Global markets entered Wednesday in tentative fashion as US Treasury yields resumed their upward march after dropping the day before ahead of a closely watched US CPI report and as the US Treasury prepared to sell more debt to fund the soaring US deficit.

The mood in stocks soured, and European equities turned lower with American futures as Asian peers erased an advance while world stocks inched off eight-week lows; market gains were checked by fears for global economic growth, greater US decoupling, escalating trade war and the possibility of an Italy-EU clash over budget spending. The result was generally a sea of red among global capital markets in early trading.

The equity rout that resulted from the global bond selloff that took bond yields to seven-year highs this week were exacerbated by continued growth concerns arising from trade conflicts and $80-per-barrel oil, with the IMF cutting its world GDP forecasts for the first time in two years.

The yield on 10-year Treasurys resumed its ascent to 3.23% from 3.20%, after falling for the first time in a week on Tuesday, putting a lid on early trader optimism.

“We are at some sort of critical moment, a crossroads, for bond and equity markets,” Marie Owens Thomsen, global head of economic research at Indosuez Wealth Management, said noting that while U.S. 10-year yields at 2% unequivocally favored equity investment, this was not so above 3%. “This January we took out the 2 percent (yield) handle and now we are wondering if we are permanently taking out the 3 percent handle as well. That makes the climate for equities much more challenging.”

The MSCI world equity index rose 0.14% after four days in the red. However, while Japan’s Nikkei and MSCI’s Asia-Pacific index outside Japan rose 0.2-0.3 percent, European shares slipped 0.2 percent, undermined by more bellicose rhetoric from Italian politicians.

The Stoxx Europe 600 Index dropped as most sectors turned lower. The European basic resources index (SXPP) – which was one of the best-performing sectors since the end of August – fell as much as 2.2%, one of Wednesday’s main sector laggards, as investors rotated toward defensive sub-groups including telecoms and health care. Milan-listed stocks traded between gains and losses, rising off 18-month lows hit earlier in the week.

Europe’s weakness followed a modest recovery of bullish sentiment in Asia, as shares in Japan rose after four days of losses, South Korean equities slumped as trading resumed after a holiday while those in China closed 0.2% higher after fluctuating between gains and losses before edging barely up after early gains slipped with lithium-related stocks tumbling, while Tencent suffered a record ninth day of declines in Hong Kong.

The retreat in emerging markets took a pause on Wednesday after Donald Trump said the Fed is moving too fast on rate hikes and as traders awaited U.S. inflation data before taking a stance on riskier assets. Equities slowed their drop and currencies eked out their first gain this week, led by India’s rupee

The yuan slipped against the dollar for the fifth session out of the past six to approach four-year lows hit in August, unresponsive to Mnuchin’s warning on devaluation. The focus is on next week’s semi-annual U.S. report on currencies amid Treasury officials’ comments that recent yuan depreciation has raised concerns in Washington.

The backdrop to global markets is still dominated by deepening U.S.-China tensions and a surge in volatility for stock and bond markets. While the Treasury rout has eased, a glut of new U.S. debt is coming to the market this week. American producer and consumer price data is also due in the next two days, and may determine where yields go from here.

“After President Trump once again criticized the Fed for raising rates too fast and he reiterated his preference for low borrowing costs, U.S. bond yields fell from their recent highs,” Rabobank strategist Piotr Matys wrote in a note. “This in turn provided the emerging-market currencies with respite. However, looking from the perspective of technical analysis the price action implies that U.S. 10-year Treasuries have entered a period of consolidation.”

Italian bonds initially dropped and bear flattened beyond the belly after Deputy PMs Salvini and Di Maio said the budget plan won’t change and there’s no going back, suggesting an unwillingness to compromise. Italy’s 10y spread to Germany blew out to 305bps, after Di Maio said that “our objective is not the spread, but the citizen… We expect that the economic growth rate will be higher” with measures included in the next year’s budget plan.

However the initial weakness reversed in a repeat of Tuesday’s action after Finance Minister Giovanni Tria, speaking before the parliament’s joint budget committee, pledged action to restore calm should market turbulence escalate into financial crisis. Yields slipped further after Tria said he expected “collaboration” with the EU on the budget issue, and added that “the rise in government bond yields recorded in the last few days is certainly a reason for concern, but I want to reiterate that it was an excessive reaction which is not justified by the fundamentals of Italy’s economy and public finances.”

