Pause In The Risk Rally?

January 21, 2020 — Mitul Kotecha

The rally in risk assets has extended into 2020 amid a stabilization in economic data, the Phase 1 trade deal and a persistent easy monetary policy stance by major central banks.  The sharp decline in volatility in most asset markets has also contributed to the rush to buy such as assets including equities and high yielding debt.  While the market is becoming increasingly susceptible to shocks given the increasing positioning in risks assets, the near term may be a period of consolidation rather than any reversal.

Attention this week will focus on US Q4 2019 earnings.  So far, with around 9% of S&P earnings released, the majority (around 70%) have beaten expectations.  In a 4 day US trading week this week there are a number of earnings releases that will help provide further clues to whether the US equity rally can be sustained in the weeks ahead.  The S&P 500 is already up around 3% this year, extending a 30%+ gain last year. This has echoed gains in most global equity markets.  Investors should be nervous, but there is little to suggest a reversal soon.

There are a number of data and events to focus on this week including central bank meetings in the Eurozone, Canada, Norway, Malaysia and Indonesia.  Unsurprisingly the Bank of Japan left policy unchanged today and the other are unlikely to change their policy settings except perhaps Indonesia, which may cut.  Aside from these central banks a series of manufacturing surveys (Markit PMIs) will garner attention.

In Asia, trading activity may slow as Chinese New Year approaches while impeachment proceedings against US President Trump in the Senate will also likely distract attention for many.  Another issue that has taken on increasing prominence is the outbreak of a virus that appears to have originated in central China.  Concerns have grown that the coronavirus could spread quickly especially as millions of Chinese migrate (estimated at around 3 billion trips) over the Chinese new year holidays.

Overall, nervousness over the virus alongside holidays in the region is likely to lead to consolidation in markets any even profit taking following a strong rally in risk assets over recent weeks and months.  Positioning indicators suggest that USD positioning has fallen sharply, suggesting also a risk of USD short covering in the current environment.  This all point to a pause in the risk rally in the days ahead.

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US-China Phase 1, Now What?

January 16, 2020 — Mitul Kotecha

Now that the long awaited Phase 1 deal has been signed between the US and China (significantly taking place in the White House) and details finally released (in a 94 page document) it’s worth asking whether much has actually changed.  After all, China still faces (high) tariffs on around two-thirds of its exports to the US while the deal does little to end Chinese state subsidies.  In return the US offers little aside from removing tariff increases.  Intellectual property transfer commitments agreed in the deal are mostly not new as China had already addressed most of these. 

Ironically the magnitude of Chinese purchases, ($77.7bn in manufactured goods, $32bn in agricultural goods, $52.4bn in energy and $37.9bn in services to Dec 2021) means that the Chinese State will have to be even more active in influencing its economy.  The reality is that to achieve this is going to be extremely difficult if not highly unlikely though this may ultimately not matter if China is seen to significantly increase its US purchases.

Looking ahead don’t expect China to be as agreeable on a Phase 2 deal; any such deal would touch on far more sensitive issues.  The likelihood of this being agreed and signed ahead of US elections or maybe at all, is low.  However, in the near term, the deal keeps the risk taps open and avoids any near-term escalation while President Trump walks away with another notch on his belt.  What it doesn’t do is stop any of the US non-tariff barriers, export controls etc, that will still hurt Chinese companies and push China to develop its own technology. Chinese growth will not get much of an uplift from the deal while markets have already largely priced it in.

The commitment from China on the Chinese yuan (CNY) looks vague (achieve market determined FX rate, strengthen underlying fundamentals, refrain from competitive devaluations, avoid large scale, persistent, one-sided intervention), but China will at least avoid any sharp devaluations (of the type experienced in mid-2015, Jan 16), not that they would want to do that again given the negative consequences on its markets/economy.  And as it is China has not been intervening significantly in FX markets for a long while so this should not be difficult either.

Posted in China, Currencies, Economics, Economy, equity markets, Trade, Trump, US, US administration. Tags: , , , . 1 Comment »

UK Elections and US-China trade: Removing Risk Factors

December 16, 2019 — Mitul Kotecha

Following the euphoria over the decisive UK election result and the US/China “Phase 1” trade deal markets look primed to end the year on a positive footing.  Two of the major risk factors threatening to detail market sentiment into year end have at least been lifted.  However, some reality may begin to set in early into 2020, with investors recognizing that there are still major issues to be resolved both between the UK and Europe and between the US and China,

Although full details have yet to be revealed, Chinese officials will likely be relieved that the hike in tariffs scheduled for December 15 will now not go ahead. However, there are still questions on how China will ramp up its purchases of US agricultural goods anywhere near the $40-50bn mark that has been touted.

Also the dollar amount of the roll back in US tariffs is relatively small at around $9bn, which hardly moves the needle in terms of helping China’s growth prospects.  “The United States will be maintaining 25 percent tariffs on approximately $250 billion of Chinese imports, along with 7.5 percent tariffs on approximately $120 billion of Chinese imports.”  This still means that a substantial amount of tariffs on Chinese goods remains in place.

According to Trade Rep. Lighthizer, the deal will take effect 30 days after its signing, likely in early January. To sustain any improvement in sentiment around trade prospects there will need to be some concrete progress in removing previous tariffs as well as progress on structural issues (state subsides, technology transfers etc) in any Phase 2 or 3 dealss. The bottom line is that agreement in principle on “Phase 1” will need to be followed by further action soon, otherwise market sentiment will sour.

In the UK Prime Minister Johnson now has the votes to move forward with Brexit on January 31 but that will leave only 11 months to negotiate a deal with the EU. The transition period finishes at the end of 2020 unless of course there is an extension, something that Johnson has ruled out.  In the meantime the immediate focus will turn to the next Bank of England governor replacing Mark Carney.  This decision could take place this week.  Markets will also look to what fiscal steps the government will take in the weeks ahead.

GBP has rallied strongly over recent days and weeks, extending gains in the wake of the Conservative Party election win.  However, further gains will be harder to achieve given the challenges ahead.  UK equities have underperformed this year and are arguably relatively cheap from a valuation perspective, but further gains will also involve removing or at least reducing much of the uncertainty that has kept UK businesses from investing over recent months.  In the near term GBPUSD could struggle to break above 1.35 unless there is progress on the issues noted above.

Posted in Asia, Bank of England, Brexit, central banks, China, Currencies, Economics, Economy, emerging markets, equity markets, Europe, Fiscal/Budget, FX, Interest rates, Monetary Policy, Trade, Trump, UK, US. Tags: , , , , , , , , , , . Leave a Comment »

China Data Fuels A Good Start To The Week

December 2, 2019 — Mitul Kotecha

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.

Posted in Asia, Australia, Canada, central banks, China, Economics, Economy, emerging markets, equity markets, FX, India, Interest rates, Monetary Policy, Trade, Trump, US, US administration. Tags: , , , , , , , , , , , , . Leave a Comment »

A Lot Of Moving Parts

November 29, 2019 — Mitul Kotecha

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.

Posted in China, Economics, equity markets, Trade, Trump, US, US administration. Tags: , , , , . Leave a Comment »
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