US index futures, European markets and Asian stocks all turned negative during the overnight session, surrendering earlier gains as investors turned increasingly concerned about China's looming slowdown - and outright contraction - amid a global stagflationary energy crunch, which sent 10Y TSY yields just shy of 1.50% this morning following a Goldman upgrade in its Brent price target to $90 late on Sunday. At 745 a.m. ET, S&P 500 e-minis were down 4.75 points, or 0.1% after rising as much as 0.6%, Nasdaq 100 e-minis were down 83 points, or 0.54% and Dow e-minis were up 80 points, or 0.23%. The euro slipped as Germany looked set for months of complex coalition talks.

While the market appears to have moved beyond the Evergrande default, the debt crisis at China's largest developer festers (with Goldman saying it has no idea how it will end), and data due this week will show a manufacturing recovery in the world’s second-largest economy is faltering faster. A developing energy crisis threatens to crimp global growth further at a time markets are preparing for a tapering of Fed stimulus. The week could see volatile moves as traders scrutinize central bankers’ speeches, including Chair Jerome Powell’s meetings with Congressional panels.

“Most bad news comes from China these days,” Ipek Ozkardeskaya, a senior analyst at Swissquote Group Holdings, wrote in a note. “The Evergrande debt crisis, the Chinese energy crackdown on missed targets and the ban on cryptocurrencies have been shaking the markets, along with the Fed’s more hawkish policy stance last week.”

Oil majors Exxon Mobil and Chevron Corp rose 1.5% and 1.2% in premarket trade, respectively, tracking crude prices, while big lenders including JPMorgan, Citigroup, Morgan Stanley and Bank of America Corp gained about 0.8%.Giga-cap FAAMG growth names such as Alphabet, Microsoft, Amazon.com, Facebook and Apple all fell between 0.3% and 0.4%, as 10Y yield surged, continuing their selloff from last week, which saw the 10Y rise as high as 1.4958% and just shy of breaching the psychological 1.50% level.

While growth names were hit, value names rebounded as another market rotation appears to be in place: industrials 3M Co and Caterpillar Inc, which tend to benefit the most from an economic rebound, also inched higher (although one should obviously be shorting CAT here for its China exposure). Market participants have moved into value and cyclical stocks from tech-heavy growth names after the Federal Reserve last week indicated it could begin unwinding its bond-buying program by as soon as November, and may raise interest rates in 2022. Here are some other notable premarket movers:

• Gores Guggenheim (GGPI US) shares rise 7.2% in U.S. premarket trading as Polestar agreed to go public with the special purpose acquisition company, in a deal valued at about $20 billion.
• Naked Brand (NAKD US), one of the stocks caught up in the first retail trading frenzy earlier this year, rises 11% in U.S. premarket trading, extending Friday’s gains. Among other so-called meme stocks in premarket trading: ReWalk Robotics (RWLK) +6.5%, Vinco Ventures (BBIG) +18%, Camber Energy (CEI) +2.9%
• Pfizer (PFE US) and Opko Health (OPK US) in focus after they said on Friday that the FDA extended the review period for the biologics license application for somatrogon. Opko fell 3.5% in post-market trading.
• Aspen Group (ASPU) climbed 10% in Friday postmarket trading after board member Douglas Kass buys $172,415 of shares, according to a filing with the U.S. Securities & Exchange Commission.
• Seaspine (SPNE US) said spine surgery procedure volumes were curtailed in many areas of the U.S. in 3Q and particularly in August.
• Tesla (TSLA US) and other electric- vehicle related stocks globally may be active on Monday after Germany’s election, in which the Greens had their best-ever showing and are likely to be part of any governing coalition.

Europe likewise drifted lower, with the Stoxx Europe 600 Index erasing earlier gains and turning negative as investors weighed the risk to global growth from the China slowdown and the energy crunch. The benchmark was down 0.1% at last check. Subindexes for technology (-0.9%) and consumer (-0.8%) provide the main drags while value outperformed, with energy +2.4%, banks +2% and insurance +1.3%.  The DAX outperformed up 0.5%, after German election results avoided the worst-case left-wing favorable outcome.  U.S. futures. Rolls-Royce jumped 12% to the highest since March 2020 after the company was selected to provide the powerplant for the B-52 Stratofortress under the Commercial Engine Replacement Program. Here are some of the other biggest European movers today

