Markets Jittery, China Soothes

  • Risk-off sentiment was pushed back a bit during the Asian session after China’s top finance officials worked to calm markets
  • China reported Q3 GDP and September retail sales and IP overnight
  • The European Commission said Italy’s draft budget was excessive and requested further explanation; Italian yields are still rising
  • Japan reported September national CPI
  • Canada reports September CPI and August retail sales
  • Chile central bank started the tightening cycle with a 25 bp hike last night

The dollar is mostly weaker against the majors even as China comments injected some calm into the markets.  Kiwi and Nokkie are outperforming, while yen and Swissie are underperforming.  EM currencies are mostly firmer.  PHP and ZAR are outperforming, while TRY and THB are underperforming.  MSCI Asia Pacific was down 0.2%, with the Nikkei falling 0.6%.  MSCI EM is flat so far today, with the Shanghai Composite rising 2.6%.  Euro Stoxx 600 is down 0.7% near midday, while US futures are pointing to a higher open.  The US 10-year yield is flat at 3.18%.  Commodity prices are mostly higher, with Brent oil up 0.7%, copper up 0.2%, and gold up 0.2%.

US stocks took another leg lower and this carried over into Asian markets before China came to the rescue.  Note that the S&P 500 recouped less than 50% of its October swoon but then turned lower to give up about half of its mid-October gains.  Break of the 2751 area is needed to set up a test of the October 11 low near 2711.  US stock futures are pointing to a modestly higher open but other equity markets remain largely in the red today.

Risk-off sentiment was pushed back a bit during the Asian session after China’s top finance officials worked to calm markets.  Coordinated statements from the central bank, securities watchdog, and regulators helped Chinese equities rally.  PBOC Governor Yi Gang said that the bank is studying measure to ease financing difficulties for Chinese firms and pledged to support credit expansion by banks.  Other statements noted healthy stock valuations and strong economic fundamentals.

For now, the jawboning has injected an element of calm, but markets remain nervous and will be looking for concrete action in the coming days.  We are concerned that China policymakers are juggling too many balls.  Efforts to support growth should not be surprising, but we always get nervous when officials can so quickly drop efforts at deleveraging as a result.  Now they seem to be targeting equity markets.  Sure, an equity market drop adds to financial stability risks but having a “Yi Put” for Chinese stocks seems risky.

China also reported Q3 GDP and September retail sales and IP overnight.  GDP grew 6.5% y/y vs. 6.6% expected, while IP rose 5.8% y/y vs. 6.0% expected.  On the other hand, retail sales rose 9.2% y/y vs. 9.0% expected.  The numbers themselves aren’t that important, however.  What’s more telling is that Chinese policymakers are stepping up stimulus and market support, which tells us that growth is slowing more than desired.

The European Commission said Italy’s draft budget was excessive and requested further explanation.  The EC wrote a letter to the Italian government requesting changes to its draft budget plan by October 22.  Commissioners Valdis Dombrovskis and Pierre Moscovici wrote that “We are writing to consult you on the reasons why Italy plans an obvious significant deviation of the recommendations adopted by the Council under the Stability and Growth Pact.”  They added that the “the size of the deviation are unprecedented.”

Italian bond yields are moving higher again.  The 10-year yield is the highest since February 2014 and the spread to Germany rose to a cycle high of 333 bp today.  The spread is approaching the March 2013 high of 347 bp and then the late 2012 highs of 362-364 bp.  Salvini dared the markets to take this spread to 400 bp and the market is obliging him.  This is clearly negative for the euro and the single currency tested last week’s low near $1.1430.  A break would set up a test of the mid-August low near $1.13.

Mario Draghi spoke on the sidelines of the EU summit in Brussels yesterday.  He said that while the eurozone growth outlook is positive, Draghi warned that the horizon has turned a bit darker recently and cited rising trade tensions as a big factor.  The ECB meets next Thursday, and we would expect a similar cautious tone then.

Sterling feels heavy due to what appears to be deadlocked Brexit negotiations.  Still, both sides seem to be zeroing in on an extended grace period as the way to break the logjam.  While it is a “can kick” of the highest order, we believe markets would take this positively.  But this is a very big question mark, as hardline Brexiteers in May’s own Tory party have come out against extending the Brexit process.  Cable is managing to hold above $1.30 for now but a break below would set up a test of the October 4 low near $1.2920.

Japan reported September national CPI.  Headline rose 1.2% y/y vs. 1.3% expected, while ex-fresh food rose 1.0% y/y, as expected.  Low inflation remains a disappointment for policymakers and underscores the likelihood that the BOJ will maintain its easy policy for as far as the eye can see.  Next policy meeting is October 31, no change is expected then.

USD/JPY has gotten whipsawed this week.  The pair has held above 112 for the last several days.  Break of Monday’s low near 111.65 would signal a deeper correction down towards the September 7 low near 110.40.  On the other hand, a break above the 113 area would signal potential for a move back to the October 4 high near 114.55.

During the North American session, the US reports September existing home sales.  Fed’s Bostic and Kaplan speak today, while Bostic speaks Saturday too.

Canada reports September CPI and August retail sales.  Headline inflation is expected to ease a tick to 2.7% y/y, while core inflation is seen remaining steady at 2.0% y/y.  Headline sales are expected to rise 0.3% m/m, while ex-auto sales are expected to rise 0.1%.

Bank of Canada meets next Wednesday and is widely expected to hike rates 25 bp to 1.75%.  However, the Loonie has gotten caught up in the greenback rally, with USD/CAD trading at the highest level since September 11 near 1.3090.  The pair is on track to test the September 6 high near 1.3225.

Chile central bank started the tightening cycle with a 25 bp hike last night.  The market was evenly split between no hike and a 25 bp hike to 2.75%.  The economy is gaining strength even as inflation picks up.  At 3.1% y/y in September, it is above the 3% target and so the bank felt comfortable starting the tightening cycle.  Chile joins many others in EM in hiking rates, and tightening financial conditions will be another headwind for EM growth.  Note that Brazil, Peru, and Colombia are expected to start tightening in Q1.