The "trade war on, trade war off" market is back.

One day after global markets tumbled, and commodities suffered the biggest one day drop in 4 years, the risk on mood is back after traders detected a subtle shift in China's rhetoric, which according to Bloomberg appeared to be toning its responses to Donald Trump’s tariff threats. Evidence of the shift continued Thursday when the Commerce Ministry held off detailing how it plans to retaliate against Trump’s latest threat to impose tariffs on $200 billion worth of Chinese-made goods.

Specifically, commerce Ministry spokesman Gao Feng said the government will take “necessary” steps to hit back, but when pressed he stopped short of repeating a previous pledge to respond with “quantitative” and “qualitative” measures and didn’t outline specifics about which measures China would retaliate with.

Perhaps China simply hasn't decided yet how to retaliate, or simply did not want to disclose it in public, but to observers, the modest change of tone suggests China could be playing for time with the aim of restarting stalled negotiations for a solution that would limit the need to unleash punitive retaliatory measures. To be sure, for President Xi Jinping, gathering problems at home and abroad may be prompting a less confrontational course. “China may be moving gradually from the current tit-for-tat mode of retaliation toward a controlled, selective retaliation,” said Chang Jian, chief China economist at Barclays Plc in Hong Kong.

Optimism was threatened when Gao Feng rejected an earlier report that Beijing was holding backdoor negotiations with the US and said that China is not in touch with the US right now for renewing trade talks, but that was largely ignored by markets who were desperate for any positive catalyst, and latched on to news of a possible de-escalation by Beijing with rabid desperation.

So, as a result of the glimmer of hope of trade war de-escalation, we are having a repeat of the Monday session and a mirror image of Wednesday, as stocks advanced globally, rebounding from yesterday's sharp selloff, while the dollar steadied while Treasuries edged lower and commodities recovered ground.

The risk on tone started in China where the Shanghai Composite surging 2.2%, recovering the 2800 level and testing the 20-day moving average, while the tech-heavy Chinext soared 3.3% to recover 1600. Chinese chipmakers and telecom companies surged after the US said it will remove the ban on Chinese telecom equipment maker ZTE.

A risk on mood sent the Yuan sharply higher, with the USDCNH sliding 0.5% to just below China's redline of 6.69.

Sentiment from Asian session carried through into European trading. U.S. equity futures joined the broad rally and were close to yesterday’s highs..

...  while European equity markets also rebounded sharply, with the Stoxx 600 rising 0.6%.

Still, not everyone was convinced: "There won’t be any winners from the trade war, and the risk is that it will have an impact on global growth, on consumer spending and will end up boosting inflation. All these elements are bad news for the equity market,” said Pictet sr. investment advisor Frederic Rollin, speaking in an interview on Wednesday.

Commodities are bouncing back strongly after yesterday's historic rout. Brent is advancing after yesterday's largest one-day drop in five years which was spurred on by trade concerns and increased Libyan production. WTI is up 0.8% and Brent up 1.8% but still well below the levels seen prior to yesterday’s trade, with WTI finding some support at its 100DMA, currently at USD 69.40. IEA maintain their forecast for 2018 global oil demand growth of 1.4mln BPD, say OPEC crude production in June reached a 4-month high of 31.87mln BPD, up 180k BPD (excl. Congo).

Meanwhile, in FX, Bloomberg notes that the low-volume summer trading in the spot market took over from Wednesday’s positioning adjustments, leaving the major currencies confined to relatively narrow ranges. Reports that the U.S. and China may look to resume trade talks helped keep the dollar firmly supported versus the yen following bullish technical breaks.  The USD/JPY rose to a fresh 6 month high, continuing to push higher; meanwhile, the SEK was weaker on CPIF miss. Emerging Markets were led higher by TRY as new treasury and finance minister - and Erdogan's son-in-law - said the central bank will be more “active” than ever.

In rates, USTs are close to overnight lows, curve marginally flatter; bunds briefly push higher on reports that Trump is considering pulling out of NATO, however, move is quickly faded after Trump announced that NATO had come to an agreement to boost spending.

