Stocks Drop As Trade War Returns; Japanese Bond Rout Leads To Emergency Margin Call

The latest trade war truce lasted less than a day, and after stocks jumped yesterday following an early report that Mnuchin had resumed trade talks with his Chinese counterpart, a late Tuesday report that the Trump admin is planning to increase the tariff rate on some $200BN of Chinese imports from 10% to 25% led to an immediate slide in risk assets around the globe, and this morning global stocks and futures were a sea of red despite Apple's stellar results which helped lift the Nasdaq.

In response, China again warned the U.S. against "blackmailing and pressuring" it over trade. China’s Ministry of Foreign Affairs said it will fight back if the U.S. further increases tariffs as it now contemplated. “If the U.S. takes measures to further escalate the situation, we will surely take countermeasures to uphold our legitimate rights and interests," spokesman Geng Shuang said at a regular press conference on Wednesday.

The return of trade war tensions initially sent the dollar higher across the board, while the Yuan tumbled, with the offshore Yuan tumbling to a one year low of 6.8642 against the dollar, before the PBOC intervened again, and the onshore Yuan reversed losses mid-afternoon after a large Chinese bank was seen selling dollars. According to Bloomberg, at least one big Chinese bank started to sell dollars aggressively around 6.83 yuan per USD, and those flows disappeared after rate went to 6.82. A large Chinese bank also sold dollars onshore earlier in the day, spurring other banks to follow.

The big overnight move, however, wasn't in China but in Japan, where one day after the BOJ tweaked its monetary policy while leaving its YCC largely intact, bond traders tried to find the new tolerance breaking point for 10Y JGB. As a reminder, during his press conference, Kuroda yesterday said that the tolerance deviation for 10Y yields was doubled from 10bps around 0% to 20bps, and overnight Japan's 10-year yields climbed 5.5bps, approaching 0.12%, the highest since February 2017, while 10-year futures dropped to 149.98, the lowest since July 2017.

The sharp slide, which did not prompt the BOJ to launch another fixed-rate operation and prevent further selling, lead to an emergency margin call for JGB Futures by the Japanese Securities Clearing Corp. This is what prompted the ominous announcement:

When the market moves beyond predetermined range at 1:00 pm (for 10-year JGB Futures, at the closing of morning session), or when JSCC deems it necessary, required amount of Clearing Margin is re-calculated and if the deposited amount falls short of the re-calculated amount, additional margin shall be deposited by 4:00 pm on the day.

As a result of the rout which was testing to see at what point Kuroda would respond, JGB bond yields traded in the widest daily range since 2016, before YCC was established and prompting new fears about bond market stability.

The latest Japanese bond rout spread across the globe, pushing 10Y TSY yields to session highs just under 2.98, while French 10-year yields were higher by 3.5bps and over 1bp wider vs Germany across the long-end, while 10-year OAT invoice spreads are about 2bps tighter. French bonds are among the largest beneficiaries of Japanese investor demand, and are underperforming as markets assess the next possible step from Japanese insurers that now face more attractive domestic yields, which may see demand for OAT dry up.

Elsewhere in Europe, stocks declined as for familiar reasons: a renewed ratcheting up of trade rhetoric, sinking commodities in the process. The Stocks Europe 600 Index fell, led by miners, as China vowed to retaliate if the U.S. follows through on threats to increase its import tariffs. Volkswagen was among companies reporting better-than-expected earnings, but carmakers were caught in the downdraft.

Earlier in the session, Asian stock markets were mostly higher as region got a tailwind from US where all majors finished positive on trade optimism - since denied - while earnings also remained in the spotlight with Apple beating on top and bottom lines. However, Asia-Pac bourses were far from solid ground and US equity futures also pared some of their gains after reports that the Trump administration is planning to propose an increase to 25% tariffs from 10% on USD 200bln of Chinese goods and as Caixin Manufacturing PMI added to the recent China PMI misses.

Futures for the S&P 500 and Dow Jones also edged lower, though contracts for the Nasdaq gained in the wake of strong results from Apple Inc.

