European stocks rebounded after the biggest one-day drop since November, alongside S&P futures, while Asian equities posted modest declines after yesterday’s weak US close. Gold and yen slid, while the dollar gained on the latest Mnuchin comments to the FT according to which Trump was “absolutely not” trying to talk down the dollar.

European equities rose 0.4% in early trading, hinting at some cautious optimism following a day of risk off sentiment, and reversing the 0.6% fall in Asian equities outside Japan which dipped to a one-month low.  U.K. shares initially traded lower as the pound held much of its gains following the surprise election announcement, however have since rebounded back to unchanged. Having dragged it lower on Tuesday after another major rout in China, commodity companies helped prop the Stoxx Europe 600 Index, which rebounded following the biggest one-day loss since November. Sterling pulled back slightly after reaching the strongest level since October on Tuesday. Oil fluctuated after dipping on yesterday’s API data which showed U.S. oil inventories fell 840,000 barrels last week, a lower than expected draw. On Wednesday official EIA data is expected to show a larger drop of 1.4 million barrels.

“Sterling rallied across the board yesterday on the back of Prime Minister May’s announcement of snap UK elections. The market interpreted the move as an effort to strengthen the prime minister’s majority and reinforce a more unified stance for the upcoming negotiations with the EU,” Unicredit analysts said in a note on Wednesday. “Geopolitical tensions are providing strong support to U.S. Treasuries … (and) in the euro zone Bunds are receiving support from the general decline in risk appetite and uncertainty related to the French presidential election.”

The flight to Treasury safety pushed JGB yields briefly back into the negative overnight, however modest selling in the complex has since seen the 10Y yield rebound back over 0.00%

As Bloomberg highlights in its overnight wrap, after declines on Tuesday, investors seem to be taking the addition of yet another macro risk in their stride. The U.K. vote joins a slew of elections to be held this year against a backdrop of rising populism in the Europe, while geopolitical tensions are simmering over both North Korea and Syria and the pace of monetary tightening in the world’s biggest economy looks uncertain. Meanwhile, the reflation trade has soured, with June rate hike odds dropping below 50% for the first time in two months.

Asian shares failed to benefit from the eventual rebound in risk sentiment, and the Shanghai Composite Index fell 0.8%, taking its four-day loss to 3.2%. The main Shenzhen market was also down a fourth day. The Hang Seng Index slid 0.4 percent and the Hang Seng China Enterprises Index dropped below the 10,000 level for the first time in two months. Japan’s Topix index was little changed, while Australia’s S&P/ASX 200 Index lost 0.6 percent and South Korea’s Kospi index fell 0.5 percent.

Risk was firmer in Europe,  where the Stoxx Europe 600 increased 0.3% as of 10:10 a.m. in London, after dropping 1.1% on Tuesday.

In the US, S&P futures rose 0.3% offsetting yesterday’s 0.3% drop in the cash market. IBM slumped in after-hours U.S. trading after its 20th consecutive quarterly sales decline.

Sterling was just off a six-month peak against the dollar above $1.28 having surged when British Prime Minister Theresa May called an early general election for June 8, seeking to strengthen her party’s majority ahead of Brexit negotiations.

The dollar was undermined in part by an eroding interest rate advantage as U.S. bond yields dived to five-month lows. Yields on 10-year Treasury paper sank to 2.17%, far away from the 2.629% peak seen in March. They were last up slightly on the day at 2.20%.

A run of disappointing U.S. economic data and doubts that the Trump administration will progress with tax cuts have quelled expectations of faster inflation and boosted fixed-income debt. That, in turn, has taken the steam out of Wall Street. The Dow fell 0.55 percent on Tuesday, while the S&P 500 lost 0.29 percent and the Nasdaq 0.12 percent. Goldman Sachs lost 4.7 percent in the largest daily drop since June after its earnings missed expectations as trading revenue dropped.

In commodity markets, profit taking nudged gold down 0.4 percent to $1,287.10 an ounce, and away from Monday’s peak of $1,295.42. Oil prices slipped as U.S. crude stockpiles fell by less than expected and a U.S. government report said shale oil output in May was likely to post the biggest monthly increase in more than two years

Economic data include weekly mortgage applications. Scheduled earnings include U.S. Bancorp, Qualcomm, Morgan Stanley.

