BLOG

Trade fears have returned with a twist, as global market weakness has spread to European banks while safe havens including the yen and sovereign bonds are broadly higher amid renewed risk-off sentiment.

Once again, it started in China where the Shanghai Composite slumped for another session, dropping 1.1%, and falling deeper into a bear market.

The weakness was prompted by a renewed decline in the "weaponized" Yuan, which fell for a 10th consecutive day, matching a record losing stretch, and prompting questions whether Beijing is seeking to retaliate to Trump's protectionism with another round of devaluation.

As we noted last night, last time the yuan devalued this fast, it unleashed hell on the world's financial markets

The continued slump in the yuan has stoked concerns that Chinese policy makers are less willing to temper its decline, which may remove an anchor of stability for emerging-market currencies. Still, it may not be all Beijing's doing as policymakers set the fixing at a level that was stronger than analysts expected on Wednesday, while the decline could have been far worse when at least one major Chinese bank sold the dollar in the onshore market to keep the yuan stronger than 6.6, according to two traders, prompting speculation of intervention.

A foreign-exchange trader in Asia told Bloomberg the offshore yuan ran into a large dollar-seller - possibly an agent bank working for Chinese authorities - after weakening beyond 6.61 per dollar.  Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd., said he wouldn’t be surprised if the People’s Bank of China intervened if speculative bets against the yuan grew. “The PBOC may think that fundamentally the yuan should weaken, but the move is too fast in the past week and that could ignite capital outflows,” Ong said. “Any intervention should aim only to smooth out such market moves

Whatever Beijing's intentions, the Chinese drop pressured the MSCI Asia Pacific index lower for third day, while the yuan led to a decline in Asian currencies, as developing-market stocks also tumbled, with the MSCI Emerging Markets Index hitting the lowest in 10 months.

In Europe, the Stoxx 600 reversed initial gains and fell with beaten-down autos sector index resuming its sell-off,  down 0.8% and hitting its lowest level since September 2017 amid worries over trade tensions.

The banking sector did not help, as Deutsche Bank suffered a sharp selloff shortly after the start of trading, sending the stock to new all time lows, and dragging the European banking sector to the lowest level since 2016, and down 14% YTD.

U.S. equity-index futures also slid amid a rush for safety, which sent the dollar higher and the yield on 10Y Treasurys as low as 2.84%, briefly sending the 2s10s below 33 bps.

In FX, the dollar was headed for a second day of gains in early trading, only surpassed by the yen, which was boosted by demand for haven assets. The pound slipped while Brexit tensions kept demand for pound puts strong across tenors, though BOE policy maker Ian McCafferty’s stance that officials shouldn’t wait any longer to increase interest rates eases pressure on the medium term. The kiwi led declines among Group- of-10 peers, dropping to its lowest since November and also dragging down the Aussie, before the RBNZ’s interest-rate decision on Thursday,

Continued mixed signals on global trade have complicated the investment picture, after President Donald Trump signaled he may take a less confrontational path toward curbing Chinese investments, only for his trade representative Robert Lighthizer to once again pour fuel on the showdown with countries including the EU, blasting the various retaliatory tariffs the U.S.' trading partners have advanced in reaction to the Trump administration's trade policies, calling the tariffs proof of the "complete hypocrisy" of the global trade system.

"[T]he European Union has concocted a groundless legal theory to justify immediate tariffs on U.S. exports. Other WTO Members, including China, have adopted a similar approach. These retaliatory tariffs underscore the complete hypocrisy that governs so much of the global trading system," Lighthizer said in a statement Tuesday evening.

Also overnight, the US House voted 400 vs. 2 in favor of passing bill to tighten oversight of US foreign investment due to concern over China. In related news, US President Trump suggested he would back down from his demand for new tight restrictions on Chinese investments into technology and instead rely on other channels already in place such as CFIUS.

