China Data Fuels A Good Start To The Week

Better than expected outcomes for China’s manufacturing purchasing managers indices (PMIs) in November, with the official PMI moving back above 50 into expansion territory and the Caixin PMI also surprising on the upside gave markets some fuel for a positive start to the week.   The data suggest that China’s manufacturing sector has found some respite, but the bounce may have been due to temporary factors, rather than a sustainable improvement in manufacturing conditions.  Indeed much going forward will depend on the outcome of US-China trade talks, initially on whether a phase 1 deal can be agreed upon any time soon.

News on the trade war front shows little sign of improvement at this stage, with reports that a US-China trade deal is now “stalled” due to the Hong Kong legislation passed by President Trump last week as well as reports that China wants a roll back in previous tariffs before any deal can be signed.  Nonetheless, while a ‘Phase 1’ trade deal by year end is increasingly moving out of the picture, markets appear to be sanguine about it, with risk assets shrugging off trade doubts for now.  Whether the good mood can continue will depend on a slate of data releases over the days ahead.

Following China’s PMIs, the US November ISM manufacturing survey will be released later today.  US manufacturing sentiment has come under growing pressure even as other sectors of the economy have shown resilience.  Another below 50 (contractionary) outcome is likely.  The other key release in the US this week is the November jobs report, for which the consensus is looking for a 188k increase in jobs, unemployment rate remaining at 3.6% and average earnings rising by 0.3% m/m. Such an outcome will be greeted positively by markets, likely extending the positive drum beat for equities and risk assets into next week.

There are also several central bank decisions worth highlighting this week including in Australia, Canada and India.  Both the Reserve Bank of Australia (RBA) and Bank of Canada (BoC) are likely to keep monetary policy unchanged, while the Reserve Bank of India (RBI) is likely to cut its policy rate by 25bps to combat a worsening growth outlook.  Indeed, Q3 GDP data released last week revealed the sixth sequential weakening in India’s growth rate, with growth coming in at a relatively weak 4.5% y/y. Despite a recent food price induced spike in inflation the RBI is likely to focus on the weaker growth trajectory in cutting rates.

Looking At Central Banks For Direction

This week feels as though its one where markets have gone into limbo waiting for developments on the trade war front, and for direction from central bankers.  So far there has been no indication that a date or even location has been set to finalise details of a Phase 1 deal between the US and China.  While officials on both sides suggest that progress is being made, markets are left wondering if a deal will even be signed this side of the new year.  Despite such uncertainty there does not seem to be too much angst in markets yet, and if anything, risk assets including equities look rather resilient.

Central bankers and central bank minutes will garner plenty of attention over coming days.   Overall it looks as though major central banks led by the Fed are moving into a wait and see mode and this means less direction from these central banks to markets over the next few weeks and likely into year end.

Fed FOMC minutes this week will give more information on the Fed’s thinking when it eased policy in October, and markets will be looking for clues as to what will make them ease again.  In his recent Congressional testimony Fed Chair Powell highlighted that he sees little need to ease policy at the December meeting, strongly suggesting no more easing from the Fed this year.

Reserve Bank of Australia minutes overnight highlighted that the Bank will also now wait to assess past monetary easing measures before cutting rates again while still holding the door open to further cuts if necessary.  While the RBA noted that a case could have been made for easing this month, it doesn’t appear that they are in a rush to move again, with easing now becoming more likely next year than in December.

Another central bank in focus is the ECB, with ECB President Lagarde delivering the keynote address at the European Banking Congress in Frankfurt.  This will be an opportunity for markets to see whether her views are in line with previous ECB President Draghi and also to see how she reacts to criticism of the ECB’s decision from outside and within the governing council, to ease policy further at the September meeting, when it cut the deposit rate to -0.5% and restarted asset purchases.

Another central bank in focus over coming days includes the PBoC in China.  The PBoC cuts its 7-day reverse repo rate by 5bps this week, the first decline in this rate since 2015 in an attempt to lower funding cots to banks.  While the move is small the direction of travel is clearly for lower rates and this is likely to be echoed in the release of the new Loan Prime Rate tomorrow, which could also reveal a small 5bps reduction.  China is likely to maintain this path of incremental easing in the weeks ahead.