Market Snapshot

• S&P 500 futures up 0.5% to 2,789.00
• STOXX Europe 600 up 0.2% to 382.25
• MXAP up 0.09% to 164.21
• MXAPJ up 0.4% to 536.58
• Nikkei up 1.2% to 22,187.96
• Topix up 0.5% to 1,709.68
• Hang Seng Index up 0.6% to 28,480.83
• Shanghai Composite up 2.2% to 2,837.66
• Sensex up 1% to 36,611.07
• Australia S&P/ASX 200 up 0.9% to 6,268.31
• Kospi up 0.2% to 2,285.06
• German 10Y yield unchanged at 0.368%
• Euro up 0.1% to $1.1686
• Italian 10Y yield rose 1.7 bps to 2.422%
• Spanish 10Y yield rose 0.6 bps to 1.31%
• Brent futures up 2.1% to $74.91/bbl
• Gold spot up 0.2% to $1,244.73
• U.S. Dollar Index little changed at 94.08

Top Overnight News

• China Ministry of Commerce: U.S. is not in touch with China in regards to renewing trade talks
• Bond traders are calling time on the Federal Reserve’s tightening cycle. The spread between December 2019 and December 2020 eurodollar contracts fell below zero Wednesday for the first time, suggesting short-end traders don’t expect the central bank to raise interest rates at all after next year. In fact, they’re giving slightly better odds that the Fed eases policy over the span instead of tightening it
• NATO: reports from DPA that Trump threatened to pull U.S. out of NATO are later refuted by Reuters citing people familiar
• BOE: 2Q defaults on unsecured lending driven by a significant increase in defaults on credit cards
• Sweden Jun CPIF y/y: 2.2% vs 2.3% est; Riksbank minutes show concerns that moderate inflation raises questions about the development of inflation in the long run
• IEA: OPEC’s Gulf members may need to pump almost as much crude as they can to cover supply losses from Iran and Venezuela
• The U.K. seeks to strike new trade deals for services around the world as part of a Brexit plan that will tie its goods to European Union rules in a bid to preserve open customs borders with the bloc
• In an unexpected twist, NATO leaders are holding an unplanned emergency session on the last day of their two-day summit, which has been upended by U.S. President Donald Trump’s attacks on allies over defense spending.
• Traders will be watching to see what Chinese policymakers do to defend the yuan after it tumbled past a key level against the dollar. The yuan sank as much as 1.1 percent in overnight offshore trading to 6.7249, its biggest loss since January 2016, as a trade conflict with the U.S. worsened
• The market probability of an Aug. 2 Bank of England rate hike stands at about 80 percent, near the levels seen in the run-up to May’s meeting when Carney intervened to damp expectations.

Asian equity markets shrugged off the energy-led declines in US and traded higher across the board with short covering in the region seen after the prior day’s trade-related losses. ASX 200 (+0.9%) and Nikkei 225 (+1.2%) were positive in which the latter coat-tailed on upside in USD/JPY and with Softbank among the biggest gainers after US investment fund Tiger Global took a stake of over USD 1bln in the Co., while broad gains were also seen in Australia aside from commodity-related sectors following recent weakness in the complex including a near-5% drop in crude. Elsewhere, Hang Seng (+0.6%) and Shanghai Comp. (+2.1%) conformed to the improved risk tone after the PBoC conducted repo operations for the 1st time in over a week and amid continued positive rhetoric regarding A-shares valuations which were said to be at historic lows. Finally, 10yr JGBs were flat with price action uneventful throughout the session amid focus on riskier assets and with the 20yr auction results largely ignored, despite showing firmer demand and higher accepted prices than previous.

