Consolidation in Capital Markets Conceals Coming Turbulence

A mixed US dollar will greet the North American participants today.
It is softer against the euro and yen, but firmer against the dollar-bloc
currencies. Among the emerging market currencies, the eastern and central
European currencies are moving higher in the euro’s draft. The US recognition
that North Korea has not escalated the war of words even though it just
announced new sanctions on 10 Russian and Chinese companies and half dozen
individuals were aiding it; the Korean
won posted its third consecutive advancing sessions.

Asian equities advanced with the MSCI Asia Pacific Index also posting
small gains for each day this week and seven of the past eight days. 

Some of the markets that are open late struggled
and European equities are mostly lower.  The Dow Jones Stoxx 600 is off
0.2%.  Financials and materials are bucking the drag from the other
sectors, led by consumer discretionary and utility sectors.  It is the
fourth losing session in the past five.   Sovereign 10-year benchmark
yields are mostly firmer, with Italy and Portugal seeing yields rise five-six
basis points.  

Although a key controversial adviser to President Trump was dismissed last week, the opportunity to
re-start may be closing.
  Last night, Trump made two unsettling
remarks.  First, he suggested that he may be willing to accept a shut down
of the government if that is what is necessary to get Congress to authorize
funding for the controversial wall on the border with Mexico.  The
spending authorization is needed by the end of September as the US begins a new
fiscal year.  Government shutdowns are not unprecedented in the US, of
course, and they typically are mildly disruptive.  They are not good for
the investment climate.   

Congress may seek to link the spending authorization bills with the debt ceiling.  The failure to renew
the spending authorization leads to a government shutdown, but failure to lift the debt ceiling impairs the
ability to service the debt.  While political maneuvering can lead to a shutdown, missing a debt payment
is considerably more serious and one that in this game of brinkmanship largely
within the Republican Party neither side seems to want to risk.  

Secondly, Trump also threatened
that he may still bring the US out of NAFTA.
  The re-opening of
negotiations just began last week.  There were
much optimism and favorable spin in most
of the media.  Although reports suggest
that, contrary to the normal course where easy issues are resolved first,
controversial issues were discussed.
  Yes, they were discussed, but it seemed to turn into a simple restatement of each main
issues.   Domestic content and the conflict resolution mechanism
seems to be on what the negotiations will ultimately turn.   
Between the new efforts to get funding for the wall and the threat to pull out
of NAFTA, it is little wonder that the Mexican peso is the weakest of the
emerging market currencies today (-0.7%) and rivaling the New Zealand dollar
(-0.8%) as the weakest currency in the world today.  

Japan and EMU have reported preliminary PMI readings for August. 
Japan’s manufacturing PMI rose to 52.8 from 52.1 in July.   Last year it
averaged 50.0. This year’s average is 52.7.  It is also the average for
Q2. Similar to many other high income countries, the pressing challenge for
Japan is not growth but prices.  Before the weekend Japan reports July
CPI.  The core rate (excluding fresh food) stood at 0.4% in June and may
have ticked up to 0.5% in July.   

In Europe, the weakness in services was offset by the strength of
manufacturing, leaving the composite virtually unchanged at 55.8 (vs. 55.7).
manufacturing reading rose to 57.4 from 56.6.  This matches the cyclical high seen in June.  The service
reading, which covers a larger part of the economy slipped to 54.9 from
55.4.  The index peaked in April at 56.4.    

There are three takeaways from the EMU PMI.  First, the economy
continues to operate at a strong level, but the momentum has moderated. 
Second, price components suggest that the pullback in inflation since February
may be coming to an end.  Third, the euro’s appreciation has so far not undermined export orders,  where the
sub-index rose to its best level in six years.  

This, in turn, may have some
bearing on how to understand the level of concern among the ECB regarding the
euro’s strength. 
We think the concern is still very mild.  It
also may impact the bias going into Jackson Hole.  In his speech earlier
today, Draghi defended the effectiveness of its asset purchase program.

The UK continues its release of position papers on the Brexit. 
Today’s was on the judiciary.  Again the UK softens its initial position, but it does not appear
that these papers have had much on the EU negotiators.  The position papers are more addressed to the domestic audience rather than as a
negotiating tool.   There still seems to be a sense of
bewilderment.  The UK, for example, still does not accept the EU’s
negotiating sequence:  first the divorce and then the arranging new
friendship with potential benefits.  

In the US Markit reports its flash US PMIs
and new home sales for July will be released.  Barring significant surprises, the data are unlikely to have much
Trading remains choppy within a consolidative phase.  We
expect the phase to end shortly.  The S&P 50 gapped higher yesterday
and closed strongly.  It set to open about 0.2% lower, and before the gap
(~2430.6-2433.7) is filled, the 2440 area
may act as a swing level. 


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