That said, markets’ pressure has not dissuaded the government from a bigger-than-expected budget deficit as ministers’ comments indicated they are prepared to defy European Union critics. The developments have raised risks of a credit ratings downgrade for the country, with a knock-on effect for Italian banks which are big holders of government bonds. However the banks’ shares received a boost after an EU official told Reuters regulators were “intensely” monitoring Italian banks’ liquidity levels but there was no cause for alarm.

“I am not saying Italy is managing the situation in an ideal fashion but at the current junction I don’t think they are anywhere near a position where they can provoke another crisis in Europe,” Owens Thomsen said.

In currencies, the dollar reversed an early decline, rising to session highs, tracking Treasury yields, while another drop in Italian bonds kept the euro under pressure. The Bloomberg Dollar Spot Index heads for its third straight weekly advance as Treasury 10-year yields hold close to cycle highs and the euro meets selling interest on rallies above 1.15.

Politics were also in focus in Britain where reports of progress between the UK and the EU in negotiating a Brexit deal pushed the pound to 3-1/2-month highs against the dollar. Analysts at Eurizon SLJ Capital said parliamentary approval looked likely for Prime Minister Theresa May’s Brexit deal. The Times newspaper reported 30-40 opposition Labour MPs would back the agreement. “Already significantly undervalued, sterling has upside risks, especially against the euro,” Eurizon SLJ told clients, arguing that $1.55 was “fair value” for the currency.

The krone led gains in G-10 on stronger Norwegian inflation. Sterling hits its strongest level in two weeks on hopes officials will reach a compromise Brexit deal that could see the U.K. remain temporarily in the EU’s customs regime; wider than forecast trade deficit data helps push the pound back toward its opening level. The South African rand dropped following Tuesday’s rally.

In geopolitics, US President Trump said a summit with North Korean leader Kim Jung Un will be after US midterm elections on November 6th. In related news, US Secretary of State Pompeo noted real progress on his trip to North Korea and sees a full path to denuclearization.

In the latest Brexit news, ITV reported that UK PM May’s negotiator Robbins has made meaningful progress in talks with EU’s Chief Negotiator Barnier on the Irish border backstop. The article stated, “The most important development would be that the EU seems close to agreeing that the backstop would apply to the whole UK and not just to Northern Ireland, as it originally demanded – or at least it would apply to the whole UK for customs.” (ITV) In related news, UK Brexit Minister Raab said the UK will not sign up to an indefinite customs union with the backstop and negotiations with the EU have intensified, some differences on the withdrawal agreement.

In commodities, WTI slipped but was still near $75 a barrel as Hurricane Michael curtailed offshore oil production and the IEA issued a warning to the global market.

Expected data include mortgage applications, PPIs, and wholesale inventories. Fastenal is among companies reporting earnings.

Market Snapshot

• S&P 500 futures down 0.1% to 2,885.25
• STOXX Europe 600 down 0.3% to 371.92
• MXAP up 0.02% to 157.41
• MXAPJ down 0.05% to 492.53
• Nikkei up 0.2% to 23,506.04
• Topix up 0.2% to 1,763.86
• Hang Seng Index up 0.08% to 26,193.07
• Shanghai Composite up 0.2% to 2,725.84
• Sensex up 1.3% to 34,758.76
• Australia S&P/ASX 200 up 0.1% to 6,049.81
• Kospi down 1.1% to 2,228.61
• German 10Y yield rose 0.2 bps to 0.551%
• Euro down 0.01% to $1.1490
• Italian 10Y yield fell 9.0 bps to 3.104%
• Spanish 10Y yield rose 1.1 bps to 1.611%
• Brent futures down 0.2% to $84.82/bbl
• Gold spot down 0.2% to $1,187.48
• U.S. Dollar Index up 0.1% to 95.76

