A Host Of Global Risks

Last week was a tumultuous one to say the least.  It’s been a long time since so many risk factors have come together at the same time.  The list is a long one and includes the escalation of the US-China trade war, which last week saw President Trump announce further tariffs on the remaining $300bn of Chinese exports to the US that do not already have tariffs levied on them, a break of USDCNY 7.00 and the US officially naming China as a currency manipulator.

The list of risk factors afflicting sentiment also includes intensifying Japan-Korea trade tensions, growing potential for a no-deal Brexit, demonstrations in Hong Kong, risks of a fresh election in Italy, growing fears of another Argentina default, ongoing tensions with Iran and escalating tensions between India and Pakistan over Kashmir.

All of this is taking place against the background of weakening global growth, with officials globally cutting their growth forecasts and sharply lower yields in G10 bond markets.  The latest country to miss its growth estimates is Singapore, a highly trade driven economy and bellwether of global trade, which today slashed its GDP forecasts.

Central banks are reacting by easing policy.  Last week, the New Zealand’s RBNZ, cut its policy rate by a bigger than expected 50 basis points, India cut its policy rate by a bigger than expected 35 basis points and Thailand surprisingly cutting by 25 basis points.  More rate cuts/policy easing is in the pipeline globally in the weeks and months ahead, with all eyes on the next moves by the Fed.  Moving into focus in this respect will be the Jackson Hole central bankers’ symposium on 22/23 August and Fed FOMC minutes on 21 August.

After the abrupt and sharp depreciation in China’s currency CNY, last week and break of USDCNY 7.00 there is evidence that China wants to control/slow the pace of depreciation to avoid a repeat, even as the overall path of the currency remains a weaker one. Firstly, CNY fixings have been generally stronger than expected over recent days and secondly, the spread between CNY and CNH has widened sharply, with the former stronger than the latter by a wider margin than usual.  Thirdly, comments from Chinese officials suggest that they are no keen on sharp pace of depreciation.

Markets will remain on tenterhooks given all the factors above and it finally seems that equity markets are succumbing to pressure, with stocks broadly lower over the last month, even as gains for the year remain relatively healthy.  The US dollar has remained a beneficiary of higher risk aversion though safe havens including Japanese yen and Swiss Franc are the main gainers in line with the move into safe assets globally.  Unfortunately there is little chance of any turnaround anytime soon given the potential for any one or more of the above risk factors to worsen.

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What To Watch This Week

Market expectations for Fed FOMC interest rate cuts have gyrated back and forth following a recent speech by NY Fed President Williams, one of the key decision makers within the Fed FOMC. He appeared to support a 50bps rate cut at the meeting at the end of the month, but unusually this was clarified later.  If anything, as the clarification may suggest, the bigger probability is that the Fed eases policy by 25bps in an insurance cut.

There will be no Fed speakers in the days ahead but the Fed will assess developments this week in helping to determine the magnitude of easing. Attention will continue to centre on US earnings, with more than a quarter of S&P 500 companies reporting Q2 earnings this week.   On the data front, US Q2 GDP and July durable goods orders will command most attention.  The consensus looks for a slowing in GDP growth to 1.8% q/q in Q1 from 3.1% q/q in Q1 while durable goods orders are expected to increase by 0.7% m/m.

A major central bank in action this week is the European Central Bank on Thursday. While policy easing is unlikely at this meeting, the ECB is likely to set to set the market up for an easing in deposit rates at the September meeting.  ECB President Draghi could do this by strengthening his forward guidance, but as a lot of this is priced in by the market, a dovish sounding Draghi is unlikely to weigh too much on the EUR.

In the UK this week it’s all about politics. Boris Johnson is widely expected to be announced as the new Prime Minister.  GBPUSD has clung onto the 1.25 handle, as worries about a no deal Brexit continue to impact sentiment towards the currency.  Once Johnson is sworn in he and the government could face a no confidence motion, which could gain support should it be seen as an alternative to the UK crashing out of the EU.

National elections in Japan yesterday resulted in a victory according to Japanese press for Shinzo Abe’s coalition, its sixth straight victory, with the governing LDP winning over half the 124 seats. The results were no surprise, and unlikely to have a significant market impact, but notably Abe suffered a setback by not gaining a supermajority. He therefore cannot change the country’s pacifist constitution.

In emerging markets, both Russia and Turkey are likely to cut interest rates this week, with Russia predicted to cut its key rate by 25bp and Turkey to cut by at least 200bps if not more.  Elsewhere geopolitical tensions will remain a major focus for markets, as tensions between the UK and Iran intensify.

