Having ignored the creeping devaluation in the Yuan in recent days, today global equity markets had no choice but to notice that the plunge in the offshore Yuan is accelerating, and with no intervention by the PBOC, the Chinese currency tumbled to the lowest level in a year, which in turn has pressured Asian and European stocks, and US equity futures as traders start to worry that China is responding to trade war with currency war.

While fading overnight, the move in world stock markets has been contained, but the real story is the dramatic move in the Yuan, which dropped as much as 0.85% to 6.8032 per dollar in offshore trading, the lowest level since July 12, 2017.

On Thursday, the PBOC weakened its fixing on the onshore yuan below 6.7 for the first time since the start of the yuan drop in June. Contrary to misguided expectations that the PBOC would not let the yuan fall beyond 6.70, the fixing lower "signals the PBOC is not defending any line in the sand for the exchange rate and is comfortable with gradual yuan depreciation," said economist Tommy Xie, at Oversea-Chinese Banking. The signs of easing are "certainly not supportive to the yuan, and the currency may see another wave of selling pressures ahead."

However the big catalyst, as we reported last night, is that Beijing has launched a quasi-QE, in which the central bank announced it would use monetary policy instruments such as its medium-term loan facility (MLF) to support the local bond market and banks, especially those that have invested in bonds rated AA+ and below. Effectively, the PBOC will provide banks with liquidity, which they will then either lend out or use to buy stressed bonds, resulting in a hybrid QE outcome.

As a result, The yuan has fallen more than 4% in the past month, the worst performance among 31 major currencies, as China's economy decelerates and the trade spat with the U.S. escalates. According to Pimco, China will tolerate higher volatility in the yuan and a moderate weakening of the currency as long as there’s no major threat to financial stability.

At the same time, the onshore rate fell 0.87% to 6.7791, while in an unexpected twist, the Shanghai Composite stock index closed lower for a fifth straight day, failing to respond to China's attempts to boost animal spirits.

"China is actually giving the green light to send the yuan weaker,” said Sue Trinh, the head of Asia foreign-exchange strategy at Royal Bank of Canada in Hong Kong. “We’ve had no verbal intervention, lame efforts to slow the RMB’s descent and announcement upon an announcement of monetary and fiscal easing.”

"Market players are looking at both the onshore and offshore exchange rate to determine whether or not the People’s Bank of China is intentionally allowing a weaker yuan,” said Sumitomo strategist Ayako Sera.

Of course, the question then becomes how will Trump respond when he learns that instead of responding tit-for-tat to his trade tariffs, Beijing is engaging in not so stealthy devaluation: and it is concerns about Trump's unpredictability, together with worries about rising Yuan volatility and growing capital outflows, that are pressuring global markets. "If the difference between the two markets becomes too big, that could mean the PBOC is intervening in the market."

As a result of the ongoing yuan devaluation, a downbeat mood gripped equities, as European and Asian stocks dropped and even as corporate earnings continued to come in strong, S&P futures slipped.

The Stoxx Europe 600 Index slumped as mixed corporate results clouded the outlook; earnings dominated the morning with the likes of Anglo-Dutch giant Unilever (+0.5%) being a key focus. French advertising group Publicis (-7.2%) tumbled after missing expectations, dragging down FTSE 100 listed WPP (-3.2%) in sympathy. On the flip side, Shell (+1.4%) shares rose to the top of the index after a broker upgrade at Raymond James.  UK’s FTSE 100 outperforms its peers on the back of the drop in the pound below 1.30 for the first time since last September, after surprisingly poor UK retail sales.

The European weakness followed a subdued Asia session in which most indices finished in the red. Australia's ASX 200 (+0.3%) and Nikkei 225 (-0.1%) both opened higher with outperformance in industrials and mining-related sectors, while corporate updates also spurred trade. Shanghai Comp. (-0.5%) and Hang Seng (-0.4%) initially gained after further liquidity efforts by the PBoC and with the central bank mulling incentives to bolster lending. However, gains were capped amid the ongoing US-China trade friction including recent comments from NEC Director Kudlow who believes President Xi Jinping is 'holding up' progress on trade talks and is doubtful on the Chinese leader’s intention of following through on trade reforms, while concerns triggered by considerable CNH weakness pushed Chinese bourses past the tipping point and in turn pared gains in Japan.

