Everything But The Kitchen Sink

Since my last post there has been an even bigger onslaught of fiscal and monetary stimulus measures globally in an attempt to combat the devasting health and economic impact of COVID-19.  Fiscal stimulus in the US will amount to over 10% of GDP while the Federal Reserve’s balance sheet is set to grow further from an already large $6+ trillion at present as the Fed throws everything but the kitchen sink to combat the impact of the virus. There is already preparations underway for another phase of fiscal stimulus in the US.

Europe meanwhile, has struggled to agree upon a package given divisions between the North and South of the region, but eventually agreed upon EUR 500bn worth of fiscal stimulus while the ECB is undertaking renewed asset purchases in a new quantitative easing programme.  Many other countries have stepped up their efforts too.  All of this will provide an invaluable cushion, but will not prevent a massive economic downturn, nor will it stop the virus from spreading.

Markets have attempted to look past the growing economic risks, spurred by data showing that in many countries the rate of growth of coronavirus cases has slowed, including in those with a substantial number of deaths such as Italy and Spain.  Even in New York, which has been the epicentre of COVID-19 infections in the US, there are positive signs though it is an ominous sign that the US has now recorded the most deaths globally.

This move towards flattening of the curve has fuelled hopes that many countries will soon be able to emerge from lock downs.  In China, which was first in, most of the manufacturing sector has opened up, while there has even been some relaxation of measures to constrain movement of people.  The net result of all of the above last week, was the biggest weekly rally in US stocks since 1974.

While the 25%+ rally in US equities since their lows is reflecting this optimism, there is a major risk that this is a bear market rally given the risks ahead.  Economic growth estimates continue to be revised lower and the IMF’s revised forecasts scheduled to be published this week are likely to show a global economy on the rails, with growth likely to be at its worst since the Great Depression according to the IMF’s Managing Director.  Emerging markets, which do not have anywhere near the firepower or health systems of developed economies are particularly at risk.

At the same time earnings expectations have yet to reflect the massively negative impact on corporate profits likely in the months ahead; Q1 earnings to be released in the days ahead will be closely watched.  Not only are earnings expectations likely to be revised substantially lower, but many companies will simply not survive and many of those that do could end up in state hands if they are important enough.  Separately there is a risk that shutdowns last longer than expected or once economies begin to open up there another wave of infections.  These risk have not yet been fully appreciated by markets unfortunately.

Fed, ECB, UK elections In Focus

An event filled week lies ahead.  Several central bank decisions including the Federal Reserve FOMC (11th Dec), European Central Bank (ECB) (12 Dec) and Swiss National Bank (SNB)  (12 Dec) are on the calendar.  All of these major central banks are likely to leave policy unchanged and the meetings should prove to be uneventful.  Fed Chair Powell is likely to reiterate the Fed’s patient stance, with last Friday’s strong US November job report (payrolls rose 266k) effectively sealing the case for no change in policy at this meeting, even as a Phase 1 trade deal remains elusive.

Similarly recently firmer data in Europe have pushed back expectations of further ECB easing, though President Lagarde is likely to sound cautious highlighting her desire to maintain an accommodative monetary policy stance.  The picture is rather different for emerging market central banks this week, with policy easing likely from Turkey (12 Dec), Russia (13 Dec) and Brazil (12 Dec) while Philippines (12 Dec) is likely to keep policy unchanged.

UK general elections on Thursday will be closely watched, with GBP already having rallied above 1.30 vs USD as polls show a strong lead for Boris Johnson’s Conservative Party.  The main question is whether Johnson will have gained enough of a share of the vote to gain a majority, allowing him to push ahead with his Brexit plans, with Parliament voting to leave the European Union by Jan 31.

Polls may not be as accurate as assumed in the past given surprises over recent years including the Brexit vote itself, but the wide margin between the two parties highlights the relatively stronger position of the Conservatives going into the election.  Nonetheless, given that a lot is in the price already, the bigger (negative) reaction in GBP could come from a hung parliament or Labour win.

This week is also crunch time for a decision on the threatened December 15 tariffs on China.  As previously noted there is little sign of any deal on any Phase 1 trade deal.  It appears that issues such as the amount of purchases of US goods by China remain unresolved.  Recent comments by President Trump suggest that he is prepared to delay a deal even as far as past the US elections in November 2020.

