Fed, ECB, UK elections In Focus

An event filled week lies ahead.  Several central bank decisions including the Federal Reserve FOMC (11th Dec), European Central Bank (ECB) (12 Dec) and Swiss National Bank (SNB)  (12 Dec) are on the calendar.  All of these major central banks are likely to leave policy unchanged and the meetings should prove to be uneventful.  Fed Chair Powell is likely to reiterate the Fed’s patient stance, with last Friday’s strong US November job report (payrolls rose 266k) effectively sealing the case for no change in policy at this meeting, even as a Phase 1 trade deal remains elusive.

Similarly recently firmer data in Europe have pushed back expectations of further ECB easing, though President Lagarde is likely to sound cautious highlighting her desire to maintain an accommodative monetary policy stance.  The picture is rather different for emerging market central banks this week, with policy easing likely from Turkey (12 Dec), Russia (13 Dec) and Brazil (12 Dec) while Philippines (12 Dec) is likely to keep policy unchanged.

UK general elections on Thursday will be closely watched, with GBP already having rallied above 1.30 vs USD as polls show a strong lead for Boris Johnson’s Conservative Party.  The main question is whether Johnson will have gained enough of a share of the vote to gain a majority, allowing him to push ahead with his Brexit plans, with Parliament voting to leave the European Union by Jan 31.

Polls may not be as accurate as assumed in the past given surprises over recent years including the Brexit vote itself, but the wide margin between the two parties highlights the relatively stronger position of the Conservatives going into the election.  Nonetheless, given that a lot is in the price already, the bigger (negative) reaction in GBP could come from a hung parliament or Labour win.

This week is also crunch time for a decision on the threatened December 15 tariffs on China.  As previously noted there is little sign of any deal on any Phase 1 trade deal.  It appears that issues such as the amount of purchases of US goods by China remain unresolved.  Recent comments by President Trump suggest that he is prepared to delay a deal even as far as past the US elections in November 2020.

Whether this is tactic to force China to agree on a deal or a real desire not to rush a deal is difficult to determine, but it seems as though Phase 1 will deal will not be signed this year given the limited time to do so.  December 15 tariffs could be delayed but this is also not guaranteed.  President Trump’s attention will also partly be on the potential for an impeachement vote in the House this week.

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.

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.

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.

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.

 

Bonds Under Pressure, UK Parliament Rejects Election Again

Market sentiment remains positive as hopes of a US-China trade deal continue to provide a floor under risk sentiment amid hopes that the escalation in tariffs can be reversed.  Weak Chinese trade data over the weekend has largely been ignored and instead markets have focused on further stimulus unleashed by China in the wake of the cut in its banks’ reserve ratios, which freed up around USD 126bn in liquidity to help shore up growth.  Expectations that the European Central Bank (ECB) will this week provide another monetary boost by lowering its deposit rates and embarking on a fresh wave of quantitative easing, are also helping to support risk sentiment though a lot is already in the price in terms of ECB expectations.

One of the casualties of the turn in sentiment has been bonds, with yields rising in G10 bond markets.  For example US 10 year yields have risen by around 18 basis points since their low a week ago.   The US dollar has also come under pressure, losing ground in particular to emerging market currencies over the past week.  Safe haven currencies such as the Japanese yen (JPY) and Swiss franc (CHF) have fared even worse.   As I noted last week I think the bounce in risk appetite will be short-lived, but how long is short?  Clearly markets anticipate positive developments in US-China trade talks, and it seems unlikely that risk appetite will deteriorate ahead of talks, at least until there is some clarity on the discussions.  Of course a tweet here or there could derail markets, but that is hard to predict.

Sterling (GBP) has been another currency that has benefited from USD weakness, but also from growing expectations that the UK will not crash out of the EU without a deal.  Developments overnight have done little to provide much clarity, however.  UK Prime Minister Boris Johnson failed in his bid for an early election on October 15, with MPs voting 293 in favour of an election against 46 opposed;  Johnson required two-thirds or 434 MPs to support the motion.  Johnson is now effectively a hostage in his own government unable to hold an election and legally unable to leave without a deal.  Parliament has been suspended until October 14, with Johnson stating that he will not delay Brexit any further, reiterating that he is prepared to leave the EU without an agreement if necessary.

This would effectively ignore legislation passed into law earlier blocking a no-deal Brexit forcing the PM to seek a delay until 31 Jan 2020. Separately parliament passed a motion by 311 to 302 to compel Downing Street to release various documents related to no-deal Brexit planning, but officials are so far resisting their release.  A lack of progress in talks with Irish PM Varadkar in Dublin on Monday highlights the challenges ahead.  GBP has rallied following firmer than expected Gross Domestic Product data (GDP) yesterday and growing hopes that the UK will be prevented from crashing out of the EU at the end of October, but could the currency could be derailed if there is still no progress towards a deal as the deadline approaches.

 

Tariffs Implemented, Talks Awaited

US and China went ahead with their tariffs implementation over the weekend, with the US adding 15% tariffs on around $110bn of Chinese imports, mainly aimed at consumer goods. Another $160bn of goods will be hit by 15% tariffs on December 15, with the implementation delayed to avoid a big impact on holiday spending.

China retaliated by implementing $75bn of tariffs on US goods on Sunday, much of which was aimed at agricultural goods including 10% on various meat, an additional 5% on top of the existing 25% on soybeans and a further 10% on sorghum and cotton and 5% on crude oil.  Chinese tariffs on US autos will resume in December.  China’s currency is likely to continue to weaken further given the tariffs intensification.

Against this background markets will closely monitor comments from both China and the US on the potential for trade talks over coming weeks, with President Trump stating that face to face talks are “still on”.  Meanwhile Chinese economic data continues to worsen, with China’s official August manufacturing PMI released on Saturday dropping to 49.5 in August from 49.7 in July, indicating ongoing contraction in China’s manufacturing sector.

There are plenty of events and data on tap this week including the August US ISM manufacturing survey, August non-farm payrolls and a slew of Fed speakers including Fed Chairman Powell.   The ISM index is forecast to remain steady around 51.2, reflecting the pressure on US manufacturers, although the index is still likely to remain in expansion.  Meanwhile consensus forecasts look for a 158k increase in August payrolls and for the unemployment rate to remain at 3.7%.

Events in the UK will also garner plenty of interest as parliament returns from their summer break, albeit only for a few days as Parliament will be prorogued in the following week.  The opposition Labour Party will aim to present legislation to prevent the country from crashing out of the EU without a deal against the background of protests against the decision to suspend parliament.  The potential for fresh elections is also in prospect.  GBP will remain volatile against this background.

%d bloggers like this: