Firm China data boosts sentiment

It is turning into a solid start to the week for global equity markets and risk assets in general.  Growth concerns are easing and central banks globally have shelved plans to tighten policy.  Comments over the weekend that finance chiefs and central bank stand ready to “act promptly” to support growth, may also reassure markets. Meanwhile, it appears that the US and China are closing in on a trade deal, with US Treasury Secretary Mnuchin stating that enforcement mechanisms could work “in both directions”, potentially easing disagreement on of the contentious issues between the two countries.

In terms of data and events, US Q1 earnings, US March retail sales and industrial production, will be in focus this week alongside more Chinese growth data, elections in Indonesia and the second phase of elections in India.  In Europe, flash purchasing managers’ indices (PMI) for April will give some indication of whether there is any turnaround in growth prospects.  The news will not be particularly good on this front, but the surveys may at least show signs of stabilisation, albeit at weak levels.

China data at the end of last week was particularly supportive, with March aggregate financing, money supply and new yuan loans all beating expectations.  The data add to other evidence of a bounce back in activity in March, with the official manufacturing purchasing managers index (PMI) moving back into expansion territory.   The data comes off a low base after weakness in January and February, but suggests that Chinese monetary and fiscal stimulus is taking effect, with the economy steering towards a soft landing.

Chinese markets clearly like what they see, with equities maintain their strong year to date rally (The CSI Index is up over 34% year to date) and CNY remaining firm (CNY has been the strongest performing Asian currency versus USD so far this year) though China’s bond market will react less well to signs of growth stabilisation.  Chinese data this week including Q1 GDP, March retail sales and industrial production are set to add further evidence of growth stabilisation, helping to keep the positive market momentum alive.

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ECB meeting, Brexit, Fed minutes, China trade, India elections in focus

This week there a number of key events to focus attention on including European Central Bank (ECB) policy meeting, Federal Reserve FOMC March minutes, the commencement of India’s general elections, China data, and further Brexit developments as UK Prime Minister May tries to gain a further short extension to the Brexit deadline, until June 30.

The better than expected US March jobs report, revealing a bigger than expected 196k increase in jobs, with a softer than expected 0.1% monthly increase in hourly earnings, which effectively revealed a firm jobs market, without major wage pressures, helped US markets close off the week on a positive note. The data adds to further evidence that the Fed may not need to hike policy rates further.

The European Central Bank decision is likely to prove uneventful though recent comments by ECB President Draghi have fuelled speculation that the central bank will introduce a tiered deposit system to alleviate the impact of negative rates on banks.   EUR is unlikely to benefit from this.  Separately Fed FOMC minutes will be scrutinised to ascertain how dovish the Fed has become as the markets shift towards pricing in rate cuts, but it is unlikely that the minutes provide further fuel to interest rate doves.

Friday is the deadline to agree on an extension with the EU to prevent a hard Brexit.  Meanwhile PM May is set to restart talks with opposition Labour Party leader Corbyn to thrash out a cross party agreement on Brexit terms ahead of an EU summit on Wednesday that will look at her request for a Brexit extension until June 30.  GBP has lost momentum lately and investors appear to be fatigued with the daily Brexit news gyrations.

Meanwhile, US-China trade talks appear to be edging towards some sort of a deal while Chinese data this week is also likely to be supportive for risk assets.   As China eases financing conditions, evidence of a pick up in the credit impulse will be evident in March aggregate financing, new loans and money supply data this week.   Meanwhile China’s March trade data is likely to look better or at least less negative than over recent months. This suggests that risk assets will likely fare well this week.

India will be in the spotlight as India’s multi stage elections kick off on Thursday.  Prime Minister Modi is in good stead to ahead of elections, boosted by his government’s reaction to recent terrorist attacks on Indian paramilitary in Kashmir.   Concerns that Modi’s ruling BJP would lose a significant amount of seats in the wake of state election losses towards the end of last year have receded.  Nonetheless, election uncertainties may keep the INR on the backfoot this week.

Not much good news

There are a plethora of issues weighing on asset markets though sentiment has improved slightly today.  Weak Chinese trade data over the weekend and a revision lower to Japanese GDP data yesterday added to growing global growth concerns, against the background of waning hopes of a resolution to the US-China trade war.