The dollar climbed against most of its major peers and the offshore yuan advanced. The Bloomberg Dollar Spot Index rose 0.2%, up a second day, before the Federal Reserve’s meeting where investors were focusing on the outlook for further rate hikes. Kiwi leads declines after disappointing earnings data. The pound and euro were slightly weaker after underwhelming readings for manufacturing gauges in the U.K. and Europe.

And speaking of the dollar, a reminder that the conclusion of the FOMC meeting is today at 2pm although this one may be one of the least anticipated as no change in policy is expected and as a reminder this is a meeting that doesn’t have a press conference, nor a fresh summary of economic projections so the only focus really will be on cosmetic changes to the statement. Most economists expect a fairly uneventful statement with the only real change perhaps being an acknowledgement of some recent softness in housing market data. As a complement to June’s removal of forward guidance language, the statement could also include some language such as the phrase “for now” featured in Fed Chair Powell’s recent monetary policy testimony. Including such verbiage would have the effect of including some uncertainty into the Fed’s gradual rate hike mantra. The team take the addition of such language as another way to de-emphasize forward guidance and reiterate that their actions are data dependent.

Commodities retreated as metals, heavily exposed to global trade, fell with oil. Oil prices slipped with WTI and Brent both down ~1.0% in early European trade, and hovering around their 100DMA’s of $67.84 and $74.14 respectively. This comes after Brent declined more than 6% in July and WTI fell around 7% in the same period, with both benchmarks having the largest decline in over 2 years. Yesterday also saw API inventories showing a surprise build of 5.6mln BBL’s, vs. and expected draw of 2.8mln BBL’s. Oil traders are now looking ahead to EIA data later in the day. In the metals scope, gold is holding steady ahead of the FOMC rate decision later on in the day. London copper has extended the losses that were seen in July (-5%) and is down 1% on the day as traders express worries on the US-China tariff threats. Zinc has fallen the most, currently down 2%, with nickel, lead and tin also slipping.

FOMC rate decision is due, while expected data include mortgage applications and manufacturing PMI. Ferrari, Sprint, T-Mobile US, and Tesla are among companies reporting earnings.

Market Snapshot

  • S&P 500 futures down 0.1% to 2,814.25
  • STOXX Europe 600 down 0.2% to 390.81
  • MXAP up 0.3% to 167.48
  • MXAPJ down 0.09% to 542.17
  • Nikkei up 0.9% to 22,746.70
  • Topix up 0.9% to 1,769.76
  • Hang Seng Index down 0.9% to 28,340.74
  • Shanghai Composite down 1.8% to 2,824.53
  • Sensex down 0.1% to 37,558.56
  • Australia S&P/ASX 200 down 0.07% to 6,275.72
  • Kospi up 0.5% to 2,307.07
  • German 10Y yield rose 2.4 bps to 0.467%
  • Euro down 0.01% to $1.1690
  • Italian 10Y yield fell 22.0 bps to 2.452%
  • Spanish 10Y yield rose 2.9 bps to 1.429%
  • Brent futures down 1.3% to $73.26/bbl
  • Gold spot little changed at $1,223.20
  • U.S. Dollar Index little changed at 94.62

Top Overnight News from Bloomberg:

  • Trump administration will propose more than doubling its planned tariffs on Chinese imports, ratcheting up pressure on Beijing to return to the negotiating table, three people familiar with the internal deliberations said
  • China responded on Wednesday to a report that the U.S. is trying to force officials back to the negotiating table through threats of even higher tariffs by saying that “blackmailing and pressuring” will never work.
  • PBOC has started actively encouraging banks to extend more credit by taking a softer stance on loan quotas, according to people familiar
  • U.K. Prime Minister Theresa May will cut her holiday short to fly to meet French President Emmanuel Macron at his holiday retreat to discuss Brexit on Friday, her office said
  • U.S. and Mexico are in final stages of negotiating a deal on rules for cars sold under Nafta, one of the biggest sticking points in discussions to overhaul the North American Free Trade Agreement, according to people familiar with the talks
  • Bank of Japan Governor Kuroda’s policy tweaks have either strengthened the long-running stimulus or mark a stealth "baby step" toward normalizing policy depending on who you talk to
  • President Trump says at political rally in Florida that the U.S. is “doing well in North Korea,” although China “maybe is getting in our way. But we are going to figure that one out before you can even think about it”
  • BNP Paribas SA became the latest European banking giant to post debt-trading results that lagged behind the largest Wall Street firms
  • U.K. manufacturing growth slowed more than expected last month, casting doubt on the strength of the economy as Bank of England policy makers hold their crunch meeting.
  • China’s central bank has started actively encouraging banks to boost lending, people familiar with the matter said, as it ratchets up efforts to bolster a cooling economy.

