A Host Of Global Risks

Last week was a tumultuous one to say the least.  It’s been a long time since so many risk factors have come together at the same time.  The list is a long one and includes the escalation of the US-China trade war, which last week saw President Trump announce further tariffs on the remaining $300bn of Chinese exports to the US that do not already have tariffs levied on them, a break of USDCNY 7.00 and the US officially naming China as a currency manipulator.

The list of risk factors afflicting sentiment also includes intensifying Japan-Korea trade tensions, growing potential for a no-deal Brexit, demonstrations in Hong Kong, risks of a fresh election in Italy, growing fears of another Argentina default, ongoing tensions with Iran and escalating tensions between India and Pakistan over Kashmir.

All of this is taking place against the background of weakening global growth, with officials globally cutting their growth forecasts and sharply lower yields in G10 bond markets.  The latest country to miss its growth estimates is Singapore, a highly trade driven economy and bellwether of global trade, which today slashed its GDP forecasts.

Central banks are reacting by easing policy.  Last week, the New Zealand’s RBNZ, cut its policy rate by a bigger than expected 50 basis points, India cut its policy rate by a bigger than expected 35 basis points and Thailand surprisingly cutting by 25 basis points.  More rate cuts/policy easing is in the pipeline globally in the weeks and months ahead, with all eyes on the next moves by the Fed.  Moving into focus in this respect will be the Jackson Hole central bankers’ symposium on 22/23 August and Fed FOMC minutes on 21 August.

After the abrupt and sharp depreciation in China’s currency CNY, last week and break of USDCNY 7.00 there is evidence that China wants to control/slow the pace of depreciation to avoid a repeat, even as the overall path of the currency remains a weaker one. Firstly, CNY fixings have been generally stronger than expected over recent days and secondly, the spread between CNY and CNH has widened sharply, with the former stronger than the latter by a wider margin than usual.  Thirdly, comments from Chinese officials suggest that they are no keen on sharp pace of depreciation.

Markets will remain on tenterhooks given all the factors above and it finally seems that equity markets are succumbing to pressure, with stocks broadly lower over the last month, even as gains for the year remain relatively healthy.  The US dollar has remained a beneficiary of higher risk aversion though safe havens including Japanese yen and Swiss Franc are the main gainers in line with the move into safe assets globally.  Unfortunately there is little chance of any turnaround anytime soon given the potential for any one or more of the above risk factors to worsen.

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US-China Trade Truce Boosts Sentiment

Weekend developments will help set up the markets for a risk on day.  However, any improvement in sentiment will likely be capped. The good news was that the US and China agreed to a trade truce at the G20 summit, President Trump and North Korean leader Kim Jong Un met at the demilitarised zone while separately the EU and Mercosur agreed upon a trade deal in a strong retort against the rising trend of protectionism.

Presidents Trump and Xi agreed to delay the implementation of new tariffs (on the remaining $300bn of Chinese exports to the US) while agreeing to restart trade talks, albeit with no time table scheduled as yet.  The delay in tariffs escalation and restart of trade talks was in line with expectations but concessions on Huawei were not.   Trump stated that US companies can sell equipment to Huawei without giving details on what can be sold while China also agreed to buy more US agricultural goods.

The chances of a US-China trade deal have risen, but it could still take several months before various remaining structural issues (forced technology transfers, state subsidies, discrimination against foreign companies, regulations on intellectual property etc)
are ironed out. The lack of time frame on US-China trade talks, ongoing structural issues, lack of details on what equipment US suppliers can sell to Huawei and a host of data releases, will limit the improvement in sentiment and reduce the likelihood of any near term deal.

Looking ahead, sentiment may be clouded somewhat by the disappointing China purchasing managers’ index (PMI) yesterday, with the manufacturing PMI coming in at 49.4 in June, the same as in May, with manufacturing continuing to contract.  However, markets may be willing to overlook this as trade tensions were likely a prime reason for the continued weakness in manufacturing confidence.   As such, China’s currency CNY and asset markets will likely react positively overall.

