It’s going from bad to worse for global equity market and US stock futures, which again are a sea of red as Sino-U.S. trade tensions continue to escalate – with a rare earth boycott by China now virtually assured – while fears of an Italy-EU confrontation are growing again, accelerating a global bond rally on Wednesday, as investors dumped shares and scurried for the safety of government debt, the dollar and gold.

Amid the rush out of risk, German yields fell deeper into negative territory and inched toward record lows around minus 0.2%. In the US, 10Y Treasury bond yields reached 20-month lows, dropping as low as 2.20%, having fallen almost 30 basis points this month.

Benchmark yields slid to the lowest since 2016 in Japan, to a record in New Zealand and below the central bank’s policy rate in Australia. The 3M-10Y yield curve continued to slide deeper into negative territory, touching -13bps in the US, the lowest since 2007, and inverted in Australia and South Korea.

“What I see as more consistent is that typically when the yield curve inverts you get central bank easings. So the question about recession would be: would the U.S. Fed ease enough to avoid a recession?” said Nikko Asset Management PM Chris Rands. In relation to that, US. rates futures are pricing in two cuts by the Federal Reserve by the middle of next year to help prop up the country’s economy. “The fact that you have got a bit more noise around the trade war now at the same time as manufacturing is rolling over — it’s getting people to think that things are a little bit worse than they had expected,” he said.

Amid the global risk off, S&P500 futures slumped, with the Emini sliding below 2,800 for the first time since March after a bout of overnight selling, indicating a weak opening in New York.

Sentiment soured after President Trump’s comment that he was “not yet ready” to make a deal with China over trade. Chinese newspapers responded on Wednesday with a warning Beijing could use rare earths to strike back at the United States, suggesting further tit-for-tat escalation is imminent.

Asian stocks dropped, led by health care and consumer staples companies, after rising in the previous three trading days. Most markets in the region were down, with South Korea’s Kospi losing its year-to-date gain. The Topix gauge fell 0.9%, driven by Takeda Pharmaceutical and Sony. The Shanghai Composite Index edged higher, though, rising 0.2%, as large insurers rallied on a tax deduction.

Later in the session, declines in European miners and tech companies pulled the Stoxx Europe 600 Index lower, after Japanese and South Korean equities bore the brunt of losses in Asia. European shares opened lower, with Germany’s exporter-heavy index down 1% and a pan-European share benchmark losing 1.3%. Europe’

Europe’s Stoxx 600 Banks Index falls as much as 1.7% on Wednesday, erasing all gains for the year 2019, to head for its worst month in three years. The decline was skewed by BNP Paribas down 7.9% as stock trades ex-dividend, however it was mostly bond yields hitting new lows that was once again weighing on the sector’s earnings outlook. Italian banks remain vulnerable as the political drama continues with EU Commission President Juncker confirming the EU is ready to open a disciplinary procedure concerning Italy’s debt, la Repubblica reported.

Italian Deputy Prime Minister Matteo Salvini, emboldened by his party’s strong EU election showing, has stepped up promises to slash taxes and is calling for new EU budget rules, raising fears his plans will drive up Italy’s huge public debt. Italian 10-year bond yields rose for the third day in a row to 2.73%.

A gauge of emerging-market stocks fell to the lowest since January and most developing-nation currencies declined versus the dollar.

It’s not just trade war and renewed Italian tensions that are spooking markets: as Morgan Stanley noted overnight, the US economy was already sliding into a slowdown ahead of the May trade war return. Recent economic data, such as purchasing-manager surveys, have disappointed — U.S. manufacturing growth dropped to 10-year lows. A barrage of American data tomorrow and Friday will give traders more to chew on as they reassess the Federal Reserve’s policy path.

“Then we have a weaker growth outlook … so we have the negative shock of trade added to lower growth and the cushion of protection isn’t as good as it was eight to nine months ago.”

Another round of tariffs would sharply raise U.S. recession risk, said Justin Onuekwusi, a fund manager at Legal & General Investment Management. “The market is simply calculating what the impact will be of the next set of tariffs as it doesn’t look like the rhetoric is calming down. Then we have a weaker growth outlook … so we have the negative shock of trade added to lower growth and the cushion of protection isn’t as good as it was eight to nine months ago.”