US administration comments that there was a hard deadline for trade talks have not helped sentiment either.  News today that Chinese Vice Premier Liu He spoke with US Treasury Secretary Mnuchin and US Trade Rep Lighthizer on a timetable and road map on trade talks provided some relief, however.

In the US, growth expectations are undergoing a shift and talk of a Fed pause is growing.  This would be considered as good news for EM if it wasn’t for the fact that a pause could be due to US growth concerns rather than any sense that the Fed was approaching its terminal rate.  US November CPI, retail sales, and industrial production data will give more clues, but I still think the Fed policy rates next week.

In the UK, Brexit worries have intensified following the decision by Prime Minister May to the delay the vote on a deal in parliament given she would most likely would have faced a defeat had it gone ahead.  May will now go on a tour of European capitals to try to improve the Brexit deal but prospects don’t look good, especially as European Council president Tusk has already ruled out any negotiation of the deal and in particular the Irish backstop.

GBP was pummeled as a result of the delay and will continue to struggle in the short term given the lack visibility.  A revised deal appears difficult while a hard Brexit and even a new referendum are all on the table.

Ukraine fallout

So far most of the damage from the escalating crisis in the Ukraine and growing tensions between the West and Russia has been inflicted on Russian markets but global asset markets are also feeling increasing pain from the fallout. The most recent developments highlight that tensions have worsened further.

Equity markets in Europe were next in line for selling pressure, with sharp declines registered while US stock also dropped, but to a lesser degree. Commodity prices have also felt the shock, with European natural gas prices rising sharply and oil also higher. Gold has been a major beneficiary extending gains to around USD 1350.

US Treasury yields settled around 2.6% while the USD bounced as risk aversion spiked. My Risk Aversion Barometer rose over 3% while the VIX “fear gauge” jumped. Asian markets are likely to feel some pressure today although the impact is likely to be much less significant than elsewhere. Nonetheless, the lack of first tier data releases means that most attention will be focussed on developments in Ukraine over today’s trading session.

USD buoyant

After finally returning from a two week trip visiting clients across North America it appears that the USD continues to remain in buoyant mood. I have been highlighting the prospects for a stronger USD against major currencies for some time and this has been borne out by the strong USD performance since early February.

Despite a lackluster performance for US stocks overnight overall sentiment remains largely upbeat as reflected by the fact that my risk barometer has breached its lower threshold and has moved into risk loving territory. Similarly the VIX fear gauge is trading at multi year lows although it did move higher overnight.

The sharp drop in UK industrial production and a warning by the Bundesbank’s Weidmann that the Eurozone crisis was not over added a dose of caution to the market. On a more positive note the Baltic Dry Index is at its highest level so far this year, sending a positive signal for global growth expectations.

While there is still much wrangling in the US over budget proposals, and in Europe, Italian political uncertainty continues, markets remain focused on the positives of improving growth against the background of highly accommodative monetary policies. Nonetheless, the divergence between the US and Europe in terms of growth is set to continue. A likely bigger than forecast increase in US February retail sales in contrast to a bigger than forecast fall in Eurozone industrial production in January will attest to this.

EUR/USD has managed to garner a semblance of stability over recent days, with the currency pair finding it difficult to sustain any decline below the psychologically important 1.3000 level. The drop in EUR/USD over much of February has been more aggressive than implied by the performance of Eurozone peripheral bonds but this is no surprise given that this is not the biggest influence on the currency.

Instead the explanation for the EUR decline is found when viewing the move in US 2 year Treasury yields relative to 2 year bunds. The strong correlation with EUR/USD highlights this relationship, reflecting the impact of lower bund yields and higher Treasury yields. The EUR’s stability over recent days is therefore a function of a slight drop in the US yield advantage.

Given that the trend of firmer US data and weaker Eurozone data is set to continue, this stability is likely to be short lived. Our quantitative model suggests EUR/USD may rally in the short term but we suggest selling into it.

