This morning the optimists reign
As China was keen to explain
They felt it unwise
That tariffs should rise
They’d rather start talking again

Equity bulls are on the rampage this morning as all the negative stories have been overwhelmed by positive sentiment from two areas, China and Italy. From China last night we heard that despite President Trumps’ latest decision to increase tariffs further on Chinese imports, the nation would not escalate the situation, and instead wanted to maintain the dialog and seek common ground. Spokesman Gao Feng said that while China is protesting, they are not responding. He also confirmed that ongoing communications would likely lead to another face-to-face meeting in Washington in September. We heard confirmation from Treasury Secretary Mnuchin that a meeting in Washington was to take place in September, although the final details have not yet been decided.

However, this was more than enough for the bulls to stampede as once again they seem willing to believe that a solution is close at hand. One need only look at the timeline of every other trade negotiation in history to recognize that these things take a very long time to come to agreement. And of course, as I have written before, there are fundamental issues that seem unlikely to ever be addressed to the satisfaction of both sides. For example, while a key issue for the US is the theft of IP by Chinese companies, the Chinese won’t even acknowledge that takes place and therefore cannot agree to stop something they don’t believe is happening. Recall, as well, the issue when talks broke down in late spring, that the issue was the US was seeking the agreement be enshrined in law, as is the case in the US and every Western nation, but the Chinese refused claiming that was an infringement of their sovereignty and that they would simply make rules that would be followed. These are very big canyons to cross and will take a long time to do so. While it is certainly good news that the Chinese are not escalating things, and in fact, are making efforts to reduce market tensions via their CNY fixing activities, we are still a long way from a deal.

The upshot of the China story is that Asian equity markets rebounded from their lows to close near unchanged while European markets are all higher on the order of 1.0%. Treasury yields have edged up slightly as have yields in most sovereign bond markets, and the two main haven currencies, yen and Swiss francs, have both weakened slightly.

The other story that has the bulls on the move is from Rome, where Italian President, Sergio Mattarella has given the nod to the coalition of 5-Star and the Democratic Party (known as the PD and which, contrary to yesterday’s comment, is actually a center left party) to try to form a government. The thing that makes this so surprising, and bodes ill for any government’s longevity, is that 5-Star came to power by constantly attacking the PD as corrupt and the major problem in the country. But their combined fear of an election, where the League is likely to win an outright majority at this time, has pushed these unlikely bedfellows together. The market, however, loves it with Italian equities higher by 1.9% and Italian BTP’s (their sovereign bonds) rallying nearly a full point driving the 10-year yield down to a new historic low of 0.96%. Think about that for a moment, Italian 10-year yields are more than 50bps lower than US yields!

All in all, it is clearly a risk-on type of day. Looking at the FX markets shows a mixed bag of results although the theme is really modest movement. For example, in the G10, the biggest mover has been NOK, which is lower by 0.25%, while the biggest gainer is AUD, up just 0.2%. The latter has been helped by the China story, while the former is suffering after weaker than expected GDP data showed Q2 growth at just 0.3% in the quarter, well below expectations of a 0.5% rebound from last quarter’s negative print.

It should be no surprise that EMG currencies have a slightly larger range, but still, the biggest mover is ZAR, which has gained 0.5% while the weakest currency is TRY, falling 0.4%. From South Africa we learned that price pressures are less acute than anticipated as PPI actually fell in July engendering hope that the SARB can encourage more growth by maintaining the rate structure rather than raising rates. Meanwhile, Turkey continues to see erosion in both the number of incoming tourists, a key industry and source of hard currency, and incoming investment, where foreigners were net sellers of both stocks and bonds last week.

The one other noteworthy move has been CNY, where the renminbi is firmer by 0.25% today after the PBOC very clearly indicated their interest in preventing a sharp decline. The fix overnight was significantly stronger than every forecast and that has helped squeeze the differential between the fix and the currency market back below 1.0%. It is worthwhile to keep an eye on this spread as it can be a harbinger of bigger problems to come if it expands. Remember, the current band is 2.0%, so actions to change that or allow a breech are clear policy statements.

This morning we finally get some useful data led by the second look at Q2 GDP (exp 2.0%) and Initial Claims (214K). Overnight we saw German state inflation data point to continued weakening growth with the national number due soon. We also heard from SF Fed president Daly yesterday who was clearly on board for another rate cut, while Richmond’s Patrick Harker was far less enthused. However, neither one is a voter, so they tend to be seen in a bit less important light.

There is no reason to think that the equity rally will fade, barring a tweet of some sort from the White House. As such, it seems the dollar will likely remain in its current holding pattern, with some gainers and some losers, until the next shoe drops.

Good luck
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