Global Markets Slide After China Says It's Ready For "Worst Case Scenario" Following Senate Vote In Support Of Hong Kong Protest

Trade deal "optimism", which together with QE4 (which even Bloomberg now admits) has helped push the S&P to all time highs, was decidedly lacking on Wednesday when the global mood soured after the U.S. Senate angered China by passing a bill requiring annual certification of Hong Kong’s autonomy and warning Beijing against violently suppressing protesters.

In response to the unanimous Senate vote, China Foreign Ministry said it strongly condemns the US Senate measure on Hong Kong and resolutely opposes the action, while calling for the US to stop interfering in Hong Kong and China affairs, as well as stop the latest bills on Hong Kong from becoming law. Furthermore, it added China must take necessary measures to safeguard its sovereignty and security, while it summoned the US Embassy representative in China and lodged stern representations with US over the Senate action on Hong Kong.

Then, shortly after 2am, China's notorious twitter troll, Global Times editor Hu Xijin opined, stating that "China wants a deal but is prepared for the worst-case scenario, a prolonged trade war."

President Donald Trump also threatened to up tariffs on Chinese goods if a trade deal is not reached soon.

As a result of the renewed flare-up in Sino-U.S. tensions and the creeping return of U.S. recession fears, world stocks were knocked off 22-month highs with US equity futures sliding as low as 3,105 amid a bid for bonds and other “safe” assets such as gold.

European markets tumbled half a percent at the open, edging further off recent four-year highs hit when it appeared - to some confused, naive souls and algorithms - that Washington and Beijing were about to agree the first phase of a trade deal. Europe's Stoxx 600 Basic Resources Index dropped as much as 2.1%, trading below its 200-DMA, as nickel neared a bear market. Diversified miners fell, with BHP -1.8%, Anglo American -1.4%, Rio Tinto -2%, Glencore -1.4% (these 4 stocks account for ~64% of the index). Steelmakers also fell: ArcelorMittal -2.5%, Evraz -2.2%, Voestalpine -2.3%.

Wall Street futures were also lower amid a sea of red in global stocks, while oil prices suffered their biggest daily loss in seven weeks. MSCI's All World index slipped 0.3%, ending a three-day winning streak.

“Markets have taken a bit of a wobble due to the talk about Hong Kong, but they had rallied a lot in recent weeks on expectations of a (trade) deal,” said Salman Ahmed, chief investment strategist at Lombard Odier.

Ahmed said both sides needed a deal to be signed — Trump cannot afford a recession because of his re-election bid next year, while China’s economy is slowing markedly. “I think we are looking at a short-term setback rather than a major issue that would derail the process. The bill still has to be signed into law by Trump so there’s a high probability he will use it as leverage against China.”

Earlier in the session, MSCI's index of Asia-Pacific shares ex-Japan tumbled 0.7%, Japan's Nikkei .N225 fell 0.8% and Shanghai blue chips lost 1%. Asia stocks fell, as the U.S. Senate passed a legislation supporting Hong Kong protesters, triggering China to repeat its threat to impose unspecified retaliation. Most markets in the region were down, with South Korea among the weakest. Hong Kong’s Hang Seng Index closed 0.8% lower, paring a world-beating rally earlier this week. In contrast, India’s benchmark Sensex headed for another record high, helped by a surge in telecommunications-related stocks. The passage of the U.S. bill on Tuesday may potentially complicate trade talks between the world’s two largest economies.

On Tuesday, US stocks closed just below record highs as world stocks remained just 0.5% off all-time peaks hit last year. “It was noticeable that fixed income markets rallied despite equity markets being stable, suggestive of a market that remains cautious about the growth outlook,” ANZ said in a note.

After falling in six out of the past seven sessions, US Treasury yields dropped again, with 10Y US paper sliding as much as 5bps, from 1.78% to 1.73% amid the flight to safety. In Europe, German Bunds yields fell for the third straight day to touch a 2-1/2 week, shrugging off European Central Bank Chief Economist Philip Lane’s comment that the euro zone economy would not fall into a recession. Bunds bull flattened after Germany’s 30-year bond sale meets steady demand, with bid-to-cover of 1.17x versus 1.20x prior, although the real subscription rate, which accounts for retention by the Bundesbank, increased to 0.91x against 0.76x at the previous sale. In Italy, BTPs outperformed euro-area peers, tightening the BTP-bund spread 2bps to 156bps.