Cautious Sentiment Towards A Trade Deal

Markets continue to focus on the potential for a “Phase 1” trade deal between the US and China.   The stakes are high. President Trump who stated that tariffs on Chinese goods would be “raised very substantially” if no deal was struck between the two sides.  US officials also poured cold water over comments by Chinese officials at the end of last week that there had been an agreement to reduce tariffs in phases.  Markets will take a cautious tone given such comments but it is still likely that a deal of sorts will agreed upon in the next few weeks.

Both sides want a deal and while Trump has said that China wants one more than he does, the US administration may want to avoid fueling market turmoil as attention increasingly turns to next year’s US elections.  This suggests that a Phase 1 deal is more likely than not, but agreement on later Phases will be much harder given that there are various structural issues that remain unresolved such as technology transfers, intellectual property theft and state subsidies.

For now what is important is that markets believe that there is progress towards a deal and an eventual signing probably sometime in December.  Despite the harder rhetoric from the US side this still looks like the most likely outcome which in turn suggests that equities and other risk assets have room to rally.  In the meantime, the situation in Hong Kong where protests have intensified will weigh not just on Hong Kong’s markets but markets across the region adding another reason for market caution in the short term.

On the data and events front attention will be on US October CPI, retail sales and a crop of Fed speakers including Fed Chair Powell who is unlikely to change the view the Fed is on pause for the time being.  Elsewhere Chinese data has been less than impressive this week, with October aggregate financing and new yuan loans both coming in weaker than expected.   This is likely to be echoed by the retail sales and industrial production data this week too.

On the FX front, the US dollar has made up around of its October losses amid some deterioration in risk appetite.  Further moves will depend on the progress towards a trade deal, with the USD likely to be pressured should it become clearer that a deal is likely to be signed and vice-versa.  US retail sales data will also have some impact in the short term, but with the Fed on pause and US data holding up the USD the will be driven by driven by the gyrations in risk assets.

Limited Relief

Now that the dust has settled on the US-China limited ‘Phase 1’ deal formulated at the end of last week markets can look to other events/data this week.  Prominent among these are Brexit discussions, which look as though they are carrying over to today as discussions towards a final deal intensify (more on this in another post).  However, casting a shadow over markets today is the news that China has threatened retaliation against the US after the House of Representatives passed a bill on reviewing the preferential treatment for HK.

Stepping back, regarding the trade deal it was probably the easiest one on the table from China’s perspective.  The US agreed to hold back on raising tariffs on $250bn of Chinese goods while China agreed to increase agricultural purchases and give limited access to its financial markets.

However, it was no “love fest”.  It is very narrowly focused, doesn’t role back previous tariffs, does little to change the growth narrative, nor does it deal with the tougher structural issues and enforcement mechanisms etc.  It is also vague on the Chinese currency, renminbi. In any case China had already highlighted and strongly hinted at increased agricultural purchases over recent weeks

Yes, there was some vague commitment to address intellectual property (IP) issues, something that hawks in the US administration have been pushing for but this is akin to closing the barn door after the horse has bolted. China has already tightened up IP regulations at home and in fact is now keen to protect its own IP so it has a big incentive to tighten up IP rules.

The US administration was probably more than happy to avoid another increase in tariffs on China given the desire not to fuel more market instability, growing focus on elections next year and to show some form of progress to take the attention away from the impeachment inquiries.  Implementation of the next tariffs round on December 15 is unclear but given the above it could be delayed or scrapped.  That would be more substantial progress.

Over the short term markets will be relieved that tensions on trade are not worsening though the passage of the bill on Hong Kong by the US House of Representatives threatens to increase tensions on another front.  The bottom line is that there is some breathing space on the trade front, with the President Trump stating that it may take up to five weeks to complete the deal.  Some form of signing may take place at the Apec Summit in Chile in mid-November.

Positive Start To The Week for Emerging Markets

Emerging Markets have started the week on a positive footing helped by some firm data releases.  Equity markets in Asia had a strong day while EM currencies except TRY strengthened.

Sentiment was helped by China’s official manufacturing purchasing managers index (PMI). This was released yesterday and came in at 50.5 in March (consensus 49.6) from 49.2 in February, while the non-manufacturing PMI also came in above expectations at 54.8 (consensus 54.4) from 54.3 in February.  An above 50 reading implies manufacturing expansion. This was followed by the Caixin PMI this morning, which came in at 50.8 in March (consensus 50.0).  The data suggests that China’s economy may finally be benefiting from official stimulus measures as well as hopes of a trade deal.