Top Asian News

• Special Effects Maker Plans Hong Kong IPO for China Unit
• China Studies Paying for Kids to Boost Population, Report Says
• Standard Chartered Cuts Yuan Forecasts on Trade War Concerns
• Indonesia to Sign Grasberg Mine Agreement With Freeport

European equities are currently higher with the Euro Stoxx 600 up 0.6%. Equities were slightly choppy amid source reports suggesting that US President Trump was criticising NATO and had threatened to drop out, reports thereafter suggested that pulling out is not on the cards. The IBEX (-0.2%) and FTSE MIB (-0.3%) are in the red, weighed on by bank stocks with exposure to Turkish assets (BBVA -0.7%) alongside broad-based financial underperformance (UniCredit -1.0%, Banca Generali -1.1%, CaixaBank -1.1%) and possible strike action at Fiat’s (-1.0%) Melfi plant over Cristiano Ronaldo’s transfer cost. Telecom Italia (-1.3%) is also underperforming after a price target cut at Barclays and is weighing on the telecoms sector, which is currently negative for the day. The FTSE is outperforming on the back of betting names such as Paddy Power Betfair (+2.7%) benefitting from England’s exit from the World Cup. Updates on Sky (+1.8%) where Comcast have tabled a GBP 26bln offer to buy the co., moving swiftly to trump Fox’s GBP 24.5bln offer earlier in the week.

Top European News

• Oil Strike Hit on Norway Output Limited to One Field for Now
• U.K. Seeks to Strike Trade Deals for Services in New Brexit Plan
• Asos Plunges, Pulling Down Zalando, as 3Q Disappoints Analysts
• Inmarsat Extends Gains; Berenberg Sees Months of M&A Speculation

In FX, JPY/AUD flanked the G10 list of worst and best performers on less investor angst over a full-blown US-China trade war even though the latter (via a Commerce Ministry official) has scotched speculation that the 2 sides have been talking already. Short covering also a factor behind the broad bounce in risk assets and resultant reduced demand for safe-havens like the Jpy that finally yielded to pressure below 111.00 vs the Usd, as the pair broke higher and into a fresh range overnight. Stops are said to have been tripped through 111.50 and major trend-line resistance around 111.57 that had been capping the upside, with more triggered when 112.00 was breached on the way to a circa 112.40 peak. Conversely, the Aud has been able to stem further losses and rebound ahead of 0.7350 vs its US counterpart, although the 0.7400 handle remains elusive. CHF - Mildly softer vs the Usd as the Franc slips through 0.9950, but still not really behaving like a true port in a currency storm given strict SNB intervention to prevent the highly valued Chf getting too strong

In commodities, oil is recovering this morning after the significant losses seen in yesterday’s trade that was spurred on by trade concerns and increased Libyan production. WTI is up 0.8% and Brent up 1.8% but still well below the levels seen prior to yesterday’s trade, with WTI finding some support at its 100DMA, currently at USD 69.40. IEA maintain their forecast for 2018 global oil demand growth of 1.4mln BPD, say OPEC crude production in June reached a 4-month high of 31.87mln BPD, up 180k BPD (excl. Congo) Gold prices are edging up on the back of trade war concerns, with the yellow metal currently at the USD 1,245/oz level. Copper (+0.8%) and nickel (+3.8%) are also seeing some reprieve and have edged up, with copper moving away from year-long lows. Steel has advanced to near 10-month highs as the Chinese Government intensifies efforts to cut pollution is raising supply concerns

Looking at the day ahead, all eyes on will be on the June CPI report in the US in the afternoon. Also out in the US will be the June monthly budget statement along with the latest weekly initial jobless claims data. In terms of central banks, Minneapolis Fed President Neel Kashkari will speak in a panel discussion on immigration issues and Philadelphia Fed President Patrick Harker will speak at the annual Rocky Mountain economic summit. I’ll be singing John Denver all days after hearing of that summit. Meanwhile, Euro Area finance ministers are also due to meeting in Brussels to discuss the EMU.

US event calendar

• 8:30am: Initial Jobless Claims, est. 225,000, prior 231,000; Continuing Claims, est. 1.73m, prior 1.74m
• 8:30am: US CPI MoM, est. 0.2%, prior 0.2%; US CPI YoY, est. 2.9%, prior 2.8%
  • US CPI Ex Food and Energy MoM, est. 0.2%, prior 0.2%; US CPI Ex Food and Energy YoY, est. 2.3%, prior 2.2%
• 9:45am: Bloomberg Consumer Comfort, prior 57.6
• 2pm: Monthly Budget Statement, est. $80.0b deficit, prior $146.8b deficit