Top Overnight News from Bloomberg

• Republican groups have been pulling back in more than a half dozen tough House races to focus their resources in districts where they see a better chance to defend against a building midterm surge by Democrats
• China plans to increase the number of companies it deems systemically important financial institutions, people familiar with the matter said, a sign that policy makers are stepping up crisis-prevention efforts as the nation’s debt burden swells to unprecedented levels
• Mnuchin warns China on competitive currency devaluations; Treasury has monitored currency issues “very carefully”; notes yuan has “depreciated significantly” during the year: FT
• Italy: Finance Minister Tria says budget watchdog approved govt economic forecast, however had different view on growth targets; rise in BTP yields are an excessive reaction
• BOE’s Haldane: risks to domestic prices are now broadly balanced; U.K. wage growth is likely to be limited and gradual
• Brexit: a group of 30-40 Labour MPs are prepared to back Chequers deal, according to people familiar: Times
• ECB’s Mersch: tightening labor market should support core inflation; reiterates ECB will be data dependent
• British and European Union officials are locked in talks in Brussels over a compromise Brexit deal that could see the U.K. remain temporarily in the EU’s customs regime, people familiar with the negotiations said
• There are growing signs China’s yuan may weaken past 7 per dollar, a key psychological level it hasn’t breached in a decade. The latest came in a China Securities Journal commentary
• The U.S. is threatening to block the U.K. from a 46- nation public procurement agreement, a move that would deny British companies from accessing a near $2 trillion-dollar marketplace after leaving the European Union, according to two officials with knowledge of the situation
• Federal Reserve Chairman Jerome Powell is pinning his hopes of stopping the U.S. economy from overheating on a variable that a former colleague called “the most significant unobservable of all:” inflation expectations
• Hurricane Michael’s winds rose to Category 4 strength of 130 miles an hour as it careened toward Florida

Asia-Pacific equities traded mixed as the region mimicked the lead from Wall St. where the S&P notched its fourth day of losses while the Nasdaq snapped its three-day losing streak. The Dow closed in the red as the major indices swung between positive and negative territory throughout the day. ASX 200 (+0.3%) was supported by strength in the healthcare and consumer discretionary sectors, while Nikkei 225 (Unch) was pressured by machinery names along with Softbank after reports emerged that the company discussed investing between USD 15bln-20bln for a majority stake in WeWork, while a firmer currency only subdued the index further. Elsewhere, mixed trade in China with Hang Seng (+0.5%) supported by oil names, while Shanghai Comp. (-0.3%) gave up initial gains to trade with no firm direction for most of the session before stabilising in the red.

Top Asian News

• China’s Banking Showdown Pits WeChat vs. 3 Million Bank Tellers
• Rocket Scientist’s Veggie Startup Is Said Valued at $7 Billion
• Hong Kong Bans E-Cigarettes in Latest Blow for Big Tobacco
• SoftBank Is Said to Consider Taking a Majority Stake in WeWork
• Luxury Shoppers in China Still Buy Bags, But Not BMWs
• Singapore Central Banker Strikes Upbeat Tone Amid Trade Risk

Major European indices (ex-SMI) trade lower (Eurostoxx 50 -0.4%) as Italian budgetary concerns remain a key focus; SMI. The CAC 40 (-0.7%) lags its peers after being weighed on by the Luxury names after the sector was downgraded to underweight by Morgan Stanley with the US bank citing concerns about a slowdown in Chinese activity. The move by MS took the shine of LVMH’s latest sales update with other Luxury names such as Kering and Burberry trading lower in sympathy. Sectors are mixed with telecom stocks leading their peers amid broad support for the sector today. Energy names are firmer by 0.7% following oil supply concerns from Hurricane Michael. Consumer discretionary is down by over 1.5% due to the aforementioned poor performance of luxury brands. Dixons is up by 3.5% after being upgraded to buy at HSBC; whilst Sage are up by 2.4% following being upgraded to Hold at Deutsche Bank.

