Evidence of a deep and prolonged slowdown in the Chinese economy is taking a toll on global risk sentiment this morning, with safe haven demand sending the dollar higher amid parched liquidity conditions. Raw materials prices are falling, commodity-linked currencies are on the defensive, and North American equity indices are setting up for a weaker open. Treasury yields are essentially flat as some investors cling to bets on a “soft landing” — in which inflation decelerates but a deep recession is avoided — in the US economy.

Consumer sentiment improved by more than expected in early August. According to estimates published Friday, the University of Michigan’s consumer sentiment index climbed to 55.1 in early August from July’s 51.5, hitting the highest levels in three months as gasoline prices slumped and the employment market improved. Survey participants said prevailing economic conditions had worsened, with the current conditions sub-index falling to 55.5, down from 58.1 in the prior month, but views on the future brightened considerably, lifting the expectations measure from 47.3 to 54.9.

A second delegation of senior US politicians landed in Taiwan. Senator Ed Markey and four Congressional leaders met with President Tsai Ing-wen in an unannounced and relatively low-profile visit last night. China made angry noises and launched threatening aircraft sorties. Markets shrugged.

Evidence of a Chinese economic slowdown mounted. Data released last night showed industrial production expanded 3.8 percent in July, well below estimates at 4.5 percent, while retail sales climbed just 2.7 percent year-over-year, against forecasts for a 5.0 percent gain. Home price declines accelerated, fixed asset investment grew by less than expected, and youth unemployment climbed toward 20 percent.

The People’s Bank of China unexpectedly intervened, lowering two key interest rates. The central bank lowered the medium-term lending rate, the rate at which it makes loans to financial institutions, by 10 basis points to 2.75 percent, and reduced its seven-day repo rate from 2.1 percent to 2.0 percent. The renminbi weakened sharply as long-term yield differentials widened against Chinese instruments.

But official liquidity provision efforts are unlikely to prove effective in reversing the decline. With reopening largely complete and stimulus spending ebbing in Western economies, consumer demand for China’s manufactured exports is beginning to weaken. Policymakers are unwilling to risk creating another asset bubble by pumping money into the property sector. And rolling lockdowns continue in major cities and provinces across China, damaging consumer sentiment.

Commodity prices are taking a proper shellacking. Both global oil benchmarks are off by more than 3 percent, copper is down, and iron ore is 4 percent cheaper as investors downgrade expectations for Chinese consumption and investment.

Today’s data calendar looks relatively quiet. Canada will release existing home sales at 9:00 am – important for gauging activity in one of the world’s most stretched real estate markets. And minutes taken during the Reserve Bank of Australia’s last meeting will be dropped at 9:30 pm, providing insight into whether another 50 basis point move is likely in September.

Tomorrow’s Canadian consumer price index report could be a market shaker. Economists think headline inflation likely fell from June’s 8.1 percent toward 7.6 percent, but major unknowns exist around how shelter costs shifted, and the degree to which imported price pressures abated during the reference period. A larger-than-expected drop could cut the implied likelihood of a jumbo-sized rate hike at the Bank of Canada’s September meeting.

Nuances in Wednesday’s Fed minutes might impact market odds on a 75 basis point move in September. Investors will read through the record of July’s meeting to determine the central bank’s willingness to continue tightening amid signs of weaker growth and inflation. We think more substantive guidance won’t come until next week’s central bank conference in Jackson Hole – or even later – implying that market reaction to this week’s minutes could prove evanescent, at best.

Karl Schamotta, Chief Market Strategist