The muted reaction of markets to the expected Trump escalation of trade measures on China reflects less calm and more hope that negotiations follow and lead to a deal. The tiered roll-out of new US tariffs on Chinese goods confirms the skirmishes leading to a larger battle but the 10% rate is lower and any 25% increase is months away, allowing time for a deal. The bounce back in Asia shares and CNY reflect that most of this isn’t news but as expected. China also didn’t immediately retaliate though it did vow to react later.  

The Chinese are stoically planning more domestic stimulus with more stockpiling to wait it out. The WSJ highlights the unintended consequences of this mess – as the process helps China be more competitive.   

However, today’s muted reactions have no voice in future risks and as such the relief rally may be less convincing. The economic battles between the US and China have a larger political backdrop as China uses this as an opportunity to win over hearts and minds with Europe clearly at the center. The battle lines for this war are growing not shrinking. For markets today, there was little other news and the muted reactions in equities helped but emerging markets are less obviously joining the party and commodity currencies like AUD and CAD are bouncing a bit but not out of their bearish range. As for the key on the day, pay attention to EUR/CNY – its flashing red for USD in general as EUR breaks 8 and opens 8.25 targets.  

The Chinese maybe in the process of looking to replace US with Europe in a more meaningful way and this means capital flows despite political risks or ECB doubts. 

Question for the Day:Does oil tell us something today? The rally up in oil in Europe was notable – 1.7% up in Brent from the open as Saudi comments suggest they are comfortable with oil over $80. Perhaps this reflects their inability to counter the Iran sanction induced supply hit and the $70-$80 range myth. Perhaps it reflects a shift on global growth as US and China tariffs haven’t hit GDP or orders as much as feared. Perhaps oil is merely reflecting the USD turndown and more depreciation risks as OPEC points toward Beijing rather than Washington. Markets need to pay attention to Brent as this $80 level looks like a breakout zone for the coiled spring risk of $87bbl. If oil prices rise, room for both ECB and FOMC to pause becomes less clear and rate normalization speeds up eventually hurting growth and stocks. 

What Happened?

• Australia 2Q house prices fell 0.7% q/q, -0.6% y/y after -0.7% q/q, +2% y/y – slightly better than -1% q/q expected– but first annual drop since June 2012. "The initial slowdown in these markets was spurred by regulatory changes and a tightening in the supply of credit to investors. A drop in investor demand over recent months appears to be adding to the slowing in housing credit growth. The effect of this is more pronounced in the larger property markets of Sydney and Melbourne." Annually, property prices fell 3.9% in Sydney, recording the largest price fall since the March quarter 2009, while annual growth in Melbourne (+2.3%) continued to slow. The total value of Australia's 10 million residential dwellings decreased $13.3 billion to $6.9 trillion. The mean price of dwellings in Australia is now $686,200.
• Australia RBA September meeting minutes: Hawkish tone despite increased uncertainty and risks. The RBA showed more confidence in its current monetary policy stance, saying this was based on not just its forecasts but also takes into account "associated risks." In the August Statement on Monetary Policy, the RBA pointed to several risks to its forecasts, which included some upside risks from depreciation in the Australian dollar. It appears that the RBA is more confident of the upside risks than the downside ones. The central bank also was positive on the labor market, not worried about the recent mortgage rate bank hikes nor about housing prices. The RBA reiterated that the direction of international trade policy in the U.S. continued to be a source of uncertainty for the world economy. For the local economy, uncertainties from abroad and low wages growth continued to be risks, the RBA said.
• Italy June industrial Sales -1% m/m, +2.9% y/y after +4.7% y/yand orders -2.3% m/m, +2.8% y/y after -1.5% m/m, 2% y/y. Sales were off 1.4% m/m domestically and -0.4% m/m foreign. The 3M average sales were +1.4% with 1.1% domestic and +1.8% foreign. 

Market Recap:

Equities: The S&P500 futures are up 0.2% after losing 0.56% yesterday. The Stoxx Europe 600 is up 0.1% - best in 2 weeks – as autos shrug off tariff fears. The MSCI Asia Pacific jumped 0.8% - best in 2 weeks – with MSCI EM also up 0.2%

• Japan Nikkei up 1.41% to 23,420.54
• Korea Kospi up 0.26% to 2,308.98
• Hong Kong Hang Seng up 0.56% to 27,084.66
• China Shanghai Composite up 1.82% to 2,699.95
• Australia ASX off 0.39% to 6,269.50
• India NSE50 off 0.82% to 11,284.75
• UK FTSE so far up 0.2% to 7,315
• German DAX so far up 0.3% to 12,134
• French CAC40 so far up 0.3% to 5,367
• Italian FTSE so far down 0.1% to 21,100

Fixed Income: US bonds are softer with global shares higher despite US/China tariff concerns, EU bonds are mixed with focus on supply and Italy rebounding then stalling – periphery is clearly key – Greek 10Y yields up 5.5bps to 4.05% Portugal up 1bps to 1.83%, Italy off 0.5bps to 2.835% and Spain off 0.5bps to 1.48%. German Bunds are off 0.5bps t 0.455%, French OATs flat at 0.77% and UK Gilts flat at 1.53%. 