Bulletin Overnight Summary from RanSquawl

• European equities trade modestly higher ahead of further notable earnings from the US with macro newsflow from the EU session relatively light
• Across FX markets, GBP has given back some of its gains against the greenback after having met resistance at 1.2920 to move within proximity to the 1.2800 level
• Looking ahead, highlights include DoEs, Fed’s George, Rosengren and ECB’s Coeure

Global Market Snapshot

• S&P 500 futures up 0.3% to 2,343.00
• STOXX Europe 600 up 0.4% to 377.49
• MXAP down 0.5% to 145.52
• MXAPJ down 0.6% to 473.43
• Nikkei up 0.07% to 18,432.20
• Topix down 0.01% to 1,471.42
• Hang Seng Index down 0.4% to 23,825.88
• Shanghai Composite down 0.8% to 3,170.69
• Sensex up 0.05% to 29,333.48
• Australia S&P/ASX 200 down 0.6% to 5,804.01
• Kospi down 0.5% to 2,138.40
• German 10Y yield rose 2.1 bps to 0.177%
• Euro down 0.1% to 1.0718 per US$
• Brent Futures up 0.1% to $54.95/bbl
• Italian 10Y yield fell 5.6 bps to 1.966%
• Spanish 10Y yield fell 0.9 bps to 1.661%
• Gold spot down 0.6% to $1,282.57
• U.S. Dollar Index up 0.2% to 99.70

Top Overnight News from Bloomberg

• Fed June Hike Odds Below 50% After Inflation Expectations Tumble
• Markets Start to Ponder the $13 Trillion Gorilla in the Room
• IBM Sales Miss Shows Return to Growth Not Without Roadblocks
• Trump Mulls Military Options for North Korea. They’re All Grim.
• European Car Sales Surge 11% as Fiat, Renault Lure Buyers
• Currency Traders Spot Fatal Flaw in Republicans’ Border Tax Plan
• Ford’s Schoch Sees ‘Strong 2017’ in China
• Maserati CEO Bigland Seeing No Signs of Any China Sales Slowdown
• Nasdaq Seeks German Power Futures Amid Potential Market Split
• Goldman Sachs Australia’s Steve Maartensz Said Leaving Bank
• Havertys to Name Richard B. Hare as CFO
• KKR, Stone Point Buy Wealth Management Firm Focus Financial
• American Air Wins Arbitration Over Flight Attendant Pay Raise

Asian equity markets traded negative following a weaker lead from Wall Street, where disappointing earnings from the likes of IBM, Johnson & Johnson and Goldman Sachs dampened sentiment. This resulted in early pressure in Nikkei 225 (Unch.) and ASX 200 (-0.5%) with weakness in financials and commodities leading the declines in the latter. Shanghai Comp (-0.8%) and Hang Seng (-0.4%) also conformed to the downbeat tone observed across their global counterparts amid mild increases in Chinese money market rates, with the PBoC’s liquidity operations failing to provide an uplift. 10yr JGBs traded higher as participants sought after safer assets due to the dampened tone in the region, while the 10yr yield declined to 0% which was its lowest since November.
PBoC injected CNY 40bIn 7-day reverse repos, CNY 20bIn in 14-day reverse repos and CNY 20bIn in 28-day reverse repos.

Top Asian News

• China’s $8.5 Trillion Shadow Bank Industry Is Back in Full Swing
• Jakarta’s Chinese Christian Governor Trails in Run-off: Polls
• Samsung Heir’s Trial Homes in on Five Minutes With Ex- President
• Alcohol Ban Another Drain on India’s Weak State Finances
• Indian Stocks Fluctuate; TCS Is Biggest Drag on Sensex Benchmark

European markets have rebounded among an air of caution this morning with the Eurostoxx trading higher by a modest 0.3% as participants continue to digest yesterday’s news that PM May is to call a snap election for June 8th. Before that though, focus remains firmly on the 1st round of the tense French election, in which some polls indicate that Macron still holds a slight advantage over his nearest rivals (Le Pen, Fillon). In stock specific news, earning updates have been coming in thick and fast with AB Foods supported by strong results this morning, while Burberry notably underperforms after the retailer stated that revenue fell short of analyst expectations. In credit markets, prices had been subdued for much of the morning with Bunds relatively flat, however recent comments from ECB’s Hansson who noted that it is not too early to discuss ECB policy (change) has pressured the German benchmark in recent trade.

