Host Of Central Banks In Focus

Well, last week, tech stocks had their worst week since March, with stability far from returning.  While the jury is still out, most still view the pull back in tech stocks as a healthy correction following a prolonged period of gains, blaming increased options activity over recent months for the magnitude of the decline. The buy on dip mentality is likely to continue to prevail, though tech stocks have not yet show any sign of wanting to make a convincing pull back.   

Signs of nervousness are clear; equity volatility remains elevated, but many investors are still sitting on healthy gains over recent months.  Given the low cost of funding, low returns in government bonds, alongside continued strong demand for stay at home electronics and a vaccine that could still take months to arrive, it is hard to see the tech sector falling too far.   

The fall in the pound sterling has been quite dramatic over recent weeks, both against the US dollar and euro.  Fears over a collapse in trade talks with the European Union have intensified.  The sudden waking up of the market to these risks has been provoked by the prospects that the withdrawal agreement with the EU will be torn up, prompting threats of legal action by the EU.

Time is running out to get a deal on the table before the end of the Brexit transition period at the end of the year, but UK Prime Minister Johnson has said that the internal market bill is necessary to prevent “a foreign of international body from having the power to break up our country.” The new legislation is already facing a rebellion in parliament. Against this background its hard to see GBP rally, with the currency likely to be particularly volatile over the coming weeks.

Attention this week will turn to several central bank decisions, with monetary policy makers in Poland (Tue), US (Wed), Brazil (Wed), Japan (Thu), Indonesia (Thu), Taiwan (Thu), South Africa, (Thu), UK (Thu) and Russia (Fri) all scheduled to announce their decisions.  After months of policy easing globally, this week will look rather boring, with none of the above likely to ease further.   

The Fed FOMC meeting will likely capture most attention, but there is potential for disappointment if the Fed does not provide further details on its shift to average inflation targeting in its forward guidance, even as the accompanying statement and Chair Powell’s press conference are likely to sound dovish. The US dollar has continued to stabilize, aided by the drop in GBP, but a dovish Fed could limit further upside in the short term. 

Aside from central bank decisions attention will be on US election polls, which take on more importance as the election creeps closer.  US fiscal stimulus talks have hit a wall, with little chance of progress this week, while US pressure on China and Chinese companies is likely to continue to be unrelenting as elections approach.  On the political front the race to take over Japan’s prime minister following the resignation of Shinzo Abe will conclude this week (Wed).   

Tough Times for the US Dollar

The US dollar had an awful July, with the USD index dropping by around 5% over the month, its worst monthly performance in 10 years. A range of factors can be cited for USD weakness including an asset allocation shift to assets outside of the US, worsening news on US Covid cases over recent weeks, improved risk appetite, US election concerns, lower real yields and fiscal cliff worries, among other factors.  Gold has been a particularly strong beneficiary of the malaise in the USD and declining real yield yields.  The Fed’s pledge to keep on aggressively supporting the economy and likely strengthening of forward guidance in the months ahead suggest that any increase in US interest rates could be years off.

It is still difficult to see the recent weakness in the USD resulting in a deterioration in its dominant reserve currency status though the longer the factors noted above remain in place, the bigger the danger to longer term confidence in the USD. As a reminder of such risks Fitch ratings downgraded US AAA credit rating to a negative outlook.  I do not expect markets and the USD to be impacted by the move, but it does highlight a worsening in US fundamentals.  While other currencies are still a long away from displacing the USD dominance in FX reserves, financial flows, FX trading and trade, the longer term risks to the USD are clear.

That said, the USD caught a bid at the end of last week resulting in a sharp retreat in the euro (EUR) from heavily overbought technical levels.  It is unlikely to be a coincide that this occurred as US Covid cases showed signs of peaking while cases in many parts of Europe began to accelerate, resulting in delays to opening up or renewed tightening of social distancing measures there.  US stocks have also continued to perform well, despite much discussion of a rotation to value stocks.  Solid earnings from US tech heavyweights solidified their position as leaders of the pack.  It is too early to say that this is the beginning of a USD turnaround, but the currency is heavily oversold in terms of positioning and technicals, which point to room for some respite.

