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China Downgrade Forgotten As Asia Closes Higher, Futures Flat Ahead Of Fed Minutes

Not even last night's Moody's credit downgrade of China - the first since 1989 - could dent the global stock rally which has pushed global stock prices to all time highs. After initially sliding, regional stocks and emerging Asian currencies pared early losses following the unexpected downgrade of China, taking their cue from the "sudden reversal" of the Shanghai Composite Index, which some speculated saw the latest intervention of the "national team."

Moody’s action on China briefly rattled Asian markets, but against a backdrop of strengthening global growth and the impending release of minutes from the Federal Reserve’s latest meeting, investors appeared to quickly move on. MSCI's broadest index of Asia-Pacific shares outside Japan was unchanged while Japan's Nikkei stock index ended 0.7 percent higher.

The Shanghai Composite gained 0.1% at the close, reversing an early decline of 1%, while the offshore yuan inched up. As reported last night, the major overnight catalyst in Asia was Moody's downgrade of China’s credit rating to A1 from Aa3 in early Asia trading, citing a worsening outlook for the nation’s financial strength - in the end of the Chinese session it had little impact, aside from another steep selloff in iron ore, which traded nearly limit down. The downgrade impact on regional currencies was likewise limited as Asia’s economic growth is seen to be improving and there are still positive stories such as S&P’s upgrade of Indonesia’s rating last week.

By the end of the session, nobody even remembered China had been downgraded: the Shanghai Composite rose 0.1 percent, reversing a drop of 1.3 percent. The Hang Seng also ended higher after an earlier decline of 0.4 percent. Japan’s Topix index climbed 0.6 percent, while Indonesia’s benchmark index slumped 0.7 percent. The Australian dollar slipped 0.1 percent, paring a steeper drop of as much as 0.5 percent.

Away from Asia, European stocks rose and U.S. equity futures and the dollar both steadied. The Stoxx Europe 600 Index climbed a second day, but struggled to gain momentum as miners slumped after China's downgrade. That triggered declines across copper, nickel, zinc and iron ore. The British pound strengthened after two days of losses, even as Prime Minister Theresa May warned that further terrorist attacks could be imminent.

"There's been a cautious start in Europe this morning with stocks in the red following a downgrade in the Chinese credit rating from Moody's," said David Cheetham, chief market analyst at brokerage XTB. "After being very much at the front and center of global risk sentiment at the beginning of last year, the Chinese slowdown story has been almost forgotten, with politics throughout Europe and the U.S. taking the limelight."

S&P500 futures were little changed as investors awaited economic data and earnings reports, while volatility dropped for a fifth day. S&P 500 contracts expiring in June added less than 0.1% to 2,398.5 at 6:30 a.m. in New York.

Crude extended gains a sixth day as OPEC prepared for Thursday’s key meeting in Vienna, and where an announcement of a 9 month productin cut extension now is fully priced in.

In currencies, the dollar was little changed against most of its peers and Treasury yields were steady before the U.S. Federal Reserve releases later Wednesday the minutes of its May 3 policy meeting. With Fed due to release its May meeting minutes, “markets are ready to catch any clue regarding the likelihood of an interest- rate hike at the FOMC’s June meeting,” writes Ipek Ozkardeskaya, senior analyst at London Capital Group. Fed Bank of Philadelphia President Patrick Harker said June “is a distinct possibility” for the U.S. central bank’s second interest-rate increase of 2017.

While equities quickly forgot the downgrade of China, the world's top user of materials, industrial metals were far more bruised, as nickel slumped 1.9% and copper fell 0.6%. Iron ore futures dropped 4.7%.  West Texas oil rose 0.2 percent to $51.56 a barrel, adding to a five-day advance ahead of tomorrow's OPEC meeting. old added 0.1 percent to $1,252.30 an ounce, after dropping 0.8 percent on Tuesday.

Elsewhere the Australian dollar fell and the yen pared losses against the U.S. currency after Moody’s Investors Service cut its rating on China’s debt for the first time in almost three decades. The euro was little changed ahead of the Fed minutes, even as ECB policy makers warned of the dangers of the ‘ripple effect’ from the house price boom and ‘significant’ bond risks spurring increased debt concerns.

