S&P futures retreated along with European and Asian shares with tech, and Apple supplier shares leading the drop while safe havens such as gold and the yen rose, as the war of words between U.S. President Donald Trump and Kim Jong Un escalated and North Korea threatened to launch a hydrogen bomb, leading to a prompt return of geopolitical concerns. Trade focus now turns to a planned speech by Theresa May on Brexit (full preview here).
As reported last night, the key overnight event was the latest threat by North Korea that its counter-measure may mean testing a hydrogen bomb in the Pacific, according to reports in Yonhap citing North Korea's Foreign Minister. North Korea's leader Kim said North Korea will consider "corresponding, highest level of hard-line measure in history" against US, while he also stated that President Trump's UN speech was rude nonsense and demonstrated insanity and inhumanity which confirmed North Korea's nuclear and missile advances are on right path and will continue to the end. There was more on the geopolitical front with the Iranian President informing armed forces that the nation will bolster its missile capabilities, according to local TV.
As a result, treasury yields pulled back and the dollar slid the most in two weeks following North Korea's threat it could test a hydrogen bomb in the Pacific Ocean. Europe's Stoxx 600 Index edged lower as a rout in base metals deepened, weighing on mining shares. WTI crude halted its rally above $50 a barrel as OPEC members gathered in Vienna.
US stock futures pulled back 0.1% though markets were showing growing signs of fatigue over the belligerent U.S.-North Korea rhetoric. “North Korea poses such a binary risk that it’s very hard to price, and at the moment investors just have to look through it,” said Mike Bell, global market strategist at JP Morgan Asset Management. Despite the latest jitters, MSCI’s world equity index remained on track for another weekly gain, holding near its latest record high hit on Wednesday as investors’ enthusiasm for stocks showed few signs of waning.
The dollar weakened versus the yen and the euro as escalating tensions between North Korea and the U.S. spurred demand for haven assets. The U.S. currency paring its gains made versus the euro since the Federal Reserve’s hawkish rhetoric on Sept. 20. The euro approached $1.20, boosted by data which showed Europe’s economy was on track for the best quarterly growth since 2015, while a gauge of private-sector output in Germany hit the highest level in more than six years. Three-month implied volatility in euro- dollar reached its highest since April. Comments by policy makers and politicians may be the main drivers for currency markets on Friday.
Germany’s benchmark index advanced and the euro headed back toward $1.20 after manufacturing and services surveys data indicated the Eurozone is on track for its best quarterly growth since 2015, buoying sentiment ahead of German elections on Sunday. Manufacturing PMIs from Germany and France and a composite euro-zone private-sector activity index provided support for European policy makers as they consider scaling back stimulus. Both France and Germany reported stronger Flash PMIs, leading to a better than expected composite Eurozone PMI print of 56.7, vs Exp. 55.5 and 55.7 last (Mfg 58.2 vs exp. 57.1, Services 55.6, vs exp. 54.7).
“This encouraging economic backdrop is strengthening the EU governments’ optimism about the future, helping to reinforce their firm stance vis a vis the UK in the Brexit negotiations,” said Societe Generale cross-asset strategists.
European equity markets pushed higher after the stronger PMIs, while L’Oreal rose 4.0% after the death of the founding family’s matriarch leads to M&A speculation, CAC 40 outperforms. Mining sector lags for a second day after base metals sell off in Asian trade again. The Stoxx Europe 600 Index was up 0.1 percent as of publication. The U.K.’s FTSE 100 Index declined less than 0.05 percent. Germany’s DAX Index increased 0.1 percent, hitting the highest in 10 weeks with its fifth consecutive advance. The UST/bund spread widens 3bps as bunds react to positive data.
Brexit bellwether sterling hovered at a two-month high against the euro having firmed against both euro and dollar this week as traders anticipated May would strike a softer tone on negotiations for Britain’s exit from the EU. Options markets were pricing a large GBP/USD reaction to the speech, as investors bought protection against sharp fluctuations.
