Tumbling Pound Rattles Global Markets; Chinese Stock Slide Forces Government Intervention

While US markets take the day off for MLK holiday, the rest of the trading world has been busy, perhaps nowhere more so than the sterling which continued its volatile session in advance of May's pre-hard Brexit speech, falling below $1.20 for the first time since October after the Sunday Times said May is ready to withdraw from tariff-free trade with the region in return for the ability to curb immigration and strike commercial deals with other countries. As a result, overnight pound-dollar volatility surged the most since the summer, and breached just twice previously: ahead of the Brexit vote, and before the Bank of England’s July and August meetings.

The dollar rose, in an apparent bid for safety, rebounding after suffering its worst week since November when it was hit by a lack of clarity over the policies of U.S. President-elect Donald Trump, whose inauguration is on Friday.

"(The movement) shows that people are looking ahead this week with Trump's inauguration and discussions on Brexit. There is a lot of uncertainty moving forward," Brian Lan, managing director at Singapore-based gold dealer GoldSilver Central, told Reuters.

Yields on low-risk German government bonds fell but those on Italian equivalents edged up after rating agency DBRS cut Italy's credit rating after markets closed on Friday in a move that could raise borrowing costs for the country's banks. Italy's downgrade will mean Italian banks will have to pay more to borrow money from the European Central Bank when they use the country's sovereign bonds as collateral. It may also make Italian debt less attractive for foreign buyers. German 10-year bond yields fell 2 basis points to 0.32 percent. Italian 10-year yields rose marginally to 1.90%.

Elsewhere, equities slid and gold climbed over the same Brexit concerns while Donald Trump suggested in an interview other countries could break from the EU block.

Having traded quietly lower for the past few days, Chinese stocks tumbled in early trading on the mainland and in Hong Kong’s offshore mkt amid weakness in Asian equities. The Shanghai Composite Index dropped as much as 2.2% to head for its fifth loss in as many days, its longest losing streak since Aug. 2015.However a sudden bout of late afternoon buying sent the loss down to just -0.3%, on speculation China's national team was once again back in the markets.

A similar fate befell stocks in China’s second-largest equity market, the Shenzhen Composite, which plunged the most in 10 months, underscoring the increasing fragility of the nation’s financial assets. The Shenzhen Composite Index sank as much as 6.1%, the biggest loss since Feb. 29. Traders pointed to concern that regulators will accelerate the pace of initial public offerings, already at a 19-year high, diverting liquidity from existing shares. The Shanghai Composite Index dropped as much as 2.2 percent in minutes before paring losses amid speculated buying by state-backed funds.

About 60 stocks fell by the daily 10% limit on the Shenzhen Composite Index, with turnover totaling 259.2 billion yuan ($37.6 billion), the highest in more than a month. Nearly 100 stocks were halted limit down on China's Nasdaq-equivalent Chinext exchange.

Meanwhile, in Europe banks led European stocks lower after Goldman Sachs Group Inc. downgraded Royal Bank of Scotland Group Plc, citing exposure to volatile politics.

In reaction to concerns about the May and Trump statements, markets have seen a subdued risk off tone, with the EURUSD sliding, and USDJPY hitting 113.65 overnight before rebounding back over 114. Bloomberg notes that British government officials are trying to limit damage to the pound will speak to major banks in London before the U.K. leader sets out her vision for leaving the bloc in a speech on Tuesday, according to people familiar with the situation. Meanwhile Trump predicted that Britain’s exit will be a success that will encourage others to do the same. He also branded NATO obsolete.

“Markets are trading in risk aversion mode,” said Neil Jones, the head of hedge-fund sales at Mizuho Bank Ltd. in London. “Investors and corporates around the world are concerned by the prospect of a hard Brexit. Pound rallies are limited and weak, while plunges are harsh and prolonged.”

Among the key notable risk moves, the Stoxx Europe 600 Index dropped 0.5 percent after retreating as much as 0.8 percent. Banks and insurers led losses in Europe after Royal Bank of Scotland slid 2.8%. The U.K.’s FTSE 100 Index dropped less than 0.1 percent, poised to halt a record streak of daily gains and 10 consecutive all-time highs, despite the latest slump in sterling.

S&P 500 futures declined 0.2% to 2,267. US stock markets are closed on Monday.

