US/China – The Gloves Are Off

August 16, 2020 — Mitul Kotecha

The delay in the Phase 1 trade deal review (initially slated for Sat 15 Aug) will come as a disappointment though it was reported that it did not reflect any substantive problem with the trade deal, but rather to give China more time to increase purchases of US goods.  China’s reported desire to include TikToK and WeChat restrictions to the discussions may have also played a part.  The Phase 1 review delay followed by President Trump’s order for ByteDance to divest TikTok’s US operations within 90 days and ending of a waiver allowing US companies to continue selling goods to Huawei, ratchets up tensions another notch.

It is abundantly clear that ahead of US elections in November the gloves have come off.  More is yet come and next steps may involve sanctions against more Chinese companies and eventually even Chinese banks.  China’s reaction continues to be measured, which suggests the broader impact on risk appetite will remain contained for now.  China wants to retain foreign investment and has continued to enact measures to open up to such investment.  Reciprocating sanctions on US companies in China would go against this path and seems unlikely to take place unless tensions worsen further.

However, it is not clear that China’s actions will remain measured. The US administration is set on pushing more sanctions on Chinese individuals and companies in what has become a whole of government approach. This is something that has broad based bipartisan support within the electorate.  The risk of crossing certain red lines, perhaps (though still unlikely as Trump sees this as a key success of his Presidency) by scrapping Phase 1 or perhaps by sanctioning Chinese banks by cutting them out of the USD liquidity and payments system and/or by some sort of military escalation in the South China Sea, could yet lead to a much more significant reaction from China and a more severe impact on global markets.

The likely path however, is that the US administration will try to keep Phase 1 alive even as China is far behind its targets on imports of US goods; according to PIIE through the first 6 months of the year China’s purchases of US goods were 39% (US exports data) or 48% (Chinese imports data) of their year-to-date targets.  Given the gap, in part due to Covid, but also due to initially ambitious targets, the delay in the Phase review should not be a big surprise.  The US may be wiling to give China some room to try to move towards reaching its targets, but the gap will not be easy to bridge.  Regardless, US/China tensions will be an ever present part of the landscape in the months ahead of US elections and markets may not remain as sanguine as they have been so far.

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Gold Loses Its Shine (For Now)

August 12, 2020 — Mitul Kotecha

The drop in the gold price over recent days has been dramatic. It is no coincide that it has occurred at a time when the US dollar is consolidating and real yields have increased again.  Gold buying had accelerated over recent weeks, resulting in a sharp and what has proven to be, an unsustainable rally.  The subsequent drop in gold prices (around 9% from its peak around $2075) may yet turn out to be a healthy correction from overbought levels amid heavy positioning.  However, in the near term it is not advisable to catch a falling knife, with some further weakness likely before any turnaround.

Prospects for gold further out remain upbeat despite the current correction.  Continued ultra easy monetary policy from the Fed and other major central banks, likely persistent low real bond yields amid central bank bond buying, continuing virus threats and importantly ongoing pressure on the US dollar, all suggest that the correction in gold prices will be met by renewed buying for an eventual upward test of $2000.  However, in the near term the pull back in gold likely has more room, with the 61.8% Fibonacci retracement level around $1835 and the 50 day moving average around $1829 important support levels.

As noted, it is no coincidence that that the dollar has strengthened at the same as gold has collapsed.  The dollar has looked increasingly oversold both from a positioning and technical perspective and was due for a correction.  Whether the correction in the dollar can turn into a sustainable rally is debatable, however.  Unless there is a sustainable turn in real yields higher or signs that the US economy will move back to outperforming other major economies, it seems likely that the dollar will struggle to recover, especially ahead of US elections and all the uncertainty that they will bring in the next few months, especially if the result of the elections is a contested one.

Another trend that is taking shape in markets is the rotation between momentum and value stocks.  Recent market action has shown a marked underperformance of tech stocks relative to value stocks. Stocks that benefit from re-opening are increasingly in favour though their performance is still far behind that of tech stocks over recent months.  Much still depends on how quickly the virus can be bought under control, which in turn will signify how well re-opening stocks will do going forward. There are encouraging signs in the US that the pace of increase is slowing but it is still early days and as seen globally the virus is hard to suppress.

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Tough Times for the US Dollar

August 2, 2020 — Mitul Kotecha

The US dollar had an awful July, with the USD index dropping by around 5% over the month, its worst monthly performance in 10 years. A range of factors can be cited for USD weakness including an asset allocation shift to assets outside of the US, worsening news on US Covid cases over recent weeks, improved risk appetite, US election concerns, lower real yields and fiscal cliff worries, among other factors.  Gold has been a particularly strong beneficiary of the malaise in the USD and declining real yield yields.  The Fed’s pledge to keep on aggressively supporting the economy and likely strengthening of forward guidance in the months ahead suggest that any increase in US interest rates could be years off.

It is still difficult to see the recent weakness in the USD resulting in a deterioration in its dominant reserve currency status though the longer the factors noted above remain in place, the bigger the danger to longer term confidence in the USD. As a reminder of such risks Fitch ratings downgraded US AAA credit rating to a negative outlook.  I do not expect markets and the USD to be impacted by the move, but it does highlight a worsening in US fundamentals.  While other currencies are still a long away from displacing the USD dominance in FX reserves, financial flows, FX trading and trade, the longer term risks to the USD are clear.

That said, the USD caught a bid at the end of last week resulting in a sharp retreat in the euro (EUR) from heavily overbought technical levels.  It is unlikely to be a coincide that this occurred as US Covid cases showed signs of peaking while cases in many parts of Europe began to accelerate, resulting in delays to opening up or renewed tightening of social distancing measures there.  US stocks have also continued to perform well, despite much discussion of a rotation to value stocks.  Solid earnings from US tech heavyweights solidified their position as leaders of the pack.  It is too early to say that this is the beginning of a USD turnaround, but the currency is heavily oversold in terms of positioning and technicals, which point to room for some respite.

Turning to the week ahead attention will be on July global Purchasing Managers Indices (PMI) data beginning with China’s private sector Caixin PMI (consensus 51.1), and the US ISM survey (consensus 53.6) tomorrow.  Central bank decisions include the Reserve Bank of Australia (Tue), Bank of England (Thu), Reserve Bank of India (Thu) and Bank of Thailand (Wed).  No change is likely from the RBA, BoE and BoT, but expect a 25bp cut from RBI.  At the end of the week two pieces of data will take precedence; US July jobs data and China July trade data.  US-China tensions will come under further scrutiny after President Trump vowed to ban TikTok in the US while pouring cold water on a sale to a third party.

 

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