And speaking of trade, the Fed’s Bostic who is a FOMC voter this year noted overnight that “the more (trade tensions) progresses in this more contentious way, the more it pulls me to feel like the risks are on the downside for the broader economy”. He added that “there is some likelihood I’ll be moving away from four (rate hikes) as a real possibility”. Elsewhere, the Fed’s Kaplan spoke on the yield curve as being a signal of recession. He said based on past experience “I’m loathe to say this time will be different. It’s significant to watch the yield curve”. For now, he noted the flattening yield curve is telling you that the short term US growth is strong while medium and long term growth is “sluggish”. Meanwhile the Fed’s Barkin noted the “aggregate effects of corporate tax cuts are especially hard to predict…and given these many uncertainties, the FOMC has been cautious when assessing the future impacts of the recent tax legislation”. That said, he added it’s reasonable to expect “at least a moderate boost” for the economy from recent tax cuts.

In commodities, oil was up ~0.8% on the day and around the month-long high levels seen post Tuesday afternoon’s rally after reports the US was pressing its allies to halt all oil imports from the nation by November. Further, API inventory report showed the largest drawdown to crude stockpiles since September 2016, although the impact was relatively contained on slight fatigue considering WTI had already rallied over 3% prior to the release. In the metals scope, gold is uneventful at its lowest levels since December 2017 as the overnight weakening has abated slightly. Copper has hit 12 week lows as trade concerns have hit the building material at USD 6,679/tonne, alongside ongoing supply concerns from Chile.

Expected data include MBA mortgage applications, wholesale inventories, and durable-goods orders. Canopy Growth, General Mills, Paychex, Bed Bath & Beyond and Rite Aid are among companies reporting earnings

Market Snapshot

  • S&P 500 futures down 0.6% to 2,713.00
  • STOXX Europe 600 down 0.8% to 374.43
  • German 10Y yield fell 2.9 bps to 0.311%
  • Euro down 0.2% to $1.1631
  • Italian 10Y yield rose 6.2 bps to 2.619%
  • Spanish 10Y yield fell 2.9 bps to 1.364%
  • Brent futures up 0.1% to $76.41/bbl
  • Gold spot down 0.2% to $1,256.19
  • U.S. Dollar Index up 0.1% to 94.78
  • MXAP down 0.7% to 165.81
  • MXAPJ down 1.1% to 535.03
  • Nikkei down 0.3% to 22,271.77
  • Topix up 0.02% to 1,731.45
  • Hang Seng Index down 1.8% to 28,356.26
  • Shanghai Composite down 1.1% to 2,813.18
  • Sensex down 0.7% to 35,244.36
  • Australia S&P/ASX 200 down 0.03% to 6,195.86
  • Kospi down 0.4% to 2,342.03

Top Overnight News from Bloomberg

  • U.S. President Donald Trump signaled he may take a less confrontational path toward curbing Chinese investments in sensitive American technologies, potentially relying on a U.S. committee that scrutinizes foreign acquisitions for national security risks
  • An accelerating slump in China’s yuan is stoking fear that policy makers are less willing to temper the currency’s decline as the economy slows and a trade battle with the U.S. worsens
  • The Canadian government is preparing new measures to prevent a potential flood of steel imports from global producers seeking to avoid U.S. tariffs, according to people familiar with the plans
  • S&P Global Ratings affirmed the U.S.’s sovereign credit score at AA+, the assessor’s second- highest grade, citing the country’s “diversified and resilient economy” while noting the impact of ongoing political wrangling on public finances
  • Oil held gains above $70 a barrel as the U.S. pressed allies to end Iranian imports by a November deadline and after industry data showed American inventories declined
  • U.K. house-price growth slowed in June, dropping to its weakest pace in five years, according to Nationwide Building Society.
  • Europe’s junk-debt investors are gaining ground after years of borrowers chipping away at the safeguards enshrined in the small print of bond documents
  • Bank of Japan’s Deputy Governor Masayoshi Amamiya sees the central bank as “very far off from the exit”, underpinning monetary policy divergence that could keep the pair in bullish trajectory as long as trade concerns ease