Aside from China’s index, PMIs across the region generally firmed, providing some relief to regional policy makers and markets.  A key event this week in the region is India’s Reserve Bank (RBI) meeting to decide monetary policy on Thursday, where a 25bp policy rate cut is likely.  Separately, attention will remain on US- China trade talks, with China’s top economic official Liu He due in Washington to continue discussions with US officials.  Both sides appear to suggest a deal is moving closer to fruition although sticky points on structural issues remain in place.

Turkey hasn’t quite embraced the risk on tone following local elections there. President Erdogan’s AKP appears to have lost control of the capital Ankara to the main opposition CHP, while opposition parties are also likely to take control of several coastal cities. In Istanbul, the gap between the AKP and opposition is extremely close, with less than 0.1% between the two.  Overall, the AKP led alliance has garnered about 51.7% of the national vote, while the opposition led by CHP, has 37.5%, with 98.9% of the votes counted, according to the state-run Anadolu agency. This was sufficient for the Erdogan to declare that the ruling party “emerged as the winner” though it is clear that AKP’s coalition party MHP played a large role.   Further developments are awaited, with Turkish markets in limbo.

 

Calm after the storm

After yesterday’s carnage, global equity markets have recovered some of their poise. Whether this is a pause before another wave of pressure or something more sustainable is debatable. It appears that US equities are finally succumbing to a plethora of bad news.  Higher US yields have driven the equity risk premium lower.  Also there’s probably a degree of profit taking ahead of the onset of the Q3 US earnings season.

At the same time valuations have become increasingly stretched.  For example, the S&P 500 price/earnings ratio is around 6% higher than its 5 year average while almost all emerging market price/earnings ratios are well below their 5 year averages.  While strong US growth prospects may justify some or even all of this differential, the gap with emerging markets has widened significantly.

While US President Trump blames an “out of control” US Federal Reserve, it would have been hard for the Fed to do anything else but raise policy rates at its last meeting.  If the Fed didn’t hike at the end of September, bond yields would like have moved even higher than the 3.26% reached on the 10 year US Treasury yield earlier this week as markets would have believed the Fed is falling behind the curve.   However, as US yields rise and the equity risk premium reacts, the opportunity cost of investing in equities rises too.

In the FX world the US dollar could succumb to more pressure if US equities fall further but as we saw yesterday, USD weakness may mainly be expressed versus other major currencies (EUR etc).  Emerging market currencies continue to face too many headwinds including higher US rates and tightening USD liquidity, as well as trade tariffs.  The fact that emerging market growth indicators are slowing, led by China, also does not bode well for EM assets.  Unfortunately that means that emerging market assets will not benefit for the time being from any rout in US assets despite their valuation differences.

China easing as data softens

China’s decision over the weekend to cut the required reserve ratio (RRR) by 100bp (effective Oct 15), the fourth cut this year, will inject around CNY 750bn in liquidity into China’s money markets. The decision to ease comes in the wake of a run of recent soft data.   There should be no big surprise.  China is reluctant to ease policy via a policy rate cut to avoid fuelling any increase in leverage and therefore continues to embark on targeted easing in the form of RRR cuts.

It is likely that further RRR cuts in addition to fiscal stimulus are in the pipeline to cushion the slowdown in the economy.   Indeed, growth was already slowing before the US tariffs impact bites and will likely slow further in the months ahead as the impact of tariffs has a greater effect.   Recent forward looking data including the official and CAIXIN purchasing managers’ indices (PMIs) of manufacturing confidence have softened, with the exports component of the PMIs dropping significantly.

Such cuts will weigh on China’s currency, CNY/CNH and a continued spot depreciation versus USD is likely.   After its sharp decline in June/July FX the PBoC has succeeded in stabilising the CNY (in trade weighted terms) however.   Any decline in foreign exchange reserves has been limited as reflected in the latest FX reserves data, which revealed that FX reserves dropped by $22.7bn only in September, suggesting that as yet there have not been significant capital outflows (ie panic) from China and limited need for FX intervention to support the CNY.

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