Good morning!

The European Central Bank (ECB) withstood yesterday another test as the second TLTRO (Targeted Long Term Refinancing Operations) auction concluded with a take-up of EUR130 billion, a result that was rather deceivable given a consensus estimate of EUR148 billion but good enough to prevent a spike in volatility. As a reminder, TLTRO is a new tool introduced by ECB early this year and broadly speaking consists of long term cheap funding made available for banks which in turn should use these proceeds for lending. Indeed that is why the facility was dubbed “Targeted LTRO” to distinguish it from the earlier LTROs measures, for which no commitment was sought regarding the use of the proceeds, and which ended up as serving as cash buffers or ammunition for investments. The first TLTRO auction was conducted in September, when EUR82 billion were allotted, way less than markets were expected although at that stage the disappointment was partly explained by the banks’ cautious attitude ahead of the October stress tests results. This time around it is harder to find an explanation other than the fact that the unsuccessful results are due to the economic outlook rather than to insufficient liquidity within the banking system. That is, the message that seems to transpire is that incentives such as TLRO have to be met with measures that address the credit demand side – i.e. reforms that improve the business environment- as even ECB’s President repeatedly stressed.

With such reforms still pending, the markets now have to digest whether the dominant trending factor should be the fundamental outlook or whether there is scope for further gains on speculations that ECB will ultimately have to expand the range of assets purchases to include corporate and/or government bonds (i.e. Quantitative Easing or better known as QE). Indeed, the possibility of QE increased after yesterday’s TLTRO and this could spur additional assets inflation but for this rally not to end sharply it has to also feed into the real economy. As things stand today, it is widely accepted that QE can provide a boost to confidence, a weaker Euro and improve the quality of the banks’ balance sheet but for this to translate into broader based growth something has to happen to boost the demand for credit in the more challenged European economies. Likewise, a lower EURUSD exchange rate bodes well for exporters but in certain Euro Area countries other factors continue to hamper competitiveness such as weak productivity (when put against wages). We find however some room for hope in the take-up of the Italian banks, which applied for at least EU24 billion yesterday; Italy stands out as one of European countries with the largest preponderance of SMEs, an inefficient labour market and an unfriendly regulatory and political environment, all of which combined to keep credit demand and credit supply at bay.

Against this background we saw the European equities fluctuating in the aftermath of the TLTRO results, the European high yield failed to rebound after a weak opening and the government yields declined. Whereas, the equity markets ultimately found a support in the strong US retail sales data that was published in the afternoon, over the upcoming days we are likely to see an undecided European market. Of note, the UK index, FTSE100 failed to join the rally as it was brought down by the commodity names which lost 2.2% following the retreat in names such as Glencore and Rio Tinto.

Greece saw a sell off for another day as political concerns (with possible fiscal repercussions) failed to alleviate. Against this backdrop, the equity index went down by 7.35%, bringing the year-to-date losses to 28%. The movements were sharp in the bond market as well, where the 10 year note now yields 8.8% and the 3 year one offers an even higher return (over 10%). The term structure of the Greek yield curve reflects the growing short term uncertainties as investors fear that a change in power and move away from the IMF’s programme (which comes with commensurate supervision) could herald a return to higher budget deficits and postpone reforms. To put it differently, in the long run the country could have a greater room for manoeuvre but in the shorter term the options are rather limited given the subdued economic outlook. On a related note, the media reported that the Italian president said that he is considering stepping down next year, a move which could increase political instability.

The US trading session was overwhelmed by the positive surprise in November sales data which served to confirm expectations that lower fuel prices will serve to increase spending on other goods and services. Indeed this effect could be larger and more rapid in the US than in Europe as fuel prices adjust faster in the former; however, the overperformance of the Eurostoxx50 consumer discretionary names yesterday suggests that investors expect similar gains in European spending. Equally important, the figures provided some evidence that a delayed pickup in consumption will somehow shield the US from the prolonged slowdown abroad. In the same vein, we note that the weekly unemployment claims improved slightly and were better than expected (although not by a wide margin).

In the commodity markets the oil remained naturally in the spotlight with the crude oil falling below USD60. As such, the energy related names, sovereigns and corporates alike, continued to be under pressure, although in the US some names gained yesterday (e.g. Diamond Energy or Range Resoruces) and the energy component of the S&P500 was flat after several days of losses. Relatedly we mention that the Brazilian state-oil company Petrobras will reportedly consider a state-backed bond issuance next year. The company’s stock and bonds fell sharply over the last few months as corruption allegation, the prospect of a perpetuation in stagflation in Brazil and the dip in oil prices combined to ward off investors. Russia on the other hand faced with the same aversion from investors had to once again increase the Central Bank key policy rate, bringing it to 10.5% from 9.5%. The monetary policymakers are trying to buffer the depreciation of the rubble which, together to the food import bans, have triggered a surge in inflation. Indeed, the weaker rubble results in higher prices because the price of the imported goods will be converted by applying a higher exchange rate. On a more positive note, it serves to diminish the effect that the lower oil prices will have on the country’s trade balance and budget because whereas the USD denominated oil sales will be lower, their value in rubble terms will be augmented by the increase in USDRUB; to put things in perspective, crude lost almost 40% this year and the rubble depreciated by more than 40%, to a record low. Mexico, another oil rich country, disclosed yesterday that the Central Bank intervened yesterday for the first time in two years to smooth the downfall of the currency. At the other end of the spectrum, among the beneficiaries of a falling oil, we highlight that Delta Airlines increased its margin forecasts for Q4 and said that see 2015 profit increasing to over USD5 billion, better than the USD4.5 billion previously forecasted.

Today on the other hand started off with negative headlines on China where the industrial production growth failed to meet expectations. For the high yield market it as well relevant to note that the US retail high yield funds experienced a USD1.9 billion outflow last week, marking one of the worst figures for this year. We attribute this to the oil slump which is due to disproportionately impact the US high yield space given the large predominance of the energy names there. On the geopolitical front, the Ukrainian president announced that the last 24 hours marked the first real cease fire since may but he also made reference in his speech to the country’s deep financial distress “To receive financial aid in order to survive in this difficult time, not to allow default, we need an international donor conference, the approval of Ukraine’s program, and to get support from our western partners”.

Have a nice day!