“It’s all about sentiment on trade ... We have this classical risk-off trade taking place again,” Rainer Guntermann, a rates strategist at Commerzbank, said.

In FX, the dollar and yen both rose versus major peers as the Senate vote threatened to complicate a potential U.S.-China trade deal. Australia’s dollar fell with other risk assets, while the euro snapped a four-day advance.

Moves on commodity prices imply fears of economic recession may be creeping back. Japan’s October exports fanned those fears further, tumbling at their quickest rate in three years, with shipments to China and the United States suffering big falls.

US WTI stocks rose far more than expected according to the latest API report, driving Brent crude into a 2.6% slide. Brent fell another half percent, inching towards the $60 mark last breached three weeks ago.

A marked flattening of the 2s10s Treasury curve also hints at a return of recession fears. The curve inverted earlier this year, returning to normal only after three U.S. interest rate cuts. But Federal Reserve officials have hinted there will be no further easing for now, a message the U.S. central bank may reiterate later in the day when it releases minutes from its last meeting. Markets are now pricing in just a 0.8% chance of a December rate cut

Dour forecasts from retailers Home Depot and Kohl’s also fueled worries about U.S. consumer spending, which has so far been extremely robust, in contrast to manufacturing. On the other hand, stellar results from Target have helped offset the downbeat retail sentiment somewhat.

“We’ve had a bit of topping out of the U.S. consumer in the past couple of months, possibly we are seeing some catch up between consumer and manufacturing sectors,” Lombard Odier’s Ahmed said.

In geopolitics, Israel attacked buildings belonging to Iranian militias in southern Damascus where heavy explosions were reported. At the same time, US aircraft carrier strike group Abraham Lincoln transited through the Strait of Hormuz on Tuesday according to US Navy statement, which officials had been considering and suggested would send a strong message to Iran. Elsewhere, Russia's Foreign Ministry said the US decision to remove sanction waivers for the Iranian Fordow nuclear plant violates US international commitments and that Moscow continues to cooperate with Iran on Fordow reconfiguration.

Looking at the day ahead, it’s fairly light on data, with October’s PPI release from Germany and CPI release from Canada, along with the weekly MBA mortgage applications from the US. From central banks, the FOMC’s October minutes and the ECB’s Financial Stability Review will be released, while we’ll hear from the ECB’s Lane and Irish central bank governor Makhlouf. Earnings out today include Lowe’s and Target, and in the US tonight there’s another Democratic primary debate.

Market Snapshot

  • S&P 500 futures down 0.3% to 3,109.25
  • STOXX Europe 600 down 0.6% to 402.94
  • MXAP down 0.6% to 164.79
  • MXAPJ down 0.7% to 527.43
  • Nikkei down 0.6% to 23,148.57
  • Topix down 0.3% to 1,691.11
  • Hang Seng Index down 0.8% to 26,889.61
  • Shanghai Composite down 0.8% to 2,911.05
  • Sensex up 0.6% to 40,690.50
  • Australia S&P/ASX 200 down 1.4% to 6,722.42
  • Kospi down 1.3% to 2,125.32
  • German 10Y yield fell 3.3 bps to -0.372%
  • Euro down 0.1% to $1.1066
  • Brent Futures down 0.4% to $60.68/bbl
  • Italian 10Y yield rose 3.7 bps to 0.899%
  • Spanish 10Y yield fell 3.5 bps to 0.396%
  • Brent Futures down 0.4% to $60.68/bbl
  • Gold spot up 0.3% to $1,476.12
  • U.S. Dollar Index up 0.1% to 97.95

