Dovish Fed Hits The US Dollar

June 20, 2019 — Mitul Kotecha

The US Federal Reserve shifted towards a dovish stance yesterday and asset markets applauded.   Against the background of signs of slowing growth, intensifying trade tensions and growing “uncertainties” about the economic outlook, the Fed removed the previous “patient” stance and instead noted that “act as appropriate to sustain the expansion”.   The bottom line is that the Fed is priming the market for easing as early as July, though the market had already primed itself by moving sharply in terms of pricing in rate cuts over recent weeks.   The market is now pricing in three rate cuts this year and at least one next year, which seems reasonable.

Clearly there are a huge number of uncertainties ahead, making the Fed’s job particularly difficult and the picture could look quite different should the upcoming G20 meeting in Japan (28-29 June) deliver some form of trade agreement between the US and China.  This would likely result in less need for Fed easing.  As I have noted previously there are still a huge number of challenges and obstacles to any such agreement, suggesting that market hopes of an agreement stand a good risk of being dashed.   Until then, risk assets will remain upbeat, with equity markets rallying in the wake of the Fed decision even as bond yields moved lower and gold prices reached a 5-year high.

The USD remains under pressure and took another blow in the wake of the FOMC meeting.  The USD has now lost ground against almost all G10 currencies except GBP amid Brexit concerns over the last month.  This has extended today and the currency looks set to remain under pressure in the short term as markets continue to price in Fed rate cuts.  The tension between President Trump and Fed Chairman Powell is not doing the USD any good either.  The USD index (DXY) is now threatening to break below its 200-day moving average (96.710) though this has proven to provide strong support in the past.  A sustained break below this level could see the USD extend losses against major and many emerging market currencies.

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Are Recession Risks Rising?

June 4, 2019 — Mitul Kotecha

It is incredible that just a few months ago most analysts were expecting at least two if not three interest rate hikes by the Federal Reserve.  How quickly things change.  Markets are pricing in at least a couple of rate cuts by the FOMC while US Treasury yields have fallen sharply as growth concerns have intensified, even as the hard economic has not yet turned that bad.  Recession risks are once again being actively talked about as trade fears intensify, with President Trump threatening increased tariffs on both Mexico and China.  As I noted earlier this week, trade tensions have escalated.

Reflecting this, core bond markets have rallied sharply, with 10 year US Treasury yields dropping by around 60bps so far this year, while bund yields are negative out to 10 years.  Historically such a plunge would be associated with a sharp weakening in growth expectations and onset of recession.  However, equity markets are holding up better; the US S&P 500 has dropped around 6.8% from its highs but is still up close to 10% for the year.  Even Chinese equities are up close to 20% this year despite falling close to 13% from their highs.  Equities could be the last shoe to fall.

In currency markets the US dollar has come under pressure recently but is still stronger versus most currencies this year except notably Japanese and Canadian dollar among major currencies and the likes of Russian rouble and Thai baht among emerging market currencies.  On the other end of the spectrum Turkish lira and Argentine peso have fallen most, but their weakness has largely been idiosyncratic.  In a weaker growth environment, and one in which global trade is hit hard, it would be particularly negative for trade orientated EM economies and currencies.

The US dollar has a natural advantage compared to most major currencies at present in that it has a relatively higher yield. Anyone wishing to sell or go short would need to pay away this yield.  However, if the market is increasingly pricing in rate cuts, the USD looks like a much less attractive proposition and this is what appears to be happening now as investors offload long USD positions build up over past months.  Further USD weakness is likely at least in the short term, but it always hard to write the USDs resilience off.

Going forward much will of course depend on tariffs.  If President Trump implements tariffs on an additional $300 billion of Chinese exports to the US as he has threatened this would hurt global growth as would tariffs on Mexico.  Neither is guaranteed and could still be averted.  Even if these tariffs are implemented fears of recession still appear to be overdone.  Growth will certainly slow in the months ahead as indicated by forward looking indicators such manufacturing purchasing managers’ indices, but there is little in terms of data yet to suggest that recession is on the cards.

 

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US/China Tensions Escalate

June 3, 2019 — Mitul Kotecha

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.

