US-China Trade Talk Hopes Begin To Fade

Attention this week will be very much centered on a few key events, most prominent of which is US-China trade talks scheduled to begin on Thursday in Washington.   A speech by Fed Chair Powell at the annual NABE conference tomorrow and Fed FOMC minutes  will also garner plenty of attention for clues to the Fed FOMC meeting at the end of this month.   In the UK, as the end October deadline approaches attention turns to whether Prime Minister Johnson can seal a deal with European officials.

Starting with US-China trade talks, reports (Bloomberg) today suggest that China is unwilling to agree to a comprehensive trade deal with the Trump administration.   The report states that senior Chinese officials have indicated that the range of topics they are willing to discuss has narrowed considerably.  The implication is that major structural issues such as intellectual property theft, technology transfers, state subsidies, and other issues are off the table, limiting the scope of any agreement emerging from meetings this week.   Markets have unsurprisingly reacted negatively to the reports.

If China is indeed unwilling to enter into a broader trade discussion, prospects for even an interim trade deal look slim especially considering that US officials were last week talking down the prospects of a narrow deal.  Markets have been pinning their hopes on some progress on trade talks and any failure to advance talks this week will cast a heavy shadow over markets in the days ahead.

Separately European leaders appear to have poured cold water on the UK government’s proposals for a deal to end the Brexit impasse.  The main sticking point is the removal of the Irish backstop and proposal to implement a customs border between Northern Ireland and the Irish Republic.  If no deal is reached an extension seems likely given the passage of the Benn Act, which requires the PM to ask the EU for a delay if parliamentary approval has not been given to a withdrawal agreement or a no deal exit.  Nonetheless, Johnson continues to warn the EU that he will take the UK out of Europe at the end of October. The uncertainty is unsurprisingly once again hurting the pound.

In  the US the release of US September CPI, speech by Fed Chair Powell and FOMC minutes will provide further clues to the Fed’s thinking ahead of the FOMC meeting this month.  Market pricing for an October rate cut increased in the wake of a recent run of weaker data (especially the September ISM surveys, which weakened) though the September jobs report (non farm payrolls increased by 136k while the unemployment rate fell to a record low of 3.5%) released at the end of last week did not provide further ammunition for those expecting a more aggressive Fed rate cut.  A 25bp cut sees likely at the October meeting.

 

 

Fed’s Powell & China trade data in focus

US jobs data released at the end of last week will diminish hopes of more aggressive policy rate cuts from the Fed FOMC at its policy meeting at the end of the month. Non-farm payrolls rose by 224,000 last month, beating market forecasts, a sharp improvement from the disappointing 72,000 increase in the previous month.

Despite the stronger than expected reading in June, the Fed is still likely to cut interest rates by 25 basis points amid concerns about a loss of growth momentum, trade tensions against the background of low inflation.  Soft US June CPI releases on Thursday this week will likely confirm the subdued inflationary backdrop.

Markets will be able to garner more clues during Fed Chair Powell’s testimony to Congress on Wednesday and Thursday while Fed FOMC minutes from the last meeting will also provide greater detail on Fed thinking.  Both are likely to help confirm expectations of a 25 basis point cut in rates at the next FOMC meeting.

The USD has recovered some if recent losses, helped at the end of last week but the US jobs report.  Further gains are likely to be limited (with the USD index likely to struggle to break 98.0) though much will depend on Powell’s testimony this week.

Also in focus this week will be China’s June trade data.  This data will be scrutinised in particular, for the trade surplus with the US and whether there are any signs of this surplus beginning to narrow.  The data will also give some indications of the health of China’s economy, with another weak print for imports, likely to show further softening in China’s growth momentum. Similarly weaker exports will highlight the softening in demand from key trading partners such as Korea.

Further evidence on the outlook for China’s economy will be seen in the release of monetary aggregates including new loan growth and aggregate financing. Meanwhile, China’s currency continues to remain stable amid the trade truce with the US.