Top Overnight News

  • The U.S. Senate unanimously passed a bill aimed at supporting protesters in Hong Kong and warning China against a violent suppression of the demonstrations -- drawing a rebuke from Beijing
  • The near-deal between the U.S. and China that fell apart six months ago is now being used as the benchmark to decide how much tariffs should be rolled back in the initial phase of a broader trade agreement, people familiar with the talks say
  • Labour Leader Jeremy Corbyn defied his negative ratings to draw level with Prime Minister Boris Johnson in a crucial television debate ahead of the U.K.’s general election. His plan to make the top 5% of earners pay more income tax could raise less than the party thinks, according to the Institute for Fiscal Studies
  • China’s base rate for new corporate bank loans dropped in November, following a series of policy-rate cuts from the central bank aimed at easing liquidity concerns
  • Japan’s export slump deepened in October, with the value of shipments dropping the most in three years, as the U.S.-China trade war weighs on global demand. Japan’s ruling coalition will ask the government to devote 10t yen in fresh spending for the extra budget it’s compiling, Nikkei reports, without attribution
  • Argentine President-elect Alberto Fernandez told International Monetary Fund Managing Director Kristalina Georgieva that he has a plan to grow the economy and tackle the nation’s debt after his predecessor agreed to a $56 billion credit line from the fund
  • Oil dropped the most in seven weeks as American crude stockpiles are forecast to rise and U.S.-China trade talks stall
  • President Donald Trump’s former special envoy to Ukraine said he only realized after the fact that the president and a few close advisers were putting “unacceptable” pressure on Ukraine to launch a politically motivated investigation
  • The European Central Bank warned of potential side effects from its loose monetary policy, highlighting how years of unprecedented economic stimulus is contributing to an erosion of financial stability. Low interest rates have encouraged excessive risk-taking by investment funds and insurers as well as in some real estate markets, the ECB said in its semi-annual Financial Stability Review released Wednesday
  • Traders should brace for heightened volatility in 2020 as the U.S. presidential election becomes one more reason for investors to hedge, according to TD Securities.
  • Helicopter money could be both the best and worst options for the European Central Bank if the euro-area slowdown morphed into a recession, according to a Peterson Institute paper.
  • European Central Bank watchers who monitor its every signal to gauge the future of interest rates would quite like new President Christine Lagarde to give them some clues when she breaks her silence this week.

Asian equity markets traded mostly lower as investor sentiment continued to hang on the US-China trade uncertainty and after the US Senate unanimously passed the legislation aimed at supporting Hong Kong protests, which was met by condemnation from China and spurred concerns of a derailment in trade talks. ASX 200 (-1.4%) and Nikkei 225 (-0.6%) were both negative with Australia pressured by losses in its largest weighted financials sector after Westpac was accused by AUSTRAC of 23mln breaches related to anti-money laundering, while the weakness in Japan was a function of the JPY-risk dynamic, tumultuous trade headlines and disappointing data including a larger than expected contraction in the nation’s Exports. Elsewhere, Hang Seng (-0.8%) and Shanghai Comp. (-0.8%) conformed to the subdued picture following China’s stern response to the US Senate’s passage of the Hong Kong Human Rights Bill, in which it called on the US to stop interfering in its affairs and suggested that it must take necessary measures to safeguard its sovereignty and security. However, losses in the mainland were somewhat limited by optimistic comments from US Commerce Secretary Ross that they still think there's hope a China deal can be done and following the PBoC’s 5bps reduction to its Loan Prime Rates. Finally, 10yr JGBs tracked the gains in T-notes and was spurred by safe-haven demand following China’s retaliation threat, while the 20yr JGB auction was inconclusive as the results showed stronger demand at lower accepted prices.