In rates, the yield on 10-year Treasury notes fell less than one basis point to 2.27 percent. Bonds fell during the previous four days. Yields on benchmark French, German and British bonds all dropped two basis points.

Today investors await the minutes of the U.S. Federal Reserve's latest policy meeting, scheduled to be released at 2pm. Fed funds futures show that traders now see a 75% chance that the U.S. central bank would will raise interest rates at its June meeting. "Our U.S. economists expect the minutes to come down on the hawkish side and continue to expect the Fed to hike in June and September and announce balance sheet reduction in December," Citi analysts wrote on Wednesday.

Bulletin Headline Summary from RanSquawk

  • Equities fail to find firm direction and seemingly looking through China's sovereign downgrade as Moody's offers little in the way of any surprises.
  • A very quiet morning in FX with focus on the FOMC minutes, alongside the OPEC/Non-OPEC meeting.
  • Looking ahead, highlights include US Building Permits, Existing Home Sales, DoE Inventories, FOMC Minutes, BoC Rate Decision, ECB's Praet and Draghi

Market Snapshot

  • S&P 500 futures little changed at 2,399.25
  • STOXX Europe 600 up 0.1% to 392.48
  • MXAP up 0.01% to 151.88
  • MXAPJ up 0.02% to 495.69
  • Nikkei up 0.7% to 19,742.98
  • Topix up 0.6% to 1,575.11
  • Hang Seng Index up 0.1% to 25,428.50
  • Shanghai Composite up 0.07% to 3,064.08
  • Sensex down 0.1% to 30,328.05
  • Australia S&P/ASX 200 up 0.2% to 5,768.98
  • Kospi up 0.2% to 2,317.34
  • German 10Y yield fell 1.1 bps to 0.399%
  • Euro up 0.1% to 1.1197 per US$
  • Brent Futures up 0.6% to $54.46/bbl
  • Italian 10Y yield fell 1.5 bps to 1.83%
  • Spanish 10Y yield fell 2.2 bps to 1.596%
  • Brent futures up 0.6% to $54.49/bbl
  • Gold spot little changed at $1,251.99
  • U.S. Dollar Index little changed at 97.30

Top Overnight News from Bloomberg

  • Moody’s Investors Service cut its rating on China’s debt for the first time since 1989, challenging the view that the nation’s leadership will be able to rein in leverage while maintaining the pace of economic growth
  • The European Central Bank said debt- sustainability concerns have risen in the past six months amid a potential increase in yields and political uncertainty in some countries
  • U.K. Prime Minister Theresa May warned that further terrorist attacks could be imminent. The country’s terrorism threat level has been raised to “critical” -- the highest level -- from “severe”, as police hunt for potential accomplices of the suicide bomber who killed 22 people at a Manchester pop concert
  • The White House said Trump’s request for fiscal 2018 would generate a fiscal surplus by 2027 after $3.6 trillion in spending reductions and $2.1 trillion in economic growth-induced revenue increases, but gave no details on how tax cuts would be paid for
  • Traders in the world’s biggest financial market are about to get a new list of do’s and don’ts. The FX Global Code, which the Bank for International Settlements will publish Thursday, aims to stamp out misconduct in foreign-exchange markets after a rigging scandal triggered about $10 billion in fines for banks
  • Glencore-Bunge Deal Would Add G to ABCD Dominating Grain
  • SoftBank Said to Take $4 Billion Stake in U.S. Chipmaker Nvidia
  • Troops Deployed in U.K. After Warning of Imminent Terror Attack
  • Fed’s Harker Calls June Rate Hike a ‘Distinct’ Possibility
  • Oil Holds Gain as Data Show U.S. Supplies Fall Before OPEC
  • Fiat Chrysler Stumbles Into U.S. Regulatory Crosshairs Again
  • Noble Group’s Wild Trading Day Demands ‘High Risk Appetite’

