Overnight Sentiment: On This Day In Manchurian Invasion History

There was a time when sentiment and newsflow mattered, and then Bernanke took over. If there is anything today's soaked vacuum tubes will focus on is that it is the 81st anniversary of the invasion of Manchuria by Japan, as developments in the East China Sea are starting to get decidedly deja vuish, if somewhat inverted. Also notable is the ever louder chatter that Spain will have to be destroyed (bonds plunge), for it to be saved (Rajoy submits bailout request), as we observed over a month ago. For that to happen, the central planners will need to allow the markets to take a deep breath and actually slide, which in turn may crush confidence in central planners' ability to keep markets rising in perpetuity. What's a central planner to do these days to be appreciated anyway. It also means that the days of innocence, when nothing at all matters on the fundamental side, will, just like in Q1 after the LTRO $1.3 trillion injection, be followed by days when fundamentals matter with a vengeance. Alas, we are not there yet. Instead, the best we can do is wonder just what asset will experience today's flash crash du jour following yesterday's still unexplained 5% plunge in crude in minutes. New Normal indeed.

For those who still do care what happened in the past few hours, here it is, via Deutsche:

Overnight markets are mostly in consolidation mode, with bourses in China, Taiwan and Japan down -0.6%, -0.3% and -0.1%, respectively. The ongoing territorial tension between Japan and China is receiving more attention overnight after the HK Economic Journal reported that China is preparing economic sanctions against Japan and may ban exports of rare earths. The FT reported that thousands of Chinese protestors gathered outside the Japanese embassy in Beijing overnight on a sensitive day which marks the anniversary of the start of Japan's invasion of China in 1931. Concerns that a political disagreement may turn into an economic one follows yesterday’s news that the US has launched a case at the WTO against China over export subsidies on cars and car parts. Japanese-affiliated retailers in China/HK and certain Japanese exporters have seen their shares suffered this week. As we go to print, ANA also announced that it has cancelled 15,000 seats on its China-Japan routes.

Elsewhere the latest Chinese home price data showed that prices rose 0.1% in August on average across 70 major cities. This was the second consecutive month of price rises (+0.1% in July, flat in June) after eight straight months of declines to May this year. In credit markets overnight the Asia IG  and Aus iTraxx indices are both about 1bp wider with some profit-taking setting the broader tone.

Recapping yesterday’s moves, the S&P500 (-0.3%) finished slightly lower yesterday not helped by another weak report on the US manufacturing sector. The disappointing NY Fed Empire State Manufacturing report (-10.4 vs -2) came after the weaker IP print last Friday. Details of the NY Fed report were also weak. New orders (-14.0 vs. -5.5 previous month) and unfilled orders (-14.9 vs. -10.6 previous) moved deeper into contraction, while shipments (+2.8 vs. +4.1) and employment (+4.3 vs. +16.5) also slowed. As Joe LaVorgna pointed out, for the economy to outperform in H2, manufacturing activity will need to further expand so all eyes will be on the Philly Fed survey this Thursday. In other markets it was also interesting to see the CRB index (-2.06%) suffered its biggest one day fall in 10 weeks and some weakness in Gold and UST 10yr breakevens.

Turning to Europe, ECB Governing Council member Coene yesterday said that rising bond yields may force Spain into asking for aid and agreeing to the EU’s conditions for granting it. Coene added that if Spain doesn’t ask for aid then it will not be long before spreads rise again which will force Spain to request for one. On policy Coene mentioned rate cuts and further LTROs are both options for the ECB. It was a poor day for Spanish bonds with the 10yr bond yields closing +19bp higher yesterday to just shy of 6%.

On the topic of banking supervision, ECB's Nowotny said it will be very ambitious for the ECB to oversee major Eurozone banks by mid-2013. At her annual summer news conference, Merkel seemed to agree that a go-slow approach was more appropriate and reiterated that a banking supervision body must be in place before direct ESM recapitalisation of banks can occur. Elsewhere, Merkel said that she had not spoken to PM Monti about an Italian bailout. Moving on to Greece the kathimerini is reporting that discussions between the government and the troika over EU11.5bn of budget cuts are continuing. Greece's coalition leaders are hoping to agree to cuts amongst themselves by this Thursday, after which Greece's finance minister will conclude talks with the Troika. Austrian Finance Minister Maria Fekter said that Greece may get a short-term extension on its program, but not more money. Asked if Athens would get a debt package extension, she said: "Yes. We are still awaiting the troika report and Greece still has to get some things on track but we will achieve a cost-neutral extension".