The Morning Track – No Breaks

Geopolitical fears remained front and center for the start of the third quarter trading. We are starting the quarter with risk off in equities, but bonds are not bid up enough to counter the pain and the USD is stronger. It’s Monday and the weekend news didn’t bring any relief for China and the trade tariffs looming. The EU warned of a $300bn hit to its auto sector over US car import tariffs. Nor did it bring much surprise, as Mexico elects AMLO as President– a left leaning populist with 53% of the vote. This brought the MXN 1.3% stronger to 19.6406 but it’s back over 20 again tracking USD gains elsewhere. The weekend didn’t offer up much respite for the embattled German Chancellor Merkel as she continues to face political turmoil over immigration with her coalition. Germany's Interior Minister Seehofer offered to resign over the migration issue as he said the EU agreement did not go far enough. However, has delayed handing in the letter for one more day of talks. The weekend didn’t bring much clarity over Italy and the EU either, as Italy's Salivini said next year's European elections are an opportunity to create an "international alliance of populists" and overcome a "Europe of the elites." The UK hopes for a Brexit deal continue to elude – with UK Robbin’s saying Brussels will not offer a bespoke trade deal and with the UK May Cabinet meeting later this week to discuss solutions. As for the oil market, Trump tweets on a side deal with Saudi were pulled back by the White House noting that King Salman bin Abdulaziz affirmed that Saudi Arabia has 2 million barrels a day of spare production capacity "which it will prudently use if and when necessary to ensure market balance and stability, and in coordination with its producer partners, to respond to any eventuality." All of these stories seem to dominate over the key economic reports with Japan Tankan weaker than expected, the EU PMI reports mostly weaker – except for Italy – and with doubts about orders and prices. There is a sense from the data that growth is holding, jobs increasing, but export concerns are hitting at optimism and that prices are beginning to hurt. This isn’t stagflation or a world set for a recession, but one that is pulling back from its best growth in a decade and so the mood depends on politics and policy. For today, it’s the USD that is leading the overall risk barometers from EM to Asia to EUR and GBP – all seems to go back to the balance of growth and inflation with 95.53 the key level to watch.

Question for the Day: Is today about growth and greed or facts and fear? The reaction function of central bankers to data in a world of geopolitical noise matters this week. Reading how the FOMC will react to tariffs and the pass-through of inflation from them to consumers and business will be key. Similarly, the rest of the world’s plans of rate normalization rests on how they balance fear from greed in the economy. The RBA meeting tomorrow will be a key test of this juggling as 1Q GDP was stronger than expected, job creation better, but worry from global risks – trade concerns between US/China, housing prices dropping, business and consumer moods. Here are some recent central bank comments on this balancing act.

• Bank of England MPC Cunliffe said that the escalating trade wars, strains in emerging markets and a rising possibility of a Chinese credit crisis could combine into a "painful"
  experience for the British economy.
• PBOC Governor Yi Gang has proposed a policy package to increase bank lending while reducing lending costs to small and micro-sized firms. The PBOC will raise the cap of relending and rediscounting by CNY150 billion to support small firms and agriculture, Yi noted. This despite the official “neutral and prudent” stance.  The China 1-year rate swaps now trade 3.01% just 40bps over the US – adding to CNY pressures.
• BOJ officials tell MNI, they see only a limited direct impact of U.S. trade disputes on global demand and business sentiment so far in the bank's latest survey but they will keep a close watch on how things will evolve on the trade front and whether rising costs will continue squeezing profits.

The ability for markets to climb back from the drop today rests on the idea that central bankers will remain easy and that the growth will hold despite dents to confidence. The currency that captures this best is JPY where the 112 level looks to be vital to any bounce leading to a happy 3Q.

What Happened?