• IWG rises as much as 7.5% after a report CEO Mark Dixon is exploring a multibillion-pound breakup of the flexible office-space provider
• AUTO1 gains as much as 6.1% after JPMorgan analyst Marcus Diebel raised the recommendation to overweight from neutral
• Cellnex falls as much as 4.3% to a two-month low after the tower firm is cut to sell from neutral at Citi, which says the stock is “priced for perfection in an imperfect industry”
• European uranium stocks fall with Yellow Cake shares losing as much as 6% and Nac Kazatomprom shares declining as much as 4.7%. Both follow their U.S. peers down following weeks of strong gains as the price of uranium ballooned

For those who missed it, Sunday's closely-watched German elections concluded with the race much closer than initially expected:

• SPD at 25.7%,
• CDU/CSU at 24.1%,
• Greens at 14.8%,
• FDP at 11.5%,
• AfD at 10.3%
• Left at 4.9%,

the German Federal Returning Officer announced the seat distribution from the preliminary results which were SPD at 206 seats, CDU/CSU at 196. Greens at 118, FDP at 92, AfD at 83, Left at 39 and SSW at 1.

As it stands, three potential coalitions are an option,

• 1) SPD, Greens and FDP (traffic light),
• 2) CDU/CSU, Greens and FDP (Jamaica),
• 3) SPD and CDU/CSU (Grand Coalition but led by the SPD).

Note, option 3 is seen as the least likely outcome given that the CDU/CSU would be unlikely willing to play the role of a junior partner to the SPD. Therefore, given the importance of the FDP and Greens in forming a coalition for either the SPD or CDU/CSU, leaders of the FDP and Greens have suggested that they might hold their own discussions with each other first before holding talks with either of the two larger parties. Given the political calculus involved in trying to form a coalition, the process is expected to play out over several months. From a markets perspective, the tail risk of the Left party being involved in government has now been removed due to their poor performance and as such, Bunds trade on a firmer footing. Elsewhere, EUR is relatively unfazed due to the inconclusive nature of the result. We will have more on this in a subsequent blog post.

Asian stocks fell, reversing an earlier gain, as a drop in the Shanghai Composite spooked investors in the region by stoking concerns about the pace of growth in China’s economy.  The MSCI Asia Pacific Index wiped out an advance of as much as 0.7%, on pace to halt a two-day climb. Consumer discretionary names and materials firms were the biggest contributors to the late afternoon drag. Financials outperformed, helping mitigate drops in other sectors.  “Seeing Shanghai shares extending declines, investors’ sentiment has turned weak, leading to profit-taking on individual stocks or sectors that have been gaining recently,” said Shoichi Arisawa, an analyst at Iwai Cosmo Securities. “The drop in Chinese equities is reminding investors about a potential slowdown in their economy.”  The Shanghai Composite was among the region’s worst performers along with Vietnam’s VN Index. Shares of China’s electricity-intensive businesses tumbled after Beijing curbed power supplies in the country’s manufacturing hubs to cut emissions. The CSI 300 still rose, thanks to gains in heavily weighted Kweichow Moutai and other liquor makers. Asian equities started the day on a positive note as financials jumped, tracking gains in U.S. peers and following a rise in Treasury yields. Resona Holdings was among the top performers after Morgan Stanley raised its view on the stock and Japanese banks. The regional market has been calmer over the past few trading sessions after being whipsawed by concerns over any fallout from China Evergrande Group’s debt troubles. While anxiety lingers, many investors expect China will resolve the distressed property developer’s problems rather than let them spill over into an echo of 2008’s Lehman crisis.

Japanese equities closed lower, erasing an earlier gain, as concerns grew over valuations following recent strength in the local market and turmoil in China. Machinery and electronics makers were the biggest drags on the Topix, which fell 0.1%. Daikin and Bandai Namco were the largest contributors to a dip of less than 0.1% in the Nikkei 225. Both gauges had climbed more 0.5% in morning trading. Meanwhile, the Shanghai Composite Index fell as much as 1.5% as industrials tumbled amid a power crunch. “Seeing Shanghai shares extending declines, investors’ sentiment has turned weak, leading to profit-taking on individual stocks or sectors that have been gaining recently,” said Shoichi Arisawa, an analyst at Iwai Cosmo Securities Co. “The drop in Chinese equities is reminding investors about a potential slowdown in their economy. That’s why marine transportation stocks, which are representative of cyclical sectors, fell sharply.” Shares of shippers, which have outperformed this year, fell as investors turned their attention to reopening plays. Travel and retail stocks gained after reports that the government is making final arrangements to lift all the coronavirus state of emergency order in the nation as scheduled at the end of this month.

