The return on capital matters more than return of capital today. Celebrations around Italian debt downgrades being less painful (in other words not junk status) that is the first driver, joy over China re-leveraging the other as shares there jump the most in 3-years up over 4%. The news isn’t all easy, however, as AUD slips back to near the yearly lows on politics as PM Morrison looks likely to lose his parliamentary majority post the Wentworth by-election. In the UK, GBP is lower as PM May faces a full rebellion of pro-Brexit Tories with EUR/GBP watching the 200-day at .8835. The data was sparse overnight but important to consider as the Japan FSR highlights real estate risks, as China house prices jump again, as the Bundesbank downplays the auto sector 3Q pullback and as the EU shows primary budget surpluses in 2017 everywhere but the periphery (and with Germany beating Greece in the surplus game). This isn’t the stuff that sparks growth, putting ECB policy decisions as central for the forecast and for the week ahead. The EUR bounce up into the EU open stalls with BTPs finding a limit to the joy of not being junk. The risk moods are tempered by the geopolitical clouds from the US/Russia nuclear treaty unwind and the ongoing Saudi/Khashoggi crisis, but the overarching driver for risk remains 3Q earnings and that brings 158 companies in the US S&P500 this week. For those trading on a quiet Monday, the AUD/JPY maybe the currency pair to watch as it captures the commodity/China growth hopes along with carry trade support against the fear about debt and politics. Watch 79 for risk downshifts and 82 for clear signals of a bigger rally.  

Question for the Day: Are markets to be manipulated or feared? There is a larger problem at play as the FOMC and others race to normalize rates and return market correlations to the old rules – bonds up, stocks down or vice-versa. The trust in markets post 2008 has never been lower and the manipulation of markets by central bankers and government never higher. The Chinese actions over Friday are still the case in point – with a bold squeeze of shorts driving out the fears about stocks and perhaps pushing back on the debt doubts behind it. The trust in markets is worth thinking about and the Mark Carney Speech last Friday at the New York Economic Club worth reading. He highlights the three lies of finance: 1) This time is different, 2) Markets are always clear, 3) Markets are moral.  

Specific to China, Carney notes the following: For example, while China’s economic miracle over the past three decades has been extraordinary, its post-crisis performance has increasingly relied on a large build-up of debt and an associated explosion of shadow banking. The non-bank finance sector has increased from around 10% of GDP a decade ago to over 100% now, with developments echoing thosein the pre-crisis US such as off-balance sheet vehicles with large maturity mismatches, sharp increases in repo-financing, and large contingent liabilities of borrowers and banks. The Chinese authorities recognize that “this time may not be different” and have begun taking measures to manage the risks.

What Happened?

• China MPC PBOC Ma: Beijing may increase tax cuts to spur confidence. The government under Premier Li Keqiang may cut taxes and administrative fees next year amounting to more than 1% of the country's economy, Ma, also the former chief economist at the People's Bank of China (PBOC), said in a press statement. "There will be a series of policy measures to enhance investors' confidence in the market in the near future," Ma said commenting on a meeting by the State Council's Financial Stability and Development Committee that followed last week’s crash. "Substantial measures" to alleviate financing difficulties for private enterprises can also be expected in the near future, Ma predicted. Regulators may forbid lenders to discriminate against private business borrowers using the clause of "lifetime liabilities on defaults," while special funds guaranteed by the government may be set up to encourage lending, said Ma.

• China September house prices  (70-major cities) up 0.9% m/m, 7.9% y/yafter 7.0% y/y - 14-month high. 64 out of the 70 cities surveyed by the National Bureau of Statistics (NBS) reported a monthly price increase for new homes, though the number was down from 67 in August. Xian led the gains up 6.2% m/m. Property sales by floor area fell 3.6 percent in September from a year earlier, compared with a 2.4 percent gain in August, according to Reuters calculations, the first decline since April. In year-to-date terms, property sales rose 2.9 percent in the first three quarters. 

• BOJ Financial Stability Report: No overheating, but warns on bank capital."In a stress event, downward pressure on the economy from the financial system -- a decrease in financial institutions' risk taking -- would be more ikely to intensify than in the past," the FSR said. "Financial institutions that have actively engaged in risk taking, in areas such as lending to middle-risk firms and the real estate sector, as well as securities investment, could experience larger declines in their capital because of credit costs and losses on securities," the report added. Two other points stand out – 1) The core capital ratios for domestic banks have gradually declined recently as banks haven't increased profits equivalent to risks. 2) The real estate loans to GDP ratio has reached a historical high, deviating from its trend.
• German Bundesbank Monthly Report: Notes temporary 3Q pause in growth. The Monthly Report states that the Bank’s experts do not expect the pause in growth to be long-lived, and that the difficulties in the automotive industry should soon be over, pointing out that business expectations in this sector again rose significantly of late. Given that, according to the ifo Institute, the overall business climate in Germany also picked up appreciably in the third quarter, the Bundesbank expects German economic output to expand considerably again in the current three-month period.
• Eurozone 2017 government deficit 1% of GDP, debt at 86.8% down from 89.1%. Government budget surpluses were recorded in Malta (3.5% of GDP), Cyprus (1.8%), Sweden (1.8%), Czech (1.5%), Luxembourg (1.4%), Netherlands (1.2%), Bulgaria (1.1%), Denmark (1.1%), Germany (1.0%), Croatia (0.9%), Greece (0.8%) while deficits were seen in Finland (-0.7%), Spain (-3.1%) and Portugal (-3%). As for debt, the highest debt to GDP was in Greece at 176.1%, Italy 131.2%, Portugal 124.8%, Belgium 103.4%, France 98.5% and Spain at 98.1%.  

