The US divergence in growth, monetary policy and in trade drives markets today. This isn’t that different than yesterday or the summer overall, but the isolationism of US policy on trade is seen as the key driver for pain abroad and indifference at home. The sharp bounce in US Manufacturing ISM to 14-year highs highlights this point.  Isolationism isn’t new to the US but many see that as ancient history and beg for a return to the old world order. The relentless moves in EM and rise in the USD reflect the capital flows to the US and leave many investors nervous waiting for a mean reversion trade in US assets. The focus today is on Canada with the Bank of Canada expected to stay at 1.5% while the US/Canada trade talk continue and the US/Canada trade statistics are both released. While everyone but Trump and Trudeau want a deal fast, the risk of failure remains. The Mexico agreement brought relief last week but that didn’t last long. The view of US isolation working for more than a few months requires Canada and Mexico deals.

The USD also reflects the doubts abroad with Europe shifting from Italy to Greece again today. While a rally in Italy is usually a sign for relief in Europe it’s not working today – Deputy PM Salvini said the budget deficit would be around 2% with the flat tax plans postponed for now but a reduction in pension age and basic income plans instead. Early  ECB Benoit Coeure warned that Greek banks' capital is lower than elsewhere in Europe, consisting partly of deferred tax assets, and there is still a large amount of non-performing exposures (NPE) as a legacy of the crisis. The ability to extend and pretend on debt both in Italy and Greece requires growth and that is the crux of the issue today as the Service PMI reports were weaker in China, weaker in Italy and not good enough to drive up hopes for rate normalization to match the FOMC. Even good growth as shown from the Australian GDP today isn’t sufficient to counter trade worries going forward.  Markets are fickle and right now, they are obsessed with isolationism working making the USD bid hold, while risk moods focus on the new EM punching bag of ZAR after yesterday’s weaker GDP confirms its recession. 

Question for the Day:Does the USD matter to the US economy? Since the US is mostly a closed economy with just 13% or so of the business exposed to trade, most economists would downplay the role of the USD in the short term as a key driver for economic outlooks. However, the stronger USD has been blamed in 2016 for some of the slower recovery and growth and, of late, Trump tweets hightlight the point about higher rates and stronger USD being a headwind to his goals of a 4% GDP. The correlation of the stronger USD to the higher S&P500 has been one of the key topics for regime shift thinking about the US economy and just how exposed the US equity market is to global pains. The disconnect between the USD and manufacturing is another notable part of the picture as US trade competitiveness has been traditionally part of the story. One way the US Fed responds to the USD is by watching financial conditions and there effect on business confidence and growth.  So far this break in tighter conditions and higher ISM holds.

What Happened?

• Australia 2Q GDP 0.9% q/q, 3.4% y/y after 1Q 1.1% q/q, 3.1% y/y – better than 0.7% q/q, 2.8% y/y expected. 1Q revised from 1.0% q/q along with other quarters. Household consumption rose 0.7% q/q, accelerating from a revised 0.5% rise (from 0.3%) in Q1 – ABS noted this accounts for over half of the 2Q growth or 0.4 pp q/q. The household savings ratio fell to 1.0% in Q2 from a downwardly revised 1.6% in Q2, and was the lowest since the December 2007. Government spending rose 1% in 2Q reflecting ongoing infrastructure work, adding 0.2pp q/q. Gross fixed capital formation was flat in Q2, with both private and public investment flat. Private dwelling construction contributed 0.1pp to Q2 GP, a slowing from 0.2pp contribution in Q1. Inventories made no contribution to GDP, and net export added 0.1 point. 
• Australia August AIG Service PMI 52.2 from 53.6 – weaker than 53.3 expected. Input prices rose 5.6 to 65.6 while selling prices fell 1 to 49.6. Wages fell 3.8 to 59 while new orders fell 1.3 to 52. Four of the five activity sub-indexes were in expansion and six of the nine sub-sectors expanded in trend terms. The rise in retail trade from 54 to 57 – best since June 2016 – stands out.  Health and education rose to 63 adding to 7 months of expansion while finance and insurance moderated. 
• Japan August Service PMI 51.5 from 51.3 – as expected – best in 4-months. The Composite Index rose to 52 from 51.8 – signaling a broad based pick-up in the economy.  New business growth accelerated to best in 9-months, along with employment at 14-month highs. Outlook for services improved back to May levels though was lower in manufacturing. 