Australia's commodity-heavy stocks advanced as energy, banking shares climb. The S&P/ASX 200 index rose 0.6% to close at 7,384.20, led by energy stocks. Banks also posted their biggest one-day gain since Aug. 2. Travel stocks were among the top performers after the prime minister said state premiers must not keep borders closed once agreed Covid-19 vaccination targets are reached. NextDC was the worst performer after the company’s CEO sold 1.6 million shares. In New Zealand, the S&P/NZX 50 index.

In FX, the U.S. dollar was up 0.1%, while the British pound, Australian dollar, and Canadian dollar lead G-10 majors, with the Swedish krona and Swiss franc lagging.

•    The Bloomberg Dollar Spot Index was little changed and the greenback traded mixed versus its Group-of-10 peers
o    Volatility curves in the major currencies were inverted last week due to a plethora of central bank meetings and risk-off concerns. They have since normalized as stocks stabilize and traders assess the latest forward guidance on monetary policy
•    The yield on two-year U.S. Treasuries touched the highest level since April 2020, as tightening expectations continued to put pressure on front-end rates and ahead of debt sales later Monday
•    The pound advanced, with analyst focus on supply chain problems as Prime Minister Boris Johnson considers bringing in army drivers to help. Bank of England Governor Andrew Bailey’s speech later will be watched after last week’s hawkish meeting
•    Antipodean currencies, as well as the Norwegian krone and the Canadian dollar were among the best Group-of-10 performers amid a rise in commodity prices
•    The yen pared losses after falling to its lowest level in six weeks and Japanese stocks paused their rally and amid rising Treasury yields

In rates, treasuries extended their recent drop, led by belly of the curve ahead of this week’s front-loaded auctions, which kick off Monday with 2- and 5-year note sales.  Yields were higher by up to 4bp across belly of the curve, cheapening 2s5s30s spread by 3.2bp on the day; 10-year yields sit around 1.49%, cheaper by 3.5bp and underperforming bunds, gilts by 1.5bp and 0.5bp while the front-end of the curve continues to sell off as rate-hike premium builds -- 2-year yields subsequently hit 0.284%, the highest level since April 2020. 5-year yields top at 0.988%, highest since Feb. 2020 while 2-year yields reach as high as 0.288%; in long- end, 30-year yields breach 2% for the first time since Aug. 13. Auctions conclude Tuesday with 7-year supply. Host of Fed speakers due this week, including three scheduled for Monday.

In commodities, Brent futures climbed 1.4% to $79 a barrel, while WTI futures hit $75 a barrel for the first time since July, amid an escalating energy crunch across Europe and now China. Base metals are mixed: LME copper rises 0.4%, LME tin and nickel drop over 2%. Spot gold gives back Asia’s gains to trade flat near $1,750/oz

In equities, Stoxx 600 is up 0.6%, led by energy and banks, and FTSE 100 rises 0.4%. Germany’s DAX climbs 1% after German elections showed a narrow victory for social democrats, with the Christian Democrats coming in a close second, according to provisional results. S&P 500 futures climb 0.3%, Dow and Nasdaq contracts hold in the green. In FX, the U.S. dollar is up 0.1%, while the British pound, Australian dollar, and Canadian dollar lead G-10 majors, with the Swedish krona and Swiss franc lagging. Base metals are mixed: LME copper rises 0.4%, LME tin and nickel drop over 2%. Spot gold gives back Asia’s gains to trade flat near $1,750/oz

Investors will now watch for a raft of economic indicators, including durable goods orders and the ISM manufacturing index this week to gauge the pace of the recovery, as well as bipartisan talks over raising the $28.4 trillion debt ceiling. The U.S. Congress faces a Sept. 30 deadline to prevent the second partial government shutdown in three years, while a vote on the $1 trillion bipartisan infrastructure bill is scheduled for Thursday.

On today's calendar we get the latest Euro Area M3 money supply, US preliminary August durable goods orders, core capital goods orders, September Dallas Fed manufacturing activity. We also have a bunch of Fed speakers including Williams, Brainard and Evans.

