China Stabilizes, Stocks and Bonds Sigh in Relief

Fears of a quick sharp devaluation of the Chinese yuan, disrupting the global economy, sparking a currency war, have eased. For the second session, the yuan stabilized.   The central reference rate (fix) was CNY6.3969, having finished the Shanghai session before the weekend at CNY6.3912.   The fix then was CNY6.3975.

While the oil downtrend is continuing today, bond prices are generally falling Curves are flattening as the long-end is down more than the short-end.  Most of the major 10-year benchmarks are off 2-3 bp today, while two year yields are most little changed (+/- 0.5 basis points).  With the hint over the weekend that Greece could qualify again for having its bonds accepted as collateral by the ECB has helped lift Greek bond yields that have fallen below 9% for the first time in six months.   We note that the officials have ruled out the bail-in of depositors, but not senior bondholders in the coming recapitalization of Greek banks.  Those bonds have fallen sharply today. 

Equities are mostly higher.  The Nikkei gained 0.5%.  Chinese shares are up about 0.7%.  The Shanghai Composite is just below 4000, and at its highest level since July 27.  Officials seem to have put in a bottom near 3500.  At 4500, some of the support fades.   Energy and financials were the two main sectors lower today.  

European bourses higher, with the FTSE being the main exception.  The Dow Jones Stoxx 600 is up about 0.2%, led by utilities and healthcare.  Telecom, materials and energy are drags.  The same sectoral performance is evident in the UK too. 

There have been two economic developments that have peppered the otherwise bland news stream.  First, Japan's GDP contracted by 1.6% at an annualized pace in Q2.  That is a 0.4% contraction on the quarter, a smidgen better than the 0.5% fall expected.  Yet private consumption and business spending fell more than expected.  Consumption slid 0.8%, twice the decline that the consensus expected and Q1 was revised to 0.3% from 0.4%.  Business spending edged lower by 0.1%.  The consensus has expected a flat report. It was revised to 2.8% from 2.7% in Q1.  Growth is expected to return to Japan in the current quarter.  The consensus is for 2.0% growth Q3 and Q4. 

The dollar is in a little more than a third of a yen range against the Japanese currency.  Support held at the top of the JPY124.00-JPY124.20 range.  The market seems poised to test JPY125 again with the slightest provocation.  

Second, the BOE's Forbes was quoted warning that keeping rates low risk creating distortions, and that rates would have to rise well before CPI was near 2%.  Although some reports suggested this was hawkish and bullish for sterling, we are skeptical.   Tomorrow's CPI report is going to underscore that that scenario is not nearly at hand.  Headline CPI is expected to fall by 0.3%, leaving the year-over-year rate at zero.  Moreover, the core rate, which might tick up to 0.9% from 0.8% is below the eurozone's core inflation.    The June 2016 June short sterling futures implies a 2 bp lower yield than it did before the weekend. 

There was a push higher on sterling before London opened that carried sterling to almost $1.5690.  This looks to have largely been the triggering of stops in a thin market.  Sterling has been slow to new session lows in the London morning near $1.5620.  A break now of $1.5580 would likely signal a reversal from the multi-week high. 

The euro has been confined to a 60 point range between roughly $1.1065 and $1.1125.  Having tested the top side again in the European morning, the risk would seem that the early North American traders have a go on the downside.   The next support is see near $1.1025.  The focus on Greece turns to the German parliament vote on Wednesday.  There is no doubt that it will be approved.  The issue is how many of CDU/CSU do not vote with their Chancellor.  In early July 60 of 311 dissented.  The German paper Bild warns that double that might break now.  It is striking to see Merkel and Schaeuble trying to win over critics by defending Greece. 

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