Asian equity markets were negative with the region cautious as trade concerns lingered, albeit with a slight moderation after US President Trump suggested he would ease off on demands for new tight restrictions regarding  Chinese investments and instead go through channels already in place such as the Committee on Foreign Investment in the United States. ASX 200 (flat) was choppy as the initial gains led by the energy sector were briefly eclipsed by weakness in telecoms and financials, while Nikkei 225 (-0.3%) exporter names were dampened by currency strength. Elsewhere, Hang Seng (-1.8%) and Shanghai Comp. (-1.1%) were also subdued amid the current backdrop of trade concerns and after a net liquidity drain by the PBoC which saw the mainland index extend on its descent through bear market territory. Finally, 10yr JGBs were relatively flat with only minimal support seen from the risk-averse tone in Japan and the BoJ’s presence for JPY 810bln of JGBs across the curve. Chinese President Xi is said to have warned leaders to be prepared in the event of a full-scale trade war with US during a 2-day meeting, according to a note from SGH Macro Advisors that also suggested the PBoC will refrain from buying US Treasuries and seek to lower them.

Top Asian News

  • BreadTalk Soars to Record High as It Presents at Citi Roadshow
  • Bank Rakyat Is Said to Revive Sale of Stake in Life Insurer
  • China H Shares, Once World’s Hottest, Tumble Into Bear Market
  • Yuan’s Rapid Selloff Puts China’s Market-Anchor Role in Danger

European equity bourses were initially negative across the board as trade concerns hit European markets following US congressional approval of increased US-Chinese investment scrutinization. There was a turnaround, however, into positive territory with the DAX currently the outperforming bourse, after hitting 2 month lows, on the back of US Defence Secretary Mattis striking a positive tone after talks with Chinese President Xi. Most bourses are still below their 100DMA, however, and have not been able to eliminate the losses seen throughout the week, with the DAX at 12,210 vs. its 50DMA of 12,761, the FTSE 100 at 7,534 vs its 50DMA of 7,616 and the CAC at 5,268 vs. its 50DMA of 5,473. The financial sector (-0.4%) is currently underperforming as falling treasury yields are weighing on the sector.

Top European News

  • European Banks Decline as Deutsche Bank Hits Fresh Low
  • Banks in Denmark Are Facing a Capital Hit as Early as This Year
  • Norway Sells Out of SAS in Move That May Ease Consolidation
  • Bulgaria Blames ‘Constantly Changing’ Demands for Euro Delay

In FX, it was a cagey start to European trade in FX markets with most majors sticking to their recent ranges.  Subsequently, the USD trades relatively unchanged thus far with the DXY sitting just above 94.50 as markets pause for breath after US President Trump took a slightly more conciliatory tone yesterday by suggesting he would ease off on demands for new tight restrictions regarding Chinese investments. That said, despite these comments from Trump, they are unlikely to signal a U-turn in US trade policy and the threat of an escalation in trade tensions remains at the forefront of investor sentiment. From a Chinese perspective, preparations are said to be made by leaders of the communist regime to help protect the nation’s economy in the event of a trade war with the US. It’s worth noting that the PBoC set the CNY mid-point fix at its softest level since 25th December last year with USD/CNY back below 6.6000 as the recent move to the downside continues to gather momentum; scepticism remains as to whether this is actually a targeted policy measure by China and how fair they would be willing to tolerate the move given the risk of capital outflows. Elsewhere, not too much to report for EUR as focus on the most recent ECB policy announcements and communications somewhat abates Subsequently, in the absence of any major USD traction at this stage of the session, option activity could dictate performance for the pair with 1.6bln in expiries at 1.1650, 3.3bln at 1.1625 and 2.4bln at 1.1600.

In commodities, oil is up ~0.8% on the day and around the month-long high levels seen post Tuesday afternoon’s rally after reports the US was pressing its allies to halt all oil imports from the nation by November. Further, API inventory report showed the largest drawdown to crude stockpiles since September 2016, although the impact was relatively contained on slight fatigue considering WTI had already rallied over 3% prior to the release. In the metals scope, gold is uneventful at its lowest levels since December 2017 as the overnight weakening has abated slightly. Copper has hit 12 week lows as trade concerns have hit the building material at USD 6,679/tonne, alongside ongoing supply concerns from Chile.