• Japan 2Q BOJ Tankan Large Manufacturing 21 from 24 – weaker than 22 expected – with outlook 21 for 3Q.  The Large Service 24 from 23 – better than 23 expected with outlook 21 for 3Q.  The big firm FY18 capex plans rise to 13.6% - better than 9.4% expected – while small firms drop to -11.8% - slightly better than -13.8% feared – and above the historical average. The BOJ noted business sentiment was affected by higher raw material prices and concerns over trade wars. The USD/JPY assumption is 107.26 down from 109.66.
• Japan June Nikkei final Manufacturing PMI 53 from 52.8 – less than 53.1 flash. Both output and employment rose at faster rates but new export orders fell for the first time since August 2016 and total inflow of new work was softest in 10-months.
• China June Caixin Manufacturing PMI 51 from 51.1 – as expected. Output and new orders sustained growth but demand from overseas dipped with new export sales down for 3rdmonth. Optimism fell to 6-month lows. Employment fell at the quickest rate since July 2017.  
• Swiss May retail sales -1.3% m/m, -0.1% y/y after +0.4% m/m, + 2.9% y/y – weaker than 2.6% y/y expected. The decline was led by a sharp fall in sales of clothing and footwear (-10.8 percent vs 0.5 percent in April) and automotive fuel (-3.5 percent vs 2.6 percent). In addition, sales rose at a softer pace for both food, beverages and tobacco (0.1 percent vs 0.2 percent), and other goods (1.9 percent vs 5.5 percent).

• Eurozone June final Manufacturing PMI 54.9 from 55.8 – weaker than 55 flash – 18-months lows. Growth of output and new orders slowed further as new exports business remains subdued. Notable supply chain pressures and rising oil prices bring input costs to 4-month highs.   
  • German June final Manufacturing PMI 55.9 from 56.9 – same as flash. IHS/Markit noted new orders showed the "slowest rise in over 2-years" and the outlook for future output "dips to lowest for more than 3-years."
  • France June final Manufacturing PMI 52.5 from 54.4 – weaker than 53.1 flash – now at 16-month lows but with resilient job creation. Input costs at 4-month highs. 
  • Italy June Manufacturing PMI 53.3 from 52.7 - better than 52.7 expected. The gains were due to improving output, new orders driving up jobs. "However, cost pressures mounted amid reports of higher prices for steel and other materials used in production processes. Moreover, optimism about the future softened to its lowest level in over five years"
  • Spain June Manufacturing PMI 53.4 from 53.4 – weaker than 53.6 expected. This was the weakest rise in output since August 2017 but new orders growth rose along with the jump in output prices – now at fastest pace since Jan 2017.

• UK June Manufacturing PMI 54.4 from 54.3 revised – better than 53.7 expected. May revised lower from 54.4. Output growth slows from May’s 5-month highs. Input costs pick up. "Output and new orders rose across the consumer, intermediate and investment goods industries. However, the overall rate of expansion in manufacturing output slowed, as growth of new order inflows improved only mildly", IHS/Markit said.

• Eurozone May unemployment 8.4% after revised 8.4% - better than the 8.5% expected – best since Dec 2008.  April revised to 8.4% from 8.5% initially reported.  Youth unemployment dips to 16.8% from 17.1%. On a monthly basis, unemployment fell 125,000 and on a yearly basis fell 1.252mn.

Market Recap:

Equities: The S&P500 futures off 0.5% after a 0.08% gain Friday. The Stoxx Europe 600 is off 1% while the MSCI Asia was off 2% with China and Japan both leading losses on trade concerns.

• Japan Nikkei off 2.21% to 21,811.93
• Korea Kospi off 2.35% to 2,271.54
• Hong Kong Hang Seng closed for the holiday
• China Shanghai Composite off 2.52% to 2,775.77
• Australia ASX off 0.26% to 6,273.30
• India NSE50 off 0.53% to 10,657.30
• UK FTSE so far off 0.95% to 7,565
• German DAX so far off 0.6% to 12,230
• French CAC40 so far off 1.15% to 5,262
• Italian FTSE so far off 1% to 21,411

Fixed Income: German Bunds are off on the day despite equity pain, 10Y yields up 0.5bps to 0.3% while French OATs are flat at 0.66% and UK Gilts are off 2bps to 1.255%. Periphery focus with Italian PMI better Greece bond ratings upgraded to B by DBRS and worries over politics beating everything – Italy 10Y yields up 7bps to 2.737%, Spain off 1.5bps to 1.295%, Portugal off 0.5% to 1.76% and Greece up 2bps to 3.92%.