“Sterling’s rally in the past couple of weeks is partly in reaction to the Bank of England but also reflects an assumption that it’s more likely we do get a transitional deal,” said Mike Bell, global market strategist at JP Morgan Asset Management. “If that’s what May is laying out today that would be supportive, but I think you have seen a lot of that move priced in already,” he added.
Asia equity markets traded mostly negative following US losses where the DJIA snapped a 9-day win streak, with the MSCI Asia Pacific Index dropping 0.2%, with sentiment dampened after North Korean verbal provocation in which its Foreign Minister suggested its counter-measures could mean testing a hydrogen bomb in the Pacific. This followed defiant comments from North Korean leader Kim who labelled Trump a dotard and pressured Nikkei 225 (-0.3%) as well as most indices in the region, although ASX 200 (+0.3%) was kept afloat by strength in its largest weighted financials sector. Hang Seng (-0.9%) and Shanghai Comp. (-0.5%) conformed to the subdued tone in the region with sentiment reeling from a downgrade to China and Hong Kong’s sovereign ratings by S&P. Taiwan’s Taiex index fell 1.2 percent, the biggest slide in Asia. Hon Hai Precision Industry Co. is heading for its biggest weekly loss since October 2014, with some analysts saying early sales of Apple’s new iPhone 8 are slower than for previous models. Finally, 10yr JGBs and T-notes gained on the safe-haven flows, although upside was capped following an enhanced liquidity auction for longer dated Japanese bonds which showed a weaker b/c than prior.
"Although we continue to believe that global stocks can grind higher, underpinned by robust economic growth and increasing earnings, rising valuations are reducing the possibility of significant further upside," UBS global chief investment officer Mark Hafele says in note. UBS reduced overweight to global equities, maintaining a moderate risk-on stance.
In currencies, the Bloomberg Dollar Spot Index decreased 0.4 percent, the biggest dip in more than two weeks. The euro increased 0.4 percent to $1.1994, the strongest in two weeks. The British pound declined 0.2 percent to $1.3557. The Japanese yen increased 0.5 percent to 111.93 per dollar, the first advance in more than a week.
In rates, German bond yields hardly budged ahead of elections on Sunday which market participants said would yield no big surprises with Chancellor Merkel likely to win a fourth term. The 10-year Treasury yield declined about 2 basis points to 2.255 percent as risk aversion favored government bonds. It had risen for nine consecutive sessions prior, brushing a six-week high of 2.289 percent. Britain’s 10-year yield declined less than one basis point to 1.375 percent.
Elsewhere, U.K. Prime Minister Theresa May is set to give a key speech on her Brexit strategy on Friday in Florence. And Germany goes to the polls on Sunday, with Chancellor Angela Merkel expected to secure a fourth term, although she may not win an outright majority leading to coalition talks to form a new government.
