Following MSCI’s second Chinese snub in as many years, when yesterday the indexer again decided not to include China in its EM index due to concerns over Chinese “market integrity”, there was some concern that Chinese stocks would tumble now that China’s market manipulation is the primary topic preventing the country from being integrated into the financial community. That was ironic because after Chinese equities opened down around a percent they promptly spiked with Shanghai closing 1.6% higher, despite the global risk off yesterday, on – you guessed it – more manipulation and government intervention, which pushed not only Chinese equities higher but the USDCNY which after rising to the highest in 5 years, dipped just fractionally below the key resistance level of 6.60.

“It’s a sharp [equities] reversal so there has to be some government intervention,” said Francis Lun, CEO at Geo Securities in Hong Kong. “The Chinese government never wants to see the market falling too much.”  Dear Francis, no government ever wants to see that.

Aside from China, the story has been more of the same: Brexit and today’s Fed meeting (to be followed by tomorrow’s BOJ decision), and after several days of muted of concentrated selling, European stocks rallied, helping end the steepest selloff in global equities since January, as the British pound rebounded ahead of the Federal Reserve’s policy review on stronger than expected UK employment data (Feb-April Unemployment 5.0%, Exp. 5.1%).

The Stoxx Europe 600 Index climbed for the first time in six days and most shares rose on the MSCI Asia Pacific Index. As noted above, Shanghai equities reversed initial losses, which according to Bloomberg spurred speculation state-backed funds were supporting prices: surely to be expected on Xi Jinping’s birtday. The British pound strengthened, after sliding more than 1 percent in two of the last three trading sessions, and the yen retreated from its strongest level since 2014. Futures on the S&P 500 Index were up 0.2%, after the U.S. benchmark ended the last session at a three-week low. The MSCI Asia Pacific Index rose 0.1 percent, after sliding 4.4 percent over the last four trading days. Japan’s Topix rebounded from a two-month low as the yen snapped a three-day advance and Hong Kong’s Hang Seng Index gained 0.2 percent. Toshiba Corp. surged more than 7 percent in Tokyo as brokerages including CLSA Ltd. turned more positive on the stock.

On the face of this modest global rebound in assets, crude continued to suffer and sank
to about $48 a barrel after a report showed U.S. stockpiles increased; it will be interesting if today’s DOE report once again violently disagrees with the API data.

Over in the wacky world of bonds, yields on Japan’s benchmark government bonds hit record lows across tenors from two to 40 years. The rate on the 10Y JGB fell to an unprecedented minus 0.195%, while 20-year and 30-year yields touched historic lows of 0.135% and 0.21%, respectively. At least they are still positive.  Ten-year U.S. Treasuries yielded 1.62 percent, after ending the last two sessions at 1.61 percent, the lowest closing level since 2012. The rate on similar-maturity German debt held near zero, after sliding into negative territory for the first time on Tuesday as the U.K.’s potential exit from the EU fueled demand for haven assets. In an auction conducted earlier today, Germany sold €3.259BN in 10Y Bunds (less than the €4.0BN expected) at an average yield of just 0.01%.

Today’s key event will be the Fed’s interest rate decision at 2pm when however, the probability of the Fed doing nothing, according to the market, is 100%. The Fed is expected to keep the benchmark lending rate unchanged when its two-day policy meeting concludes in Washington, though the central bank’s statement and Chair Janet Yellen’s comments at a press briefing will be scrutinized for clues on the likely timing of the next increase. Futures indicate the odds of a move by July tumbled to 16 percent from 53 percent since the start of this month, damped by weak U.S. payrolls data and turbulence in global financial markets.

Meanwhile pessimism persists: “While we get a bounce following the huge knockdown across markets, investors should probably sell into the strength ahead of the Brexit vote,” said Nicholas Teo, a trading strategist at KGI Fraser Securities Pte in Singapore. “There’s a lot of uncertainties out there. A statement from the Fed tonight may help calm the market, but concerns remain on the timing of the rate hike.”

Market Snapshot

• S&P 500 futures up 0.3% to 2071
• Stoxx 600 up 1.5% to 325
• FTSE 100 up 1.1% to 5986
• DAX up 1.3% to 9648
• German 10Yr yield up 1bp to 0.01%
• Italian 10Yr yield down 3bps to 1.48%
• Spanish 10Yr yield down 3bps to 1.54%
• S&P GSCI Index down 0.6% to 377.1
• MSCI Asia Pacific up 0.1% to 127
• Nikkei 225 up 0.4% to 15920
• Hang Seng up 0.4% to 20468
• Shanghai Composite up 1.6% to 2887
• S&P/ASX 200 down 1.1% to 5147
• US 10-yr yield up 2bps to 1.63%
• Dollar Index down 0.13% to 94.81
• WTI Crude futures down 1.2% to $47.92
• Brent Futures down 1.4% to $49.12
• Gold spot down 0.3% to $1,282
• Silver spot up less than 0.1% to $17.41