Top European News

• U.K. Economy Set for Best Quarter Since 2016 Despite Flat August
• Patisserie Valerie Owner Suspends CFO Amid Accounting Probe

In FX, the Greenback has regained some composure overall after Tuesday’s rather sharp and abrupt sell-off on a degree of US Treasury yield retracement, and to a lesser extent another expression of dissent about the rate of Fed tightening from President Trump. To recap, the broad Dollar and DXY recoiled from best levels in relatively quick order, with the index down to 95.500 vs 96.000+ and circa 95.750 now, as rival currencies also derived bullish momentum on independent factors. The JPY is back below 113.00 vs the Usd and still unable to really test a key Fib level at 112.73, but perhaps drawn towards decent option interest from the big figure to 113.05 (1.2 bn) if the headline pair fails to break above 113.25. Some retracement from peaks for the Zar after a broadly positive reaction to the new SA Finance Minister appointment, while in contrast the Try has pared losses following initial disappointment over the Turkish Government’s inflation-fighting measures.

In commodities, both WTI and Brent are down just under 0.5%, trading just under USD 75/bbl and USD 85/bbl following further supply shortages from Hurricane Michael with 40% of Gulf of Mexico production now suspended in preparation. Note, APIs will be released otnight at 2130BST due to the Columbus Day holiday on Monday. Iron ore futures are up by over 0.6% following comments from Australia’s Port Hedland that Iron ore shipments to China to rise to 37.4mln tonnes. Gold is uneventful once again trading within a thin USD 5/oz range. Zinc hit a 4-month high in Shanghai overnight amid tightening supplies.

Looking ahead, in the US, focus will be on the September PPI report ahead of Thursday’s CPI, as well as August wholesale inventories data. Brexit negotiations will remain in focus, the BoE’s Chief Economist Haldane will speak in London, and regional Fed Presidents Bostic and Evans will speak on the economic outlook later in the evening.

US Event Calendar

• 7am: MBA Mortgage Applications, prior 0.0%
• 8:30am: PPI Final Demand MoM, est. 0.2%, prior -0.1%;
  • PPI Ex Food and Energy MoM, est. 0.2%, prior -0.1%
  • PPI Ex Food, Energy, Trade MoM, est. 0.2%, prior 0.1%
  • PPI Final Demand YoY, est. 2.7%, prior 2.8%
  • PPI Ex Food and Energy YoY, est. 2.5%, prior 2.3%
  • PPI Ex Food, Energy, Trade YoY, prior 2.9%
• 10am: Wholesale Inventories MoM, est. 0.8%, prior 0.8%; Wholesale Trade Sales MoM, est. 0.5%, prior 0.0%

DB’s Jim Reid concludes the overnight wrap

It was another day to wear your seatbelts if you were trading BTPs yesterday. By late morning London time 10yr yields had climbed another 14bps to 3.711%. However by the close we were almost 10bps tighter on the day at 3.476%. An impressive turnaround. Yields seemed to start to fall at the same time as the following headlines came through from Tria’s parliamentary hearing. He said that the “Government would act in case of an unexpected rise in bond spreads,” and that Italy’s current government bond yield spread is “unacceptable” and hopes to bring it down by explaining the budget measures. To be fair, this was all very vague and it’s not clear what the government could do other than reduce the budget deficit – which he hasn’t had much power over in the first place. Nevertheless the rally had started and seemed to get a further leg when headlines came through that “Conte, Tria, Salvini and Di Maio to meet at 8pm over budget.” We haven’t seen any follow through on this but Tria will address parliament at 10AM local time today.

If BTP trading required a seatbelt yesterday, Treasury and Bund markets required a small dose of motion sickness pills as 10yrs traded to both sides of a 6bp and 4bps range respectively. Given the risk off of the last few days and the weak global day for risk across the US bond market holiday on Monday, it was a bit of a surprise to see US Treasuries sell off 3bps in the morning to nearly 3.26%. However, we closed 3.0bps lower at 3.203% (3.208% in Asia). Bunds closed largely unchanged.

US equities were mixed again, though the recent underperformers bounced, with the NYFANG index up +0.63% and the NASDAQ eking out a +0.03% gain after 3 sessions of losses over which time it had shed -3.60%. The S&P 500 and DOW fell -0.14% and -0.21% respectively, while the VIX index rose as much as 1.8pts, but fell throughout the evening to close only 0.26pts higher at 15.95. That’s still a 3-month high.

