Taking Stock

As we get to the end of the week trade headlines are still continuing to capture most attention. However, it has been increasingly difficult for anyone to guess what comes next in the long running trade war between the US and China.  Most investors and analysts think the trade war will persist for a long while but President Trump tweeted that it would “fairly short” and that talks with China were on track to resume next months.

Markets are not convinced and becoming increasingly desensitised to the news flow over trade, which seems to shift from good to bad news on a regular basis.  For example, the decision to delay the imposition of tariffs on around $156bn of Chinese exports until December failed to fuel a bounce in US equities. The decision has also left Chinese officials unperturbed.  China has vowed to retaliate, stating that the US had “deviated from the correct track of consultation and settlement of differences”.

The situation in Hong Kong is adding another dimension to the trade war.   President Trump has said that believed China’s President Xi could “work that out in a humane fashion” while in contrast many in the US Congress are pushing for a stronger stance. The eventual reaction will depend on whether demonstrations persist and how China moves going forward.

Hong Kong’s economy and markets are under pressure too, unsurprisingly. The economy is now facing the prospect of a technical recession, with growth in the third quarter likely to be negative following a -0.3% q/q drop in GDP in the second quarter.   Industry bodies have revealed that tourism has dropped sharply, with double digit declines in hotel occupancy and sharp reductions in purchases by mainland tourists. The number of tour groups from mainland China have declined by close to 30% in June compared to the average this year while hotel occupancy rates are expected to drop 40% y/y in July.

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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.

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.

Fed’s Powell & China trade data in focus

US jobs data released at the end of last week will diminish hopes of more aggressive policy rate cuts from the Fed FOMC at its policy meeting at the end of the month. Non-farm payrolls rose by 224,000 last month, beating market forecasts, a sharp improvement from the disappointing 72,000 increase in the previous month.

Despite the stronger than expected reading in June, the Fed is still likely to cut interest rates by 25 basis points amid concerns about a loss of growth momentum, trade tensions against the background of low inflation.  Soft US June CPI releases on Thursday this week will likely confirm the subdued inflationary backdrop.

Markets will be able to garner more clues during Fed Chair Powell’s testimony to Congress on Wednesday and Thursday while Fed FOMC minutes from the last meeting will also provide greater detail on Fed thinking.  Both are likely to help confirm expectations of a 25 basis point cut in rates at the next FOMC meeting.

The USD has recovered some if recent losses, helped at the end of last week but the US jobs report.  Further gains are likely to be limited (with the USD index likely to struggle to break 98.0) though much will depend on Powell’s testimony this week.

Also in focus this week will be China’s June trade data.  This data will be scrutinised in particular, for the trade surplus with the US and whether there are any signs of this surplus beginning to narrow.  The data will also give some indications of the health of China’s economy, with another weak print for imports, likely to show further softening in China’s growth momentum. Similarly weaker exports will highlight the softening in demand from key trading partners such as Korea.

Further evidence on the outlook for China’s economy will be seen in the release of monetary aggregates including new loan growth and aggregate financing. Meanwhile, China’s currency continues to remain stable amid the trade truce with the US.

 

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.

US-China Trade Truce Boosts Sentiment

Weekend developments will help set up the markets for a risk on day.  However, any improvement in sentiment will likely be capped. The good news was that the US and China agreed to a trade truce at the G20 summit, President Trump and North Korean leader Kim Jong Un met at the demilitarised zone while separately the EU and Mercosur agreed upon a trade deal in a strong retort against the rising trend of protectionism.

Presidents Trump and Xi agreed to delay the implementation of new tariffs (on the remaining $300bn of Chinese exports to the US) while agreeing to restart trade talks, albeit with no time table scheduled as yet.  The delay in tariffs escalation and restart of trade talks was in line with expectations but concessions on Huawei were not.   Trump stated that US companies can sell equipment to Huawei without giving details on what can be sold while China also agreed to buy more US agricultural goods.

The chances of a US-China trade deal have risen, but it could still take several months before various remaining structural issues (forced technology transfers, state subsidies, discrimination against foreign companies, regulations on intellectual property etc)
are ironed out. The lack of time frame on US-China trade talks, ongoing structural issues, lack of details on what equipment US suppliers can sell to Huawei and a host of data releases, will limit the improvement in sentiment and reduce the likelihood of any near term deal.

Looking ahead, sentiment may be clouded somewhat by the disappointing China purchasing managers’ index (PMI) yesterday, with the manufacturing PMI coming in at 49.4 in June, the same as in May, with manufacturing continuing to contract.  However, markets may be willing to overlook this as trade tensions were likely a prime reason for the continued weakness in manufacturing confidence.   As such, China’s currency CNY and asset markets will likely react positively overall.

The events over the weekend will likely reduce the chances of a 50bps rate by the Fed at their next meeting, but much will depend on upcoming data.   This includes the June US ISM survey today and employment report on Friday.  Markets expect a 160k bounce back in payrolls in June after the surprisingly weak 75k increase in the previous month.  Assuming the data is line with expectations it seems unlikely that the Fed will feel the need to ease policy by more than 25bp when they meet at the end of the month.

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