Looking at regional markets, we traditionally start in Japan where equity markets were resilient and shrugged off the weak lead from the US to trade mostly higher, although still lingers on Brexit concerns and the looming FOMC capped upside. Nikkei 225 (+0.4%) was initially pressured at the open but then recovered as USD/JPY found support at the 106.00 level, while ASX 200 (-0.5%) was led lower by commodity names after iron ore fell over 4% and crude prices declined for the 4th consecutive day with WTI below USD 48/bbl following an API Inventory build. Elsewhere, Hang Seng (+0.4%) and Shanghai Comp (+1.6%) recovered despite the initial disappointment from the MSCI decision to delay China inclusion in the EM index, with the rebound led by outperformance in Shenzhen markets on hopes of action for future MSCI inclusion. Finally, 10yr JGBs lead futures rose to record highs as yields continued to slump with the 5yr, 10yr, 20yr and 30yr yields all printing record lows, while the BoJ entered the market to purchase JPY 1.15trl of government debt and also kick-started its 2-day policy meeting.

Top Asian News

• MSCI Rebuffs Chinese Shares for Third Time in Blow to Xi’s Goals:Measures on trading halts, quotas failed to sway index firm
• China Cracks Down on $1.5 Trillion Dark Corner of Fund Industry: CSRC regulations target funds’ role as shadow banking channel
• China Coal Firm Flags Bond Default Risks as Debt Woes Spread: Sichuan Coal Industry unsure it can repay 1.057b yuan
• Ultra-Low Japan Yields Go Global as Hedged Yen Buying U.S. Bonds: Japanese investors bought record amount of Treasuries in March
• Carry Trade Success Convinces Funds Rupee Will Ride Coming Storm: Rupee Sharpe ratio is second highest among developing nations

It has been a relatively quiet start to the session in terms of newsflow after the recent volatility seen and ahead of the key risk event of the FOMC rate decision later today, the DAX has made a slow start to the session but has ticked slightly higher in a retracement from the lows seen yesterday. So far in the session, financial names have outperformed in a corrective move after the sharp selloff yesterday. Despite also being in positive territory, the energy sector is the worst performing and the larger than expected build in API inventory levels may be a catalyst for the sectors underperformance. Bund yields are back in positive territory today after slipping below 0 for the first time on record yesterday. In terms of price action, the upside in equities has seen Bunds come off their best levels and firmly back below 165.50, however still remaining above the 165 level. Additionally, the latest Bund auction was technically uncovered with yields continuing to hover between negative and positive territory.

Top European News

• Osborne Warns of Brexit Tax Toll as ‘Leave’ Gains in Polls: Says that reduced trade, investment would leave GBP30b “black hole.”; Rising Brexit Angst Drives Weaker-Pound Wagers to $35b
• VW Said to Plan Merging Components Units, Weigh Asset Sale: CEO to present sweeping strategy update to public on Thursday
• U.K. Unemployment Falls to Lowest Rate in Almost 11 Years: Jobless rate declined to 5% in 3 months through April, the lowest since 2005.
• Steinhoff Mulls Poundland Bid in Latest European Retail Push: Announcement made without Poundland’s consent, Steinhoff said.
• Schneider’s Second Attempt to Acquire Aveva Ends Abruptly: Cos. had sought to resurrect earlier talks that snagged on concern that integration costs would be too high.

In FX, the yuan fell as much as 0.1 percent to a five-year low of 6.6047 a dollar in Shanghai, before trading little changed at 6.5933. The pound strengthened 0.4 percent to $1.4166. It slid 1.1 percent on Tuesday after five opinion polls in two days put the ‘Leave’ campaign ahead of ‘Remain’ in the run-up to the EU vote and as Britain’s best-selling newspaper, The Sun, backed a withdrawal. The amount wagered on the currency falling to $1.35 or lower — levels last seen in the 1980s — after the referendum has more than doubled during the past three months. The yen weakened 0.2 percent to 106.28 per dollar, after rallying almost 1 percent over the past three sessions. It touched 105.55 on May 3, the strongest level since October 2014. New Zealand’s dollar rose 0.5 percent, the best performance among 16 major currencies tracked by Bloomberg. It recovered from earlier weakness as shares rallied in China, the country’s biggest export market.