Asian equity markets were mostly higher as region got a tailwind from US where all majors finished positive on trade optimism from initial reports that US and China are to seek a restart of talks, while earnings also remained in the spotlight with Apple beating on top and bottom lines. However, Asia-Pac bourses were far from solid ground and US equity futures also pared some of their gains after reports that the Trump administration is planning to propose an increase to 25% tariffs from 10% on USD 200bln of Chinese goods and as Caixin Manufacturing PMI added to the recent China PMI misses. As such, ASX 200 (-0.1%) and Nikkei 225 (+0.9%) were mixed throughout most the session with Australia dampened by weakness in financials and energy, while Tokyo trade was driven by a weaker currency and earnings deluge. Elsewhere, Apple suppliers were varied despite the tech giant’s earnings beat as they also digested softer than expected product sales, and Chinese markets (Hang Seng -0.9%; Shanghai Comp. -1.8%) opened positive but then gains later proved to be flimsy on the conflicting trade reports and disappointing data. Finally, 10yr JGBs fell around 80 ticks to break below 150.00 as the BoJ’s more flexible approach on yields continued to reverberate in the bond market, with the 10yr yield back above 0.1% and the 5yr yield at a 6-month high. Of note, it was reported that Japan Securities Clearing Corporation stated that emergency margin calls related to JGB futures were triggered. Trump administration plans to propose a higher tariff of 25% (Prev. 10%) on USD 200bln of imports from China with an announcement possible as soon as today, according to sources.

Top Asian News

  • China Tower Said to Raise $6.9 Billion in Biggest IPO in 2 Years
  • Chinese Investors Flee Into Money Market Funds From Stocks
  • HNA Chief’s Death Is Said to Delay Hong Kong Airlines Share Sale
  • BlackRock Snaps Up Turkish Bonds Derided by Goldman Sachs

European equites are marginally lower as focus once again remains on earnings. The FTSE 100 is currently underperforming (-1.1%) on the back of softer mining names (i.e. Rio Tinto missing on expectations), as well as the retail sector sliding after Next posted uninspiring earnings. The CAC (flat) is currently outperforming off the back of ArcelorMittal posting strong earnings. The IT sector is currently in the green and following in step with the positivity seen after Apple’s earnings last night, with the FAANG stock beating on both the top and bottom line; up 3.5% pre-market. Dialog Semiconductor is leading the gains in the Stoxx 600 after strong financial results, and Volkswagen also reported positive earnings, beating on both revenue and profit expectations, but are struggling to hold on the early gains, currently down 1.8%.

Top European News

  • U.K. Manufacturing Growth Ebbs as New Orders, Output Slow
  • Euro- Area Factories Put on the Brakes in July Amid Trade Qualms
  • Mediobanca CEO Eyes Acquisitions After Wealth Unit Lifts Profit
  • Kosovo Rejects Serbian Idea of Partition Along Ethnic Lines

In FX, the DXY index and Greenback overall has rebounded further from Tuesday’s lows, the former back above 94.500 within a range up to 94.700 at best and the Buck up vs all G10 peers, plus many EMs again following yet another higher Usd/Cny setting by the PBoC (ongoing reaction to or precaution against US-China trade war risk). Ahead, several potentially key US data points ahead of the FOMC and NFP on Friday, but no real expectations of any major policy guidance changes from the Fed. NZD/AUD - The Kiwi is underperforming again and only just keeping tabs with big figure levels vs its US and antipodean rivals at 0.6800 and 1.0900 respectively in wake of disappointing NZ data overnight (unemployment rate weaker than forecast and bigger miss on wages). However, the Aud is also on the backfoot amidst heightened US tariff threats vs China and the aforementioned Yuan depreciation, with Aud/Usd retreating towards 0.7400 after yesterday’s post-Aussie building approvals boost. JPY - Extending post-BoJ losses vs the Usd to 112.00+, but not quite testing Fib support around 112.18 and wary of huge option expiry hedging for tomorrow and Friday at the big figure strike (3.6 bn in total). CAD - The Loonie has retreated from sub-1.3000 highs vs its US counterpart on the back of upbeat Canadian data, with weak oil prices and ongoing NAFTA neglect niggling ahead of the manufacturing PMI. EM - The Rand is recovering after a slide beyond 13.3750 vs the Usd in wake of ANC action to alter SA’s constitution on land appropriation excluding financial compensation.

