Stocks Jump into Quarter-End, Euro Bounces on Immigration Deal

Global equities are posting impressive gains to close out the quarter.  The Shanghai Composite rose nearly 2.2%, its strongest gain in a couple of years on signals from the PBOC that focus may shift to growth stabilization, which could facilitate easing of credit conditions.  The onshore yuan snapped a six-day slide, while the offshore yuan rose for the first time in 12 sessions.  

More broadly, the MSCI Asia Pacific Index ended a four-day slide to finish 0.9% higher, recouping a third of this week's losses.  Nearly all markets in the region rose but Australia (-0.3%) and Thailand (-0.5%).  Indonesian stocks rallied 2.3% even after the central bank surprised investors by a 50 bp rate hike.  Many had expected a quarter-point move.  The MSCI Asia Pacific Index rose one week in May and one week in June.  It fell 3.8% over Q2, after slipping 0.6% in Q1.  The benchmark rose in all four quarters last year.

European stocks are moving higher as well.  Coming into today, the Dow Jones Stoxx 600 was up about 1.6% for the quarter and is tacking on another 1.2% today.  All the major industry groups are advancing, led by information technology and financials.  It is still off 1% on the week, and its the fifth week of the past six that the benchmark has moved lower.   

There are two main developments in Europe today.  First, a deal appears to have been struck on immigration.  It is very much along the lines that Italy's new government advocated, and one that will likely be sufficient to ease the tension within Merkel's CDU/CSU alliance.  Essentially, the agreement calls for increased border security, holding centers for asylum seekers, an expedited process to determine eligibility for asylum and overhaul the distribution of migrants when the gateway states, like Italy, Malta, and Greece, are overwhelmed.  Illegal immigrants will be expelled. 

The second development was the flash June CPI report.  It was in line with expectations.  The headline rate rose to 2.0% from 1.9%, while the core rate slipped to 1.0% from 1.1%.  The rise in the headline rate likely stems from the increase in energy prices.    

The euro, which had returned its recent lows yesterday (near $1.1525) is moving higher today.  It took out yesterday's high in Asia to reach $1.1665.  Although the high was reapproached after the CPI report, it stalled.  The midweek high was a little above $1.1670, and the high for the week was near $1.1720.  There was a large option struck at $1.15 (3 bln euros) which seems irrelevant now, and another nearly 900 mln euros struck at $1.1550 is not in play.  However, the 2 bln euro option at $1.1600 could still impact activity in the North American morning.  

Sterling eased to a new 2018 low yesterday near $1.3050, effectively meeting the objective of the double top pattern from the spring.  It bounced off smartly, alongside the euro, in Asia.   It reached almost $1.3185 in early Europe but turned down after the batch of data, which included a tick up in Q1 GDP estimate to 0.2% from 0.1%.   Today's data for Q2 suggest the economy has done a bit better.   The market appears to be pricing in about a 70% chance of a BOE rate hike in August.  This is around twice the probability that was discounted at the end of May. 

European bonds are mixed.  Italy's 10-year yield is off eight basis points to bring this week's decline to 12 bp.  Spain and Portugal's 10-year benchmark yields are three basis points lower, while the core yields are slightly firmer.   The US and UK 10-year yields are 1-2 basis points higher but are still 2-3 lower on the week.  

An unexpected decline in Japanese unemployment and a smaller than forecast decline in industrial output failed to stir investors.  May's unemployment fell to 2.2%, but the mild wage pressure (~0.9% year-over-year) blunts the significance for many investors.  Industrial production was expected to have fallen by at least 1% in May but instead slipped a mild 0.2%, which allowed the year-over-year pace improve to 4.2% from 3.4% in April.

The dollar is consolidating this week's small gains. Impressively consistent, the greenback has risen every week here in Q2 except two, for an overall gain of near 4.1%.  Today there is a $466 mln option stuck at JPY110.50 expiring.  Another $372 mln JPY110 option also will be cut.

The Canadian dollar rallied strongly yesterday as the market reconsidered the meaning of Bank of Canada Governor Poloz comments.  Initially, most seemed to think that the uncertainty over trade and the impact of new mortgage rules was a sign that the Bank of Canada would leave rates on hold at the July 11 meeting.

The US dollar surged from near CAD1.3300 to CAD1.3385.  However, beginning in Europe, and then through the North American session, the greenback's gains were peeled back.  It finished near the session lows just below CAD1.3250, where there is an option for $685 mln today.  The next important chart support is seen near CAD1.3200.  Interpolating from the OIS, the market is discounting almost a 70% chance of a hike next month up from a little more than 50%.

The S&P 500 set a new low for June yesterday but recovered and may gap higher today.  This is likely to be a "normal" gap that is quickly filled.  However, there is a gap from earlier this week, which if closed would help lift the near-term technical tone.  The gap was created on Monday's lower opening, and the gap also appears on the weekly bar charts.  The gap was entered on Wednesday but was not fully closed.  It can still be found between Wednesday's high near 2746.1 and last Friday's low near 2752.7.  

Trade conflict may impact the movement of good and services crossing national borders, but it may encourage another foreign direct investment.  The origins of modern direct investment were the overvalued dollar after WWII.  Tax incentives followed, perhaps under the regulatory-capture model. Japanese auto and parts manufacturers built plant and production in the US in responses to the protectionism of the early 1980s. The US wants foreign companies to build their products in the US but does not want US companies to build their products abroad.

Chinese officials are concerned about capital outflows, and capital flows remain in place.  It wants to encourage capital inflows.  Gradually, officials are opening up more of the economy to foreign direct investment.  China announced that it was reducing or eliminating the caps on foreign ownership in some agriculture crop breeding, shipbuilding, airplane manufacturing, power grids, and commercial banking.  China is committed to removing ownership caps on some financial services and auto manufacturing by 2021 and 2022 respectively.

Lastly, Brent is extending its advance.  It is up 0.8% as the rally enters a fourth session and the fifth of the past six.  It was up nearly 4% this week after a 3% gain last week.  The year's high was set near $80.50 in mid-May.  It reached $78.60 in the European morning.  August WTI is flat today after surging about 7.5% over the past three sessions.  The previous high for the year was near $72.70 seen in late May.  It briefly poked through $74.00 yesterday before consolidating so far today.  

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