 

Ecofin, ECB, US jobs report in focus

The USD index remains close to its recent highs, maintaining a positive tone amid elevated risk aversion. Data releases have tended to take a back seat to events over recent weeks, but this week the all important US September jobs report may provide the bigger focus for US markets. The consensus expectation is for a 50k increase in payrolls and the unemployment rate remaining at 9.1% an outcome that would do nothing to assuage US growth worries. As usual markets will gauge clues to the jobs data from the ADP jobs data and employment components of the ISM data but an outcome in line with consensus expectations will likely keep risk aversion elevated and the USD supported unless the data is so bad that it results in an increase in expectations for Fed QE3.

There will be plenty of attention on the Ecofin meeting of European finance ministers today especially given that much of the reason for the stability in markets recently is the hope of concrete measures to resolve the crisis in the region. In this respect the scope for disappointment is high, suggesting that the EUR is vulnerable to a further drop if no progress is made at today’s meeting. While the extent of short market positioning has left open some scope for EUR short covering the absence of any good news will mean the impetus for short covering will diminish.

While attention in Europe will predominately remain on finding a resolution to the debt crisis and the saga of Greece’s next loan tranche, the European Central Bank (ECB) meeting will also be in focus this week especially given expectations that the ECB will cut interest rates. While hopes of a 50 basis points rate cut may have taken a knock from the firmer than expected reading for September flash CPI released at the end of last week the EUR could actually react positively to an easing in policy given that it may at least help to allay some of the growing growth concerns about the eurozone economy. However, any EUR will be limited unless officials in the eurozone get their act together and deliver on expectations of some form of resolution to the crisis in the region.

Strong words from Japan’s Finance Minister Azumi failed to have any lasting impact on USD/JPY. Japan will bolster funds to intervene in currency markets by JPY 15 trillion and extend the monitoring of FX positions until the end of December. Japan did not intervene during September but spent around JPY 4.5 trillion in FX intervention in August to little effect. For markets to be convinced about Japan’s conviction to weaken the JPY it will require putting intervention funds to active use, something that doesn’t seem to be forthcoming at present. A factor that may give some potential upside momentum for USD/JPY is the slight widening of US versus Japan bond yield differentials over recent days, which could finally result in a sustained move above 77.00 if it continues into this week.

Euro still looks uglier than the dollar

Currency markets continue to vacillate between US debt ceiling concerns and eurozone peripheral debt worries. Despite a lack of agreement to raise the debt ceiling, with House Republicans failing to back a proposal by House speak Boehner, the USD actually strengthened towards the end of the week as eurozone peripheral issues shifted back into focus.

The resilience of the USD to the lack of progress in raising the debt ceiling is impressive and reveals that the EUR looks even uglier than the USD, in many investors’ eyes.

Much in terms of direction for the week ahead will depend on the magnitude of any increase in the debt ceiling and accompanying budget deficit reduction measures. Assuming that a deal is reached ahead of the August 2 deadline it is not obvious that the USD and risk currencies will enjoy a rally unless the debt ceiling deal is a solid and significant one.

Given the limited market follow through following the recent deal to provide Greece with a second bailout, the EUR remains wholly unable to capitalise on the USD’s woes.

A reminder that all is not rosy was the fact that Moody’s ratings agency placed Spain’s credit ratings on review for possible downgrade while reports that the Spanish parliament will be dissolved on September 26 for early elections on November 20 will hardly help sentiment for the EUR. Compounding the Spanish news doubts that the EFSF bailout fund will be ready to lend to Greece by the next tranche deadline in mid-September and whether Spain and Italy will participate, have grown.

Some key data releases and events will also likely to garner FX market attention, with attention likely to revert to central bank decisions including the Bank of Japan, European Central Bank, Bank of England, Reserve Bank of Australia and US July jobs report. None of the central banks are likely to shift policy rates, however.

The risk for the USD this week is not only that there is disappointing result to the debt ceiling discussions, but also that there is a weak outcome to the US July jobs report. An increase of around 100k in payrolls, with the unemployment rate remaining at 9.2%, will fixate market attention on weak growth and if this increases expectations for a fresh round of Fed asset purchases the USD could be left rather vulnerable.