Looking at the day ahead, the main focus will likely be on the preliminary May durable and capital goods orders data, while the May advance goods trade balance is also due along with May pending home sales. Central bank speak continues with the BoE's Carney speaking in the morning about the BoE's Financial Stability Report, followed later by the ECB's Praet and Fed's Rosengren.

US Event Calendar

  • 7am: MBA Mortgage Applications, prior 5.1%
  • 8:30am: Advance Goods Trade Balance, est. $69.0b deficit, prior $68.2b deficit, revised $67.3b deficit
  • 8:30am: Wholesale Inventories MoM, est. 0.2%, prior 0.1%; Retail Inventories MoM, prior 0.6%, revised 0.5%
  • 8:30am: Durable Goods Orders, est. -1.0%, prior -1.6%; Durables Ex Transportation, est. 0.5%, prior 0.9%
  • 8:30am: Cap Goods Orders Nondef Ex Air, est. 0.45%, prior 1.0%; Cap Goods Ship Nondef Ex Air, est. 0.3%, prior 0.9%
  • 10am: Pending Home Sales MoM, est. 0.5%, prior -1.3%; Pending Home Sales NSA YoY, prior 0.4%

DB's Jim Reid concludes the overnight wrap

Unlike London’s rail network during a heatwave, the fallout from the weekend trade related headlines proved to be fairly short-lived in the end with the last 24 hours making for a much calmer affair in markets. Last night the S&P 500  closed +0.22% with energy names leading the way after WTI Oil surged +3.60% while the Dow (+0.12%) rose for only the second time in the last eleven sessions. The Nasdaq closed +0.39% while prior to that in Europe the Stoxx 600 closed out an uneventful session +0.02% with volumes well below average. The VIX edged back below 16 and is now back to its YTD average again more or less while moves for bond markets were similarly muted outside of the periphery with Bunds just 1.3bp higher while Treasuries nudged down -0.3bps. The US dollar index (+0.41%) was stronger also.

As for the newsflow, well Peter Navarro’s soothing words on Monday night appeared to do its job although to be honest yesterday felt more like a no news is good news sort of day. President Trump did tweet his disdain at Harley Davidson’s pledge to move production out of the US, saying that “it will be the beginning of the end” and that “they  will be taxed like never before”. Harley Davidson’s shares fell as much as -2.70% before ending -0.60% lower. Trump also tweeted that his administration is finishing its study of tariffs on cars from the EU, while House Speaker Paul Ryan also weighed in with some comments of his own yesterday afternoon. Speaking to reporters in response to the Harley-
Davidson situation, Ryan said that “there are better tools than tariff increases” and that “tariffs aren’t the right way to go”. All in all then, nothing that really got the market too excited. Later in the session though Trump then spoke at the White House and indicated that he might be favouring Treasury Secretary Steven Mnuchin’s softer approach towards protecting US intellectual property from China, specifically by using the Committee on Foreign Investments in the US (CFIUS).

Despite that, this morning, after China’s Shanghai Comp won the race to be the first major equity index to hit correction territory this year, the index is extending on losses (-0.45%) while the rest of Asia is also trading modestly lower with the Nikkei (-0.27%), Kospi (-0.13%) and Hang Seng (-0.58%) all down. In the US, rating agency S&P has affirmed the US’s sovereign credit rating of AA+ with stable outlook and noted “we expect that debates over funding the government and raising the debt ceiling will continue to be resolved at the last minute”. Meanwhile Reuters cited unnamed sources saying that Canada may be preparing higher tariffs on steel to prevent a flood of steel imports as producers divert their output away from the US. Back in Asia, BOJ’s Deputy Governor Amamiya sees the BOJ as “very far off from exit” in terms of stimulus policies, in part as he does not think “the side effects exceed the benefits at this point”, although “the effects are cumulative and we’re watching this carefully”. As for data this morning, China’s May industrial profits moderated 0.8ppt mom to a still solid level of 21.1% yoy.

Moving on. There was a bit of macro data out yesterday in the US with the June consumer confidence print coming in at a weaker than expected 126.4 (vs. 128.0 expected). It also fell 2.4pts from May although the absolute level is still indicative of an upbeat US consumer (130.0 is the post-recession high made back in February). In the details the present conditions gauge was actually more or less unchanged at 161.1 although the expectations gauge did slip 4pts to 103.2. Meanwhile the Richmond Fed manufacturing index rose 4pts to 20 (vs. 15 expected) with new orders rising to the highest since February and prices paid the highest since 2012.

