Market Overview: European Open


Overnight Headlines

  • US Treasury designates China as a currency manipulator
  • Yuan hits new lows but PBOC seeks to stem slide with stronger fix
  • China halting new agricultural purchases, may slap tariffs on farm goods
  • RBA leaves cash rate on hold; to adjust policy if needed to support growth

US equities opened sharply lower yesterday and suffered their largest one-day drop of the year, closing near their lows, down 3-3.5%. The S&P500 closed below its well-watched 200-day moving average hitting two-month lows, although futures have bounced overnight taking the index back above 2800. All sectors closed lower leaving the benchmark index down 6% from its record high in July.

USD generally weakened in response to trade tensions with the DXY falling the most since January. There was a noticeable bearish reversal pattern that typically occurs at the top of uptrends on the weekly chart, having made new cycle highs close to 99. 

US bond yields tumbled down more than 12bp below 1.70%, with 10-year yields hitting their lowest level since November 2016. This was the seventh straight day of declines, the longest streak since 2012. Ten-year yields have dropped more than 30bps in three trading days and this has resulted in more curve inversion. This is the difference between the yield on three-month treasury bills and the benchmark 10-year bond which is now at its widest since the eve of the fininancial crisis in April 2007.

Currently, a Fed rate cut in September is fully priced in and there is a growing chance of a 50bp cut. The Fed funds futures market is pricing in a 31% chance that the Fed will move two notches.

All eyes are on the ongoing US-China trade conflict. The US government last night determined that China is manipulating its currency and will engage with the International Monetary Fund (IMF) to eliminate unfair competition from Beijing, US Treasury Secretary Steven Mnuchin said in a statement.

This is the first time China is being labelled a currency manipulator by US Treasury since 1994 and although it is primarily symbolic given the new tariffs already in place, the move is certainly yet another escalation of the trade war. Market participants are increasingly discussing if China is now changing its tactics and moving from a trade war to a currency war by weakening the yuan. 

It seems the market is not blinking and is now increasingly pricing in that the trade war will have long-term consequences. We note that yesterday saw long-term US inflation indicators fall to their lowest in three years. This is essentially saying that the market is telling the Fed that it is behind the curve and that rate cuts will not be able to push up long-term inflation meaningfully. 

However, USD/CNY has come off its highs made overnight even as the PBOC set the mid-point for onshore trading at a stronger level than expected this morning. The stronger yuan level has helped stabilise US equity futures so the market will now be focusing on how the US President views today's move, with his tweets looking increasingly like he is personally taking control of US trade policy. 

As expected, the RBA left its cash rate unchanged at 1% after cutting rates by 50bps over its last two meetings. However, the central bank pointed to threats to growth posed by a slowdown in the global economy and a housing market downturn, as well as the ramifications of rising trade tensions. The risks are skewed towards a modestly higher unemployment rate in the next couple of months which means more rate cuts are in the pipeline. 

Currency Majors

EUR pushed above 1.12 overnight as equities tumbled, with weaker than expected ISM non-manufacturing data also weighing on the USD. A further rally to test July’s highs of 1.1281 is on the cards today although short-term momentum indicators are quite stretched. Meanwhile, support is at 1.1200 and 1.1160. Over the longer-term, EUR is likely to consolidate recent gains and trade in a higher range between 1.1150 and 1.1300. A drop below 1.1160 would indicate that the recent strength in the euro has run its course and may be resuming its downtrend.

GBP is consolidating its recent losses with prices trading in very tight ranges over the last few sessions. Somewhat bizarrely, GBP is therefore the most 'stable' currency this week, with strong support at 1.2100 holding for a third day while 1.2190 has limited price gains. The next breakout is likely to be a strong one given the price action as price compression often precedes periods of higher volatility. 1.1985 is the minor low from January 2017 on the weekly chart, with 1.2260 offering strong resistance on the upside.

JPY is strongest major currency this month in the current risk-off environment due to its safe haven status and little correlation to daily CNH moves. Price action is volatile with key support at 105.50 and then January’s flash crash low of 104.96 in focus. On the upside, resistance is expected at 107.21 and only a recovery above 107.90/108 would indicate that downside pressures on the USD have eased. 

Key Events

Watch out for Trump's tweets (aka more 'dollar jawboning') and any official announcements regarding concrete retaliation from China. The risk of an all-out trade war and potential currency conflict is rising and with risk-off trade comes a weaker dollar. 

In terms of economic data releases, it is a quiet day but there will be some focus on Fed Bullard's speech tonight. He is one of the most dovish FOMC members but has only hinted that he wants one interest rate cut. It will therefore be interesting to see whether he has changed his stance given the latest development in the trade war and markets.

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