The RBA is highly unlikely to raise interest rates but the tone of the accompanying statement is unlikely to be dovish. The RBA noted the strong emphasis on the Q2 CPI inflation data and in the event it came in higher than expected, a fact that supports my expectation that the Bank will hike policy rates at least once more by the end of this year.

Markets have largely priced out expectations of a rate cut but there is still scope for a more hawkish shift in Australian interest rate markets, which will give the AUD a boost. However, AUD remains vulnerable to developments in the US and Europe as well as overall risk aversion, and a preferable way to play a positive AUD view in the current environment is via the NZD.

Euro crisis intensifies

The blowout in eurozone non-core debt has intensified and unlike in past months the EUR has been a clear casualty. The lack of a concrete agreement over a solution given divergent views of EU officials, the European Central Bank (ECB) and private sector participants threatens a further ratcheting higher of pressure on markets over coming weeks.

The only real progress overnight as revealed in the Eurogroup statement appeared to be in the renewing the option of buying back Greek debt via the eurozone bailout fund, extending maturities and lowering interest rates on loans. This will be insufficient to stem the pressure on the EUR, with the currency verging on a sharp drop below 1.40.

The USD continues to take advantage of the EUR’s woes and has actually staged a break above its 100-day moving average yesterday after several attempts previously. This sends a bullish signal and the USD is set to remain supported given that there is little in sight of a resolution to the problems festering in the eurozone.

Today’s release of the June 22 Fed FOMC minutes will give some clues to Fed Chairman Bernanke’s testimony to the House of Representatives tomorrow, but as long as the minutes do not indicate a greater willingness to embark on more asset purchases, the USD is set to remain resilient.

GBP has also benefitted from the EUR’s weakness, and unlike the EUR has only drifted rather than dived versus the USD. However, the UK economy is not without its own problems as revealed in a further drop in retail sales overnight, albeit less negative than feared, with the British Retail Consortium (BRC) like for like sales falling 0.6% in June.

A likely increase in June CPI inflation in data today to a 4.8% annual rate will once again highlight the dichotomy between weak growth and high inflation. In turn, such data will only provoke further divisions within the Bank of England MPC. While further gains against the beleaguered EUR are likely, with a test of EUR/GBP 0.8721 on the cards in the short term, GBP will struggle to sustain any gain above 1.6000 versus USD.

Both AUD and NZD are vulnerable against the background of rising risk aversion and a firmer USD in general. However, both currencies are not particularly sensitive to risk aversion. Interestingly the major currency most sensitive to higher risk aversion in the past 3-months is the CAD and in this respect it may be worth considering playing relative CAD underperformance versus other currencies.

As for the AUD it is more sensitive to general USD strength, suggesting that it will be restrained over coming sessions too and given that market positioning is still very long AUD, there is scope for further downside pressure to around 1.0520 versus USD.

Which is the ugliest currency?

The contest of the uglies has once again been set in motion in FX markets as last Friday’s weak US jobs report, which revealed a paltry 18k increase in June payrolls, downward revisions to past months and a rise in the unemployment rate, actually left the USD unperturbed. Europe’s problems outweighed the negative impact of more signs of a weak US economy, leaving the EUR as a bigger loser.

The USD’s resilience was even more impressive considering the drop in US bond yields in the wake of the data. However, news over the weekend that talks over the US budget deficit and debt ceiling broke down as Republicans pulled out of discussions, will leave USD bulls with a sour taste in their mouth.

Should weak jobs recovery dent enthusiasm for the USD? To the extent that it may raise expectations of the need for more Fed asset purchases, it may prove to be an obstacle for the USD. However, there is sufficient reason to look for a rebound in growth in H2 2011 while in any case the Fed has set the hurdle at a high level for more quantitative easing (QE).