As Reuters adds, the news was gloomy on the political front as well. Eurosceptic parties gained in recent EU elections, Austria and Greece face elections and Italy’s dispute with the European Commission over its budget may be escalating. In Britain, many speculate risks of a hard Brexit have risen, because candidates lining up to succeed Prime Minister Theresa May are mostly eurosceptic.

Currency activity was muted, with the dollar edging higher versus its major counterparts for a third day. The dollar is on track for its fourth straight month of gains, benefiting from flows away from markets such as Asia that are considered at greater risk from trade wars. The yuan steadied following news that the People’s Bank of China had injected the most in money-market operations since January. The euro was unchanged at $1.1159 after falling two straight days. The British pound slid to $1.2639.

On Tuesday, in its delayed report, the US Treasury said no major trading partner met currency manipulation list but added that China, Germany, Japan, Ireland, Italy, South Korea, Malaysia, Singapore and Vietnam warrant placement on its currency monitoring list (Switzerland and India were removed). Furthermore, it lowered 2 thresholds used to designate FX manipulators and urged China to take necessary steps to avoid a persistently weak currency

In commodities, West Texas oil futures dropped, losing all of their gains from Tuesday and more, dipping below $59 a barrel in New York. Gold recovered most of Tuesday’s losses as U.S.-China trade tensions climbed and global growth concerns escalated, as investors continue to seek haven assets. The metal has missed out on some haven buying in recent days, with investors favoring the dollar and bonds. Gold is on pace for its fourth monthly decline.

Expected data include mortgage applications. Canada Goose, Trulieve Cannabis and Palo Alto Networks are among companies reporting earnings

Market Snapshot

• S&P 500 futures down 0.5% to 2,790.25
• STOXX Europe 600 down 1.2% to 371.30
• MXAP down 0.7% to 152.67
• MXAPJ down 0.7% to 497.36
• Nikkei down 1.2% to 21,003.37
• Topix down 0.9% to 1,536.41
• Hang Seng Index down 0.6% to 27,235.71
• Shanghai Composite up 0.2% to 2,914.70
• Sensex down 0.4% to 39,606.99
• Australia S&P/ASX 200 down 0.7% to 6,440.03
• Kospi down 1.3% to 2,023.32
• Brent futures down 2.2% to $68.60/bbl
• German 10Y yield fell 0.2 bps to -0.163%
• Euro down 0.02% to $1.1158
• Italian 10Y yield rose 0.6 bps to 2.31%
• Spanish 10Y yield fell 4.9 bps to 0.738%
• Gold spot up 0.4% to $1,284.73
• U.S. Dollar Index up 0.1% to 99.04

Top Overnight News

• The Trump administration again refrained from labeling China a currency manipulator. The U.S. Treasury Department issued its semi-annual foreign-exchange report, expanding the number of countries it scrutinizes for currency manipulation to 21 from 12
• Traders are pricing in quicker and deeper rate cuts by the Federal Reserve as global macro risks ratchet higher. Swap markets now indicate expectations for three 25 basis point cuts by the end of 2020, a new dovish extreme for this cycle
• China accused the U.S. of abusing a national security exception at the WTO by cutting off Huawei Technologies to American suppliers and warned the move could have grave consequences
• Treasuries are in the vanguard of a bull run in global bonds, bringing into sight the prospect of benchmark 10-year yields dropping to 2% for the first time since late 2016
• Oil climbed for a second day as supply risks from the Middle East to the U.S. Great Plains overwhelmed concerns trade tensions will swamp energy demand
• Beijing is gearing up to use its dominance of rare earths as a counter in its trade battle with Washington, according to a salvo of media reports in China that included hints from the state planning agency
• Angela Merkel has decided that Annegret Kramp-Karrenbauer, who took over as leader of the Christian Democratic Union in December, is not up to the country’s top job, according to two officials with knowledge of her thinking
• Escalating U.S.-China trade tensions and faltering global growth have seen U.S. 10-year yields tumble and has brought into sight the prospect of benchmark yields dropping to 2% for the first time since late 2016
• German unemployment unexpectedly rose by 60,000 in May, compared with economists’ forecasts for a decline of 8,000. This was the first climb in almost two years as the economic slowdown finally started to take a toll on the labor market
• China’s central bank moved to curb the risk of a funding squeeze on banks after the government’s surprise seizure of Baoshang Bank Co. sparked a jump in borrowing costs. The PBOC injected a net $36 billion Wednesday