In commodities, West Texas Intermediate crude slipped 1.1 percent to $47.95 a barrel, falling for a fifth day. Concern over a global glut in the commodity reemerged with the American Petroleum Institute reporting a 1.16 million-barrel increase in U.S. oil inventories for last week. Nigerian militants, whose attacks on oil infrastructure have sent the country’s output plunging to its lowest level in 27 years, also said for the first time they are considering peace talks. Copper rose 1.5 percent in London and nickel gained 1 percent, advancing for the first time in a week. Gold was little changed, after surging 3.4 percent over the last five days.

On today’s US event calendar, highlights Include the Producer Price Index and Empire Fed reports, Industrial Production, the DoE crude inventory report, as well as the latest TIC data, however the main event will be the June FOMC rate decision at 2pm  and subsequent comments from Fed Chair Yellen.

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Bulletin Headline Summary from RanSquawk and Bloomberg

• Risk on sentiment across European equities amid upside in financial names ahead of the FOMC meeting.
• GBP regains its footing against major counterparts with early Brexit fears subsiding.
• Highlights Include, FOMC rate decision, US PPI Final Demand, DoE crude inventory report and comments from Fed Chair Yellen.

• Treasuries lower in overnight trading as global equities rally, oil and precious metal drop; FOMC rate decision and SEP at 2pm ET followed by presser at 2:30pm; Fed will skip rate move at meeting and is likely to retain its forecast for 2 hikes this year, based on published research by economists and others; next possible move seen in 3Q or 4Q
• Fed fund futures fully pricing next rate hike around June 2017, implied rate 62bp, near midpoint of 50-75bp target range
• The campaign to keep the U.K. in the European Union is seeking to regain momentum with a warning from Chancellor of the Exchequer George Osborne that a vote to leave could create a fiscal crisis
• Over in Canada, a $7 billion fund manager is loading up on cash in an attempt to profit if the U.K. votes to leave the European Union
• The U.K. jobless rate declined to 5% in the three months through April, the lowest since 2005, as labor market showed signs of resilience in the face of the referendum on European Union membership
• China’s stocks jumped the most in two weeks, reversing an earlier loss and spurring speculation that state-backed funds may be supporting the market after MSCI Inc. refused to add the nation’s domestic equities to benchmark indexes
• China’s overall growth numbers are stabilizing. However, beneath the surface, signs of increasing weakness in hiring and private-sector investment are ringing alarm bells
• As well as a surging yen, non-existent inflation and a weak economy, Bank of Japan Governor Haruhiko Kuroda has something else to think about when deciding monetary policy this week: unhappy banks

DB’s Jim Reid concludes the overnight wrap

Asian markets have stabilised though despite the risk off yesterday and despite the news last night that MSCI has decided to delay the inclusion of Chinese equities into their global benchmark. Chinese equities opened down around a percent but the Shanghai and Shenzhen are up around 1.5% and 3% as we type. Bloomberg is reporting speculation that perhaps the Chinese government is intervening to soften the blow. The Nikkei is 0.55% higher ahead of the BoJ tomorrow. GBPUSD is at $1.414 up from around $1.410 at the time of the ComRes poll.

The slightly better Asian risk sentiment followed another day of risk off globally. European equities extended their losses to a fifth consecutive day, dropping by -1.92% yesterday. UK equities were also hit hard as the FTSE also posted its fourth consecutive day in the red with losses amounting to -2.01%. Both indices saw broad based declines across all sectors, with every company but one declining in the latter index. Credit markets were also caught in the crossfire with both iTraxx Main and Crossover spiking off yesterday’s three month highs as spreads widened further by +5.5bps and +22.8bps respectively on the day. US equities yet again outperformed and impressively only closed down -0.18%. The VIX also stabilised after Monday’s outsized move. Decent US data (see below) perhaps helped.

As we discussed at the top, Germany 10Y yields turned negative for the first time in recorded history, hitting -.004% (-2.7bps). The demand for safe haven assets also caused US 10Y treasuries to rally for the sixth consecutive day as yields dropped to 1.6% (-1.2bps) – although we’re back above 1.62% this morning.

Trading the possible Brexit outcomes saw another layer of complexity yesterday as a widely read Reuters article suggested that the ECB will soon release a public statement pledging that they will backstop financial markets alongside the Bank of England if the UK does vote to leave the EU. The ECB’s pledge is expected to involve opening swap lines with the Bank of England to provide unlimited funding to banks in Euro and Sterling in hopes of preventing a liquidity crunch and subsequent economic fallout.