Bulletin Headline Summary from RanSquawk
- Asian equities faced selling pressure overnight amid threats of further hydrogen bomb tests from North Korea. Europe supported amid upbeat data
- The risk-off sentiment spurred flows into JPY. Focus for GBP remains on today’s speech by UK PM May
- Looking ahead, highlights include Canadian retail sales & CPI, UK PM May and a slew of central bank speak
- Dow futures fall 0.1%
- S&P 500 futures down 0.2%
- Nasdaq 100 futures down 0.3%
- S&P 500 down 0.3% to 2,500.60 on Thursday
- VIX up 2.2% to 9.88%
- STOXX Europe 600 down 0.2% to 382.20
- MSCI Asia down 0.2% to 162.97
- MSCI Asia ex Japan down 0.4% to 538.52
- Nikkei down 0.3% to 20,296.45
- Topix down 0.3% to 1,664.61
- Hang Seng Index down 0.8% to 27,880.53
- Shanghai Composite down 0.2% to 3,352.53
- Sensex down 1.1% to 32,005.00
- Australia S&P/ASX 200 up 0.5% to 5,682.14
- Kospi down 0.7% to 2,388.71
- German 10Y yield rose 0.7 bps to 0.462%
- Euro up 0.4% to $1.1994
- Italian 10Y yield rose 3.7 bps to 1.816%
- Spanish 10Y yield fell 0.3 bps to 1.619%
- WTI Futures little-changed at $50.6/bbl;
- Brent crude down 0.1% to $56.02
- Gold spot up 0.4% to $1,296.51
- U.S. Dollar Index down 0.4% to 91.91
Top Overnight News
- Kim says he’ll tame ‘mentally deranged’ Trump ‘with fire’: KCNA
- North Korea Says Actions May Include Pacific H-Bomb Test
- CDU/CSU unchanged at 36%, SPD 21.5% in ZDF Politbarometer poll ahead of German election Sunday
- New Zealand election still too close to call, Newshub poll shows
- In the space of just seven weeks, Jacinda Ardern has led her opposition Labour Party out of the wilderness and given it the chance of a stunning upset in Saturday’s New Zealand election; what had looked like a cakewalk for the ruling National Party has become a riveting contest of ideas and left the ballot too close to call
- Ministers from OPEC nations and its allies broadly signaled that their meeting on Friday wouldn’t take concrete steps to address concerns that their agreement may end too early
- In her speech, U.K. PM May will seek a transition period of up to two years after Brexit, and will also pledge to strengthen legal protections for the 3 million EU citizens living in the U.K., according to media reports
- ECB President Draghi doesn’t make any reference to euro in his speech earlier Friday; says strengthening recovery will reduce youth joblessness
- China’s Credit Rating Cut as S&P Cites Risk From Debt Growth
- Europe’s Economy on Track for Best Quarterly Growth Since 2015
- L’Oreal Advances on Prospect of Sale of Nestle’s Holding
- OPEC, Allies Wait and See If Oil Cuts Need to Be Extended
- Trump’s Travel Ban Decision Could Set Off New Wave of Turmoil
Asia equity markets traded mostly negative following US losses where the DJIA snapped a 9-day win streak, and with sentiment dampened after North Korean verbal provocation in which its Foreign Minister suggested its counter-measures could mean testing a hydrogen bomb in the Pacific. This followed defiant comments from North Korean leader Kim who labelled Trump a dotard and pressured Nikkei 225 (-0.3%) as well as most indices in the region, although ASX 200 (+0.3%) was kept afloat by strength in its largest weighted financials sector. Hang Seng (-0.9%) and Shanghai Comp. (-0.5%) conformed to the subdued tone in the region with sentiment reeling from a downgrade to China and Hong Kong’s sovereign ratings by S&P. Finally, 10yr JGBs and T-notes gained on the safe-haven flows, although upside was capped following an enhanced liquidity auction for longer dated Japanese bonds which showed a weaker b/c than prior. S&P downgraded Hong Kong’s sovereign rating to AA+; outlook stable from AAA; outlook negative. PBoC injected CNY 100bln via 7-day reverse repos and CNY 20bln via 28-day reverse repos, for a net weekly injection of CNY 450bln vs. last week's CNY 260bln net injection.