Asian equity markets were mostly lower following the headwinds from US where all major indices declined on return from the extended weekend and in which the E-mini S&P eventually broke below the 2800 level. The weakness was attributed to lingering trade tensions after Chinese press pointed the blame on US for the recent breakdown in talks and as the outspoken Global Times Editor suggested China is seriously considering restricting rare earth exports to the US. ASX 200 (-0.7%) and Nikkei 225 (-1.2%) were negative with broad weakness seen across nearly all sectors in Australia and with financials subdued by the recent declines in global yields, while currency strength added to the pressures for Tokyo stocks. Hang Seng (-0.6%) and Shanghai Comp. (+0.1%) declined amid the trade uncertainty and as early data indicators reportedly suggested China’s economy weakened this month, although the losses were cushioned by a substantial liquidity operation of CNY 270bln which resulted to the PBoC’s largest daily net injection since mid-January. Finally, 10yr JGBs were higher as they tracked the upside in global counterparts amid declining yields and the negative risk sentiment, which lifted prices of the Japanese 10yr benchmark to above 153.00 and its best level since early April.

Top Asian News

• The Old Yen-as-Haven Trade Just Isn’t Panning Out as It Should
• Malaysia Weighs Bids for Return to Euro, Swiss Franc Bond Market
• Bank of Thailand MPC Member Expects Period of Key Rate Stability

European equities are lower across the board [Eurostoxx -1.6%] following on from a downbeat session in Asia as sentiment took the queue from Wall Street after the E-Mini S&P took out the 2800 level to the downside. Sectors are all in the red with IT names lagging after Huawei signalled that it is pressing ahead with its lawsuit against the US government as US-China tech tensions intensify. Defensive stocks such as utilities and healthcare names are somewhat faring better, albeit still in the red. In terms of individual movers, ProsiebentSat1 (+4.0%) spiked higher amid reports that Mediaset (-0.8%) are to purchase a 9.1% stake in the company, which would grant 9.9% of voting rights, although Mediaset noted that they do not seek board representation. Elsewhere, Casino (-4.6%) shares slid after the company announced that it will not pay an interim dividend this year, whilst S&P downgraded its credit after its parent company entered French safeguard procedures. Finally, ArcelorMittal (-4.0%) opened lower by as much as 7% after cutting production guidance in Europe amid weak market demand. In light of the recent sell-off in stocks amid trade woes, Nomura believe that the downside can be seen as orderly and sentiment is not out of control. The analysts state that the recent sell off in equities is being fuelled by transient stock selling via speculative players and a seasonal rise in volatility, as global equities pass through a predictable second wave of selling. Following the E-mini S&P’s declined below 2800, eyes turn to the cash market at the US open where Nomura warns that “CTAs have been pressed to close out long positions and cut their losses once the S&P 500 broke below 2,820”, but CTAs have already unwound over 80% of their longs, thus the risk of a chain reaction sell-off has diminished.

Top European News

• German Unemployment Rises as Weaker Economy Starts to Bite
• Berlusconi’s Mediaset Buys Stake in Germany’s ProSiebenSat.1
• Swiss Open Criminal Probe After Complaint Against Glencore
• Varta Acquires Varta Consumer Batteries Business From Energizer

In FX, we start with CHF/JPY/USD – The Franc’s resurgence or rebound from yesterday’s lows seems symptomatic of the wider safe-haven demand and deeper risk-off sentiment. Usd/Chf has retreated towards 1.0050 again vs a fraction shy of 1.0100 at one stage on Tuesday, while Eur/Chf is drifting back down to 1.1200 compared to almost 1.1280, albeit with the single currency under pressure independently on the back of latest bleak German data – see below. Usd/Jpy has also recoiled to retest key Fib support ahead of 109.00 at 109.23 (Fib retracement level) having bounced firmly to just over 109.60, but decent option expiry interest may prop up the headline pair (1 bn between 109.00-15) on top of anticipated buying interest at the big figure. Note also, the Buck has extended its recovery in wake of upbeat US consumer confidence and with the aid of gains vs riskier/high beta currencies, with the DXY back above 98.000, albeit just and eyeing last week’s 98.373 ytd best within a 98.043-97.861 range.