Market Snapshot

• S&P 500 futures down 0.1% to 4,442.50
• STOXX Europe 600 up 0.3% to 464.54
• MXAP little changed at 200.75
• MXAPJ little changed at 642.52
• Nikkei little changed at 30,240.06
• Topix down 0.1% to 2,087.74
• Hang Seng Index little changed at 24,208.78
• Shanghai Composite down 0.8% to 3,582.83
• Sensex up 0.2% to 60,164.70
• Australia S&P/ASX 200 up 0.6% to 7,384.17
• Kospi up 0.3% to 3,133.64
• German 10Y yield fell 3.1 bps to -0.221%
• Euro down 0.3% to $1.1689
• Brent Futures up 1.2% to $79.04/bbl
• Gold spot little changed at $1,750.88
• U.S. Dollar Index up 0.15% to 93.47

Top Overnight News from Bloomberg

• House Speaker Nancy Pelosi put the infrastructure bill on the schedule for Monday under pressure from moderates eager to get the bipartisan bill, which has already passed the Senate, enacted. But progressives -- whose votes are likely vital -- are insisting on progress first on the bigger social-spending bill
• Olaf Scholz of the center-left Social Democrats defeated Chancellor Angela Merkel’s conservatives in an extremely tight German election, setting in motion what could be months of complex coalition talks to decide who will lead Europe’s biggest economy
• China’s central bank pumped liquidity into the financial system after borrowing costs rose, as lingering risks posed by China Evergrande Group’s debt crisis hurt market sentiment toward its peers as well
• Global banks are about to get a comprehensive blueprint for how derivatives worth several hundred trillion dollars may be finally disentangled from the London Interbank Offered Rate
• Economists warned of lower economic growth in China as electricity shortages worsen in the country, forcing businesses to cut back on production
• Governor Haruhiko Kuroda says it’s necessary for the Bank of Japan to continue with large-scale monetary easing to achieve the bank’s 2% inflation target
• The quant revolution in fixed income is here at long last, if the latest Invesco Ltd. poll is anything to go by. With the work-from-home era fueling a boom in electronic trading, the majority of investors in a $31 trillion community say they now deploy factor strategies in bond portfolios

A more detailed look at global markets courtesy of Newsquawk

Asian equity markets traded somewhat mixed with the region finding encouragement from reopening headlines but with gains capped heading towards month-end, while German election results remained tight and Evergrande uncertainty continued to linger. ASX 200 (+0.6%) was led higher by outperformance in the mining related sectors including energy as oil prices continued to rally amid supply disruptions and views for a stronger recovery in demand with Goldman Sachs lifting its year-end Brent crude forecast from USD 80/bbl to USD 90/bbl. Furthermore, respectable gains in the largest weighted financial sector and details of the reopening roadmap for New South Wales, which state Premier Berijiklian sees beginning on October 11th, further added to the encouragement. Nikkei 225 (Unch) was kept afloat for most of the session after last week’s beneficial currency flows and amid reports that Japan is planning to lift emergency measures in all areas at month-end, although upside was limited ahead of the upcoming LDP leadership race which reports noted are likely to go to a run-off as neither of the two main candidates are likely to achieve a majority although a recent Kyodo poll has Kono nearly there at 47.4% of support vs. nearest contender Kishida at 22.4%. Hang Seng (+0.1%) and Shanghai Comp. (-0.8%) were varied with the mainland choppy amid several moving parts including back-to-back daily liquidity efforts by the PBoC since Sunday and with the recent release of Huawei’s CFO following a deal with US prosecutors. Conversely, Evergrande concerns persisted as Chinese cities reportedly seized its presales to block the potential misuse of funds and its EV unit suffered another double-digit percentage loss after scrapping plans for its STAR Market listing. There were also notable losses to casino names after Macau tightened COVID-19 restrictions ahead of the Golden Week holidays and crypto stocks were hit after China declared crypto activities illegal which resulted in losses to cryptoexchange Huobi which dropped more than 40% in early trade before nursing some of the losses, while there are also concerns of the impact from an ongoing energy crisis in China which prompted the Guangdong to ask people to turn off lights they don't require and use air conditioning less. Finally, 10yr JGBs were flat but have clawed back some of the after-hour losses on Friday with demand sapped overnight amid the mild gains in stocks and lack of BoJ purchases in the market. Elsewhere, T-note futures mildly rebounded off support at 132.00, while Bund futures outperformed the Treasury space amid mild reprieve from this month’s losses and with uncertainty of the composition for the next German coalition.

Top Asian News

• Moody’s Says China to Safeguard Stability Amid Evergrande Issues
• China’s Tech Tycoons Pledge Allegiance to Xi’s Vision
• China Power Crunch Hits iPhone, Tesla Production, Nikkei Reports
• Top Netflix Hit ‘Squid Game’ Sparks Korean Media Stock Surge

Bourses in Europe have trimmed the gains seen at the open, albeit the region remains mostly in positive territory (Euro Stoxx 50 +0.4%; Stoxx 600 +0.2%) in the aftermath of the German election and amid the looming month-end. The week also sees several risk events, including the ECB's Sintra Forum, EZ CPI, US PCE and US ISM Manufacturing – not to mention the vote on the bipartisan US infrastructure bill. The mood in Europe contrasts the mixed handover from APAC, whilst US equity futures have also seen more divergence during European trade – with the yield-sensitive NQ (-0.3%) underperforming the cyclically-influenced RTY (+0.4%). There has been no clear catalyst behind the pullback since the Cash open. Delving deeper into Europe, the DAX 40 (+0.6%) outperforms after the tail risk of the Left party being involved in government has now been removed. The SMI (-0.6%) has dipped into the red as defensive sectors remain weak, with the Healthcare sector towards to bottom of the bunch alongside Personal & Household Goods. On the flip side, the strength in the price-driven Oil & Gas and yield-induced Banks have kept the FTSE 100 (+0.2%) in green, although the upside is capped by losses in AstraZeneca (-0.4%) and heavy-weight miners, with the latter a function of declining base metal prices. The continued retreat in global bonds has also hit the Tech sector – which resides as the laggard at the time of writing. In terms of individual movers, Rolls-Royce (+8.5%) trades at the top of the FTSE 100 after winning a USD 1.9bln deal from the US Air Force. IWG (+6.5%) also extended on earlier gains following reports that founder and CEO Dixon is said to be mulling a multibillion-pound break-up of the Co. that would involve splitting it into several distinct companies. Elsewhere, it is worth being cognizant of the current power situation in China as the energy crisis spreads, with Global Times also noting that multiple semiconductor suppliers for Tesla (Unch), Apple (-0.4% pre-market) and Intel (Unch), which have manufacturing plants in the Chinese mainland, recently announced they would suspend their factories' operations to follow local electricity use policies.

Top European News

• U.K. Relaxes Antitrust Rules, May Bring in Army as Pumps Run Dry
• Magnitude 5.8 Earthquake Hits Greek Island of Crete
• German Stocks Rally as Chances Wane for Left-Wing Coalition
• German Landlords Rise as Left’s Weakness Trumps Berlin Poll

In FX, the Aussie is holding up relatively well on a couple of supportive factors, including a recovery in commodity prices overnight and the Premier of NSW setting out a timetable to start lifting COVID lockdown and restrictions from October 11 with an end date to completely re-open on December 1. However, Aud/Usd is off best levels against a generally firm Greenback on weakness and underperformance elsewhere having stalled around 0.7290, while the Loonie has also run out of momentum 10 pips or so from 1.2600 alongside WTI above Usd 75/brl.

• DXY/EUR/CHF - Although the risk backdrop is broadly buoyant and not especially supportive, the Buck is gleaning traction and making gains at the expense of others, like the Euro that is gradually weakening in wake of Sunday’s German election that culminated in narrow victory for the SPD Party over the CDU/CSU alliance, but reliant on the Greens and FDP to form a Government. Eur/Usd has lost 1.1700+ status and is holding a fraction above recent lows in the form of a double bottom at 1.1684, but the Eur/Gbp cross is looking even weaker having breached several technical levels like the 100, 21 and 50 DMAs on the way down through 0.8530. Conversely, Eur/Chf remains firm around 1.0850, and largely due to extended declines in the Franc following last week’s dovish SNB policy review rather than clear signs of intervention via the latest weekly Swiss sight deposit balances. Indeed, Usd/Chf is now approaching 0.9300 again and helping to lift the Dollar index back up towards post-FOMC peaks within a 93.494-206 range in advance of US durable goods data, several Fed speakers, the Dallas Fed manufacturing business index and a double dose of T-note supply (Usd 60 bn 2 year and Usd 61 bn 5 year offerings).
• GBP/NZD/JPY - As noted above, the Pound is benefiting from Eur/Gbp tailwinds, but also strength in Brent to offset potential upset due to the UK’s energy supply issues, so Cable is also bucking the broad trend and probing 1.3700. However, the Kiwi is clinging to 0.7000 in the face of Aud/Nzd headwinds that are building on a break of 1.0350, while the Yen is striving keep its head afloat of another round number at 111.00 as bond yields rebound and curves resteepen.
• SCANDI/EM - The Nok is also knocking on a new big figure, but to the upside vs the Eur at 10.0000 following the hawkish Norges Bank hike, while the Cnh and Cny are holding up well compared to fellow EM currencies with loads of liquidity from the PBoC and some underlying support amidst the ongoing mission to crackdown on speculators in the crypto and commodity space.