Whether this is tactic to force China to agree on a deal or a real desire not to rush a deal is difficult to determine, but it seems as though Phase 1 will deal will not be signed this year given the limited time to do so.  December 15 tariffs could be delayed but this is also not guaranteed.  President Trump’s attention will also partly be on the potential for an impeachement vote in the House this week.

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.

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.

 

 

Oil Surges, Central Banks Galore

Oil prices jumped following drone attacks on Saudi Arabian oil facilities over the weekend.  Oil rose by around 20% to just shy of $72, before halving its gain later.  Even after failing to hold onto initial gains the rise in oil prices still marks one if its biggest one day gains.  Concerns about reduced oil supply have risen as a result of the attacks as they could reduce Saudi oil production for a prolonged period, with around 5% of global oil supply impacted.  Additionally the attacks could raise geopolitical tensions in the region.

As markets digest the impact of the drone attacks, there will also be several central bank decisions globally to focus on this week.  The main event is the Fed FOMC meeting mid-week, where a 25bp cut is largely priced in by the market.  Given that a rate cut is well flagged markets will pay close attention to the Fed’s summary of economic projections, in particular the Fed’s dot plot.  It seems unlikely that Fed Chair Powell is going to sound too dovish, with little to suggest that the Fed is on path for a more aggressive easing path.

Another major central bank meeting this week is the Bank of Japan (BoJ) on Thursday.  While a policy move by the BoJ at is unlikely this week BoJ policy makers have sounded more open to easing.  A consumption tax hike planned for next month together with a strong JPY have increased the pressure for the BoJ to act. Separately easier policy from other major central banks amid slowing global growth are unlikely be ignored.  However, policy is already ultra- easy and the BoJ remains cognisant of the adverse secondary impact of policy on Japanese Banks.

The Bank of England deliberates on policy this week too but it seems highly unlikely that they would adjust policy given all the uncertainties on how Brexit developments will pan out.  Until there is some clarity, the BoE is likely to remain firmly on hold, with the base rate remaining at 0.75%.  GBP has rallied over recent weeks as markets have stepped back from expectations of a hard Brexit, but this does not mean that a deal is any closer than it has been over the past months.  Elsewhere the SNB in Switzerland and Norges Bank in Norway are also expected to keep policy rates on hold this week.

Several emerging markets central banks will also deliberate on policy this week including in Brazil, South Africa, Indonesia and Taiwan.  The consensus (Bloomberg) expects a 50bp rate cut in Brazil, no change in South Africa and Taiwan and a 25bp rate cut in Indonesia.  Overall many emerging markets continue to ease policy amid slowing growth, lower US policy rates and declining inflation pressures.

 

Combating Recession Risks

Following a volatile last week market attention will remain on trade tensions, measures to combat the risks of recession and will turn to the Jackson Hole central bankers’ symposium at the end of the week. The inversion of the US yield curve has led to growing expectations that the US is heading into recession and has spurred inflows into bonds. As a result US Treasury yields continue to fall and the stockpile of negative yielding debt has risen to well over $16 trillion. While economic data in the US remains relatively firm, the picture in the rest of the world has deteriorated sharply as reflected in weakening German and Chinese trade, against the background of a weak trade backdrop.

There have been some mixed headlines on trade over the weekend – Larry Kudlow, Director of the National Economic Council under President Trump, said yesterday that recent phone calls between US and Chinese trade negotiators had been “positive”, with more teleconference meetings planned over the next 10 days.  Separately US media reported that the US commerce department was preparing to extend a temporary license for companies to do business with Huawei for 90 days. However, Trump poured cold water on this by stating that “Huawei is a company that we may not do business with at all”.  A decision will be made today.

In the wake of growing expectations of recession, attention is turning on what will be done by governments and central banks to combat such risks.  The Jackson Hole meeting on Thursday will be particularly important to gauge what major central bankers are thinking and in particular whether and to what degree Federal Reserve Chairman Powell is planning on cutting US rates further.  We will be able to garner further evidence of Fed deliberations, with the release of the Fed FOMC July meeting minutes on Wednesday.

While central bankers look at potential monetary policy steps governments are likely to look at ways of providing further fiscal stimulus.  Kudlow stated that the US administration was “looking at” the prospects of tax cuts, while pressure on the German government to loosen is purse strings has also grown.  Even in the UK where a hard Brexit looms, the government is reportedly readying itself with a fiscal package to support growth in the aftermath.   Such news will come as a relief to markets, but recession worries are not likely to dissipate quickly, which will likely keep volatility elevated, and maintain the bias towards safe haven assets in the weeks ahead.

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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