Posted in Asia, Asian currencies, Australia, Bond markets, central banks, China, Currencies, ECB, Economics, emerging markets, Europe, eurozone, Federal Reserve, FX, India, Interest rates, Monetary Policy, Trade, Trump, US, US administration. Tags: , , , , , . 1 Comment »

Awaiting More US Tariffs And China Retaliation

May 13, 2019 — Mitul Kotecha

Weekend developments in the trade war included China’s denial that they had reneged on any prior agreements, contrary to what the US administration has said as a rationale for ratcheting up tariffs on China.  In fact, China’s vice-minister Liu He said that such changes (to the draft) were “natural”.  He also said the remaining differences were “matters of principle”,  which implies that China will not make concessions on such some key structural issues.  This does not bode well for a quick agreement.

Meanwhile Trump’s economic advisor Larry Kudlow suggested that Trump and China’s President Xi could meet at the G20 meeting at the end of June. This offers a glimmer of hope but in reality such a meeting would achieve little without any agreement on substantive issues, which appears a long way off.  Markets now await details from the US administration on tariffs on a further $325bn of Chinese exports to the US effectively covering all Chinese exports to the US.

China has promised retaliation and we could see them outline further tariffs on US exports in the next couple of days as well as the possible introduction of non-tariff barriers, making life harder for US companies in China.  The bottom line is that any deal now seems far off while the risk of further escalation on both sides has risen.  Global markets are increasingly taking fright as a result, especially emerging market assets.

There are no further negotiations scheduled between the US and China though Kudlow has said that China has invited Treasury Secretary Mnuchin and trade representative Lighthizer to Beijing for further talks.  Given that Trump now appears to have a unified administration as well as many Republicans and Democrats behind him while China is digging its heels in this, don’t expect a resolution anytime soon.

China’s currency CNY is facing growing pressure as the US-China trade war escalates.   The CNY CFETS index has weakened by around 1% in just over a week (ie CNY has depreciated relative to its trading partners) and is now at its weakest since 20 Feb 19.  While not weaponising the currency, there’s every chance that China will manage CNY depreciation to help compensate Chinese exporters for the pressure faced from higher tariffs (as appeared to take place last summer). Expect more pain ahead.

Posted in Asia, Asian currencies, China, Currencies, Economics, Economy, emerging markets, Trump, US, US administration. Tags: , , , , , , , , . 1 Comment »

‘Beautiful’ Letter Fails To Stop Tariffs

May 10, 2019 — Mitul Kotecha

At 12.01 EST the US escalated tariffs on China, following up on US President Trump’s tweets last weekend.  The tariffs escalation follows what the US administration says was backtracking by China on a number of structural issues in an earlier draft of a trade agreement.   Markets had been nervously anticipating this escalation all week, but also hoping that it could be avoided in some way.

A day of talks in Washington between Chinese officials led by Chinese vice-minister Liu He and US officials including US Trade Representative Lighthizer and Treasury Secretary Mnuchin failed to lead to any agreements or even any sign of progress despite President’s Trump’s tweeting that he received a “beautiful” letter from Chinese President Xi.

Talks are set to resume later but chances of any breakthrough appear slim.  China appears to have taken a harder line on subordinating to some of the US demands for structural changes and don’t appear to have been too phased by the increase in US tariffs on $200bn of Chinese goods from 10 to 25%.  The US side on the other hand appear to be taking a tough stance emboldened by the strength of the economy.

China has vowed retaliation but at the time of writing has not outlined any plans for any reciprocal tariffs.  Trump has also stated that the US is preparing to levy 25% on tariffs on a further $325bn of Chinese goods though this could take some weeks to roll out.  China does not however, appear unduly worried about talks extending further and may be content to play a waiting game.

Market reaction in Asia has been muted today and Chinese stocks have actually registered strong gains, reportedly due active buying by state backed funds, while the Chinese currency, CNY has registered gains.  The USD in contrast has been under broad pressure.

Overall however, markets will end the week bruised and in poor shape going into next week unless something major emerges from the last day of talks.   The CNY meanwhile, could end up weakening more sharply in the weeks ahead, acting as a shock absorber to the impact of higher tariffs on Chinese exports.

For more on this topic I will be appearing on CNBC Asia at 8.00am (Singapore Time) on Monday morning.

Posted in Asia, Asian currencies, China, Economics, Economy, emerging markets, equity markets, Trump, US, US administration. Tags: , , . 1 Comment »
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