In commodities, WTI and Brent front-month futures kicked the week off on a firmer footing, which saw Brent Nov eclipse the USD 79.50/bbl level (vs low 78.21/bbl) whilst its WTI counterpart hovers north of USD 75/bbl (vs low 74.16/bbl). The complex could be feeling some tailwinds from the supply crunch in Britain – which has lead petrol stations to run dry as demand outpaces the supply. Aside from that, the landscape is little changed in the run-up to the OPEC+ meeting next Monday, whereby ministers are expected to continue the planned output hikes of 400k BPD/m. On that note, there have been reports that some African nations are struggling to pump more oil amid delayed maintenance and low investments, with Angola and Nigeria said to average almost 300k BPD below their quota. On the Iranian front, IAEA said Iran permitted it to service monitoring equipment during September 20th-22nd with the exception of the centrifuge component manufacturing workshop at the Tesa Karaj facility, with no real updates present regarding the nuclear deal talks. In terms of bank commentary, Goldman Sachs raised its year-end Brent crude forecast by USD 10 to USD 90/bbl and stated that Hurricane Ida has more than offset the ramp-up in OPEC+ output since July with non-OPEC+, non-shale output continuing to disappoint, while it added that global oil demand-deficit is greater than expected with a faster than anticipated demand recovery from the Delta variant. Conversely, Citi said in the immediate aftermath of skyrocketing prices, it is logical to be bearish on crude oil and nat gas today and forward curves for later in 2022, while it added that near-term global oil inventories are low and expected to continue declining maybe through Q1 next year. Over to metals, spot gold and silver have fallen victim to the firmer Dollar, with spot gold giving up its overnight gains and meandering around USD 1,750/oz (vs high 1760/oz) while spot silver briefly dipped under USD 22.50/oz (vs high 22.73/oz). Turning to base metals, China announced another round of copper, zinc and aluminium sales from state reserves – with amounts matching the prior sales. LME copper remains within a tight range, but LME tin is the outlier as it gave up the USD 35k mark earlier in the session. Finally, the electricity crunch in China has seen thermal coal prices gain impetus amid tight domestic supply, reduced imports and increased demand.

US Event Calendar

• 8:30am: Aug. Cap Goods Ship Nondef Ex Air, est. 0.5%, prior 0.9%
• 8:30am: Aug. Cap Goods Orders Nondef Ex Air, est. 0.4%, prior 0.1%
• 8:30am: Aug. -Less Transportation, est. 0.5%, prior 0.8%
• 8:30am: Aug. Durable Goods Orders, est. 0.6%, prior -0.1%
• 10:30am: Sept. Dallas Fed Manf. Activity, est. 11.0, prior 9.0

Central Banks

• 8am: Fed’s Evans Speaks at Annual NABE Conference
• 9am: Fed’s Williams Makes Opening Remarks at Conference on...
• 12pm: Fed’s Williams Discusses the Economic Outlook
• 12:50pm: Fed’s Brainard Discusses Economic Outlook at NABE Conference

DB's Jim Reid concludes the overnight wrap

Straight to the German elections this morning where unlike the Ryder Cup the race was tight. The centre-left SPD have secured a narrow lead according to provisional results, which give them 25.7% of the vote, ahead of Chancellor Merkel’s CDU/CSU bloc, which are on 24.1%. That’s a bit narrower than the final polls had suggested (Politico’s average put the SPD ahead by 25-22%), but fits with the slight narrowing we’d seen over the final week of the campaign. Behind them, the Greens are in third place, with a record score of 14.8%, which puts them in a key position when it comes to forming a majority in the new Bundestag, and the FDP are in fourth place currently on 11.5%.

Although the SPD appear to be in first place the different parties will now enter coalition negotiations to try to form a governing majority. Both Olaf Scholz and the CDU’s Armin Laschet have said that they will seek to form a government, and to do that they’ll be looking to the Greens and the FDP as potential coalition partners, since those are the most realistic options given mutual policy aims. So the critical question will be whether it’s the SPD or the CDU/CSU that can convince these two to join them in coalition. On the one hand, the Greens have a stronger policy overlap with the SPD, and governed with them under Chancellor Schröder from 1998-2005, but the FDP seems more in line with the Conservatives, and were Chancellor Merkel’s junior coalition partner from 2009-13.  So it’s likely that the FDP and the Greens will talk to each other before talking to either of the two biggest parties.