Top Asian News
- S&P Strips Hong Kong of AAA Rating After China Downgrade
- S&P’s First China Downgrade Since ’99 Is Good News for Bulls
- ZhongAn Is Said to Raise $1.5 Billion in IPO Priced at Top End
- Day Traders Reap Profits in Japan When North Korea Tensions Jump
- Iron Ore Routed in Woeful Week as Questions Stack Up on China
European equities shrugged off some of the downbeat sentiment seen during Asia-Pac trade which stemmed from fresh North Korean provocations. More specifically, the NK Foreign Minister suggested its counter-measures could mean testing a hydrogen bomb in the Pacific. Nonetheless, European bourses have chosen to look through these threats and have taken a more in-looking view amid this morning’s slew of PMI readings which showed beats for Germany, France and the Eurozone as a whole. In terms of sector specifics, material names underperform while consumer staples have lead markets higher, with the notable stock specific mover being L’Oreal (OR FP) amid speculation over Nestle’s stake in the Co. in the wake of heiress Battencourt’s death. Bund futures have seen a bit of a retracement towards 161.00 as risk-off sentiment eased and upbeat Eurozone PMI’s, with the region having already digested this week’s sovereign supply. Elsewhere, peripheral yields have seen some modest tightening with little activity seen in core paper.
- Top European News
- May to Reboot Brexit Plan by Requesting Transition Period
- Steer Clear of Spanish Debt on Catalan Concern, Allianz GI Says
- Russia Sees ‘Full-Scale Cyberwar’ as Bomb-Threat Wave Continues
- French Economic Good News Continues as Macron Pushes Reforms
- Vestas Shares Fall; HSBC Sees Pressure at Onshore Wind Auctions
- Macron’s Man in Senate Warns French President Can’t Win This One
In FX markets, in-fitting with the sentiment seen across the continent, the EUR has been given a helping hand with the EUR/USD pair eyeing 1.2000 to the upside once again which also comes amid a broader USD retracement. Elsewhere, GBP/USD has seen a pullback from yesterday’s gains as markets now await further clarity on the UK’s Brexit path from PM May today via her speech from Florence later today. NZD will most likely also be one to watch heading into the weekend ahead of the election on Saturday; albeit polls have recently suggested that the incumbent National Party should secure victory. North Korean rhetoric spurred some safe-haven flows, as USD/JPY took some extra impetus from some week end unwinds. The touted resistance around the 112.70 area has been evident of profit taking, as many investors seem concerned to hold weekend positions following further threats of hydrogen bomb tests from the rebel state.
In commodities, Chinese metal prices were lower with Dalian Iron Ore prices slipping around 4%, plumbing multi week lows, given expectations of slower winter demand and steel output curbs, while S&P downgrading China’s credit rating also added to the recent headwinds. Elsewhere, gold prices rose over 0.5% on flight-to-quality flow after reports that North Korea is willing to conduct a H-Bomb test in the Pacific. Energy markets will be focusing on the fallout from today’s OPEC/non-OPEC meeting, with two delegates suggesting that today’s sit down will be “brief.” Furthermore, the Russian energy minister has briefed media saying that discussions will focus on export monitoring and US shale production. OPEC and non-OPEC producers are looking at all parameters for export monitoring, according to the Venezuelan oil minister. Libya's national oil production is at about 900,000 BPD, according to a Libyan oil source.
Looking at the day ahead, the Markit PMIs on services, manufacturing and the Composite will be available for the US, Eurozone, Germany and France. Onto other events, there will be three Fed speakers today, including John Williams, Esther George and Robert Kaplan. Over in Europe, the ECB’s Vice President Constancio will also speak and the EU foreign ministers will also hold an informal meeting. In Italy, UK’s PM Theresa May will give her big speech updating her government’s position on Brexit.