Meanwhile in FX, as the Yuan tumbled, the dollar advanced against all G-10 peers after the Federal Reserve signaled that the U.S. economy is on solid footing, and in response to the ongoing yuan devaluation. The Bloomberg Dollar Spot Index advanced for a third day, touching a fresh two-week high; greenback strength helped the euro dip below $1.16, taking its losses in the past three days to almost 1%. 

“Sentiment right now is still very much in favor of buying the dollar,” said Crédit Agricole FX strategist Manuel Oliveri. "It is positively correlated with risk appetite and risk appetite remains supported by the U.S. earnings season and there is a very strong notion among clients that there is further room for improvement."

Elsewhere, Australia’s dollar jumped the most in a week after employment rose in June more than economists forecast, only to reverse the gain and fall as much as 0.7% as USD/CNY rose. Meanwhile, the pound dropped as tensions over Brexit endured and retail sales figures disappointed: the warm weather and World cup hit non-food items and resulted in a negative overall m/m sales figure, on top of yesterday’s softer than forecast CPI. Cable slumped through 1.3000 having breached daily support (1.3055) earlier to a fresh ytd base around 1.2985, but has regained big figure status amidst short covering and almost certainly with a mega 2 bn option expiry at the strike in mind.

The strengthening dollar did little to lift the mood elsewhere, and EMs are suffering more against the USD with the Rand looking for some potential support

Core European bonds fell alongside Treasuries, with the 10Y yield rising by 2bps to 2.8931. 

China fears hit metals markets (Beijin is the world’s biggest consumer of most industrial metals so worries about its economy can have a serious impact). Copper and nickel were both down over 2 percent on London’s metal exchange, while zinc was down more than 3 percent and lead shed 2.5 percent. Oil and gold also dropped again. Gold hit another one-year low of $1218.34 per ounce, while Brent and WTI U.S. crude futures were down 80 and 53 cents at $72.10 and $68.20 a barrel respectively.

Brent has fallen almost 9 percent from last week’s high above $79 on emerging evidence of higher production from Saudi Arabia and other members of the Organization of the Petroleum Exporting Countries as well as Russia and the United States. “The outlook remains negative,” said Robin Bieber, technical analyst at London brokerage PVM Oil Associates.

Looking at the day ahead, expected data include jobless claims, Philadelphia Fed Index and the Conference Board Leading Index. Bank of New York Mellon, Blackstone, Danaher, Philip Morris, Union Pacific and Microsoft are among companies reporting earnings.

Market Snapshot

• S&P 500 futures down 0.2% to 2,810.25
• STOXX Europe 600 down 0.3% to 386.11
• MXAP down 0.3% to 164.71
• MXAPJ down 0.4% to 533.69
• Nikkei down 0.1% to 22,764.68
• Topix down 0.09% to 1,749.59
• Hang Seng Index down 0.4% to 28,010.86
• Shanghai Composite down 0.5% to 2,772.55
• Sensex down 0.1% to 36,336.12
• Australia S&P/ASX 200 up 0.3% to 6,262.70
• Kospi down 0.3% to 2,282.29
• German 10Y yield rose 0.5 bps to 0.347%
• Euro down 0.3% to $1.1607
• Italian 10Y yield rose 3.7 bps to 2.241%
• Spanish 10Y yield fell 1.7 bps to 1.263%
• Brent futures down 1.1% to $72.13/bbl
• Gold spot down 0.8% to $1,217.92
• U.S. Dollar Index up 0.3% to 95.41

Top Overnight News

• The White House struggled for a second straight day on Wednesday to explain President Donald Trump’s posture on Russian election meddling, and some administration officials are concerned there may be no shaking public perception that Trump is too cozy with Vladimir Putin
• The European Union is preparing a new list of American goods to hit with protective measures, according to a person familiar with the move, in case a mission to Washington next week fails to persuade Trump not to raise car tariffs
• China accused American officials of making false accusations as it fired back against a claim Xi Jinping is blocking talks with the U.S. over the trade war between both nations
• Trump said he may prioritize a bilateral trade deal with Mexico over Canada and that he’s building a good rapport with Mexican President-elect Andres Manuel Lopez Obrador
• Fed Chairman Jerome Powell said the U.S. economy may not yet have reached full employment, while also noting that risks to the central bank’s inflation forecast were “roughly balanced”
• Trump’s economic adviser Larry Kudlow blamed Chinese President Xi Jinping for holding back talks aimed at easing a trade confrontation with the U.S