This morning in Asia markets are continuing to trade mixed with the Hang Seng (+0.43%) up while the Shanghai Comp (-0.18%), Nikkei (-0.09%) and Kospi (-1.10%) are all down. Elsewhere, futures on S&P 500 (-0.15%) are pointing to a slightly softer start while EM FX is generally stronger against the greenback. On oil, IEA Executive Director Fatih Birol made a direct appeal to OPEC and other major oil producers to boost output, warning that high prices are inflicting damage on the global economy at a time when global economy is already losing growth momentum.

The pound rallied 0.41% versus the dollar yesterday on positive-sounding headlines, with Dow Jones reporting that the EU and UK will agree to a solution on the Northern Ireland issue at next week’s EU Council meeting. Separately, Brexit Secretary Raab told Parliament that the backstop for Northern Ireland will be temporary and limited. It’s hard to see how this will satisfy the EU but the headlines over the last 24 hours suggest we getting closer to a deal. The DUP’s Arlene Foster reiterated that on the Northern Ireland border issue they are trying to find a deal that works for everyone which sounded a little more dovish while the Government’s spokesman James Slack said that the UK’s new proposal for how to prevent a hard border with Ireland is coming “in due course,” signaling that the government expects the EU to flesh out how it sees UK’s future ties with the EU. In the meantime, The Times reported that the UK PM Theresa May is planning to have an extended discussion on Brexit at next Tuesday’s cabinet meeting in hopes of outlining a compromise deal on the Irish border. Overall, our strategists remain cautious, since the actual agreement of the deal will not be the key stumbling block; the real issue is if a deal can pass through Parliament. Positive movement from Labour MPs or from “hard” Brexiteers would be a more bullish catalyst for the pound. Interestingly the FT reports this morning that up to 30 Labour MPs are assessing whether they would vote against the government if it meant a no-deal.

In terms of central bank speak, the Fed’s Kaplan said on inflation that the cyclical inflation pressures are building and didn’t think that inflation is going to “run away from us” On rates he reiterated his previous view that he is comfortable hiking rates three more times till June while adding that higher productivity could lift neutral interest rates. He also added that I “don’t know the answer yet” on whether the U.S. central bank should lift interest rates past the neutral level that neither spurs nor slows growth, or “sit tight for a while.” Philadelphia Fed President Harker continued his recent hawkish shift by describing the labour market as having “very little slack left.” Overnight the Fed’s John Williams said that he expects the US economy to grow by c.3% in 2018 and 2.5% in 2019 while adding that the above trend growth should lead to decline in unemployment levels to slightly below 3.5% in 2019. On inflation he said he expects it to move a bit above 2% but doesn’t see any signs of greater inflationary pressures on the horizon.

Emerging market currencies gained 0.32% yesterday, amid positive news in Turkey and South Africa. Turkey’s treasury and finance minister Berat Albayrak announced a new plan to cut inflation, including price controls/cuts and lower bank loan rates. The Turkish lira erased morning declines to close 0.26% stronger. In South Africa, Finance Minister Nene resigned after a corruption scandal and was replaced by Tito Mboweni, a former central bank governor. Mboweni has a strong reputation as an orthodox inflation hawk, and the markets greeted the new appointment with the Rand rallying 1.88% versus the dollar. The  Brazilian Real also outperformed, gaining 1.74% for its 7th consecutive day of gains. It has now appreciated every day in October, as investors anticipate a victory by rightwing candidate Bolsonaro in the October 28 runoff Presidential election.

In Europe, Germany’s August trade balance came in at €17.2bn (vs. €16.2bn expected) while the current account balance stood at €15.3bn (vs. €16.2bn expected). German exports declined -0.1% mom (vs. +0.4% mom expected) for the second month in a row, however the decline in imports was more accentuated at -2.7% mom (vs. -0.1% mom expected). In the US, the NFIB small business confidence fell modestly from its all-time high of 108.8 in August, printing at 107.9 versus expectations for 108.3.

Looking ahead to today, August industrial production will print in the UK and France. After a soft reading in Germany, the stakes are marginally higher than normal. The UK will also have its monthly GDP reading and trade balance report. In the US, focus will be on the September PPI report ahead of Thursday’s CPI, as well as August wholesale inventories data. Brexit negotiations will remain in focus, the BoE’s Chief Economist Haldane will speak in London, and regional Fed Presidents Bostic and Evans will speak on the economic outlook later in the evening.