China’s economy slows…what to watch this week

The week has started off with attention firmly fixed on Chinese data. In the event, second quarter (Q2) growth domestic product (GDP) came in at 6.2% year-on-year (y/y) following a 6.4% increase in the previous quarter, matching market expectations.  However, higher frequency Chinese data for June released at the same time looked far better, with industrial production up 6.3% y/y (market 5.2% y/y), retail sales up 9.8% y/y (market 8.5%) and fixed assets investment up 5.8% YTD y/y (market 5.5%).

Although growth in China has slowed to its weakest in many years, this was well flagged in advance and the GDP data is backward looking in any case.  The other data released today as well as increases in new loans and aggregate financing data released last week, suggest less urgency for fresh stimulus.  Overall, markets will be relieved by the fact that higher frequency data is holding up, but hopes of more aggressive stimulus in the near term may be dashed.

Attention elsewhere this week will focus on data and central banks.  After last week’s testimonies from Fed Chair Powell, during which he cemented expectations of a quarter percent from the Fed at the end of this month, attention in the US this well will be on June retail sales data where the consensus looks for a weaker 0.1% m/m increase in headline and ex-autos sales.   Further comments from Fed speakers will also garner attention, with Powell and New York Fed President Williams, likely to maintain market expectations of Fed easing.

Emerging Markets central banks will also be in focus, with monetary policy easing expected in South Africa, Indonesia and South Korea as central banks take the cue from the Fed.  Declining inflation pressure, weaker domestic growth, will also add support to further policy easing.  Stronger currencies in South Africa and Indonesia provide further impetus to cut rates.  I expect many emerging market central banks, especially in Asia, to ease policy in the weeks ahead, for similar reasons as above.

Watch me Guest Host on CNBC Asia tomorrow morning from 8-9am Singapore time where I will discuss these and other topics in more detail. 

Fed’s Powell, China trade, Japan-Korea tensions

Markets cheered Fed Chair Powell’s testimony to the US Congress this week, with Powell all but confirming that the Fed will cut interest rates in the US by 25bps later this month.  Powell’s comments yesterday and Wednesday highlighted the risks to the US economy including the threats from persistently low inflation, worsening global trade outlook, weak global growth, and possibility that Congress does not raise the debt ceiling, even as he saw “the economy as being in a good place”.  His comments highlight that any easing this month, would be an insurance cut, but markets are expecting the Fed to ease further in the months ahead, with at least one more priced in by the market this year.

Meanwhile attention remains focused on trade tensions. On this front, president Trump complained overnight that China hasn’t increased its purchases of US farm products, something that he said China had pledged to do at the G20 meeting when he met with China’s President Xi.  Data released yesterday showed that Chinese purchases of US agricultural good have actually slowed.  According to the US department of Agriculture China bought 127,800 metric tons of US soybeans last week and 76 tons of US pork, both sharp reductions compared to previous weeks.  Chinese media for its part says that the country had not committed to increasing purchases, but rather that Trump had hoped China would buy more goods.  Clearly, there is has left plenty of confusion about what was actually agreed upon.

Trade tensions have also risen in Asia, with tensions between South Korea and Japan intensifying.  Japan is implementing restrictions on exports to Korea of chemicals essential for chip making in retaliation over a ruling by Korea’s Supreme court awarding damages against Japanese companies for forced labour during the second world war. Japan says that such claims were settled under a 1965 treaty and is seeking arbitration. Korea evidently disagrees. The trade spat could also have widespread implications given the wide range of products that South Korean chips are used in, impacting supply chains globally.  Meetings between Japanese and Korean officials today will be watched for any rapprochement but any near term solution looks unlikely.

Waiting For US Jobs Data

Ahead of the US jobs report later today and following a lack of leads from US markets after the 4th July Independence Day holiday, markets are likely to tread water, at least until the employment report is released.  However, there are plenty of factors lurking in the background including the ongoing US-China trade war, US-Iran geopolitical tensions, and growing trade spat between Korea and Japan.

Markets continue to be supported by expectations of monetary easing globally.  This week, bond markets have continued to rally, helped by President Trump’s nomination of July Shelton and Christopher Waller for the Board of Governors of the Federal Reserve, both of which are considered dovish.  Separately, markets applauded the backing of Christine Lagarde to lead the European Central Bank after weeks of wrangling by European leaders.

Immediate attention will be on the US June jobs data.  Market expectations are for a 160,000 increase in non-farm payrolls, unemployment rate at 3.6% and average earnings growth of 0.3% compared to the previous month, 3.2% compared to the year earlier.  Anything much worse, for example an outcome below 100k would likely lead to an intensification of expectations that the Fed FOMC will cut by as much as 50 basis points later this month.  An outcome around consensus would likely result in a 25bp easing by the Fed FOMC.