Asian markets were mixed as trade concerns and a weakening CNH clouded over the mostly positive lead from Wall Street where earnings remained in focus and the DJIA notched a 5th consecutive gain. ASX 200 (+0.3%) and Nikkei 225 (-0.1%) both opened higher with outperformance in industrials and mining-related sectors, while corporate updates also spurred trade. Shanghai Comp. (-0.5%) and Hang Seng (-0.4%) initially gained after further liquidity efforts by the PBoC and with the central bank mulling incentives to bolster lending. However, gains were capped amid the ongoing US-China trade friction including recent comments from NEC Director Kudlow who believes President Xi Jinping is 'holding up' progress on trade talks and is doubtful on the Chinese leader’s intention of following through on trade reforms, while concerns triggered by considerable CNH weakness pushed Chinese bourses past the tipping point and in turn, pared gains in Japan. Finally, 10yr JGBs were uneventful with prices flat for most the session although some support was seen in late trade as Japanese stocks wiped out gains, while a reduction in the BoJ’s Rinban purchases of 10yr-25yr and 25yr+ bonds also failed to spur any reaction. PBoC injected CNY 70bln via 7-day reverse repos and CNY 30bln via 14-day reverse repos, for a net daily injection of CNY 70bln, while the PBoC was also reported to gauged 1yr Medium-term Lending Facility demand for today

Top Asian News

• China Flirts With Easier Monetary Policy Amid Slowing Growth
• Aramco Mulls Sabic Stake Purchase Amid Oil Giant’s IPO Plans
• Astellas Is Said to Mull Selling Europe Assets to Raise Cash
• BOJ Cuts Purchases of 10-25 Year Bonds, Those Due In Over 25 Yrs

European equities traded on the backfoot (Eurostoxx 50 -0.2%) after initially trading choppy as earning season kicks into gear. UK’s FTSE 100 outperforms its peers on the back of currency effects amid weak UK retail sales. Energy names outperform, in-fitting with price action in WTI and Brent yesterday, while material names are subdued by the fall in base metals prices. As mentioned, earnings dominated the morning with the likes of Anglo-Dutch giant Unilever (+0.5%) being a key focus. French advertising group Publicis (-7.2%) fell to the foot of the French benchmark after missing expectations, dragging down FTSE 100 listed WPP (-3.2%) in sympathy. On the flip side, Shell (+1.4%) shares rose to the top of the index after a broker upgrade at Raymond James

Top European News

• Nordea Reaps Reward of Strategy Upheaval After a Punishing Year
• ABB Maintains New-Order Momentum as CEO’s Revamp Bears Fruit
• Generali Agrees to Sell Wealth, Services Units for $476 Million
• Sports Direct Tumbles as Ashley’s Debenhams Bet Backfires

In FX, the DXY index looks on the brink if not braced to test 95.531 ytd peaks after another upbeat rendition of the Fed’s semi-annual testimony from Chair Powell, and as rival currencies continue to underperform on yield divergence alongside ramped up global trade war maneuvers. As the import tariff spat between the US and China rages on, the YUAN has waned further to 6.7700+ in Cny terms and not far from 6.8000 on an off-shore basis (Cnh), which is viewed by some as the line in the sand for ‘official’ intervention. GBP:  Flogged anew after another UK data miss, as the warm weather and World cup boosted the sales of BBQ fodder, but hit non-food items and resulted in a negative overall m/m figure, on top of yesterday’s softer than forecast CPI. Cable slumped through 1.3000 having breached daily support (1.3055) earlier to a fresh ytd base around 1.2985, but has regained big figure status amidst short covering and almost certainly with a mega 2 bn option expiry at the strike in mind. EM - The rationale is well documented, so suffice to say that EMs are suffering more vs the Usd, with the Rand looking for some potential support from the SARB later.

