Tuesday, August 27, 2019

Capital Markets: "Realism Fights Back After Hope Dominated Yesterday"

From Marc to Market:
Overview: Hope triumphed over realism yesterday, and realism is fighting back toward. Asia Pacific markets, however, traded on the echo from the recovery in North America on Monday. The MSCI Asia Pacific recouped part of yesterday's drop, led by Chinese markets. Hong Kong was the main exception. The enthusiasm faded by the European morning and the Dow Jones Stoxx is threating a fourth consecutive losing session, dragged down by communication, consumer staples, and health care sectors. US shares are trading lower in Europe, and the early call is for the S&P 500 to open about a little lower. Bonds yields edged higher in the Asia Pacific but are coming in lower in Europe. Hopes of a Five Star/PD government has sent Italian bonds sharply lower, though no deal has been announced and the early gains have been pared. The dollar is trading mixed, with the Antipodean currencies off about 0.3% and the yen and Swedish krona are battling for top honors and are up about 0.3%. The liquid and freely accessible emerging market currencies are trading 0.2%-0.4% lower.

Asia Pacific
The PBOC set the dollar's reference rate at CNY7.0810. A Reuters survey found a median forecast for CNY7.1055
This illustrates that the PBOC continues to temper the market pressure. The pressure remains, and the dollar is trading above CNY7.16 in late mainland dealings. The offshore yuan is weaker still, and the dollar is a little below CNH7.18. It is the ninth consecutive decline for CNY. Separately, China reported a 2.6% rise in July industrial profits after a 3.1% slump in June. Year-to-date, profits are off 1.7%.

Some observers are looking at how China responded to the latest round of US tariffs and are concluding that it is running out of leverage. We think this is mistaken. First, there are more commercial steps China could take, including targeting US companies for which there is a strong European alternative, such as aircraft. It could also expand the list of companies on its "unreliable entity list." Second, and more importantly, if the US dominates the trade escalation ladder, and we assume a rational actor, then China could be expected to move to a different escalation ladder.

Two developments in Japan are noteworthy. First, Trump conditioned his decision not to levy new auto tariffs on Japan by reserving the right to do so in the future. This does not sit well with Japanese officials, and they will seek to block this in the final agreement expected next month. Second, South Korea indicated that if a rapprochement with Japan can be struck before the current intelligence-sharing pact ends on November 23, it can be renewed. The tension between the two remains high....