Top Asian News

  • World’s Largest Wealth Manager Says Add Asian Stocks on Earnings
  • Nissan Plans First Bond Sale Since Scandals After Leader Changes

Concerns regarding the state of US/China trade negotiations are weighing on major European bourses (Euro Stoxx 50 -0.8%) on Wednesday morning, after the US Senate unanimously voted in favour of the Hong Kong Human Rights bill and sent it to the House of Representatives overnight, drawing strong condemnation from China and raising fears that trade talks will be complicated. Downside has extended during European trade, with negative comments from China’s Global Times Editor Hu Xijin only exacerbating things. In terms of the sectors, Energy (-1.6%) is the laggard, as yesterday’s steep decline weighs. Other more risk sensitive sectors including Consumer Discretionary (-1.0%), Tech (-0.5%) and Financials (-1.3%) are also suffering, while defensive sectors are holding up better. Moving on to the most notable stock specific movers; Nexi (+3.1%) tops the Stoxx 600 table, with the news that it is in preliminary talks with Intesa Sanpaolo (-0.4%) regarding a possible commercial partnership supportive. Moreover, positive broker moves for Novozymes (+2.5%) and ADP (+1.5%) from Citigroup and RBC respectively saw their shares move higher. In terms of the laggards; Kingfisher (-6.7%) sunk after downbeat earnings, in which the Co. noted there is clearly much to be done to improve performance and that they had not found the correct balance between group scale benefits and local market. Sage Group (-3.6%) is lower after underlying operating profit and EPS fell, although the Co. did increase its FY dividend. Swedbank (-3.8%) shares are lower, with US authorities investigating the Co’s Baltic unit to determine if transactions violated US sanctions on Russia; the Co.’s CEO said he was not aware of any violations and internal investigations to be concluded early next year. Elsewhere amongst the laggards are Wirecard (-2.8%); auditors at EY have reportedly refused to approve Co’s 2017 Singapore accounts, reported Handelsblatt citing documents.

Top European News

  • ECB Flags Risks to Financial Stability From Its Own Stimulus
  • Emirates Trims Boeing Wide-Body Plan as It Curbs Global Ambition
  • Corbyn Holds Johnson to Debate Draw: U.K. Campaign Trail

In FX, the broad Dollar and Index gains traction in early European trade amid underlying safe-haven support given the bleaker rhetoric out of China regarding an imminent Phase One deal and potential complications from the US Hong Kong bill. On trade, Global Time’s Chief Editor highlighted China’s readiness for a prolonged trade spat, aiding the DXY to test 98.00 to the upside (vs. an overnight low of ~97.80) shortly after the cash open and eclipse its 100 DMA (98.02) before stabilising below the round figure. Meanwhile, China condemned the US bill supporting Hong Kong protesters which was unanimously passed in Senate and makes way to the House for a re-vote, with some wondering whether this could be another wedge in trade talks despite the official previously highlighting the issues are separate. USD/CNH sees renewed upside in early hours (after little move on the expected PBoC LPR cut) with the pair now above its 21 and 100 DMAs (7.0288 and 7.0411) and at the top of its current 7.0250-0430 intraday range.

  • AUD, NZD, CAD - All moving in-line with the current trade-induced risk aversion. The non-US Dollars are all pressured in wake of the aforementioned pilling of bearish-sentiment factors which dwindle the prospect of a long-lasting truce between the two nations. AUD/USD reversed a bulk of yesterday’s gains and retested 0.6800 to the downside at one point, currently residing just off the lower bound of today’s 0.6800-30 parameter. Similarly, its Kiwi counterpart fell below its 100 DMA (0.6432) in overnight trade following China’s condemnation of US Senate’s action and tested support at 0.6400 (vs. high of 0.6435). The Loonie meanwhile bears the brunt of softer energy prices but looks forwards to the Canadian CPI metrics with the headline YY remaining steady at 1.9%. USD/CAD took out its 200 DMA (1.3275) in early EU hours as it takes a stab at 1.3300 to the upside.
  • JPY, CHF - Supported by their safe-haven statuses as the trade landscape shifts away from the recent hopefulness. USD/JPY meanders a touch below the 108.50 mark ahead of a Fib level and its 50 DMA both at 108.26 whilst notable option expiries include USD 1bln at strikes 108.50-65. Correspondingly, the Franc sees modest gains with EUR/CHF back under its 100 DMA and 21 DMAs both at 1.0960.
  • GBP, EUR - Both modestly softer and largely at the whim of a firming Buck. Last night’s UK leadership debate provided little by way of new substance, whilst a YouGov snap poll on performance (1600 respondents) showed the leaders more-or-less neck and neck, and the election survey from the same pollster indicated a slight narrowing in Tory’s lead over Labour. GBP/USD hovers around a 38.2.% Fib level just above 1.2900 having dipped below the figure earlier on a firmer Buck. EUR/USD losses more ground below its 100 DMA (1.1089) but found a base at 1.1060 ahead of its 21 DMA at 1.1042.