Asia equity markets traded mixed following the mildly positive US close, where indices eked a 4th consecutive daily gain and the S&P 500 briefly advanced above 2,400 to within close proximity of its all-time highs. This provided the initial impetus for the ASX 200 (flat) and Nikkei 225 (+0.3%), while JPY weakness also underpinned Japanese exporter sentiment. Conversely, Shanghai Comp. (+0.1%) and Hang Seng (flat) underperformed after Moody's downgraded China's sovereign credit rating amid expectations of a deterioration in China's financial strength in the upcoming years. 10yr JGBs traded lower on spill-over selling from T-notes and alongside the increased risk sentiment in Japan, although downside was stemmed amid the BoJ's presence in the market for a total JPY 1.03trl in 1yr-10yrs government debt. Moody's downgraded China's sovereign credit rating to Al from AA3; outlook revised to stable from negative. Moody's commented that the rating reflects expectations that China's financial strength will erode somewhat over the approaching years. PBoC injected CNY 40bIn in 7-day reverse repos and CNY 50bIn in 14-day reverse repos. The PBoC set CNY mid-point at 6.8758 (Prey. 6.8661)

Top Asian News

  • China State Firms Face Threat of Higher Debt Costs After Moody’s
  • Freeport Says Grasberg Output on Target as Union Extends Strike
  • Evergrande Climbs Most Since July 2015, Leading Gains on HSCI

European equities trade with little in the way of firm direction (Eurostoxx 50 flat) as earnings season continues to peter out and markets shrug of overnight news that Moody's downgraded China's sovereign debt rating. Chinese bourses were initially hit on the news given the surprise of the timing but ultimately the action taken is of little surprise given debt concerns and Moody's bringing their rating in-line with that of Fitch and as such European traders have largely looked through the announcement. On a sector stand-point, energy names outperform ahead of this week's OPEC meeting despite a lack of clarity on the duration of any potential extension. Material names underperform amid Dalian ore futures sliding over 5% over night. In fixed income markets, price action has been particularly uneventful with prices stuck in a somewhat narrow range. In peripheral markets, spreads are also relatively unchanged to their core counterparts with markets most likely looking for further direction from today's speech by ECB's Draghi and any further update on the Greek situation after the IMF and German Finance Minister Schauble reportedly struck an agreement on Greek bailout with the IMF willing to participate in the program if Greece proves debt is sustainable.

Top European News

  • Morgan Stanley to ‘Significantly Reduce’ Recruiting of Brokers
  • Constancio Says Brexit Won’t Materially Harm Euro-Area Recovery
  • Understanding Poland’s Retreat From Costly Swiss-Loan Fix
  • Wynnstay Shares Slump as Just for Pets Weakness Hits Profit
  • Safran, Zodiac Shares Halted Pending Press Release: Euronext
  • Ikea Names Brodin New CEO to Lead Asia Expansion, Online Growth

In currencies, the Bloomberg Dollar Spot Index was flat after climbing 0.3 percent Tuesday. The pound rose 0.1 percent to $1.2971 following a two-day loss. The euro fell by less than 0.1 percent to $1.1178. It has been a very quiet morning in FX and if anything stands out it is the resilience in the cross JPY rates. This is in the face of the Moody's downgrade of China's credit rating, which garnered brief attention in Asia, but little else. USD/JPY has tested 112.00, but good selling interest seen here despite a small tip over the figure level. EUR/USD is still in pullback mode, but fresh demand coming in already. The FOMC minutes ahead may underpin expectations of a Jun move, and this should see USD bids picking up dips — 1.1200 intact as a result. Not that this is deterring Cable buyers still intent on tripping stops through 1.3060-70. We see little other reason for the resilient bid tone in the Pound given what lies ahead, with some suggesting traders are pre-empting a Tory win in the elections. We doubt this would lead to a significant charge higher from current levels, but impulsive markets are here to stay.

In commodities, Iron ore led metals lower across the board today as the overnight markets reacted to the Moody's downgrade of China's credit rating. The DCE lost over 4.5% today, with the indices here requiring little to tip the balance these days. Copper has found some resistance at USD2.60 as many anticipated, but the pullback has been tame so far to suggest a more consolidative tone going forward. All eyes on Oil prices at the present time, and with the OPEC meeting not until tomorrow, but ongoing rhetoric supportive of an extension — though to what degree. 6 months is the minimum required to keep WTI above USD50.00, currently trading closer to USD52.00 while Brent is in the upper USD54.00's. Precious metals are out of the spotlight, but Silver has crept back above USD17.00.