Separately trade tensions between Japan and Korea have intensified. Japan is implementing restrictions on exports to Korea of chemicals essential for chip making. Japan is Korea’s fourth largest export market. The new approval process required by Japanese exporters of three semiconductor industry chemicals will hit Korea’s tech industry at a time when it is already suffering.  The trade spat could also have widespread implications given the wide range of products that South Korean chips are used in, impacting supply chains globally.

G20, Fed and Iran

Market attention this week will focus on Fed speakers, the G20 meeting and tensions between the US and Iran.  Here are my thoughts on all three:

Federal Reserve Chairman Powell and Vice Chair Williams are both scheduled to speak tomorrow.  Investors will be looking for any further clues on the path, timing and magnitude of Fed interest rates in the months ahead and whether they validate market expectations of easing at the July FOMC meeting.   Markets are already pricing in several cuts and a result the USD has weakened sharply over recent months, suggesting that the bar to an even more dovish stance is high.  Nonetheless, the Fed is at least likely to deliver a 25bp rate cut at the July meeting followed by at least one or two further hikes this year.

The main event this week (Fri-Sat) is the G20 meeting in Japan and in particular the potential meeting between Presidents Trump and Xi on the sidelines.  Expectations/optimism towards some form of progress on trade talks appears high.  Markets are set to remain upbeat heading into the G20, suggesting that risk assets will maintain their rally this week, which will bode well for equities. However, the reality is that the gap between both sides remain wide and there may be some positive noises emanating from the G20 on trade, concrete progress is likely to be limited.

Trump and Xi are likely to discuss a range of issues, with trade teams from both sides preparing the topics for discussion, after talks broke down last month.  It is likely that both Trump and Xi will agree to continue more formal talks, with both leaders sounding positive in the run up to the G20.  However, the threat of additional 25% US tariffs on the remaining $300bn of Chinese exports to the US, remains in place and it is unlikely that this will be taken off the table without some major concessions from China.  As I’ve previously stated it could take months before a concrete deal is agreed upon.  In the meantime global trade will continue to deteriorate.

Elsewhere geopolitical tensions remain in focus as President Trump threatens Iran with additional sanctions in an effort to force Iran to renegotiate the 2015 nuclear accord, as early as today. This follows Trump’s decision to call off planned air strikes in response to Iran’s shooting down of an unmanned drone.  Iranian oil exports have plunged as a result of sanctions and oil prices continue to react, rallying by around 8.7% in just under a week.  Markets will remain nervous over the risks of any further escalation, leaving oil prices susceptible to a further push higher.

 

Central Banks Galore

It’s a big week for central banks.  Several central banks globally meet to decide upon monetary policy this week.  The biggest focus will be on the Fed FOMC but this week also sees Norges Bank, Bank of England, Bank of Japan and central banks in Indonesia, Philippines, Taiwan, and Brazil meet.

Markets are already aggressive in pricing in Fed rate cuts.  As US-China trade tensions have worsened markets have intensified their expectations of Fed easing, with around 75bps of easing already priced in.  Given how much is priced in in terms of Fed easing, if the Fed does not validate this with a dovish statement and/or shift in the dot plot there could be a significant risks of disappointment, which could weigh on equities, but leave the USD on a firmer footing.

Admittedly the Bank of Japan is more constrained than the Fed in terms of policy room, but their rhetoric has become more dovish.  I don’t expect easing anytime soon but the BoJ is likely to sound dovish and could offer some enhanced forward guidance.  BoJ governor Kuroda outlined four options in terms of more policy stimulus, with one being a further cut in the deposit rate.  However, BoJ would need to outline how they plan to alleviate the pressure on bank profits from such a move.

Bank of England is unlikely to move.  Data in the UK has been mixed, with softening in Q2 growth but ongoing pressure on inflation given the tightness of the labour market.  It’s also difficult for the BoE given the large amount of Brexit uncertainty. GBP risks remain to the downside over the short term especially given the heightening political noise in the UK.  The Norges Bank is likely to stand out amongst the crowd, with a rate hike expected, its second in just three months.

Elsewhere in Asia I expect no change from Bank Indonesia, BSP in the Philippines, and CBC in Taiwan. Bank Indonesia is edging towards a rate cut amid low inflation and slowing activity, but will likely want to see further signs of IDR stability before pulling the trigger to begin reversing the 175bp of hikes implemented in 2018.

Weaker activity in Taiwan calls for some sort of stimulus but the reality is that a rate cut will do little to alleviate the pain given that much of the problem is due to external factors.  Instead much of the adjustment may take place on the currency front.

I expect the BSP in the Philippines to maintain its overnight borrowing rate at 4.50% at this week’s meeting while signalling more RRR cuts ahead. Although CPI came in above expectations in May, at 3.2% y/y, it remains close to the midpoint of the BSP’s 2-4% band and I don’t expect it to stand in the way of further easing, but think BSP may wait until at least August to move again.

 

 

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