For those wanting more information, our research colleagues in Frankfurt have released a post-election update (link here) on the results and what they mean. An important implication of last night’s result is that (at time of writing) it looks as though a more left-wing coalition featuring the SPD, the Greens and Die Linke would not be able for form a majority in the next Bundestag. So the main options left are for the FDP and the Greens to either join the SPD in a “traffic light” coalition or instead join the CDU/CSU in a “Jamaica” coalition. The existing grand coalition of the SPD and the CDU/CSU would actually have a majority as well, but both parties have signalled that they don't intend to continue this. That said, last time in 2017, a grand coalition wasn’t expected after that result, and there were initially attempts to form a Jamaica coalition. But once those talks proved unsuccessful, discussions on another grand coalition began once again.

In terms of interesting snippets, this election marks the first time the SPD have won the popular vote since 2002, which is a big turnaround given that the party were consistently polling in third place over the first half of this year. However, it’s also the worst ever result for the CDU/CSU, and also marks the lowest combined share of the vote for the two big parties in post-war Germany, which mirrors the erosion of the traditional big parties we’ve seen elsewhere in continental Europe. Interestingly, the more radical Die Linke and AfD parties on the left and the right respectively actually did worse than in 2017, so German voters have remained anchored in the centre, and there’s been no sign of a populist resurgence. This also marks a record result for the Greens, who’ve gained almost 6 percentage points relative to four years ago, but that’s still some way down on where they were polling earlier in the spring (in the mid-20s), having lost ground in the polls throughout the final weeks of the campaign.

Markets in Asia have mostly started the week on a positive note, with the Hang Seng (+0.28%), Nikkei (+0.04%), and the Kospi (+0.25%) all moving higher. That said, the Shanghai Comp is down -1.30%, as materials (-5.91%) and industrials (-4.24%) in the index have significantly underperformed, which comes amidst power curbs in the country. In the US and Europe however, futures are pointing higher, with those on the S&P 500 up +0.37%, and those on the DAX up +0.51%.

Moving onto another big current theme, all the talk at the moment is about supply shocks and it’s not inconceivable that things could get very messy on this front over the weeks and months ahead. However, I think the discussion on supply in isolation misses an important component and that is demand. In short we had a pandemic that effectively closed the global economy and interrupted numerous complicated supply chains. The global authorities massively stimulated demand relative to where it would have been in this environment and in some areas have created more demand than there would have been at this stage without Covid. However the supply side has not come back as rapidly. As such you’re left with demand outstripping supply. So I think it’s wrong to talk about a global supply shock in isolation. It’s not as catchy but this is a “demand is much higher than it should be in a pandemic with lockdowns, but supply hasn't been able to fully respond” world. If the authorities hadn’t responded as aggressively we would have plenty of supply for the demand and a lot of deflation. Remember negative oil prices in the early stages of the pandemic. So for me every time you hear the phrase “supply shock” remember the phenomenal demand there is relative to what the steady state might have been.

This current “demand > supply” at lower levels of activity than we would have had without covid is going to cause central banks a huge headache over the coming months. Should they tighten due to what is likely to be a prolonged period of higher prices than people thought even a couple of months ago or should they look to the potential demand destruction of higher prices? The risk of a policy error is high and the problem with forward guidance is that markets demand to know now what they might do over the next few months and quarters so it leaves them exposed a little in uncertain times. This problem has crept up fast on markets with an epic shift in sentiment in the rates market after the BoE meeting Thursday lunchtime. I would say they were no more hawkish than the Fed the night before but the difference is that the Fed are still seemingly at least a year from raising rates and a lot can happen in that period whereas the BoE could now raise this year (more likely February). That has focused the minds of global investors, especially as Norway became the first central bank among the G-10 currencies to raise rates on the same day. Towards the end of this note we’ll recap the moves in markets last week including a +15bps climb in US 10yr yields in the last 48 hours of last week.

One factor that will greatly influence yields over the week ahead is the ongoing US debt ceiling / government shutdown / infrastructure bill saga that is coming to a head as we hit October on Friday - the day that there could be a partial government shutdown without action by the close on Thursday. It’s a fluid situation. So far the the House of Representatives has passed a measure that would keep the government funded through December 3, but it also includes a debt ceiling suspension, so Republicans are expected to block this in the Senate if it still includes that.

