US and China nerves continue

US, Chinese markets fall on Covid worries

Financial markets wobbled overnight after the US Manufacturing PMI didn’t hit the heady heights expected by markets. To be fair, a print of 59.5 is still impressive, but like technology stocks, the bar is set high, and markets have itchy trigger fingers nowadays if the music isn’t playing loud enough. ISM Manufacturing New Orders also missed slightly, while ISM Manufacturing Prices slid to 85.7, still stratospheric, but less sub-orbital than June’s 92.1. Interestingly, markets completely ignored a rise in the Employment Index to 52.9.

Never one to say no to an opportunity to send yields lower, the “peak recovery” interpretation saw US 10-year yields shed ten basis points intra-day before settling under 1.20% at around 1.18%. To be fair to the bond market, the US data followed China’s PMIs earlier in the day, which also underwhelmed, reinforcing the peak recovery narrative.

We can also throw the Covid-19 delta-variant into the mixture, with concerns rising once again, that the global recovery could be thrown off track by the virus. The rise in US cases, and ASEAN’s situation, is well known, but what is spooking markets is China, which has seen a small number of cases popping up across a number of cities. It’s not a huge reach to extrapolate even more supply chain disruptions, especially if it proves as elusive to control for Chinese authorities as it has to officials globally.

Apart from a vigorously flattening US yield curve, the other big casualty was oil. Crude prices plunged overnight but nowhere near the same scale as the panicked “delta-dip” a couple of weeks ago. Somewhat surprisingly, the US dollar held its ground, and I suspect that support may be coming from haven flows, some of which were probably heading to US Treasuries.

So, the delta variant and its potential knock-on effect on the world’s two largest economies looks like it will temper animal spirits amongst the FOMO crown for now. Even that “bargain-hunting” seen in the China equity market yesterday might not be looking quite as rosy today. I have said previously that a resurgent virus is the number one threat to global recovery. I still hold to that view, albeit with the acceptance that it will be very uneven geographically. Readers should take their cues from China this week, though, where a sudden surge in delta variant cases across the mainland would potentially be a game-changer for that worldview. I am not saying this is what will happen, but we should be monitoring the situation in case it does happen.

Asian markets are off to a negative start today after the developments overnight, with the Reserve Bank of Australia’s latest policy decision at 1230 SGT the session’s highlight. We have already had South Korean Inflation and Tokyo CPI this morning. South Korean Inflation rose to 2.60% YoY for July, slightly above expectations. That leaves the Bank of Korea on track for a Q4 hike, although the won has not reacted, sinking under delta-variant nerves like the rest of Asia. Tokyo CPI YOY for July fell to -0.10%, leaving its 20-year trend intact. Nothing to see here; move along, please.

Today’s RBA decision is subject to much speculation as to whether the central bank will change its guidance and backtrack on its tapering schedule or even move to a “flexible” framework regarding tapering. With lockdowns having spread to greater Brisbane and no progress being seemingly made in Greater Sydney regarding case numbers, some downward adjustment in Australian GDP is inevitable. Qantas is putting 2,500 workers back into furlough as air travel domestically grinds o a halt, which won’t help matters. A dovish outcome seems inevitable, which is likely to be felt most keenly in the currency.

In contrast, a firm Global Dairy Trade auction later today or robust New Zealand Employment data tomorrow has the potential to make a rate hike by the Reserve Bank of New Zealand all but certain at its next meeting. The kiwi is already 0.35% higher today, and it is set to rally further under this scenario, notably versus its trans-Tasman neighbour.

The rest of the day’s data calendar is relatively quiet for this week. Eurozone PPI will be of passing interest, but most attention will be focused on US Factory Orders this evening, which are expected to ease to 1.0% in July from June’s 1.70% gain. Given the reaction to the PMI data overnight and the global recovery delta-nerves, a weaker than 1.0% print will likely spur another fall in US 10-year yields and probably see the Dow Jones and Russell 2000 under pressure. The US dollar may finally capitulate in this scenario as well if the US yields head south, and oil could see another wave of exit trades.

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