Top European News

• French Election Shocker: Pollsters Baffled by Four-Way Race
• Banks and Clients Tussle Over What It Will Cost to Read Analysts
• How May’s Election Bet Could Help Scots Independence Forces
• Pound May Top $1.30 on Short-Gamma Positioning, Charts: Analysis
• Michael Spencer’s NEX Group Plans Relocation in New York, London
• Burberry Sales Miss Estimates as New CEO’s Task Gets Tougher
• Germans Fly to U.S. Ready to Counter Trump’s Surplus Complaints
• Zalando Drops After Reporting Quarterly Profit to Miss Estimates

In  currencies, the yen dropped 0.4 percent to 108.86 per dollar after gaining 0.5 percent Tuesday. The Bloomberg Dollar Spot Index rose 0.2 percent following a two-day decline. The pound dropped less than 0.1 percent to $1.2836 after its 2.2 percent surge Tuesday. The euro also slipped less than 0.2 percent.  Cable has given back some of its gains against the greenback after having met resistance at 1.2920 to move within proximity to the 1.2800 level with markets now awaiting the Parliamentary confirmation for the go-ahead from yesterday’s announcement. Elsewhere, USD/JPY has continued to climb throughout the European session as geopolitical fears continue to abate, at least for the time being with the pair approaching 109.00 to the upside. Elsewhere, commodity currencies have been a touch softer this morning with USD/CAD tripping above 1.34, while there has been no respite for the AUD as we are back testing 0.7500 against the USD, but the flow looks to be going through AUD/NZD, which is now just below the 1.0700 mark. Finally, EUR has lost some modest ground to the broadly firmer USD with this morning’s inflation data from the Eurozone coming broadly in line with expectations.

In commodities, gold declined 0.5 percent to $1,282.84 an ounce after closing at the highest since November in the previous session. West Texas Intermediate crude oil was little changed at $52.43 a barrel, after two days of losses. Trade across the commodities complex remained uneventful with WTI crude futures only slightly pressured following a smaller than expected headline crude drawdown in the latest API Inventory Report. EU trade has seen some rhetoric from OPEC Sec-Gen Barkindo who said that March compliance data is showing higher conformity with supply cut pact but this has failed to provide too much traction for energy prices ahead of the US crossover. Elsewhere, gold (-0.2%) continued to pull back from 5-month highs as the USD attempted to nurse yesterday’s weakness, while copper found some reprieve and rebounded from 3-months lows.

Looking at the day ahead, this morning in Europe the only data due is the final CPI report for the Euro area where headline CPI is expected to come in at +0.8% mom and +1.5% yoy, and the core at +0.7% yoy. There is no data due in the US although we will get the Fed’s Beige Book while the Fed’s Rosengren is also due to speak. The ECB’s Coeure also speaks this afternoon in NY. Earnings wise, today we will get 16 S&P 500 companies including Morgan Stanley and eBay.

US Event Calendar

• 7am: MBA Mortgage Applications, prior 1.5%
• 12:30pm: Fed’s Rosengren Speaks at Bard College Conference
• 2pm: U.S. Federal Reserve Releases Beige Book

* * *

DB’s Jim Reid concludes the overnight wrap

We were actually watching the news on TV last night after the surprise snap UK election decision. On this the biggest call out of DB over the last 24 hours was to reverse the 2 year bearish house view on Sterling immediately after the announcement yesterday. Our FX strategists argued last year that an early general election was the only way to resolve the political impasse the U.K. government faces in conducting Brexit negotiations. The 2020 General Election was a problem domestically (small dwindling majority likely forcing policy gridlock and compromises) and externally in as far as negotiating with Europe from a weak position in 2019 as the Brexit deadline approached.

The election on June 8th will likely result in a larger Conservative majority (see latest polls below). This should have three material implications, in their opinion. First, it makes the deadline to deliver a “clean”  Brexit without a lengthy transitional arrangement by 2019 far less pressing given that no general election will be due the year after. Second, it will dilute the influence of MPs pushing for hard Brexit, strengthening the government’s domestic political position and allowing earlier compromise over key EU demands for a transitional arrangement. Third, it strengthens the PM’s overall negotiating stance who  in recent weeks has clearly fallen in line with the European negotiating approach. This will involve a settlement of the Brexit payments and other divorce aspects first, to be followed by a lengthy transitional period during which the final outcome of Brexit will emerge. This sequenced approach materially reduces the “crash risk” of Brexit negotiations as well as strengthening the Prime Minister’s hand in pursuing an orderly (and very lengthy) withdrawal. All of the above in turn reduce downside risks for the U.K. growth outlook over Brexit negotiations. Our FX team will look to publish fresh targets in the coming days. In terms of the economic impact, DB’s Mark Wall believes that a larger government majority should also reduce Brexit-related downside risks. However, he hesitates from assuming much upside yet for economic growth or for BoE policy rates. Mark believes that the Conservatives are likely to campaign on an uncompromising “hard Brexit” message and the capacity to concede in negotiations in the EU will come later. He holds his 1.8% GDP growth forecast for 2017 and sees little upside relative to his 1.1% GDP forecast for 2018. A link to both reports can be found here.