The coming week could also see the House of Representatives vote on the bipartisan infrastructure bill (c.$550bn) that’s already gone through the Senate, since Speaker Pelosi had previously committed to moderate House Democrats that there’d be a vote on the measure by today. She reaffirmed that yesterday although the timing may slip. However, there remain divisions among House Democrats, with some progressives not willing to support it unless the reconciliation bill also passes. In short we’ve no idea how this get resolved but most think some compromise will be reached before Friday. Pelosi yesterday said it “seems self-evident” that the reconciliation bill won’t reach the $3.5 trillion hoped for by the administration which hints at some compromise. Overall the sentiment has seemingly shifted a little more positively on there being some progress over the weekend.

From politics to central banks and following a busy week of policy meetings, there are an array of speakers over the week ahead. One of the biggest highlights will be the ECB’s Forum on Central Banking, which is taking place as an online event on Tuesday and Wednesday, and the final policy panel on Wednesday will include Fed Chair Powell, ECB President Lagarde, BoE Governor Bailey and BoJ Governor Kuroda. Otherwise, Fed Chair Powell will also be testifying before the Senate Banking Committee on Tuesday, alongside Treasury Secretary Yellen, and on Monday, ECB President Lagarde will be appearing before the European Parliament’s Committee on Economic and Monetary Affairs as part of the regular Monetary Dialogue. There are lots of other Fed speakers this week and they can add nuances to the taper and dot plot debates.

Finally on the data front, there’ll be further clues about the state of inflation across the key economies, as the Euro Area flash CPI estimate for September is coming out on Friday. Last month's reading showed that Euro Area inflation rose to +3.0% in August, which was its highest level in nearly a decade. Otherwise, there’s also the manufacturing PMIs from around the world on Friday given it’s the start of the month, along with the ISM reading from the US, and Tuesday will see the release of the Conference Board’s consumer confidence reading for the US as well. For the rest of the week ahead see the day-by-day calendar of events at the end.

Back to last week now and the highlight was the big rise in global yields which quickly overshadowed the ongoing Evergrande story. Bonds more than reversed an early week rally as yields rose for a fifth consecutive week. US 10yr Treasury yields ended the week up +8.9bps to finish at 1.451% - its highest level since the start of July and +15bps off the Asian morning lows on Thursday. The move saw the 2y10y yield curve steepen +4.5bps, with the spread reaching its widest point since July as well. However, at the longer end of the curve the 5y30y spread ended the week largely unchanged after a volatile week. It was much flatter shortly following the FOMC and steeper following the BoE. Bond yields in Europe moved higher as well with the central bank moves again being the major impetus especially in the UK. 10yr gilt yields rose +7.9bps to +0.93% and the short end moved even more with the 2yr yield rising +9.4bps to 0.38% as the BoE’s inflation forecast and rhetoric caused investors to pull forward rate hike expectations. Yields on 10yr bunds rose +5.2bps, whilst those on the OATs (+6.3bps) and BTPs (+5.7bps) increased substantially as well, but not to the same extent as their US and UK counterparts.

While sovereign debt sold off, global equity markets recovered following two consecutive weeks of declines. Although markets entered the week on the back foot following the Evergrande headlines from last weekend, risk sentiment improved at the end of the week, especially toward cyclical industries. The S&P 500 gained +0.51% last week (+0.15% Friday), nearly recouping the prior week’s loss. The equity move was primarily led by cyclicals as higher bond yields helped US banks (+3.43%) outperform, while higher commodity prices saw the energy (+4.46%) sector gain sharply. Those higher bond yields led to a slight rerating of growth stocks as the tech megacap NYFANG index fell back -0.46% on the week and the NASDAQ underperformed, finishing just better than unchanged (+0.02). Nonetheless, with four trading days left in September the S&P 500 is on track for its third losing month this year, following January and June.

European equities rose moderately last week, as the STOXX 600 ended the week +0.31% higher despite Friday’s -0.90% loss. Bourses across the continent outperformed led by particularly strong performances by the IBEX (+1.28%) and CAC 40 (+1.04%).

There was limited data from Friday. The Ifo's business climate indicator in Germany fell slightly from the previous month to 98.8 (99.0 expected) from 99.4 on the back a lower current assessment even though business expectations was higher than expected. In Italy, consumer confidence rose to 119.6 (115.8 expected), up just over 3pts from August and at its highest level on record (since 1995).