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Chinese stocks appear to be headed for a new 10-3/4 month low
Fed Beige Book is released as 10-2 yield spread flattens to a 10-1/2 year low
Weekly EIA report

Chinese stocks appear to be headed for a new 10-3/4 month low — The Shanghai Composite index on Tuesday closed sharply lower by -1.41%, falling to a new 2-1/4 month low and barely surviving a test of the 10-3/4 month low posted in early-February. A breach of February’s 10-3/4 month low would be a bearish short-term indicator and would suggest that Chinese regulators aren’t even pushing state-funds to support that level.

Tuesday’s sell-off was sparked by continued heavy technical selling and by weakness in Chinese tech stocks after the U.S. government announced a 7-year ban on ZTE Corp’s sales to U.S. customers and purchases of U.S. technology such as chips. ZTE is China’s second largest telecom equipment producer.

The ban was ostensibly imposed because ZTE violated Iranian sanctions. However, the markets suspect that the U.S. is simply using the Iranian sanction violations as an excuse to hammer a key Chinese technology company since the Trump administration has yet to receive any satisfaction on its IP complaints against China. The U.S. action against ZTE therefore sparked broader weakness in the Chinese tech sector since further U.S. measures against the Chinese tech sector may be forthcoming.

Chinese stocks are weak more generally due to broadening trade tensions after China announced anti-dumping tariffs on the import of U.S. grain sorghum. Meanwhile, there are reportedly no high-level U.S-Chinese talks in progress as yet to address the U.S. IP complaints that led to the reciprocal tariff announcement on $50 billion worth of U.S. and Chinese goods and President Trump’s threat to slap tariffs on another $100 billion of Chinese products. China and the U.S. have so far only exchanged letters on the issue, according to press reports. Meanwhile, the clock is running on the 60-day public comment period for the U.S. tariffs on $50 billion of Chinese goods.

Tuesday’s Chinese stock market sell-off came despite the bullish news of a 1 percentage point cut in the required reserve rate on a broad range of Chinese banks, which will free up about $65 billion of extra bank lending. In addition, Tuesday’s Chinese Q1 GDP report of +6.8% came in as expected, indicating that the Chinese economy is holding its ground despite the government’s deleveraging drive and overcapacity in a variety of industries. The consensus is for Chinese GDP to ease slightly to 6.6% in Q2 and Q3 and then to 6.4% in Q4.

Despite the weakness in Chinese stocks, Japan’s Nikkei index on Tuesday closed slightly higher. The Japanese markets on Tuesday were hoping for some trade progress at the Abe-Trump summit on Tue/Wed at Mar-a-Lago. Prior to the meeting, President Trump dangled the possibility of dropping the current tariffs on Japanese steel and aluminum imports if Japan could deliver sufficient trade concessions at this week’s summit.

Fed Beige Book is released as 10-2 yield spread flattens to a 10-1/2 year low — The Fed today will release its Beige Book survey of the regional U.S. economies ahead of the next FOMC meeting in two weeks on May 2-3. The Fed’s last Beige Book report, released on March 7, said that, “Economic activity expanded at a modest to moderate pace across the 12 Federal Reserve Districts in Jan and Feb.”

The market consensus is that there is only a 28% chance that the FOMC will raise its funds rate target by another notch at its next meeting on May 2-3. The FOMC just raised its funds rate target by +25 bp to 1.50-1.75% at its last meeting on March 14-15. By contrast, the market is discounting a 100% chance for a Fed rate hike at the following meeting on June 12-13, which is the next meeting that will feature a Powell press conference.

Market expectations for rate hikes through 2018/19 have risen substantially in the past two weeks as trade tensions have eased and as the stock market has stabilized. The market is now discounting a total of 91.5 bp of further rate hikes through the end of 2019, which is up by +12 bp (i.e., one-half rate hike) just since April 6 (based on the Dec 2019 federal funds futures contract). The expectation for 91.5 bp of rate hikes through the end of 2019 is only 3 bp below the peak of 94.5 bp posted on March 21.

The increase in rate-hike expectations caused the 2-year T-note yield yesterday to rise to a new 9-3/4 year high of 2.39%. The 10-year T-note yield has been more subdued and is near the middle of its 2-month consolidation range. In fact, the current 10-year T-note yield level of 2.83% is 12 bp below the 4-1/4 year high of 2.95% posted in late Feb.

The continued rise in the 2-year yield, combined with the subdued 10-year yield, has caused a further flattening of the yield curve. The spread of the 10-year yield over the 2-year yield yesterday fell to a new 10-1/2 year low of 0.43%. The flattening of the yield curve continues to be seen by many market participants as a negative sign for the economy. The yield curve has not yet inverted, but an inverted yield curve is often associated with a recession. We are less worried about the consequences of a flat or even inverted yield curve, by contrast, because the Fed is raising rates so slowly and because short-term rates remains at very low levels from an historical perspective.

Weekly EIA report — The consensus for today’s EIA report is for a 1.5 mln bbl rise in crude oil inventories, a -250,000 bbl decline in gasoline inventories, and a -500,000 bbl decline in distillate inventories. U.S. crude oil inventories are currently -2.4% below the 5-year average, a little higher than the 9-1/2 year low of -2.6% posted in the last week of March. U.S. oil production is at a record high of 10.525 mln bpd and active oil rigs are at a 3-year high of 815 rigs.

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