Just on those polls, a snap online ICM poll released yesterday in the hours following the election announcement showed that, with a polling sample of 1000 people, support for the Conservatives stands at 46%, with Labour at 25% and the Lib Dems at 11%. The 3 polls prior to this (ICM, YouGov, ComRes) showed the Conservatives as holding an average 20% lead over Labour, so not too dissimilar. The FT poll tracker also shows the Conservatives as holding 43% of the support compared to 25% for Labour (or an 18% lead). The FT also references Electoral Calculus which predicts a Conservative majority of 130 seats in the 650-seat House of Commons. That compares with a working majority of just 17 seats currently.

Unsurprisingly the news of the snap election was initially most felt in FX with Sterling rallying immediately and closing 3 big figures higher or +2.20% at $1.284 – the highest level since October 3rd. That was the biggest rally for the Pound versus the Dollar since January 17th when PM May delivered what was largely considered a fairly balanced Brexit speech. That move in Sterling yesterday weighed heavily on UK equities with the FTSE 100 (-2.46%) ironically suffering its biggest one-day loss since the post-Brexit aftermath on June 27th. The index is also now back to within just 0.7% of the February lows. The big dollar earning blue-chips suffered most of all with some of the biggest losers including BHP (-5.59%), Glencore (-5.58%), BP (-3.93%), GlaxoSmithKline (-3.67%) and Antofagasta (-3.41%). In contrast the more domestically orientated FTSE 250 closed down just -1.16%. For me I have to weigh up whether the potential cheaper cost of my next iPhone purchase (never too far away) offsets my declining domestic share portfolio. It’s a close one!!!

There wasn’t much better news for risk assets outside of the UK yesterday either. In Europe the Stoxx 600 closed down -1.11% while last night the S&P 500 bounced back to pare its loss to a more modest -0.29%. One sector which notably underperformed was US Financials (-0.83%) which came after Goldman Sachs disappointed analysts with a miss at both the revenue and earnings lines following its Q1 report yesterday. In contrast to what we’ve seen with other US banks this reporting season – including BofA yesterday – the miss was largely as a result of disappointing performance in the FICC business. The other  story in markets yesterday was the move in rates. In keeping with the largely risk-off tone but perhaps also reflecting the lingering geopolitical concerns and also the upcoming French presidential election this weekend to some degree, 10y Bund yields initially rallied 3.1bps to 0.153% for the lowest closing yield this year before 10y Treasuries then rallied 8.2bps to 2.169% for the lowest close since November.

This morning in Asia the majority of bourses are following the lead from Wall Street and Europe yesterday and are currently tracking lower. The Hang Seng (-0.74%), Shanghai Comp (-1.10%), Kospi (-0.50%) and ASX (-0.56%) are all in the red. It’s worth noting that materials names are underperforming, which isn’t a surprise given the moves for metals over the last 24 hours. Most notable is the latest leg lower for iron ore which fell another -4.60% yesterday and is now down over -33% from the February highs. Elsewhere, the Nikkei is currently little changed, helped by a slightly weaker Yen. US equity index futures are a touch higher however despite IBM reporting softer than expected sales figures after closing bell last night which saw shares tumble 5% in extended trading. Meanwhile in bond markets this morning the most notable move is that for JGB’s where the 10y (using the March-2027 maturity bond) has fallen below 0% (touching -0.005%) for the first time since mid-November. It’s worth adding that the BoJ today maintained the amount of 5y and 10y bond purchases in its regular bond buying exercise.

Yesterday we saw the latest CSPP numbers and it’s looking like I might have to say ‘I was wrong’ soon which are words a research analyst always struggles with. I thought that the ECB might taper corporate purchases alongside Government bonds but the early evidence suggests some evidence otherwise. However the ‘strong’ numbers of the last two weeks (post taper) might be slightly distorted by two pretty weak weekly numbers in March and the Easter break but the average daily purchases in the 4 business days last week of €423mn were comfortably above the daily average of €368mn since the program started. But if you average it over 5 days it goes down to €338mn/day. So until we see the full month’s purchases on May 2nd (two weeks time) we really can’t be sure. At that point the ECB will surely want to have signalled how they have split the taper. To be fair my colleague Michal has been more of the opinion that they’ll keep CSPP ‘stronger for longer’ than me. It’s important as for the last few months I’ve felt that although technicals have been strong for credit, the technicals for Bunds have been even stronger (see a recent Credit Bites for more https://goo.gl/XmY0dQ) thus creating headwinds for spreads. If the CSPP is staying ‘stronger for longer’ it will help redress that balance a little but it’s too early for this to be confirmed.