• Germany sold E3.102bn of 2Y Sep 2020 Schatz at -0.54% with 2.4 cover– previously -0.61% with real cover 1.268%. 
• Spain sold E2.0bn of 3M and 9M bills– E0.53bn of 3M Dec 2018 at -0.487% with 5.19 cover and E1.47bn of 9M at -0.386% with 2.87 cover. 
• US Bonds are lower with bear steepening trade– 2Y up 0.4bps to 2.782%, 3Y up 0.6bps to 2849%, 5Y up 1bps to 2.898% 10Y up 1.1bps to 2.998% and 30Y up 1.4bps to 3.142%. 
• Japan JGBs catch up from long-weekend curve steeper, focus is on BOJ– 2Y off 0.1bps to -0.12%, 5y flat at -0.073%, 10Y off 0.1bps to 0.107%, 30Y up 0.5bps to 0.839%. Rinban today left size unchanged at Y690bn but offer to cover ratios in long-end jumped notably – 5-10Y 2.5 from 2.3, 10-25Y 3.23 from 3.0 and 25+Y 4.08 from 2.67. The MOF sold Y1.725trn of 1Y notes at -0.1358% with 4.78 cover – previously -0.1557% and 5.136 cover. 
• Australian bonds lower with less scary US/China tariffs, hawkish RBA minutes– 3Y up 3.9bps to 2.065%, 10Y up 3.7bps to 2.658%. AOFM syndicated A$3.75bn of a new 1% Feb 2050 linker with real yield 1.16% - there were $7.78bn in bids, in conjunction they also repurchased $2.07bn of 4% Aug 2020 linkers at real yield 0.24%. 
• China PBOC adds net CNY200bn on the day, the central bank injects CNY150bn via 7-day reverse repos, CNY50bn via 14-day reverse repos. There are CNY270bn in reverse repos maturing this week, but none today.  Money market rates rose with O/N up 20bps to 2.657% and 7-day up 6bps to 2.685%. 10Y yields up 1bps to 3.635%. 

Foreign Exchange: The US dollar index is up 0.1% to 94.56 with 100-day focus. The USD is mixed in EM today with TRY lower key focus along with CNY relative calm. In EMEA, USD mixed: RUB up 0.5% to 67.75 but ZAR off 0.3% to 14.96 and TRY off 1.15% to 6.3850. In Asia USD mostly lower– TWD flat at 30.806, KRW up 0.3% to 1123.3, INR off 0.3% to 72.72. 

• EUR: 1.1675 off 0.05%.Range 1.1667-1.1718 with test of 1.1720 failed again and focus back on US rates/data
• JPY: 112.10 up 0.2%.Range 111.67-112.28 with 112 pivot for 113.20 next. EUR/JPY 130.85 up 0.15% with focus on 130 base for 132.50 with stocks the key. 
• GBP: 1.3125 off 0.25%.Range 1.3119-1.3171 with EUR/GBP .8895 up 0.2% - waiting for data and more Brexit news. 1.30-1.32 consolidation
• AUD: .7200 up 0.3%.Range .7144-.7221 with RBA and China rally key. NZD up 0.2% to .6590 with .6540-.6620 keys – growth central to holding bid. 
• CAD: 1.3025 off 0.15%.Range 1.3013-1.3065 with AUD leading and hopes for NAFTA talks rising 1.30 pivot for 1.2880 retest. 
• CHF: .9620 off 0.1%.Range .9601-.9631 with EUR/CHF 1.1230 off .1% - still flashing yellow with SNB key. 
• CNY: 6.8554 fixed 0.09% weaker from 6.8509, trades off 0.2% to 6.8675 after promises of retaliation to US tariffs. Range 6.8538-6.8818. 

Commodities: Oil up, Gold off, Copper up 1.8% to $2.7210. 

• Oil: $69.83 up 1.3%. Range $68.53-$69.95. Oil reverses from -0.1% into Europe as Saudi comments suggest they are comfortable with Brent over $80 – which would be a key technical breakout. WTI watching $66.86 Sep 7 lows against $71.40 Sep 4 highs with $70 pivot in play. Brent up 1.5% to $79.22 - watching $80 resistance still with 55-day as base at $75.21. 
• Gold: $1199 off 0.2%.Range $1197-$1202. Gold remains stuck with $1213 55-day capping and $1183.20 Aug 24 base. Silver $14.19 up 0.1%, watching $13.942 Sep 11 lows against $14.41 20-day resistance. Platinum up 0.5% to $804.40 and Palladium up 0.4% to $991. 

Conclusions: Is inflation the real risk for markets? The US unemployment rate below 4% and the surge up in equities in the US has been the key story for bond bears. The wait for the Phillips Curve to work again and drive 10-year yields over 3.05% back to 3.25% or 3.5% is underway. This ties into the expectation that tariffs matter and will also increase in the short-term US prices. It also ties into an increase of the term-risk premium for US bonds as foreigners (particularly China) seem less likely to buy US debt. The yield curve in the US will be something to watch in the weeks ahead as the bears on growth meet the realities of supply/demand and inflation risks again. 

Economic Calendar:

• 0830 am Canada July Manufacturing Shipments 1.1%p 0.7%e
• 1000 am US Sep NAHB housing market index 67p 66e
• 0400 pm US July TIC long-term flows $114.5bn p $112bn e
• 0430 pm US weekly API crude oil stocks -8.63mb p -0.9mb e