US/China Tensions Escalate

Risk appetite starts the week in poor form. The shock announcement of 5% tariffs on all Mexican exports (from June 10) to the US and an intensification of tensions with China, have fuelled growing expectations of a worsening in the global growth outlook. Safe haven assets such as JPY and CHF are likely to remain in demand while core bond yields are likely to continue to move lower, with markets continuing to raise bets on Fed rate cuts this year.  Indeed the 10y US Treasury yield has dropped by 1.1% since 8 November last year, with the fall in yields accelerating over recent weeks.

US/China tensions escalated over the weekend, with the deputy head of China’s negotiating team, Wang Shouwen, accusing the US of “resorting to intimidation and coercion”.  This coincides with the increase in US tariffs on $200bn of Chinese goods coming into effect over the weekend as Chinese shipments reached US shores, while earlier on Saturday Chinese tariffs on $60bn of US exports came into effect.  There is also growing speculation that China may curb exports of rare earth exports to the US.

Wang accused the US of abusing export controls and persisting with “exorbitant” demands and insisting on “mandatory requirements that infringe on China’s sovereign affairs”.   Meanwhile China’s defence minister Wei Fenghe, said that China will “fight to the end” on trade if needed.  China is also starting to investigate foreign companies who have violated Chinese law.  Soon after Chinese state media reported that the government was investigating FedEx for allegedly “undermining the legitimate rights and interest” of its Chinese clients.

Attention this week will be on several central bank decisions including the ECB (6th June), RBA (4th June) and RBI (6th June).  The market is fully priced in for an RBA rate cut to 1.25% this week.  The ECB is unlikely to surprise, with no change in policy likely.  Attention will be on terms of the TLTRO III while ECB President Draghi is likely to sound dovish in his press conference.  RBI is set to cut policy rates again, with Friday’s release of weaker than expected Q1 GDP adding to pressure on the Reserve Bank to boost growth amid low inflation.

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Central banks in focus this week

Several central bank decisions are on tap this week including Japan (BoJ), Switzerland (SNB), Norway (Norges Bank), Brazil (BCB) and Thailand (BoT).  Among these only the Norges Bank looks likely to hike rates.

US data is largely second tier this week, with August housing data due for release.  After a run of weak readings a bounce back in starts and existing home sales is expected.   RBA minutes in Australia and NZ Q2 macro data are also in focus.

Political events will garner most attention, with the delayed announcement on China tariffs ($200bn) possible as early as today after being delayed due to the consideration of revisions raised via public comment.  Another twist in the saga is that China is considering declining the US offer of trade talks given the recent Trump threat of fresh tariffs (WSJ).

Other political events include Japan’s LDP election and US trade negotiations (assuming China participates) at the end of the week.   A few Brexit events this week include the General Affairs Council and Informal EU Summit.

 

AUD supported but be wary of profit taking

AUD/USD broke above its 200 day moving average (0.9137) encouraged by upbeat comments about economic growth prospects from Reserve Bank of Australia Governor Stevens. The fact that AUD remains supported despite higher risk aversion overnight is encouraging.

A run of better than expected data including Q4 GDP, retail sales, trade and jobs report have underpinned the currency. Additionally bad news is good in the case of the China impact on AUD as weaker data has led to growing expectations of a stimulus package to boost China’s economy.

Against the background of some improvement in risk appetite, and low volatility, the AUD looks like an attractive bet. My view has been consistently constructive on the AUD over past months and I remain of the view that there are further gains in store although in the near term profit taking is expect to emerge around resistance at AUD/USD 0.9342.

Impressive Aussie jobs data

Feb employment rose 47.3k in Australia, much bigger than expected (consensus 15k) while the unemployment rate remained at 6%. The components were positive, with full time employment rising by 80.5k and part time employment dropping by 33.3k. The participation rate rose to 64.8% too. AUD rallied following the release of the data and looks set to consolidate gains. However, upside may still be limited given the various headwinds of higher risk aversion and lower commodity prices, with AUD/USD 0.9133 set to act as near term resistance.

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AUD the “Teflon” currency

Despite further concerns about Chinese growth, following the release of the much worse than expected trade data over the weekend, AUD continues to hold gains above 0.90. Additionally declines in key commodities such as iron ore have done little to dent the enthusiasm for AUD. In this respect, AUD is fast becoming the new “Teflon” currency, helped by the neutral stance of the Reserve Bank of Australia and recently positive domestic data such as building approvals, Q4 GDP and January trade data.

The next major test for AUD will be Thursday’s release of the February jobs report. Clearly there has been a worsening in jobs conditions but the worst is likely over and after a decline in employment over the last couple of months some rebound is expected (our forecast +20k, consensus +15k).

AUD is set to consolidate over the near term, with technical support seen around 0.8980.

The week ahead

There are plenty of events to chew on over coming days including central bank decisions in Japan tomorrow and New Zealand on Wednesday. The Bank of Japan is unlikely to ease policy further so soon after its actions to boost loan growth while in contrast the RBNZ is set to begin its hiking cycle. On the data front US releases will still be weather impacted to some extent although February retail sales is likely to post a small gain. Moreover, Michigan confidence is set to rise, boosted by higher equity prices.

In Europe, attention will focus on industrial production releases in January, with French and Spanish IP data due to be released today. Overall production is likely to have expanded at a healthy clip of 0.4% MoM in the Eurozone as indicated by survey data. Finally, Australian jobs data is set to show some improvement on Thursday as the pace of deterioration in job market conditions slows.

In Asia the reverberations from the weaker Chinese data will likely impact sentiment across the region. Exports dropped by whopping 18.1% in February while imports rose more strongly than expected at 10.1% yielding a trade deficit of USD 22.99 billion. Central bank decisions in Korea and Thailand are on tap this week. Thailand is a close call, with risks of another policy rate cut but we expect the BoT to stay on hold. Currencies in Asia strengthened last week led by the IDR and INR. Gains this week will be morel limited, especially against the background of higher US yields.

Good data boosts AUD

Australia released some solid data this morning, with both January retail sales (1.2% MoM versus 0.4% consensus) and trade data (AUD 1433 mn versus AUD 100 mn consensus) beating expectations. Following on from yesterday’s better than forecast Q4 GDP data the news gave a boost to AUD helping it to break 0.90 versus the USD. The data especially retail sales highlights the growing strength of the consumer in Australia and reaffirms that the next move in policy rates will be up. Taken together with a firmer tone to risk appetite and the relatively solid 7.5% official growth target set for China’s economy this year, AUD/USD is set to remain well supported.

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