China Data Fuels A Good Start To The Week

Better than expected outcomes for China’s manufacturing purchasing managers indices (PMIs) in November, with the official PMI moving back above 50 into expansion territory and the Caixin PMI also surprising on the upside gave markets some fuel for a positive start to the week.   The data suggest that China’s manufacturing sector has found some respite, but the bounce may have been due to temporary factors, rather than a sustainable improvement in manufacturing conditions.  Indeed much going forward will depend on the outcome of US-China trade talks, initially on whether a phase 1 deal can be agreed upon any time soon.

News on the trade war front shows little sign of improvement at this stage, with reports that a US-China trade deal is now “stalled” due to the Hong Kong legislation passed by President Trump last week as well as reports that China wants a roll back in previous tariffs before any deal can be signed.  Nonetheless, while a ‘Phase 1’ trade deal by year end is increasingly moving out of the picture, markets appear to be sanguine about it, with risk assets shrugging off trade doubts for now.  Whether the good mood can continue will depend on a slate of data releases over the days ahead.

Following China’s PMIs, the US November ISM manufacturing survey will be released later today.  US manufacturing sentiment has come under growing pressure even as other sectors of the economy have shown resilience.  Another below 50 (contractionary) outcome is likely.  The other key release in the US this week is the November jobs report, for which the consensus is looking for a 188k increase in jobs, unemployment rate remaining at 3.6% and average earnings rising by 0.3% m/m. Such an outcome will be greeted positively by markets, likely extending the positive drum beat for equities and risk assets into next week.

There are also several central bank decisions worth highlighting this week including in Australia, Canada and India.  Both the Reserve Bank of Australia (RBA) and Bank of Canada (BoC) are likely to keep monetary policy unchanged, while the Reserve Bank of India (RBI) is likely to cut its policy rate by 25bps to combat a worsening growth outlook.  Indeed, Q3 GDP data released last week revealed the sixth sequential weakening in India’s growth rate, with growth coming in at a relatively weak 4.5% y/y. Despite a recent food price induced spike in inflation the RBI is likely to focus on the weaker growth trajectory in cutting rates.

A Lot Of Moving Parts

There are lot of moving parts driving market sentiment at present.  US economic news has helped to buoy markets this week after US Q3 GDP was revised higher in its second estimate, to 2.1% q/q while October durable goods orders came in stronger than expected.  However, the news that President Trump signed the Hong Kong Human Rights and Democracy Act after almost unanimous passage in Congress, has fueled some cautious.  Investors now await any retaliation from China and whether the Bill will get in the way of a Phase 1 trade deal.

On the trade front both the US and Chinese governments have said that there are closing in on a Phase 1 deal but as yet there has been no confirmation, with less and less time to agree a deal before the end of the year and more importantly before the next phase of tariffs kicks in on December 15.  One sticking point between the two sides appears to be what extent will the US administration roll back tariffs, with China likely wanting not only the tariffs scheduled to be implemented in mid-December to be rolled back but also the ones implemented in August.

Such a roll back in tariffs would be take place in exchange for increased Chinese purchases of US goods and perhaps stricter intellectual property regulations, but more structural issues such as state subsidies, technology transfers etc may be put back to later deals.  In the meantime markets do not appear overly concerned, with risk assets and equities in particular continuing to rally and volatility continuing to decline.  If there is no deal announced in the weeks ahead, markets could face a set back, but if agreement on a deal is to be merely pushed back into Q1 2020, the damage will be limited.

After its sharp fall over October the US dollar has gradually clawed back ground over recent weeks, helped by US asset market outperformance and consequently strong inflows into US assets.  As we move towards the end of the year it appears that the USD will maintain its top spot, much to the chagrin of the US administration and their preference for a weaker USD.

Looking At Central Banks For Direction

This week feels as though its one where markets have gone into limbo waiting for developments on the trade war front, and for direction from central bankers.  So far there has been no indication that a date or even location has been set to finalise details of a Phase 1 deal between the US and China.  While officials on both sides suggest that progress is being made, markets are left wondering if a deal will even be signed this side of the new year.  Despite such uncertainty there does not seem to be too much angst in markets yet, and if anything, risk assets including equities look rather resilient.

Central bankers and central bank minutes will garner plenty of attention over coming days.   Overall it looks as though major central banks led by the Fed are moving into a wait and see mode and this means less direction from these central banks to markets over the next few weeks and likely into year end.

Fed FOMC minutes this week will give more information on the Fed’s thinking when it eased policy in October, and markets will be looking for clues as to what will make them ease again.  In his recent Congressional testimony Fed Chair Powell highlighted that he sees little need to ease policy at the December meeting, strongly suggesting no more easing from the Fed this year.

Reserve Bank of Australia minutes overnight highlighted that the Bank will also now wait to assess past monetary easing measures before cutting rates again while still holding the door open to further cuts if necessary.  While the RBA noted that a case could have been made for easing this month, it doesn’t appear that they are in a rush to move again, with easing now becoming more likely next year than in December.

Another central bank in focus is the ECB, with ECB President Lagarde delivering the keynote address at the European Banking Congress in Frankfurt.  This will be an opportunity for markets to see whether her views are in line with previous ECB President Draghi and also to see how she reacts to criticism of the ECB’s decision from outside and within the governing council, to ease policy further at the September meeting, when it cut the deposit rate to -0.5% and restarted asset purchases.

Another central bank in focus over coming days includes the PBoC in China.  The PBoC cuts its 7-day reverse repo rate by 5bps this week, the first decline in this rate since 2015 in an attempt to lower funding cots to banks.  While the move is small the direction of travel is clearly for lower rates and this is likely to be echoed in the release of the new Loan Prime Rate tomorrow, which could also reveal a small 5bps reduction.  China is likely to maintain this path of incremental easing in the weeks ahead.