Turning to the week ahead attention will be on July global Purchasing Managers Indices (PMI) data beginning with China’s private sector Caixin PMI (consensus 51.1), and the US ISM survey (consensus 53.6) tomorrow.  Central bank decisions include the Reserve Bank of Australia (Tue), Bank of England (Thu), Reserve Bank of India (Thu) and Bank of Thailand (Wed).  No change is likely from the RBA, BoE and BoT, but expect a 25bp cut from RBI.  At the end of the week two pieces of data will take precedence; US July jobs data and China July trade data.  US-China tensions will come under further scrutiny after President Trump vowed to ban TikTok in the US while pouring cold water on a sale to a third party.

 

Market Volatility Continues To Compress

The US Independence Day holiday kept trading, market activity and volatility subdued for much of last week.  In any case equity markets and risk assets have been struggling on the topside and appear to be losing momentum.  Markets are being buffeted by conflicting forces; economic news has beaten expectations. For example, the US June jobs report was better than expected though total job gains of 7.5 million in recent months are still only around a third of total jobs lost.  In contrast, worsening news on Covid 19 infections, with the WHO reporting a one day record high in global infections, threatens to put a dampener on sentiment.  Consolidation is likely, with Summer trading conditions increasingly creeping in over the weeks ahead. As such volatility is likely to continue to be suppressed, aided by central banks’ liquidity injections.

Over recent weeks geopolitical risks have admittedly not had a major impact on markets but this doesn’t mean that this will remain the case given the plethora of growing risks.  China’s installation of new security legislation into Hong Kong’s basic law and the first arrests utilizing this law were in focus last week.  A US administration official has reportedly said that the president is considering two or three actions against China, and markets will be on the lookout for any such actions this week, which could include further sanctions against individuals are more details of what the removal of HK’s special trading status will entail.  Meanwhile the US has sent two aircraft carriers to the South China Sea reportedly to send a message against China’s military build up in the area, with China’s PLA conducting a five-day drill around the disputed Paracel Islands archipelago.

Data releases and events this week are unlikely to lead to a change in this dynamic.  At the beginning of the week attention will focus on further discussions between the UK and EU over the post Brexit landscape while in the US the June non-manufacturing ISM survey will garner attention.  So far talks on a trade deal between the UK and EU have stalled though there were hints of progress last week, even as officials admitted that “serious divergencies remain”.  The US ISM non-manufacturing survey is likely to move back to expansion (above 50) but is increasingly being threatened by the increase in Covid infections, which could yet again dampen service sector activity. On the policy front there will be fiscal updates from the UK and Canada on Wednesday against the backdrop of ramped up spending, and monetary policy decisions by the Reserve Bank of Australia (RBA) and BNM in Malaysia on Tuesday.  The RBA is widely expected to keep policy unchanged while BNM may cut rates by 25 basis points.

 

Revoking Hong Kong’s Special Status – Data/Events This Week.

In a further escalation of US-China tensions, President Trump revoked Hong Kong’s (HK) “Special Status” as revealed in a speech on Friday.  What does this mean? At this stage there is scant detail to go on.  Trump also promised to implement sanctions against individuals in China and HK who he deems responsible for eroding HK’s autonomy, but no names were given. Markets reacted with relief, with US equities closing higher on Friday, perhaps in relief that that the measures outlined by Trump were not more severe, or that the lack of detail meant that there could be various exemptions.