Away from that, yesterday’s macro data was largely a sideshow. In the US industrial production was confirmed as increasing +0.5% mom as expected with capacity utilization also edging up four-tenths to 76.1%. Manufacturing production did however decline -0.4% mom, led by the auto sector. Elsewhere, housing starts were confirmed as declining a relatively steep -6.8% mom (vs. -3.0% expected) although that was somewhat offset by a two percentage point upward revision to the February print to +5.0%. Building permits was reported as rising +3.6% mom (vs. +2.0% expected). Away from this, there was no  data of note in Europe however we did get other economic news out of the IMF with the latest quarterly forecasts released. The fund revised its global growth forecast up one-tenth to 3.5% this year and left its 2018 forecast for 3.6% unchanged.

The forecast for the US was also left unchanged at 2.3% and 2.5% for this year and next. There was also a little bit of Fedspeak yesterday from Kansas City Fed President Esther George, although again it didn’t do much to move the dial. George said that “balance sheet adjustments will need to be gradual and smooth” and that “importantly, once the process begins, it should continue without reconsideration at each subsequent FOMC meeting”.

Looking at the day ahead, this morning in Europe the only data due is the final CPI report for the Euro area where headline CPI is expected to come in at +0.8% mom and +1.5% yoy, and the core at +0.7% yoy. There is no data due in the US although we will get the Fed’s Beige Book while the Fed’s Rosengren is also due to speak. The ECB’s Coeure also speaks this afternoon in NY. Earnings wise, today we will get 16 S&P 500 companies including Morgan Stanley and eBay.

According to a report by Korea JoongAng Daily, China appears to be preparing measures in case North Korea tests a nuclear device or performs another provocation, including possibly suspending oil to the regime, and adds that relations between Beijing and Pyongyang appear frostier than ever before.

Additionally, the Korea publication references the Chinese-language Boxun News, which cites a Beijing source, according to whom Chinese President Xi Jinping attempted to send Wu Dawei, China’s special representative for Korean Peninsula affairs, to Pyongyang after his summit with U.S. President Donald Trump, but North Korean leader Kim Jong-un allegedly rejected Wu’s visit.

Boxun adds that it was unclear if North Korea did not conduct a sixth nuclear test last Saturday because of Beijing’s warning not to do so, however it adds that according to “analysts” there’s a high likelihood of a provocation on the 85th anniversary of the founding of the North Korean People’s Army next Tuesday and the days leading up to the South Korean presidential election on May 9.

Citing its Chinese source, Boxun said that “China believes there is the “highest possibility” of a nuclear test on April 25, but “does not leave out the possibility it might take action in early May.”

One assumes the Carl Vinson, wherever it may be in the world currently, will eventually make it to North Korea by then.

Meanwhile, South Korean officials cited by JoongAng Daily confirmed that Wu, China’s top nuclear envoy, during a visit to Seoul last week said he proposed to visit Pyongyang in person to persuade the North to refrain from further provocations but he was spurned.

Lu Chao, a Chinese expert on Korean studies at the Liaoning Academy of Social Sciences, was among multiple analysts that told the state-affiliated tabloid Global Times Tuesday that if North Korea did not refrain from conducting its sixth nuclear test, it would “definitely trigger” more intense United Nations sanctions, and that China will implement them.

Victor Cha, the Korea Chair at the Washington-based Center for Strategic and International Studies (CSIS), said the “provocation window” between South Korean elections and North Korean provocations has become narrower over time, referring to database collected over the past 60 years. That window refers to the proximity in time between a South Korean election and a provocative act by North Korea, meaning a nuclear or missile test.

Cha said such a pattern “suggests a provocation as early as two weeks” before the South Korean presidential elections on May 9.  That two-week window overlaps with North Korea’s military foundation day on April 25.

* * *

Meanwhile, amid escalating military tensions in the region, the Chinese navy tested its new guided-missile destroyer, the Xining, in its first live-fire exercise conducted in the Yellow Sea, near the Korean Peninsula, broadcast on China’s state-run CCTV on Tuesday.  The Xining, China’s Type 052D-class missile destroyer with was put into service by the People’s Liberation Army Navy in January.

The exercise, possibly warning against a North Korean military provocation, was reported to have lasted several days and comes as Beijing has called for North Korea to give up its nuclear ambitions under renewed pressure from the Trump administration. U.S. Vice President Mike Pence warned Monday in Seoul the “era for strategic patience is over.”

Trump has been lauding Beijing for helping with the Pyongyang situation, especially over sending back North Korean vessels bringing coal to a Chinese port. Trump told Fox News Tuesday in reference to Chinese President Xi Jinping, “He’s working so nicely that many coal ships have been sent back. Fuel is being sent back. They’re not dealing the same way. Nobody’s ever seen it like that.” As reported previously, in February, China announced it would suspend all coal imports from North Korea to the end of the year in accordance with a UN Security Council resolution.

