Waiting For The Fed To Come To The Rescue

COVID-2019 has in the mind of the market shifted from being a localized China and by extension Asia virus to a global phenomenon.  Asia went through fear and panic are few weeks ago while the world watched but did not react greatly as equities continued to rally to new highs outside Asia.  All this has changed dramatically over the last week or so, with markets initially spooked by the sharp rise in cases in Italy and Korea, and as the days have progressed, a sharp increase in the number of countries recording cases of infection.

The sell off in markets has been dramatic, even compared to previous routs in global equity markets.  It is unclear whether fading the declines is a good move given that the headline news flow continues to worsen, but investors are likely to try to look for opportunity in the malaise.   The fact that investors had become increasingly leveraged, positioning had increased significantly and valuations had become stretched, probably added more weight to the sell-off in equity markets and risk assets globally.  Conversely, G10 government bonds have rallied hard, especially US Treasuries as investors jump into safe havens.

Markets are attempting a tentative rally in risk assets today in the hope that major central banks and governments can come to the rescue.  The US Federal Reserve on Friday gave a strong signal that it is prepared to loosen policy if needed and markets have increasingly priced in easing , beginning with at least a 25bps rate cut this month (19 March).  The question is now not whether the Fed cuts, but will the cut be 25bp or 50bp.  Similarly, the Bank of Japan today indicated its readiness to support the economy if needed as have other central banks.

As the number of new infections outside of China is now increasing compared to new infections in China, and Chinese officials are promising both fiscal and monetary stimulus, China is no longer the main point of concern.  That said, there is no doubt that China’s economy is likely to tank this quarter; an early indication came from the sharp decline in China’s official manufacturing purchasing managers’ index, which fell to a record low of 35.7 in February, deep into contraction territory.  The imponderable is how quickly the Chinese economy will get back on its feet.  The potential for “V” shape recovery is looking increasingly slim.

Volatility has also risen across markets, though it is notable that FX volatility has risen by far less than equity or interest rate volatility, suggesting scope for catch up.  Heightened expectations of Fed rate cuts, and sharp decline in yields, alongside fears that the number of virus cases in the US will accelerate, have combined to weigh on the US dollar, helping many currencies including the euro and emerging market currencies to make up some lost ground.  This is likely to continue in the short term, especially if overall market risk appetite shows some improvement.

Markets will likely struggle this week to find their feet.  As we’re seeing today there are attempts to buy into the fall at least in Asia.  Buyers will continue to run into bad news in terms of headlines, suggesting that it will not be an easy rise. Aside from watching coronavirus headlines there will be plenty of attention on the race to be the Democrat Party presidential candidate in the US, with the Super Tuesday primaries in focus.  UK/Europe trade talks will also garner attention as both sides try to hammer out a deal, while OPEC will meet to deliberate whether to implement output cuts to arrest the slide in oil prices.  On the data front, US ISM manufacturing and jobs data will be in focus.

Pause In The Risk Rally?

The rally in risk assets has extended into 2020 amid a stabilization in economic data, the Phase 1 trade deal and a persistent easy monetary policy stance by major central banks.  The sharp decline in volatility in most asset markets has also contributed to the rush to buy such as assets including equities and high yielding debt.  While the market is becoming increasingly susceptible to shocks given the increasing positioning in risks assets, the near term may be a period of consolidation rather than any reversal.

Attention this week will focus on US Q4 2019 earnings.  So far, with around 9% of S&P earnings released, the majority (around 70%) have beaten expectations.  In a 4 day US trading week this week there are a number of earnings releases that will help provide further clues to whether the US equity rally can be sustained in the weeks ahead.  The S&P 500 is already up around 3% this year, extending a 30%+ gain last year. This has echoed gains in most global equity markets.  Investors should be nervous, but there is little to suggest a reversal soon.

There are a number of data and events to focus on this week including central bank meetings in the Eurozone, Canada, Norway, Malaysia and Indonesia.  Unsurprisingly the Bank of Japan left policy unchanged today and the other are unlikely to change their policy settings except perhaps Indonesia, which may cut.  Aside from these central banks a series of manufacturing surveys (Markit PMIs) will garner attention.

