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.

 

 

Bonds Under Pressure, UK Parliament Rejects Election Again

Market sentiment remains positive as hopes of a US-China trade deal continue to provide a floor under risk sentiment amid hopes that the escalation in tariffs can be reversed.  Weak Chinese trade data over the weekend has largely been ignored and instead markets have focused on further stimulus unleashed by China in the wake of the cut in its banks’ reserve ratios, which freed up around USD 126bn in liquidity to help shore up growth.  Expectations that the European Central Bank (ECB) will this week provide another monetary boost by lowering its deposit rates and embarking on a fresh wave of quantitative easing, are also helping to support risk sentiment though a lot is already in the price in terms of ECB expectations.

One of the casualties of the turn in sentiment has been bonds, with yields rising in G10 bond markets.  For example US 10 year yields have risen by around 18 basis points since their low a week ago.   The US dollar has also come under pressure, losing ground in particular to emerging market currencies over the past week.  Safe haven currencies such as the Japanese yen (JPY) and Swiss franc (CHF) have fared even worse.   As I noted last week I think the bounce in risk appetite will be short-lived, but how long is short?  Clearly markets anticipate positive developments in US-China trade talks, and it seems unlikely that risk appetite will deteriorate ahead of talks, at least until there is some clarity on the discussions.  Of course a tweet here or there could derail markets, but that is hard to predict.

Sterling (GBP) has been another currency that has benefited from USD weakness, but also from growing expectations that the UK will not crash out of the EU without a deal.  Developments overnight have done little to provide much clarity, however.  UK Prime Minister Boris Johnson failed in his bid for an early election on October 15, with MPs voting 293 in favour of an election against 46 opposed;  Johnson required two-thirds or 434 MPs to support the motion.  Johnson is now effectively a hostage in his own government unable to hold an election and legally unable to leave without a deal.  Parliament has been suspended until October 14, with Johnson stating that he will not delay Brexit any further, reiterating that he is prepared to leave the EU without an agreement if necessary.

This would effectively ignore legislation passed into law earlier blocking a no-deal Brexit forcing the PM to seek a delay until 31 Jan 2020. Separately parliament passed a motion by 311 to 302 to compel Downing Street to release various documents related to no-deal Brexit planning, but officials are so far resisting their release.  A lack of progress in talks with Irish PM Varadkar in Dublin on Monday highlights the challenges ahead.  GBP has rallied following firmer than expected Gross Domestic Product data (GDP) yesterday and growing hopes that the UK will be prevented from crashing out of the EU at the end of October, but could the currency could be derailed if there is still no progress towards a deal as the deadline approaches.

 

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