As a final word on the EU referendum for today, yesterday my team published a report “Brexit Risk in GBP and EUR Credit”. Firstly, we provide a performance overview of GBP vs. EUR and USD credit in terms of both cash bond spreads and currency-adjusted spreads. Secondly, we compare the performance of UK issuers’ bonds vs. Eurozone and US issuers’ bonds across currencies. We find that GBP bonds have underperformed EUR and USD bonds, especially in the non-financial sector. There has also been some underperformance of UK issuer credit recently, particularly in the GBP space. However, it seems that Brexit risk mainly manifests itself via the currency channel rather than credit risk here. See your emails at 1525 BST yesterday from Michal Jezek for the report or contact him (Michal.Jezek@db.com) if you haven’t got it.

A few weeks ago when Fed rate hike expectations started to build it would have been hard to imagine that the preview of today’s FOMC would be relegated to the 9th paragraph but that reflects how events have changed. DB’s Joe Lavorgna expects the Fed to remain on hold tonight (along with everyone else) and the tone of the statement to be mixed. While the Fed is unlikely to signal a July hike with risks of a possible labor market slowdown following the May employment report, it will likely leave the growth, employment and inflation forecasts largely intact with only minor tweaks to the Summary of Economic Projections (SEP). In particular he does not expect the Fed’s 2016 and 2017 median rate forecasts as per the ‘dot plot’ to fall, thus allowing the Fed the option to raise rates in the coming months should the data improve. The Fed should also address the fact that its five-year forward breakeven inflation rate has moved substantially downward. Yellen’s post-meeting Press conference will likely focus on many of the themes of her speech last week, with an emphasis on the uncertainty associated with the Fed’s forecasts and the data dependent nature of the monetary policy action. Brexit will also likely feature as a risk to their outlook.

Data took an understandable back seat yesterday but for completeness let’s look at what we saw. Starting off in the UK, we saw May inflation numbers which largely came in softer than expected. CPI (+0.2% mom vs. +0.3% expected) and PPI (+0.1% mom vs. +0.3% expected) both came in lower than expected, and while RPI was in line with expectations on a monthly basis (+0.3% mom) but disappointed in annual terms (+1.4% YoY vs. +1.5% expected). We also saw the final May CPI numbers for Italy (-0.3% YoY) and Spain (+0.5% mom; -1.1% YoY), both of which were in line with expectations. One major positive data point was the April industrial production data out of the Eurozone, which clocked in at the very upper end of the forecast range and well above expectations (+1.1% mom vs. +0.8% expected).

Heading over to the US, the data was positive across the board. The NFIB Small Business Optimism index for May surprised on the upside to hit its highest level since January (93.8 vs. 93.6). Despite May’s weak payrolls report, the uptick was largely supported by a better labour market outlook among small business owners, with both a moderate improvement in plans to hire (12% vs. 11% previous) as well as raise worker compensation (26% vs. 24% previous). Although expectations for the economy remained negative, the sub index improved on the month (-13% vs. -18% previous).

Thereafter we saw the closely watched US retail sales also beat expectations, posting an increase of +0.5% mom in May (vs. +0.3% expected). The uptick was a general broad-based gain, as nine out of 13 categories demonstrated increases in demand with online merchants and clothing stores leading the way. We also saw the import price index for May beat estimates (+1.4% vs. +0.7% expected), primarily driven by the rising cost of oil. Both the improved retail sales data and the rising import prices could have sparked a more interesting debate ahead of the FOMC meeting had it not been for last month’s weak unemployment numbers.

After a relatively quiet start to the week, today is certainly a busy day in terms of data. We start off in Europe where we’ll get final May CPI numbers for France, which is expected to come in at +0.3% mom without any revisions. Thereafter we’ll get the employment report from the UK, where the April unemployment rate is expected to hold steady at 5.1% (5.1% previous). Average weekly earnings are expected to have grown at a slower rate (expected +1.7% 3M/YoY vs. 2.0% previous), while jobless claims for May are expected to be unchanged (vs. -2.4k previous). We will also see the Eurozone trade balance for April (expected 21.5b vs. 22.3b previous).

It’s even busier day over in the US. First off we’ll get PPI numbers for May, which are expected to clock in at +0.3% mom (+0.1% ex-Food and Energy). DB’s Joe Lavorgna notes that the PPI data will be important for market participants and Fed policymakers because they should provide clues as to the near-term direction of the core PCE deflator. The PPI series on selected healthcare industries, a direct input into estimating the medical care component of the core PCE deflator (the Fed’s preferred measure of inflation), should be closely watched. It should also be noted that the PPI data will be the last inflation data point that the Fed’s policymakers will see before the conclusion of the FOMC meeting.

Thereafter we’ll get a forward and backward looking perspective on the health of the US factory sector with the NY Fed’s Empire State Manufacturing Survey (expected -4.50 vs. -9.02 previous) and the industrial production numbers for May (expected -0.2% vs. +0.7% previous) respectively, both of which are expected to indicate weakness in the industrial sector.