In Asia, trading activity may slow as Chinese New Year approaches while impeachment proceedings against US President Trump in the Senate will also likely distract attention for many.  Another issue that has taken on increasing prominence is the outbreak of a virus that appears to have originated in central China.  Concerns have grown that the coronavirus could spread quickly especially as millions of Chinese migrate (estimated at around 3 billion trips) over the Chinese new year holidays.

Overall, nervousness over the virus alongside holidays in the region is likely to lead to consolidation in markets any even profit taking following a strong rally in risk assets over recent weeks and months.  Positioning indicators suggest that USD positioning has fallen sharply, suggesting also a risk of USD short covering in the current environment.  This all point to a pause in the risk rally in the days ahead.

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.

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.

Firm China data boosts sentiment

It is turning into a solid start to the week for global equity markets and risk assets in general.  Growth concerns are easing and central banks globally have shelved plans to tighten policy.  Comments over the weekend that finance chiefs and central bank stand ready to “act promptly” to support growth, may also reassure markets. Meanwhile, it appears that the US and China are closing in on a trade deal, with US Treasury Secretary Mnuchin stating that enforcement mechanisms could work “in both directions”, potentially easing disagreement on of the contentious issues between the two countries.

In terms of data and events, US Q1 earnings, US March retail sales and industrial production, will be in focus this week alongside more Chinese growth data, elections in Indonesia and the second phase of elections in India.  In Europe, flash purchasing managers’ indices (PMI) for April will give some indication of whether there is any turnaround in growth prospects.  The news will not be particularly good on this front, but the surveys may at least show signs of stabilisation, albeit at weak levels.

China data at the end of last week was particularly supportive, with March aggregate financing, money supply and new yuan loans all beating expectations.  The data add to other evidence of a bounce back in activity in March, with the official manufacturing purchasing managers index (PMI) moving back into expansion territory.   The data comes off a low base after weakness in January and February, but suggests that Chinese monetary and fiscal stimulus is taking effect, with the economy steering towards a soft landing.

Chinese markets clearly like what they see, with equities maintain their strong year to date rally (The CSI Index is up over 34% year to date) and CNY remaining firm (CNY has been the strongest performing Asian currency versus USD so far this year) though China’s bond market will react less well to signs of growth stabilisation.  Chinese data this week including Q1 GDP, March retail sales and industrial production are set to add further evidence of growth stabilisation, helping to keep the positive market momentum alive.

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.

 

FX ‘Flash Crash’

Happy New Year! What a start its been so far.  Weak Chinese data kicked off the year yesterday, with a manufacturing sentiment gauge, the Caixin purchasing manager’s index (PMI), falling into contraction territory for the first time in 19 months, another sign of slowing growth in China’s economy.  This was echoed by other manufacturing PMIs, especially those of trade orientated countries in Asia.   Taking a look at global emerging market PMIs reveals a picture of broadly slowing growth.

Lack of progress on the trade front despite positive noises from both the US and China, and no sign of an ending of the US government shut down are similarly weighing on sentiment as are concerns about slowing US economic growth and of course Fed rate hikes.  The latest contributor to market angst is the lowering of Apple’s revenue outlook, with the company now expecting sales of around $84bn in the quarter ending Dec 29 from earlier estimates of $89bn to $93bn.

All of this and thin liquidity, with a Japanese holiday today and many market participants not back from holidays, contributed to very sharp moves in FX markets.  The biggest mover was the JPY, which surged, leading to an appreciation of around 7.7% versus the AUD at one point and strong gains against other currencies.  Some have attributed algorithmic platform pricing to the sharp FX moves today, but whatever the reason, it shows that markets are on edge.

Although US equity markets closed in positive territory yesterday (barely), the above factors suggest another day in the red for equity markets and risk assets today.  While the JPY has retraced some its sharp gains, it and other safe haven assets such as CHF and US Treasuries are likely to find firm demand in the current environment.   Although I would not suggest extrapolating early year trading too far into the future, the volatility in the first two trading days of the year will be concerning for investors after a painful 2018. More pain in the weeks ahead should not be ruled out.

 

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