UK Elections and US-China trade: Removing Risk Factors

Following the euphoria over the decisive UK election result and the US/China “Phase 1” trade deal markets look primed to end the year on a positive footing.  Two of the major risk factors threatening to detail market sentiment into year end have at least been lifted.  However, some reality may begin to set in early into 2020, with investors recognizing that there are still major issues to be resolved both between the UK and Europe and between the US and China,

Although full details have yet to be revealed, Chinese officials will likely be relieved that the hike in tariffs scheduled for December 15 will now not go ahead. However, there are still questions on how China will ramp up its purchases of US agricultural goods anywhere near the $40-50bn mark that has been touted.

Also the dollar amount of the roll back in US tariffs is relatively small at around $9bn, which hardly moves the needle in terms of helping China’s growth prospects.  “The United States will be maintaining 25 percent tariffs on approximately $250 billion of Chinese imports, along with 7.5 percent tariffs on approximately $120 billion of Chinese imports.”  This still means that a substantial amount of tariffs on Chinese goods remains in place.

According to Trade Rep. Lighthizer, the deal will take effect 30 days after its signing, likely in early January. To sustain any improvement in sentiment around trade prospects there will need to be some concrete progress in removing previous tariffs as well as progress on structural issues (state subsides, technology transfers etc) in any Phase 2 or 3 dealss. The bottom line is that agreement in principle on “Phase 1” will need to be followed by further action soon, otherwise market sentiment will sour.

In the UK Prime Minister Johnson now has the votes to move forward with Brexit on January 31 but that will leave only 11 months to negotiate a deal with the EU. The transition period finishes at the end of 2020 unless of course there is an extension, something that Johnson has ruled out.  In the meantime the immediate focus will turn to the next Bank of England governor replacing Mark Carney.  This decision could take place this week.  Markets will also look to what fiscal steps the government will take in the weeks ahead.

GBP has rallied strongly over recent days and weeks, extending gains in the wake of the Conservative Party election win.  However, further gains will be harder to achieve given the challenges ahead.  UK equities have underperformed this year and are arguably relatively cheap from a valuation perspective, but further gains will also involve removing or at least reducing much of the uncertainty that has kept UK businesses from investing over recent months.  In the near term GBPUSD could struggle to break above 1.35 unless there is progress on the issues noted above.

Fed, ECB, UK elections In Focus

An event filled week lies ahead.  Several central bank decisions including the Federal Reserve FOMC (11th Dec), European Central Bank (ECB) (12 Dec) and Swiss National Bank (SNB)  (12 Dec) are on the calendar.  All of these major central banks are likely to leave policy unchanged and the meetings should prove to be uneventful.  Fed Chair Powell is likely to reiterate the Fed’s patient stance, with last Friday’s strong US November job report (payrolls rose 266k) effectively sealing the case for no change in policy at this meeting, even as a Phase 1 trade deal remains elusive.

Similarly recently firmer data in Europe have pushed back expectations of further ECB easing, though President Lagarde is likely to sound cautious highlighting her desire to maintain an accommodative monetary policy stance.  The picture is rather different for emerging market central banks this week, with policy easing likely from Turkey (12 Dec), Russia (13 Dec) and Brazil (12 Dec) while Philippines (12 Dec) is likely to keep policy unchanged.

UK general elections on Thursday will be closely watched, with GBP already having rallied above 1.30 vs USD as polls show a strong lead for Boris Johnson’s Conservative Party.  The main question is whether Johnson will have gained enough of a share of the vote to gain a majority, allowing him to push ahead with his Brexit plans, with Parliament voting to leave the European Union by Jan 31.

Polls may not be as accurate as assumed in the past given surprises over recent years including the Brexit vote itself, but the wide margin between the two parties highlights the relatively stronger position of the Conservatives going into the election.  Nonetheless, given that a lot is in the price already, the bigger (negative) reaction in GBP could come from a hung parliament or Labour win.

This week is also crunch time for a decision on the threatened December 15 tariffs on China.  As previously noted there is little sign of any deal on any Phase 1 trade deal.  It appears that issues such as the amount of purchases of US goods by China remain unresolved.  Recent comments by President Trump suggest that he is prepared to delay a deal even as far as past the US elections in November 2020.

Whether this is tactic to force China to agree on a deal or a real desire not to rush a deal is difficult to determine, but it seems as though Phase 1 will deal will not be signed this year given the limited time to do so.  December 15 tariffs could be delayed but this is also not guaranteed.  President Trump’s attention will also partly be on the potential for an impeachement vote in the House this week.

China Data Fuels A Good Start To The Week

Better than expected outcomes for China’s manufacturing purchasing managers indices (PMIs) in November, with the official PMI moving back above 50 into expansion territory and the Caixin PMI also surprising on the upside gave markets some fuel for a positive start to the week.   The data suggest that China’s manufacturing sector has found some respite, but the bounce may have been due to temporary factors, rather than a sustainable improvement in manufacturing conditions.  Indeed much going forward will depend on the outcome of US-China trade talks, initially on whether a phase 1 deal can be agreed upon any time soon.

News on the trade war front shows little sign of improvement at this stage, with reports that a US-China trade deal is now “stalled” due to the Hong Kong legislation passed by President Trump last week as well as reports that China wants a roll back in previous tariffs before any deal can be signed.  Nonetheless, while a ‘Phase 1’ trade deal by year end is increasingly moving out of the picture, markets appear to be sanguine about it, with risk assets shrugging off trade doubts for now.  Whether the good mood can continue will depend on a slate of data releases over the days ahead.

Following China’s PMIs, the US November ISM manufacturing survey will be released later today.  US manufacturing sentiment has come under growing pressure even as other sectors of the economy have shown resilience.  Another below 50 (contractionary) outcome is likely.  The other key release in the US this week is the November jobs report, for which the consensus is looking for a 188k increase in jobs, unemployment rate remaining at 3.6% and average earnings rising by 0.3% m/m. Such an outcome will be greeted positively by markets, likely extending the positive drum beat for equities and risk assets into next week.

There are also several central bank decisions worth highlighting this week including in Australia, Canada and India.  Both the Reserve Bank of Australia (RBA) and Bank of Canada (BoC) are likely to keep monetary policy unchanged, while the Reserve Bank of India (RBI) is likely to cut its policy rate by 25bps to combat a worsening growth outlook.  Indeed, Q3 GDP data released last week revealed the sixth sequential weakening in India’s growth rate, with growth coming in at a relatively weak 4.5% y/y. Despite a recent food price induced spike in inflation the RBI is likely to focus on the weaker growth trajectory in cutting rates.

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