US-China Trade Talk Hopes Begin To Fade

Attention this week will be very much centered on a few key events, most prominent of which is US-China trade talks scheduled to begin on Thursday in Washington.   A speech by Fed Chair Powell at the annual NABE conference tomorrow and Fed FOMC minutes  will also garner plenty of attention for clues to the Fed FOMC meeting at the end of this month.   In the UK, as the end October deadline approaches attention turns to whether Prime Minister Johnson can seal a deal with European officials.

Starting with US-China trade talks, reports (Bloomberg) today suggest that China is unwilling to agree to a comprehensive trade deal with the Trump administration.   The report states that senior Chinese officials have indicated that the range of topics they are willing to discuss has narrowed considerably.  The implication is that major structural issues such as intellectual property theft, technology transfers, state subsidies, and other issues are off the table, limiting the scope of any agreement emerging from meetings this week.   Markets have unsurprisingly reacted negatively to the reports.

If China is indeed unwilling to enter into a broader trade discussion, prospects for even an interim trade deal look slim especially considering that US officials were last week talking down the prospects of a narrow deal.  Markets have been pinning their hopes on some progress on trade talks and any failure to advance talks this week will cast a heavy shadow over markets in the days ahead.

Separately European leaders appear to have poured cold water on the UK government’s proposals for a deal to end the Brexit impasse.  The main sticking point is the removal of the Irish backstop and proposal to implement a customs border between Northern Ireland and the Irish Republic.  If no deal is reached an extension seems likely given the passage of the Benn Act, which requires the PM to ask the EU for a delay if parliamentary approval has not been given to a withdrawal agreement or a no deal exit.  Nonetheless, Johnson continues to warn the EU that he will take the UK out of Europe at the end of October. The uncertainty is unsurprisingly once again hurting the pound.

In  the US the release of US September CPI, speech by Fed Chair Powell and FOMC minutes will provide further clues to the Fed’s thinking ahead of the FOMC meeting this month.  Market pricing for an October rate cut increased in the wake of a recent run of weaker data (especially the September ISM surveys, which weakened) though the September jobs report (non farm payrolls increased by 136k while the unemployment rate fell to a record low of 3.5%) released at the end of last week did not provide further ammunition for those expecting a more aggressive Fed rate cut.  A 25bp cut sees likely at the October meeting.

 

 

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Bumpy Ride Ahead

Just as it looked as though there was some hope of stabilisation in global economic conditions, the September US ISM (Institute of Supply Management) Index released on Monday was not only weak but it was a lot worse than expected at 47.8 (below 50 means contraction).  Markets clearly took fright, with the sell off in stocks intensifying yesterday in the wake of the US ADP jobs report for September, which recorded an increase of 135k jobs by private sector employers, its weakest reading in three months.

This all sets up for a nervous wait ahead of tomorrow’s September jobs report in which markets will be on the look out for any slowing in nonfarm payrolls and/or increase in the unemployment rate.  The consensus expectation is for a 148k increase in payrolls in September and for the unemployment rate to remain at 3.7%, but risks of a weaker outcome have grown.  The US dollar has also come under pressure as US economic risks increase.

Rising geopolitical risks are adding to the market malaise, with the impeachment enquiry into President Trump intensifying and risks of a hard Brexit in the UK remaining elevated.  On the latte front UK Prime Minister Johnson published his plans for a Brexit strategy yesterday replacing Theresa May’s “backstop” plan with two new borders for Northern Ireland.

If the proposal isn’t agreed with the EU, there is a strong chance that Johnson will be forced to seek another extension to Article 50 from the end of October, prolonging the three and a half years of uncertainty that the UK has gone through.  GBP didn’t react much to the new plan, and surprisingly did not fall despite the sharp sell off in UK equities yesterday, with the FTSE falling by over 3%.

The fact that the US has now been given the green light to impose tariffs on EU goods after the EU lost a World Trade Organisation (WTO) ruling adds a further dimension to the trade war engulfing economies globally.  The US administration will now move ahead to impose 25% tariffs on a range of imports from the EU, with the tariffs implementation likely to compound global growth fears.  If the EU wins a similar case early next year, expect to see an onslaught of EU tariffs on EU imports of US goods.

This is taking place just as hopes of progress in trade talks between the US and China in talks scheduled for next week have grown.  But even these talks are unlikely to be smooth given the array of structural issues that remain unresolved including technology transfers, Chinese state subsidies, accusations of IP theft, etc.  Additionally, the fact that the US administration has reportedly discussed adding financial restrictions on Chinese access to US capital suggests another front in the trade way may be about to open up.

The bottom line is that there is a host of factors weighing on markets at present and adding to global uncertainty, none of which are likely to go away soon.  Now that fears about the US economy are also intensifying suggests that there is nowhere to hide in the current malaise, implying that risk assets are in for a bumpy ride in the weeks ahead while market volatility is likely to increase.

 

 

 

 

Oil Surges, Central Banks Galore

Oil prices jumped following drone attacks on Saudi Arabian oil facilities over the weekend.  Oil rose by around 20% to just shy of $72, before halving its gain later.  Even after failing to hold onto initial gains the rise in oil prices still marks one if its biggest one day gains.  Concerns about reduced oil supply have risen as a result of the attacks as they could reduce Saudi oil production for a prolonged period, with around 5% of global oil supply impacted.  Additionally the attacks could raise geopolitical tensions in the region.