As for the day ahead, the main focus should be the FOMC meeting outcome this evening. In terms of data releases, we'll get the remaining July manufacturing PMIs in Europe while in the US the July ADP employment change reading, final July manufacturing PMI, June construction spending, July ISM manufacturing and July total vehicle sales data are all due. Away from that, Tesla and Metlife will be reporting Q2 earnings. As noted earlier, the US Treasury will also unveil its latest borrowing plans

US Event Calendar

  • 7am: MBA Mortgage Applications, prior -0.2%
  • 8:15am: ADP Employment Change, est. 186,000, prior 177,000
  • 9:45am: Markit US Manufacturing PMI, est. 55.5, prior 55.5
  • 10am: Construction Spending MoM, est. 0.3%, prior 0.4%
  • 10am: ISM Manufacturing, est. 59.3, prior 60.2
  • 2pm: FOMC Rate Decision
  • Wards Total Vehicle Sales, est. 17.1m, prior 17.4m

DB's Craig Nicol concludes the overnight wrap

Welcome to August and with that only nine days until the football season officially kicks off again here in the UK. As it’s the first day of a new month we’ve got our usual monthly performance review at the end of today’s EMR and the usual charts and table in the PDF. July wasn’t quite the slow summer lull in markets that we’re used to expecting but all-in-all it was still a fairly decent month for most asset classes. In fact the S&P 500 had its strongest month since January.

The first day of August also brings with it the second of three central bank meetings this week. The conclusion of the FOMC meeting is tonight although of the three meetings, the Fed might be the least anticipated of the lot which isn’t something we would normally say. No change in policy is expected and as a reminder this is a meeting that doesn’t have a press conference, nor a fresh summary of economic projections so the only focus really will be on cosmetic changes to the statement. Our US economists expect a fairly uneventful statement with the only real change perhaps being an acknowledgement of some recent softness in housing market data. As a complement to June’s removal of forward guidance language, the statement could also include some language such as the phrase “for now” featured in Fed Chair Powell’s recent monetary policy testimony. Our colleagues believe that including such verbiage would have the effect of including some uncertainty into the Fed’s gradual rate hike mantra. The team take the addition of such language as another way to deemphasise forward guidance and reiterate that their actions are data dependent.

Also out today will be the US Treasury’s latest borrowing plans which should keep the Treasury market preoccupied. DB’s Steven Zeng expects $1bn to be added to each of the nominal coupon and FRN auction sizes, resulting in an additional $21bn of new issuance for the August-October Period. So worth keeping an eye on that announcement also.

Going into today, markets had no shortage of headlines to feed off yesterday. The early focus was the BoJ, which as DB’s Alan Ruskin described was a ‘Houdini like’ dovish spin (we’ll come back to that shortly), while the European session included a surprisingly soft Q2 GDP reading but stronger than expected July CPI print. We also had a raft of data releases  in the US including inflation data which was largely steady, while risk assets fed off the news that China and the US were supposedly working to restart trade talks. By the end of play the S&P 500 had closed up +0.49% to snap a three-day losing run with industrials leading the charge, while the NASDAQ and DOW also closed +0.55% and +0.43% respectively. In Europe the Stoxx 600 had earlier finished +0.18% while bond yields generally were slightly lower (Treasuries -1.3bps and Bunds -0.2bps), with curves back to flattening.