Cautious Sentiment Towards A Trade Deal

Markets continue to focus on the potential for a “Phase 1” trade deal between the US and China.   The stakes are high. President Trump who stated that tariffs on Chinese goods would be “raised very substantially” if no deal was struck between the two sides.  US officials also poured cold water over comments by Chinese officials at the end of last week that there had been an agreement to reduce tariffs in phases.  Markets will take a cautious tone given such comments but it is still likely that a deal of sorts will agreed upon in the next few weeks.

Both sides want a deal and while Trump has said that China wants one more than he does, the US administration may want to avoid fueling market turmoil as attention increasingly turns to next year’s US elections.  This suggests that a Phase 1 deal is more likely than not, but agreement on later Phases will be much harder given that there are various structural issues that remain unresolved such as technology transfers, intellectual property theft and state subsidies.

For now what is important is that markets believe that there is progress towards a deal and an eventual signing probably sometime in December.  Despite the harder rhetoric from the US side this still looks like the most likely outcome which in turn suggests that equities and other risk assets have room to rally.  In the meantime, the situation in Hong Kong where protests have intensified will weigh not just on Hong Kong’s markets but markets across the region adding another reason for market caution in the short term.

On the data and events front attention will be on US October CPI, retail sales and a crop of Fed speakers including Fed Chair Powell who is unlikely to change the view the Fed is on pause for the time being.  Elsewhere Chinese data has been less than impressive this week, with October aggregate financing and new yuan loans both coming in weaker than expected.   This is likely to be echoed by the retail sales and industrial production data this week too.

On the FX front, the US dollar has made up around of its October losses amid some deterioration in risk appetite.  Further moves will depend on the progress towards a trade deal, with the USD likely to be pressured should it become clearer that a deal is likely to be signed and vice-versa.  US retail sales data will also have some impact in the short term, but with the Fed on pause and US data holding up the USD the will be driven by driven by the gyrations in risk assets.

Brexit Developments Sharply In Focus

Two major market risks have been sidelined, though admittedly not taken off the table.  Firstly the prospects of an intensification of the US-China trade war appears to have diminished and secondly the risks of the UK crashing out of the EU without a deal have lessened.  This presents a calmer and less volatile backdrop for markets even as global growth continues to remain under pressure.  Separately markets are hoping and expecting for some icing on the cake in the form of Fed easing later this month. As long as US Q3 earnings are not too bad, this suggests a period of calm ahead.

US-China trade developments are likely to take a back seat in the run up to the APEC meeting on 16-17 November in Chile where a ‘Phase 1’ trade deal may be signed by both US and Chinese leaders.  Talks rumbling in the background appear to progressing well, with US Treasury Secretary Mnuchin and Trade Representative Lighthizer scheduled to speak to China’s Vice Premier Liu He this week by phone.  Markets will carefully eye what the prospects are for a delay of the $156bn of US tariffs on China that are due to take effect on December 15.

Brexit developments will move sharply back into focus today, with UK Prime Minister Boris Johnson set to make a fresh attempt at passing a ‘meaningful vote’ today or gaining a majority in a vote on legislation implementing the deal tomorrow.  This follows having to jettison a vote on Saturday and being forced to write to the EU requesting a three-month delay to the Article 50 exit process.  The government thinks it has the number of votes necessary to pass the vote and the fact that GBP has only lost a little ground today (at the time of writing) suggests that markets think the chances are high.

Other than this, the European Central Bank meeting on Thursday will garner attention although President Draghi is unlikely to offer any further changes in policy, having come under criticism from hawks in the ECB governing council who opposed the renewed bond buying from the ECB.  Expect Draghi to maintain a dovish stance at this meeting.  Other central banks in focus this week include Norway, Sweden, Turkey and Indonesia.  The former two are likely to leave policy unchanged while both Turkey and Indonesia are likely to ease policy.

 

Limited Relief

Now that the dust has settled on the US-China limited ‘Phase 1’ deal formulated at the end of last week markets can look to other events/data this week.  Prominent among these are Brexit discussions, which look as though they are carrying over to today as discussions towards a final deal intensify (more on this in another post).  However, casting a shadow over markets today is the news that China has threatened retaliation against the US after the House of Representatives passed a bill on reviewing the preferential treatment for HK.

Stepping back, regarding the trade deal it was probably the easiest one on the table from China’s perspective.  The US agreed to hold back on raising tariffs on $250bn of Chinese goods while China agreed to increase agricultural purchases and give limited access to its financial markets.

However, it was no “love fest”.  It is very narrowly focused, doesn’t role back previous tariffs, does little to change the growth narrative, nor does it deal with the tougher structural issues and enforcement mechanisms etc.  It is also vague on the Chinese currency, renminbi. In any case China had already highlighted and strongly hinted at increased agricultural purchases over recent weeks

Yes, there was some vague commitment to address intellectual property (IP) issues, something that hawks in the US administration have been pushing for but this is akin to closing the barn door after the horse has bolted. China has already tightened up IP regulations at home and in fact is now keen to protect its own IP so it has a big incentive to tighten up IP rules.

The US administration was probably more than happy to avoid another increase in tariffs on China given the desire not to fuel more market instability, growing focus on elections next year and to show some form of progress to take the attention away from the impeachment inquiries.  Implementation of the next tariffs round on December 15 is unclear but given the above it could be delayed or scrapped.  That would be more substantial progress.

Over the short term markets will be relieved that tensions on trade are not worsening though the passage of the bill on Hong Kong by the US House of Representatives threatens to increase tensions on another front.  The bottom line is that there is some breathing space on the trade front, with the President Trump stating that it may take up to five weeks to complete the deal.  Some form of signing may take place at the Apec Summit in Chile in mid-November.

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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