Capital Markets: "China Strikes Back"

From Marc to Market:

Overview: Chinese officials took the US tariff hike quietly last week but struck back today. The PBOC fixed the dollar higher (CNY6.90), which it has not done, and will halt imports of US agriculture. The dollar shot through CNY7.0 to finish the mainland session a little above CNY7.03 and CNH7.07 for the offshore yuan. This has sent ripple effects through the global equities, which were already on the defensive at the end of last week. Most markets in the Asia Pacific region were off 1%-2%, which the Hang Seng down among the most (~-2.8%). Korea's NASDAQ equivalent plummeted almost 8%, helping to send the Korean won down 1.4%, the most among the emerging market currencies. European shares are following suit and the Dow Jones Stoxx 600 gapped lower and is off around 1.5% in mid-morning dealings after shedding nearly 2.5% before the weekend. The prospects of a full-blown currency and trade war also are seeing yields tumble. European bond yields are two-three basis points lower, while the 10-year US Treasury yield is off nearly eight basis points to 1.77%. The yen and Swiss franc are the strongest of the major currencies, while the dollar-bloc, Scandis, and sterling are on their back foot. Gold is a big beneficiary of the turmoil and is trading a little above $1455, new six-year highs. Oil has given back about half of its pre-weekend gains, leaving September WTI straddling the $55-level.

Asia Pacific
Over the weekend, the Nikkei reported that the US and Japan will seek to strike a trade agreement by the end of next month. As we have noted, Japan's free trade agreements (TPP and with the EU) have put US producers at a disadvantage. The US is pressing to be given the best terms that Japan has struck with others in agriculture. Japan reportedly is pushing for the US to remove tariffs on industrial goods, including car parts. There will be two opportunities for Trump and Abe to meet directly. August 24 is the G7 summit in France and September 17 the opening of the UN General Assembly.

The demonstrations in Hong Kong are escalating and is drawing in more of the public than the Umbrella Movement, and the protesters have developed new tactics. Top party officials are meeting in their annual conclave, and their restraint is like limited. In response, the risk is that people and capital leave Hong Kong. The Hang Seng fell 5.2% last week and finished more than three standard deviations below the 20-day moving average (Bollinger Band is set at two standard deviations). Today, it saw among the sharpest losses in the region with a 2.8% drop. The economy is being squeezed. The July manufacturing PMI fell to 43.8 from 47.9. Output fell to 40.5, the lowest since March 2009.

Japan's composite PMI for July was confirmed at 51.2, up from 50.8. China's Caixin composite PMI edged to 50.9 from 50.6. The price action in the foreign exchange market paid little notice. The dollar, which had briefly traded above JPY109 in the middle of last week, is being pushed through JPY106 today. The flash crash low at the start of the year saw the dollar trade to almost JPY104.80. Below there, and the JPY100 looms. The strength of the yen and the weakness of the yuan conspired to send the Australian dollar sharply lower. Recall that before the weekend, the Aussie posted the most minor of gains to snap a 10-day slide. The slide resumed today as it was sold a little through $0.6750. Its flash crash low was closer to $0.6740, which it has not traded below since 2009. Chinese officials offered a small olive branch. It noted that the CNY7.0 level "was not like an age that when passed, cannot return."

Europe
The escalation of the US-Chinese trade conflict will not do Europe any favors. It comes as the eurozone is struggling. Germany's July composite PMI fell to 50.9 from the flash reading of 51.4 and 52.6 in June. France ticked up to 51.9 from 51.7 flash report but is still off from June's 52.7 results. Spain disappointed with its composite falling to 51.7 from 52.1. Italy offered a rare and pleasant upside surprise. Its composite rose to 51.0 from 50.1. The UK composite PMI popped back above the 50 boom/bust level reaching 50.7. It had fallen to 49.7 in June....

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