Meanwhile, Sterling was kept busy yesterday with a couple of BoE speakers doing the rounds in the morning. Incoming MPC member Jonathan Haskel said that “given current conditions and economic data, I agree with the broad direction of travel” but also that “the first risk involved in raising interest rates would be if this is done too quickly, disturbing investment and borrowing plans by more than would have been expected”. Haskel’s testimony leant slightly dovish at  the margin which was in contrast to outgoing MPC member and well-known hawk Ian McCafferty who said that the BOE “should not dally” in raising rates.

Unsurprisingly there was greater weight placed on Haskel’s comments with Sterling falling as much as -0.55%, before paring some of that move into the close to finish -0.42%. Gilts were also the relative outperformer yesterday in bond markets (2y closing +0.4bps higher and 10y +1.0bps higher) while the probability of a hike at the August meeting continues to hover just north of a coin flip (currently 58%).

Over in the US, the Fed’s Bostic who is a FOMC voter this year noted “the more (trade tensions) progresses in this more contentious way, the more it pulls me to feel like the risks are on the downside for the broader economy”. He added that “there is some likelihood I’ll be moving away from four (rate hikes) as a real possibility”. Elsewhere, the Fed’s Kaplan spoke on the yield curve as being a signal of recession. He said based on past experience “I’m loathe to say this time will be different. It’s significant to watch the yield curve”. For now, he noted the flattening yield curve is telling you that the short term US growth is strong while medium and long term growth is “sluggish”. Meanwhile the Fed’s Barkin noted the “aggregate effects of corporate tax cuts are especially hard to predict…and given these many uncertainties, the FOMC has been cautious when assessing the future impacts of the recent tax legislation”. That said, he added it’s reasonable to expect “at least a moderate boost” for the economy from recent tax cuts.

Coming back to Oil, the complex rallied around 3% (WTI +3.60%; Brent +2.11%) yesterday on the prospect of reduced oil supply after Bloomberg reported the US has pressed its allies to stop importing oil from Iran by the November 4 deadline as part of its sanction efforts. Notably, an unnamed State Department official said the US administration would not rule out waivers or extensions to the November deadline, but it is not discussing those options either. Meanwhile, the US energy secretary Perry also noted the recent OPEC plans for higher crude output “may be a little short” of what’s required to prevent an oil price spike.

As for other news, there was some positive headlines in Germany yesterday with two CSU leaders (Seehofer and Dobrindt) stressing that they do not want to break up the coalition. Merkel also added that the CDU sees scope for broad agreement with the CSU on migration however she also added that it’s unlikely that this week’s EU summit will make for an overall deal on all aspects of migrant policy. So expect this to drag on a little longer. Elsewhere, it was interesting to note a Bloomberg story yesterday suggesting that Special Counsel Robert Mueller is intending to accelerate his investigation into the Russia-US election probe. The story suggested that Mueller and his team have a view to present conclusions by Autumn, conveniently timed with the US mid-terms.

Before we wrap up, a quick mention that yesterday our House View team published a note focusing on the latest trade war developments. The report has a special focus on (1) Trade tensions – different measures, potential macro impact and the scope for policy response in the US and China, and (2) Policy divergence between the Fed and ECB. It also covers the upcoming EU council summit later this week. The document as usual also summarises our economists’ macro and monetary policy outlook and forecasts, as well as the key strategy views across rates, FX and Credit. You can find a link to the report here.

Looking at the day ahead, it looks set to be a relatively quiet session in Europe with the only data due being June consumer confidence data in France and May M3 money supply data for the Euro area are due. In the US the main focus will likely be on the preliminary May durable and capital goods orders data, while the May advance goods trade balance is also due along with May pending home sales. Central bank speak continues with the BoE's Carney speaking in the morning about the BoE's Financial Stability Report, followed later by the ECB's Praet and Fed's Rosengren.