Trade Tensions Weigh on Equities, Lift Yen

Reports confirm that later this week, the US Treasury will announce new curbs on Chinese investment and trade. The US considering preventing Chinese companies with a 25% (though could be lowered) government stake from buying US companies with industry significant technology." Also, the US will block technology exports to China aimed at frustrating China's "Made in China 2025" initiative.

This is separate from the 25% tariff that the US is levying on $34 bln of Chinese goods on July 6. Another $16 bln of goods will be subject to the tariff after the public comment period concludes later in July. Chinese has threatened to match this first round of $50 bln. The US has threatened to put a tariff on another $200 bln of Chinese goods for retaliation but has not specified the goods or timing.

The US is putting more emphasis on economic rivalry than the traditional ideological conflict. The first US tariffs that were placed on washing machines and solar panels and the next tariffs on steel and aluminum for national security grounds have been estimated to hurt Canada the most and the EU second. These actions taxed about $12 bln of Canadian exports, $8 bln of EU exports, and $3.5 bln of Chinese goods. The US has launched an investigation into auto imports on national security grounds, and before the weekend President Trump threatened to put a 25% tariff on Europan car imports unless the EU reduced its tariff and non-tariff barriers.

The implications of more protectionist action on trade and growth are weighing on global equities. The People's Bank of China 0.5% cut in the required reserve ratio for some banks failed to lift sentiment. It had been well-telegraphed and is seen as too small.

Initial gains in Chinese A and H shares quickly fizzled. The Shanghai Composite finished 1.05% lower.  It held above the pre-weekend low but posted a 2-year low close, which is off 20% from the high seen in January.  Most markets in the region finished lower, with the MSCI Asia Pacific Index off 0.80%. The notable exception was Korea, where minor gains were recorded, though foreign investors were net sellers.

European investors have little reason to cheer. Germany, Italy, and Spain are experiencing more than 1% losses in late morning activity. The Dow Jone Stoxx 600 is off 1%, surrendering the pre-weekend gains. No sector has been spared, but information technology and financials are leading the retreat.

The only data of note was the German IFO survey, and it disappointed. The assessment of the economy slipped to 101.8 from 102.03 (initially102.02) to match the low from last May. The expectations component was unchanged at its lowest level since March 2016. Nor did the weekend meeting on immigration produce a quick victory for Merkel, whose government may be at risk unless a new deal can be reached at this week's head of state summit.

And it does not look particularly promising without a significant compromise. In Italy, the League's success in the second round of municipal elections yesterday will only strengthen Salvini's hand and embolden the confrontation. Italy's proposal to have processing centers outside of Europe and to abandon the current system that makes the first EU country of entrance responsible appears to enjoy broad support.

Nor does the German-Franco agreement the direction forward post-Brexit find easy acceptance. At least a dozen EU members, mostly from northern Europe, are opposed to a new EMU budget to promote stability and convergence. It looks like the summit will be an uphill struggle for Merkel, and without tangible success, especially on immigration, she will come under strong domestic pressure next week as the Bavarian-based CSU may take actions that foster a split with the CDU.

The combination of Fed tightening, rising trade tensions, and a softening of European and Chinese growth on top of numerous idiosyncratic challenges continue to weigh on emerging markets. The MSCI Emerging Markets Index is off 1% today to bring the decline since the multi-year high set in January to 16%. The US dollar is firmer against all the emerging market currencies today but the Turkish lira. Erdogan's success in the weekend election has spurred some home of more supportive action for the economy. The lira is up 0.8% (@TRY4.6380), but the upside momentum is already easing (the US dollar traded as low as TRY4.5380).

The euro stalled near the pre-weekend high of around $1.1675. There is a 600 mln euro option struck at $1.1695 that expires today. Support is seen ahead of $1.1620.  The yen is the strongest of the major currencies, up about 0.4%, with the greenback near JPY109.50. The dollar found bids just below there in late Asia turnover and the European morning. The JPY109.80-JPY110.00 may act as resistance.

Sterling was turned back ahead of the weekend after briefly poking through $1.33. Ideas that the EU summit will still find the UK far from an agreement on Brexit may be offsetting last week's hawkish BOE. It is finding support near $1.3220. On the upside, the $1.3260 area may offer a cap today.

The US dollar posted a potential key downside reversal against the Canadian dollar before the weekend, but there has been no follow-through selling today.  The pre-weekend loss snapped a six-day greenback advance and a move now back above CAD1.3320 warns that US dollar rally is resuming. The Australian dollar is consolidating the gains scored in the past two sessions. A break of $0.7400 warns of a retest on the one-year low seen last week just below $0.7350. The Reserve Bank of New Zealand meets. It is widely expected to stand pat. The Kiwi is little changed, though slightly lower on the day, tracking the Aussie closely.