US Event Calendar:
- 9:45am: Markit US Manufacturing PMI, est. 53, prior 52.8; Services PMI, est. 55.7, prior 56; Composite PMI, prior 55.3
- 6am: Fed’s Williams Speaks to Media at Swiss National Bank Event
- 9:30am: Fed’s George Speaks at Dallas/Kansas City Fed Oil Conference
- 1:30pm: Fed’s Kaplan Speaks at Dallas/Kansas City Fed Oil Conference
DB's Jim Reid concludes the overnight wrap
It doesn’t feel like this week has reached its peak yet. This week has been, and still is, all about (arguably) the three most powerful women in the world. Yellen was certainly on the hawkish side on Wednesday and now we have a big Mrs May speech on Brexit today ahead of Mrs Merkel’s re-election vote on Sunday. Before we preview both these events we’ll first highlight that there has been further verbal escalations in the North Korean situation. Yesterday President Trump ordered new sanctions on individuals, companies and banks doing business with North Korea. He said ‘foreign banks will face a clear choice, do business with the US or facilitate trade with…NK”. He added that China has also asked its banks to stop dealing with the regime. In response, Kim Jong Un has threatened the “highest level of hard-line countermeasure in history” with his foreign minister suggesting that this could include testing a hydrogen bomb in the Pacific Ocean. Asian markets all trading lower on the back of these comments with the Nikkei (-0.35%), Kospi (-0.82%) and Hang Seng (-0.84%) down as we type. Note that we have the flash services PMIs today in Europe and the US which will give us the latest live barometer of economic activity.
Back to Brexit. There has been lots of headlines in the UK speculating about Mrs May’s Florence speech today which starts at 2.15pm BST. However none of Thursday’s headlines told us much that hadn’t been speculated beforehand. Perhaps the speech is still being finalised although there was a 2 and a half hour cabinet meeting yesterday where she briefed her team about the contents. Hopes of Mrs May announcing a figure the UK would be prepared to pay as a divorce settlement or interim annual payment seems a bit optimistic to us as it would end up being the focal point of the speech and all that the press would care about. We’re not sure she’ll want it remembered for that. Having said that the BBC reported in the afternoon that Mrs May is willing to pay 20bn euros during a transition period of two years. However the headline is slightly misleading as the story says the package might be worth up to 20bn without necessarily having that figure explicitly mentioned in the speech. So lots to look forward to on this.
Politics should remain the focus for markets heading into this weekend with Germany’s federal election due on Sunday. Our economists in Germany published a report earlier this week laying out their expectations. In summary they note that according to the ARD Deutschland-tre nd, only a renewed Grand Coalition or a coalition between Merkel’s CDU/CSU, the liberals (FDP) and the Greens (“Jamaica”) would be arithmetically possible. However they highlight that given the tight polls of late and accounting for the usual typical margins of error, other alternative coalitions for the CDU/CSU are still possible. In fact they note that in some polls up to half of the voters still remain undecided. For a CDU/ CSU and FDP/Greens coalition, they highlight that there are question marks about the Greens agreeing to join, as well as the FDP willing to give up its renewed “trade mark” for the sake of government jobs. A Grand Coalition on the other hand they highlight as being a “coalition of last resort” should all else fail. It might also require massive concessions to the SPD. There may be a lot of negotiations ahead.
Before we move back to markets a word of note that the next couple of weeks are likely to see lots of noise on tax reform (and possibly on healthcare again). I listened to DB’s Frank Kelly speak yesterday on this topic and he thinks it’s going to be a very hard road ahead to get a workable agreement through. Next week, the so called “group of six” will come up with a tax plan but it’s likely to be vague and designed to whip Congress into action rather than put firm proposals through. This may initially disappoint markets although I’m not sure there is much reform priced into markets at the moment. The hope would be that something more substantial will be forthcoming the following week. So plenty of headlines likely.
Back onto yesterday’s markets performance. US bourses all softened with the S&P (-0.30%) down for the first time in five days, while the Dow (-0.24%) and Nasdaq (-0.52%) also fell slightly. Within the S&P, most sectors were in the red, with only the Industrials and Financials sector (+0.20%) up slightly. Conversely, European markets were marginally higher, with the Stoxx 600 and DAX both up c0.2%, supported by banks on the prospect of higher yields, but the FTSE 100 dipped 0.11%. Notably, low volatility has returned with the VIX closing a bit lower at 9.67 while the VSTOXX touched the lowest level on record intraday, but ended the day at 11.19 (-0.60 from previous day).