• US Bonds bid with belly of the curve leading – 2Y off 1.6bps to 2.512%, 5Y off 2.5bps to 2.713%, 10Y off 2.7bps to 2.833% and 30Y off 1.9bps to 2.97%
• Japan JGBs rally with focus on the belly of the curve – 10 and 30Y supply next drivers. 10Y bond yields fell 0.5ps to 0.025%. BOJ Rinban was unchanged in volume and cover. BOJ bought Y190bn in 10-25Y and Y70bn over 25Y.
• Australian bonds bid on global trade worries, waiting for RBA next – 3Y rates fell 3bps to 2.03% and 10Y fell 4bps to 2.59%. AOFM sold A$300mn of 4Y 2.25% Nov 2022 #TB153 at 2.2034% with 7.6833 cover – previously 2.2176% with 4.03 cover.
• China PBOC skips open market operations, net drains CNY20bn on the day. Money market rates fell with 7-day off 32bps to 2.688% and O/N off 17bps to 2.47%. 10Y bonds were steady at 2.475%.

Foreign Exchange: The US dollar index is up 0.25% to 94.79 – watching 100-week at 95.545 as double top resistance, 95.09 June 28 lows as breakdown level and pivot with 94.40 and 94.03 June 13 highs as support.

In Asia EM FX, USD bid – KRW off 0.4% to 1117.80, INR off 0.45% to 68.753; In EMEA same, TRY off 0.8% to 4.6250, RUB off 0.5% to 63.104, ZAR off 0.6% to 13.806

• EUR: 1.1645 off 0.35%. Range 1.1626-1.1693 – reversal early on politics and then on equity pain with 1.16 key pivot. 1.15-1.18 summer prison.
• JPY: 110.75 up 0.1%. Range 110.51-111.06 with EUR/JPY off 0.3% to 128.95 – holding despite equity pain – with rates supporting.
• GBP: 1.3160 off 0.35%. Range  1.3140-1.3209 with EUR/GBP flat at .8845 – watching 1.30 and 1.33 but Brexit key.
• AUD: .7365 off 0.55%. Range .7356-.7416 with NZD off 0.45% to .6735 – all about commodities, China and rate spreads with .7340 pain for .72 next.
• CAD: 1.3165 up 0.25%. Range 1.3140-1.3189 back to 1.32 pain with 1.34 in play with oil focus.
• CHF: .9925 up 0.25%. Range .9898-.9937 with EUR/CHF 1.1560 off 0.1%. Strange that it’s not .98 with Italy pain focus.
• CNY: 6.6157 fixed 0.01% stronger from 6.6166, trades weaker off 0.65% to 6.6605. The weekly RMB index fell 1.77% last week to 95.66 – lowest since Jan 19.

Commodities: Oil lower, Gold lower, Copper lower off 0.55% to $2.9830.

• Oil: $74.10 off 0.1%. Range $72.51-$74.13. WTI watching $74.46 the June 29 highs the $76 the bull channel top againt $72.50 and $71.40 support.  Brent $78.80 off 0.4% - watching $78.85 and $79.56 the Friday highs for $80 barrier test against $78 base with $76.11 the June 27 lows.
• Gold: $1249.15 off 0.3%. Range $1247-$1251. The USD still driving. $1245 support against $1261.20 resistance (June 21 lows). Silver off 0.9% to $15.97, platinum off 1.75% to $838.35 and palladium off 0.85% to $947.25.

Economic Calendar:

• 0945 am US June Markit Manufacturing PMI 54.6p 55.0e
• 1000 am US June ISM Manufacturing PMI 58.7p 58.0e
• 1000 am US May Construction Spending (m/m) 1.8%p 0.5%e