Meanwhile, the Chinese Foreign Ministry Wednesday warned Pyongyang to exercise restraint on any actions that could heighten tension on the Korean Peninsula in response to Pyongyang’s recent bellicose rhetoric.

Lu Kang, a spokesman of the ministry, said at a briefing, “China objects to any words that could heighten tensions since the current situation on the Korean Peninsula is highly complicated and sensitive.” Within China, there is talk about playing a key card to pressure North Korea – cutting off oil supplies to the Kim Jong-un regime.

In an editorial last week, the state-run tabloid Global Times said that if Pyongyang engaged in further provocations, Chinese society would approve of “severe restrictive measures that have never been seen before, such as restricting oil imports to the North.” On Monday, the paper again called for China to cut off most oil supplies to North Korea if there was another nuclear test.

In an editorial Tuesday, it pointed out that China and U.S. cooperation is increasing over the North Korean problem, and that the possibility of dragging out the North Korea issue indefinitely has “decreased drastically.”

“North Korea and China are a blood alliance, interdependent like no other,” said a South Korean government official Tuesday.  “But the atmosphere in China, which has left a back door open to North Korea regardless of the international community’s sanctions, is changing little by little.”

North Korea depends on China for some 90 percent of its crude oil supply.

Lee Gee-dong, head of the Strategic Team on North Korea at the Seoul-based Institute for National Security Strategy, said, “Though it may not be immediate, if North Korea conducts a strategic provocation such as a sixth nuclear test or launches an intercontinental ballistic missile (ICBM), Beijing will have to use the halting of oil exports card.” However, some analysts think the threat of cutting oil supplies to the North is mere rhetoric.

“In the 1990s, when the North Korea nuclear issue first escalated, China could have blocked oil then,” one former South Korean official said. “The oil supply card could be a performance by China to impress President Trump, but bears more watching.”

With every other asset class roundtripping the November election outcome, it was only a matter of time before Japan’s 10Y JGB – which on February 2 briefly peaked above the BOJ’s “yield curve controlling” 0.10% yield ceiling, rising as high as 0.15% to the shock of a market ready to declare that Japan had finally lost control of its bond market – retraced the entire “reflationary” move from 0.0% to 0.1%. And, sure enough, following today’s violent deflationary capitulation moments ago Japan’s JGB 0.1% of 2027 once again dipped back under 0%, sliding as low as -0.003% on Wednesday morning in Japan.

What happens next?

According to traders, focus will turn to whether the BOJ, in pursuing “yield curve control”, will reduce the amount of JGBs it monetizes.  “Amid favorable environment for bonds, focus is on BOJ as whether there will be a reduction in purchase amounts will test the bank’s tolerance for 10-year yield falling into negative,” Katsutoshi Inadome, senior bond strategist at Mitsubishi UFJ Morgan Stanley Securities, wrote in note according to Bloomberg.

As a reminder, in the BOJ’s latest “rinban” or open market operation, it bought around 280bn yen of 1-to-3, 350bn yen of 3-to-5 and 450bn yen of 5- to-10-year maturities at previous operation. And material declines from these amounts may lead result in the market roiling again, on fears the BOJ is being forced into an involuntary taper by external deflationary forces.

Meanwhile, the USDJPY continues to track treasury yields tick for tick, and as Yujiro Goto, senior FX strategist at Nomura in London said, the “dollar/yen remains top-heavy with yields falling and weak U.S. economic data. It’s hard to take risk aggressively ahead of the French election, keeping it in 108-109 range.”

Which means that while continued declines in Japanese yields are virtually assured all else equal, it will be up to the BOJ to telegraph to the market just how low it will let the 10Y drop. Should Kuroda unveil another “taper”, the result may be the uncoordinated move in global bond markets, leading to a negative feedback loop of JGB selling and TSY bond buying, which incidentally is the worst case scenario for global central bankers whose primary intention over the past year has been to achieve as much rate coordination as possible.

In discussing the key overnight news in an otherwise quiet session, JPM writes that “the most important headline was prob. the one concerning China loosening some currency outflow curbs” so focusing on that, Reuters, and SCMP before it, reports that after months of draconian and ever tightening capital control, China’s central bank has relaxed some of the curbs on cross-border capital outflows it put in place just months ago to shore up the yuan currency.

Specifically, as of last week, the People’s Bank of China (PBOC) is no longer demanding that banks match outflows with equal inflows, the sources said. The South China Morning Post first reported the relaxation of the capital controls earlier on Wednesday.

