• A subdued start to the week for Asian indices as China released a White Paper blaming the US for trade talks deteriorating, and are to create an unreliable entity list
• In FX, the DXY remains below the 98.0 level as the US faces a two-front trade war; while, EUR and GBP are benefiting from the USD weakness
• Looking ahead, highlights include EZ, UK and US mfg PMIs, ISM mfg PMI, Fed’s Quarles, Barkin and Bullard

ASIA-PAC

Asian equity markets traded negatively with risk appetite subdued as the US faces a 2-front trade war against China and Mexico, although stronger than expected Caixin PMI data helped limit losses in China. Nonetheless, a risk averse tone was seen from the reopen after China released a white paper that blamed the US for the setback of trade talks which pressured US equity futures to extend on the losses from Wall St’s worst May performance since 2010. ASX 200 (-1.0%) and Nikkei 225 (-1.4%) declined with the energy sector the underperformer in Australia after the recent oil slump, while safe-haven currency flows weighed on Tokyo stocks and with weakness in SoftBank exacerbated on reports of funding difficulties for its next USD 100bln tech fund. Hang Seng (-0.5%) and Shanghai Comp. (-0.5%) were initially higher after the PBoC maintained net liquidity through CNY 80bln of reverse repos and after Chinese Caixin Manufacturing topped estimates, although the gains were short-lived as trade concerns remained heavily in focus with China playing the blame game, while it is also set to draft its own blacklist of 'unreliable' entities and probe FedEx over possible infringement of Huawei’s legal rights regarding rerouted packages. Finally, 10yr JGBs were steady with only marginal gains seen despite the widespread risk aversion and the BoJ presence in the market for JPY 800bln in up to 5yr JGBs.

China State Council Information Office released a white paper which formalized its position on trade negotiations and stated that the US government bears the responsibility for setback in trade talks, while it also noted that China does not want a trade war but is not afraid of one either. However, China also suggested negotiations remain a priority and State Councillor/Defence Minister Wei Fenghe said both sides should follow the consensus by the 2 heads of state and promote a relationship involving coordination, cooperation and stability, while a researcher at the state-backed think tank China Center for International Economic Exchanges suggested China “is expressing its wish to work together”. (Newswires/WSJ)

PBoC injected CNY 80bln via 7-day reverse repo for a net neutral position on the day. (Newswires) PBoC set CNY mid-point at 6.8896 (Prev. 6.8992)

Chinese Caixin Manufacturing PMI (May) 50.2 vs. Exp. 50.0 (Prev. 50.2). (Newswires)

UK officials alleged that a security test on Huawei 5G equipment was rigged by China to make it look safer. (Telegraph)

UK/EU

UK Foreign Minister Hunt said no-deal must be kept on the table but does not want to have to choose between no-deal and no Brexit. (Newswires) Conservative leadership candidate Leadsom says that she will not look to renegotiate the Brexit deal and insisted she would pursue a managed no deal if Conservative MPs and members back her as the next PM. (Guardian). Elsewhere, fellow leadership contender Javid has ruled out the prospect of carrying out a 2nd referendum or revoking Article 50. (Sky News) UK Environment Secretary Gove is reportedly to be considering an additional extension of the Brexit process, an idea which has attracted backlash from Tory members stating that a delay to Brexit will lead to opposition Labour Leader Corbyn becoming PM. While a cabinet minister has stated that Gove is likely to acquire strong support, as he become the ‘compromise candidate’. (Times/Telegraph) UK Health Secretary Hancock has published a five-point plan for leaving the EU, which proposes a time limit to the Irish backstop; a source close to Hancock states that European level Officials have been open to his plan regarding a time limited backstop. (Telegraph)

Northern Ireland’s DUP could call on the future UK PM to commit to seeking “alternative arrangements” to the Brexit backstop plan for when their agreement with the government comes up for “review” this summer. (FT)