In commodities, WTI and Brent crude futures have seen a pullback in European trade from the highs reached yesterday. Gains yesterday were largely fuelled by a covering of shorts post-DoEs, which despite revealing record US production, was accompanied by Cushing stockpiles falling to their lowest levels since 2014. Since then, energy newsflow has remained light with some traders mindful of supply disruptions amid reports that Yemeni rebels struck a Riyadh refinery, causing a fire; Aramco said, however, that operations were not impacted and that the fire was due to an operational incident. In metals markets, spot gold and silver sit at 1-year lows as the precious metals continue to fall victim to the firmer USD. Copper mirrored the lacklustre tone across most of the commodities complex during the Asia-Pac session as trade tensions lingered and CNH weakness clouded risk sentiment, whilst steel rebar futures hit their highest level in 10 months in Shanghai amid supply concerns. In terms of metals newsflow, Anglo American reported a 6% Y/Y increase in Q2 output whilst upgrading platinum production guidance.

Looking at the day ahead, in the US, the latest weekly initial jobless claims data is then followed by the release of the July Philadelphia Fed business outlook and June leading index print. Away from that, Microsoft will be releasing its Q2 earnings. The Fed's Quarles is also due to speak in the afternoon.

US Event Calendar

• 8:30am: Initial Jobless Claims, est. 220,000, prior 214,000; Continuing Claims, est. 1.73m, prior 1.74m
• 8:30am: Philadelphia Fed Business Outlook, est. 21.5, prior 19.9
• 9am: Fed’s Quarles Speaks on Alternative Reference Rates
• 9:45am: Bloomberg Economic Expectations, prior 56; Consumer Comfort, prior 58

DB's Craig Nicol concludes the overnight wrap

The bright spot for markets continues to be with equities for now. Another solid earnings report from the last of the big US banks – Morgan Stanley – helped the S&P 500 (+0.22%) climb for the 8th time in the last 10 sessions and take the index to within 2% of the all-time high made back at the start of this year. In fairness, it wasn’t the most exciting of days with the intraday range on the S&P just 0.39% and the 7th smallest this year. That said, banks – which rose +0.68% yesterday - have now risen close to 3% since the start of reporting season in the US and yesterday’s move helped to offset a more benign day for the tech sector with the Nasdaq (-0.01%) more or less flat and the NYSE FANG index slumping to a -0.66% loss. A quick glance at the headlines and you might have thought that Google’s $5bn fine from the EU would be to blame but the stock actually recovered to finish slightly up on the day.

It was a fairly decent day for equities in Europe meanwhile with the Stoxx 600 (+0.54%) up for the 10th time in the last 12 sessions. Tech actually led gains in Europe although it’s worth noting the climb for autos (+0.99%) too with President Trump saying yesterday that he expects the auto tariffs topic to be a focus at next week’s meeting with European Commission President Jean-Claude Juncker. Elsewhere bond markets continue to be a relative sideshow for now and despite supposedly being in the midst of a trade war and also having heard from Fed Chair Powell over the last 2 days, 10y Treasury yields moved a grand total of 0.9bps higher yesterday, having been virtually unchanged the day prior. The MOVE index is now down to the lowest level since mid-December last year having fallen close to 18pts from the end of May while 30-day realized volatility on the 10y is now at the lowest since 2007. In fairness it’s hardly been much more exciting in Europe with 10y Bunds 0.5bps lower in yield yesterday. On an intraday basis, the range on 10y Bunds has actually been just 9.7bps in July so far. So it’s fair to say that bond markets are reasonably quiet right now.

In other markets, despite giving up bigger gains midway through the day yesterday the USD index (+0.11%) continued its recent strong run while EM FX was generally a bit weaker. One exception was the Mexican Peso which made a bit of a U-turn in the late afternoon after President Trump suggested that the US and Mexico were “getting closer” to negotiating on a trade deal between the two countries. In commodities Oil had another volatile day, swinging from a -1.53% loss to a +1.00% gain by the end of play.

In Asia, this morning markets are starting to lose a bit of momentum as we type. The Nikkei (+0.17%) and Hang Seng (+0.04%) are the only bourses still up but both have faded from earlier highs, while the CSI 300 (-0.11%) and Shanghai Comp (-0.54%) have both dipped along with the Kospi (-0.20%). That’s despite China’s regulator asking financial institutions to start to implement plans to help financing for small firms, while the PBoC has also announced the plan to use its MLF to help encourage bank loans. Meanwhile, the Chinese Yuan is 0.28% weaker to the lowest since July 2017 while a spokeswoman for the country’s FX regulator noted that China will improve macro-prudential, counter-cyclical measures for foreign exchange management. Elsewhere, after the bell in the US, eBay’s share price dropped -5.6% after the company trimmed its full-year revenue forecasts, while American Express fell -2.8% post-earnings. S&P 500 futures are more or less flat, however. It’s worth also noting that early this morning the BoJ cut purchases in the 10-25y JGB bucket by 10bn Yen, as well as buying in the >25y bucket by 10bn Yen. So further evidence that the BoJ is continuing with stealth tapering. JGBs and the Yen are little changed.

