S&P Futures Slide After Chinese Stock And Bond Rout; Spain Rebounds, Dollar Drops

U.S. futures slid 0.2% as investors await a barrage of announcements including Wednesday’s Fed decision, Friday’s jobs report and, most importantly Trump’s imminent announcement of who the next Fed chairman will be, although, after the latest trial balloons, Jay Powell is now largely priced in. Asian equities edged modestly higher despite a tumble in Chinese stocks and bonds with Japan’s Nikkei closing 3 points in the green, while European shares hold steady after concerns eased about the Catalan crisis with no notable developments over the weekend, pushing Spanish stocks and bonds higher.

As reported last night, the big overnight event was the tumble in Chinese stocks, which fell the most since early August, dropping as much as 1.7% before closing below 3,400, down 0.8%, and breaking the calm that persisted through the recent Party Congress, as government bonds extended a monthly rout amid concern the government will step up efforts to reduce leverage in the financial sector. Small-cap shares bore the brunt of the selling, with the ChiNext gauge tumbling as much as 2.5%.

This was the biggest drop in the Shanghai Composite since August 11:

The rout was matched by China’s bonds, where 10-year TSY bond futures dropped 0.88%, the biggest tumble in over 10 months…

… with volumes surged to the highest since Mar this year. The 10Y yield rose for the 6th consecutive day…

… increasing by the most since December, climbing 8 basis points to 3.93% as of late Monday in Shanghai, a three year high; the yield on five-year notes surged 9 basis points to 3.97% as the Chinese yield curve remains inverted.

While China’s equity market was subdued for most of this month amid state efforts to limit volatility during the 19th Party Congress, sovereign yields have been climbing. This happened despite a tsunami of liquidity: the PBOC provided more than 1 trillion yuan ($150 billion) in funding this week, the most since February. On Monday, the PBOC added a net 40 billion yuan ($6 billion) via open-market operations and used the 63-day reverse repos – meant to cover the liquidity period through year-end – for the second day.

Formerly euphoric comments about China turned on a dime, and from exuberant enthusiasm in recent week, turned to fearful pessimism what happens next:

“Pessimism in the bond market is spilling over to the stocks,” said Hao Hong, chief China strategist at Bocom International Holdings Co. in Hong Kong. “Surging yields of the government bonds are resulting in worsened sentiment and higher funding costs for companies, of which smaller ones will suffer most as they rely more heavily on the market rather than bank loans for financing.”

“Previously the market was stable because the National Team was there during the Party Congress,” said Ken Chen, an analyst at KGI Securities Co. “Now the meeting is over, and October’s economic data are expected to be worse than September’s, which worries investors.”

“Sentiment is still fragile – as the government bond yield keeps hitting new highs, market sentiment is only getting worse and worse,” SWS Research analysts led by Meng Xiangjuan wrote in a note according to Bloomberg who added that “irrationality will accelerate the declines of bonds.”

“China is facing the toughest financial regulations ever,” according to Huachuang Securities analysts, who said that “the adjustment in bonds will continue and yields will climb this year. Investors should be cautious, and shouldn’t bottom fish before a clear floor appears.”

“The surge in China’s government bond yield last week and expectation for tighter financial regulation have triggered concern of tighter liquidity,” said Qiu Zhicheng, a strategist at ICBC International Research Ltd. in Hong Kong. “This prompted the slide in small caps as their valuations are still expensive, and thus they are more sensitive to changes in liquidity conditions”

Short-term funding markets were also impacted, with the overnight repo rate rising 2 basis points to 2.78%, while the 7-day repo jumped 10 bps to 2.96%. One-year interest-rate swaps rose 3 basis points to 3.64% while the onshore yuan climbs for the first time in four days, up 0.14% at 6.6425 per dollar.

China’s weakness spilled to Hong Kong, where equity indexes reversing gains and closed down 0.4%, although other Asian markets were mostly immune, with Australia’s200 (+0.4%) benefiting from the latest record highs in the US and the Nikkei 225 rising +0.1% with the energy sector leading in Australia after Brent crude rose back above USD 60/bbl for the first time since July 2015, while gains in Japan were later pared due to a firmer JPY. Taiwanese Apple suppliers coat-tailed on the tech giant’s recent strength due to overnight reports of strong iPhone X demand. 10yr JGBs were mildly higher amid an indecisive risk tone in Japan and with the BoJ also active in the belly to short-end of the curve.

Japan’s equity benchmarks were little changed after a rally that saw the Nikkei 225 Stock Average close above 22,000 for the first time since 1996 as declines by defensive stocks canceled out gains by technology companies. The Topix index earlier declined as much as 0.5%, with banks, pharmaceuticals and retailers the biggest drags. More than 800 Japanese companies are expected to report results this week. “Profit-taking after stellar gains is possible,” said Nader Naeimi, who helps manage about $110 billion at AMP Capital Investors Ltd. “The U.S. dollar has had a strong run recently and a short-term pull-back is likely. With that, any short-term strength in the yen is triggering profit-taking in Japanese exporters.” The Topix remains near a 10-year high and above its 20-day and 50-day moving averages. A technology-related gauge was the biggest boost to the benchmark after the Nasdaq 100 rose to a record Friday on strong earnings from Amazon.com Inc. and Alphabet Inc. Komatsu Ltd. gained 3.5 percent after boosting its full-year operating profit forecast 39 percent.

European equities were subdued, with the Stoxx Europe 600 Index nudging lower, though markets showed little sign of distress as the Spanish government began the process of reasserting control after Catalonia’s declaration of independence. The country’s stocks outperformed and bonds gained, along with debt of other peripheral European nations after S&P Global ratings upgraded Italy on Friday. Spain’s IBEX 35 led its peers, higher by 1.5%. Spanish sentiment was bolstered by the recent announcement of fresh Catalan elections on December 21st with the latest polling data suggesting that support for the independence push is beginning to wane.

Italian BTPs rallied after Friday’s upgrade of Italian sovereign rating by S&P. USD grinds lower against G-10 with focus on month end and positioning before a potential announcement on Fed Chair this week. Bunds push higher after German regional CPIs suggest national reading could be below consensus, USTs dragged higher in tandem with 10Y yield back below 240bps, short end of UST curve flattens