• NZD/CAD/GBP/AUD/EUR – All softer vs the Greenback, and with the Kiwi underperforming after the latest RBNZ FSR and NBNZ business survey showing that expectations remain weak. Nzd/Usd has slipped back below 0.6550 to around 0.6515, with the Aud/Nzd cross climbing over 1.0600 again even though the Aussie is also struggling to retain 0.6900+ status following yet another uber dovish RBA call overnight as JPM is now predicting a total of 100 bp worth of easing by mid-2020. Elsewhere, the Loonie is really trading on the defensive as the clock ticks down to a potentially dovish BoC with Usd/Cad not far from 1.3520+ late April peaks and options pricing a circa 53 pip break-even over the event – see our policy meeting preview on the Research Suite. Meanwhile, Cable is slipping further from 1.2700 towards the big figure below as another Tory leadership hopeful joins the list and the EU stresses no renegotiation of the WA, and Eur/Usd is hovering just above 1.1150 stops having failed to hold above the 30 DMA (1.1191) again. Note, a shock jump in German unemployment and uptick in the jobless rate that was only partly mitigated by a reclassification of the labour force also weighed on the Euro as noted above.
• NOK/SEK – Divergence between the Scandi Crowns as Eur/Nok rebounds through 9.7500 amidst another retreat in oil prices (that may also be niggling the Cad), but Eur/Sek is capped around 10.7000 after significantly stronger than forecast Swedish Q1 GDP data (largely due to a healthy export contribution vs depressed domestic consumption however).
• EM – Contrasting fortunes for the Lira and Rand as well, like yesterday, as Usd/Try revisits 6.0000, but Usd/Zar pivots 14.8000 within 14.8900-7000 parameters on a further fall-out from SA political developments and the return of Mabuza to Ramaphosa’s fold.

In commodities, WTI (-2.3%) and Brent (-2.0%) futures continue to free-fall amidst the risk-off tone in the market, with the former extending loses below the psychological USD 58.00/bbl and under its 100 DMA at USD 58.46/bbl. Similarly, its Brent counterpart trades south of the USD 69/bbl level and closer to the USD 68.50/bbl mark. News flows has been relatively light in the complex although the Druzhba pipeline will be pumping clean oil to Hungary as of 1700BST following the halt in operations amid contaminated oil from Russia in mid-April. Turning to OPEC, ahead the upcoming meeting of the cartel (date yet to be confirmed), Kazakhstan’s Energy Minister noted that it stands ready to join the extension of the global oil cut deal if the decision in taken. On that front, Russia’s First Deputy PM noted that they will consider an extension to the deal but have arguments in favour and against an extension, adding that Moscow will continue to weight the arguments. Finally, as a reminder, the API crude inventory data will be released tonight due to US’ market absence on Monday, and thus the EIA release has been delayed until tomorrow.

Over in the metal complex, gold (+0.4%) continues to rise despite a firmer USD as investors flee to the safe haven amid the current risk aversion; meanwhile, copper (-0.8%) falls in tandem with the risk tone. Further for the red metal, workers at the Chilean Chuquicamata copper mine of have been voting on a potential strike after labour unions rejected management’s final offer on wages. The results of the vote are expected this evening.

US Event Calendar

• 7am: MBA Mortgage Applications, prior 2.4%
• 10am: Richmond Fed Manufact. Index, est. 7, prior 3

DB’s Jim Reid concludes the overnight wrap

If like me you are looking to fill the Game of Thrones void you can do worse than to watch “Chernobyl” if it’s available in your region. I got home late from Madrid last night and didn’t even say hello to my wife but instead rushed in and sat down next to her to watch the gripping penultimate episode after binge watching the previous three over the last week. Obviously the subject matter and scenes are not for the faint hearted but it really is very good. I looked at the definitive big screen database IMDb last night and remarkably it’s already become the highest ranked TV show in history. For those interested, the full top 10 are Chernobyl, Planet Earth II, Band of Brothers, Planet Earth I, Breaking Bad, Game of Thrones, Our Planet, The Wire, Cosmos and Blue Planet. Obviously a lot of natural history fans on this site. The only problem about getting hooked on the five episodes of Chernobyl is that I’m pretty sure that it’s not going to have a season 2!!