• China August Caixin Service PMI 51.5 from 52.8 – weaker than 52.7 expected – slowest since Oct 2017. The Composite PMI fell to 52 from 52.3 – 5-month lows – as expected. Employment rose in Services and fell in Manufacturing. New orders were the slowest in 26-months. Input costs rose with manufacturing reflecting raw material prices while services saw higher operating costs citing fuel and staffing. Prices charged also rose for the 15th month. Overall business outlook rose from July lows but is still weak – with services below the long-run average and manufacturing at 6-month lows. 
• Sweden August industrial production -1.7% m/m, 7.3% y/y after -1.1% m/m, 5.2% y/y – weaker than -0.4% m/m expected.  June revised from -0.9% m/m, 5.3% y/y. The 3M average rose 0.8% q/q. Among the industry sub-sectors, the largest increase compared with the previous month was found in the electronics industry, while the largest decrease was in the industry for fabricated metal products.
• German July VDMA machine orders up 3% y/y with domestic up 9% y/y and foreign up 1% y/y. The 3M average now 5% y/y with domestic up 7% and foreign up 4%. Eurozone orders rose 1% and non-EU up 5%. "The large-scale plant business, which went well in the previous year, played a role here. In addition, we must not forget the uncertainties that mechanical engineering customers, particularly from third countries outside the eurozone, have experienced in recent months," said VDMA Economist Wiechers. "In view of all this, the mechanical engineering industry can be satisfied with the July result."
• Eurozone July retail sales -0.2% m/m, 1.1% y/y after +0.3% m/m, 1.2% y/y – weaker than 1.3% y/y expected. The July sales are up 0.1% q/q after 2Q 0.6%. The drop was due to a 0.7% decline in auto fuel, 0.6% drop in food and drink while non-food products rose 0.4%. Biggest drop in retail trade volume was in Belgium -2.1%, Portugal -1% and Sweden -1% while best was Slovakia up 1.1% and Estonia up 1.1%.

Eurozone August final Service PMI 54.4 from 54.3 – same as flash– puts Composite PMI 54.5 from 54.2 – slightly better than 54.4 flash. "The Eurozone PMI shows the recent run of robust growth of business activity, new orders and employment extending into August," said Chri Williamson, Chief Business Economist at IHS Markit. He noted that this implies 0.4% GDP for 3Q matching 2Q at least. The uneven growth was also noted with Germany and France still in solid expansion but Italy at 2-year lows and Spain 3Q implying the worst growth in 5-years.  

• Spanish Service PMI 52.7 from 52.6 – better than 52.1 expected.Optimism at 5-year lows. 
• Italy Service PMI 52.6 from 54 – weaker than 53.1 expected.Optimism worst  in over 5-years. 
• French final Service PMI 55.4 from 54.9 – weaker than 55.7 flash- puts Composite at 54.9 from 54.4 – weaker than 55.1 flash. Confidence weakest in 19-months.
• German final Service PMI 55 from 54.1 – weaker than 55.2 flash– puts Composite 55.6 from 55 – weaker than 55.7 flash – but at 6-month highs. Optimism rose from July but remains below April highs. 

• UK August Service PMI 54.3 from 53.5 – better than 53.8 expected. The bounce was led by new work and better employment at 6-month highs. However, confidence fell to 12-month lows with Brexit uncertainty cited. Higher wages led to input price rises but output prices were limited. IHS noted that the report implies 0.4% q/q growth for 3Q. Optimism drops back to March lows. 

Market Recap:

Equities: The US S&P500 futures are off 0.24% after losing 0.17% yesterday. The Stoxx Europe 600 is off 0.65% with focus on EM pain and Asia declines from the start – the index is now back to April lows. The MSCI Asia Pacific fell 1.4% - worst decline in 3-weeks. The MSCI EM index is off 1.5% - worst decline in 3-weeks with Indonesia the hardest hit off 4%.. 

• Japan Nikkei off 0.51% to22,580.83
• Korea Kospi off 1.03% to 2,291.77
• Hong Kong Hang Seng off 2.61% to 27,243.85
• China Shanghai Composite off 1.68% to 2,704.34
• Australia ASX off 0.93% to 6,339.20
• India NSE50 off 0.38% to 11,476.95
• UK FTSE so far off 0.45% to 7,423
• German DAX so far off 0.55% to 12,140
• French CAC40 so far off 0.95% to 5,291
• Italian FTSE so far up 1.1% to 20,835

Fixed Income: Risk-off in equities should bring buyers of bonds globally, but not today. US Treasuries follow the rules with a bull steepening trade into heavy data and Fed speakers today. However, Europe reflects other stories. The better UK PMI is one, with UK 10-year Gilt yields up 1bps to 1.435%. The sharp bounce back in Italy puts pressure on spreads so the core EU bonds suffer – German Bunds up 1.5pbs to 0.37% and French OATs up 2bps to 0.707%. Italy leads with BTPs off 13bps to 2.875%, Spain up 1.2bps to 1.435%, Portugal up 0.5bp to 1.85% and Greece up 8.5bps to 4.575%. 

