New Lockdown in China and the First Drop in South Korea's Chip Exports in 2 years Euthanizes Animal Spirits

Overview: The precipitous fall in equities continues while the dollar remains buoyant. Nvidia’s warnings about US curbs on sales to China and the first drop in South Korea’s chip exports in two years, coupled with the largest lockdown in China since Shanghai encouraged investors to move to the sidelines. Most of the major equity markets in the Asia Pacific region were off 1-2%. The Stoxx 600 is off for the fifth consecutive session and the second session of more than a 1% drop. US futures point to a gap lower opening of the US indices today. The 10-year US Treasury yield is flat around 3.18%, though the two-year rose to a new high above 3.50% before easing a bit. The greenback is firm. It set a new 24-year high against the yen and a new two-year high against sterling. Nearly all the emerging market currencies are lower today, as well. The $1700 level held in gold, but it continues to trade heavily and threatens to extend its loss for the fifth consecutive session. October WTI is below $88.50, bringing its three-day tumble to nearly $9 a barrel, despite OPEC+ now warning of a shortage of supply next year, switched from a previously anticipated surplus. US natgas is giving back yesterday’s almost 1% gain, while the European benchmark is snapping a four-day drop. China’s lockdown helped send iron ore more than 5% lower to approach the July low near $95. December copper is off 1.8%, extending its drop for the fifth consecutive session. December wheat bounced 1.4% yesterday but has come back offered today and is off nearly 1%.  

Asia Pacific

Japan's stronger than expected Q2 capex and corporate profits (4.6% and 17.6%, year-over-year, respectively), were the bright spots today in the region, and they were too old to be impactful. Japan separately reported its August manufacturing PMI fell to 51.5 from 52.1. This was a little better than the preliminary estimate.

News that China's Caixin manufacturing PMI fell to 49.5 from 50.4, unexpectedly falling below the 50 boom/bust level was overshadowed by even worse news. China's fourth largest city, Chengdu (~21 mln) and accounting for around 1.75% of GDP was put under indefinite lockdown. Separately, after firing warning shots earlier this week, Taiwan reportedly shot down a PRC drone.

Australia's preliminary August manufacturing PMI of 54.5 was revised down to 53.8. In July, it stood at 55.7. It also reported weaker than expected private capital expenditure (-0.3%) after an upward revision in Q1. Home loan values tumbled 8.5% in July, a drop of more than twice expectations. The Reserve Bank of Australia meets on September 6. The cash rate futures market is pricing in about a 66% chance of another 50 bp hike, virtually unchanged this week.

South Korea's Q2 GDP was in line with expectations. The economy expanded by 0.7% on the quarter and 2.9% year-over-year. However, it stunned with a near-doubling of its August trade deficit to a record $9.47 bln (from a revised $4.8 bln deficit). Exports were a bit better than expected, rising 6.6% year-over-year (down from 9.2%), but imports surged 28.2%. What makes these South Korean figures important more broadly is that its chief export semiconductors fell by 7.8%, the first decline in two years and speaks volumes about world demand. Separately, it reported its August manufacturing PMI fell to 47.6 from 49.8. It is the weakest reading since July 2020. Taiwan's manufacturing PMI has been falling uninterrupted since the end of last year. In August, it stood at 42.7, down from 44.6 and is the third consecutive month below 50. It is the lowest since May 2020, when it bottomed at 41.9.

The dollar rose to new 24-year highs against the yen near JPY139.70 in the local session. It pulled back to almost JPY139.00 in early European turnover, and the intraday momentum indicators do not to expect much more. The divergence of monetary policy and the high bar to intervention makes a stronger dollar the path of least resistance. The BOJ's 0.25% cap on the 10-year yield is approaching and this will likely force officials to activate its defense. The Australian dollar was sold below $0.6800, falling to its lowest level since July 18. It recovered to $0.6850, which had previously offered support, but met new selling in early Europe. The intraday momentum indicators warn of the risk of a retest on the lows. The greenback has been straddling the CNY6.90-level in what has largely been a consolidative session. It remained within yesterday's range and above the five-day moving average (~CNY6.8960). For the seventh consecutive session, the PBOC set the dollar's reference rate lower than expected (Bloomberg survey). It was fixed at CNY6.8821 vs CNY6.8924. Rather than reverse the yuan's weakness or target some level, we see the PBOC's efforts chiefly aimed at moderating the pace.

Europe

The poor EMU CPI report may have been the last straw in favor of a 75 bp hike by the ECB next week. We had thought a 50 bp hike was more likely to be followed by two more half-point moves in Q4. When the staff updates its inflation forecast from issued in June (6.5% this year, 3.5% next, and 2.1% in 2024), will likely be higher. The case for a 50 bp cut is weaker and ultimately rests, it seems, on the past revealed preference for more stable moves. This may have helped the euro outperform yesterday, as sterling, in contrast, which plumbed to a new two-year low, and the dollar bloc was soft.

