Good morning!

Notwithstanding the flurry of economic statistics that came out yesterday, the markets were more focused on the geopolitical events, which at this stage are more unpredictable. The equity markets closed lower after Ukraine said that Russian troops have entered the country and that a key border city is now controlled by separatist rebels. The conflict is thus deepening, forcing President Poroshenko to cancel his visit to Turkey. The Western powers reckoned that Russia’s involvement has become bolder and David Cameron stressed that under the current conditions the official negotiations could be fruitless: "It is simply not enough to engage in talks in Minsk, while Russian tanks continue to roll over the border into Ukraine. Such activity must cease immediately." The US has also backed the Ukrainian accusations against Russia although the latter continues to deny such peace-threatening acts. According to US officials, "Russia has … stepped up its presence in eastern Ukraine and intervened directly with combat forces, armoured vehicles, artillery, and surface-to-air systems, and is actively fighting Ukrainian forces as well as playing a direct supporting role to the separatists' proxies and mercenaries." As such, the US is reportedly working to impose additional sanctions. Meanwhile, Europe is trying to limit the economic effects of the Russian food imports ban by working on aid measures for the diary sector.

Given the renewed escalation in political risks, the safer assets saw increased demand and the US and German yields dropped adding to the strong performance we have seen this month. Even so, the peripheral yields underperformed likely reflecting concerns that investors’ expectations for additional ECB stimulus in September might have become overoptimistic. Indeed, the sole data point that surpassed estimates yesterday was the increase in the broad measure of money supply (M3), which might be indicative of stronger than expected inflation. Such concerns are likely to be augmented by the German Finance Minister Wolfgang Schaeuble’s cautionary press statements on the limited effectiveness of monetary policy. That is, the German official added up to Draghi’s call for structural reforms and other forms of pro-growth measures by saying that ‘‘monetary policy can only buy time […] Liquidity in markets is not too low, it’s even too high. Therefore I think monetary policy has come to the end of its instruments and therefore what we urgently need is investments, regaining confidence by investors, by markets, by consumers.” Indeed, liquidity is likely not a concern at this stage as the interbank rate remains at low levels and the overnight borrowing costs (Eonia) actually turned negative yesterday; the challenge is rather channelling the surplus liquidity towards the real economy and for this to happen confidence must be lifted and structural barriers, such as malfunctioning labour markets or corruption, removed.

Against this background, Italy, Spain, Portugal and Greece 10 year bonds reversed their upward trend even as many of the statistics published yesterday support the view that additional monetary easing might be warranted in Europe; Spain’s inflation continued to dip in the negative territory, German unemployment unexpectedly increased and private lending contracted more than expected.

However, the outcome of the next ECB meeting is highly debatable and speculation is rife ahead of the European inflation figures due today. To us it seems like wagers on more stimulus are rising again, likely supported by an unexpected drop in German retail sales, as the markets are currently positioned for a positive opening. Other statistics to be published today are the EU unemployment rate and, in the US, personal spending, income growth and consumer expectations.

The Asian market took cue from the US and European stocks and lost a few points particularly as it also had to contend with disappointing macro data coming from Japan. Specifically, the latest statistics showed that Japan’s economic recovery from deflation remains challenging as industrial production growth was only a fraction of what was expected, unemployment unexpectedly gained, housing starts fell by 14.1% YoY (vs estimated for -10.3%) and household spending contracted much more than anticipated.

In sharp contrast to the European and Japanese statistics, US data continued to point to a strengthening economy; the preliminary GDP figures outpaced forecasts with QoQ growth standing at 4.2% (vs 3.9% estimated), pending home sales advancing by a healthy 3.3% from a month earlier and unemployment claims dropping from another week. What is more, the pickup in growth was brought about by the gain in business investments which bodes well for future growth and speaks of increasing confidence in the outlook of the economy.

Have a nice day!