Germany’s SPD party leader and ruling coalition partner Andrea Nahles resigned; German Chancellor Merkel says her coalition government will continue despite the setback. (BBC/Newswires)

Fitch affirmed Austria at 'AA+'; Outlook Positive. (Newswires)

FX

DXY remained subdued after its drop below the 98.00 level on Friday as the tariff announcement on Mexico weighed on NAFTA currencies and with the greenback also pressured by declining yields, while Goldman Sachs was also bearish on the US economy in which the bank lowered its US Q2 GDP growth estimate to 1.1% from 1.3% and sees an increasing chance of a Fed rate cut but not enough to include it in its baseline scenario. Elsewhere, the trade concerns spurred safe-haven flows into JPY which dragged USD/JPY to the bottom end of the 108.00 handle, while EUR/USD and GBP/USD also extended on Friday’s gains amid the USD-woes. AUD/USD was also lifted despite the anticipation for a looming rate cut by the RBA tomorrow and NZD/USD gained in the absence of participants in New Zealand for holiday, as antipodeans took their cue from CNH after the better than expected Chinese PMI data and stronger fix by the PBoC.

COMMODITIES

Commodities were mixed with WTI crude futures below the USD 53.00/bbl and at 4-month lows as ongoing trade concerns triggered a further slippage in oil which had already declined over 5% on Friday, while geopolitical news flow including a strike by Israel on an Iran-linked base in Syria and Iran dismissing US suggestions to come to the table have failed to spur prices. Elsewhere, gold extended on gains above the USD 1300/oz level amid the subdued greenback and safe-haven demand, whilst copper was indecisive as pressure from the risk averse tone was counterbalanced by better than expected Chinese PMI data.

Baker Hughes (May 31) US oil rigs +3 at 800 (prev. 797), US nat gas rigs -2 at 184 (prev. 182), total US rigs +1 at 984 (prev. 983). (Newswires)

GEOPOLITICS

US Secretary of State Pompeo said US is prepared to talk to Iran without pre-conditions about its nuclear program but that Iran needs to behave normally, although Iran dismissed the offer a word-play. (Newswires)

US

US 5yr yields fell to sub-2% last week, the 3m/10yr spread moved further into inversion (resulting in more commentary about the risks of recession over a 12-24 month horizon), and some data surprised to the downside, seeing the market price in three Fed rate cuts by the end of 2020. The fixed income bid was also supported by a slide in equities, although month-end models had suggest positive inflows into stocks. And the latest US measures against Mexico have added to Treasury upside as we close out the week; With 2s, 5s sub-2%, 7s are a couple of basis points away. Bund yields fell in sympathy, seeing German 10yr yields flirt with fresh all-time lows. Comments from Clarida on Thursday and the aforementioned risk-off were underpinning the bid on Friday. At settlement, the curve had bull-flattened, though major curve spreads were steeper (notably the 2s20s widened 6bps, 2s10s +5bps, 5s30s +3bps, 2s5s +3bps). US T-note futures (M9) settled +22 ticks at 126-12.

US President Trump tweeted that Mexico is sending a big delegation to talk about the border and suggested that the problem is that they’ve been “talking” for 25 years and we want action not talk. President Trump also suggested they could solve the border crisis in one day if they so desired but added that our companies and jobs are coming back to the USA. (Twitter) Furthermore, Trump has confirmed that the US will end preferential trade status for India this week. (BBC)

US Trade Representative Lighthizer was said to have opposed new Mexican tariffs and argued that it could harm USMCA, while US Treasury Secretary Mnuchin was also said to be against new measures against Mexico, according to sources. (WSJ/CNBC)

US President Trump said White House Economic Adviser Hassett will be leaving shortly and that a replacement will be announced when he returns to the US. (Twitter)

Fed's Daly (Non-Voter, Dove) maintained forecast for economic growth at 2% and said trade discussions are creating uncertainty in the economy, while she added her stance is to be patient and wait what the details of the trade discussions are. (Newswires)