GBP/USD’s decline has continued unabated and there appear to be little to stand in the way of further weakness apart perhaps from the fact that a lot of bad news is priced in. Sentiment for GBP has clearly deteriorated as reflected in the CFTC IMM data revealing four straight weeks of negative positioning. The deviation with the 3 month average positioning has widened significantly, highlighting the pace of the move but also that the drop is beginning to look excessive.

Nonetheless, the bigger than expected drop in January industrial production data revealed yesterday has helped to compound the negativity towards the currency in the wake of deteriorating economic data and in turn heightened expectations of more BoE quantitative easing. Strong technical support around GBP/USD 1.4767 may hold in the short term but momentum indicators are showing no sign of a slowing in GBP selling pressure.

For GBP bulls (if there any left) there may be more value in looking to eventually re-enter long positions against EUR but we would not rush into this trade. .

Euro under growing pressure

A risk off tone has developed in the wake of disappointing economic data (Eurozone April purchasing managers indices, rise in March Eurozone and German unemployment, weaker US ADP jobs report). Additionally the second round of French Presidential elections is helping to keep Eurozone markets nervous. While hitting equities, the weaker market tone is likely to keep the USD buoyed.

The soft ADP report in particular highlights downside risks to the consensus for the April non-farm payrolls data, with analysts set to revise lower their forecasts fuelling concerns about a renewed weakening in the US jobs market. Ahead of this data, markets will contend with the outcome of the European Central Bank (ECB) policy meeting and bond auctions in France and Spain today. Several Fed speakers today will also be on tap.

The EUR will struggle to make any headway in the short term, having suffered in the wake of weak data. An unchanged policy decision from the ECB will give the EUR no assistance leaving EUR/USD vulnerable to a test of strong support around 1.3104. The ECB considers current policy settings as ‘appropriate’ but weaker growth data argue for lower rates.

The reality is that the ECB does not want to give Eurozone governments an excuse to renege on reforms. Should the ECB hint at lower rates in the near future it might actually play well for the EUR helping to alleviate growth concerns, but I suspect such a message is unlikely to emerge.

GBP has lost some ground after hitting a high just above 1.63 at the end of April but the currency looks reasonably well supported, especially against EUR. UK data remains relatively better looking as reflected in stronger readings for the PMI construction index, consumer credit and mortgage approvals.

EUR/GBP has broken its relationship with movements in EUR/USD for the time being, with independent GBP strength being seen. This is been reinforced by the shift in interest rate differentials between the UK and Eurozone, a move which has gone in favour of GBP strength. Indeed my quantitative model for EUR/GBP points to some further downside potential in this currency pair, with a test of technical support around 0.8067 on the cards.

The Devil is in the details

The “partial solution” delivered by European Union (EU) leaders last week has failed to match the high hopes ahead of the EU Summit. Nonetheless, the deliverance of a “fiscal compact”, acceleration of the European Stability Mechanism (ESM) to July 2012 , no forced private sector participation in debt restructuring (outside Greece), and possible boost to the International Monetary Fund (IMF) of up to EUR 200 billion, are steps in the right direction. The fact that UK Prime Minister Cameron threw a spanner in the works to veto a joint proposal to revise the EU Treaty should not detract from the progress made.

Nonetheless, the measures may not be sufficient to allay market concerns, with disappointment at the lack of European Central Bank (ECB) action in terms of stepping up to the plate as lender of the last resort still weighing on sentiment. Data will add to the disappointment this week as “flash” Eurozone purchasing managers indices (PMI) drop further in December.

This week events in the US will garner more attention, including the Federal Reserve FOMC meeting, November inflation and retail sales data plus manufacturing confidence gauges as well as November industrial production on tap. The Fed will not shift its policy stance at this meeting but may sound a little more upbeat on the economy following recent firmer data. Inflation will likely remain subdued while the other data will continue to show gradual recovery.

Overall, the market is likely to thin further as the week progresses and holidays approach, with ranges likely to dominate against the background of little directional impetus. Our call to sell risk assets on rallies remains in place, however. The EUR will likely struggle to make much headway in the current environment, especially given that many details of the EU agreement still need to be ironed out and once again the risk to market confidence lies in implementation or lack of it. A range of EUR/USD 1.3260-1.3550 is likely to hold over the short term.

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