What To Watch This Week

Market expectations for Fed FOMC interest rate cuts have gyrated back and forth following a recent speech by NY Fed President Williams, one of the key decision makers within the Fed FOMC. He appeared to support a 50bps rate cut at the meeting at the end of the month, but unusually this was clarified later.  If anything, as the clarification may suggest, the bigger probability is that the Fed eases policy by 25bps in an insurance cut.

There will be no Fed speakers in the days ahead but the Fed will assess developments this week in helping to determine the magnitude of easing. Attention will continue to centre on US earnings, with more than a quarter of S&P 500 companies reporting Q2 earnings this week.   On the data front, US Q2 GDP and July durable goods orders will command most attention.  The consensus looks for a slowing in GDP growth to 1.8% q/q in Q1 from 3.1% q/q in Q1 while durable goods orders are expected to increase by 0.7% m/m.

A major central bank in action this week is the European Central Bank on Thursday. While policy easing is unlikely at this meeting, the ECB is likely to set to set the market up for an easing in deposit rates at the September meeting.  ECB President Draghi could do this by strengthening his forward guidance, but as a lot of this is priced in by the market, a dovish sounding Draghi is unlikely to weigh too much on the EUR.

In the UK this week it’s all about politics. Boris Johnson is widely expected to be announced as the new Prime Minister.  GBPUSD has clung onto the 1.25 handle, as worries about a no deal Brexit continue to impact sentiment towards the currency.  Once Johnson is sworn in he and the government could face a no confidence motion, which could gain support should it be seen as an alternative to the UK crashing out of the EU.

National elections in Japan yesterday resulted in a victory according to Japanese press for Shinzo Abe’s coalition, its sixth straight victory, with the governing LDP winning over half the 124 seats. The results were no surprise, and unlikely to have a significant market impact, but notably Abe suffered a setback by not gaining a supermajority. He therefore cannot change the country’s pacifist constitution.

In emerging markets, both Russia and Turkey are likely to cut interest rates this week, with Russia predicted to cut its key rate by 25bp and Turkey to cut by at least 200bps if not more.  Elsewhere geopolitical tensions will remain a major focus for markets, as tensions between the UK and Iran intensify.

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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 Tensions Escalate

Risk appetite starts the week in poor form. The shock announcement of 5% tariffs on all Mexican exports (from June 10) to the US and an intensification of tensions with China, have fuelled growing expectations of a worsening in the global growth outlook. Safe haven assets such as JPY and CHF are likely to remain in demand while core bond yields are likely to continue to move lower, with markets continuing to raise bets on Fed rate cuts this year.  Indeed the 10y US Treasury yield has dropped by 1.1% since 8 November last year, with the fall in yields accelerating over recent weeks.

US/China tensions escalated over the weekend, with the deputy head of China’s negotiating team, Wang Shouwen, accusing the US of “resorting to intimidation and coercion”.  This coincides with the increase in US tariffs on $200bn of Chinese goods coming into effect over the weekend as Chinese shipments reached US shores, while earlier on Saturday Chinese tariffs on $60bn of US exports came into effect.  There is also growing speculation that China may curb exports of rare earth exports to the US.

Wang accused the US of abusing export controls and persisting with “exorbitant” demands and insisting on “mandatory requirements that infringe on China’s sovereign affairs”.   Meanwhile China’s defence minister Wei Fenghe, said that China will “fight to the end” on trade if needed.  China is also starting to investigate foreign companies who have violated Chinese law.  Soon after Chinese state media reported that the government was investigating FedEx for allegedly “undermining the legitimate rights and interest” of its Chinese clients.

Attention this week will be on several central bank decisions including the ECB (6th June), RBA (4th June) and RBI (6th June).  The market is fully priced in for an RBA rate cut to 1.25% this week.  The ECB is unlikely to surprise, with no change in policy likely.  Attention will be on terms of the TLTRO III while ECB President Draghi is likely to sound dovish in his press conference.  RBI is set to cut policy rates again, with Friday’s release of weaker than expected Q1 GDP adding to pressure on the Reserve Bank to boost growth amid low inflation.

Brexit – What next?

The drubbing that the main UK political parties (Conservatives and Labour) received in the European elections highlights the increasing polarisation of UK politics.  Both took a fudged view on how to go about Brexit while the remainers including the Lib Dems and the hard brexiters led by the newly formed Brexit Part, garnered most votes.  The outcome sends a clear signal of public frustration and impatience at the lack of progress in leaving the EU three years after the Brexit referendum.

A new leader of the Conservative party will likely steer towards a harder Brexit, but this may not resolve the impasse, something that has already brought down Prime Minister Theresa May.  In any case it is unlikely that the EU will want to renegotiate the terms of the Brexit deal agreed with May just because there is a new leader.  Divisions within the Conservative party itself continue to remain stark.  In the meantime Labour leader Corbyn is under pressure to make a clearer shift towards remaining in the EU.

Parliament meanwhile, has already voted against allowing a hard Brexit, suggesting that it is going to be extremely difficult to deliver a no deal or hard Brexit without fresh general elections.  However, as the European elections have shown, fresh UK general elections would spell doom for both the Conservatives and Labour unless they moved to harder stances on either side of the spectrum.  The Conservatives may not risk such an outcome.

This leaves a second referendum as an increasingly viable option, one which would put the question of remaining or a hard Brexit back to the public and out of the hands of parliament.  Indeed given the lack of alternatives and inability of parliament to move forward on Brexit, this may turn out to be the most prescient option although this runs risks of its own including fuelling demands for a fresh Scottish referendum.

GBP has continued to slide amid a clear lack of progress among politicians to arrive at a viable Brexit strategy and increasing risks of a hard Brexit.  However, if markets see a growing chance of a fresh referendum, GBPUSD could reverse some of its recent losses as remain hopes are rekindled, possibly breaking back above 1.30 at the least.   It is not by any means clear that remainers would win such a referendum, but at least they would have a chance that did not exist previously and that could be sufficient to give GBP a bounce.

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.

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.

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