Fed Chairman Bernanke’s reaction and outlook will be gleaned from his semi-annual testimony before the House (Wed) although he will likely stick to the script in terms of US recovery hopes for H2. This ought to leave the USD with little to worry about. There will be plenty of other data releases this week to chew on including trade data, retail sales, CPI and PPI inflation and consumer confidence as well as the kick off to the Q2 earnings season.

Fresh concerns in Europe, this time with contagion spreading to Italy left the EUR in bad shape and unable to capitalise on the soft US jobs report. In Italy high debt levels, weak growth, political friction and banking concerns are acting in unison. The fact that there is unlikely to be a final agreement on second Greek bailout package at today’s Eurogroup meeting will act as a further weight on the EUR.

Discussions over debt roll over plans, the role of the private sector and the stance of ratings agencies will likely drag on, suggesting that the EUR will not find any support over coming days and will more likely lose more ground as the week progresses. If these issues were not sufficiently worrisome, the release of EU wide bank stress tests on Friday will fuel more nervousness. Against this background EUR/USD looks vulnerable to a drop to technical support around 1.4102.

The Bank of Japan is the only major central bank to decide on interest rates this week but an expected unchanged policy decision tomorrow is unlikely to lead to any JPY reaction. In fact there appears to be little to move the JPY out of its current tight range at present. USD/JPY continues to be the most correlated currency pair with 2-year bond yield differentials and the fact that the US yield advantage has dropped relative to Japan has led to USD/JPY once again losing the 81.0 handle.

However, as reflected in the CFTC IMM data the speculative market is still holding a sizeable long position in JPY, which could result in a sharp drop in the currency should US yields shift relatively higher, as we expect over coming months. In the short-term USD/JPY is likely to be well supported around 80.01.

US Dollar Finding Support

The US dollar is finding growing relief from the fact that the Fed is putting up a high hurdle before more quantitative easing (QE3) is even considered. As highlighted by Federal Reserve Chairman Bernanke last week he is not considering QE3 despite a spate of weak US data. Of course until US bond yields move higher the USD will fail to make much of a recovery and in turn this will need some improvement in US economic data.


The May retail sales release is unlikely to provide this with headline sales likely to undergo an autos related drop while core CPI released on Wednesday is set to remain benign in May. There will be better news on the US manufacturing front, with surveys and hard data likely to bounce back.

There is still plenty of scope for USD short covering as reflected in the fact that IMM USD positions fell further as of the 7th June, with the market still heavily short USDs. The USD index has likely found a short term bottom, with a break above the 50-day moving average level around 74.6874 in focus.

EUR has lost momentum , with the European Central Bank’s (ECB) confirmation of a July policy rate hike prompting a major sell off in the currency, even with interest rate markets barely flinching. The EUR is susceptible to developments regarding Greece and the news on this front is not good. Divisions between policy makers including the ECB about the extent of private sector involvement in a second bailout package threaten to prolong the pain.

Similarly divisions within the Greek parliament about further austerity measures needed to secure a second bail could also derail the process. Further negotiations this week will be closely scrutinised, likely taking more importance than data releases, with only the final reading of May inflation and industrial production of note this week.

As revealed by the CFTC IMM data, EUR long positions jumped early last week leaving plenty of scope for unwinding, something that is likely to take place this week. Nonetheless, support around the 30 May low of EUR/USD 1.4256 is likely to prove difficult to break on the downside this week.

GBP took a hit in the wake of yet more weak activity data in the form of May industrial and manufacturing production data. The economic news will be no better this week, with retail sales set to drop in May and CPI inflation set to rise further in April. The data will only add further to the confusion about UK monetary policy as the dichotomy between weak data and persistently high inflation continues.

Admittedly the weak data releases can at least partially be explained away by the Royal wedding and Easter holidays but this will provide little solace to GBP bulls. GBP will likely struggle against a firmer USD this week although its worth noting that GBP speculative position has been negative for 3-straight weeks, suggesting that at least there is less room for GBP position unwinding. GBP/USD is likely to hold above support around 1.6055 this week.

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