On the face of it, removing Hong Kong’s “Special Status” would deal a heavy blow to Hong Kong’s economy and to US companies there, while hurting China’s economy too.  However, while still an important financial centre, Hong Kong’s economy relative to China is far smaller than it was at the time of the handover in 1997, at around 3%.   As such, removing Hong Kong’s “Special Status” could be less painful on China than it would have been in the past.  This may explain why the US administration is focusing on other measures such as student visa restrictions, sanctioning individuals, restricting investment etc.  Even so, tensions will continue to cast a shadow over markets for some time to come and will likely heat up ahead of US elections in November.

Data wise, the week began with the release of China’s May manufacturing and non-manufacturing purchasing manager’s indices (PMIs) today.  The data revealed a slight softening in the manufacturing PMI to 50.6 in May from 50.8 in April, indicating that manufacturing activity continues to remain in expansion.  However, the trade related components were weak, suggesting that China’s exports and imports outlook is likely to come under growing pressure, weighing on overall recovery.  China’s currency, the renminbi, has been weakening lately against the US dollar and against its peers, though it rallied against the dollar on Friday.  Further gradual weakness in the renminbi looks likely over coming weeks.

This week there will be attention on various data releases and events including US May jobs data, ISM manufacturing, European Central Bank (ECB) and Reserve Bank of Australia (RBA) policy decisions and UK-EU Brexit discussions.  Of course markets will remain tuned into Covid-19 developments as economies around the world continue to open up.   While the US jobs and ISM data will likely remain very weak, the silver lining is that the extent of weakness is likely to lessen in the months ahead.  Consensus forecasts predict a massive 8 million drop in US non-farm payrolls and the unemployment rate to increase to close to 20%.  The RBA is likely to leave policy unchanged at 0.25% while the ECB is expected to step up its asset purchases. Meanwhile UK-EU Brexit discussions are likely to continue to be fraught with difficulty.

 

 

 

Covid-19 Economic Toll Worsening

Unease about the economic toll of Covid-19 is starting to dent the rebound in equity markets.  The disconnect between the strength of the rally in equities and the reality on the ground has become increasingly visible following recent earnings releases including from tech heavyweights Apple and Amazon, and dismal economic data which included sharp falls in US and Eurozone Q1 GDP data.  Q2 will look even worse as most of the economic damage was inflicted in April, suggesting that the pain is just beginning.

Meanwhile geopolitical tensions between the US and China are adding another layer of pressure on markets, with US President Trump stating that he had seen strong evidence that Covid-19 originated from a laboratory in Wuhan.  Trump’s comments have raised the spectre of a renewed trade war between the two countries at a time when in any case it was looking increasingly difficult for China to live up to its end of the agreement to purchase a substantial amount of US goods in the wake of a Phase 1 deal.

Some of the economic pain emanating from the shutdowns will be on show this week, with the US April jobs report likely to reveal a sharp rise in the jobless rate and massive decline in non-farm payrolls, with markets looking for an increase to around 16% and a drop of 22 million, respectively.  Already jobless claims have risen to over 30 million, with the only silver lining being that the rate of increase in claims has declined over recent weeks.  The extremely sharp deterioration in job market conditions threatens to weigh heavily on recovery.

The US dollar fell towards the end of March due in part to month end rebalancing (given US equity and bond market outperformance over the month), but also due to a general improvement in risk sentiment, reducing any safe have demand for dollars.  If as is likely markets become increasingly nervous about the sustainability of the rally in risk assets, the USD is likely to move higher during the next few weeks. Even in an environment where global equities sell off, US assets are still better placed in terms of return potential than those elsewhere, implying US dollar outperformance.

In terms of data and events focus this will turn to the Bank of England and Reserve Bank of Australia policy meetings.  Neither are likely to cut interest rates further, but the BoE could announced a further increase in asset purchases, while conversely the RBA is likely to maintain its asset purchases tapering path.  Aside from the US jobs data noted above, the other piece of data globally that will be watched carefully is China’s April trade report.  A weak outcome is likely for sure, but the extent of deterioration in exports and imports, will have very negative global consequences.

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