As markets digest the impact of the drone attacks, there will also be several central bank decisions globally to focus on this week.  The main event is the Fed FOMC meeting mid-week, where a 25bp cut is largely priced in by the market.  Given that a rate cut is well flagged markets will pay close attention to the Fed’s summary of economic projections, in particular the Fed’s dot plot.  It seems unlikely that Fed Chair Powell is going to sound too dovish, with little to suggest that the Fed is on path for a more aggressive easing path.

Another major central bank meeting this week is the Bank of Japan (BoJ) on Thursday.  While a policy move by the BoJ at is unlikely this week BoJ policy makers have sounded more open to easing.  A consumption tax hike planned for next month together with a strong JPY have increased the pressure for the BoJ to act. Separately easier policy from other major central banks amid slowing global growth are unlikely be ignored.  However, policy is already ultra- easy and the BoJ remains cognisant of the adverse secondary impact of policy on Japanese Banks.

The Bank of England deliberates on policy this week too but it seems highly unlikely that they would adjust policy given all the uncertainties on how Brexit developments will pan out.  Until there is some clarity, the BoE is likely to remain firmly on hold, with the base rate remaining at 0.75%.  GBP has rallied over recent weeks as markets have stepped back from expectations of a hard Brexit, but this does not mean that a deal is any closer than it has been over the past months.  Elsewhere the SNB in Switzerland and Norges Bank in Norway are also expected to keep policy rates on hold this week.

Several emerging markets central banks will also deliberate on policy this week including in Brazil, South Africa, Indonesia and Taiwan.  The consensus (Bloomberg) expects a 50bp rate cut in Brazil, no change in South Africa and Taiwan and a 25bp rate cut in Indonesia.  Overall many emerging markets continue to ease policy amid slowing growth, lower US policy rates and declining inflation pressures.

 

Will The Risk Rally Endure?

There has been a definitive turnaround in risk sentiment this week, with equities rallying and bonds falling.  Whether it can be sustained is another question. I think it will be short-lived.

Markets are pinning their hopes on trade talks which have been agreed be US and Chinese officials to take place in October.  These would be the first official talks since July and follow an intensification of tariffs over recent weeks.  However, talks previously broke up due to a lack of progress on various structural issues and there is no guarantee that anything would be different this time around.  Nonetheless, such hopes may be sufficient to keep market sentiment buoyed in the short term.

Data overnight was bullish for risk sentiment, with the US August ADP employment report revealing private sector gains of +195k, which was higher than expected.  The US ISM non-manufacturing index was also stronger than expected, rising to 56.4 in August from 53.7 previously.  This contrasted with the slide in the manufacturing PMI, which slipped in contraction below 50, reported earlier this week.  The data sets up for a positive outcome for the US August jobs report to be released later today, where the consensus (Bloomberg) is for a 160k increase in payrolls and for the unemployment rate to remain at 3.7%.

As risk appetite has improved the US dollar has come under pressure, falling from its recent highs.  Nonetheless, the dollar remains at over two year highs despite speculation that the US authorities are on the verge of embarking on intervention to weaken the currency.  While I think such intervention is still very unlikely given that it would do little to change the factors driving the dollar higher, chatter about potential intervention may still keep dollar bulls wary.  While intervention is a risk, I don’t think this stop the USD from moving even higher in the weeks ahead.

Conversely China’s currency, the renminbi has reversed some of its recent losses, but this looks like a temporary retracement rather than a change in trend.  China’s economy continues to weaken as reflected in a series of weaker data releases and a weaker currency is still an effective way to alleviate some of the pressure on Chinese exporters. As long as the pace of decline is not too rapid and does incite a sharp increase in capital outflows, I expect the renminbi to continue to weaken.

Combating Recession Risks

Following a volatile last week market attention will remain on trade tensions, measures to combat the risks of recession and will turn to the Jackson Hole central bankers’ symposium at the end of the week. The inversion of the US yield curve has led to growing expectations that the US is heading into recession and has spurred inflows into bonds. As a result US Treasury yields continue to fall and the stockpile of negative yielding debt has risen to well over $16 trillion. While economic data in the US remains relatively firm, the picture in the rest of the world has deteriorated sharply as reflected in weakening German and Chinese trade, against the background of a weak trade backdrop.

There have been some mixed headlines on trade over the weekend – Larry Kudlow, Director of the National Economic Council under President Trump, said yesterday that recent phone calls between US and Chinese trade negotiators had been “positive”, with more teleconference meetings planned over the next 10 days.  Separately US media reported that the US commerce department was preparing to extend a temporary license for companies to do business with Huawei for 90 days. However, Trump poured cold water on this by stating that “Huawei is a company that we may not do business with at all”.  A decision will be made today.

In the wake of growing expectations of recession, attention is turning on what will be done by governments and central banks to combat such risks.  The Jackson Hole meeting on Thursday will be particularly important to gauge what major central bankers are thinking and in particular whether and to what degree Federal Reserve Chairman Powell is planning on cutting US rates further.  We will be able to garner further evidence of Fed deliberations, with the release of the Fed FOMC July meeting minutes on Wednesday.

While central bankers look at potential monetary policy steps governments are likely to look at ways of providing further fiscal stimulus.  Kudlow stated that the US administration was “looking at” the prospects of tax cuts, while pressure on the German government to loosen is purse strings has also grown.  Even in the UK where a hard Brexit looms, the government is reportedly readying itself with a fiscal package to support growth in the aftermath.   Such news will come as a relief to markets, but recession worries are not likely to dissipate quickly, which will likely keep volatility elevated, and maintain the bias towards safe haven assets in the weeks ahead.

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.

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.

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