It feels like the trade war still has a number of episodes left with the option of being renewed for a new season. The stand-off continues to dominate proceedings in markets with yesterday’s highlight being a fresh new low for 10y Treasuries after they closed at 2.266%, down -5.4bps (a further -2.4bps this morning) and to the lowest for over 20 months. Though equities opened higher and held up well for most of the day, they ended up selling off in the last two hours of NY trading. The S&P 500 fell -0.84%, with the DOW and NASDAQ down -0.93% and -0.39%, respectively. The utilities sector fell -1.61%, retracing some of its recent outperformance, while the NYFANG index was the rare bright spot after a +0.05% advance.

Earlier comments from President Trump about the US not being ready to reach a trade deal with China and that tariffs could go up “very very substantially”, as well as the not-so-insignificant news that the Chinese government had taken control of Baoshang Bank – the first Chinese bank seized in 20 years – and also that China is “seriously considering” restricting rare earth exports to the US according to the Global Times Editor, all contributed to the negative sentiment even if the full sell off only occurred late in the day. In fairness a surprisingly upbeat consumer confidence reading (more on that below) was reason for some earlier optimism.

A flight to quality dominated though and not only did yields fall but the US curve flattened with 2s10s -1.5bps at +13.9bs and to the lowest since March. It has reversed this move this morning though as 2yr yields are over 4bps lower. Bunds ticked down another -1.7bps yesterday to close at -0.161%. I must admit that after they sold off from their all time record low of -0.189% in July 2016, I was pretty confident that we may not see these lows again for perhaps a thousand years given where yields have traded over the last millennium. I’m 2.7bps from being 997 years wrong.

Meanwhile the STOXX 600 closed -0.22% with Italian assets remaining choppy yesterday. They initially opened much weaker although they did at least attempt to bounce back late afternoon. The FTSE MIB closed -0.50% after being down -1.33% in the morning session and 10y BTPs finished flat after rallying back 5bps from the earlier wides. The partial recovery appeared to be supported by the EU’s Moscovici stating that he didn’t support sanctions for Italy. A reminder that this followed stories of the European Commission proposing a disciplinary procedure for Italy as soon as next week following failure to reduce its debt. Regardless, Northern League leader Salvini said he plans to push ahead with his tax cut plan by submitting it to the cabinet, so this issue will continue to fester for many more months.

After US markets had closed, the US Treasury released their latest FX Report, which refrained from labeling any countries as “currency manipulators,” but expanded the list of countries under review and added Italy, Ireland, Singapore, Malaysia, and Vietnam to the “watch list.” Notably, they did not designate China as a manipulator, which would have automatically triggered a new bilateral negotiation process and possible additional sanctions, though the language criticised the “misalignment and undervaluation of the RMB relative to the dollar.” The new countries join China, Japan, Korea, and Germany on the watch list, while India and Switzerland were removed. The criteria used to evaluate countries were also modified, with stricter definitions for a material current account surplus and persistent one-sided intervention.

Turing to trade war related news, most of China’s news dailies are carrying articles today signifying that China could use rare earth exports as a bargaining chip in the ongoing trade war with the US. The Global Times carried an editorial today saying that “sooner or later” China will use “the weapon of rare earth” if the US keeps escalating the trade war while adding that although this weapon is powerful, it will only be used as a tool for defence to convey a message that China won’t bow to US pressure. The People’s Daily, a flagship newspaper of the ruling Communist Party, also carried an editorial today stating that the US shouldn’t underestimate China’s ability to fight the trade war while using some historically significant language on the weight of China’s intent, like the phrase “don’t say I didn’t warn you.” The specific wording was used by the paper in 1962 before China went to war with India and in 1979 before conflict broke out between China and Vietnam. The Global Times had said in an article in April that “those familiar with Chinese diplomatic language know the weight of this phrase.” Meanwhile, an official at the China’s National Development & Reform Commission told CCTV that people in the country won’t be happy to see products made with exported rare earths from China being used to suppress China’s development. Elsewhere, at a meeting of the WTO’s Committee on Market Access in Geneva yesterday, China said that the US had violated WTO rules and urged the Trump administration to “immediately lift all unilateral sanction measures against Chinese companies” while warning that the move could have grave consequences for the global trading system. So lots of more negative rhetoric.

