European Morning Briefing: Euro Extends Gains but Stocks Seen Flat

Snapshot:

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Stocks seen edging lower; EUR/USD 1.2074-77; bund yield 0.303%; Brent crude $54.61; gold $1350.22

-Trump Won't Rule Out Military Action on North Korea

-France's Emmanuel Macron Takes EU Renewal Push to Greece

-Spanish Court Suspends Catalonia's Vote on Independence

-Volkswagen Not Planning to Delay Restructuring, CEO Says

-Fed's Dudley Touts Gradual Rate Rises; Mester Says Further Gradual Rate Increases Will Be Needed

-Irma Batters Caribbean, Takes Aim at Florida

Watch For: Germany foreign trade; France industrial production; U.K. trade, industrial production; speech by Bundesbank's Weidmann; Jean-Claude Juncker meets EU nations' Permanent Representatives in Brussels

Headline News:

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President Donald Trump refused to rule out military action against North Korea on Thursday, but he stopped short of answering a reporter's question as to whether he would tolerate a nuclearized North Korean state if the threat were contained.

"North Korea is behaving badly and it's got to stop," Mr. Trump said at a White House news conference.

Continuing several months of rhetoric between the U.S. and North Korea over Pyongyang's accelerating pace of weapons tests, the president told reporters that he would prefer a diplomatic solution to the prolonged impasse. Mr. Trump also noted that years of talks have done little to rein in North Korea.

"Is it inevitable? Nothing is inevitable," Mr. Trump said when asked about a military confrontation. "But it's something that certainly could happen." The president said if the U.S. is compelled to use military force, "it would be a very sad day for North Korea."

The European Union will crumble if it isn't overhauled, French President Emmanuel Macron said Thursday in Athens, attempting to reinvigorate his call for greater sharing of financial burdens in the eurozone.

The French leader's trip to Greece is part of a tour of European capitals to marshal support for the changes the 39-year-old says are needed to shelter the eurozone and Europe from further economic or debt crises.

Mr. Macron said he would propose to fellow European leaders a road map in coming weeks for greater economic and social convergence in Europe. For the eurozone, he says it should have new structures to create its own a budget, parliament and executive.

"In Europe, today, sovereignty, democracy and trust are in danger," Mr. Macron said.

Spain's constitutional court on Thursday moved to block Catalonia from holding a referendum on separating from Spain, prompting vows from regional officials to push ahead with the vote in defiance of the ruling.

Prime Minister Mariano Rajoy had asked the court earlier on Thursday to declare illegal the laws enabling the referendum, which were passed by the Catalan regional parliament just a day earlier. Late Thursday night, the court said it agreed unanimously to suspend the legislation while it weighs whether a referendum on independence breaches Spain's constitution. The court has previously ruled against Catalonia's steps to hold an independence vote.

Catalonia regional President Carles Puigdemont said his government and other separatists were undeterred by the court's decision.

Stocks:

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European stocks are likely to drift lower Friday, with DAX futures down 10 points and FTSE 100 futures down 7 points.

Many Asia-Pacific markets were lower Friday, with China and Hong Kong the exceptions, as risk appetite was tepid due to worries about a massive storm nearing the U.S. Investors were also concerned about the direction of global monetary policy and North Korea.

On Saturday, North Korea will observe the anniversary of the founding of the nation. On the same day a year ago, it conducted a nuclear test and investors are worried the isolated nation may do another weapons test this year. As a result, investors could opt to close out positions ahead of this weekend, noted Rob Carnell, head of Asia research at ING.

The Nikkei was recently 0.3% lower, while stocks in Australia and South Korea were down slightly. U.S. benchmarks closed little changed on Thursday.

Corporate News:

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Volkswagen is actively working on deals for its noncore assets as well as acquisitions, but discussions of a possible merger with Fiat Chrysler Automotive was "speculation," Chief Executive Matthias Müller said in an interview.

Speaking to The Wall Street Journal, Mr. Müller said the company is open to talks and a new team is working to sell a businesses no longer considered critical. These noncore assets account for as much as 20% of the company's current annual revenue, he added.