Looking at today’s calendar, we’ll get the March FHFA house price index reading and also April existing home sales data. This evening we then get the FOMC minutes from the meeting on May 3rd where most be will combing through for discussion on the Fed’s balance sheet strategy. It’s another busy day for Fedspeak today too with Kaplan (6pm ) and Kashkari (6.30pm ) both scheduled. ECB President Draghi also speaks in Madrid at 1.45pm BST.

US Event Calendar

  • 7am: MBA Mortgage Applications, prior -4.1%
  • 9am: FHFA House Price Index MoM, est. 0.5%, prior 0.8%
  • 9am: House Price Purchase Index QoQ, prior 1.5%
  • 10am: Existing Home Sales, est. 5.65m, prior 5.71m
  • 10am: Existing Home Sales MoM, est. -1.05%, prior 4.4%
  • 2pm: FOMC Meeting Minutes
  • 6pm: Fed’s Kaplan Speaks in Toronto
  • 6:30pm: Fed’s Kashkari Speaks in Wisconsin

DB's Jim Reid concludes the overnight wrap

Back in 1990 in an attempt to impress the young ladies on the school bus which we shared with the girls school next door I started watching Twin Peaks. I hated it but had to continue watching in case I could possibly be part of their arty, seemingly sophisticated conversation. They adored it (the show, not my input sadly). So it was some intrigue to me that a new series aired this week 25 years after the last one. I haven't watched it yet but I wonder whether any of it will make sense. For the uninitiated it was a surreal, confusing supernatural drama that amongst other things included a red room where everyone spoke backwards. At 16 this was the height of cool and it was the most popular show of 1990. Thankfully the days of trying to impress a potential new partner are over. What impresses my wife most these days is me changing a nappy so I do that when I can instead.

Talking of twin peaks, US equities have again edged up towards the highs after the S&P 500 closed last night within 0.30% of the all time peak from intraday last Tuesday before all the political headlines hit. The index was up +0.18% yesterday which means it has now gained for four consecutive sessions. You’d have to go back to February to find the last time it did that. The Dow (+0.21%) also edged up while there was a similarly positive mood in Europe with the Stoxx 600 (+0.22%) also finishing in positive territory. Some decent PMIs on both sides of the pond seemed to be the catalyst (we’ll come to those shortly) and it didn’t hurt that Oil continues to solidify gains. Indeed WTI (+0.66%) was up for the fifth day in a row yesterday and is holding above $51/bbl ahead of tomorrow’s OPEC meeting where there was more chatter yesterday from energy ministers that a nine-month extension agreement appears likely. In bond markets Treasuries (+2.6bps) and Bunds (+1.3bps) were a little weaker while in currencies the US Dollar (+0.38%) was up for only the second time in the last nine sessions. Needless to say that the tragic events in Manchester dominated the front pages around the world with UK PM Theresa May subsequently raising the terror alert in the UK to ‘critical’ from ‘severe’. Sterling (-0.30%) was a touch weaker yesterday and is holding just below $1.300 this morning.

Before we go any further, the main news to report overnight is Moody’s cutting China’s sovereign credit rating by one notch to A1/Stable (was previously on Negative outlook). That is the first time Moody’s have cut China’s rating since 1989. The rating agency noted the likelihood of a “material rise” in economy-wide debt and expectations that China’s financial strength could “erode somewhat” as a result. China’s rating at Moody’s is now level with that of Japan and below other Asia economies of Taiwan and Macau.

While there were no real revelations in the Moody’s statement the timing appears to have caught markets by surprise a little. Equity markets in China initially fell sharply on the news and while having pared back some of the losses, are still underperforming this morning. The Shanghai Comp is currently -0.63% and at the lowest level in nearly 8 months. It was initially down as much as -1.28%, while the CSI 300 and Shenzhen are -0.75% and -0.19% respectively. The Hang Seng is now flat after being in the red. Both the onshore (-0.10%) and offshore (-0.05%) renminbi are a shade weaker, while China’s sovereign 5y CDS is 1bp wider. The China sensitive Aussie Dollar is also down -0.40%. Elsewhere in Asia bourses are firmer and seemingly following the lead from Wall Street. The Nikkei (+0.48%), ASX (+0.10%) and Kospi (+0.20%) are all up.