This morning in Asia markets are mostly trading down with the Nikkei (-1.17%), Hang Seng (-0.40%), Shanghai Comp (-0.11%) and Kospi (-1.47%) all lower. The South Korean won is down -0.631% this morning while the onshore Chinese yuan is trading flattish (-0.06% to 6.9142). Meanwhile, yields on 10yr JGBs are down -0.4bps to -0.09% and crude oil prices (WTI -1.03% and Brent -0.68%) are heading lower. Elsewhere, futures on the S&P 500 are down -0.32%. In commodities, base and ferrous metals are heading lower with iron ore futures (down c.3%) leading the declines.

In other news, the PBOC stepped up its efforts to bridge the funding gap in China’s financial system after the surprise seizure of Baoshang Bank Co. led to a jump in borrowing costs by injecting c. CNY 250bn into the financial system via open-market operations today. So lots of moving parts at the moment.

In terms of data yesterday, US consumer confidence in May surprisingly jumped +4.9pts to 134.1, exceeding expectations for a 130.0 reading. In fact the headline reading is now back to being at the highest level since last November. Both the present situations and expectations components rose also with the data collected through the 18th of this month, and thus capturing some of the recent risk off. So a surprisingly positive set of data given the recent trade escalation. It’s worth noting that within that survey, the jobs plentiful/hard-to-get differential hit the highest since 2000 which points to a still healthy labour market. Elsewhere, we also got plenty of house price data yesterday including the FHFA house price index (+0.1% mom vs. +0.2% expected) and S&P CoreLogic index (+0.09% vs. +0.46% expected) – both of which disappointed in March and confirmed that home price appreciation has slowed meaningfully in recent months. Finally, the Dallas Fed’s manufacturing activity survey dropped to -5.3 from 2.0, close to its multi-year low.

As for Europe, the most significant release was the ECB’s M3/credit report for April. Our economists in Europe noted that in summary the monthly credit data were positive in aggregate with net bank loan flows, after recent soft prints, recovering to EUR +43bn, the highest monthly print in the current cycle. As a result, the euro area credit impulse rebounded from negative levels in recent months to its strongest reading since summer 2018, with credit growth picking up to +3.7% yoy. However, the team also flagged that country details show signs of concern due to underperformance in the periphery. Though the credit impulse rebounded in Italy and Spain, it was boosted by base effects and it is set to turn negative again if the current pace of loan flows, with negative corporate credit growth, continues. For the ECB, the credit data continue to favour generous TLTRO3 terms but less so deposit tiering in the view of the team. On that topic of deposit tiering and the adverse impact of negative interest rates, Bank of France Governor Villeroy said yesterday that “the issue should certainly not be ignored, but we also need to avoid blowing it out of proportion.”

As for the other data yesterday, the May economic confidence reading for the Euro Area improved 1.2pts to 105.1, far exceeding expectations for a broadly flat print. In addition industrial and service sector confidence was higher however industrial order books, and especially export orders, were down once again. On a country level, Germany’s consumer confidence ticked down slightly while France’s rose. Over in Turkey, consumer confidence fell to 55.5, its lowest level on record going back to 2004, though the lira nevertheless strengthened +0.50%.

To the day ahead now, which is another quiet one for data with the preliminary May CPI and final Q1 GDP reports in France this morning, May unemployment data in Germany and then the May Richmond Fed manufacturing survey in the US being the only releases due. Away from, that we’re due to hear from the ECB’s Mersch and Rehn this morning before we get the release of the ECB’s financial stability review. The BoC rate decision is also due this afternoon.