coming from China. This week was testament to how vulnerable the economy really is to any form of external shocks, and this seems to be worrying investors.

Furthermore, there seems to be little room, fiscally, for the eurozone to work around, lending itself in the main to its high level of public debt. EU Commission President Jean-Claude Juncker’s has made the commissions’ plans of boosting infrastructure spending, however, it is not yet clear how such a plan would be financed. On a national scale, any recent attempts by France and Italy to move away from fiscal consolidation have been met with criticism from the EC as the draft budgets of both countries risk being rejected by the European Commission.

Meanwhile, markets appear to have growing doubts on the willingness and possibly the ability of the ECB to respond effectively to the recent shockwaves that have hit the economy. Indications point towards the ECB’ planning to increase its balance sheet back towards 2012 levels in the form of asset-backed securities (ABS) and covered bonds purchases. In fact, the market seems to be doubting the ECB’s plan of achieving price stability; as eurozone bond spreads, which had remained remarkably stable, have recently widened and not only in the eurozone periphery.

At these cross-roads, it is difficult to see how the ECB can avoid a broader programme of quantitative easing as the longer the current turmoil persists, the more likely we are to get a “we’ll do whatever it takes” type of commitment from ECB’s Mario Draghi at the forthcoming November 6 meeting, unless markets compel him to act (comment/intervene) well before the scheduled meeting date. In the run-up to that, we’ve got the imminent Q3 releases by European companies, as well as key data releases this week, such as German and French PMI, and Spanish Unemployment and Eurozone Consumer Confidence on Thursday coupled with German GfK consumer climate and Italian retail sales on Friday.

Across the Atlantic, it is somehow more cumbersome to decipher the recent performance in credit and equity markets with that of the economy. True, retail sales have certainly disappointed, but other indicators, notably the Fed’s Beige Book as well as initial claims and industrial production, have surprised to the upside and continue to indicate sustainable levels of growth. The recent decline in the price of oil should translate into an increase in consumer purchasing power. Nevertheless, last week we had St. Louis Fed President James Bullard state that the “Fed could continue with QE beyond October” and that if the economy remained strong, the Fed “could end QE in December”, thereby suggesting that the US economy could be also subject to external shocks. Despite this, we expect Fed Chairman Yellen to reiterate her stance that the Federal Reserve’s policy continues to be data dependent and will primarily focus on the sustainable domestic economic recovery. This week, we’ve got a flurry of data releases to contend with, starting with Existing Home Sales today, CPI tomorrow, Initial Jobless on Thursday and New Home Sales on Friday.

Meanwhile, inflation data in China have also recently confirmed a possibly deflationary scenario; PPI deflation deteriorated in September and, more importantly, CPI inflation surprised to downside for a second consecutive month. Economists’ concerns are now that inflation could decline into negative territory if oil and house price falls gather momentum as the imbalance between housing supply and demand, combined with the latest foreign-reserves data, showing a record pace of hot-money outflows, suggests house price falls will likely deepen. Of great importance is the Q3 GDP released earlier this morning, coming in at 7.3% y-o-y (vs an expected 7.2%) coupled with Thursday’s HSBC China Manufacturing PMI, both key gauges of internal real growth.

Have a nice day!