In commodities, crude futures are relatively flat following a mammoth sell-off in the prior session where anti-production cut commentary out of Russia and bearish supply updates in Europe saw the complex sell off. There was little by way of reactions to last night’s mixed API Inventory data; headline crude stocks built much more than expected but gasoline and distillates posted larger than expected draws, and front month WTI and Brent contracts stabilised around the USD 55.20/bbl and USD 60.80/bbl levels overnight, although both have since crept slightly lower since the arrival of European players. Subdued risk appetite has lent a hand to gold, which advanced to near the USD 1480/oz mark before pulling back slightly, with upside being capped by a firmer buck. Meanwhile, copper was caught between the conflicting forces of the PBoC’s latest LPR cuts and negative developments on the US/China trade front overnight, but has since seen some upside since the arrival of European players, making new highs for the week at USD 2.666/lbs.

US Event Calendar

  • 7am: MBA Mortgage Applications, prior 9.6%
  • 2pm: FOMC Meeting Minutes

DB's Jim Reid concludes the overnight wrap

If you’re looking to top up the performance of your fund before year end you could do worse than to visit Blackhall Colliery, County Durham, North England. This week has seen the twelfth time in five years that a bundle of notes totalling exactly £2000 pounds has been found in a bag on a street and handed into Police. If twelve bags have been handed in, how many have actually been “absorbed” into the local economy. I would wager many many more. Police are totally confused by these “drops” and made this info public late yesterday. Maybe we’ll get the 21st century version of The Gold Rush on our hands today.

There wasn’t quite the same rush in markets yesterday as Equity markets traded in the red for most of the day after some poor US retail earnings, before more positive trade headlines spurred risk assets back towards flat into the close. The S&P 500 had been down as much as -0.27% but it ended -0.06%. The DOW lost -0.36%, with most of that attributable to Home Depot’s -5.44% move after they said that comparable sales in Q3 rose +3.6% (vs. +4.6% expected), and downgraded their comparable sales growth guidance to 3.5%, having been 4.0% previously. Kohl’s (-19.49%) also reported soft demand, lowering their guidance for adjusted annual earnings per diluted share to $4.75-$4.95, down from $5.15-$5.45 previously. Investor attention will now turn to Lowe’s (-1.41%) and Target (-0.96%), both of whom are releasing results today.

Offsetting the poor earnings reports were some optimistic trade headlines, with Bloomberg reporting that the US-China deal that fell through in May is now the benchmark in terms of the amount of tariffs to be rolled back in an initial agreement between the two sides. The reports suggest that China is asking that all tariffs applied since May be immediately removed, then earlier tariffs removed in tranches moving forward. If realised, this would be a notably more risk-positive outcome than most had expected. However, the article also noted apparent differences among US officials as to how comprehensive the phase one deal would be and how much tariffs would be rolled back. So if this is right it doesn’t look as though there’s an agreed viewpoint within the US administration. So hard to get too excited one way or other by the story.

Staying with trade, in a move that could well have significance for upcoming discussions, the US Senate unanimously passed the Hong Kong Human Rights and Democracy Act that would require the US State Department to assess each year whether Hong Kong has sufficiently “autonomous decision-making” to justify retaining its different tariff treatment compared to China. Last month the House of Representatives passed a modestly different version, so the two will now be reconciled in committee. President Trump has been silent on the bill. Both the Chinese and Hong Kong governments expressed disappointment over the legislation. Chinese Foreign Ministry spokesman Geng Shuang urged the US to take immediate measures to prevent the bill from becoming law, although it appears to have sufficient support to over-ride a Presidential veto.