The events over the weekend will likely reduce the chances of a 50bps rate by the Fed at their next meeting, but much will depend on upcoming data.   This includes the June US ISM survey today and employment report on Friday.  Markets expect a 160k bounce back in payrolls in June after the surprisingly weak 75k increase in the previous month.  Assuming the data is line with expectations it seems unlikely that the Fed will feel the need to ease policy by more than 25bp when they meet at the end of the month.

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.

Awaiting More US Tariffs And China Retaliation

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.

‘Beautiful’ Letter Fails To Stop Tariffs

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.

Trump Threatens Tariffs Escalation

A trade deal between US and China appeared close to being agreed over recent weeks and markets had become rather sanguine about the issue. Indeed headlines over recent weeks had been encouraging, with both sides sounding conciliatory, and progress noted even on structural issues (technology theft, IP transfers, state subsidies, monitoring etc).  Against this background the tweets by President Trump yesterday that he may increase tariffs on $200bn of Chinese imports to 25% from 10% on Friday and add another $325bn to goods that are not currently covered “shortly”, were all the more disturbing. Maybe such comments should not be so surprising, however.

The tweets need to be put into perspective. There may be an element of posturing from. It fits Trump’s style of deal making.  In this case it appears that Trump and the China hawks in his administration are frustrated with the time taken to achieve a deal. Trump may also be emboldened to take a tougher stance by the resilience of the US economy, strength of US equity markets and limited impact on the US economy from current tariffs, though this would surely change if tariffs were ramped up. Trump may feel that such as gamble is worth it to take the deal across the line.

China’s reaction has been muted so far and talks this week in Washington may still be on, albeit with some delay.  Assuming that discussions do take place Trump may feel that he has the stronger hand especially as there is broad political and public support for a strong stance on China. He may feel that if he agrees to a deal too easily, he could lose support from his core supporters, hence he is now doubling down on his stance. Pressure on China to agree on a deal sooner rather than later has clearly intensified as a consequence, but I would still take earlier statements that both sides are moving closer to a deal at face value.

Admittedly the stakes are higher now, but I would not be surprised if at some point in the talks, assuming they take place, the US administration declares that progress is being made and that tariff escalation is once again delayed. After all, that’s what has happened previously. Markets would be relieved of course, and the consequences of failure would be higher given the new tariffs at stake, but at least it would buy more time for China to avoid facing a ramp up in tariffs.

China Stimulus Paying Off

For anyone doubting whether China’s monetary and fiscal stimulus measures are having any impact, the recent slate of March data releases should allay such concerns.  While a soft base early in the year may explain some of the bounce in March there is little doubt that China’s growth engine is beginning to rev again.

China data released today was firmer than expected almost across the board.  Notably industrial production rose 8.5% y/y (consensus 5.9%), retail sales were up 8.7% y/y (consensus 8.4%) and last, but not least, GDP rose 6.4%, slightly above the market (consensus. 6.3%).

This data follows on from last week’s firm monetary aggregates (March new loans, M2, aggregate financing) and manufacturing PMIs, all of which suggest that not only is stimulus beginning to work, but it could be working better than expected.   The turnaround in indicators in March has been particularly stark and has managed to overcome the softness in data in Jan/Feb.

The data is likely to bode well for risk assets generally, giving a further boost to equities, while likely keeping CNH/CNY supported.  Chinese equities are already up around 36% this year (CSI 300) and today’s data provides further fuel.  In contrast, a Chinese asset that may not like the data is bonds, with yields moving higher in the wake of the release.

Indeed with credit growth likely to pick up further this year and nominal GDP declining, China’s credit to GDP ratio is on the up again, and deleveraging is effectively over.  This does not bode well for bonds even with inflows related to bond index inclusion.

For the rest of the world’s economies, it will come as a relief that China’s economy is bottoming out, but it is important to note that China’s stimulus is largely domestically focussed.  The global impact will be far smaller than previous stimulus periods, suggesting that investors outside China shouldn’t get their hopes up.

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