Late last night the focus swiftly turned to Apple’s Q3 earnings which came in above market while it also guided to Q4 revenue that was above consensus expectations. Shares were up +4.1% in extended trading which has helped NASDAQ futures to post a small gain. Markets in Asia are being held back however with China bourses in the red (Shanghai Comp -0.32%) following a new Bloomberg report that the Trump administration is considering to now raise the 10% tariff on $200bn worth of Chinese imports to 25%. It’s amazing how these stories can seemingly swing from one extreme to the other. China’s Xinhau news agency has also reported that China’s Politburo signalled yesterday that policy makers are to focus more on supporting economic growth in light of risks from deleveraging and the trade situation. Perhaps having the least impact on markets this morning is China’s Caixin PMI which printed at 50.8 (vs. 50.9 expected) and down 0.2pts from June. While we’re with China it’s worth noting that our China economists have revised their CNY forecasts for the end of this year and next to 6.95 and 7.40 respectively, from 6.80 and 7.20 previously.

Coming back to the BoJ, as noted earlier DB’s Alan Ruskin summed up yesterday’s policy decision nicely by calling it ‘Houdini like’ insofar as it was a brilliant execution of what amounts to a dovish spin on what was ultimately a mild tightening in policy. Indeed you couldn’t really have asked for a much better way to start the very slow process of withdrawing the safety net with JGB yields rallying 4-8bps at the 10-30y parts of the curve despite the upper bound for the 10y being doubled to 20bps (it’s worth noting that JGBs have given a lot of that back this morning however with the 10y back to 0.10%). As our economists in Japan noted in their report yesterday, Governor Kuroda highlighted in his press conference that the adjustments were aimed at repairing the damage to market functioning and at increasing the sustainability of policy, rather than the side effects. The team believe that a comprehensive review of the side effects could however still be possible in the future. Ultimately our economists believe that there are still three necessary conditions for a change in the JGB yield target. The first is stable core CPI, the second a comprehensive assessment of yield curve control and the third a government declaration to end deflation. The team see little evidence to suggest that the first condition won’t be met before 2020, and hence reiterate that current policy will be in place until then. In the near term the most interesting dynamic in markets in our view will be how far the market pushes that new upper bound for 10y JGB yields and where the BoJ decides to step in.

Back to some of those other stories in markets yesterday. The trade update that we mentioned at the top concerned a Bloomberg report which hit the wires in the early afternoon. It suggested that the US and China were willing and trying to kick off talks again with the view to avert a trade war. The story went on to say that representatives of US Treasury Secretary Mnuchin and Chinese Vice Premier Liu He were having private conversations however it’s worth noting that in recent weeks it’s been US Trade Representative Lighthizer, rather than Mnuchin, who has been the much more hard-lined and aggressive spokesman on the trade conflict with China, and the general feeling is that it is Lighthizer who has the better access to Trump on trade issues. So perhaps worth taking with a pinch of salt, especially given the new developments overnight which appear to completely contradict this initial story.

As for the raft of data releases yesterday, in the US the June core PCE reading came in in-line with expectations at +0.1% mom, with the annual rate now down at +1.9% yoy. The Q2 ECI was however a shade softer than expected at +0.6% qoq (vs. +0.7% expected) albeit not enough to take the Fed off the gradual hike path. Also out yesterday was a bumper July Chicago PMI (65.5 vs. 62.0 expected) with the index up 1.3pts from June, while the July consumer confidence reading also came in at a better than expected 127.4 (vs. 126.0 expected) and up from June. However the arguably more important expectations gauge did slip 2.3pts to 101.7, putting it at the lowest level since December last year.

In Europe it was all about the Q2 GDP and July CPI prints yesterday. The former came in at a surprisingly below market +0.3% qoq (vs. +0.4% expected) although it’s worth noting that the extra decimal place does take it to +0.35% qoq so it was a very marginal miss. Our economists do however still expect H2 growth to be stronger than H1 with recent survey level data still upbeat. There was better news in the July CPI data however with the core reading nudging up two-tenths and a bit more than expected to +1.1% yoy (vs. +1.0% expected), matching the YTD high made back in May.

Finally, as for the day ahead, the main focus should be the FOMC meeting outcome this evening. In terms of data releases, we'll get the remaining July manufacturing PMIs in Europe while in the US the July ADP employment change reading, final July manufacturing PMI, June construction spending, July ISM manufacturing and July total vehicle sales data are all due. Away from that, Tesla and Metlife will be reporting Q2 earnings. As noted earlier, the US Treasury will also unveil its latest borrowing plans.