Staying with trade themes, Bloomberg reported overnight that China’s antitrust regulator is closely monitoring US chipmaker Diodes Inc.’s proposed $428mn takeover of Taiwan’s Lite-On Semiconductor Corp, responding to complaints that a deal will deliver the Taiwanese company’s Shanghai-based affiliate On-Bright Electronics Inc. into US hands. Lite-On Semiconductor shares fell by their daily limit of 10% overnight.

Overnight Asian markets are trading lower as the passage of the Hong Kong bill casts a shadow over the US-China trade deal. The Nikkei (-0.66%), Hang Seng (-0.67%), Shanghai Comp (-0.39%) and Kospi (-1.15%) are all lower. Elsewhere, futures on the S&P 500 are -0.14% lower and yields on 10y USTs are down -3.5bps this morning. As for overnight data releases, Japan’s October adjusted trade balance came in at JPY -34.7bn (vs. JPY 248.1bn expected) as declines in exports (-9.2% yoy vs. -7.5% yoy expected) outpaced small declines in imports (-14.8% yoy vs. -15.2 yoy expected).

The main highlight today will be the FOMC minutes, which will likely signal that policy is on hold for now, barring a material reassessment in the outlook, per Chair Powell’s recent rhetoric. It’ll be interesting to see if the minutes shed any light on what exactly would qualify as a “material reassessment,” as well as details on how deep the internal disagreement over the rate cut was. Also any updates on the policy review, and any new thoughts on dealing with funding market disruptions will be looked for. Staying with the Fed, the New York Fed’s Williams spoke yesterday, and maintained his existing rhetoric, saying that “the current stance of monetary policy seems appropriate” for the economy’s current position. He also noted that the current system of ad hoc repo operations is a temporary solution to problems in funding markets, the need for which will hopefully be obviated by the Fed’s balance sheet expansion currently underway.

Turning to sovereign bonds, peripheral spreads widened yesterday, with Italian debt leading the sell-off. 10yr BTP yields were up +3.8bps, while Spanish (+1.4bps) and Portuguese (+2.3bps) yields also rose. Sovereign debt elsewhere advanced however, with 10yr Bunds -0.5bps and Treasuries -3.4bps to 1.781%. The 2s10s curve flattened for a 5th consecutive session, taking it -8.8bps lower over the last week (-3.3bps yesterday). Meanwhile in commodities, oil fell for a second successive day, with both WTI (-3.24%) and Brent Crude (-2.51%) losing ground, as expectations are for official data to show a large inventory build later today.

Here in the UK, with just over 3 weeks now until the general election, last night’s TV leader’s debate is unlikely to change anyone’s view of either candidate measurably. A YouGov poll people canvassed immediately after the event showed that Johnson edged it by a wafer thin 51%/49%. On balance given how far Corbyn’s personal ratings are below Johnson’s and how far Labour are behind in the polls, then such a split could be seen a small victory for the opposition. Sterling is trading down -0.13% this morning.

Indeed a poll out yesterday from Kantar put the Conservatives 18pts ahead of Labour, their biggest lead of the campaign so far in any opinion poll. The Tories were on 45% (up 8pts on the previous week), Labour on 27% (unchanged), while the Brexit Party collapsed to 2% (down 7pts). However, another poll from YouGov showed the Tories 12pts ahead of Labour, down from a 17pt lead on Friday, so it’s a slightly volatile picture even if the range of the lead continues to be in the 8-18 percentage point area.

We got some strong housing data out of the US yesterday, with building permits rising to a seasonally-adjusted annual rate of 1461k in October (vs. 1385k expected), their highest level since May 2007. Looking within the data, all four US regions saw an increase in building permits, and the less-volatile single-family permits also rose to a post-crisis high of 909k. October’s housing starts were also up to 1314k (vs. 1320k expected).

To the day ahead now, and it’s fairly light on data, with October’s PPI release from Germany and CPI release from Canada, along with the weekly MBA mortgage applications from the US. From central banks, the FOMC’s October minutes and the ECB’s Financial Stability Review will be released, while we’ll hear from the ECB’s Lane and Irish central bank governor Makhlouf. Earnings out today include Lowe’s and Target, and in the US tonight there’s another Democratic primary debate.