Slower Chinese Growth and Italy and Spanish Woes Weigh on Sentiment Ahead of the Weekend

Overview:  Weaker data from China coupled with pressure on the European periphery is weighing on sentiment after yesterday's retreat in  US stocks saw the S&P 500 again retreat below the 200-day moving average.  Chinese shares staged a power reversal after making new four-year lows with the help of supportive comments by officials and pledges to ease the strain from the consequences of using equity for collateral.  However, the coattails of the rally proved short, and most other Asian equity markets fell, and Europe is off to a soft start.  A court ruling yesterday that found that Spanish banks were liable for some mortgage tax which is usually passed on to customers spurred sharp losses in shares prices yesterday and today.  Italian bank shares also remain under pressures.  The index of Italian bank shares is off 18% over the past three weeks and is down more than 5% this week.  All told, the Dow Jones Stoxx 600 is holding on to about a 0.3% gain for the week through the European morning.  European peripheral yields are seven-eight basis points higher while core yields are slightly lower.  The dollar is narrowly mixed, with the dollar bloc firm alongside, whereas most of the majors are nursing small losses.  The euro is consolidating yesterday's losses and has been confined to 20 pips on either side of $1.1450.  The dollar has also been limited to about 20 pip range around JPY112.35.  Sterling held $1.30 but could not regain a foothold above $1.3050.  

China:  Third-quarter GDP  disappointed at 6.5%, which is the slowest since 2009.  It appears that manufacturing was particularly weak.  Some will want to attribute this to trade, though the Chinese economy appeared to be losing some momentum prior to the escalation of trade tensions.  Economists had looked for 6.6% growth after 6.7% in Q2, but the data is hardly precise enough to give a 0.1% deviation much significance.  Still, monthly September data, which included softer industrial output (5.8% vs. 6.1% August), suggests weakness.  On the other hand, retail sales accelerated to 9.2% from 9.0% and fixed-asset investment ticked up (5.4% vs. 5.3%).  On the week, the US dollar rose a net 0.1% against the yuan.  It is the third consecutive decline.  Since the end of March, the US dollar has risen against the yuan consistently except for five weeks.  

Japan: Core CPI, which excludes fresh food, edged up to 1% in September from 0.9% in August. The BOJ targets 2%.  The headline pace slowed dipped from 1.3% to 1.2%.  The underlying impulse, however, flat. A full three-quarter of the rise in the headline rate is due to fresh food and energy.  Excluding both, and Japan's CPI remains flat at 0.4%.   The dollar was flat for the week against the yen coming into today's session.  It briefly poked through JPY112.50, where a $1.1 bln option is struck that expires today.  The heavier yen tone did nothing for Japanese shares, finished softer.  The Nikkei's 0.55% decline on the day brought its week-decline to about 0.75%. 

Europe:  Italy and Spain are dominant stories today.  The Italian government has until Monday to respond to the EC's request for an explanation of the budget proposals, which deviate from the previous agreement.  It is difficult to envision any explanation that the EC will find acceptable.  The request for an explanation is best understood as a prelude to an unprecedented step to return the budget to Italy and formally request a revision.  The continued increase in Italian sovereign yields also takes a toll on Italian banks.  Spanish sovereign bonds are under more pressure than Italian bonds today.  Many small and medium-sized Spanish banks were already under pressure before yesterday's court ruling, which found banks liable for a one-time tax of about 1% of mortgages (though there is some variance across the country).  It is difficult to calculate the full cost of the tax as it is not clear, for example, if it will be retroactively enforced.   In Spain, tax refunds can be claimed for four years.   Over the past four years, Spanish banks have extended more than 160 bln euros in mortgages.  

Euro and Sterling: The euro held the month's low (just above $1.1430) in early European turnover.  It is extending its losing streak into a fourth session and has fallen almost 1% this week.  There are nearly 3 bln euros of options expiring between $1.1400 and $1.1420 today, which appear safe. On the upside, there is a 1.3 bln euro option at $1.15 that will be cut, and if that weren't enough, there are another 2.3 bln euros in $1.1525-$1.1540 options that expire today.  Intraday technicals warn of scope for some short-covering ahead of the weekend.  Next week's highlights include the ECB meeting, where the previous optimism may be wearing thin) and the flash PMIs.  Sterling is steady to firmer today but locked in the lower end of yesterday's ranges.  Although the UK and EC are thought not to be far apart, the risk of an exit without an agreement is still palpable.  Talk of an extension of the transition period is giving some of May's domestic critics more fodder.  Sterling met seller near $1.3050.  While $1.30 offers psychological support, there is a nearly GBP490 mln option at  $1.2975 that expires today. 

North America:  The US reports September existing home sales.  They have not risen since March, and another modest decline is expected.  Note that several banks have pared their mortgage operations and many economists have downgraded the interest-rate sensitive sector, which is part of the accumulating late-cycle evidence.  Watch the 96.00 in the Dollar  Index.  Although intraday penetration has been seen this month, it has been two months since it managed to close above there. Attention turns to Canada today.  It reports August retail sales and September CPI.  The former is expected to most a modest (0.3%) gain, while the later may ease at the headline level but remain steady at the core.  For all practical purposes, there is little here that will stand in the way of a rate hike next week.  The US dollar has risen by 1% against the Canadian dollar over the past two sessions to approach CAD1.3100. Although the greenback's upside momentum has eased, weakness in equities could see it rekindled.