Mr. Müller declined to comment directly on talks the company is believed to be holding with Fiat Chrysler about developing light utility vehicles. He did say the company is now routinely engaged in such exploratory talks with many manufacturers, but it isn't likely that Volkswagen is going to get involved soon in a merger of mass volume car makers, as Fiat Chrysler's Chief Executive Sergio Marchionne has been preaching for the past two years.

Forex:

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Concerns about the euro's strength, as expressed recently in unofficial channels, are giving European Central Bank policy makers pause for thought in winding down any stimulative efforts, according to State Street macro strategy chief Timothy Graf.

That's because the currency's recent rise is likely to limit price pressures and keep inflation below target. Graf said that Mario Draghi talking about the euro's strength only ended up pushing it higher, not what he and colleagues wanted.

Mr. Draghi on Thursday stressed that the volatility of the euro was a concern for the ECB's governing council.

"It hasn't actually been very volatile at all, that's probably a euphemism for the appreciation," said Patrick O'Donnell, senior investment manager at Aberdeen Standard Investments.

"The cyclical recovery in Europe has really become more obvious this year, and with the positive political outcomes that has really released a euro rally."

Investors are still positioned for more euro strength. In the week to Sept. 1, speculators held 86,519 more long contracts -- bullish bets on the value of the euro -- than short contracts.

The dollar took another leg lower in late-morning Asian trading, resulting in it hitting a fresh 32-month low versus the euro and another 2-plus-year nadir against the Aussie dollar.

A series of factors is prompting market participants to further lower the prospects of any more U.S. rate hikes in 2017. Odds are now just 32%, according to CME Group data, versus 46% a month ago. In addition to slow inflation and dimmed prospects of U.S. fiscal stimulus, hurricane damage and Stanley Fischer's impending departure from the Federal Reserve have added fresh uncertainties.

As the euro topped last month's high of $1.2070, that likely triggered stop-loss buying orders and the currency got to $1.2090. But it's now back to $1.2065. The WSJ Dollar Index was down 0.3% while the ICE Dollar Index, which measures the U.S. currency against a basket of six others, was recently at 91.46, its lowest level since January 2015.

At 0350 GMT, EUR/USD was 1.2074-77, USD/JPY was 108.09-10 and GBP/USD was 1.3137-39.

Bonds:

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Eurozone government bond yields fell Thursday, many to their lowest levels since the end of June, with most of the reaction coming in the hours after Mr. Draghi's post-ECB comments.

Germany's 10-year bund yields fell from 0.36% before the meeting began to 0.3% as European markets closed.

Declines in Spanish and Italian yields were steeper, falling from 1.44% to 1.36% and 2.01% to 1.91% respectively.

"It was a strange meeting for markets, because there was something for everyone there," said Lyn Graham-Taylor, senior rates strategist at Rabobank. "In light of them not announcing anything, a bid for bunds makes some sense, you could generally interpret that as dovish."

Despite the reduction in inflation forecasts Thursday, many analysts expect the ECB to have to begin reducing bond purchases, as the technical constraints of this quantitative-easing program begin to bite.

The central bank can't hold more than 33% of any country's bonds. At its current pace of purchases, many analysts expect the ECB to hit the limit in the German bund market next year.

"Unless they change the rules of the game, they're all out of juice," said Eoin Murray, head of investment at Hermes Investment Management.

A two-month rally in U.S. government bonds picked up fresh momentum Thursday, sending the yield on the 10-year note to a new postelection low.

The yield on the benchmark 10-year Treasury note settled at 2.061%, compared with 2.108% Wednesday. It was the lowest close since Nov. 8, Election Day, when it settled at 1.867%.

Energy:

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Oil prices were also little changed in Asia after muted moves Thursday.

Hurricane Irma, a Category 5 storm, was packing sustained winds of 175 miles an hour. It is projected to hit Florida on Sunday and OCBC Bank said "energy prices could edge lower" if that path persists.

At 0224 GMT, Nymex crude was up 8 cents at $49.17 a barrel and Brent was 12 cents higher at $54.61.

Metals:

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Gold ticked modestly higher after climbing to fresh one-year highs on Thursday. It was recently around $1,350.22 a troy ounce.

Write to paul.larkins@wsj.com

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September 08, 2017 00:14 ET (04:14 GMT)