Overview: More constructive signals from Chinese officials and a Federal Reserve that is gradually moving toward slowing its bond purchases have had a beneficial impact on the risk-appetites.Led by a 3% recovery in the Hang Seng, the large equity markets in the Asia Pacific region advanced after the MSCI benchmark recorded the lows for the year yesterday. Europe's Dow Jones Stoxx 600 is posting modest gains that were sufficient to lift the benchmark to new record highs.US equity futures are firm. US and European 10-year yields are little changed. The US is firm around 1.26%. European yields are also 1-2 bp higher. The biggest reaction in the capital markets is the setback in the dollar, which is softer against nearly all currencies through the European morning. Among the majors, the New Zealand and Canadian dollars and the Norwegian krone are the strongest. The yen and Swiss franc are the laggards. Among emerging market currencies, the South African rand and Hungarian forint are the strongest. The JP Morgan Emerging Market Currency Index extended yesterday's gains and is poised for its best two days this month. Meanwhile, the decline in real yields and a weaker dollar appear to be helping lift gold above its 200-day moving average near $1821.Falling oil inventories in the US are helping to lift crude prices. The September WTI contract is up by more than 1% for the second day as prices push above $73 a barrel. After falling on Tuesday, the CRB rose yesterday, its sixth gain in the past seven sessions.  

Asia Pacific

Chinese officials moved to calm markets. They did so by the regulators meeting with banks and trying to isolate the crackdown on private education while signaling that IPOs in the US are not banned. State funds may have been deployed to support equities. The PBOC provided additional liquidity. The CNY30 bln (~$4.6 bln) via seven-day repo was the largest such operation this month. Even if Chinese officials succeed in stabilizing the market, the damage to sentiment and confidence among foreign investors will take some time to heal. First, outside of some general narrative, it is not clear what is Beijing's end game. Second, what appears to be capriciousness and clumsiness did not just begin in recent days but is part of a sequence of events that goes back to the intended Ant IPO last year. Third, the opaqueness and activist state approach does not attract foreign investment. Fourth, these recent events show why integrating China into the world's capital markets is a gradual process that is not simply moving in one direction. The main challenge is not technology, which means that a digital yuan may not be the game-changer that some have suggested.  

After buying a record among Japanese bonds in the week through July 16 (JPY2.57 trillion), foreign investors pared their holdings last week by JPY223 bln. The most interesting development last week with Japanese portfolio flows was the continued divestment of foreign bonds. Japanese investors sold JPY1.09 trillion of foreign bonds. It was the fourth liquidation in the past five weeks. Indeed, the average weekly sales over this run have been JPY544 bln, the most in a five-week period since March as the fiscal year was drawing to a close. 

The dollar is hovering near this week's lows against the yen set on Tuesday near JPY109.60. There is little support below there until last week's low closer to JPY109. There is an option for about $380 mln at JPY109.30 that expires today. On the upside, the greenback has not been able to poke above JPY110.00 today. The Australian dollar is bid, and it is straddling $0.7400 near midday in Europe. It has not closed above $0.7400 since July 15. It appears to be absorbing offers that may be related to the A$1.1 bln in options expiring today between $0.7385 and $0.7400.The $0.7425 area holds the 20-day moving average, and the Aussie has not closed above it since mid-June. The dollar had broken out of the recent range against the Chinese yuan and reached its best level in three months on Tuesday (~CNY6.5125). It has since surrendered the gains and moved back to the lower end of the previous trading range (~CNY6.45). It is on track for its biggest two-day drop against the yuan in six months. The dollar's reference rate was set at CNY6.4942, nearly spot-on the median projection (CNY6.4944) in the Bloomberg survey.  

Europe

Germany reported a larger than expected decline in unemployment and what appears to be an upside surprise on inflation. The unemployment queues fell by an impressive 91k in July after a 39k decline in June. It was the largest drop since late 2006. The median forecast called for a 29k decline. The unemployment rate fell to 5.7% from 5.9%. It was at 5% before the pandemic struck. The German states have reported their CPI figures, and the national figures will be out shortly.The states reported a monthly rise of 0.8%-1.0%, which poses an upside risk to the median forecast expecting a 0.6% rise in the national calculation, which would lift the year-over-year rate to 3.2% from 2.3%. The EU harmonized measure was expected to rise by 0.4% for a 2.9% year-over-year pace (up from 2.1% in June).  