In currencies, sterling traded 1.1% lower to $1.2052 at 10:49 a.m. in London after touching $1.1986, its weakest level since October. Overnight implied volatility in the pound against the dollar climbed to a five-month high before May’s speech. The measure exceed 30% a level only breached before three events in 2016 - Britain’s EU vote and the Bank of England’s July and August meetings. The euro dropped 0.5 percent to $1.0588. The yen rose 0.2 percent to 114.25 per dollar, extending gains for the longest winning streak since June. Turkey’s lira resumed its slide after it weakened 1.2%.The currency jumped 3.7 percent over Thursday and Friday after the central bank took steps to prop it up by tightening liquidity.

In commodities, gold climbed 0.4 percent, extending last week’s surge to trade at $1,202.25 an ounce. Oil rose 0.3 percent to $52.51 a barrel. Iron ore futures jumped as much as 6.4% to $82.12 a metric ton, the highest level since October 2014.

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DB's Jim Reid concludes the overnight wrap

Martin Luther King Day means a quiet start to a busy week culminating in Donald Trump's inauguration on Friday. I say quiet but I'll be forever haunted by suggesting back in January 2008 that the MLK Day ahead was likely to be very quiet only for it to herald one of the worst days in stock market history after the rouge trader's positions were discovered at SocGen. The CAC and DAX were down -6.83% and -7.16% respectively that day and I've never taken public holidays lightly since.

It's hard to see the inauguration being a market moving event (famous last words given what I've said above) but it will mark the point where we'll start the landmark first 100 days in office when the phoney war will end and action starts. Of more market interest will likely be the UK PM's speech tomorrow night where it was reported in the Sunday Times that Theresa May will signal plans for a “hard Brexit’’ by saying she’s willing to quit the single market in order to regain control of migration and law making. Sterling fell -1.83% and -0.85% against the Euro and Dollar last week as speculation mounted about this speech. In Asia it's down -1.34% as we go to print at $1.202 although it did temporarily test the waters below the $1.200 mark at one stage – a level not seen since the October flash crash. There’s some suggestion that comments from President-elect Trump, who said that the US is prepared to offer the UK a quick and fair trade deal, as well as a Bloomberg report suggesting that the UK Government is putting in place plans to speak to major Banks to calm any nerves in the event of another big selloff, is helping to at least put a bit of a floor in the price for now.

On a related note, interestingly Mark Carney speaks tonight with no details on what he'll discuss while we’ve also got the Supreme Court appeal on the government’s Triggering of Article 50 around the corner (DB expects this to be on one of the forthcoming two Wednesday’s). So plenty to keep the market on its toes in the short term.

The other main events of the week are discussed at the end but the highlights are the ECB lending survey tomorrow which was a bit soft last quarter but may be helped by a rebounding European banking sector. UK, US and Euro inflation numbers and a Yellen speech appear on Wednesday. We have what might be a lower profile ECB policy meeting on Thursday with Friday seeing the mass China monthly data dump. We also see a ramping up of US earnings and the annual Davos shindig which will guarantee plenty of headlines. I'll know I've made it in life if I ever get invited this event.

In the meantime the moves for Sterling this morning appear to have sparked a bit of across the board risk aversion in Asia to begin the week. The Shanghai Comp is currently -1.40% and is on a run of 5 consecutive down days which is actually the longest since August 2015. The Hang Seng (-1.03%), Nikkei (-1.09%) and Kospi (-0.56%) are also in the red while the ASX (+0.50%) is the only index currently trading higher with materials leading the way. Currencies in Asia are also generally weaker while 10y JGB yields are little changed around 0.040%. Interestingly they’ve now held above that 0% band for over 2 months now.

Moving on. As we highlighted above, with earnings likely to be one of the events to keep an eye on this week, the early signal from Friday’s releases were fairly encouraging after JPM, BofA and Wells Fargo all came in with Q4 reports that bettered market expectations. A combination of cost cuts and strong FICC revenues seemed to be the driving force for JPM and BofA in particular while the former encouragingly said on the conference call that they are starting to see better data at a US retail level too. The results helped the S&P 500 Financials index to close +0.55% which compares to a +0.18% gain for the wider S&P500. The Dow closed -0.03% and it does feel like there is some unwinding of the Trump trades passing through still. The European session had been a much better story though with the Stoxx 600 closing +0.95% to help the index nudge back into positive territory for the week. Financials also outperformed in credit, particularly so in Europe where Senior and Sub Fins closed 4bps and 10bps tighter respectively, compared to a 2bp tighter move for Main.