• Greece sold E812.5mn of 3M Dec 2018 bills at 0.65% with 1.66 cover. 
• US Bonds are bid with bull steepening play into data– 2Y off 0.4bps to 2.649%, 5Y off 0.8bps to 2.763%, 10y off 0.5bps to 2.893%, 30Y flat at 3.062%. 
• Japan JGB focus is on Typhoon in Osaka, solid 10Y sale– 2Y off 3bps to -0.127%, 5Y off 0.7bps to -0.082%, 10y off 0.5ps to 0.104% and 30Y off 1.3bps to 0.837%. MOF sold Y1.7822trn of 10Y at 0.113% with 4.548 cover – previously 0.138% with 4.174 cover.
• Australian bonds sold on stronger GDP– 3Y up 2bps to 1.998%, 10Y up 2.5bps to 2.547%.
• China PBOC skips open market operations for 11thday, leaves liquidity neutral. Money market rates fell with O/N off 2bps to 2.149% and 7-day repo off 12bps to 2.396%. 10Y bond yields were flat at 3.62%. 

Foreign Exchange: The US dollar index is flat at 95.45 with 95.10 and 96 the goal posts and range today 95.28-95.66.  In EM FX USD still bid – EMEA: ZAR off 1.2% to 15.526, TRY flat at 6.665, RUB off 0.15% to 68.28; ASIA: TWD off 0.15% to 30.81, KRW off 0.55% to 1121, INR off 0.25% to 71.76. 

• EUR: 1.1585 flat. Range 1.1543-1.1608 with focus on Italy, EM and US rates. Data ahead matters along with trade talks. 
• JPY: 111.60 up 0.15%.Range 111.37-111.71 with EUR/JPY 129.30 up 0.2% - all about rates and Typoon hit with 112 key. 
• GBP: 1.2825 off 0.25%.Range 1.2786-1.2870 with EUR/GBP .9035 up 0.25% - all about Brexit and EU hardball. 
• AUD: .7175 off 0.05%.Range .7218-.7145 with GDP up but not enough, technical selling from .7220 holding. NZD up 0.1% to .6560 with .6530 key. 
• CAD: 1,3175 off 0.1%.Range 1.3164-1.3206 with focus on BOC and NAFTA talks – risk is 1.2880 on a deal or 1.3350 on dovish BOC. 
• CHF: .9740 flat. Range .9729-.9754 with EUR/CHF1.1285 flat – watching Italy and EM balance with .96-.98 consoldiation. 
• CNY: 6.8266 fixed 0.12% weaker from 6.8183, trades weaker to 6.8385 into London from 6.8290 closing yesterday, now up 0.2% to 6.8320 with range 6.8271-6.8470. 

Commodities: Oil lower, Gold higher, Copper up 0.8% to $2.6590

• Oil: $69.15 off 1.1%.Range $68.67-$69.57. Weather watch calmed as Gordon became a tropical storm, reversing some of the buying – pushes focus to inventories with API/EIA next. WTI watching $68 pivot against $71.63 May 22 highs. Brent $77.53 off 0.85% - watching $75-$80 consolidation now. 
• Gold: $1194.10 up 0.2%.Range $1193-$1196. Watching $1183.4 Aug 24 against $1198 20-day with USD driving. Silver $14.14 flat, Platinum off 0.65% to $773.40 and Palladium up 0.4% to $984.30. 

Conclusions: Are US politics going to drive markets into November? The flash-back to 2006 as a guide for the mid-term elections is in play. An important read on that subject comes from the WSJ today.  While Bush lost his Republican majority to the Democrats in Congress then, some have doubts that Trump loses it so easily now. He is the wild card in the election ahead with the economy better, his supporters motivated and Democrats leaning further to the left than to the center where many voters seem to want. There is a risk that the democrats win the popular vote but fail to win control of Congress. 

The uncertainty over the US election is going to be a headwind to the USD and to US growth but just how much remains unclear.

Economic Calendar:

• 0800 am Polish Central Bank rate decision – no change from 1.5% expected
• 0830 am US July trade deficits $46.3bn p $50bn e
• 0830 am Canada July trade deficit C$0.63bn p C$1.3bn e
• 0830 am Canada 2Q productivity -0.3%p +0.2%p
• 1000 am Bank of Canada (BOC) rate decisions and statement – no change from 1.5% expected.
• 0300 pm US NY Fed Williams speech
• 0400 pm US Minn Fed Kashkari speech
• 0430 pm US weekly API crude oil stocks 0.038mb p -1.6mb e
• 0630 pm US Atlanta Fed Bostic speech