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EU data disappoints, risk-off mood again
Markets becoming numb to US-China trade updates
Markets are extruding a bit of skepticism and exhaustion when it comes to US-China trade negotiations. US Treasury Secretary Steven Mnuchin sound positive in remarks on trade talks yesterday stating they have “made a lot of progress”. He stated that the Chinese trade delegation including PBoC Governor YI Gang, would be traveling to Washington in October indicating “good faith”. Mnuchin stated that “conceptual” agreement on enforcement concerns had been agreed on. The issue of monitoring and enforcement seems to be a major blocker for moving forward. Finally, throwing in a grenade to risk appetite, he stated that President Trump has no problem keeping tariffs on China if a deal cannot be reached. Wall Street was un-impressed as S&P 500 was flat and DJIA eked out 0.1% gain. Today, concerns over slow developed on trade have held equities down. Also hurting sentiment, data indicated that China's factory-gate prices contracted, dropping deeper into the deflationary zone and underpinning the need for Beijing to increase economic stimulus as the trade war with the US drags-on. Rates, however, were more active, with a sharp rise in global bond yields. US yield curve shifted higher with US 10-yr yields jumping 8bps to 1.64% and 30-yr yields climbed 10bp to 2.13%. German 10-yr yields increased 5bp to -0.585%.
Oil also has a big day with WTI up 2.7% as Saudi Arabia's energy minister signaled there would be no drastic shift in his country's (or that of OPEC) oil policy to lower production by 1.2 million barrels per day. Rumors of a fiscal stimulus out of Germany have support Euro buying (offsetting further ECB easing). Todays, the calendar is light with JOLTS job opening potential providing insight into the strength of US labor market deceleration. In broad terms, while US-China trade tensions and Brexit threaten growth they also force looser financial conditions. Expansionary monetary policy has the support risk appetite for the last 12 years and will continue to do so.
EU data on the soft side
The latest batch of European data does not paint a bright picture of the economy. The first signs of weakness came from German when manufacturing PMIs dropped below the 50 threshold and economic growth contracted in the second quarter. On the other hand, it seems that the weakness was contained to Germany as France, Portugal and even Spain appeared surprisingly resilient. However, some cracks are appearing in the other economies as well, especially in the industrial and manufacturing sectors. In July, Italy’s industrial production contracted 0.7%y/y (versus +0.3% expected and -1.2% in June), France’s gauge fell -0.2%y/y (+0.5% exp. and -0.1% in June), while the German one dropped 4.2%y/y compared to -3.9% forecasted and -1.1% in the previous month. However, this weakness may be due to temporary factors, it is still too early to determine.
The market is waiting for the ECB bazooka stimulus that should be announced on Thursday. The recent weakness, together with the collapse of inflation expectation - 5y5y swap rate fell to 0.99% compared to 1.59% at the beginning of the year – clear up any doubts that the ECB will under deliver. We are convinced that the ECB announce the full package, i.e. 20bps cut to the deposit rate and a return to QE on corporate and sovereign debt with substantial buying. Against such a backdrop, the euro should experience further weakness; while equities should get a boost (one should remain careful with banks, though).