Spain is the other large EMU country reporting unemployment and inflation figures today. The Q2 unemployment rate eased even if not as much as expected, falling to 15.26% from nearly 16% in Q1. The EU harmonized inflation measure fell 1.2% on the month, which due to the base effect saw the year-over-year rate rise to 2.9% from 2.5%.  

Tomorrow is a big day of releases for the eurozone. It reports the June unemployment rate (seen steady at 7.9%, though the risk is on the downside), CPI (seen at 2% but the risk is on the upside), and the first estimate for Q2 GDP ( a 1.5% quarterly gain, which would be the first expansion in three quarters and only the second quarterly expansion since Q3 19 (it was stagnant in Q4 19).  

The euro is extending its rally for the fourth consecutive session.  It has forged a base around the $1.1750-$1.1760 area and tested it at the start of the week. Today it is pushing against $1.1880, a three-week high. It closed above the 20-day moving average yesterday for the first time since June 7, and the five-day moving average is crossing above the 20-day moving average for the first time since then as well. It has not traded above $1.19 this month, and there is an 800 mln euro option struck there that expires today. Sterling is also advancing for the fourth consecutive session. It settled last week slightly below $1.3750 and reached $1.3970 today, its highest level since June 23. Recall that sterling peaking on June 1 is near $1.4250. It is moving above the (50%) retracement level (~$1.3910) today, and the next retracement (61.8%) is just shy of $1.40.  

America

There are two main takeaways from yesterday's FOMC statement and press conference. First, the Fed is still on track to make a formal tapering announcement in a couple of months. The actual tapering could begin before year-end, depending on the economy. Powell seemed relatively calm about the prospects that the new Delta variant will cause a major economic disruption. The Jackson Hole-September FOMC meeting timeframe still seems reasonable, especially if the upcoming employment data is as strong as anticipated, and there are several forecasts for non-farm payrolls to rise by a million when announced at the end of next week. Second, the Fed continues to argue that elevated price pressure is temporary. Powell has argued that a relatively small basket of goods in the CPI basket accounts for the prices. We have noted that only about a third of the components are rising faster than 2%. Powell pointed to cars (new, used, and rental), airfare, and hospitality as significant contributors. The Fed Chair continued to push back against linking house price increases to its MBS purchases and seemed to suggest early tapering off those purchases did not have wide support. The minutes will shed light on this debate.  

More than a month after President Biden said a deal was struck, the Senate appears to be on the verge of approving a bipartisan physical infrastructure bill. It will be around $550 bln in new spending, and almost another $500 bln is anticipated in federal money for highways that are part of the regular cycle. It will be partly paid for by reallocated unspent covid relief funds and tapping the Strategic Oil Reserves and a few other more gimmicky measures like counting revenue for future growth and boosting the reporting for crypto trades to capture more tax revenues.  

The US reports its preliminary estimate for Q2 GDP. The median forecast in Bloomberg's survey calls for an 8.5% annualized pace after 6.4% in Q1. Personal consumption is expected to have risen by double digits for the second consecutive quarter. The GDP deflator is projected to rise to 5.4% from 4.3%. We suspect US economic growth is peaking, and the slowing will be gradual, but by H2 22, the sub 3% pace will return. Separately, the US reported weekly jobless claims. They unexpectedly rose by 50k in the previous week, which was the second increase in three weeks and the first back above the 400k-mark since mid-June. Unperturbed, economists in the Bloomberg survey are looking for 385k claims last week.

The US dollar is breaking down against the Canadian dollar.  It is convincingly falling through the 20-day moving average (~CAD1.2525) for the first time since mid-June. The greenback is trading near two and a half week lows against the Canadian dollar to test CAD1.2450. Recall it peaked near CAD1.28 on July 19. The next target is near CAD1.24, the halfway mark of the US dollar's recovery from the five-year low set on June 1 near CAD1.20. The Mexican peso shrugged off Moody's downgrade of Pemex deeper below investment grade (Ba3 and retained a negative outlook). Of the main rating agencies, only S&P sees Pemex as an investment-grade risk. The dollar has approached MXN19.85 to take out last week's low. The next area of support is seen near MXN19.80. It should be capped in front of MXN19.97.