Over in government bonds, core yields were little changed while peripherals underperformed. For 10y yields, UST, Bunds and French OATs all rose c1bp while Gilts were 2.5bp higher. Elsewhere, peripherals underperformed, with Italy, Spain and Portugal 10y yields all c4bp higher. At the two year part of the curve, USTs was flat while Bunds and Gilts rose c0.8bp.
Turning to currencies, the US dollar index weakened 0.27%, enabling the Euro and Sterling to gain 0.41% and 0.63% respectively. The AUD dropped 1.27%, partly as its central bank governor said “a rise in global rates has no automatic implications for Australia”. In commodities, WTI oil was little changed (-0.28%) but Iron Ore fell 5.11% on growing concerns that Chinese iron ore stockpiles are rising just as winter steel production cuts are about to reduce demand. Elsewhere, precious metals traded slightly lower (Gold -0.76%; Silver -1.28%) yesterday, while industrial metals are trending lower this morning, with Copper (-1.43%), Zinc (-2.42%) and Aluminium (-2.83%) all down modestly.
Away from markets, S&P has downgraded China’s sovereign credit rating for the first time since 1999, now one notch lower, from AA-/Negative to A+/Stable, citing that a prolonged period of strong credit growth has increased China’s economic and financial risks. The change should not be a big surprise as it follows that of Moody’s downgrade back in May and now both agencies effectively have the same rating on China. The markets’ reaction seemed somewhat muted with China’s sovereign 5y USD CDS widening by 0.5bp to 58.5bp.
Turning to Europe, Draghi’s keynote address as Chair of the European Systemic Risk board contained little material developments, although he noted that “the use of monetary policy is not the right instrument to address financial imbalances” when financial and business cycles diverge. Over at Italy yesterday, the EU’s Chief negotiator Barnier seemed a bit more optimistic ahead of PM May’s big speech. He noted “I’m convinced a rapid agreement on the conditions of the UK’s orderly withdrawal and a transition period is possible…for that to happen, we would like the UK to put on the table, as soon as next week, proposals to overcome the barriers”. Finally, circling back to Spain, we watch and wait to see if Catalonia’s independence referendum vote scheduled for 1 October will go ahead or not, in part as BBC has reported Spain’s constitutional court has imposed daily fines of €12k on top Catalan officials with police raids on key Catalan government buildings with some officials arrested.
Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the macro data was solid and above market expectations. The Philly Fed manufacturing index rose 4.9pts to 23.8 in September (vs. 17.1 expected ). Within the details, the readings were also strong with the shipments index up 8.4pts to 37.8 and the new orders index up 9.1pts to 29.5. The Conference board leading index also slightly beat, up 0.4% mom (vs. 0.3% expected). Elsewhere, the initial jobless claims print was much stronger than expected at 259k (vs. 302k expected), suggesting limited impact from the storms for now, while continuing claims were broadly in line at 1,980k (vs. 1,975k expected). The slight disappointment was the FHFA house price index which rose 0.2% mom (vs. 0.4% expected).
Moving along, the Eurozone’s confidence index edged up 0.3pts to -1.2 (vs. -1.5 expected) to a fresh 16-year high. Over in the UK, the August credit data for the private and public sector were both modestly lower than expected, with PSNB ex banking net borrowing at £5.7bln (vs. £7.1bln expected) and public sector net borrowing at £5.1bln (vs. £6.4bln expected).
Looking at the day ahead, In France, the final reading of 2Q GDP (0.5% qoq, 1.7% yoy expected) and wages will be out. Over in Canada, there is August inflation and retail sales. Elsewhere, the Markit PMIs on services, manufacturing and the Composite will be available for the US, Eurozone, Germany and France. Onto other events, there will be three Fed speakers today, including John Williams, Esther George and Robert Kaplan. Over in Europe, the ECB’s Vice President Constancio will also speak and the EU foreign ministers will also hold an informal meeting. In Italy, UK’s PM Theresa May will give her big speech updating her government’s position on Brexit.