DB's Jim Reid concludes the overnight wrap

One of the main reasons we’re moving from our wonderful home is that it’s on a busy road and I decided that for our forever family home it was time for a little more peace and quiet. However, between 7-10pm last night we had all the windows open and I’ve never known the road so quiet as everyone in the country was at home watching telly. If England could be in a perpetual World Cup semifinal there would be no need to ever move. In fact, if I could have got potential buyers to only do a viewing during England games this World Cup, I could have got an extra 50% on the price. Sadly the road will be busy again on Sunday afternoon as England after being on top in the first half and 1-0 up, slowly got outplayed by Croatia. So it’s a France vs Croatia final and to rub in the hurt from last night’s loss I’ll be watching it in France where I leave for holiday tomorrow. I will make sure I barricade myself inside on Sunday afternoon. You may see me on telly next Wednesday though as the Tour de France is going past the place we stay at very close to the mountain finish in La Rosiere. We are planning to put big banners out for the cameras so keep an eye out for the church 8km from the finish as the whole family will be cheering them on up a steep uphill climb. See you in a couple of weeks. Craig and Jeff will be manning the fort until then.

A bit like England’s defense at times last night, risk assets spent most of yesterday waving the white flag following a step-up in the trade war rhetoric on Tuesday night. Indeed equities, metals, and EM FX were the markets which bore the brunt of the latest developments with Brent Oil (-6.92%) also seeing the worst day since February 2016, more on Libyan supply increases (see below). In Europe the Stoxx 600 (-1.26%) snapped a run of six consecutive daily gains in style with all sectors ending lower, although metals & mining (-3.64%) and energy (-2.36%) names were particularly hard hit, while the DAX (-1.53%), FTSE MIB (-1.58%) and CAC (-1.48%) were also sharply lower. Last night the S&P 500 (-0.71%) and Dow (-0.88%) also closed in the red albeit not to the extent of those markets in Europe.

Measures of vol also crept higher although to be fair it wasn’t that aggressive with the VIX finishing less than a point higher at 13.63 and the VSTOXX 1.6pts higher at 14.60. It’s worth noting that both measures have been hovering down closer to the lows for the year recently and indeed the VIX is still 3pts or so below its YTD average and the VSTOXX 1.5pts below. So these aren’t particularly stressful times for vol in equities right now.

This morning in Asia, markets are surprisingly rebounding across the board with the Shanghai Comp. (+1.90%), Nikkei (+1.30%) and Hang Seng (+0.71%) all higher. Meanwhile, futures on the S&P are c0.4% higher, Brent is up c1.5% while the Yuan is paring back bigger losses to be -0.1% lower as we type.

Back to yesterday in commodities, LME Lead, Copper, Zinc, and Aluminium finished -4.89%, -2.96%, -2.55% and -1.44% respectively. The fall for Copper was the biggest since late 2017. Oil was also caught up in the selloff which didn’t help performance for stocks with WTI and Brent falling -5.03% and -6.92% respectively, although it appears that Libya’s National Oil corporation lifting oil export restrictions and boosting the global oil production by c800k barrels per day was a key factor. Finally, the big movers in EM FX included the Brazilian Real (-1.61%), Russian Ruble (-1.02%) and Mexican Peso (-0.81%). The Turkish Lira (-3.59%) was the biggest faller though, with a Bloomberg headline quoting President Erdogan as saying that interest rates are to go down in the upcoming period, which heavily weighed on the currency.

By contrast credit and bond markets were a lot more muted. CDX IG, for example, was just 1.2bps wider while iTraxx Main and Crossover ended 1.3bps and 4.7bps wider respectively. Treasuries actually ended the day unchanged at 2.85% after trading in a smallish 3bp range while yields in core Europe were flat to half a basis lower at best.

Back to the trade spat, there was a fairly constant stream of unsurprising reactions out of China yesterday although it’s worth noting that there is still no official retaliation just yet. A WSJ story did attract some attention in the market though. The story suggested that China was now considering delaying merger approvals involving US companies along with holding up licenses for US firms and increasing inspections of US products at borders. However, the story also suggested that behind the scenes, officials were more cautious and “weighing how far to press the retaliation without hurting other national interests”. Meanwhile, Bloomberg noted China’s Vice Minister of Commerce Wang Shouwen has called on his US counterparts to resolve conflict through more bilateral negotiations.

