Good morning!

The news that Banco Espirito Santo (BES) is not undercapitalized, Argentina’s downgrade to selective default and the already stressing geopolitical environment drove the markets lower yesterday even as several European statistics surprised on the upside. In Europe, the worst performers were BES (-42%), the UK explorer Afren (-26%) which announced that two top executives are probed for unauthorized payments, Addidas (-15%), the advertising company JCDecaux (-7.5%) and Lufthansa (-7%); for the last three the plunge followed the disappointment in quarterly earnings. However, the retreat in equities was broad based as the volatility (as captured by VIX index) increased significantly yesterday albeit from a low base. As a result, the emerging markets and Asian stocks were also weaker notwithstanding that data published this morning confirmed the analysts’ expectations for an increase in Chinese PMI to a two-year high.

The increase in risk aversion was also evident in the performance of the German government bonds (bunds), with the 10 year rate remaining close to 1.15% after briefly dipping below this level. This performance was also supported by the inflation data which yet again failed to meet expectations for a 0.5% gain in prices. The CPI increased by merely 0.4% in July with the Italian figure particularly disappointing at -0.1% versus forecasts for 0.1%. As such, the better than projected unemployment, including in Italy (12.3% compared to 12.6% a month earlier) and the increase by 1.3% in German retail sales (vs 1.1% expected) failed to lift investors’ spirits. On the upside, the retreat in bund yields is beneficial for credit markets as it helps offset at least to some degree the widening in spreads. It is also an early indication of a likely over performance of the European corporate bond markets over the US market where the increase in yields appears likely.

Indeed, in contrast to the performance of the Bunds, the US 10 year Treasury had a worse day as the revision in jobless claims boosted beliefs that the labour market is truly healing. The four-week average is now at 297,250, the lowest number since April 2006 according to Bloomberg; in the aftermath of this report, the 10 year US bond rose marginally above 2.6% and although it retreated afterwards it still closed higher. As such, investors appeared somehow more nervous ahead of today’s string of data (non-farm employment change for July, unemployment rate, personal spending, average hourly earnings, personal income) all of which are due to help more accurately gauge the risks for an earlier than expected increase in rates. Today’s economic calendar also includes European Manufacturing PMI.

In addition, investors will be scrutinizing the new corporate earnings releases that are due to come out and the news flow on Argentina. According to the media, the country is not against negotiating with JP Morgan and other parties which are reportedly seeking to acquire the bonds held by the holdout investors.

Have a nice day!