Market Recap:

Equities: The S&P500 futures are up 0.2% after losing 0.04% Friday. The Stoxx Europe 600 is up 0.3% with miners and insurers leading. The Asia Pacific Index rose 1% as China bounces but India and Australia lag on politics. 

• Japan Nikkei up 0.37% to 22,614.82
• Korea Kospi up 0.25% to 2,161.71
• Hong Kong Hang Seng up 2.32% to 26,153.15
• China Shanghai Composite up 4.09% to 2,654.88
• Australia ASX off 0.61% to 6,006.20
• India NSE50 off 0.57% to 10,245.25
• UK FTSE so far up 0.65% to 7,096
• German DAX so far up 0.55% to 11,615
• French CAC40 so far up 0.3% to 5,100
• Italian FTSE so far up 0.7% to 19,212

Fixed Income: EU bonds see unwinding of fear trade, Bunds lower with curve steeper. Italy is the main focus still with relief rally post Moody’s downgrade. German 10-year Bund yields up 1.5bps to 0.47%, French OATs up 0.5bps to 0.835%, UK Gilts off 0.5bps to 1.57% while periphery rallies with Italy off 6bps to 3.41%, Spain off 4.5bps to 1.68%, Portugal off 3bps to 1.98% and Greece off 5bps to 4.255%. 

• US Bonds sold off with risk-on mood, supply ahead– 2Y up 0.4bps to 2.908%, 5Y up 0.9bps to 3.055%, 10Y up 1bps to 3.202%, 30Y up 0.6bps to 3.382%. 
• Japan JGBs stuck in tight ranges again– 2Y up 0.2bps to -0.122%, 5Y up 0.5bps to -0.063%, 10Y up 0.6bps to 0.145%, 30Y up 0.4bps to 0.908%. 
• Australian bonds track US with risk-on focus with China shares beating Wentworth by-election fears– 3Y up 0.6bps to 2.04%, 10Y up 2.3bps to 2.70%. The AOFM sold A$500mn of 3Y 2.25% Nov 2022 bonds TB153 at 2.1921% with 6.45 cover –previously 2.1725% with 5.898 cover. 
• China PBOC injects net CNY120bn via 7-day reverse repos, Money market rates were higher with 7-day up 4bps to 2.64%. 

Foreign Exchange: The US dollar index is flat at 95.75. In EM FX, USD mostly lower with risk-on but CNY flip still key – EMEA:ZAR up 0.75% to 14.30 ahead of budget; RUB up 0.35% to 65.22 with US/oil key; TRY off 0.5% to 5.667 – unwinding stocks key; ASIA:TWD up 0.1% to 30.9, KRW up 0.3% to 1129 with BOK Nov hike talk key, INR off 0.2% to 73.47. 

• EUR: 1.1505 off 0.1%. Range 1.1496-1.1550 with rally up on Italy fading into US and watching crosses and rates with 1.1420 key. 
• JPY: 112.85 up 0.25%.Range 112.35-112.88 with EUR/JPY 129.85 up 0.2% - focus is on equity bounce with 112 base for 114 retest. 
• GBP: 1.3030 off 0.1%.Range 1.3021-1.3090 with EUR/GBP .8830 up 0.2% - focus is on Brexit and politics still with 1.30 pivotal.
• AUD: .7100 off 0.25%.Range .7088-.7127 with by-election blues for government with .70 barrier next play – NZD 0.6580 off 0.2% waiting for trade data. 
• CAD: 1.3090 off 0.1%.Range 1.3080-1.3117 with oil and rates helpping but BOC and outlook key focus for the week and risk post CPI/retail sales for 1.3250. 
• CHF: .9970 up 0.1%.Range .9940-.9980 with EUR/CHF 1.1470 flat – no Italy or China fears so tracking EUR and JPY with 1.00 key pivot. 
• CNY: 6.9236 fixed 0.08% strongerfrom 6.9287, now 6.9400 off 0.2% with range 6.2958-6.9445 – stronger shares, weaker currency? 

Commodities: Oil up, Gold off, Copper up 0.5% to 2.8340

• Oil: $69.20 up 0.1%.Range $$69.03-$69.65 with WTI focus on $66 and $68 support against $70 pivot. Brenat up 0.3% to $80.03 with $80 pivot in play for $82.15 tests against 55-day at $78.26. IEA also downplays Saudi oil production shutdown over Khashoggi but market still tight. 
• Gold:  $1224.30 off 0.2%with USD/Rates and less Italy/China fear driving – watching $1202 55-day against $1230 resistance. Silver up 0.2% to $14.65 - watching 55-day at $14.56 against $14.91 Oct 2 highs. 

Conclusions: Is the US debt the next big problem? The rise in the US borrowing needs in 2018 has been a quiet driver for rates in the US and the front-end of the curve reflects some of this supply issue. The Carney speech noted above is worth reading in the context of government debt and the stark comparison of the UK and EU actions to that of the US in the last 5 years is worth noting – particularly given the EU 1% budget deficit in 2017 compared to the US.  The risk of US debt being the fear that drags down the USD and the stock market isn’t on the radar now but after the mid-terms it maybe back in play. 

Economic Calendar:

• 0830 am US Sep Chicago Fed National Activity 0.18p 0.15e
• 0830 am Canada Aug wholesale sales (m/m) 1.5%p 0.2%e
• 1130 am US Treasury sells 3M and 6M bills