There was no immediate comment from the People’s Bank of China when contacted by Reuters. The State Administration of Foreign Exchange (SAFE) did not have an immediate response to Reuters’ questions on the SCMP report. While expectations of further yuan depreciation have eased in recent months, opening a window for authorities to relax recent measures, Beijing is not likely to let go totally, said Raymond Yeung, chief Greater China economist at ANZ in Hong Kong. In addition to checking exchange rate expectations, the authorities were also using capital controls to control where Chinese money flows, limiting investments in foreign sectors deemed undesirable, he noted.

“The current macro environment obviously favors an easing of the (rules on) fund flows, but that doesn’t mean that it is going to have solved the structural issue of the mismatch between the corporate desire to go out versus the central government’s centrally-driven approach when they talk about offshore investment,” Yeung said.

This first easing of capital flught measures comes as “China’s leaders and financial markets feel more confident that pressure on the yuan and the country’s foreign exchange reserves has diminished, thanks largely to a pullback in the surging U.S. dollar.” It also comes at a time when increasingly more Chinese companies have complained they are unable to consummate offshore M&A due to the PBOC’s limit on how much capital they can park offshore.

In March the U.S. owner of Dick Clark Productions Inc said that one of its affiliates terminated an agreement to sell assets to Chinese conglomerate Dalian Wanda Group, with Reuters reporting earlier the deal was under pressure amid tight scrutiny by Beijing on outbound deals.

Facilitating Beijing’s decision has been the steep drop in the US Dollar in 2017. As a reminder, the yuan slumped around 6.5% against the USD last year, but has since firmed nearly 1% in 2017, defying many analysts’ expectations of further depreciation, and benefiting from Trump’s recent attempt to talk down the dollar, no matter how hard Mnuchin may try to deny it. Suggesting that Yuan appreciation may just be getting started, a Reuters poll earlier this month indicated investors likely increased their bullish bets on the yuan to the most since July 2015.

Furthermore, with less incentive for capital flight, China’s foreign exchange reserves have clawed back above the closely watched $3 trillion level. Xinhua reported that on Tuesday, Premier Li Keqiang said that market confidence in the yuan has significantly improved.

Still, the small relaxation step won’t help much in terms of outbound investment approvals, said Greg Burch, who works on mid-market China outbound M&A deals as a Hong Kong-based partner at the Locke Lord law firm. “This particular move won’t help on real M&A deals…It’s like the brakes aren’t totally locked up any more, but the foot is still on the brake pedal pretty hard,” said Burch.

On Tuesday, China reported that its non-financial outbound direct investment (ODI) slumped 30.1 percent in March from a year earlier as authorities kept a tight grip on outflows. In the first quarter, it fell nearly 49 percent. While Beijing says it supports legitimate overseas investment, regulators have warned they would pay close attention to “irrational” investment in property, entertainment, sports and other sectors.

China did not spell out what criteria would still be applied to outflows. “Actually, it’ll be the same as SAFE’s previous policy stance, emphasizing that cross-border settlements for legal and compliant business are guaranteed,” said one of the sources, who declined to be identified.

Ultimately, the fate of China’s capital control regime may depend on the outlook for the U.S. currency, which while until recently was expected to rebound as the Federal Reserve continues to slowly raise interest rates, such expectations were put in question yesterday when Goldman ended its long-held bullish dollar call.

But perhaps the best indicator of whether Chinese capital outflows will moderate can be observed in bitcoin, which has been the biggest beneficiary of China’s escalating capital controls over the past two years. As of this morning, BTC was trading at $1,200 just shy of all time highs. As such, at least the electronic currency does not expect major changes in the trajectory or size of Chinese capital flows

Theoretical warnings about risks inherent in China’s shadow banking system became all too for 150 customers of China’s largest private bank, when Minsheng Banking Corp found itself involved in a 3 billion yuan (US$436 million) fraud case, after it emerged that a branch chief of the lender in Beijing allegedly issued false bank acceptance bills and later secured funds from individual investors to cover up the misdeed.

According to SCMP, an accidental inquiry from an investor exposed the fact that the WMPs sold by a Minsheng branch didn’t even exist. When shocked investors rushed to the bank, they found the head of the branch had been taken into police custody and the supposed due payment date had passed.

A little background: bank acceptance bills, one of the shadier funding pathways of China’s shadow banking system, and a form of bank-backed IOU, are commonly used as a form of payment between Chinese companies. The holder of such bills is entitled to cash the bill at a bank under any circumstances… unless of course fraud is involved. It is different from commercial acceptance bills, which are issued by companies and do not guarantee repayment despite companies’ trustworthiness.

Well, in this case fraud was involved.