The final Eurozone manufacturing PMI eased to 49.6 from the preliminary estimate of 49.7, and 49.8 in July. Some observers arguing that the mild contraction may embolden the ECB. Still, our analogy of a person jumping off a skyscraper, and passing the 50th floor and economists observing that the person is alright still seems apropos. It is the seventh consecutive month without an uptick. Moreover, many are concerned that after unexpected maintenance that has shut Nord Stream 1 pipeline, it may not come back on Saturday as Gazprom says, with another pretext used to squeeze Europe, which agreed yesterday to limit tourist visas from Russia. The German manufacturing PMI stands at 49.1, down from the 49.8 flash reading and 49.3 in in July. In France, the revision went the other way. Its final manufacturing PMI rose to 50.6 from 49.0 preliminary estimate and 49.5 in July. Italy's manufacturing PMI fell to 48.0 from 48.5 previously. It is the lowest since June 2020. Spain's manufacturing PMI edged rose to 49.9 from 48.7. Separately, both Germany and Italy, reported some better news. In Germany, retail sales unexpectedly jumped 1.9% in July. The median forecast (Bloomberg survey) expected a 0.1% decline. The 1.6% decline in June was shaved to -1.5%. In Italy, the July unemployment rate surprised with a small decline to 7.9% from 8.0%, and Q2 GDP was revised to show a 1.1% quarter-over-quarter expansion rather than 1.0%.

In the UK, the Nationwide house price index rose 0.8% in August, stronger than the 0.1% rise expected. The year-over-year gain of 10% was better than the 8.9% pace anticipated, even if slower than the 11% rate seen in July. The UK's manufacturing PMI stands at 47.3, an improvement from the preliminary estimate of 46.0, but below the 50 boom/bust level for the first time since May 2020. The Bank of England warns of a recession that has not yet begun despite the poor data and contraction in Q2 GDP.

The euro has been confined to yesterday's range (~$0.9970-$1.0080). It has thus far held above $1.000 but the bounce in early Europe to almost $1.0050 met new sellers. There are options for around 600 mln euros at $1.000 today that expire. Yesterday's high was just in front of the nearly 420 mln euro options at $1.0090 that also roll off today. Sterling was sold through $1.17 on Monday and earlier today it was sold below $1.16, slipping slightly below $1.1570. Options for more than GBP500 mln at $1.16 expire tomorrow and the break today likely forced some sterling sales. That said, the downside momentum appears to have stalled. The $1.1650 area may offer the nearby cap. 

America

The market rightfully shrugged off what seemed like a surprisingly weak ADP private sector estimate. It showed 132k increase in private sector employment as it unveiled the results of its new methodology. The July estimate of 268k was around half of the BLS estimate. We have long argued that the ADP estimate was a poor guide in the short-run and, and although it did better in the longer-term, it may have been an exercise in curve fitting. Now, it appears to have given up the ghost:  ADP say it is "an independent indicator and complementary to government data" and is not a forecast of the BLS monthly private sector nonfarm payroll estimate.

The US has a busy economic calendar ahead of tomorrow's jobs report. First are the weekly jobless claims. Here the takeaway is that the four-week moving average, used to smooth out some of the inevitable noise, has stabilized between about 245k-250k since mid-July. During the week of the monthly survey, weekly claims has slipped a bit from July survey week. Non-farm productivity and unit labor costs are derived from the Q2 and not measured directly. The smaller contraction in Q2 means that the initial estimate of productivity can be revised to show less of a fall (initially -4.6%) and the increase in unit labor costs can be trimmed (from 10.8%). Then comes the final reading of the August manufacturing PMI. The preliminary estimate, which does a very good job of anticipating the final report, slowed for the fourth consecutive month (to 51.3). The manufacturing ISM tracks it well though because more of the details are available without a subscription, it often draws attention. Finally, the August auto sales will be reported. They are expected to be little changed from July's 13.35 mln pace. They have averaged a 13.7 mln unit rate this year through July, about 17% lower than the year ago period. That translates into about 280k few vehicles at an annualized rate. The sparse inventory, given the chip shortage, is still understood to be part of the issue, but increasing reports suggest the cost-of-living squeeze appears to be playing a role.

The disappointing current account figures from Canada warned of disappointment with Q2 GDP which was estimated at 3.3% rather the meeting the median projection of 4.4%. Exports were strong, but imports stronger and overall, the external sector cut the growth by 5.2 percentage points. Another way of saying this is a foreign supply helped meet the demand from houses and business. Businesses built inventories and this was the largest contributor to Q2 growth. The impact from higher rates was evident 28% annualized decline in residential investment. Capex remained strong, rising at a 14% annualized clip. The best days of Canada's economic outperformance is behind it, but inflation is high. The swaps market toyed with another 100 bp hike next week (September 7), following the July surprise, and is now coming around to recognize that a 75 bp move is much more likely. July building permits are expected to have fallen when reported later today. Shortly after that, the August manufacturing PMI, which is not often a market-moving data point. It slowed in June and July, and further deceleration would not surprise.

The US dollar is rising against the Canadian dollar for the third consecutive session amid the risk-off climate, illustrated by the four-day slide in the S&P 500 (poised to gap lower today). The greenback approached CAD1.32 earlier today, after posting its highest close in two-years yesterday (~CAD1.3130). It had reached almost CAD1.3225 on an intraday basis in mid-July. The near technical target is seen in the CAD1.3300-CAD1.3350 area. However, the market is stretched, and the intraday momentum indicators suggest some backing and filling is likely. Initial USD support is seen in the CAD1.3140-50 area. The central bank of Mexico slashed next year's growth forecast to 1.6% from 2.4% and helps keep the peso under pressure. The US dollar bottomed earlier this week near MXN19.91 and is pushing near MXN20.22-MXN20.24. A move above MXN20.27 would target the MXN20.37 area. Mexico reports July remittances and PMI/IMEF surveys. Brazil reports Q2 GDP (0.9% quarter-over-quarter is expected after 1.0% in Q1), the August manufacturing PMI and trade figures. The dollar tested the BRL5.20 area yesterday after gapping higher. The next technical target is closer to BRL5.26. 

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