Yesterday our China Chief Economist Zhiwei Zhang published a Q&A on the latest developments. Zhiwei believes that if fully implemented, the impact of the tariffs on the real economy would be 0.3% of GDP, which will likely show up mostly in 2019. Zhiwei writes that the list of $200bn of products will go through the same consultation process the $50bn list went through. The US administration’s timeline is (1) receive comments by Aug 17, (2) hold a public hearing on Aug 20, and (3) receive post-hearing comments by Aug 30. Therefore he expects the earliest time some of the products on this list are subject to the 10% tariff would be in early September. That said Zhiwei expects half or more of the products of the list will be challenged in this consultation process. In the previous round of consultation, 16bn out of the 50bn Chinese exports were removed from the list and replaced by other products. Consequently, the 16bn new products are still in their consultation process and yet to turn effective. The 200bn list announced will likely be more challenged as it is much more extensive and touches many final products, including consumer goods such as refrigerators and air conditioners. You can find more in Zhiwei’s note here.

In Europe, Reuters cited unnamed officials who noted ECB policymakers are divided on when the ECB will raise rates next year, in part given the different interpretation of the ECB’s guidance that rates will stay on hold “through the summer of 2019”. Some officials say an increase is possible as early as July 2019 while others do not see a hike until summer is officially over, which suggests a hike at the October 24 meeting as the earliest. Elsewhere the ECB’s Villeroy noted that rate hikes “could come at the earliest through the summer of 2019, depending on the inflation outlook” and added that the ECB is now “implementing its strategy of gradual and predictable normalization”. Overall these comments today are largely meaningless as a lot can happen before next summer but there does seem to have been some pushback to Draghi’s dovishness from others at the ECB of late.

Staying in Europe and onto the NATO meetings where there were some focus on how much NATO members should put into their military budget. The Bulgarian President Radev told reporters that “President Trump, raised the question (of) not just to reach 2% (of GDP by member countries on defense spending)…but set a new target - 4%”. According to Bloomberg, NATO Secretary General Stoltenberg indicated that “I’ll focus on what we’ve agreed…(which is) that we are committed to the pledge (of) increasing defense spending to 2%”.

Over in the US, the Fed’s Evans told WSJ that he is comfortable with one or two more rate hikes this year, in part as the “economy seems so strong it seems natural that businesses and consumers can live with slightly higher borrowing costs”. Elsewhere, the Fed’s Williams noted that the common culprit in past financial crisis tends to be higher leverage, but currently “we’re not seeing the kind of buildup in leverage…that was pretty obvious in the mid-2000’s”.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the headline June PPI rose 0.3ppt mom to a c6.5 year high (3.4% yoy), mainly due to gains in the costs of services and motor vehicles. The core PPI (ex-food & energy) was also above market at 0.3% mom (vs. 0.2% expected) and 2.8% yoy (vs. 2.6% expected) - which was the fastest pace since September 2011. Meanwhile, the healthcare services component, used in the construction of the core PCE deflator, fell 0.1% mom – a second consecutive decline – so that annual inflation in this component declined 0.3ppt to 1.7% yoy. Elsewhere the final reading for the May wholesale inventories was revised 0.1ppt higher to 0.6%.

Looking at the day ahead, all eyes on will be on the June CPI report in the US in the afternoon (DB & consensus expect 2.3% yoy for core CPI). Away from that, the final June CPI prints for Germany and France are due in the morning. Following those, we get May IP in the Eurozone. Also out in the US will be the June monthly budget statement along with the latest weekly initial jobless claims data. In terms of central banks, Minneapolis Fed President Neel Kashkari will speak in a panel discussion on immigration issues and Philadelphia Fed President Patrick Harker will speak at the annual Rocky Mountain economic summit. I’ll be singing John Denver all days after hearing of that summit. Meanwhile, Euro Area finance ministers are also due to meeting in Brussels to discuss the EMU.