Away from earnings, the US data was also in the spotlight on Friday. Most notable was the December retail sales numbers where headline sales (+0.6% mom vs. +0.7% expected) missed by a smallish margin. There was a much bigger miss for the ex auto and gas component though (0.0% vs. +0.4% expected) while the control group component (+0.2% mom vs. +0.4% expected) also disappointed. The rest of the data was a bit of a wash. Headline PPI (+0.3% mom) printed in line, as did the core ex food, energy and trade print (+0.1% mom). Business inventories rose a little bit more than expected in November (+0.7% mom vs. +0.6% expected) while the flash University of Michigan consumer sentiment reading for this month was a touch on the softer side (98.1 vs. 98.5 expected; from 98.2 in December). That said 1y inflation expectations were bumped up from 2.2% to 2.6% while 5-10y inflation expectations were nudged up to 2.5% from 2.3%. The Atlanta Fed revised their Q4 GDP forecast down one-tenth to 2.8% following the retail sales numbers, while the USD index (-0.17%) softened a touch to finish with a -1.02% weekly loss. 10y Treasury yields did nudge up 3.3bps to 2.397% but still finished the week a few basis points down from the prior week close.

There wasn’t much of note in Europe although it’s worth highlighting that our economists reported that their SIREN momentum and surprise indicators are now in the top deciles of their respective readings over the past decade. It’s been almost six years since both indices were in their top deciles. Indeed, their combined message stands close to the top 1% of its historical readings. They also go on to note that the SIREN momentum per reference quarter points to annualised euro area growth in Q4 2016 close to, if not above 2%, which would be the strongest quarter since Q1 2015. So while we’re expecting no fireworks from the ECB this week, the recent data – should it continue – could force the outright tapering debate into a sooner than expected timeframe.

Staying in Europe, it’s worth noting that Canadian rating agency DBRS downgraded Italy’s sovereign rating on Friday to BBB High from A Low, citing their ability to pass reforms and the weakness in the banking sector and fragile growth. The decision will add to banking pressures for Italy given that it’ll force an increase in haircuts on some Italian collateral posted at the ECB. The move has also stripped Italy of what was its final A rating amongst the big 4 rating agencies.

Turning now to the week ahead and expanding on the brief highlights at the top. With markets closed in the US today for Martin Luther King Day it’s an unsurprisingly quiet start to the week with just the Euro area trade balance reading in November due. Tuesday kicks off in Japan where industrial production data is due. In Europe there will be plenty of focus on the ECB’s bank lending survey due early on, while the December inflation report in the UK will also be under the spotlight. The January ZEW survey for Germany is also due out. Over in the US tomorrow the only data due out is the January Empire manufacturing print.

Turning to Wednesday, Germany and the Euro area will release the final revisions to December CPI reports while the UK will release the latest labour market data. Over in the US inflation data will also be the focus with the December report due out. Industrial and manufacturing production, as well as the NAHB housing market index will also be due. With little else of note on Thursday morning the main focus will be on the ECB policy meeting. In the US we’ll get housing starts and building permits data as well initial jobless claims and the Philly Fed business outlook print. It’s a blockbuster end to the week in China on Friday with the Q4 GDP print due along with December activity indicators including industrial production, retail sales and fixed asset investment. During the European session we’ll get PPI in Germany and retail sales in the UK. There’s nothing of note in the US on Friday.

As well as the above, there’s also plenty of Fedspeak this week. Both Dudley and Williams are scheduled to speak tomorrow, before Kashkari and Yellen speak on Wednesday. The latter is taking part in a   discussion at the Commonwealth Club in San Francisco however is also expected to give an economic assessment. The Fed Chair then speaks again on Friday, along with Harker and Williams. The ECB’s Villeroy and Praet also speak today along with the BoE’s Carney while we’ll also get the usual ECB press conference on Thursday. Earnings will also be in the spotlight with Morgan Stanley tomorrow, Goldman Sachs, Citigroup and Netflix on Wednesday, IBM on Thursday and Schlumberger and General Electric on Friday due. Away from that world leaders will also congregate in Davos this week for the World Economic Forum while UK PM Theresa May is due to outline Brexit plans on Tuesday. Clearly the other big focus this week is the inauguration of Donald Trump as US President on Friday.