Moving on. Where we did get a bit of a wakeup call yesterday was with the inflation data in the UK. Indeed core CPI missed fairly materially (+1.9% yoy vs. +2.1% expected) and fell two-tenths from May, while headline CPI (0.0% mom vs. +0.2% and +2.4% yoy vs. +2.6% expected) also came in softer than what both the market and BoE expected. Declining prices for clothing and recreation were attributed to the miss, with retail in particular guilty of discounted prices to attract customers away from the online retailers. Sterling immediately dropped post the data and touched an intraday low of $1.301 (-0.80%) before paring a bit of that to close at $1.3069, albeit still the lowest since last November. Gilt yields were also lower across the curve with 2y yields closing down -1.0bps and 10y yields down -3.2bps. A BoE rate hike next month was not quite a dead cert and that inflation data perhaps adds a bit of a curveball. That said other data in the UK has been fairly solid of late and the market continues to price in a slightly greater than 80% change of a hike next month.

Meanwhile, the core CPI print for the Euro area also came in on the softer side at +0.9% yoy, a one-tenth of a percent downward revision from the flash reading. However, that masked what was really just a bit of rounding as the actual difference between the flash and final print was only 0.02%. Bond markets were once again incredibly muted in Europe with 10y Bunds finishing just 0.5bps lower.

Since we rolled to the new on-the-run 10y Bund contract last week, the average daily move (up or down) has been just 1.5bps. It’s worth also noting that the MNI report quoting sources as saying that “wide margins of uncertainty” persist about a possible Euro area slowdown seemingly had little follow through to markets.

Over at the Fed, as expected there wasn’t a great deal of new news to come from Fed Chair Powell’s testimony before the House. Powell faced a question about whether a flatter yield curve could cause the Fed to accelerate the balance sheet unwind, to which Powell responded that the Committee is not thinking about changing it unless there was a meaningful downturn. The Fed Chair also confirmed that risks to inflation are “roughly balanced” but that the Fed is slightly “more worried about low inflation still”. He also noted that in terms of financial stability, “risks are at their normal levels” and “nothing really is flashing red in the financial markets”.

Staying with the Fed, last night’s Beige Book revealed that the US economy remains solid but with increased concerns on trade tensions, which didn’t sound particularly ground-breaking. In the details, 10 of the 12 districts reported “moderate to modest” growth with the exception in the Dallas District which reported “strong growth”, in part as it’s linked to the energy sector. On trade, “manufacturers in all districts expressed concerns about tariffs and in many districts reported higher prices and supply disruptions” and a number of districts reported higher input costs due to the import tariffs raising prices. Notably, there was only a “slight to moderate” pass-through of higher lumber and metal prices to end consumers for now. Elsewhere the report continued to note tight labor markets and a shortage of skilled workers, but wage increases remained “modest to moderate”, although it was noted that a couple of Districts had seen a pickup in the pace of wage growth.

Turning to trade, the US Commerce Department has confirmed it will open an investigation to “probe whether….uranium ore and product imports into the US threaten to impair the national security”, which could lead to higher import tariffs. Based on 2017 EIA data, US nuclear reactors get 33% of their uranium inputs from Canada, 19% from Australia and 16% from Russia.

Finally, as for the other US economic data out yesterday. The June housing starts data fell to a nine-month low, weighed down by higher mortgage rates, lumber prices, as well as ongoing labor shortages. Housing starts were down -12.3% mom to 1,173k (vs. 1,320k expected) while building permits fell for the third straight month, down -2.2% mom to 1,273k (vs. 1,330k expected).

Looking at the day ahead, the UK June retail sales print is due this morning, while in the US, the latest weekly initial jobless claims data is then followed by the release of the July Philadelphia Fed business outlook and June leading index print. Away from that, Microsoft will be releasing its Q2 earnings. The Fed's Quarles is also due to speak in the afternoon.