The branch head at the Beijing branch of Minsheng, Zhang Ying, allegedly helped a corporate client disguise commercial acceptance bills as bank acceptance bills by using a false seal of the bank. The bills were issued by the client to a number of companies, which later discovered the bills were fake, Caixin said.

Then, in order to cover up the fact that the fake bills were not able to be cashed by the bank, Zhang later sold 3 billion yuan of unauthorized wealth-management products to the bank’s private customers to get funds for the client to repay the bills. Caixin said a huge amount of funds may be transferred between the client and Zhang.

Zhang Ying, the branch head, has been detained by Beijing police, while Xiao Ye, vice head of the branch, is still missing, Caixin magazine reported on its website. Minsheng said it is assisting the police with an investigation into Zhang, according to its public announcement yesterday, and will “investigate thoroughly the incident and try to recover investors’ funds to the utmost.”

Meanwhile, the investors in the WMPs sold by Minsheng, realizing their money is now gone, are understandably furious.

“If we can’t even trust a big national bank, what other financial institutions can we trust?” Liu Min, who bought 12 million yuan worth of WMPs from Minsheng, said as he waited in the lobby of the Hangtianqiao branch of Minsheng Bank to hear news. Two million yuan of the WMP he invested in is was “due” April 17 but he can’t get the money back. Liu, 52, was one of 150 private banking customers of Minsheng who had bought the WMPs. In most cases, their ties with the lender go back 10 years when the Hangtianqiao branch joined them up in a “golf club”. Under the programme, they frequently invested in the products offered by the branch and in return, the bank paid for them to go on golfing trips domestically and overseas.

“We have bought the banks products for many years and none of the previous one had trouble,” said an investor surnamed Li. “Many other institutions peddle various products to me but I didn’t buy them because we trusted the [Minsheng] bank. We are not yield hunters.”

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While there have been numerous allegations and warnings that China’s entire shadow banking facade, dominated by WMPs and other “investment products”, is nothing but a giant ponzi scheme in which  recoveries – should there be a bank run (a topic recently discussed on Bloomberg) – would be non-existant if there is ever a bank run, defaults of WMPs issued by big banks – and this case an unapproved WMP – are rare. For now.

The Minsheng case involved an “innovative” WMP in which yields were amplified by purchasing a secondhand WMP. For a rough analogy, think CDO-squared products sold to retail investors.

According to investor contracts seen by the South China Morning Post, Minsheng’s private banking customers purchased transferred WMPs from the original investors. Bank employees told the buyers that the original investors urgently needed cash and were willing to cash out of the WMPs, which at the time were not yet due, and forego the supposed yields. As a result, the original WMPs that guaranteed principle and at least 4.2 per cent annual return “turned into” a product with more than 8 per cent annual return. Bank employees said the products were exclusively for longstanding private banking customers who owned at least 10 million yuan in financial assets.

How the fraud was uncovered: last week an investor happened to ask a friend who works at a bigger branch of Minsheng about the WMP at Hangtianqiao, but was told it didn’t exist. Officials at the Beijing branch of Minsheng subsequently reported Zhang Ying to the police, who then arrested her. By Thursday night all investors had become aware of the situation.

The 150 members of the so-called “golf club”gathered at the Hangtianqiao branch the next day demanding an explanation. They also visited the China Banking Regulatory Commission and its Beijing subsidiary, as well as the headquarters of Minsheng Bank, and the China Securities Regulatory Commission. However, no clear answers have been given to them to date.

Unfortunately for the 150 members of the “golf club”, their money is long gone, and without any backstop or guarantee, their hope of recovering their funds is zero.

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Ironically. the Minsheng case comes at a time when the Chinese banking regulator, the CBRC, has launched a crackdown on banks’ transgressions, including bank employees’ colluding with clients to forge unapproved lending programmes and sell them to investors. Last Monday, the China Banking Regulatory Commission issued risk management guidelines for lenders that included a section on WMPs. The regulator said the products should be simple and transparent, avoid excessive leverage and invest in distinct assets – rather than pooling funds with other WMPs.

And yet this is precisely what happened. As a result, what the CBRC will find as part of its inquiry, is sure to shock it. Meanwhile, as Bloomberg recently wrote in “China Is Playing a $9 Trillion Game of Chicken With Savers” the biggest risk for China’s financial system at this moment may be a wholesale run by investors on the “shadow banking” system, demanding their money back, as they would promptly find this money no longer exists. Indicatively, there is now over 30 trillion in total WMP assets in China, or over $4 trillion USD, nearly half of China’s GDP.

A few more cases of big bank fraud such as this one at Mingsheng, and said bank run may be inevitable.