Away from markets, there were some interesting comments to come from the ECB’s Benoit Coeure yesterday. Speaking at a conference in Paris, Coeure said that “our current analysis of the secondary effects of negative rates suggest that there is no reason to change the indications we’ve given”. The board member also said that the ECB would start raising rates “well beyond the horizon” of asset purchases. Last week Coeure had said that the future path for rates was “not set in stone”. This suggests that the ECB is not about to change sequencing and is important as Coeure was previously seen as someone who had  suggested a change in sequencing previously. We should get more hints at next month’s ECB meeting.

Another focus for the market yesterday was Trump’s budget. Despite the wide acknowledgment that it stands little chance of being passed as proposed it was interesting to look at some of the details still. One questionable aspect is that the plan assumes that US economic growth would reach 3% by 2021 whereas the Fed and Congressional Budget Office project the US economy growing at an annual rate of just 1.8% and 1.9% in the coming years. In addition, the budget assumes to only balance in 10 years through strong growth. This follows the point we made in yesterday’s EMR about the UK not seeing a balanced budget  until 2025 in the Conservative Party’s manifesto. Indeed one wonders how budgets will ever balance again in most countries especially given the demographic headwinds. Staying with the US the White House issued a statement yesterday saying that it does not confirm or deny ‘unsubstantiated claims based on illegal leaks from anonymous individuals’ concerning the investigation of the links between Russia and Trump’s presidential campaign. A reminder that former FBI Director James Comey is likely to testify next week which will no doubt be a talking point for the market.

Back to those PMIs yesterday. In Europe the flash May composite for the Euro area came in at a fairly solid 56.8 which was modestly better than what the market was expecting and steady versus the April reading. The manufacturing reading edged up 0.3pts to 57.0 (vs. 56.5 expected) which offset a 0.2pt decline in the services reading to 56.2 (vs. 56.4 expected). In the country details there was a positive read-through in the data for both Germany and France. The former saw its composite rise 0.6pts to 57.3, driven by the manufacturing sector while the latter saw its composite rise 1pt to 57.6, driven by the  services sector. This does however imply a roughly 1.1pt decline in the average composite for the periphery. Taken as whole, the composite reading for the Euro area implies GDP growth in Q2 of +0.8% qoq according to our economists, compared to their forecast of +0.5% qoq.

Across the pond, the composite flash May reading in the US came in at 53.9 which was up 0.7pts from April. The details were a little more mixed however with the driver of the increase in the composite coming from the services sector where the PMI rose 0.9pts to 54.0. The manufacturing PMI actually edged down 0.3pts to 52.5.

Away from the PMIs, the rest of the data in the US was a tad disappointing. New home sales fell sharply in April (-11.4% mom vs. -1.8% expected) albeit from a March reading which was revised up to an almost 10-year high. Meanwhile the Richmond Fed manufacturing index tumbled 19pts to +1 (vs. +15 expected), confirming some of the weaker data in the factory sector. In Germany Q1 GDP was confirmed as growing +0.6% qoq while the IFO business climate reading in May was revealed as climbing 1.6pts to a better than expected 114.6 (vs. 113.1 expected). The present situation index actually hit a new multi- decade high while the expectations index rose to its highest since February 2014. Finally in the UK the CBI’s distributive trades survey was disappointing with a net 2% of respondents reporting higher sales in May, down from 38% in April.

Before we wrap up and look at the day ahead, it’s worth highlighting that German press outlet Handelsblatt was running a story yesterday suggesting that the IMF and German Finance Minister Wolfgang Schaeuble have reportedly reached an agreement on Greece. The article suggests that the IMF has signalled its willingness to participate in the program and would only provide money if Greece proves its debt is sustainable.

Looking at today’s calendar, the only data due out in Europe this morning comes from Germany where the flash June consumer confidence reading is due. This afternoon in the US we’ll get the March FHFA house price index reading and also April existing home sales data. This evening we then get the FOMC minutes from the meeting on May 3rd where most be will combing through for discussion on the Fed’s balance sheet strategy. It’s another busy day for Fedspeak today too with Kaplan (11pm BST) and Kashkari (11.30pm BST) both scheduled. ECB President Draghi also speaks in Madrid at 1.45pm BST while Praet  speaks this morning.