Lingering Disappointment

Another soft close to US stock markets at the end of last week sets up for a nervous start to the week ahead.  The S&P 500 has now declined for a third straight week, with tech stocks leading the way lower as more froth is blown way from the multi-month run up in these stocks.  Lingering disappointment in the wake of the Federal Reserve FOMC meeting is one factor that has weighed on risk assets.  More details on how the Fed plans to implement its new policy on average inflation targeting will be sought. Markets will also look to see whether the Fed is pondering any changes to its Quantitative Easing program. This week Fed officials will get the opportunity to elaborate on their views, with several Fed speeches in the pipeline including three appearances by Fed Chair Powell. 

Disappointment on monetary policy can be matched with a lack of progress on the fiscal front, with hopes of an agreement on Phase 4 fiscal stimulus ahead of US elections fading rapidly.  A loss of momentum in US economic activity as reflected in the NY Fed’s weekly economic index and declining positive data surprises as reflected in the Citi Economic Surprise Index, are beginning to show that the need for fresh stimulus is growing.  On the political front, the situation has become even more tense ahead of elections; following the death of Supreme Court justice Ruth Bader Ginsburg attention this week will focus on President Trump’s pick to replace her, adding another twist to the battle between Democrats and Republicans ahead of the election.    

Another major focal point ahead of elections is US-China tensions, which continue to simmer away. China’s economy and currency continue to outperform even as tensions mount.  August’s slate of Chinese data were upbeat and China’s currency (CNY) is increasingly reflecting positive economic momentum, with the CNY CFETS trade weighted index rising to multi week highs.  There is every chance that tensions will only get worse ahead of US elections, likely as the US maintains a tough approach in the weeks ahead but so far Chinese and Asian markets in general are not reacting too much.  This may change if as is likely, tensions worsen further. 

After last week’s heavy slate of central bank meetings, this week is also going to see many central banks deliberate on monetary policy.  The week kicks off with China’s Loan Prime Rate announcement (Mon), followed by policy decisions in Hungary and Sweden (both Tue), New Zealand, Thailand, Norway (all on Wed), and Turkey (Thu).  Markets expect all of the central banks above to keep policy unchanged as was the case with the many central banks announcing policy decisions last week.  The lack of central bank action adds further evidence that 1) growth is starting to improve in many countries and 2) the limits of conventional policy are being reached.  While renewed rounds of virus infections threaten the recovery process much of the onus on policy action is now on the fiscal front. 

Pause In The Risk Rally?

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.

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.

 

Central banks in focus this week

Several central bank decisions are on tap this week including Japan (BoJ), Switzerland (SNB), Norway (Norges Bank), Brazil (BCB) and Thailand (BoT).  Among these only the Norges Bank looks likely to hike rates.

US data is largely second tier this week, with August housing data due for release.  After a run of weak readings a bounce back in starts and existing home sales is expected.   RBA minutes in Australia and NZ Q2 macro data are also in focus.

Political events will garner most attention, with the delayed announcement on China tariffs ($200bn) possible as early as today after being delayed due to the consideration of revisions raised via public comment.  Another twist in the saga is that China is considering declining the US offer of trade talks given the recent Trump threat of fresh tariffs (WSJ).

Other political events include Japan’s LDP election and US trade negotiations (assuming China participates) at the end of the week.   A few Brexit events this week include the General Affairs Council and Informal EU Summit.

 

Fed leaves the dollar in positive mood, euro at risk ahead of ECB

The Fed FOMC unsurprisingly left policy settings unchanged but the statement was perceived as less dovish, leaving a sour taste for risk assets. Crucially the statement did not validate market expectations that the Fed would hold off from tapering (reduction of Treasury and MBS purchases) until March next year, leaving the option of an earlier tapering on the table.

The bottom line is that the decision to taper will be highly data dependent, but the impact on markets was to leave the USD firmer and equity markets lower. The reaction is consistent with our view that a lot of dovishness was already priced into the market and that the risk / reward is for a more constructive USD environment.

Improvements in economic data, albeit from a weak level and a contracting balance sheet, have provided the EUR with support over past months. However, gains will not last and we suspect the EUR will be a casualty of relatively better US growth, Fed tapering and higher US yields over coming months. EUR has lost momentum this week and looks vulnerable to further slippage ahead of next week’s ECB meeting.

Soft inflation data out of Spain and German states yesterday highlights the room for the ECB to sound more dovish next week. Although firmer than expected October Eurozone confidence surveys limited some of the downdraft on the EUR overnight and highlighted further evidence of recovery, it is likely to do little to prevent further pressure on the EUR.

A couple of stronger than expected data releases helped the NOK to strengthen both against the USD and EUR. The August unemployment rate came in lower than expected (at 3.5%) while retail sales beat expectations in September (+0.7%). The NOK has been the only G10 currency to strengthen against the USD during October and after previous underperformance against the EUR, NOK looks set to make further gains against the latter.

One hurdle may be the announcement of Norway’s daily foreign exchange purchases for the coming month. Over September and October FX purchases were NOK 100 million per day and there is little reason to expect any change in November. Assuming that the October manufacturing PMI also registers some improvement tomorrow there is little to stand in the way of further NOK strength. We retain our long NOK/CHF trade idea.

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